The Turning Tide: How Vulnerable are Asian Corporates?

IMF Working Papers, May 6, 2019

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Using a new firm-level dataset with comprehensive information on Asian firms’ FX liabilities, the paper shows Asia’s nonfinancial corporate sector is vulnerable to a tightening of global financial conditions.
Higher global interest rates and exchange rate depreciation increase the probability of default of Asian firms.
A 30 percent currency depreciation is associated with a two-notch downgrade in the corporate credit rating (e.g., from A to BBB+), resulting in 7 percent of Asian firms falling into bankruptcy.
The impact of depreciation is nonlinear:
- As firms’ FX liability increases, the balance sheet channel of exchange rate effects offsets, then dominates, the competitiveness channel.
- The balance sheet channel offsets the competitiveness channel when the share of U.S. dollar debt is between 10 and 20 percent.
Investment responses to depreciation are heterogeneous:
- Currency depreciation increases firm-level investment on average.
- For firms with the share of FX liabilities above 20 percent, investment contracts with depreciation.

Channels identified:
- Balance sheet channel: depreciation increases local-currency value of FX liabilities, weakening balance sheets when FX liabilities are sizable.
- Competitiveness channel: depreciation can improve exporters’ competitiveness and revenues, supporting firm performance.
Nonlinearity: the relative strength of the balance sheet and competitiveness channels depends on the share of FX liabilities; once U.S. dollar debt share is between 10 and 20 percent, the balance sheet channel begins to offset competitiveness gains and ultimately dominates as FX exposure rises.

Monitor firm-level FX liabilities: vulnerability rises with higher shares of U.S. dollar debt and overall FX liabilities.
Consider corporate sector exposure when assessing macrofinancial risks from global interest rate increases and exchange rate movements.
Tailor firm- and sector-level policy responses recognizing heterogeneous investment responses:
- Support may be needed for firms with FX liabilities above 20 percent, where depreciation contracts investment and raises default risk.
- Policies that mitigate balance sheet currency mismatches (e.g., hedging facilitation, liability management) could reduce sensitivity to depreciation.