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Local Crowding Out in China

Yi HuangMarco PaganoUgo Panizza

Lead Article, Journal of Finance, 2020


Best Paper Award, China International Conference in Finance 2017

In China, local public debt issuance between 2006 and 2013 crowded out investment by private manufacturing firms by tightening their funding constraints, while it did not affect state-owned and foreign firms. Using novel data for local public debt issuance, we establish this result in three ways. First, local public debt is inversely correlated with the city-level investment ratio of domestic private manufacturing firms. Instrumental variable regressions indicate that this link is causal. Second, local public debt has a larger negative effect on investment by private firms in industries more dependent on external funding. Finally, in cities with high government debt, firm-level investment is more sensitive to internal funding, also when this sensitivity is estimated jointly with the firm's likelihood of being credit-constrained. Altogether, these results suggest that the massive public debt issuance associated with the post-2008 fiscal stimulus curtailed private investment thus weakening China's long-term growth prospects.

NBER  CEPR

In Brief: Voxeu, VoxChina

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We show that an increase in aggregate uncertainty—measured by stock market volatility— reduces productivity growth more in industries that depend heavily on external finance. The mechanism at play is that during periods of high uncertainty, firms that are credit con- strained switch the composition of investment by reducing productivity-enhancing invest- ment—such as on ICT capital—which is more subject to liquidity risks (Aghion et al., 2010). The effect is larger during recessions, when financing constraints are more likely to be binding, than during expansions. Our statistical method—a difference-in-difference approach using productivity growth of 25 industries from 18 advanced economies over the period 1985–2010—mitigates concerns with omitted variable bias and reverse causal- ity. The results are robust to the inclusion of other sources of interaction effects, instru- mental variable approaches, and different datasets. The results also hold if economic policy uncertainty (Baker et al., 2016) is used instead of stock market volatility as a mea- sure of aggregate uncertainty.

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Saving China’s Stock Market

Yi Huang, Jianjun MiaoPengfei Wang

IMF Economic Review, 2018

We estimate the value creation for the stocks purchased by the Chinese government between the period starting with the market crash in mid-June and the market recovery in September. We find that the government intervention increased the value of the rescued firms with a net benefit between RMB 2,464 and 3,402 billion, which is about 5% of the Chinese GDP in 2014. The value creation came from the increased stock demand by the government, the reduced default probabilities, and the increased liquidity. The intervention may come at a long-run cost of creating moral hazard, preventing price discovery, creating more uncertainty, and damaging government credibility. 

In Brief: Voxeu

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This paper evaluates the effect of capital controls on the transmission of domestic and international monetary policy shocks (IMP) to an emerging market.  Using detailed regulatory data from Colombia, we test whether a mild form of capital controls that restricts short-term cross-border inflows is able to shield the Colombian economy from monetary policy shocks from the euro area and the United States.  We find that, for the period in which Colombian authorities imposed capital controls (2007:Q2 to 2008:Q4), local monetary policy was more effective in controlling loan rates and loan growth, with some heterogeneity across local and foreign banks.  The effects of IMP shocks on loan conditions tend to be greater for loans granted by foreign banks. We also document some variations across banks depending on their dependence on cross-border lending and analyse potential costs of capital controls.

NBER Conference: Capital Flows, Risks, and Growth, 2020

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We use firm-level data to analyze international bond issuance by Chinese non-financial corporations, distinguishing those by sectors classed as ‘risky’. Dollar issuance is positively correlated with the differential between domestic and foreign interest rates, and this effect is particularly strong for firms in risky sectors. Strikingly, firms in risky sectors use the proceeds to do more interfirm lending than firms in non-risky sectors. Moreover, this lending rose significantly after the authorities sought to restrict the financial activities of risky sectors in 2008-09. Firms in risky sectors compound risk by engaging in speculative activities that mimic the behavior of financial institutions while escaping prudential regulation.

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Using data for advanced and emerging economies, we show that there is a negative correlation between public debt and corporate investment. Industry-level regressions show that high levels of government debt are particularly damaging for industries that need more external financial resources. Firm-level regressions show that government debt increases the sensitivity of corporate investment to cash flow. These results indicate that the relationship between public debt and investment is likely to be causal and that public debt crowds out corporate investment by tightening credit constraints.

CEPR 

In Brief: Voxeu

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Liquidity and Exchange Rate: Theory and Evidence From FX Trading Platforms

Nuno CoimbraWei Cui and Yi Huang

Does liquidity matter in explaining the exchange rate dyanmics? Using daily information of prices and trading volume from Thomson Reuters and the Electronic Broking Services (EBS) between 2000 and 2017, we demonstrate the role of liquidity of major currencies in explaining exchange rate movements. The empirical evidence, ranging from daily, weekly and monthly, elaborates the mechanisms of market liquidity. We then build a two-goods small open economy model with asset liquidity. We show how the transmission mechanism of liquidity shocks on exchange rate and aggregate dynamics can depend on the endogenous liquidity premium. The novel feature is that liquidity shocks also affect the composition of consumption goods because the relative price depends on asset liquidity.

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China’s Offshore Dollar Debt and Corporate Investment

Book chapter in China’s Bond Market in a Global Context, International Monetary Fund Press, 2019

Ding Ding, Yi Huang, Yue Zhou

Offshore bond issuances and redemptions by Chinese nonfinancial corporations have been a major driver of China’s capital flows since 2013. In this paper, we show that the surge of China’s offshore dollar debt resembles the characteristics of carry trade, similar to those in other major emerging market economies. By interacting the sectoral dummies and offshore issuances of dollar bonds, we also find that offshore bond financing has different impacts on corporate investment across sectors, corresponding to the sectors’ reliance on external financing.

JIE Trade networks and firm value_edited_

We study the financial implications of the 2018–2019 U.S.-China trade war for global supply chains. Around the dates when higher tariffs are announced, U.S. firms that depend more on exports to and imports from China experience larger declines in market value, with the negative effect spilling over to the affected firms' suppliers and customers through production networks. The trade war effect is mainly concentrated among U.S. firms that sell to Chinese customers with low R&D intensity or outsource to Chinese differentiated input suppliers. We also exploit the within-firm variation in tariff exposure according to the detailed product lists and conduct a reverse experiment based on the 2019 trade talks. To explain the findings, we propose a theoretical model that highlights how complex trade structures shape shareholder wealth.

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