Corporate Investment and the Exchange Rate: The Financial Channel

35 Pages Posted: 22 Jan 2021

See all articles by Ryan Banerjee

Ryan Banerjee

Bank for International Settlements (BIS)

Boris Hofmann

Bank for International Settlements (BIS) - Monetary and Economic Department

Aaron N. Mehrotra

Bank for International Settlements (BIS)

Multiple version iconThere are 2 versions of this paper

Date Written: February 27, 2020

Abstract

Using firm-level data for 18 major global economies, we find that the exchange rate affects corporate investment through a financial channel: exchange rate depreciation dampens corporate investment through firm leverage and FX debt. These findings are consistent with the predictions of a stylised model of credit risk in which exchange rates can affect investment through FX debt or borrowing in local currency from foreign lenders. Empirically, the channel is more pronounced in emerging market economies (EMEs), reflecting their greater dependence on foreign funding and their less developed financial systems. Moreover, we find that exchange rate depreciation induces highly leveraged firms to increase their cash holdings, supporting from a different angle the notion of a financial channel of the exchange rate. Overall, these findings suggest that the large depreciation of EME currencies since 2011 was probably a significant amplifying factor in the recent investment slowdown in these economies.

JEL Classification: E22, F31, F41, O16

Suggested Citation

Banerjee, Ryan and Hofmann, Boris and Mehrotra, Aaron N., Corporate Investment and the Exchange Rate: The Financial Channel (February 27, 2020). BOFIT Discussion Paper No. 6/2020, Available at SSRN: https://ssrn.com/abstract=3764761 or http://dx.doi.org/10.2139/ssrn.3764761

Ryan Banerjee (Contact Author)

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

Boris Hofmann

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

Aaron N. Mehrotra

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

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