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Consumption baskets and currency choice in international borrowing

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  • Bengui, Julien
  • Nguyen, Ha

Abstract

Most emerging markets do not borrow much internationally in their own currency, although doing that has been argued as an attractive insurance mechanism. This phenomenon, commonly labeled"the original sin", has mostly been interpreted as evidence of the countries'inability to borrow in domestic currency from abroad. This paper provides a novel explanation for that phenomenon: not that countries are unable to borrow abroad in their currency, they might not need to do so. In the model, the small prevalence of external borrowing in domestic currency arises as an equilibrium outcome, despite the absence of exogenous frictions or limits on market participation. The equilibrium outcome is driven by the fact that domestic and foreign lenders have differential consumption baskets. In particular, a large part of domestic lenders'consumption basket is denominated in domestic currency whereas all of foreign lenders'is in dollars. A depreciation of domestic currency, which tends to occur in bad times, is therefore less harmful to domestic savers than to foreign investors. This makes domestic lenders require a lower premium than foreign lenders on domestic currency debt. For plausible calibrations, this consumption basket effect can induce foreign investors to pull out of the domestic currency debt market.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 5870.

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Date of creation: 01 Nov 2011
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Handle: RePEc:wbk:wbrwps:5870

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Keywords: Debt Markets; Currencies and Exchange Rates; Economic Theory&Research; Emerging Markets; Labor Policies;

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  1. Ariel Burstein & Martin Eichenbaum & Sergio Rebelo, 2004. "Large Devaluations and the Real Exchange Rate," RCER Working Papers 513, University of Rochester - Center for Economic Research (RCER).
  2. Alan Sutherland & Michael B Devereux, 2007. "Country Portfolio Dynamics," 2007 Meeting Papers, Society for Economic Dynamics 386, Society for Economic Dynamics.
  3. Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Closing Small Open Economy Models," NBER Working Papers 9270, National Bureau of Economic Research, Inc.
  4. Martin Schneider & Aaron Tornell, 2000. "Balance SHeet Effects, Bailout Guarantees and Financial Crises," NBER Working Papers 8060, National Bureau of Economic Research, Inc.
  5. Olivier Jeanne, 2003. "Why Do Emerging Economies Borrow in Foreign Currency?," IMF Working Papers 03/177, International Monetary Fund.
  6. Sanjay K. Chugh, 2005. "Optimal fiscal and monetary policy with sticky wages and sticky prices," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 834, Board of Governors of the Federal Reserve System (U.S.).
  7. Philip R. Lane & Jay C. Shambaugh, 2007. "Financial Exchange Rates and International Currency Exposures," The Institute for International Integration Studies Discussion Paper Series iiisdp229, IIIS.
  8. Tatiana Didier & Roberto Rigobon & Sergio L. Schmukler, 2013. "Unexploited Gains From International Diversification: Patterns Of Portfolio Holdings Around The World," The Review of Economics and Statistics, MIT Press, vol. 95(5), pages 1562-1583, December.
  9. Sebastian Galiani & Eduardo Levy Yeyati & Ernesto Schargrodsky, 2003. "Financial Dollarization and Debt Deflation under a Currency Board," Working Papers 64, Universidad de San Andres, Departamento de Economia, revised Nov 2003.
  10. Ize, Alain & Yeyati, Eduardo Levy, 2003. "Financial dollarization," Journal of International Economics, Elsevier, vol. 59(2), pages 323-347, March.
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