China: To Float or Not To Float? (E)- ABB Investment in China

Laura  Alfaro; Rafael M. Di Tella; Ingrid  Vogel

Case | HBS Case Collection | March 2006 (Revised November 2006)

China: To Float or Not To Float? (E)- ABB Investment in China

by Laura Alfaro, Rafael M. Di Tella and Ingrid Vogel

Abstract

In July 2005, China revalued its currency by 2.1% and adjusted its exchange rate regime toward a more market-based system. ABB, a global power and automation technologies company based out of Switzerland with operations in China, was among those companies confronted with the challenge of addressing the revaluation of the yuan and the possibility of future appreciation. Provides background on ABB's activities in China as well as incentives provided by Chinese officials for multinational corporations to move inland.

Keywords: Currency Exchange Rate; Investment; Multinational Firms and Management; International Relations; Problems and Challenges; Value Creation; China; Switzerland;

Format: Print

10 pages

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Citation:

Alfaro, Laura, Rafael M. Di Tella, and Ingrid Vogel. "China: To Float or Not To Float? (E)- ABB Investment in China." Harvard Business School Case 706-035, March 2006. (Revised November 2006.)

In the past decade, foreign participation in local-currency bond markets in emerging countries increased dramatically. We revisit sovereign debt sustainability under the assumptions that countries can accumulate reserves and borrow internationally using their own currency. As opposed to traditional sovereign-debt models, asset-valuation effects occasioned by currency fluctuations act to absorb global shocks and render consumption smoother. Countries do not accumulate reserves to be depleted in “bad” times. Instead, issuing domestic debt while accumulating reserves acts as a hedge against external shocks. A quantitative exercise of the Brazilian economy suggests this strategy to be effective for smoothing consumption and reducing the occurrence of default.

The post-Global Financial Crisis period shows a surge in corporate leverage in emerging markets and a number of countries with deteriorated corporate financial fragility indicators (Altman’s Z-score). Firm size plays a critical role in the relationship between leverage, firm fragility, and exchange rate movements in emerging markets. While the relationship between firm leverage and distress scores varies over time, the relationship between firm size and corporate vulnerability is relatively time invariant. All else being equal, large firms in emerging markets are more financially vulnerable and also systemically important. Consistent with the granular origins of aggregate fluctuations in Gabaix (2011), idiosyncratic shocks to the sales growth of large firms are positively and significantly correlated with GDP growth in our emerging markets sample. Relatedly, the negative impact of exchange rate shocks has a more acute impact on the sales growth of the more highly levered large firms.

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China: To Float or Not To Float? (E)- ABB Investment in China

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