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Does sovereign risk in local and foreign currency differ?

Author

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  • Marlene Amstad
  • Frank Packer
  • Jimmy Shek
Abstract
Historically, sovereign debt in local currency has been considered safer than debt in foreign currency. Yet the literature offers scant theoretical or empirical guidance as to why such a gap exists, or why it appears to have slowly and steadily diminished for all regions over the past two decades, as expressed in the ratings widely used by global investors and regulators to assess credit risk. We suggest and empirically test five hypotheses. We find that differences in inflation do not explain the assessed gaps between local and foreign currency credit risk. The banking sector's vulnerability to sovereign debt problems is a significant determinant of the spread, but does not account for its decline over time. Instead, the surge in global reserves, and to lesser extent the reduced reliance on overseas foreign currency borrowing (ie the decline of original sin), as well as lower global volatility, appear to have lessened the gap. But if these variables were to go into reverse, the gap could again widen.

Suggested Citation

  • Marlene Amstad & Frank Packer & Jimmy Shek, 2018. "Does sovereign risk in local and foreign currency differ?," BIS Working Papers 709, Bank for International Settlements.
    • Handle: RePEc:bis:biswps:709
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    References listed on IDEAS

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    Cited by:

    1. Aizenman, J. & Jinjarak, Y. & Park, D. & Zheng, H., 2021. "Good-bye original sin, hello risk on-off, financial fragility, and crises?," Journal of International Money and Finance, Elsevier, vol. 117(C).
    2. Wang,Dieter, 2021. "Natural Capital and Sovereign Bonds," Policy Research Working Paper Series 9606, The World Bank.
    3. Bossone, Biagio, 2024. "A Modigliani-Miller theorem for the public finances of globalized economies," International Review of Financial Analysis, Elsevier, vol. 94(C).
    4. Dimic, Nebojsa & Piljak, Vanja & Swinkels, Laurens & Vulanovic, Milos, 2021. "The structure and degree of dependence in government bond markets," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 74(C).
    5. Hideaki Matsuoka, 2022. "Debt Intolerance: Threshold Level and Composition," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 84(4), pages 894-932, August.
    6. Francesco Manaresi & Nicola Pierri, 2018. "Credit supply and productivity growth," BIS Working Papers 711, Bank for International Settlements.
    7. Vojtěch Siuda & Milan Szabo, 2021. "Measuring Sovereign Credit Risk of the EU countries," Journal of Central Banking Theory and Practice, Central bank of Montenegro, vol. 10(3), pages 169-192.
    8. Claudio Borio & Juan Contreras & Fabrizio Zampolli, 2020. "Assessing the fiscal implications of banking crises," BIS Working Papers 893, Bank for International Settlements.
    9. Angela Ifeanyi Ujunwa & Augustine Ujunwa & Emmanuel Onah & Nnenna Georgina Nwonye & Onyedikachi David Chukwunwike, 2021. "Extending the determinants of currency substitution in Nigeria: Any role for financial innovation?," South African Journal of Economics, Economic Society of South Africa, vol. 89(4), pages 590-607, December.
    10. Malin Gardberg, 2022. "Exchange Rate Sensitivity and the Net Foreign Asset Composition," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 54(2-3), pages 569-598, March.
    11. Guilherme Suedekum, 2023. "Local Currency Sovereign Debt Markets, Global Financial Conditions and the Role of Foreign Investors," IHEID Working Papers 19-2023, Economics Section, The Graduate Institute of International Studies.
    12. Zaremba, Adam & Cakici, Nusret & Bianchi, Robert J. & Long, Huaigang, 2023. "Interest rate changes and the cross-section of global equity returns," Journal of Economic Dynamics and Control, Elsevier, vol. 147(C).
    13. Claudio Borio & Marc Farag & Fabrizio Zampolli, 2023. "Tackling the fiscal policy-financial stability nexus," BIS Working Papers 1090, Bank for International Settlements.

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    More about this item

    Keywords

    sovereign risk; local currency debt; foreign currency debt; credit ratings;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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