Currency Depreciations in Emerging Markets: Financial Transfers and Borrowers Heterogeneity

The present paper investigates from the perspective of individual firms the channel between currency depreciations, currency mismatch and profits. In particular, we use a dataset on publicly listed, non-financial firms operating in Argentina, Brazil and Mexico during the period 1992-2004. Our key interest hereby is to explain why most of the considered episodes of large currency depreciations have been contractionary to the economies as opposed to the implications of the traditional Mundell-Fleming model. We develop a stylized partial equilibrium model of an individual firm that faces an unexpected currency depreciation to highlight three main channels: (1) a positive competitiveness effect for exporting firms; (2) a negative balance sheet effect for firms indebted in foreign currency; and (3) an adverse impact on interest payments. Thereafter, we quantify the relative importance of these channels in explaining the firms’ profitability during the depreciation episodes as a function of the currency composition of firms’ income and finance. Using panel regressions, we find evidence that the match between the currency-denomination of income and liabilities has been significantly better in Brazil than in Mexico and, especially, than in Argentina. JEL classification: F31, F34, F43