Operational currency mismatch

Abstract

This paper looks at the determinants and effects of exchange rate exposure using data on 500 Indian firms over the period 1995-2011. Unlike the existing papers in the literature, we use a measure of 'operational' currency exposure based on foreign currency revenues and costs of firms. Among other factors, exchange rate volatility appears as a significant determinant of average firm level exposure with the direction of relationship supporting the presence of 'Moral Hazard' in firm’s risk taking behavior. Further large 'operational' exposure is associated with significantly lower output growth, profitability and capital expenditure during episodes of large currency depreciation at the firm level. Together this indicates that the policy makers must take into account the incentive effects of their intervention in foreign exchange markets.