Corporate investment and the exchange rate: The financial channel

Currency depreciation dampens corporate investment through a financial channel. Using firm-level data for 16 major economies, we find that depreciation reduces investment by interacting with firm leverage. The finding is consistent with predictions from a stylized model of credit risk in which the exchange rate affects credit supply and investment when firms borrow in foreign currency, or in local currency from foreign lenders. Empirically, the channel is significantly more pronounced in emerging market economies (EMEs), reflecting greater dependence on foreign funding and less developed financial systems. Our findings suggest that the depreciation of EME currencies since 2011 probably contributed in a significant way to the investment slowdown in these economies.