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Title: Foreign Currency Borrowing of Corporations as Carry Trades: Evidence from India

Author(s): Viral V. Acharya and Siddharth Vij

Publication Date: November 2020

Keyword(s): emerging markets, foreign currency debt, Foreign exchange risk and taper tantrum

Programme Area(s): Financial Economics

Abstract: We establish that macroprudential policies limiting capital flows can curb risks arising from corporate foreign currency borrowing in emerging markets. Using detailed firm- level data from India, we show that propensity to issue foreign currency debt for the same firm is higher when the difference in short-term interest rates between India and the US is higher, i.e., when the dollar 'carry trade' is more profitable; this behavior is driven by the period after the global financial crisis. The positive relationship between issuance and the 'carry trade' breaks down once regulators institute more stringent interest-rate caps on foreign currency borrowing. Riskier borrowers such as importers and those with higher interest costs cut issuance most. Firm equity exposure to foreign exchange risk rose after issuance in favorable funding conditions and emerged as a source of external sector vulnerability during the 'taper tantrum' of 2013. Macroprudential policy action limiting capital flows is able to nullify this effect, such as during the market stress due to the COVID-19 pandemic.

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Bibliographic Reference

Acharya, V and Vij, S. 2020. 'Foreign Currency Borrowing of Corporations as Carry Trades: Evidence from India'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=15440