Working Paper: NBER ID: w19098
Authors: Laura Alfaro; Fabio Kanczuk
Abstract: In the past decade, foreign participation in local-currency bond markets in emerging countries has increased dramatically. We revisit sovereign debt sustainability under the assumptions that countries can borrow internationally using their own currencies and accumulate reserves. As opposed to traditional sovereign-debt models, asset-valuation effects occasioned by currency fluctuations act to absorb global shocks and smooth consumption. Countries do not accumulate reserves to be depleted in “bad” times. Instead, issuing domestic debt while accumulating reserves acts as a hedge against external shocks. A quantitative exercise of the Brazilian economy suggests this strategy to be effective for smoothing consumption and reducing the occurrence of default.
Keywords: debt redemption; reserve accumulation; emerging markets; sovereign debt sustainability
JEL Codes: F31; F34
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| higher reserves (E51) | improved debt sustainability (H63) |
| joint issuance of domestic-denominated debt + accumulation of reserves (H63) | hedge against external shocks (F31) |
| joint issuance of domestic-denominated debt + accumulation of reserves (H63) | consumption smoothing (D15) |
| joint issuance of domestic-denominated debt + accumulation of reserves (H63) | minimizes default likelihood (C51) |
| initial borrowing of domestic currency debt (F34) | accumulation of reserves (E22) |
| accumulation of reserves (E22) | mitigate adverse effects of external economic fluctuations (F41) |
| asset valuation effects (G32) | absorb global shocks (F69) |
| accumulation of reserves (E22) | better management of debt obligations (H63) |