Effects of foreign currency debt on investment of the firms in emerging economy

In this study, we examine the effect of external commercial borrowings on investment of the firms in the wake of currency depreciation by drawing the firm‐level data from India. Despite steep growth in dollar debt and its critical implications for firms and macroeconomic stability, the issue was not explored before. This article attempt to fills this gap and contribute to the literature on dollar debt and open economy macroeconomics. We estimate the panel regression to quantify the balance sheet and competitiveness effects. We show that currency depreciation does not adversely affect the investment of those firms that borrow in foreign currency. The findings of the study imply that the gradualist approach to liberalization and prudential policy measures laid by regulatory bodies were effective. We also find that firms that incur dollar debt do not possess adequate natural hedge against exchange rate volatility. This finding calls for the mandatory hedging by firms to immune the economy from the contagion effect. The development of offshore derivatives markets is indispensable for such hedging. The findings also call for the availability of easy and cheaper domestic credit to the corporate sector to lessen the over‐reliance on external commercial borrowings.