The Dominant Currency Financing Channel of External Adjustment

By Camila Casas, Sergii Meleshchuk, Yannick Timmer

August 11, 2023

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Format: Chicago

Camila Casas, Sergii Meleshchuk, and Yannick Timmer. The Dominant Currency Financing Channel of External Adjustment, (USA: International Monetary Fund, 2023) accessed November 5, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

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.

Subject: Currencies, Depreciation, Exports, Financial regulation and supervision, Hedging, Imports, International trade, Money, National accounts

Keywords: Capital Structure, Currencies, Currency financing, Debt Revaluation, Depreciation, Exchange Rates, Exports, Financing channel, Foreign Currency Exposure, Global, Hedging, Home currency depreciation compress import, Imports, Liquidity shock

Publication Details

Pages:

81
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2023/164
Stock No:

WPIEA2023164
ISBN:

9798400248788
ISSN:

1018-5941

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