IDEAS home Printed from https://ideas.repec.org/p/gii/giihei/heidwp09-2020.html
   My bibliography  Save this paper

Local Currency Denominated Sovereign Loans - A Portfolio Approach to Tackle Moral Hazard and Provide Insurance

Author

Abstract

This paper studies how the currency composition of public debt affects debt sustainability in developing countries. We show empirically that the debt-to-GDP ratio tends to grow at a faster rate when countries with a high share of foreign currency debt face a currency depreciation. The paper also discusses the moral hazard problems associated with the presence of domestic currency debt and shows that, for the average country, there is no evidence of a positive correlation between local currency borrowing and inflation. However, moral hazard is a concern for countries with weak institutions where we find that a large share of domestic currency debt is associated with higher inflation. The paper also develops a stylized model that emphasizes the complementarities between foreign and local currency borrowing and highlights that they are complements rather than substitutes. The key intuition is that, while foreign currency debt reduces the incentives to debt monetization, local currency improves debt sustainability by providing a better hedge against external shocks. The paper concludes that the policy framework should consider encouraging a mix of foreign and domestic currency borrowing. This is likely to be particularly useful for low-income countries that are jointly characterized by weak institutions (hence, the importance of the commitment device associated with foreign currency debt) and large external shocks (hence, the importance of the insurance element associated with the presence of domestic debt).

Suggested Citation

  • Ugo Panizza & Filippo Taddei, 2020. "Local Currency Denominated Sovereign Loans - A Portfolio Approach to Tackle Moral Hazard and Provide Insurance," IHEID Working Papers 09-2020, Economics Section, The Graduate Institute of International Studies.
  • Handle: RePEc:gii:giihei:heidwp09-2020
    as

    Download full text from publisher

    File URL: http://repec.graduateinstitute.ch/pdfs/Working_papers/HEIDWP09-2020.pdf
    Download Restriction: no
    ---><---

    More about this item

    Keywords

    Sovereign debt; Currency mismatches; Fiscal sustainability; Developing Countries;
    All these keywords.

    JEL classification:

    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • C82 - Mathematical and Quantitative Methods - - Data Collection and Data Estimation Methodology; Computer Programs - - - Methodology for Collecting, Estimating, and Organizing Macroeconomic Data; Data Access

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:gii:giihei:heidwp09-2020. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dorina Dobre). General contact details of provider: http://edirc.repec.org/data/ieheich.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.