Currency depreciation and emerging market corporate distress

BIS Working Papers  |  No 753  | 
23 October 2018



Emerging market firms that borrow in US dollars but accumulate cash in domestic currency are vulnerable to a depreciation of the domestic currency against the dollar.


This paper looks back at the period of emerging market stress between mid-2014 and early 2016. Combining detailed firm balance sheet data and market variables for individual companies, the paper identifies "carry trade" activities of non-financial firms in emerging market economies (EMEs) - where they finance cash in local currency with the proceeds of dollar borrowing - as a source of vulnerability when the local currency depreciates against the dollar.


There are three major findings. First, firms with larger increases in cash holdings up to 2015 suffer larger declines in stock prices during subsequent periods of currency depreciation. This negative impact on stock prices is largest for firms that had borrowed in dollars. 

Second, the vulnerability to currency depreciation comes not from foreign currency debt as such, but from the combination of foreign currency debt and the holding of cash and liquid assets in domestic currency. In other words, the adverse impact of currency depreciation arises not solely from the liabilities side of the firm's balance sheet, but in combination with the asset side. 

Third, higher cash holdings go hand in hand with higher dollar bond issuance. 

Taken together, the findings support the hypothesis that EME firms took advantage of favourable funding conditions to accumulate financial assets in domestic currency by issuing dollar debt. In effect, they were engaged in a carry trade funded with dollars, leaving them vulnerable to risk of loss when the dollar strengthened.



How do emerging market corporates fare during periods of currency depreciation? We find that non-financial firms that exploit favorable global financing conditions to issue US dollar bonds and build cash balances are also those whose share price is most vulnerable to local currency depreciation. In particular, firms' vulnerability to currency depreciation derives less from the foreign currency debt as such, but from the cash balances that are built up by using foreign currency debt. Overall, our results point to a financial motive for dollar bond issuance by emerging market firms in carry trade-like transactions that leave them vulnerable in an environment of dollar strength.

JEL classification: E44, G15

Keywords: emerging market corporate debt, currency mismatch, liability dollarization, global financial conditions