Currency Valuation, Export Competitiveness, and Firm Profitability: Evidence from Bangladeshi Firm-Level Data

Abstract

The aim of this paper is to empirically investigate whether and how domestic currency valuation is related to firm-level export competitiveness and profitability by using the unique firm-specific dataset on Bangladeshi nonfinancial firms which have been listed continuously from 2010 to 2018. To achieve the aim of this paper, 63 exporting firms are extracted from a total of 125 firms which have been continuously listed during 2010-2018 and used as the final sample firms. The Pedroni cointegration test reveals that export and import prices of the exporting firms are cointegrated in the short-run as well as long-run. The panel dynamic ordinary least square (DOLS) analysis finds that a firm's export competitiveness is maintained by high import inputs even in the presence of depreciation of Bangladeshi currency against the US dollar. Finally, the DuPont analysis finds that the depreciated Bangladeshi currency enhances an exporter's profitability. Conclusions based on the findings are consistent regardless of exchange rate types, such as, real bilateral exchange rate and nominal or real effective exchange rate indexes. Consequently, the firm-level findings of this investigation suggest that undervalution of home currency is essential for Bangaldesh which is one of the frontier markets in South Asia whose exporting firms are mostly price followers in global markets.

1. Introduction

According to a conventional trade theory, depreciated home currency plays a key role in increasing exports and consequently contributes to economic growth. In fact, the path of economic growth has been witnessed in South Korea from 1970s to 1980s as well as China for over 30 years, which has been frequently cited as a role model for many developing countries managing exchange rate undervaluation. There also exists a long tradition of empirical research to support the theory and actual policies implemented.

Although the positive relationship between home currency undervaluation and exports has been explained well by country-level analyses, there are very few explanations for such firm-level analyses. Firm-level analysis on the basis of a relationship is essential for designing a more detailed policy which enables promoting firm profitability and then leading to bottom-up growth of an aggregated economy. Further, there exists little research clarifying whether a firm’s global competitiveness is affected by currency valuation especially for developing economies. Difficulty in obtaining firm-level data in developing economies is expected to render such small amounts of research on a firm’s competitiveness and currency valuation.

By using an unique firm-level dataset from Bangladesh, this paper seeks to find empirical evidence for two research questions: (1) whether and how Bangladeshi currency valuation affects export competitiveness of a firm (2) whether and how the valuation affects profitability of a firm. As one of the leading markets as well as an outstanding participant in the global market during the past decade¹, Bangladesh is the case that has inspired researchers to discover new evidence on South Asia which is recognized as the fastest growing region in the world during last year (World Bank, 2019). Moreover, this paper is significant in that it is the first to suggest firm-level evidence on the relationship between home currency value and a firm’s profitability for a case of a large developing economy in South Asia, where market- based policies have been implemented extraordinarily during the last two decades.

Empirical analyses using the Bangladeshi firm-level data find that a firm’s exporting and importing prices are positively cointegrated during the sample period from 2010 to 2018, implying that exports were not adversely affected by Bangladeshi currency appreciation which could be positively related to imports. Thus, export competitiveness of the firm’s could be maintained even in the presence of domestic currency appreciation. In addition, the DuPont model analysis found that a firm’s profitability measured by returns on equity was adversely affected by domestic currency valuation, meaning that Bangladeshi currency depreciation enhanced a firm’s profitability whereas its appreciation harmed the profitability.

This paper provides a significant implication to exchange-rate policy makers in developing economies, that undervaluation of domestic currency matters by encouraging firms to promote exports and profitability. Because exporters in developing economies participated in global markets with price-competitive products, appreciated home currency will not help exporting performance, which will consequently harm profitability of these firms. Considering that export margins are typically thin and glocal competition continually squeezes profits in the textile and garment industry, exporters in developing economies, including Bangladesh will be negatively exposed to the economic environment of appreciated home currency. In conclusion, Bangladeshi exchange rate policy needs to be managed in the direction of undervaluation of home currency for enhancing export- competitiveness as well as profitability of firms which are mostly price followers in competitive global markets.

The remainder of this paper is organized as follows. In section two, this paper reviews the existing literature with focuses on the concept of price-competitiveness as well as relatively insufficient evidence from firm-level studies in developing economies about the effect of currency valuation on export and

profitability. Section three describes the data, variables, and summary statistics. Section four presents empirical results for the two research questions mentioned above. Section five suggests concluding remarks with impications.

2. Literature Review

Since competitiveness of a firm is recognized as a term with various economic concepts that cover national, industrial, regional, and enterprise capability (Kantha, 2015), how to appropriately measure it is controversial. From the perspective of international trades, competitiveness in global markets in which a firm is involved is a key indicator. Yet, it is not conclusive to make appropriate measurement for the competitveness because of its various measurement approaches. For example, trade-based approach suggests revealed comparative advantage (RCA) analysis and constant market share (CMS) analysis, and productivity/efficiency- based approach suggests total factor productivity (TFP) and stochastic production functions. More recently, price-based approach used relative trade prices, unit labour cost and real effective exchange rate (Zia & Mahmood, 2013). Based on the definition of firm-level competitiveness by Altomente et al. (2011)², the global perspective approach seems to be most appropriate for measuring competitiveness of a firm in an open economy.

Although the question on measurement and definition of firm competitiveness is still debated, it is well documented in theoretical and empirical literature that the exchange rate is closely related to the global competiveness of a firm. Abeysingh and Yeok (1998) argue that Singapore exporters maintain competitiveness in the global market by reducing their profit margins in the presence of home currency appreciation. If there is high import content in the production of exports, then exports are not adversely affected by currency appreciation, because low imported input prices due to appreciation of currency reduce the cost of production of exportables. Fang et al. (2006) also confirmed that home currency depreciation encouraged exports in Indonesia, Japan, Korea, Singapore, Taiwan, and Thailand although export growth was weak. Alternatively, by appreciation of home currency the cost of production of exportables decreases to the extent of the import content of exports. At the same time, export price in local currency decreases with an appreciation of the currency. The net impact would depend on whether the effect of appreciation on export price offsets the effect of decrease in cost of production due to the use of low price imported inputs. Recent studies have been gradually moving to focus on the relationship between exchange rate volatility and trade margins, rather than exchange rate level and trade volume (Auboin & Ruta, 2011).

Additionally, most of the existing studies on the relationship between exchange rate and international trade competitiveness have been carried out by macroeconomic perspectives. As one of the most known approaches, Bostan et al. (2018), pointed out the “absorbance theory” which clarifies how exchange rates affect national income and international trade. Based on the theoretical approach, there exists abundant evidence from various countries and different periods. For example, Bostan et al. (2018) cited that the effect of home currency depreciation on national income and trade was manifest not at once but after a certain period of time, and Dornbusch (2000) found that the effect of exchange rate on international trade evolved with the national interest rate alteration because depreciation is expected to cause inflation. Recent studies have been focusing on the transmission channel from exchange rate to interest rate in capital markets, international trade in goods markets, jobs in labor markets and national monetary and economic policy according to the fact that the exchange rate is recognized as the most important price in any economy because it affects all other prices (Egilsson, 2020; Frieden, 2016). Besides, the recent Asian case studies dealing with the export competitiveness consequnently aimed at finding its relationship with the national economic growth. Sujianto et al. (2020) aimed at finding the effect of net exports on economic growth in Indonesia, Nguyen (2020) focused on the effect of exports on economic growth in Vietnam, and Khusainov et al. (2017) suggested the importance of export competitiveness enhanced by Eurasian economic union for economic growth in a central Asian country, Kazakhstan.

Observing that exsiting empirical studies do not provide abundant firm-level evidence on the relationship between an exporter’s competitiveness and currency valuation especially for developing economy cases, this paper seeks to find the effect of the exchange rate on an exporter’s competitiveness and profitability for a case of Bangladesh. This firm- level study contributes to filling the lack of material in the long history of the relevant literature, influenced by macroeconomic perspectives. Also, this paper is expected to provide a policy implication about the importance of currency valuation to developing economies which have been recently implemented by a market-based exchange rate policy and following the successful path of a China and South Korea economic developement.

3. Data: Exchange Rate and Sample Firms

As the exchange rate variable, we use the monthly nominal³ bilateral exchange rate of the Bangladeshi Taka against the US dollar (BDT/USD) from the Bangladesh Bank, the central bank of Bangladesh. In Figure 1, the time- series plots of the foreign exchange rate and the exchange rate changes in Bangladesh are shown; the figure shows that the exchange rate rose sharply from January 2010 to September 2011 and gradually from January 2017 to December 2018. In addition, the rate fell from October 2010 to December 2012 and the movements were stable from January 2013 to Decemebr 2016. The exchange rate data is basically the same as the one of Choi et al. (2020).

Figure 1: Monthly exchange rate of BDT/USD, 2010–2018 Source: Bangladesh Bank

For the sample firms, this paper first retrieved 125 nonfinancial firms which had been listed continuously in the Dhaka Stock Exchange (DSE) from 2010 to 2018. Table 1 shows the firms by industry classification. The number one industry that the sample firms are affiliated with is Textile, which is consistent with the fact that Bangladesh is a significant participant in the global value chain of the apparel industry.

Table 1: Classification of the 125 Sample Firms Source: Annual Reports of Firms, Bangladesh

We then extracted the 63 firms with exports from the total 125 firms to examine export-competitiveness of firms and their profitability. Although all firms are exposed to exchange rate fluctuations regardless of whether they export or not,⁴ focusing on firms with exports helps estimate firm profitability exposure to exchange rate risk more precisely because the value-making structure is different between exporters and non-exporters as Choi et al.’s (2020) theoretical model explains. For example, when the domestic currency depreciates (appreciates), firms exporting price-competitive products enhance (reduce) their firm profitability by increasing relatively cheap exports, whereas non-exporters do not expect to do the same.⁵ More importantly, because it is tested how currency appreciation affects firm’s exporters and its profitability later, we need to now segregate the sub- sample firms with exports from the total. Table 2 shows that descriptive statistics of the sample firms about operational and financial performance variables during the sample period. These variables are selected to use for estimating the effect of exchange rate changes on firm-level profitability, such as, return on assets (ROA). All these statistics are the same as those of Choi et al. (2020), but the subsequent analyses are for the firms with exports.

Table 2: Descriptive Statistics

Source: Annual Reports of Firms, Bangladesh.

4. Empirical Analysis

4.1. Domestic Currency Valuation, Export, and

Import Following Abeysingh and Yeok (1998); Razafimahefa and Hamori (2007); Zia and Mahmood (2013), we use the models, namely, the exchange rate appreciation and export- price competitiveness model to analyze the export-price competitiveness. We use export (Px) to reflect export-price competitiveness. This export allows estimating changes in the country’s competitiveness over time (t). The long run relationship can be modeled as folows

\(\ln P x_{i, t}=\alpha_{0}+\alpha_{1} \ln P m_{i, t}+\alpha_{2} \ln U B C_{i, t}+\epsilon_{i, t},\)       (1)

where Px_i,t is the export of firm i in year t, Pm_i,t is the import of firm i in year t, UBC is unit business cost, which is a composite index of unit labour cost, fuel and utilities costs of firm i in year t. Px, Pm and UBC are expressed in Bangladeshi Taka (TK) which converted in natural logarithm. In the case of Bangladesh, export can be directly related to unit business cost (UBC) and import (Pm) in which includes the cost of importing raw materials and intermediate goods.

To investigate the causal relationships between lnPx, lnPm, and lnUBC, we propose to conduct vector error correction model (VECM). The VECM approach requires that the time series be fixed and the existence of cointegration among the variables to be pretested. First, we test a panel unit root to examine whether or not the variables in our model are stationary. Second, we test for cointegration among the variables employing the heterogeneous panel cointegration test developed by Pedroni (1999). Third, once cointegration relationship is established, we investigate the causal relationship between lnPx, lnPm, and lnUBC by employing panel VECM. VECM is employed to discern the short-run and long-run Granger causality by applying the OLS method.

The order of the integration of the variables is examined by panel unit root tests Fisher-ADF, test equation is none and automatic lag selection based on standard industrial classification (SIC), which are defined by Maddala and Wu (1999) and Choi (2001). The results of these tests are reported in Table 3, indicating that the statistics significantly confirm the level values of all series are non-stationary; that is, all variables are I (1). After the first differencing, it is found that all the variables are stationary at the 1% significance level.

Table 3: Panel Heterogeneous Unit Root Test Results

Note: *** Denote significance at the 1% level.

In Table 4, [The panel A] summarizes the results of the Pedroni panel cointegration test, no intercept and automatic lag selection based on SIC, which evaluate the null against both the homogeneous and the heterogeneous alternatives. In this case, six of the eleven statistics do not reject the null hypothesis of no cointegration among three variables: lnPx, lnPm and lnUBC at the 5% level. [The panel B] provides the results of Pedroni panel cointegration test, no intercept and automatic lag selection based on SIC, between the pair: lnPx and lnPm. The cointegration tests of Pedroni indicate eight of the eleven statistics reject the null hypothesis of no cointegration relationship between the variables at the 1% or 5% significance level. Thus, it is concluded that lnPx , lnPm, and lnUBC do not form a cointegrating relation whereas the export and import pair, lnPx and lnPm, do form a cointegrating relationship. Since cointegration implies causation (Granger, 1988), a finding that export and import prices are cointegrated renders strong support for our argument of the leverage provided by a high imported input content towards maintaining export competitiveness (Abeysingh & Yeok , 1998).

Table 4: Pedroni’s Heterogeneous Panel Cointegration Test Results Note: The null hypothesis is that the variables are not cointegrated. *** indicate statistical significance at the 1% level. ** indicate statistical significance at the 5% level.

Note: *** denote significance at the 1% level.

Since InPx and lnPm are cointegrated, it is necessary to proceed to estimate the long-run cointegration coefficients using the panel DOLS approach (Kao & Chiang, 2000), pooled panel method and automatic lag selection based on SIC. Table 5, the panel parameter is 0.735 for lnPm. Because the cointegration coefficient with positive sign is statistically significant at the 1% level, it is meant that 1% increase in import raises export by around 0.735%. Also, the positive coefficient supports the argument of high imported input content towards maintaining export competitiveness (Abeysingh & Yeok , 1998).

Table 5: Panel DOLS Estimates (dependent variable is InPx)

Note: *** denote significance at the 1% level.

To identify the direction of the relationship, we estimate a panel-based error correction model and use it to conduct Granger causality tests on lnPx and lnPm. We conduct this identification by using Engle and Granger’s (1987) procedure for the short-run and long-run relationships between the variables.

\(\begin{aligned} \Delta \ln P x_{i, t} &=\varphi_{1, t}+\sum_{L=1}^{p} \varphi_{11 L} \Delta \ln P x_{i t-L} \\ &+\sum_{L=1}^{p} \varphi_{12 L} \Delta \ln P m_{i t-L}+\partial_{1} e c t_{i t-1}+\varepsilon_{1 i t} \end{aligned}\)       (2)

\(\begin{aligned} \Delta \ln P m_{i, t} &=\varphi_{2 i}+\sum_{L=1}^{p} \varphi_{21 L} \Delta \ln P m_{i t-L} \\ &+\sum_{L=1}^{p} \varphi_{22 L} \Delta \ln P x_{i t-L}+\partial_{2} e c t_{i t-1}+\varepsilon_{1 i t} \end{aligned}\)       (3)

where Δ denotes first differences and L is the optimal lag length determined by the Schwarz Bayesian Criterion. Using the specification in Eq. (2) and (3) allow us to test for both short-run and long-run causality. As Table 6 shows, in the short- run import does not Granger-cause export if and only if all the ϕ_12L are equal to zero in Eq. (2). In the reverse coefficients of case, export does not Granger-cause import if and only if all ϕ_22L are equal to zero in Eq. (3). Second, we the coefficients of implement a joint test of ect _it−1and the respective interactive terms to check for the long-run causality in Eqs. (2) and (3).

Table 6: Panel DuPont Test Results for the 64 Firms with Exports

Note: ***, ** and * indicate statistical significance at the 1%, 5% and 10% levels of significance, respectively.

By estimating the equations, (2) and (3), we could obtain the results on causality relation between two variables for the short-run as well as the long-run. It is found that a bidirectional causality running between lnPm and lnPx in the short run because we estimated that the coefficient from lnPx to lnPm is 3.079 at the 5% level of significance and the coefficient for adverse direction is 8.416 at the 1% significance level. Moreover, we could find the long run causality because it is estimated that the coefficient from the ect variable to lnPx is -0.146 at the 1% significance level. Therefore, based on the estimation results, we could come to two conclusions. First, there exists unidirectional long-run Granger causality from lnPm to lnPx approach. Second, both the panel short-run and long-run causality results imply that changes in import lead to changes in export which is in complete conformity with the result obtained above using the panel DOLS approach. It is worthwhile noting that, our panel short-run and long- run relationship results, which export competitiveness hypothesis is supported in Bangladesh.

4.2. Currency Valuation and Exporter’s Profitability: DuPont Model Analysis

Developed in 1919 by E.I. du Pont de Nemours, the DuPont analysis, a common and straightforward method, has been widely adopted in practice for assessing factors that influence a firm’s financial performance since its development. Items of a financial statement can be broken down through DuPont for the stakeholders purpose of company performance analysis (Chang et al., 2014; Liang & Yu, 2014; Palepu & Healy, 2008; Stickney & Brown, 2006; Bernstein et al., 2001). Using DuPont analysis, we breakdown ROE (Net_Income/Equity) into asset turnover (Sales/Total_Asset), sales margin (Net_Income/Sales) and leverage ratio (Total_Asset/ Equity). Classical DuPont analysis involves the break down of return on assets (ROA) and return on equity (ROE). It is theoretically argued that TK appreciation will reduce import costs of capital goods, intermediate goods and advanced technologies. Considering the reduction of production cost and strengthening of export competitiveness, it is worthwhile to explore whether TK appreciation has had a negative or positive effect on the profitability of exporters. We estimate the impact of exchange rate movement on exporters’ profitability for the 64 firms with exports only. An empirical equation is specified as follows:

\(V_{i, t}=\beta_{0}+\text { Post }_{t}+\text { Post }_{t}{ }^{*} E x_{i, t}+\varepsilon_{i, t}\)       (4)

where V is the outcome variable, here referring to ROE, sales margin and ROA, of firm i in year t. post is a dummy variable whether year t is after TK appreciation. Ex is the ratio of foreign sales to total sales of firm i in year t.

Using the DuPont analysis, we investigate how exchange rate appreciation affects ROE, sales margin and ROA. Table 8 shows the regression results. TK appreciation has a significantly negative effect on the sales margin of exporters which means that the sample firms have a weak capacity for generating revenues in the presence of home currency appreciation, implying that competitiveness of the product price could be deteriorated by the appreciation. Also, we test the interaction effects between exchange rate and export, to total sales on ROE, sales margin and ROA. The results turn out that the coefficient for the ROE, sales margin and ROA are significantly negative. In other words, export profit declines for exporters. There is strong evidence that when the exchange rate appreciated, export profit decreased.

5. Conclusions

By using the 63 exporting firms out of the unique dataset of the total 125 Bangladeshi nonfinancial firms which have been listed constinuously from 2010 to 2018, this paper suggests firm-level evidence how domestic currency valuation is related to a firm’s export prices and profitability measured by the financial performance variable, such as, return of asset (ROA) or return of equity (ROE).

From 2010 to 2018, a long-run cointegration model showed that firm’s export and import prices are cointegrated, which supports the rational argument by Abeysingh and Yeok (1998), implying the leverage provided by a high imported input content towards maintaining export competitiveness. Also, the panel DOLS approach figured out that 1% increase in import raises export by 0.735%, which supports the argument of high imported input content towards maintaining export competitivenes. Further, using the panel-based error correction model approach, this paper confirmed the results from the panel DOLS approach and arrived at the conclusion that export competitiveness hypothesis is supported in these Bangladeshi nonfinancial exporting firms which have been continuously listed from 2010 to 2018.

Most important finding on how domestic currency appreciation affects the exporting firm’s export and their profitability was made by the DuPont analysis. By estimating the interaction effects between exchange rate and export to total sales on ROE, sales margin, and ROA, it is found that ROE, sales margin and ROA were negatively related to Bangladeshi currency appreciation. The result clarifies that export profit declines in the presence of domestic currency appreciation.

This paper provides a meaningful implication to exchange-rate policy makers in developing economies, that undervaluation of domestic currency is important for encouraging firms to promote exports and profitability. Because exporters in developing economies participated in global markets with price-competitive products, appreciated home currency will not help exporting performance, which will consequently harm the profitability of these firms. Considering that export margins are typically thin and glocal competition continually squeezes profits in the textile and garment industry, exporters in developing economies including Bangladesh will be negatively exposed to the economic environment of an appreciated home currency.

Further study still remains due to some limitations. First, it is necessary to simultaneously check the effect of exchange rate change on export price competitiveness and firm profitability. This paper has a limititation because we deal with each relationship, respectively, by panel DOLS model and DuPont model. Second, it is necessaty to include other South Asian developing economies although it is very hard to obtain the firm-level data in developing economies. Enriched sample firms across different countries will enable suggesting a more generalized conclusion.