Exchange Rate Fluctuations and Firm Leverage

IMF Working Papers, December 11, 2020

Source details

We quantify the effect of exchange rate fluctuations on firm leverage.
When home currency appreciates, firms who hold foreign currency debt and local currency assets observe higher net worth as appreciation lowers the value of their foreign currency debt; these firms can borrow more and increase their leverage.
When home currency depreciates, the reverse happens: firms face negative balance-sheet shocks and must de-lever.
Using firm-level data for leverage from 10 emerging market economies during the period from 2002 to 2015, the authors show that firms operating in countries whose non-financial sectors hold more of the debt in foreign currency increase (decrease) their leverage relatively more after home currency appreciations (depreciations).
Combining the leverage data with firm-level FX debt data for 4 emerging market countries, the authors further show that results hold at the most granular level.
The quantitative results are asymmetric: the effects of depreciations, that are generally associated with sudden stops, are quantitatively larger than those of appreciations, which take place at a slower pace over time during capital inflow episodes.
As the exercise compares depreciations and appreciations of similar size, results are suggestive of financial frictions being more binding during depreciations than a possible relaxation of such frictions during appreciations.

Data scope:
- Firm-level leverage data from 10 emerging market economies.
- Sample period: 2002 to 2015.
- Additional firm-level FX debt data for 4 emerging market countries to confirm granular-level effects.
Main empirical regularities:
- Home currency appreciation → lower value of firms' foreign currency debt → higher net worth → increased borrowing → higher leverage.
- Home currency depreciation → higher burden of foreign currency debt → negative net worth shock → de-leveraging.
- Countries with larger shares of non-financial sector debt denominated in foreign currency exhibit stronger leverage responses to exchange rate movements.
Asymmetry:
- Depreciation effects > Appreciation effects for comparable-sized currency moves.
- Depreciations often coincide with sudden stops; appreciations tend to occur more gradually during capital inflows.
- Suggests financial frictions tighten more during depreciations than they loosen during appreciations.

Subject: Currencies, Depreciation, Exchange rate adjustments, Exchange rates, Foreign exchange
Keywords: Capital Flows, COVID-19, debt share, Exchange Rates, Firm Leverage, FX bond, FX Borrowing, FX debt, FX loan, government FX, WP

Exchange Rate Fluctuations and Firm Leverage — Ilhyock Shim and Sebnem Kalemli-Ozcan, IMF Working Papers 2020, 283 (2020).