Debt Composition and Balance Sheet Effects of Exchange Rate Volatility in Mexico: A Firm Level Analysis

We use Mexican firm-level data to study the role of currency mismatches in exacerbating the negative effects of a devaluation in the corporate sector and to investigate what drives Mexican firms to borrow in foreign currency. Our results show that large firms and exporters tend to borrow more heavily in foreign currency. The presence of foreign currency denominated debt poses a significant risk to balance sheets at the time of devaluation. Our findings suggest that in Mexico, the balance sheet effects of a devaluation far outweigh the competitiveness effects.

Devaluation (levels versus rates) and balance of payments in a cash-in-advance economy

This paper investigates the consequences of the currency devalution, both in levels and rates, on the balance of payments in a cash-in-advance economy with finite horizons, endogenous capital accumulation and international capital immobility. In this context, a once and for all currency devaluation induces a balance of payments surplus, whereas a sustained increase in the rate of devaluation produces, in principle, an ambiguous effect on the balance of payments. If however non-restrictive assumptions on some structural parameters are made, an increase in the devaluation rate leads to a balance of payments surplus, the exact opposite of Calvo's result (1981).Devaluation; Balance of payments; Cash-in-advance constraint; Overlapping generations.

Debt Valuation Effects when there is Foreign Currency-Denominated Debt

This paper discusses the way in which the existence of debt denominated in both domestic and foreign currency affects debt-sustainability analyses. Ignoring valuation issues can lead to misleading conclusions regarding fiscal sustainability. We show that a devaluation of the domestic currency can significantly change the path of a sustainable fiscal policy. In our model, the adjustment not only comes through the change in the value of the foreign currency-denominated public debt, but also though the effects on the interest rate and growth. We find that the required fiscal adjustment to achieve fiscal sustainability after a devaluation increases with the size of the devaluation, the length of the adjustment period, the effect on interest rates and growth, and the share of public debt that is denominated in foreign currency.Public debt, valuation effects, debt management

FOREIGN DIRECT INVESTMENT AND EXCHANGE RATES: A CASE STUDY OF U.S. FDI IN EMERGING MARKET COUNTRIES

This paper investigates the impact of exchange rates on US Foreign Direct Investment (FDI)inflows to a sample of 16 emerging market countries using panel data for the period 1990-2002. Threevariables are used to capture separate exchange rate effects. The nominal bilateral exchange rate tothe $US captures the value of the local currency (a higher value implies a cheaper currency andattracts FDI). Changes in the real effective exchange rate index (REER) proxy for expected changes inthe exchange rate: an increasing (decreasing) REER is interpreted as devaluation (appreciation)being expected, so that FDI is postponed (encouraged). The temporary component of bilateralexchange rates is a proxy for volatility of local currency, which discourages FDI. The results supportthe ‘Chakrabarti and Scholnick’ hypothesis that, ceteris paribus, there is a negative relationshipbetween the expectation of local currency depreciation and FDI inflows. Cheaper local currency(devaluation) attracts FDI while volatile exchange rates discourage FDI.

Expectations and Contagion in Self-fulfilling Currency Attacks

This paper shows how expectations-driven contagion of currency crises can arise even if the currency market has a unique equilibrium when viewed in isolation. The model of Morris and Shin (1998) is extended to allow speculators to trade in a second currency market. If speculators believe that a devaluation of this other currency will make a domestic devaluation more likely, they will engage in trades that link the two markets. A sharp devaluation of the other currency will then be propagated to the domestic market and will increase the likelihood of a crisis there, fulfilling the original expectations. Even though this contagion is driven solely by expectations, the model places restrictions on observable variables, and these restrictions are broadly consistent with existing empirical evidenceContagion, Currency Crisis, Coordination, Global Games

Expectations and Contagion in Self-Fulfilling Currency Attacks

This paper shows how expectations-driven contagion of currency crises can arise even if the currency market has a unique equilibrium when viewed in isolation. The model of Morris and Shin (1998) is extended to allow speculators to trade in a second currency market. If speculators believe that a devaluation of this other currency will make a domestic devaluation more likely, they will engage in trades that link the two markets. A sharp devaluation of the other currency will then be propagated to the domestic market and will increase the likelihood of a crisis there, fulfilling the original expectations. Even though this contagion is driven solely by expectations, the model places restrictions on observable variables, and these restrictions are broadly consistent with existing empirical evidence.

Currency Devaluations, Product Pricing and Trade Deficits

This paper explains why currency movements and trade volumes, while theoretically related, have minimal effect on each other, in practice. In addition, it argues that volatile currency movements and trade deficits are not beneficial in the long run. A separate set of measures on how to deal with each issue is also discussed.trade sector, devaluation, foreign exchange liberalization, currency and banking crisis

BRAZIL'S NEW FLOATING EXCHANGE RATE REGIME AND COMPETITIVENESS IN THE WORLD POULTRY MARKET

In early 1999, Brazil devalued its currency, increasing its competitiveness in the poultry industry and capturing world market share. This paper discusses the devaluation and its effects on Brazil's trade, evaluates preliminary statistics on the impact of the devaluation on world poultry markets, and reports the results from a computable general equilibrium (CGE) simulation of the devaluation. The medium-run CGE results are compared to the short-run impacts reflected in the preliminary statistics.Brazil, currency devaluation, GTAP, poultry, world market share, Financial Economics,

Finantial Dollarization and Debt Deflation under a Currency Board

In the late currency board years, Argentina faced a real exchange rate adjustment through price deflation amidst growing devaluation expectations. Using a firm-level panel database to analyze the incidence of these factors on the currency composition of private debt and on firms’ performance, we find that widespread debt dollarization showed no relationship with the firms’ production mix or the ever-changing probability of a nominal devaluation. While relative price changes favored export-oriented firms with the expected impact on sales, earnings and investment, increases in devaluation expectations elicited only a marginal differential response in investment from more financially dollarized firms. Our findings provide support to two criticisms faced by the Argentine currency board in recent years, namely, that by fueling beliefs in an implicit guarantee it stimulated across-the-board debt dollarization, and that it could not fully isolate the economy from real shocks, as the feared balance sheet effect was replaced by a gradual but equally deleterious debt deflation effect.

Fiscal and social impact of a nominal exchange rate devaluation in Djibouti

Limited fiscal space limits Djibouti's ability to meet the Millennium Development Goals and improve the living conditions of its population. Djibouti's fiscal structure is unique in that almost 70 percent of government revenue is denominated in foreign currency (import taxes, foreign aid grants, and military revenue) while over 50 percent of government expenditure is denominated in local currency (wages, salaries, and social transfers). Djibouti's economic structure is also unusual in that merchandise exports of local origin are insignificant, and the country relies heavily on imported goods (food, medicines, consumer and capital goods). A currency devaluation, by reducing real wages, could potentially generate additional fiscal space that would help meet Djibouti's fundamental development goals. Using macroeconomic and household level data, the authors quantify the impact of a devaluation of the nominal exchange rate on fiscal savings, real public sector wages, real income, and poverty under various hypothetical scenarios of exchange-rate pass-through and magnitude of devaluation. They find that a currency devaluation could generate fiscal savings in the short-term, but it would have an adverse effect on poverty and income distribution. A 30 percent nominal exchange rate devaluation could generate fiscal savings amounting between 3 and 7 percent of GDP. At the same time, a 30 percent nominal devaluation could cause nearly a fifth of the poorest households to fall below the extreme poverty line and pull the same fraction of upper middle-income households below the national poverty line. The authors also find that currency devaluation could generate net fiscal savings even after accounting for the additional social transfers needed to compensate the poor for their real income loss. However, the absence of formal social safety nets limits the government's readiness to provide well-targeted and timely social transfers to the poor.Economic Theory&Research,Economic Stabilization,Rural Poverty Reduction,Fiscal&Monetary Policy,Macroeconomic Management