International Spillovers and Local Credit Cycles

We study the transmission of global financial uncertainty to an emerging market economy, Turkey, using data on the universe of corporate loan transactions over 2003-2013. International arbitrage implies that a decline in global uncertainty reduces country risk, which narrows the deviation from uncovered interest parity, and pushes capital flows into Turkey, allowing domestic banks to lend to firms at lower interest rates. This leads to a domestic credit expansion since local currency borrowing becomes cheaper. Our estimates explain 43% of observed credit growth, where bank heterogeneity in access to international markets explains 94% of this aggregate impact. We show that collateral- based borrowing constraints do not relax during capital flow surges, while borrowing becomes cheaper for all firms on average. We rule out various alternative mechanisms such as exchange rate appreciation driven balance-sheet effects. Our results highlight a new international spillover mechanism, which we call the "interest rate channel."