The Dominant Currency Financing Channel of External Adjustment
Abstract: We provide evidence of a new channel of how exchange rates affect trade. Using a novel identification strategy that exploits firms' foreign currency debt maturity structure in Colombia around a large depreciation, 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. Dominant currency pricing mutes the effects of dominant currency financing on imports relative to producer currency pricing.
File(s): File format is application/pdf https://www.federalreserve.gov/econres/ifdp/files/ifdp1343.pdf
Part of Series: International Finance Discussion Papers
Publication Date: 2022-05-12