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What Makes Balance Sheet Effects Detrimental For The Country Risk Premium?

  • ALICIA GARCIA HERRERO

    (BANCO DE ESPAÑA)

  • JUAN CARLOS BERGANZA

    (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 depreciation. 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://econwpa.repec.org/eps/if/papers/0408/0408002.pdf
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Paper provided by EconWPA in its series International Finance with number 0408002.

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Length: 32 pages
Date of creation: 06 Aug 2004
Date of revision:
Handle: RePEc:wpa:wuwpif:0408002
Note: Type of Document - pdf; pages: 32
Contact details of provider: Web page: http://econwpa.repec.org

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  12. 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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