Foreign Currency Borrowing of Corporations as Carry Trades: Evidence from India

Viral Acharya and Siddharth Vij

No 15440, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We establish that macroprudential policies limiting capital flows can curb risks arising from corporate foreign currency borrowing in emerging markets. Using detailed firm- level data from India, we show that propensity to issue foreign currency debt for the same firm is higher when the difference in short-term interest rates between India and the US is higher, i.e., when the dollar ‘carry trade’ is more profitable; this behavior is driven by the period after the global financial crisis. The positive relationship between issuance and the ‘carry trade’ breaks down once regulators institute more stringent interest-rate caps on foreign currency borrowing. Riskier borrowers such as importers and those with higher interest costs cut issuance most. Firm equity exposure to foreign exchange risk rose after issuance in favorable funding conditions and emerged as a source of external sector vulnerability during the ‘taper tantrum’ of 2013. Macroprudential policy action limiting capital flows is able to nullify this effect, such as during the market stress due to the COVID-19 pandemic.

Keywords: Emerging markets; Foreign currency debt; Foreign exchange risk; Taper tantrum (search for similar items in EconPapers)
JEL-codes: F31 F34 G15 G30 (search for similar items in EconPapers)
Date: 2020-11
New Economics Papers: this item is included in nep-cwa, nep-fdg and nep-ifn
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Citations: View citations in EconPapers (4)

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Working Paper: Foreign Currency Borrowing of Corporations as Carry Trades: Evidence from India (2020)
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