Summary:
According to the China Financial Stability Report (2024) released by the People's Bank of China, the corporate sector leverage ratio reached 168.0% at the end of 2023, an increase of 6.1 percentage points from the end of 2022, accounting for 52% of the total rise in the macro leverage ratio. The report suggests that the structure of corporate sector leverage has been improving, contributing positively to the ongoing economic recovery. As China's economic conditions have evolved, the understanding of leverage-related issues has also shifted. While the Central Economic Work Conference in 2015 emphasized “deleveraging”, it was later recognized that excessive deleveraging could trigger balance sheet recession risks and unfavorable for economic growth. In 2019, the Central Economic Work Conference proposed the goal of “maintaining economic performance within a reasonable range and keeping the macro leverage ratio basically stable”, marking a policy shift toward balancing “leverage stability” and “growth stability” as dual objectives. Currently, with China's economy showing steady and positive momentum, maintaining relatively stable or moderately rising corporate leverage may help sustain recovery and growth. Since the reform of China's exchange rate regime in July 2005, fluctuations in the RMB exchange rate have had a significant impact on the leverage of manufacturing enterprises. During the general appreciation of the RMB's real effective exchange rate, the corporate sector's leverage ratio rose from 99.00% in 2006 to 168.00% in 2023, closely tracking the exchange rate trend. This raises a crucial question: is there a causal relationship between RMB exchange rate movements and corporate leverage？ If so, what are the underlying mechanisms？ This paper addresses these questions through both theoretical modeling and empirical analysis. First, it develops a three-stage decision-making model of firms' debt financing under exchange rate change, demonstrating that exchange rate changes affect leverage through three mechanisms: the innovation effect, the cost-saving effect of imported intermediate goods, and the balance sheet effect. Second, using a panel dataset of Chinese listed manufacturing firms from 2007 to 2016, this study merges customs trade data, CSMAR firm-level data, and IMF-IFS macroeconomic data to empirically test the impact of RMB real effective exchange rate fluctuations on firm leverage. The results show that RMB appreciation increases firm leverage through the innovation and balance sheet effects, while it decreases leverage through the cost-saving effect from imported intermediates. Overall, the positive effects of appreciation on leverage outweigh the negative, leading to a net increase in firm leverage. Further analysis by type of intermediate goods reveals that the cost-saving effect of RMB appreciation is more significant for imported parts and components than for primary intermediates. Heterogeneity tests indicate that the leverage-enhancing effect of RMB appreciation is more pronounced among state-owned enterprises and high-tech firms. Compared with existing literature, this paper contributes in several ways. (1) Theoretically, it is the first to build a three-stage decision framework from the perspective of firms' production and R&D decisions, where firms sequentially choose optimal debt levels, R&D investment, and product pricing to maximize profits. (2) Empirically, this study identifies that the RMB appreciation influences firm leverage through three mechanisms: innovation effects(positive), balance sheet effects (positive), and the cost-saving effects of imported intermediate goods (negative). The policy implications of this paper are as follows: First, in light of China's steady economic recovery and the likely future trend of a “stable-to-strong” RMB, moderate increases in firm leverage may be tolerated. It is recommended that policymakers actively support corporate innovation by facilitating access to innovation financing under controllable risk. Empirical results indicate that firms tend to enhance innovation to maintain global competitiveness during RMB appreciation, which typically involves higher leverage. Overemphasis on “deleverage” could inadvertently constrain firm financing and growth. Second, optimizing the structure of intermediate goods imports—especially by increasing imports of parts and components—could help reduce manufacturing firms' leverage. Results demonstrate that firms can effectively reduce the cost of imports, and hence leverage, by importing intermediate goods when the local currency appreciates. While the cost-saving effect of imported intermediates is generally smaller, the growing role of Chinese firms in global production networks means that importing technologically advanced components can yield greater financial benefits under a stronger RMB. Looking forward, the logic won't change that strong economy is accompanied with strong currency. With the future trend of a “stable-to-strong” RMB, firms could make full use of the cost advantage of importing intermediates, increase imports of intermediate goods and optimize the structure of imported intermediate goods will, to some extent, help to reduce corporate leverage. Third, as China's trade continues to expand, improving the debt financing environment for manufacturing firms is essential to help them adapt to the future trend of a “stable-to-strong” RMB. Heterogeneity analysis reveals that the leverage-enhancing effect of RMB appreciation is more pronounced among state-owned firms and high-tech firms. Moreover, exchange rate appreciation significantly increases both financial leverage and long-term leverage of firms. These findings suggest that the innovation and balance sheet effects induced by RMB appreciation tend to increase firms' demand for external financing. In response, policymakers should take the opportunity to optimize the financial supply system, enhance the accessibility and inclusiveness of financial services, and foster a favorable debt financing environment.
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