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There are two leading views on how financial crises turn into recessions. The first view highlights the importance of a troubled banking sector that cannot provide credit to domestic firms. The second view stresses the relevance of short-term borrowing in foreign currency and the associated decline in net worth through a weak balance sheet. Both views underline the role of financial constraints as mechanisms that can lead to an aggregate investment collapse. By utilizing a new firm-level database from six Latin American countries between 1990-2005 and using a differences-in-differences methodology, we empirically test the importance of each view. We find that foreign exporters that hold short-term foreign currency denominated debt, increase investment by 13 percentage points compared to domestic exporters with foreign currency denominated debt. This result only holds when the currency crisis is combined with a banking crisis, implying that the key factor that hinders investment and growth is the decline in the supply of credit.JEL Classification: E32, F15, F36, O16
This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. This paper assesses the effects of capital controls imposed in Colombia in 2007 on capital flows and exchange rate dynamics. The results suggest that the controls were successful in reducing external borrowing, but had no statistically significant impact on the volume of non-FDI flows as a whole. We find no evidence that restrictions to capital mobility moderated the appreciation of Colombia's currency, or increased the degree of independence of monetary policy. We also find that controls have significantly increased the volatility of the exchange rate. Additional research is needed to assess the effects of capital controls on financial stability. JEL Classification Numbers: F31 ,F32, G13
Using a unique dataset with information on the currency composition of firms' assets and liabilities in six Latin-American countries, I investigate how the choice of exchange rate regime affects firms' foreign currency borrowing decisions and the associated currency mismatches in their balance sheets. I find that after countries switch from pegged to floating exchange rate regimes, firms reduce their levels of foreign currency exposures, in two ways. First, they reduce the share of debt contracted in foreign currency. Second, firms match more systematically their foreign currency liabilities with assets denominated in foreign currency and export revenues-effectively reducing their vulnerability to exchange rate shocks. More broadly, the study provides novel evidence on the impact of exchange rate regimes on the level of un-hedged foreign currency debt in the corporate sector and thus on aggregate financial stability.
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