Chile is a fast-growing economy and an active member of trade agreements. We would expect Chilean firms to reap the benefits of a larger market for their exports as well as more choices for the sources of their input. In fact, using foreign inputs is likely to enhance productivity, product quality, and the ability to export. However, as a small open economy, Chilean firms also face the risk associated with exchange rate fluctuations.

In particular, firms that import intermediate inputs have to consider changes to their production cost if there is a sudden depreciation. Furthermore, an environment with volatile exchange rates makes it difficult for firms or plants to decide on a production plan including choosing between imported and domestic intermediate inputs. We want to quantify the effect of exchange rate volatility on this particular decision, a task best done at the micro-level data. Fortunately, we work with a rich dataset of about 5,400 plants per year from 1995 to 2007. Since each firm often owns only one plant, we use these two terms interchangeably.

What is the right real exchange rate measurement?

First, it is important to measure the real exchange rate that is most relevant for each importing and exporting plant. We combine our plant-level information with the input-output tables to construct a novel measure of the real exchange rates (RERs) that are relevant for importing decisions.
A plant that obtains its inputs from one country while exports to another faces two different bilateral RERs. Therefore, we propose RERs weighted by the import sources and another series of RERs weighted by the export destinations. Now what if a plant in a downstream sector is indirectly affected by what happens to its input provider upstream? In that case, the domestic inputs may not be purely domestic. By using the input-output table, our derived weighted RERs measure both the direct effect on a sector and the indirect effect via its upstream industries, allowing us to accurately estimate the effects of RER volatility on importing decisions.

What makes a plant an importer?

It is apparent in our data that importers and non-importers are different. Approximately 21% of the plants import intermediate inputs. About 50% of plants that import also export, compared to only 12% of non-importing plants. Also 16% of importers have foreign owners; while only about 4% of non-importers have any amount of foreign interest. The extent of reliance on imported intermediate input also varies widely across plants.

To understand if there are other significant differences between importers of intermediate inputs and non-importers, we estimate the import premia, i.e., how much each characteristic of a plant is associated with its being an importer (see Figure 1). As we would expect, larger and more productive plants, plants with foreign ownership or foreign technology licenses, and those paying higher wages are more likely to be importers.

Import probability and import intensity

We study both the binary measure of whether a plant imports at all and the ratio of imported over the total intermediate inputs. As shown in Table 1, an increase in either the level of RERs or the RER volatility significantly decrease the fraction of intermediate inputs that is imported, but it does not affect the probability of importing intermediate inputs.

Column (1) in table 1 indicates that neither changes in the level of the import-relevant RERs nor their volatility affect plants' initial decision to use foreign inputs. Hence, whether a plant imports its inputs is mainly a function of its characteristics and its desire to export. This result also supports the hypothesis that plants incur fixed costs when importing and exporting. As a result, they are less likely to completely exit foreign markets even when facing large fluctuations in the RERs. They could also be part of global supply chains which limits the choices for inputs. Table 1, column (2), shows that a one standard deviation increase in volatility decreases the import intensity on average by 0.4 percentage points. We document no significant effects of RERs and RER volatility on total sales, total exports and total inputs.

Liquidity constraint amplifies the effect of uncertainty

It is well established in the literature that liquidity constraint can amplify the effect of uncertainty, whether on irreversible investment decisions (Gilchrist et al., 2013) or on the scope of production planning (Arellano et al., 2012). The same mechanism applies to the case of Chile where firms often sign contracts in advance with payments finalized in the future and invoiced in foreign currencies. Given the RER fluctuations and the financial constraints, it is more likely the firm will not meet its payments. Hence, the firm may decide ex-ante to lower its exposure by importing less intermediate inputs.

We measure the average liquidity level of a plant by the inventory-turnover ratio— the ratio of sales divided by the annual average inventory. Our results show that plants having higher levels of liquidity are less affected by RER volatility. The coefficients of the interaction terms suggest that one standard deviation increase in the volatility of import-relevant RER has a 6% smaller impact on plants with high liquidity.

Concluding remarks

We construct a new measure of RERs that are relevant for import decisions. In our research, we find no evidence that the changes in RER and its measure of volatility affect the level of exports, total inputs, total sales or the plant’s market share in the overall exporting market. The changes in the level of RER and the volatility of RER only affect the relative amount of imported to domestic intermediate inputs.

The lack of an effect on the probability of importing is consistent with the hypothesis that firms pay a fixed cost to establish trading relationship. It could also be that these firms are part of global supply chains or domestic and foreign inputs are not close substitutes. Similar to Amiti, Itskhoki and Konings (2014), our results support the role of fixed cost for importing and the channel of imported inputs in explaining the exchange rate disconnect puzzle.

Ricardo A. López and Huong D. Nguyen would like to thank seminar participants at Brandeis University, the 2013 Canadian Economic Association Annual Meetings, and the 2014 LACEA Annual Meetings for helpful comments. This article represents the views of the authors and does not necessarily represent IMF views or IMF policy.

References:

Mary Amiti, Oleg Itskhoki, and Jozef Konings, 2014, “Importers, exporters, and exchange rate disconnect,” American Economic Review, 104(7):1942-78.

Cristina Arellano, Yan Bai and Patrick Kehoe, 2012, “Financial Frictions and Fluctuations in Volatility”, Staff Report 466, Federal Reserve Bank of Minneapolis.

Simon Gilchrist, Jae W. Sim, and Egon Zakrajsek, 2013, “Misallocation and Financial Market Frictions: Some Direct Evidence from the Dispersion in Borrowing Costs”, Review of Economic Dynamics, 16(1): 159-176.

Ricardo López and Huong D. Nguyen, 2014, “Real Exchange Rate Volatility and Imports of Intermediate Inputs - the Case of Chilean Plants,” Working Paper.