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IAI Actuarial Core Principles · Business Economics · Recent macroeconomic history

Several Asian economies had borrowed abroad in US dollars but earned revenues in domestic currency. When their currencies depreciated sharply in 1997, what was the direct effect on borrowing firms?

Depreciation raised the local-currency cost of servicing dollar-denominated debt, while firms' revenues stayed in domestic currency. This currency mismatch weakened balance sheets, increased defaults and spread distress to banks, deepening the 1997 Asian crisis.

  1. AThe domestic-currency cost of servicing dollar debt rose, damaging balance sheetsCorrect
  2. BThe real value of their dollar debt fell, easing repayment
  3. CTheir export prices in dollars rose automatically, cutting sales
  4. DTheir interest costs fell because domestic rates were cut immediately
  5. Their debt was converted into equity by foreign creditors

Explanation

This is a currency mismatch. If revenue is in rupee-like local currency and debt is in dollars, depreciation raises the local-currency burden of principal and interest, causing losses and defaults. The key distractor, a fall in debt value, has the effect reversed.

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