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, unanticipated, and ar- guably exogenous increase in capital inflows to the sovereign debt market in Colombia. This was due to J.P. Morgan’s inclusion of Colombian bonds into its emerging markets local currency government debt index, which led to an increase in the share of sovereign debt held by foreigners from 8.5 to 19 percent. This event had significant and hetero- geneous effects on Colombia’s commercial banks: banks that acted as market makers in the treasury market reduced their sovereign debt holdings by 7.8 percentage points of assets and increased their commercial credit availability by 4.2 percentage points of assets compared to the rest of the banks. The differential increase in credit was around 2 percent of GDP. Industry level evidence suggests that this had positive ef- fects on the real economy. A higher exposure to market makers led to a higher growth in employment, production, sales and GDP.