The choice of invoicing currency is a key strategic decision for a firm in managing exchange risk. When exporters choose their home currency for trade invoicing, they can avoid any foreign exchange risk at least in the short run. Invoicing currency choice is closely related to the exchange rate pass-through and pricing-to-market (PTM) discussed in the literature (e.g. Krugman 1987, Marston 1990, Knetter 1989, 1993).
Theory and stylised facts
What determines invoicing currency? In practice it is determined by negotiation or bargaining between exporters and importers. Previous studies that employed a partial equilibrium model theoretically showed that exports of differentiated products tend to be invoiced in the exporter’s currency (Giovannini 1988, Friberg 1998, Bachetta and van Wincoop 2005). The more (or less) differentiated the export product, the lower (or higher) the elasticity of demand for them, which leads to exporter’s (or importer’s) currency invoicing. The degree of product differentiation is often regarded as the degree of export competitiveness. Thus, export firms with strong export competitiveness are considered to have more bargaining power and, hence, to choose their currency for invoicing in their exports.
The above discussion is consistent with the following ‘stylised facts’ of invoicing currency choice:
- First, trade in manufactured goods between advanced countries tends to be invoiced in the exporter’s currency (Grassman 1973).
- Second, trade of manufactured goods between advanced and developing countries tend to be invoiced in the advanced country’s currency (Grassman 1973, Page 1977).
- Third, differentiated goods tend to be invoiced in the exporter’s currency, while homogeneous goods tend to be invoiced in an international currency such as US dollars (McKinnon 1979).
Two puzzles of invoicing currency choice
Japan, however, is well known to violate the above stylised facts (Tavlas and Ozeki 1992, Fukuda and Ji 1994, Kawai 1996, Sato 1999). First, Japanese exports to advanced countries tend to be invoiced in the importer’s currency, which is the ‘first puzzle’ of Japan’s invoicing currency choice. Specifically, in Japanese exports to the US, the share of the yen never exceeded 20% and was just 12.5% as of 2018 (see Figure 1b), while 85% or more has been invoiced in US dollars since 2000. More interestingly, the share of the yen in Japan’s exports to the EU was just 29.8% as of 2018 (Figure 1c). And although not presented in Figure 1c, 55.4% was invoiced in EU currencies as of 2018.
Figure 1 Choice of invoicing currency in Japan’s exports, 1980–2018 (%)
Note: Data for 1999 are not available. September data are used for 1992–1997, March data for 1998, the second half of the year data for 2000–2018.
Source: Ito et al. (2018a) and updated by the data published by the Ministry of Finance, Japan.
Second, the yen is not the most used currency in Japanese exports to Asia. Since 2011, the share of the yen has been lower than that of the US dollar (Figure 1d), which is the second puzzle of Japan’s invoicing currency choice. Japanese firms have built regional supply chains and a production network in Asia, which promotes intra-firm trade between Japan and Asia where Japanese exporters may well have a strong incentive to choose the yen for trade invoicing. However, the US dollar has been used more than the yen in Japanese exports to Asia in recent years.
In Ito et al. (2018a), we present the results of two questionnaires with Japanese overseas subsidiaries conducted in 2010 and 2014, as well as two surveys with Japanese head offices conducted in 2009 and 2013, which reveals that the first puzzle can be explained by the PTM behaviour of Japanese firms. Specifically, Japanese manufacturing firms tend to choose the importer’s currency in exports to advanced countries, especially when the importers are their own local subsidiaries. As discussed in the literature on PTM, since local subsidiaries face stiff market competition in advanced countries, Japanese head offices do not pass through exchange risk to their own subsidiaries by choosing yen invoicing. Instead, they tend to choose the local currency to shoulder the exchange rate risk, because head offices can better manage exchange risk with hedging expertise and scale economies.
In Ito et al. (2018a) we also examined the second puzzle – i.e. why the yen is used less than the US dollar in Japanese exports to Asia. One reason is that the destination for final exports of Asia-based subsidiaries is the US. As long as exports of final goods from Asia to the US are invoiced in US dollars, the dollar tends to be chosen even in intra-Asian trade (including Japan) of intermediate goods along production chains (Ito et al. 2012).
A new puzzle of invoicing currency choice
In 2017, we conducted a third questionnaire survey with Japanese head offices (Ito et al. 2018b), which reveals new evidence that the share of local currency invoicing has increased markedly in Japanese exports to Asia.
Table 1 shows the share of invoicing currency in Japanese firms’ exports to China, Korea, and Thailand by firm size. The result of the 2009 survey shows that the share of yen invoicing is far larger than that of US dollar invoicing in Japanese exports to the three countries, which is inconsistent with what Figure 1(d) shows. The main reason is that the share in Table 1 is computed by a simple arithmetic average of answers by respondent firms, and the export amounts by respondent firms are not taken into consideration. Table 1 also presents the firm-size breakdown data, which shows that the larger (smaller) the firm size, the higher the share of US dollar (yen) invoicing is. If focusing on large-size firms, the share of US dollar invoicing exceeded that of yen invoicing as of 2013 in all three countries.
Table 1 Share of invoicing currency choice by Japanese firms (%)
Note: All figures are based on the RIETI Questionnaire Survey on the Choice of Invoice Currency by Japanese Firms conducted in 2009, 2013, and 2017. We divide the respondent firms into three size categories (large, medium, and small) by their consolidated sales amounts.
Source: Ito et al. (2018b).
The more interesting evidence is that the share of importer’s currency invoicing increased markedly from 2009 to 2017, especially in exports to China and Thailand where the shares of renminbi and baht invoicing are 12.3% and 14.1%, respectively, as of 2017. On the other hand, the share of US dollar invoicing declines considerably from 2013 to 2017 in all three countries. What has caused such a rapid increase in local currency invoicing and such a decline in US dollar invoicing?
One major reason is that Asian countries have achieved steady economic growth and gradually removed control on financial and capital transactions. As discussed above, Japanese head offices have an incentive to shoulder foreign exchange risk by invoicing the importer’s currency even in exports to Asian-based subsidiaries. But, due to strict capital control and restrictions, Japanese head offices used to choose not the local currency but the US dollar. However, as financial and capital markets have been gradually deregulated in Asia, Japanese head offices have started to use the local currency in their exports to Asia-based subsidiaries. In addition, Asian countries, especially China, have become more important consumer markets for Japan. As long as Asia is the final destination market, Asian local currencies can be chosen as the invoicing currency along Asian production and value chains.
Asian local currencies are increasingly used above previous levels in Japanese exports, as Japan has become more involved in Asian value chains. If Asian countries advance financial and capital liberalisation much further, the role of the US dollar will continue to decline. To avoid a decline in the role of the yen in Asia, Japan should increase its imports from Asia through intra-firm trade and become a more important consumer market for Asian exporters.
Authors’ note: The questionnaire surveys are financially supported by the Research Institute of Economy, Trade and Industry (RIETI).
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