New spare tires: local currency credit as a global shock absorber

Summary

Focus

Emerging market corporates saw a surge of dollar debt over the past two decades, potentially making them more vulnerable. We examine the ability of emerging market corporates to offset global shocks to their dollar debt by borrowing in local currency. We use data on bonds and syndicated loans to document long-run trends, and firm-level data to examine how dollar and local currency debt react to global shocks.

Contribution

Much of the existing literature focuses on external debt, which tends to be denominated in US dollars. We examine corporate debt across lenders (domestic and external), instruments (loans and bonds) and currencies (local and dollar). This comprehensive study of emerging market corporate balance sheets provides nuanced insights regarding the impact of global shocks.

Findings

Local currency credit to emerging market corporates expanded significantly alongside their dollar borrowing. An appreciation of the dollar – which tightens dollar credit conditions – leads to a decline in the debt of firms that are relatively small, do not export or are less profitable. Firms that are very large, have substantial exports or are more profitable see no impact on their debt. Firms in the mid-range of these measures see a decline in their dollar debt, but this is offset by a rise in their local currency debt. Thus, for many firms, local currency debt can act as a "spare tire" for global shocks that decrease dollar credit.

Abstract

It is well-known that dollar credit to emerging market (EM) corporates has expanded dramatically in the past two decades. However, the concurrent expansion of local currency credit, facilitated by more developed domestic financial systems, has been less recognized. This paper first uses data on EM corporates' borrowing through bonds and syndicated loans to show the considerable rise of their local currency debt. It then utilizes comprehensive firm-level data to document that EM corporates' local currency  borrowing can offset shocks to their dollar debt, and how this varies across firms and countries. A broad dollar appreciation is associated with a decline in credit to ''local'' firms (smaller, non-exporting, with low profitability) but has no significant impact on ''global'' firms (larger, exporting, highly profitable). Firms in the mid-range (of these  dimensions) see lower dollar debt in response to a stronger dollar, but replace it with local currency debt, thus offsetting the shock.

JEL Classification: F30, G30

Keywords: emerging markets, local currency debt, foreign currency debt, global factors, dollar debt