Working Paper: NBER ID: w21333
Authors: Carmen M. Reinhart; Miguel Angel Santos
Abstract: Recent work has supported that there is a connection between the level of domestic debt level and sovereign default on external debt. We examine the potential linkages in a case study of Venezuela from 1984 to 2013. This unique example encompasses multiple financial crises, cycles of liberalization and policy reversals, and alternative exchange rate arrangements. This experience reveals a nexus among domestic debt, financial repression, and external vulnerability. Unlike foreign currency-denominated debt, debt in domestic currency may be reduced through financial repression, a tax on bondholders and savers producing negative real interest rates. Using a variety of methodologies, we estimate the magnitude of the tax from financial repression. On average, this financial repression tax (as a share of GDP) is similar to those of OECD economies, in spite of the much higher domestic debt-to-GDP ratios in the latter. However, the financial repression “tax rate” is significantly higher in years of exchange controls and legislated interest rate ceilings. In line with earlier literature on capital controls, our comprehensive measures of capital flight document a link between domestic disequilibrium and a weakening of the net foreign asset position via private capital flight. We suggest these findings are not unique to the Venezuelan case.
Keywords: financial repression; external distress; capital flight; Venezuela; sovereign default
JEL Codes: E4; E5; E58; E6; F31; F36; N26
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financial repression (G28) | domestic debt (H63) |
| domestic debt (H63) | sovereign default on external debt (F34) |
| financial repression (G28) | capital flight (F21) |
| domestic economic instability (F52) | capital flight (F21) |
| financial repression (G28) | negative real interest rates (E43) |
| negative real interest rates (E43) | capital flight (F21) |
| financial repression (G28) | fiscal savings for government (E62) |
| exchange controls and interest rate ceilings (E64) | financial repression tax (F38) |