Exchange Rate Exposure and Firm Dynamics

Abstract

This paper develops a heterogeneous firm-dynamics model with endogenous currency debt composition to jointly study financing and investment decisions in developing economies. In our model, firms’ foreign currency borrowing arises from a trade-off between exposure to currency risk and growth. We assess econometrically the pattern of foreign currency borrowing using firm-level census data on Hungary, calibrate the model and quantify its aggregate impact. Our counterfactual exercises show that foreign currency borrowing can lead to higher growth and that the efficiency of the banking sector to screen productive and capital-scarce firms is essential to reap up the benefits of this financing.