Determinants of Domestic Sovereign Bond Yields: Fiscal Policy and the Sovereign–Bank Nexus in Emerging Market and Developing Economies

Domestic sovereign bonds have become a central source of government financing in Emerging Market and Developing Economies (EMDEs). This paper examines how fiscal policy expectations shape domestic bond yields and how this sensitivity depends on debt structure. A tractable framework grounded in the Fiscal Theory of the Price Level clarifies why fiscal shocks affect domestic, but not external, bond yields, emphasizing the importance of the sovereign–bank nexus, investor composition, and debt maturity profile. Following Laubach (2009)'s approach, a 1 percentage point increase in expected primary deficits results in a persistent increase in 10-year domestic bond yield by about 36 basis points over 2.5 years, whereas external bond spreads are more sensitive to global risk factors. The effect is magnified when domestic banks hold a larger share of sovereign debt, reflecting balance-sheet amplification. The post-pandemic shift toward domestic bank financing therefore suggests a tighter link between fiscal and financial risks, underscoring the importance of credible fiscal frameworks, diversified investor bases, and vigilant supervision to preserve debt sustainability in high-debt EMDEs.