Capital Inflows, Sovereign Debt and Bank Lending: Micro-Evidence from an Emerging Market

This paper uses a natural experiment to show that government access to foreign credit increases private access to credit. I identify a sudden, and unanticipated increase in capital inflows to the sovereign debt market in Colombia, due to a rebalancing in a government bond index by J.P. Morgan. I find that market makers banks in the treasury market reduced their sovereign debt by 7.8 percentage points of assets and increased their credit availability by 4.2 percentage points of assets. Using industry level data, I show that a higher exposure to market makers led to a higher growth in economic activity. Received August 17, 2017; editorial decision January 25, 2018 by Editor Philip Strahan. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.