The role of inflation targeting in international debt denomination in developing countries

This paper analyzes the inflation targeting experience of developing countries as an effective monetary policy framework to promote changes in the currency composition of their international debt. Using matching with difference-in-differences to address the self-selection bias, we find that inflation targeting has led to a 3–6 percentage point reduction in the foreign currency share of international debt in targeting countries when compared to non-targeting countries, with the effect especially pronounced for sovereign international debt. Differentiating by type of owner, we find a reduction of the foreign currency share in foreign-held total sovereign debt but no effect on domestic-held debt. Furthermore, from the analysis of the US dollar and euro shares, we find that inflation targeting has contributed to a 9 percentage points lower dollar share in international debt in targeting countries compared to non-targeting countries, while the effect on the euro share is negligible. This not only provides evidence that the structural features of international financial markets matter, but also that monetary policy can help developing countries reduce their reliance on foreign currency debt, especially if it is held by foreign investors.