Corporate Responses to Currency Depreciations:
Evidence from Indonesia1
School of Business, Atma Jaya Catholic University, Jakarta
This paper examines the impact of macro fluctuation on firm’s balance sheet to
understand firm’s net worth as well as the corporate distress probability. We argue that
debt policies could be pro-cyclical, since it enhances corporate distress risk when
currency depreciation comes.
Key words: currency depreciation, firm performance, debt ratio
JEL Classification: D21, F3, G32
1 We thanks to Professor Alain Sand for his valuable comment. Also discussants and participants of the
conferences in Hamburg and Barcelona. We thank also to French Embassy for giving an opportunity to stay in
French during 3 years. All remaining error is mine.
Several studies, both empirical and theoretical, have been mobilized to understand
what happened in the 1997 Asian crisis. Some studies accentuate on the macroeconomic
weaknesses, for instance, by linking speedy financial liberalization and unsound regulation or
supervision on banking and financial institutions. However, it is irresponsible to blame macro
economic variables as a single factor provoking financial turbulence.
Meanwhile, some strands of studies focus on micro side of the story of crises. In these
strands, corporate sector vulnerabilities, indicated by weak performance and high leverage
accompanied by the poor governance system have frequently been cited as main sources of
Asian crisis. In hindsight, Claessens, Djankov and Xu (2000) explain that it has become
apparent that the corporate financial structure of many companies was too weak to withstand
the combined shocks of increased interest rates, devalued currencies, and sharp declines in
domestic demand. Corporate financing policies and performance in response to external
shocks such as falls in aggregate demand and increases in interest rate pay a major attention in
understanding how crisis devastated countries in East-Asian region or other regions, such as
Latin American countries.
This chapter intends to investigate empirically the corporate responses to the currency
crises in Southeast Asian countries by focusing on the case of Indonesia. Theoretical and
empirical works, for example Aguiar (2004), show that basically currency depreciation could
affect firm sector by two principal channels, namely competitiveness effect and net worth or
balance sheet effect. In some cases, depreciation gives a competitive effect when it is
followed by a surge in export performance and improvement in economic growth. While, in
other cases the depreciation were followed by a decline in production activities, including
tradable or exportable firms, which is accompanied by severe recession. The latter case is
mostly due to the financing constraints of the corporate sector to pursue their investment
The objective of the chapter is twofold, firstly it engages in the impact of
“extraordinary” currency depreciation on the firm sector in Indonesia, and second, it is
concerned with the impact of debt-equity ratio of the firms on their firm value, due to
currency depreciation. Subsequently, this chapter also examines the factors inducing the
likelihood of corporate distress. Basically, this chapter argues that firms with higher debt-
equity ratio will have lower profitability when currency depreciation is present. This study
employs econometrical analysis of panel data for 238 firms listed in Jakarta Stock Exchange
(JSX) with 5 consecutive years for the period of 1994 – 2004.
2. Related Studies
2.1. Asian vulnerability
Pomerleano (1998) demonstrates that Indonesia is a country with highest rate of
change in tangible fixed asset where the average between the period of 1992 to 1996 was 33
percent. Thailand is in the second rank with 29 percent average fixed asset growth. The
question is where the main source of this high rate of investment came from. And the answer
is external debt. Average debt-equity ratio to investment is high for Asian countries: Thailand
(78 percent), Korea (69 percent) and Indonesia (67 percent), which means that most
investment in these countries was financed by external debts (Pomerleano, 1998).
Figure 1. Average Change in Tangible Fixed Assets, 1992-96
Source: World Bank staff calculations based on the Financial Times Information’s Extel database; taken
from Pomerleano (1998).
Figure 2. Average Corporate Leverage, 1996
Note: Data are for December 31
Source: World Bank staff calculations based on the Financial Times Information’s Extel
database; taken from Pomerleano (1998).
Unsustainable rapid investment in fixed asset was financed by excessive borrowing.
For comparison, the average ratio is 8 percent in USA and 6 percent in Germany. Latin
American countries, over all, have 19 percent average ratio.
Indonesia is one of the countries with high rate of firm-level profitability. Claessens et
al. (1998) document that the average of Return on Asset (ROA) in local currency of Indonesia
during 1988 – 1996 was 7.1 percent, 9.8 percent in Thailand, and 7.9 in Philippines. For
comparison, ROA in US in the same period was 5.3 percent, and Germany 4.7 percent. If it is
measured by ROA in US currency the average ROA in the same period was higher than ROA
in local currency. 13.0 percent in Indonesia, 17.2 percent in Philippines and 14.7 in Thailand.
Operating margin of the three countries was also high, Indonesia had 32.9 percent of
operating margin, Thailand had 25.2 percent and Philippines had 27.7 percent. For
comparison, operating margin in same period was just 14.4 percent in US and 14.6 in
Germany. The same tendency was in real sales growth.
Meanwhile, Harvey and Roper (1999) describe also that stock exchange in Indonesia,
Malaysia, the Philippines, Taiwan, and Thailand increased their market capitalization by
factors of 10, 5, 12, 2, and 3 respectively. The growth of market capitalization of Asian stock
markets, with the exception of Taiwan ad Korea, exceeded the 270 percent growth rate that
emerging markets as a group posted during the same period. Overall, local Asian stock
markets increased their market capitalization at a faster pace than most developed markets.
To be compared with the combined stock markets in Latin American countries, Asian
stock markets were four times, even though the growth of stock markets in Latin America was
higher than those in Asian countries. Furthermore, Harvey and Roper (1999) also mention
that the increase in market capitalization on the Latin American stock exchanges resulted
primarily from share price appreciation, while on the Asian markets market capitalization in
large part increased through the successful floatation of new equity offerings.
Harvey and Roper (1999) also describe that in the period of 1990 to 1996 equity
markets in Indonesia and Thailand were more aggressive in issuing shares relative to the
larger markets in East Asia.
In Latin America, the ratio of total value of new equity to market capitalization
averages 1.41 percent between 1990 and 1996, while in Asia, the ratio averaged 2.89 percent
during the same period.
Economic value added is commonly used to measure the corporate sector profitability.
EVA is net operating profits after taxes minus the cost of capital, including borrowed capital
and equity capital, used to generate those profits.
Figure 3. Average Economic Value Added, 1992 - 1996
Note: Calculated as return on capital employed minus the lending rate
Source: World Bank staff calculations based on the Financial Times Information’s Extel database; taken
from Pomerleano (1998).
The following table shows the result of Altman’s Z Score2 for several countries. The Z
Score use of multiple discriminant analysis (MDA) is modelled to predict corporate distress.
Pomerleano (1998) in this result of Z Score use the old-fashioned formula. Z-Score statistical
technique use five ratios of the corporate financial statements, namely return on total assets,
2 Edward I. Altman, The Z-Score Bankruptcy Model: Past, Present, and Future (New York: John
Wiley & Sons, 1977, and Corporate Financial Distress and Bankruptcy, 2nd edition (New York: John
Wiley & Sons, 1993.
sales to total assets, equity to debt, working capital to total assets, and retained earnings to
Table 1. Altman’s Z-Score
Source: Pomerleano (1998)
2.2. Currency depreciation
Recent crises in emerging markets have highlighted the role of the corporate sector in
transmitting financial shocks to the macro economy. The central mechanism is relied on the
reciprocal relation between corporate net worth and macro fluctuation such as currency
depreciation. Depreciation devastates corporate balance sheet, and subsequently by net worth
effect of corporate balance sheet, micro sector condition could propagate the mechanism of
crisis. Balance sheet effects basically bear if a firm has far more leverage than its capacity to
repay the debts.
The firm’s balance sheet healthiness is considered as an important factor inducing
economic vulnerability. Dornbusch (2001) mention that there are three primary sources of
vulnerability: a substantially misaligned exchange rate, balance sheet problems in the form of
nonperforming loans, and balance sheet problems in the form of mismatched exposure.
Mismatched exposures contain maturity mismatches leading to liquidity problem and
There is a link between misaligned exchange rate and corporate balance sheet. In this
research, we are concerned with the impact of currency depreciation and corporate balance
sheet. Currency depreciation itself actually is not necessarily a cause of the crisis. There is a
good depreciation and a bad one. Bad depreciation, by definition, is that a rapid real
appreciation, over 2 or 3 years, amounting to 25 percent or more, and an increase in the
current account deficit that exceed 4 percent of GDP, without the prospect of a correction,
takes a country into the red zone (Dornbusch, 2001). Bad depreciation leads to currency crisis.
In general term, currency crisis could be defined as rapid outflows of financial capital
in anticipation of a possible currency depreciation, inducing depletion of reserves, financial
instability and subsequent of economic contraction. More technically, Forbes (2002) includes
countries in a currency crisis if the local currency depreciated by 10 percent or more to US
currency. A currency crisis occurs when market participants lose confidence in the currency
of a particular country and seek to escape assets denominated in that currency. Because
investors try to avoid short-term capital losses, they exit from countries where they expect
that large nominal exchange rate depreciation will soon take place.
Dornbusch (1996) explain that vulnerability means that if something goes wrong, then
suddenly a lot goes wrong. Some researches show the economic vulnerability by providing
data from micro sector.
The relation between corporate balance sheet and currency depreciation is subject to
several studies. Mulder, Perrelli and Rocha (2002) examine the extent to which increased
leverage on corporate balance sheets can exacerbate macroeconomic imbalances and increase
the likelihood of a macroeconomic crisis. They find that corporate balance sheet variables
have a very significant impact on both the likelihood of crisis and its depth. Higher levels of
debt and shorter maturities are associated with higher probability of a macroeconomic crisis.
Meanwhile, Stone (2000) investigates corporate sector dynamics during systemic financial
crises. He documents the extent to which the crises were amplified through the corporate
sector through exchange rate and interest rate effects.
Claessens, Djankov and Nenova (2000) examine corporate risk measures globally and
relate them to a variety of firm-level, institutional and macroeconomic factors. They find that
legal origin, creditor rights and the nature of the financial system all play an important role in
determining the level of risk that a firm is willing to hold. And Claessens, Djankov and
Klapper (1999) studies the extent to which distressed firms exploit bankruptcy in order to
resolve their problems and the factors, both corporate and institutional, that influences the
bankruptcy decision. They find that ownership structure and creditor rights are important
determinants of the use of bankruptcy. Their analysis provides considerable insight into the
nature of bankruptcy in several countries and the conditions under which firms enter into that
process, but they provide little insight into the factors, either within the firm or outside the
firm, that cause firms to become distressed in the first place.
Another strand of studies shown by Allayanis, Brown and Klapper (2003) who are
able to decompose the capital structure of a sample of Asian firms by currency denomination.
As a result, they are able to examine the extent to which firms that had significant foreign
currency denominated exposures performed worse during the crisis than other firms.
Interesting, they find that firms with higher foreign exchange exposure were also more likely
to have foreign currency denominated revenues, allowing them to perform reasonably well
during the crisis. They also examine the ratio of cash flow to interest expense in their analysis
and find that use of foreign currency denominated debt did not result in additional distress for
2.3. Net-worth effect
Before Asian crisis in 1997 (and Mexican and Latin American countries in 1995), little
attention was paid to the analysis of the relation between corporate balance sheets and macro
economic condition. The fashionable financial crisis in 1990s disclosed corporate sector
contribution on the macro economic fragility.
The recent literatures based on the third generation models of crisis pay more attention
on the negative net worth effect of the currency depreciation on economies. According to this
approach, two sources of financial fragility are the currency mismatch and maturity mismatch,
in firm and country-level. It means therefore that financing policies or capital structure of the
firms contribute significantly on the macro economic fragility.
Traditional literature explains that depreciation should enhance competitiveness of the
countries, since the price of goods for the concerned countries would be cheaper than those
countries of competitors. Nevertheless, since most of firms (and economy) are indebted on
foreign denominated debt and short-term maturity debt, depreciation decreases net worth of
the firms (and economy).
In many previous researches, it is found that the impacts of currency depreciation are
mixed among different types of firms, industries and countries. Forbes (2002) differentiates
several channels by which currency depreciations affect firm performance. First, depreciation
could downgrade firm competitiveness since the cost of imported inputs raises relatively to
foreign competitors. Second, depreciation may provide exporters with a relative cost
advantage relative to foreign competitors. Third, depreciation could generate higher
borrowing costs and a contraction in lending. The impact of currency depreciation should be
based on the heterogeneity of the firms.
In macro-level analysis, Kruger and Tornell (1999) provide empirical evidence that
currency depreciation give different competitiveness effect on the different sector of economy.
Calvo and Reinhart (2000) differentiate the impact of crisis on separate characteristic of
countries, namely developed countries and emerging countries. They find that currency crises
in emerging countries are more likely to have large contraction effects.
Forbes (2002) pioneered another strand of research by linking directly currency
depreciation and firm performance. She finds that firms with greater foreign sales exposure
have significantly better performance after depreciations and firms with higher debt-equity
ratios tend to have lower net income growth. Desai, Foley and Forbes (2004) find different
responses between U.S. multinational affiliates and local firms when depreciation is present.
U.S. multinational affiliates have higher sales, assets and investment than local firms during,
and subsequent to, currency crisis.
3. Data and Methodology
This chapter begins with the analysis of the financial ratio of listed companies by
using accounting data provided by Jakarta Stock Exchange (JSX) and Indonesian Capital
Market Directory published by ECFIN (Institute for Economic and Finance Research) in
The accounting data covers the period of 1994-2004. We include all non-financial
sectors and exclude the financial sector, since the debt structure of banks and investment
institutions is not comparable with other sectors. All variables of data are deflated by
wholesale price index (WPI) in 2000 for gaining a current value. This chapter includes 238
listed companies with at least 5 consecutives years. For ownership structure, we access
directly to the annual report of the firms documented by JSX. In this research, we note
ownership structure in two different periods, namely 1996 for pre-crisis ownership structure
and 2003 for post-crisis ownership structure.
3.2. Simple Models
For capturing the general impact of currency depreciation on firm’s net worth, we
employ equation as written in equation (1). This method is used by Forbes (2002), Desai,
Foley and Forbes (2004) on their research for cross-country data. Firstly, we use the existing
method as shown by equation (1). This equation measures the general impact of depreciation
and analyzes by different characteristic of firms, namely sector (tradable versus non-tradable)
and ownership (firm owned by foreign parties versus local parties).
T DeptT DepT Dep MNCDepMNCDep
Equation (2) measures directly the impact of debt-equity ratio to firm value. In this
case, we use longer period to test the interaction with debt-equity ratio. In equation (1), we
just use three years, which are 1996 for pre-crisis period, 1998 for crisis period and 1999 for
post-crisis period. In the equation (2), we use years from 1996 – 2000. The interest is to check
the result of regression in each year during longer period, whether the behaviour changes each
) 1998(4) 1997(3)1996(2
where i is a subscript for each firm, and t for each year. Yit represents corporate net
worth (asset and liabilities). Since the interest of this chapter is to measure the balance sheet
effect of the currency depreciation, we use profitability (proxied by natural logarithm of total
asset and sales) and the change of market capitalization3 in one side, and debt-equity ratio on
the other side.
Dep represents depreciation dummy. The depreciation dummy variables are
respectively set equal 1 for observations from one year before Depreciation (t-1), the year of
Depreciation (t) and one year after Depreciation (t+1). In this study, we include a macro
variable for controlling the estimation, namely inflation rate4. DER is debt-equity ratio, which
represents the level of debt.
This chapter has three main goals. First, it intends to understand the different response
to the currency depreciation among firms with different characteristics, such as tradable
versus non-tradable sector and the degree of foreign ownership participation. Second, this
study wants to understand the impact of the using debt in their firm-value. And third, it is also
concerned with the impact of debt-equity ratio to the corporate distress probability due to
For equation (1), we define depreciation period as 1998, instead of 1997, because we
assume that the impact of depreciation on the firms would be evident in the end of 1998 (not
1997). Meanwhile, 1996 is defined as a pre-crisis period. And post-crisis period is defined as
1999, since the fluctuation of exchange rate started to be stable. Meanwhile, for equation (2),
we consider longer period in examining the different impact of currency depreciation on firm
value. In the equation (2), we employ each year from 1996 to 2000.
3 Change of market capitalization are calculated by equation as follows:
4 Measured by
, where WPI is wholesales price index
For examining the general effects of currency depreciation, we use equation (1),
whereas to test the role of debt on firm value we use equation (2). For equation (2), Our
specific question is whether firms with higher debt-equity ratio will have less firm value,
measured by market capitalization growth and firm profitability, following currency
depreciation. The findings of this study are expected to be interesting in micro-level as well as
The relation between currency depreciation, firm net worth and corporate distress is
described as following figure. In the first step, currency depreciation would affect separately
firm value (asset) and debt-equity ratio (liabilities). The impact of currency depreciation on
firm value is examined by equation by equation (1). And then, debt-equity ration would
induce the firm value, due to currency depreciation (equation 2). Afterwards, firm value and
debt-equity ratio – as firm net worth—influence directly the probability of corporate distress.
The latter issue is addressed by equation (3).
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Figure 4. Currency Depreciation, Firm Net-worth and Distress
Note: dashed line is feedback effect, dashed-dot line represents the firm net worth
3.3. Probability model
For verifying the findings of the previous regression, especially the results from
equation (2), we employ probit and logit model for the likelihood of financial distress. This
chapter employs the conventional method of a discrete regression model to analyze the
determinants of financial distress.
The likelihood of financial distress is modelled as follows.
μ β +=
if yi >0, i.e. firm i is financial distress