Corporate investment and the exchange rate : The financial channel

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Title: Corporate investment and the exchange rate : The financial channel
Author: Banerjee, Ryan ; Hofmann, Boris ; Mehrotra, Aaron
Organization: Bank of Finland
Department / Unit: Institute for Economies in Transition (BOFIT)
Series: BOFIT Discussion Papers
Series number: 6/2020
Year of publication: 2020
Publication date: 27.2.2020
Pages: 35
Subject (yso): investoinnit; yritykset; valuuttakurssit
Keywords: Bofit-kokoelma; kehittyvät markkinat
JEL: E22; F31; F41; O16
Other keywords: corporate investment; emerging markets; exchange rates; financial channel; financial constraints
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.
Table of contents: Abstract .. 4 1 Introduction .. 5 Related literature .. 8 2 Model .. 10 Foreign currency borrowing .. 10 Borrowing in local currency .. 13 Main predictions for the empirical analysis .. 15 3 Data .. 15 4 Testing for the financial channel in firm investment dynamics .. 19 5 Robustness checks .. 26 6 The cash flow sensitivity of cash and the exchange rate .. 27 7 Conclusions .. 29 References .. 31

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