Discussion of Foreign Currency Debt and Macroeconomic Volatility by Anton Korinek. Romain Ranciere PSE

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1 Discussion of Foreign Currency Debt and Macroeconomic Volatility by Anton Korinek Romain Ranciere PSE

2 This paper Analyzes the trade-offs between local currency and foreign currency debt. Risk-neutral borrowers and lenders. Local currency debt: domestic borrowers are buying costly insurance from risk-averse foreign borrowers. Mitigation of exchange rate volatility. Foreign currency debt: foreign lenders are insured. Debt is cheaper but exchange rate volatility is higher. Balance sheet Effects. Endogeneity of Real Exchange Rate and Macro Volatilitity

3 Literature Third generation of crisis models Currency Mismatch and Balance sheet Effects : Exchange Rate Risk -> Default Risk. Tornell-Schneider (2004), Jeanne (2003), Ranciere- Tornell (2003) Chamon (2003, 2004, 2007), IMF(2004) Chamon (2003) Why Can't Developing Countries Borrow from Abroad in Their Currency? Here No default Risk-averse lenders. Broner, Lorenzoni and Schmukler (2007) Similar problem on maturity structure.

4 Set-up Two goods economy N and T. Yn, Yt Risk-Averse Investors. Insurance Story Shock to T endowment (A) Demand for N goods->price of N goods (Real Exchange Rate) 1. Local Currency Debt 2. Foreign Currency Debt. Balancesheet effects: (A) differs between 1. and 2.

5 Local Domestic Debt. Issue Dn Repay Pn(1+Rn)Dn Risk-Premium due to exchange rate variability. Insurance Property. Cost of Debt is indexed to value of non-tradable goods (PnYn) A positive shock to Yt increase demand for Yn Pn up but Pn also increases debt burden. Balancesheet effect: > Mitigating effect on Pn: lower real exchange rate volatility (and consumption volatility) Feedback on risk-premium: the more local debt the cheaper local debt.

6 Foreign Currency Debt Issue Dt Repay (1+r)Dt A positive shock to Yt increase demand for Yn Pn up But the debt burden is now unchanged. No mitigating effect. Higher exchange rate volatility and consumption volatility. No feedback on price of debt.

7 What is missing? Default Risk. Consider a slightly modified set-up to make default risk clear. Non-Tradable Producers (Yn). Consumers have an endowment of Yt Profits: PnYn-(1+Rt)Dt-Pn(1+Rn)Dn Local Currency Only: Pn(Yn-(1+Rn)Dn) Default Free. Domestic Currency: PnYn-(1+Rt)Dt Defaultable Debt Default Risk and Risk-Premium on T-debt

8 A look at the data. Ranciere, Tornell-Vamvakidis (Economic Policy, forthcoming) Eastern Europe: Huge Currency Mismatch! EBRD Firm-Level Survey (2005) Currency Denomination of Last Loan. Panel of Loans. Terms: Interest Rate and Maturity Firms in Non-Tradable Sector (evidence of currency mismatch) Extra for Tradable Sector.

9 Table 7. Loan Interest Rate and Currency Mismatch Dependant Variable Sample Estimation Interest Rate on Last Loan Reported in 2005 BEEPS Survey Small Firms in Non-Tradables Sectors OLS Currency Mismatch Dummy -2.50*** -2.46*** -2.31*** -2.28*** -2.23*** -2.04*** Log of Sales (2004) -0.29*** -0.33*** -0.37*** -0.24* -0.27** -0.29** Log of Years in Operation -0.76*** -0.76*** -0.63** -0.68** -0.69** Collateral Dummy for: Land or Building Equipment Accounts Receivable 1.17* 1.22* 1.55* Personal Assets Other Collateral Number of Firms Adjusted R-squared Country Fixed Effects Yes Yes No Yes Yes No Industry Fixed Effects No Yes No No Yes No Country-Industry Fixed Effects No No Yes No No Yes * significant at 10%; ** significant at 5%; *** significant at 1%

10 Table 8. Loan Interest Rate and Currency Mismatch; Robustness: The Role of Exchange Rate Depreciation Dependant Variable Sample Estimation Currency Mismatch Dummy -3.49*** -3.47*** -3.40*** -3.12*** -3.09*** -2.76*** Log of Sales (2004) -0.24* -0.29** -0.30** * Log of Years in Operation -0.94*** -0.92*** -0.91** -0.75** -0.72* -0.70* Collateral Dummy for: Land or Building Equipment Accounts Receivable Personal Assets Other Collateral Number of Firms Adjusted R-squared Country Fixed Effects Yes Yes No Yes Yes No Industry Fixed Effects No Yes No No Yes No Country-Industry Fixed Effects No No Yes No No Yes * significant at 10%; ** significant at 5%; *** significant at 1% Adjusted Interest Rate on Last Loan Reported in 2005 BEEPS Survey Small Firms in Non-Tradables Sectors OLS

11 TRADABLE FIRMS VARIABLES rate rate rate2 rate2 Currency Mismatch -2.42*** -2.38*** -3.84*** -3.83*** ln_sales -0.40*** -0.43*** -0.31*** -0.35*** ln_age Constant 21.4*** 19.9*** 19.4*** 14.9*** Observations Adjusted R-squared Standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1

12 What affects the spread Exchange Rate Risk: but tail risk rather than normal time volatility or predictable depreciation. Tail Risk Default Risk. How to explain lack of difference between firms with and without currency mismatch. Hypothesis: Bailout Expectations.

13 Conclusion Very nice paper. Incoporate Default Risk stemming from currency mismatch. Compare more with existing literature (Chamon) Confront with data.

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