Exchange Rate Exposure and Firm Performance: Comparing Manufacturing and Service Based Firms in India

Mohapatra, S M and Rath, Badri Narayan (2018) Exchange Rate Exposure and Firm Performance: Comparing Manufacturing and Service Based Firms in India. PhD thesis, Indian Institute of Technology, Hyderabad.

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Abstract

The estimation of exchange rate exposure is a relatively recent area of research in international finance. Exposure represents the sensitivity of the value of the firm to exchange rate fluctuations. One of the first contributions of this field is by Adler and Dumas (1984). Exchange rate fluctuations or movements affect a country‟s economic activity. When a country‟s currency changes (appreciates or depreciates) against the currency of other countries, it influences both export and import oriented firms in the country.India‟s share in total global trade has been increasing substantially after 1991. Despite the global trade, there are some recurrent concerns about the impact of exchange rate movements on trade activities in particular. The overall trade performance of a country depends on the aggregation of exports and imports decision of individual firms. Thus, in order to understand the effect of exchange rate changes on trade activities, it is important to analyze how exchange rate exposure affects the decisions of a wide range of firms‟ performances. Such an analysis provides insights into heterogeneous responses across firms to exchange rate exposure and it relates policy implications of the central bank‟s efforts in managing and stabilizing foreign exchange variations. In this backdrop, this thesis has made an attempt to examine the following objectives. First this study measures the exchange rate exposure Indian manufacturing vis-à-vis service-based firms. Second, the major determinants of the exchange rate exposure are identified for both the manufacturing and service-based firms. Finally, this study examines the impact of exchange rate exposure on firm‟s performance for both the sectors To achieve these objectives, this thesis collected data from secondary sources. Firm level data collected from Prowess database (CMIE), the exchange rate data collected from Reserve Bank of India (RBI) Bulletin. Apart from that output, energy, salaries and wages related deflated data obtained from Office of the Economic Adviser (OEA), the Ministry of Commerce and Industry of India. The capital deflated data obtained from Handbook of statistics on Indian economy, published by RBI. To examine first objective, time series regression model is used to examine the relationship between exchange rate changes and firm‟s stock returns, keeping market return constant. The estimated results indicated that Indian firms are significantly affected by exchange rate changes. Manufacturing sector firms are highly exposed to exchange rate changes than service sector firms. When comparing the exchange rate exposure across the industries, this study found that within the manufacturing sector, machinery, except electrical and electronics industry, is more vulnerable to the exchange rate exposure. The degree of exposure is high in machinery, except electrical and electronics industry, in manufacturing sector. Likewise, in the service sector, the degree of exposure is highest in case of the wholesale and retail trading industry and it is also highly exposed to exchange rate changes. Further, it found that the firms of both sectors are more exposed to the exchange rate changes in the post-crisis period than pre-crisis period. The individual subgroups of firms from both the sectors give a similar picture, that is, firms are more exposed to exchange rate changes in the post-crisis period than the pre-crisis period. Finally, the import-oriented firms are more exposed to the exchange rate than the export-oriented firms. The panel regression model is used to examine the factors which determine the exchange rate exposure of both manufacturing and service sector firms. The results revealed that market to book; export and size are the three major significant factors that determine the exposure for Indian manufacturing as well as service sector firms. Similarly, market to book, size and export variables are found significant in case of export and import oriented firms. Whereas, the study find that debt and asset turnover has no significant effect on exchange rate exposure. Further, this study documented that there is a positive association between exchange rate exposure with the market to book and export. A negative relationship existed between the size with a level of exchange rate exposure of firms. In the third objective, exchange rate exposure and firm performance in terms of productivity is analyzed. Using Instrumental Variable Panel Regression Model the result revealed that appreciation of exchange rate exposure has an unfavorable impact on productivity. It also showed that there existed a positive relation between productivity and export and also between productivity and foreign. Discussing the relation between productivity and size, this study found a negative relation between them. This study also explored that firm performance is affected more by the exchange rate exposure in post-crisis than pre-crisis periods. Import oriented firms are more performed than export oriented firms. The overall findings of the study strongly recommends the policy makers to minimize the exchange rate fluctuation, which directly affecting the firm‟s business and firm valuation and for promoting export and import policies in India. India‟s experience of slowdown of export and increasing dependence on import clearly shows that export markets have not served as a significant competitive pressure on domestic firms to invest and improve their technological capabilities and productivity. It also suggests the policy makers to concentrate on those factors which minimize the risk for exposure. Finally, it suggests increasing the volume of production by targeting the domestic markets or engaging in hedging activities.

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