Institute for Financial Management & Research (IFMR)
In recent years, central banks in emerging markets have accumulated large amounts of foreign exchange reserves. For many countries, a key intent has been to increase the resilience of their economies to a possible sudden stop in capital inflows. Yet such policies may have the undesired effect of increasing corporate sector vulnerability: foreign exchange hoarding can be perceived as a free insurance against short term movements of the exchange rate, leading firms to borrow excessively in foreign currency. We investigate this possibility by using a novel firm-level balance sheet database for close to 1500 firms between 1995 and 2007 in six Latin American economies, Argentina, Brazil, Chile, Colombia, Mexico and Peru. Results suggest that over the sample period, an increase in the level of reserves is statistically and economically associated with an increase in the dollar borrowing of non-financial sector firms of these economies. We investigate several potential explanations for this result, and find evidence that at least part of this positive correlation reflects greater corporate risk taking as a causal response to an improvement in a country's reserve buffers against external shocks. These findings suggest that central banks, while formulating their foreign exchange intervention policies, may need to take into consideration the impact of reserve accumulation on firms incentive to hedge exchange rate risk.
Date: April 4, 2012
Time: 03:00 P.M.
AMEX Conference Room (Second Floor)
Department of Economics,
Delhi School of Economics,
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