Trade Credit and Exchange Rate Risk Pass Through

Discussion by Valentina Bruno

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6th IMF Annual Macro-Financial Research Conference - April 3-4, 2024

Synopsis

• Model how exchange rate risk is propagated along value chains
• Financial, not trade channel
• When supplier is unconstrained, no pass through
• When constrained, exchange rate risk pass through along the chain. Suppliers provide less trade credit and ask from more cash in advance
• Empirical analysis supports the theory
• Local currency depreciation is particularly damaging in an economy where most firms are exposed to currency risk

At glance

• The paper falls in the category of those papers I wish I had written

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• Alternative titles:
• Dollars buy you stuff
• Bigger is better
• Give me dollars and I’ll see the world
• Beware of what you read in the textbooks.

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A recap: The proof is in the pudding

Annual growth rate of global manufacturing accounts receivable and nominal broad dollar index

–12

–6

0

6

–30

–15

0

15

07

09

11

19

21

23

%

30

%

12

13 15 17

Accounts receivable, rhs:²

Lhs:

Nominal broad dollar index¹

Median

Range 40th-60th percentiles

¹ Federal Reserve Board trade-weighted nominal dollar index, broad group of major trading partners of the US (“broad”), based on trade in goods and services.

An increase indicates appreciation of the US dollar. Based on a balanced sample of companies from all industries within manufacturing sector globally with quarterly data from Q1 2005 until Q2 2023.

Sources: Federal Reserve Bank of St Louis, FRED; S&P Capital IQ; BIS.

2

19

Correlation = -0.31

Annual growth rate of global manufacturing inventories and nominal broad dollar index

6

–12

–6

0

6

–20

–10

0

10

07

09

11

17

19

21

23

%

20

%

12

13 15

Inventories, rhs:²

Lhs:

Nominal broad dollar index¹

Median

Range 40th-60th percentiles

¹ Federal Reserve Board trade-weighted nominal dollar index, broad group of major trading partners of the US (“broad”), based on trade in goods and services.

An increase indicates appreciation of the US dollar. Based on a balanced sample of companies from all industries within manufacturing sector globally with quarterly data from Q1 2005 until Q2 2023.

Sources: Federal Reserve Bank of St Louis, FRED; S&P Capital IQ; BIS.

2

Correlation = -0.15

Global trade relative to GDP has fluctuated with financial conditions, as measured by the broad dollar index

7

2002 2005

Lhs:

Nominal broad dollar index¹

2008 2011 2014 2017 2020 2023

Rhs:

World goods exports (volume) / GDP (at constant prices)

¹ Federal Reserve Board trade-weighted nominal dollar index, broad group of major trading partners of the US (“broad”), based on trade in goods and services. An increase indicates appreciation of the US dollar.

Sources: Bruno and Shin (2023) “Dollar and exports” Review of Financial Studies;

What I like the most

• It’s all about how binding financial constraints are: Financial channel of exchange rates

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Testable Prediction #2

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• Sellers more vulnerable to exchange rate depreciation extend less trade credit and pass through more exchange rate shocks via account receivables

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• Exchange rate depreciation makes it more costly for the seller to raise FX funding

10

Inventories

(1 period old) (=w)

Inventories

(2 periods old) (=2w)

Inventories

(3 periods old) (=3w)

3w

2w

Assets

Stage 1

Date Date Date

1 2 3

Stage 2

Stage 3

Liabilities

Cash

Receivables Long-term assets

Equity

Payables Long-term liabilities

Funding need grows rapidly – at rate of square of length of GVC.

Short-term debt

w

Theory of supply chains with an “Austrian” theme (Kim and Shin, 2012 and 2023)

Quibbles

• FX exposure: just look at FXL (liability side = credit supply shock), with a greater effect on non exporters
• Referee #2 comment on the structure (empirics -> theory -> empirics). Alternative: Killer chart upfront (with analysis in the Appendix) -> theory -> empirics
• Broad US dollar vs. Bilateral Exchange rate
• Stronger effect in manufacturing countries (e.g., Korea)

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Case of Korean exports: booming in 2021, when the dollar was weak and despite bottlenecks

12

¹ Federal Reserve Board trade-weighted nominal dollar index, broad group of major trading partners of the US (“broad”), based on trade in goods and services. An increase indicates appreciation of the US dollar. ² In current prices.

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Source:

https://www.bis.org/speeches/sp230216.htm

References

• Sustaining Production Chains through Financial Linkages, Se-Jik Kim, Hyun Song Shin, American Economic Review 2012
• Trade Credit and Profitability in Production Networks, Gofman and Wu, Journal of Financial Economics, 2022
• Theory of supply chains: a working capital approach, Se-Jik Kim and Hyun Song Shin, 2023, BIS WP 1070
• Shin (2023) Global value chains under the shadow of Covid https://www.bis.org/speeches/sp230216.htm

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