The Dominant Currency Financing Channel of External Adjustment

Camila Casas, Sergii Meleshchuk and Yannick Timmer

No 2023/164, IMF Working Papers from International Monetary Fund

Abstract: We provide evidence of a new channel through which exchange rates affect trade. Using a novel identification strategy that exploits firms’ maturity structure of foreign currency debt around a large depreciation in Colombia, we show that firms experiencing a stronger debt revaluation of dominant currency debt due to a home currency depreciation compress imports relatively more while exports are unaffected. Dominant currency financing does not lead to an import compression for firms that export, hold foreign currency assets, or are active in the foreign exchange derivatives markets, as they are all hedged against a revaluation of their debt. These findings can be rationalized through the prism of a model with costly state verification and foreign currency borrowing. Quantitatively, the dominant currency financing channel explains a significant part of the external adjustment process in addition to the expenditure switching channel. Pricing exports in the dominant currency, instead of the producer’s currency, mutes the effect of dominant currency financing on trade flows.

Keywords: Imports; Exports; Foreign Currency Exposure; Capital Structure; Exchange Rates; Debt Revaluation; Hedging; home currency depreciation compress import; financing channel; currency financing; liquidity shock; Currencies; Depreciation; Global (search for similar items in EconPapers)
Pages: 81
Date: 2023-08-11
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Related works:
Working Paper: The Dominant Currency Financing Channel of External Adjustment (2023)
Working Paper: The Dominant Currency Financing Channel of External Adjustment (2022)
Working Paper: The Dominant Currency Financing Channel of External Adjustment (2020)
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