Corporate Responses to Currency Depreciations: Evidence from Indonesia
ABSTRACT 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.
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ABSTRACT: This paper examines how 12 "major depreciations" between 1997 and 2000 affected different measures of firm performance in a sample of over 13,500 companies from around the world. Results suggest that in the year after depreciations, firms have significantly higher growth in market capitalization, but significantly lower growth in net income (when measured in local currency). Firms with greater foreign sales exposure have significantly better performance after depreciations, according to a range of indicators. Firms with higher debt ratios tend to have lower net income growth, but there is no robust relationship between debt exposure and the other performance variables. Larger firms frequently have worse performance than smaller firms, although the significance and robustness of this result fluctuates across specifications. Copyright 2002, International Monetary FundNational Bureau of Economic Research, Inc, NBER Working Papers. 01/2004;
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.