Pricing-to-Market with Trade Liberalization: The Role of Market Heterogeneity and Product Differentiation in India's Exports

Abstract

This paper studies the links between pricing to market (PTM) and trade liberalization using data for India's exports (at the 4-digit level of classification) during the economic reforms period (1992-2005). We estimate a PTM model for exports to the G3 and three other emerging markets (Brazil, China and South Africa), distinguishing homogeneous from differentiated goods and correcting for changes in the level of protection faced by India's exporters (import tariffs in destination markets), inflation and openness in the export destination market, a macroeconomic policy index partly reflecting changes in exporter's costs, the share of the exporter in the destination market and the share of the product in the exporter's total exports. We find that market heterogeneity changes the level of PTM, but PTM does not significantly differ between homogeneous and differentiated products. Indian exporters practice PTM by absorbing exchange rate changes into their mark-up in G3 markets, where they face tougher competition, but fully pass-through exchange rate changes in emerging markets. On the contrary, Indian exporters seem to be taking advantage of trade liberalisation in destination markets by marginally increasing exporter currency prices into emerging markets but not into the G3. However, in the case of differentiated goods, we find this effect of trade liberalisation for both G3 and emerging markets.

Keywords: Exchange-rate pass-through, Pricing to market, Product differentiation, India

JEL Classification: F4, O1