Does exchange rate depreciation have contractionary effects on firm-level investment?
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Working Paper 26
Does exchange rate depreciation have contractionary effects on firm-level investment? The implications of alternative types of bond financing
This paper shows that exchange rate depreciations can have a contractionary impact on investment spending when firms hold foreign currency-denominated debt.
Authors: Jose Maria Serana (Bank for International Settlements) and Ricardo Sousa (European Stability Mechanism)
Abstract:
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.
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JEL codes: F2, F3, E2, E3