Foreign Currency-denominated Debt Research Articles

Rapid credit expansion and firm behavior: A case study from Türkiye

This study examines the impact of a sudden and remarkable credit expansion experienced in Türkiye during the first half of 2022 on firm behavior by utilizing a novel dataset containing the universe of all incorporated firms in Türkiye. The results of the combination of coarsened exact matching and difference-in-differences methodology show that, amid the credit expansion coupled with the deterioration in expectations of inflation and depreciation in local currency, the firms with higher credit usage tended to engage in alternative channels rather than undertaking real economic activities in short term, such as pulling-forward imports and input demand and taking position against local currency to gain financial profit more than those with less credit usage during the first half of 2022. While SMEs with higher credit usage increased their imports, domestic input purchases, foreign currency purchases, and foreign currency-denominated debt settlement before maturity, large firms increased their foreign currency purchases relative to their counterparts with less credit usage.

Limits to Fiscal and Monetary Policy in Small Open Economies

ABSTRACT In this paper we investigate the impact of the balance-of-payments constraint on output, income distribution and policy space in a small economy open to both commercial and financial flows. We do so by extending a Sraffian supermultiplier growth model to consider current and capital accounts and endogenous money. Expansionary fiscal policies increase output and its long run growth rate but have a negative impact on the balance-of-payments. Based on these results, we derive the value of government spending that maximises output while maintaining external equilibrium. Monetary policy also influences the balance-of-payments by attracting foreign financial flows through higher interest rates. This relationship is non-monotonic, since these flows can finance the external deficit resulting from a high output level but can also lead to a greater interest burden. This trade off allows us to find the level of the interest rate that maximises external space. It also implies that, with limits, raising interest rates might allow for higher real wages. Lastly, we examine the effects of the currency denomination of debt. We find that, in case of a depreciation, debt in domestic currency allows for a less contractionary adjustment than foreign currency-denominated debt but does not lead to higher economic growth.

The dynamic effect of corporate financial hedging on firm value: The case of Indian MNCs

This paper explores the effect of financial instruments for exchange rate hedging on a firm's value in the presence of non-operating profit or loss from foreign exchange transactions. This study uses Tobin's Q ratio as a proxy for firm value and a two-step generalized method of moments (GMM) model to estimate the effect of financial hedging. Our dynamic panel analysis using extensive data on 61 Indian multinational corporations (MNCs) in 2009–2020 shows that financial hedging instruments, such as foreign currency derivatives (FCD) and foreign currency–denominated debt (FDD), enhance firm value by 16.91% and 10.21%, respectively. The results of the robustness test confirm the findings.

The resurgence of currency mismatches: Emerging market economies are not out of the woods yet?

The emerging market economies (EMEs) are experiencing significant financial distress due to the rapid accumulation of foreign currency-denominated debt in recent years. We develop the foreign exposure indicators such as original sin and currency mismatches using a novel data set. Our computations suggest that Latin American economies suffer from the original sin problem, followed by Central European countries. We find a higher degree of currency mismatches in Argentina, Chile, Colombia, Indonesia, Poland, Mexico, and Turkey. The resurgence of currency mismatches and the Covid-19 pandemic is a stress test for monetary policy frameworks. We find that country’s size, inflation volatility, and exchange rate depreciation cause currency mismatches. We show that the currency mismatch and original sin problem are lower in countries following de-dollarization policies such as limiting debt exposure, effective monetary and fiscal policies, better institutional quality, and export openness. The EMEs need to adopt policies to control currency mismatches, which are consistent with their growth-oriented policies. We suggest the independence of monetary policy, the implementation of macroprudential policies, and the development of offshore bond markets in a local currency. These policies control currency mismatches without changing the growth orientation of the EMEs. South Africa, Hungary, and Asian economies hold lessons for EMEs in controlling currency mismatches.

외환파생상품과 외화표시부채의 사용이 기업가치에 미치는 영향 : 중국 자동차 부품제조기업을 대상으로

외환파생상품과 외화표시부채의 사용이 기업가치에 미치는 영향 : 중국 자동차 부품제조기업을 대상으로

The impact of exchange volatility exposure on firms’ foreign-denominated debts

PurposeThis research began by acknowledging that conventional analysis on the foreign exchange exposure could not adequately reflect firms’ risk management strategies, which firms take actions against uncertainties raised by foreign exchange. In order to conceptualize uncertainty aroused by foreign exchange, the purpose of this paper is to develop an index that could measure corporate profits’ sensitivity to foreign exchange uncertainty and examine its possibility of utilization.Design/methodology/approachAs an alternative to foreign exchange exposure, the present research derived the foreign exchange volatility exposure and analyzed the determinants of foreign currency-denominated debt in terms of foreign exchange volatility exposure. The foreign exchange volatility exposure draws from partially differentiating a firm’s operating profits to the exchange rate volatility.FindingsThe major findings are as follows. First, before the Asian financial crisis, South Korean enterprises had similar responses to the exchange volatility exposure as compared with the exchange exposure on procuring foreign-denominated debt. Second, since the global financial crisis (GFC), not only have Korean firms’ response mechanisms to both exposures changed, but also the significance of exchange volatility exposure has been further emphasized. Furthermore, Korean companies have dealt with exchange uncertainties by decreasing foreign-denominated debt as their foreign exchange volatility exposure increased after GFC. In contrast, the influence of conventional exchange exposure on foreign-denominated debt has diminished.Research limitations/implicationsFuture research should focus on several points. First, additional research could extend to foreign investors who have divergent perception and consideration in regard to foreign exchange risk management. Second, research on decision making and motivation in foreign currency choice should be conducted in order to deepen academic understanding. Third, research that refines the variables added in the current research should be conducted. Finally, as a way to manage foreign exchange volatility exposure, further investigation based on this study is possible.Practical implicationsThe results of this study have several important theoretical and empirical implications for companies’ foreign exchange risk management strategy. First, through foreign exchange volatility exposure, which can usefully take over the role of the existing foreign exchange exposure, the authors can confirm market uncertainty as being relevant to the foreign exchange risk management strategy. Second, through the financial influence that the foreign exchange volatility exposure has on the foreign currency-denominated debt, the authors can observe the Korean firms’ paradigm shifts in their foreign exchange risk management strategies.Originality/valueThis research confirms the importance of foreign exchange volatility exposure in the research works dealing with firms’ exchange risk management, also the possible influence of foreign exchange volatility exposure in the future might be increased as uncertainty is raised from foreign exchange escalating.

Does foreign currency-denominated debt affect dividend payout policy? Evidence from Korea

This study examines the effect of foreign currency-denominated debt on dividend payouts in the context of risk hedging and debt financing costs. We find that firms with a higher proportion of foreign currency debt are more likely to pay dividends; furthermore, we also find that these firms pay higher dividends. We further find that the positive relation between the proportion of foreign currency debt and dividend payouts is more pronounced in firms with lower credit risk and cash flows than their counterparts. Our results are robust to alternative estimation methods, endogeneity concerns, and alternative proxies for foreign currency debt and dividend payouts.

Foreign Currency Denominated Debt and the Fiscal Multiplier

This paper aims to explain why fiscal multipliers are generally low, even close to zero, in emerging economies (EMEs). Our explanation jointly relies on the behavior of the exchange rate following a fiscal shock and on the proportion of external debt denominated in foreign currency, which is usually important in EMEs. According to the recent literature, the real exchange rate can depreciate following an increase in public spending. If this is the case, the debt burden denominated in foreign currency increases, and the domestic firms’ balance sheets deteriorate, raising their external finance premium and further crowding out private investment. Finally, this phenomenon may offset the initial crowding-in impact of the public spending shock. We demonstrate that such an explanation is theoretically valid: the higher the share of external debt denominated in foreign currency is, the lower the fiscal multiplier.

Foreign Currency Denominated Debt as A Hedging tool for Foreign Exchange Rate Risk Exposure

Foreign Currency Denominated Debt as A Hedging tool for Foreign Exchange Rate Risk Exposure

Does Exchange Rate Depreciation Have Contractionary Effects on Firm-Level Investment?

We assess the conditions under which exchange rate fluctuations are contractionary for firm-level investment. To address this question, we match firm-level balance sheet data with a large dataset of firm-level bonds for about 1,000 firms from 36 emerging market economies over the period 1998–2014. We augment a standard firm-level investment model to control for (country-specific) macroeconomic variables, and interact the effect of an exchange rate depreciation with several dimensions of bond composition, namely: 1) currency of issuance; 2) maturity structure of bonds; and 3) market of issuance. We find that, conditional on the amount of debt issued in foreign currency, an exchange rate depreciation can have a contractionary impact on a firm’s investment spending. We also find that the market of issuance and maturity structure, in particular, when coupled with foreign currency-denominated debt can influence this impact.

Currency devaluations, aggregate demand, and debt dynamics in economies with foreign currency liabilities

ABSTRACTThe article uses a post Kaleckian model to analyze how currency devaluations affect aggregate demand and capital accumulation in an economy with foreign currency liabilities in the short-run. In benchmark post Kaleckian open economy models, currency devaluations have two effects. First, they change international price competitiveness and thus affect net exports. Second, devaluations change income distribution and thereby affect consumption and investment demand. The overall effect on aggregate demand and investment is ambiguous and depends on parameter values. Existing models, however, disregard balance sheet effects that arise from foreign currency-denominated external debt. The article develops a novel post Kaleckian open economy model that introduces foreign currency-denominated external debt and balance sheet effects to examine the demand-effects of devaluations. Furthermore, the article models the dynamics of external and domestic corporate debt. It discusses how an economy may end up in a vicious cycle of foreign-currency indebtedness and derives the conditions under which indebtedness becomes stable or unstable. It shows that the existence of foreign currency-denominated debt means that contractionary devaluations are more likely, and that foreign interest rate hikes, and high illiquidity and risk premia compromise debt sustainability. Devaluations only stabilize debt ratios if they succeed in boosting domestic capital accumulation.

Revisiting the nexus between currency misalignments and growth in the CFA Zone

In this paper, we revisit the link between currency misalignments and economic growth by taking into account foreign currency-denominated debt dynamics for the CFA zone countries over the period 1985–2011. Relying on a BEER approach and using panel cointegration techniques, we first derive currency misalignments. We then estimate a panel smooth transition growth equation that allows currency misalignment to exert nonlinear impacts on both economic growth and foreign currency-denominated debt dynamics. We find that the nonlinear impact of currency misalignments on growth through the competitiveness channel is mitigated by the foreign currency-denominated debt dynamics through a valuation effect.

Foreign Currency Denominated Debt and Firm Value

Foreign Currency Denominated Debt and Firm Value

Asymmetric Foreign Exchange Exposure, Option Trade, and Foreign Currency‐Denominated Debt: Evidence from Korea

AbstractWe examine the measurement and determinants of asymmetric foreign exchange exposure with a focus on the role of firms' usage of foreign currency‐denominated debt (FCDD). Employing a large sample of Korean firms, we find significant asymmetries in exchange exposure. We also find that firms with dollar‐denominated debt exhibit substantially lower asymmetries in exchange exposure than firms without such debt. Most interestingly, both a firm's export ratio and dollar‐denominated debt ratio are significantly related to its asymmetric exposure but in the opposite direction. In contrast, a firm's option trading has little impact on its asymmetric exchange exposure. Consistent with the FCDD effect hypothesis, these results provide strong evidence that increased asymmetries in exchange exposure resulting from exporting activities can be effectively reduced by the usage of FCDD. Our results offer a broadly applicable implication that firms with high asymmetric exchange exposure can effectively manage their exchange risk from operating activities by selectively using exporting and FCDD financing.

Effects of Currency Devaluations on the Economic Growth in Developing Countries: The Role of Foreign Currency-Denominated Debt

Assuming that a developing country has to denominate its debts in the currencies of the principal creditor countries, how is the country’s economic performance affected when currency devaluation occurs? The aim of this paper is to prove that devaluation can be contractionary and that its occurrence can be the result of a self-fulfilling prophecy. Assuming credit constraints on firms’ borrowing capacity and nominal price rigidities, a sharp change in the value of the domestic currency leads to an increase in the real costs of foreign currency-denominated debt. Hence, firms’ profits as well as their borrowing capacity decrease, provoking a drop in future investment and output. Moreover, expectations about future output can alone trigger a currency devaluation, confirming the initial expectations in a self-fulfilling way. Finally, it is discussed in an empirical analysis the impact of devaluation on the economic growth in a sample of five countries.

Regulating Capital Flows to Emerging Markets: An Externality View

This paper provides welfare theoretic foundations for risk-adjusted capital flow regulations based on a standard class of macroeconomic models of financial crises that exhibit financial amplification dynamics. We show that during crisis episodes when such amplification effects are triggered, decentralized agents do not internalize that capital outflows are magnified through a systemic feedback cycle of depreciating exchange rates, tightening financial constraints, and declining aggregate demand, akin to Fisher's process of debt deflation. As a result, agents undervalue the social cost of repayments in crisis states and take on too much systemic crisis risk in their ex ante financing decisions. We construct an externality kernel that captures the state-contingent magnitude of systemic externalities of outflows. Constrained social efficiency can be restored by imposing Pigovian taxes on capital inflows that can be calculated as the product of the externality kernel times the state-contingent vector of payoffs of the respective type of financial instrument. We develop a sufficient statistics method to quantify the externalities imposed by different categories of capital flows. Using historical data from Indonesia, we find that optimal Pigovian taxes range from approximately zero for FDI flows to 1.54% for foreign currency-denominated debt.

Foreign currency-denominated borrowing in the absence of operating incentives

It is well known that corporations issue foreign currency-denominated debt to hedge foreign currency cash flows with offsetting interest payments. We test an alternative “opportunistic” motive for foreign currency-denominated borrowing. We do so by constructing a comprehensive sample of foreign currency-denominated bonds issued by sovereign government and agency issuers with no foreign currency cash flows or foreign operations. We find strong and consistent evidence that the borrowers in our sample consider cross-currency differences in covered and uncovered interest yields in choosing the currency in which to denominate their international debt. We estimate the average gains to opportunistic covered yield borrowing to be 4 to 18 basis points. Interestingly, we also find that the average bond offering in our sample precedes a large and beneficial depreciation of the issue currency over the course of the following year. These results support what has been a frequent conjecture in the foreign debt market.

Balance sheets, exchange rate policy, and welfare

We evaluate the welfare implications of fixed and flexible exchange rate regimes in a small open-economy model that incorporates the financial accelerator coupled with liability dollarization. We solve the model up to a second-order approximation which allows us to rigorously address the relationship between uncertainty and welfare. We identify leverage and debt-to-GDP ratios above which an exchange rate peg is welfare superior to a flexible exchange rate regime. The results indicate that emerging market countries with even moderate levels of foreign currency-denominated debt may find it beneficial to stabilize their exchange rates.

Foreign Currency Denominated Borrowing in the Absence of Operating Incentives

It is well known that corporations issue foreign currency-denominated debt to hedge foreign currency cash flows with offsetting interest payments. We test an alternative motive for foreign currency-denominated borrowing. We do so by constructing a comprehensive sample of foreign currency-denominated bonds issued by sovereign government and agency issuers all of whose cash inflows are exclusively denominated in their respective local currencies. We find strong and consistent evidence that the prevailing covered and uncovered interest yields across currencies matter to these borrowers in choosing the currency in which to denominate their international debt. We estimate the average gains to opportunistic covered yield borrowing at 4 to 18 basis points. Interestingly, we also find that the average bond offering in our sample precedes a large and beneficial depreciation in the selected currency in the year following the issuance. These results support what has been a frequent conjecture in the foreign debt market.

Pathways Through Financial Crisis: India

India survived near-crisis situations twice in the 1990s. How did internal and external constraints shape that country's ability to respond to the crises? This article argues that India's success can be attributed to four sets of decisions taken during the period 1991-1997: devaluation, involvement of the IMF, partial liberalization of the domestic financial sector, and gradual opening up of the external sector. The article analyzes the options, political opposition, and eventual outcomes for each set of decisions. India's ownership of its reform program helped set the pace of reform, while close interaction between technocrats and the IMF added credibility. But the balance between entrenched traditional interest groups and the demands of new interests determined the scope of reform. KEYWORDS: India, financial crisis, economic reform, IMF, interest groups. ********** India survived near-crisis situations twice in the 1990s, and in 1991 was nearly bankrupt. In response, a reform process began. Engagement with the International Monetary Fund (IMF) had its risks: if India could not deliver on its promises of economic reform, investors would exit again; if the government pushed too hard on reforms, domestic opposition would become unmanageable. In 1997-1998 the Asian financial crisis again threatened India. Macroeconomic fundamentals were vastly different, but political instability and external shocks were common in both episodes. How did internal and external constraints shape India's ability to handle financial crises in the 1990s? The 1991 Crisis In 1991, India experienced a classic external payments crisis: high fiscal and current account deficits, external borrowing to finance the deficits, rising debt service obligations, rising inflation, and inadequate exchange rate adjustment. In 1979, the oil shock, agricultural subsidies, and a consumption-driven growth strategy had pushed up the fiscal deficit. It further increased in the mid-1980s as defense expenditure was substantially increased and direct taxes were progressively reduced. (1) The result was that the deficit ballooned from 1985 to reach 9.4 percent by 1990-1991. (2) India's current account position also worsened. Increasing dependence on foreign oil imports, vulnerability to oil price fluctuations, declining remittances from abroad, strong domestic demand (a result of public sector wage increases in the mid-1980s), and rising debt service payments ensured that the current account deficit averaged 2.2 percent of gross domestic product (GDP) during 1985-1990. Also, export competitiveness was adversely affected by the rupee's steady appreciation: 20 percent between 1979 and 1986. (3) In 1987 it steadily depreciated, but the real exchange rate remained overvalued until 1991. To finance the twin deficits, India relied on external funds. Foreign investment at 0.1 percent of GDP during 1985-1990 was negligible. (4) During 1980-1985, nearly half of external financing needs were met by external assistance. (5) By the mid-1980s, aid weariness forced the government to rely more on commercial borrowing. (6) Soft loans declined in proportion from 89 percent (1980) to 35 percent (1990). (7) Thus, external debt (with a large proportion of short-term debt) started dominating the balance sheet, peaking at 38.7 percent of GDP in 1991-1992, with the debt-export ratio at 563 percent. (8) Notwithstanding the weakening fundamentals, one key factor that reduced vulnerability was the absence of private sector external debt. Unlike many other countries, individuals and firms could not raise foreign currency-denominated debt, and the banking sector was not allowed to hold financial assets abroad. One effect of this was that the private sector's interests were geared more toward internal deregulation than toward external liberalization. (9) Two immediate external shocks contributed to the large current account deficit of 3. …