Emerging markets’ resource booms and busts, borrowing risk and regime change

Resource booms create real sector and credit expansion in resource-rich countries; however it can also give rise to over-borrowing. If a resource bust hits, the affected economies contract through declining export revenues, and possibly face increased default risk. Thus, both booms and busts can create macroeconomic instability. Using a dynamic growth model, we model regime changes which reveal nonlinear effects of debt on the economy, depending on the level of leveraging. We find a change from stable to unstable dynamics if the external debt to capital ratio rises above a certain threshold. Risk premia are introduced highlighting the state-dependent borrowing costs for the dynamic paths. We study excess debt and over-leveraging as deviations from sustainable ratios. We find country-specific risk premia that are likely associated with booms and busts for the given debt assessment. Our empirical estimates suggest that certain oil-exporting countries are at a heightened risk for debt crises.