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Rare disasters, local currency-denominated external debt and sovereign default risk

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  • Cheng, Jiahui
  • Chang, Senfeng

Abstract

This study investigates the impact of rare disaster shocks on sovereign default and the role of local currency-denominated external debt (LCED) in mitigating the effects of disasters. Using panel data of 52 developing countries from 2000 to 2022, we find that rare disaster shocks significantly increase sovereign default risk, while LCED can mitigate the adverse effects of rare disaster shocks. Moreover, the effect is more pronounced in lower-income countries. Mechanism analysis shows that disaster shocks increase sovereign default risk by increasing external debt service and government expenditure, while LCED weakens the mechanism of external debt service. This study provides a theoretical foundation for developing countries to increase the proportion of LCED issuance as a strategic hedge against rare disaster shocks.

Suggested Citation

  • Cheng, Jiahui & Chang, Senfeng, 2025. "Rare disasters, local currency-denominated external debt and sovereign default risk," Economics Letters, Elsevier, vol. 250(C).
    • Handle: RePEc:eee:ecolet:v:250:y:2025:i:c:s0165176525001508
    DOI: 10.1016/j.econlet.2025.112313
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    Keywords

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    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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