School of Economics

Imported Inputs and Invoicing Currency Choice: Theory and Evidence from UK Transaction Data

Imported Inputs and Invoicing Currency Choice

Wanyu Chung

What determines the invoicing currency choice in international trade? For a long time, little was known beyond several stylized facts based primarily on aggregated data. For instance, trade in primary products is mostly denominated in US dollars, whereas trade between developing and industrialized countries is predominantly invoiced in the industrialized country's currency. Also, it’s been documented that inflationary currencies are less likely to be used as an invoicing currency. This calls for new firm-level evidence with more disaggregated data, if we are to understand how exporters choose their invoicing currencies in an environment where exchange rates fluctuate. In particular, many firms engaged in international trade also import raw materials to make goods that they can then export. Intuitively, if the price of the imported inputs rises due to the home currency being weaker, then a firm that prices its exports in the foreign country’s currency can prevent itself from losing out.

In this Nottingham School of Economics working paper, published in the Journal of International Economics, Wanyu Chung evaluates theoretically and empirically how exporters' dependence on imported inputs affects their choice of invoicing currency. The model predicts that exporters that depend more on foreign currency-denominated inputs are less likely to price in their home currency. The author tests this and other theoretical results using a novel dataset that covers 10 million UK trade transactions with non-EU countries in 2011. The firm-level evidence strongly supports the model's predictions. A 10 percentage point higher share of foreign currency-denominated inputs is associated with a 20 percentage point higher probability of pricing in the same foreign currency relative to the producer's currency. The model’s predictions also hold at the country level: by examining the currency denomination of UK imports, the author documents a systematic finding that countries more involved in the global production chains are more likely to deviate from using their home currencies for exports.

Forthcoming Journal of International Economics, "Imported Inputs and Invoicing Currency Choice: Theory and Evidence from UK Transaction Data", by Wanyu Chung


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Posted on Tuesday 15th December 2015

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