From Carry Trades to Trade Credit: Financial Intermediation by Non-Financial Corporations� Hardy & Saffie

Discussion by Valentina Bruno

From the first to the second phase of global liquidity

• First phase of global liquidity (up to 2008 crisis)
• Banking channel
• Procyclical leverage driven by wholesale bank funding as source of finance

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• Second phase of global liquidity (from 2010)
• Shift from banking sector to capital markets
• Focus on market liquidity
• Focus on corporate borrowers, especially EME corporates
• Impact on real economy; what happens in financial markets does not always stay in financial markets

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The 12 trillion-dollar question

Why are many non-US firms so hungry of US dollars? What do they do with it?

Data

• Listed companies on the Mexican Stock Exchange
• Hand collected from financial statements
• Detailed information on of the currency composition of both liabilities and assets
• Capture all sources of FX borrowing (bonds + loans)
• 2005q1 to 2015q2

Empirical Findings

• Firms accumulate short-term peso assets out of their short-term FX borrowing
• Every $1 increase in FX funding, firms increase s-t assets by $0.43 ($0.21 in FX and $0.19 pesos)
• Non-financial firms act as financial intermediaries by extending trade credit
• Currency exposure and trade credit increases with interest rate differentials
• Following depreciation, firms cut investments rather than trade credit

Connecting the dots (1)

• Firms accumulate short-term peso assets out of their short-term FX borrowing
• Every $1 increase in FX funding, firms increase s-t assets by $0.43 ($0.21 in FX and $0.19 pesos)
• Non-financial firms act as financial intermediaries by extending trade credit
• Currency exposure and trade credit increases with interest rate differentials
• Following depreciation, firms cut investments rather than trade credit

The 12 trillion-dollar question: What do non-US firms use US dollar for?�

• Accumulate financial assets

• Including cash and short-term instruments in the domestic currency.
• Corporate version of “Carry Trade”: dollar liabilities, holding short-term assets in local currency, the company as a whole has taken on a currency mismatch
• Carry Trade is a by-product of the real investment by the firm
• Bruno and Shin (2017) “Global dollar credit and carry trades: a firm-level analysis” Review of Financial Studies; Bruno and Shin (2020) “Currency depreciation and EME corporate distress” Management Science
• Felipe and Bryan’s paper

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From Carry Trades to Trade Credit�

Felipe’s paper goes one step further and with high quality data: firms act as financial intermediaries and provide trade credit.

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These findings are novel. Existing literature focuses on bank financing as the main factor [Fisman and Love (JF, 2003); Love, Preve, Sarria-Allende (JFE, 2007)]

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Felipe’s story is that firms are like banks, they borrow cheap and invest at a higher rate

Stronger post 2010 (second phase of liquidity)?

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Connecting the dots (2)

• Firms accumulate short-term peso assets out of their short-term FX borrowing
• Every $1 increase in FX funding, firms increase s-t assets by $0.43 ($0.21 in FX and $0.19 pesos)
• Non-financial firms act as financial intermediaries by extending trade credit
• Currency exposure and trade credit increase with interest rate differentials
• Following depreciation, firms cut investments rather than trade credit

Trade credit, trade finance, and the Covid-19 Crisis, BIS Bulletin #24

Why broad dollar index?

• Consider global lender with diversified portfolio of dollar credits to borrowers around the world
• Some borrowers face currency mismatch
• Dollar depreciation against whole basket implies:
• Reduction in credit risk for individual borrowers
• Reduced tail risk for diversified loan portfolio
• Increased lending capacity
• Payables and receivables are direct measures of value chains.
• Incremental impact of the broad dollar index above and beyond the bilateral peso-dollar exchange rate?
• Bruno and Shin (2020) “Dollar and Exports”

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Link to USA & Canada

Car Sector

Connecting the dots (3)

• Firms accumulate short-term peso assets out of their short-term FX borrowing
• Every $1 increase in FX funding, firms increase s-t assets by $0.43 ($0.21 in FX and $0.19 pesos)
• Non-financial firms act as financial intermediaries by extending trade credit
• Currency exposure and trade credit increases with interest rate differentials
• Following depreciation, firms cut investments rather than trade credit. After the 2008 Mexican peso depreciation firms with higher FX exposure performed poorly, but did not decrease trade credit.

Additional comments

• Oil and gas sector (Pemex)
• Short-term effect (quarterly)? Or second phase of liquidity?
• Love, Preve, Sarria-Arrende (2007) study the effect of the 1994 peso devaluation. Although the provision of trade credit increases right after a crisis, it contracts in the following months and years. Firms that are financially more vulnerable to crises extend less trade credit to their customers.

Additional comments

Bruno, Kim, and Shin (AER P&P 2018)

Conclusions�

1) Key role of US dollar credit for EME non-financial firms

• More liabilities in FX and short-term peso assets when Sharpe ratio of carry trade is high
• Firms act as financial intermediaries

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2) Good or Bad?

• Short-term assets are endogenous
• Need to look at how they are funded from the other side of the balance sheet
• Correlated with FX liabilities as an indicator of vulnerabilities that are building up
• Global trade returns faster than expected (Dollar funding recovered quickly + FED new framework > supply/financial story)

Provocative and important paper, we need more papers like this one in the literature.