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What makes balance sheet effects detrimental for the country risk premium?

  • Juan Carlos Berganza

    ()

    (Banco de España)

  • Alicia García-Herrero

    ()

    (Banco de España)

This paper builds upon the empirical literature on the macroeconomic impact of real exchange rate depreciations for a sample of 27 emerging economies. We find that real exchange rate depreciations tend to increase a country's risk premium. This effect is neither linear nor symmetric: large real exchange depreciations are much more detrimental and real appreciations do not seem to reduce the risk premium. We also show that the main channels for the real exchange rate to affect country risk are external and domestic balance sheet effects, stemming from the sudden increase in the stock of external or domestic dollar denominated debt, respectively. This is particularly the case in the countries with the largest financial imperfections. Competitiveness is not an important enough factor to outweigh this negative effect. Finally, fixed exchange rate regimes tend to amplify balance sheet effects, beyond the extent of real depreciations. The data indicates that it could be due to a larger accumulation of external debt under fixed regimes.

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File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosTrabajo/04/Fic/dt0423e.pdf
File Function: First version, December 2004
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Paper provided by Banco de España & Working Papers Homepage in its series Working Papers with number 0423.

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Length: 33 pages
Date of creation: Dec 2004
Date of revision:
Handle: RePEc:bde:wpaper:0423
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Web page: http://www.bde.es/bde/en/secciones/informes/Publicaciones_se/docs/
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  1. Carmen M. Reinhart & Kenneth S. Rogoff & Miguel A. Savastano, 2003. "Addicted to Dollars," CEMA Working Papers 594, China Economics and Management Academy, Central University of Finance and Economics.
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  13. Galindo, Arturo & Panizza, Ugo & Schiantarelli, Fabio, 2003. "Debt composition and balance sheet effects of currency depreciation: a summary of the micro evidence," Emerging Markets Review, Elsevier, vol. 4(4), pages 330-339, December.
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