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The Dominant Currency Financing Channel of External Adjustment
Author:
Camila Casas https://isni.org/isni/0000000404811396 International Monetary Fund

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Sergii Meleshchuk https://isni.org/isni/0000000404811396 International Monetary Fund

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Mr. Yannick Timmer
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Series:
IMF Working Papers
Volume/Issue:
Volume 2023: Issue 164
Language:
English
Publication Date:
11 Aug 2023
DOI:
https://doi.org/10.5089/9798400248788.001
ISBN:
9798400248788
ISSN:
1018-5941
Pages:
81
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
Legal-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.
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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.
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Cover IMF Working Papers
IMF Working Papers
ISSN:
1018-5941
Publisher:
International Monetary Fund