Debt composition and balance sheet effects of exchange rate volatility in Mexico: a firm level analysis

We use Mexican firm-level data to study the role of currency mismatches in the corporate sector in exacerbating the negative effects of a devaluation. We also investigate what drives Mexican firms to borrow in foreign currency. We find that holding dollar denominated debt in a devaluation adversely affects firms’ earnings and investment. However, exporters invested more than non-exporters in the same period. We also find that the negative effect of dollar debt was stronger than the positive effect of exports in the 1994 crisis for firms with positive dollar debt and/or exports, relative to firms that did not borrow abroad and/or export. This was a result of imperfect currency matching by firms. However, in the 1998 crisis firms managed the denominations of their inflows and outflows much better and these two effects were roughly equal in magnitude. We also find some evidence of currency matching by exporters, especially after the introduction of the floating exchange rate.