Carry Trade and Precautionary Saving of Foreign Currency Debt: Evidence from Korean Firms

Substantially increased global corporate debt in the past decade revives macro stability concerns of foreign currency liability in emerging countries. Due to data unavailability, there is limited understanding of how the debt proceeds are used. We empirically study the use of proceeds of debt issuance in different currencies using a rich firm-level dataset from Korea which provides information on the currency denomination of both assets and liabilities of firms. We establish six key empirical findings: 1) Consistent with a carry trade hypothesis, firms that issue foreign currency short-term loans increase local currency liquid assets. 2) Consistent with a precautionary saving hypothesis, firms that issue foreign currency loans, regardless of the maturity of loans, increase foreign currency liquid assets. 3) Consistent with the corporate finance pecking order prediction, firms that issue local currency loans reduce both local and foreign currency liquid assets and lower dividend payouts. 4) Investment decreases with short-term foreign currency debt but increases with other types of debt. 5) Stronger carry trade and precautionary saving behavior are observed when the interest rate differential and exchange rate volatility are high, respectively. 6) Sectors that are financially dependent or export exposed have shown a stronger carry trade and precautionary saving behavior.