Exchange Rate and Utilization of Free Trade Agreements: Focus on rules of origin

Author Name HAYAKAWA Kazunobu (Institute of Developing Economies, JETRO) / Han-Sung KIM (Ajou University) / YOSHIMI Taiyo (Nanzan University)
Creation Date/NO. January 2017 17-E-007
Research Project Exchange Rates and International Currency
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This paper investigates how exchange rates affect the utilization of a free trade agreement (FTA) scheme considering the importance of rules of origin (RoOs). Exchange rates affect exporters' compliance with RoOs by changing the so-called value-added ratio, which is defined as [1 - (Non-originating input price / Export product price)]. We present theoretical underpinnings on this potential linkage with a model of pricing-to-market and provide an empirical examination using rich tariff-line-level data on the utilization of FTA schemes in Korea's imports from the Association of Southeast Asian Nations (ASEAN) countries. The theoretical framework proposes that a depreciation of exporters' currency against importers' currency enhances FTA utilization by improving the value-added ratio, and such effects are stronger for products with higher demand elasticity. We also show strong empirical support for our theoretical predictions.

Published: Hayakawa, Kazunobu, Han-Sung Kim, and Taiyo Yoshimi, 2017. "Exchange rate and utilization of free trade agreements: Focus on rules of origin," Journal of International Money and Finance, Vol. 75, pp. 93-108