Foreign Currency Borrowing, Exports and Firm Performance: Evidence from a Currency Crisis

It is well documented that before the East Asian 1997 crisis both the banking and corporate sectors of many Asian economies had become fragile through the accumulation of short-term debt that was denominated in foreign currencies. The fragility was due to the currency mismatch in their balance sheets. While their liabilities were vulnerable to a potential currency depreciation their incoming revenues and assets where valued in domestic currency. Lessons were learned and mismatch was contained, and governments built up reserves to avoid the risk of a currency crisis. In recent years renewed growth in foreign currency borrowing in Asia has been noted by many observers. At first the exposure to a larger market with access to a wider group of investors was regarded as a positive step. Many firms that issued debt or took out loans in international currencies were to some degree naturally hedged by their earnings in the same currency. Governments in Asia promoted bond market development. However, as firms have issued large volumes of foreign currency debt, or have borrowed larger amounts in foreign currency from banks, concerns have increased about the consequences of the large borrowings in international currency, particularly when exchange rates might be more volatile. Our paper explores the relationship between foreign currency borrowing, exporting and performance. In particular, it develops a simple signaling model of foreign currency borrowing that yields predictions about firm survival and performance during a currency crisis. It then uses a large panel of firm-level data for South Korea around the time of the 1997 Asian crisis to test the predictions. By looking at this question it shifts the focus from foreign currency borrowing per se, to the characteristics of the firms that typically borrow in foreign currency focusing on low and high productivity firms and their chances of survival. Many firms borrow in foreign currency, but our model predicts that those lower productivity firms that borrowed in foreign currency and sell into the domestic market are least likely to survive a collapse of the currency. The empirical study by Kim et al. (2015) offers strong support for this prediction. Our model also predicts that conditional on survival the high productivity firms, which are the best performers, are most likely to have borrowed in foreign currency. These firms are also likely to be exporters, who benefit after a crisis from the fact that their foreign sales become more competitive after a crisis.