Monday , November 19 2018
Home / Bank of International Settlement / Currency depreciation and emerging market corporate distress

Currency depreciation and emerging market corporate distress

Summary:
BIS Working Papers  |  No 753  |  23 October 2018 by  Valentina Bruno and Hyun Song Shin PDF full text (381kb)  |  53 pages Summary Focus 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. Contribution 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

Topics:
International Settlement considers the following as important:

This could be interesting, too:

Amol Agrawal writes RBI and Government spat: What was once a ‘joint family’ is fighting like two nuclear families today…

Amol Agrawal writes Revisiting Bombay Plan and its message

International Settlement writes Incentives to centrally clear over-the-counter (OTC) derivatives

Amol Agrawal writes Polish Economists in Nehru’s India: Making Science for the Third World in an Era of De-Stalinization and Decolonization

BIS Working Papers  |  No 753  | 
23 October 2018
PDF full text
 (381kb)
 |  53 pages

Summary

Focus

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.

Contribution

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.

Findings

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.

 

Abstract

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

International Settlement
The Bank for International Settlements (BIS) is an international company limited by shares owned by central banks which "fosters international monetary and financial cooperation and serves as a bank for central banks". The BIS carries out its work through subcommittees, the secretariats it hosts and through an annual general meeting of all member banks. It also provides banking services, but only to central banks and other international organizations. It is based in Basel, Switzerland, with representative offices in Hong Kong and Mexico City.

Leave a Reply

Your email address will not be published. Required fields are marked *