Corporate dollar debt and depreciations: all's well that ends well?

Summary

Focus

When a country's exchange rate falls, the effect on corporate balance sheets may become significant. A firm that borrows in foreign currency is vulnerable to unexpected exchange rate movements if its currency exposures are not fully hedged operationally (eg the firm exports) or financially (eg with financial derivatives). A depreciation can weaken the firm's balance sheet and thus hinder investment. This paper studies such balance sheet effects in a sample of 15 emerging market economies (EMEs).

Contribution

There is scant cross-country evidence on how depreciations affect corporate investment. This is mainly due to data limitations, as there are no available cross-country databases on the currency composition of firms' liabilities. This paper assembles a novel firm-level database on foreign currency debt based on data for the issuance of corporate bonds by listed non-financial corporations in 15 EMEs in the period 2000-15. The paper further uses data on firms' balance sheets, income and cash flow statements to control for time-varying firm-specific factors that may affect investment decisions, including firms' export status and access to foreign financing via foreign listings and equity ownership by foreign investors.

Findings

The results indicate that currency depreciations do affect corporate investment, as measured by capital expenditure. A depreciation of 10% is associated with a ratio of capital expenditure to assets of between 0.3 and 0.4 percentage points less in the year of the depreciation, and between 0.5 and 0.6 percentage points less in the following year. This result applies to firms with previous outstanding stocks of foreign currency bonds vis-à-vis their peers with no such exposure. As a reference, the average ratio of capital expenditure to assets in the estimating sample is 5.6%; thus, the effect is also economically significant.

Abstract

This paper explores the effect of depreciations on investment when firms hold foreign currency debt. The paper employs a novel database of stocks of foreign currency bonds issued by seven thousand firms from emerging economies in 2000-2015. The results indicate that currency depreciations exert a significant negative effect on balance sheets. A depreciation of 10 percent is associated with a ratio of capital expenditures to assets of between 0.3 and 0.6 percentage points less for firms with outstanding stocks of foreign currency bonds in the year following the depreciation. This result is robust to different inference techniques and to controlling for a
large number of potential confounders.

JEL classification: E22, F34, F40, G31

Keywords: fixed investment, bond issuance, currency mismatch, balance sheets