The Effect of Private Sector FX Indebtedness on Sovereign Risk in Emerging Markets

Year 2023, Volume: 8 Issue: 4, 696 - 728, 30.12.2023

Haydar Anıl Küçükgöde Ahmet Köse

https://doi.org/10.30784/epfad.1310292

Abstract

In this study, the spread of default risk on local currency (LC) sovereign bonds serves as the metric for assessing country risk across 17 emerging nations. Despite traditional theoretical views deeming these bonds risk-free or default-free, recent research indicates that they carry a risk premium and are not priced at risk-free interest rates. The intriguing explanation lies in the cost of printing money. When local companies have excessive FC debt funded by LC assets, then printing money to pay LC debt will trigger an inflationary process, eventually ending up with a collapse in the real economy and LC. Thus, we run a panel VAR model, spanning a period between 2010-2020, where LC sovereign default risk, LC public debt, FC public debt, private sector external debt, and external finance need are included in the main model. Results show that public debt in LC and private external debt are found to be positively associated with LC sovereign spread, in line with the literature. However, the observation that the need for one-year external financing relative to gross reserves has a much stronger effect on the country's risk premium than the total effect of private sector external debt and public debt in local or foreign currency represents an original contribution of this study.

Keywords

Panel VAR, Sovereign Risk, Impulse-Response, External Finance Need, Private Sector External Debt

Gelişmekte Olan Ülkelerde Özel Sektör Döviz Borçluluğunun Ülke Riskine Etkisi

Abstract

Son dönem literatürde, teoride risksiz kabul edilen yerel para cinsinden devlet tahvillerinin bir risk primi ile fiyatlandığı görülmektedir ve bunun sebebi özel sektörün taşıdığı yüksek döviz borcundan dolayı para basarak borç ödemenin maliyetlerini göze alamayıp temerrüdü tercih etme olasılıklarıdır. Bu çalışmada 17 gelişmekte olan ülkenin yerel para cinsinden tahvillerinin temerrüt riski primi ülke riski göstergesi olarak alınarak; 2010-2020 arası dönemde mili gelire oranla kamunun döviz borcu, kamunun yerel para cinsinden borcu, özel sektörün dış borcu ve brüt rezervlere oranla kısa vadeli dış borç, bir yıllık dış finansman ihtiyacı olmak üzere toplam 5 değişkenle beraber panel VAR yöntemi kullanılarak nedensellik analizleri ve etki-tepki fonksiyonları incelenmiştir. Literatürle uyumlu olarak milli gelire oranla özel sektör döviz borçluluğundaki artışların, ülke risk primini arttıcı etkiye sahip olduğu görülmüştür. Brüt rezervlere oranla bir yıl vadeli dış finansman gereksiniminin, ülke risk primi üzerinde özel sektör dış borçluluğu ve yerel veya yabancı para birimi cinsinden kamu borçluluğunun toplam etkisinden çok daha güçlü bir etkiye sahip olduğunun görülmesi, bu çalışmanın özgün katkısı olarak öne çıkmaktadır.

Keywords

Panel VAR, Ülke Riski, Etki-Tepki, Dış Finansman İhtiyacı, Özel Sektör Dış Borcu

References

• Alejandro, D.C.F. (1983). Stories of the 1930s for the 1980s. In P.A. Armella, R. Dornbusch and M. Obstfeld (Eds.), Financial policies and the world capital market: The problem of Latin American countries (pp. 5-40). Chiago: University of Chicago Press.
• Alejandro, D.C.F. (1984). The 1940s in Latin America. In M. Syrquin, L. Taylor and L.E. Westphal (Eds.), The 1940s in Latin America (pp. 341-362). https://doi.org/10.1016/B978-0-12-680060-9.50024-6
• Alfaro, L. and Kanczuk, F. (2009). Optimal reserve management and sovereign debt. Journal of International Economics, 77(1), 23-36. https://doi.org/10.1016/j.jinteco.2008.09.005
• Anderson, T.W. and Hsiao, C. (1982). Formulation and estimation of dynamic models using panel data. Journal of Econometrics, 18(1), 47-82. https://doi.org/10.1016/0304-4076(82)90095-1
• Andrews, D.W.K. and Lu, B. (2001). Consistent model and moment selection procedures for GMM estimation with application to dynamic panel data models. Journal of Econometrics, 101(1), 123-164. https://doi.org/10.1016/S0304-4076(00)00077-4
• Barrios, S., Iversen, P., Lewandowska, M. and Setzer, R. (2009). Determinants of Intra-Euro Area government bond spreads during the financial crisis (European Commission Economic Papers No. 388). Retrieved from https://op.europa.eu/en/publication-detail/-/publication/0ef2315c-6b52-4dd1-b345-9df9ca6ba9c9/language-en
• Beck, R. (2001). Do country fundamentals explain emerging market bond spreads? (CFS Working Paper No. 2001/02). Retrieved from https://www.econstor.eu/bitstream/10419/25374/1/330870505.PDF
• Benetrix, A., Gautam, D., Juvenal, L. and Schmitz, M. (2019). Cross-border currency exposures (IMF Working Papers No. 19/219). https://doi.org/10.5089/9781513522869.001
• Bernoth, K., Von Hagen, J. and Schuknecht, L. (2012). Sovereign risk premiums in the European government bond market. Journal of International Money and Finance, 31(5), 975-995. https://doi.org/10.1016/j.jimonfin.2011.12.006
• Bianchi, J., Hatchondo, J.C. and Martinez, L. (2018). International reserves and rollover risk. American Economic Review, 108(9), 2629-70. https://doi.org/10.1257/aer.20140443
• Bouchet, M.H., Clark, E. and Groslambert, B. (2003). Country risk assessment: A guide to global investment strategy. New York: Wiley.
• Burger, J.D., Sengupta, R., Warnock, F.E. and Warnock, V.C. (2015). US investment in global bonds: As the Fed pushes, some EMEs pull. Economic Policy, 30(84), 729-766. https://doi.org/10.1093/epolic/eiv012
• Damodaran, A. (2020). Equity risk premiums: Determinants, estimation and implications - The 2020 edition (SSRN Working Paper No. 3550293). Retrieved from https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3550293
• Du, W. and Schreger, J. (2016). Local currency sovereign risk. The Journal of Finance, 71(3), 1027-1070. https://doi.org/10.1111/jofi.12389
• Du, W. and Schreger, J. (2022). Sovereign risk, currency risk, and corporate balance sheets. The Review of Financial Studies, 35(10), 4587-4629. https://doi.org/10.1093/rfs/hhac001
• Edwards, S. (1984a). The order of liberalization of the external sector in developing countries (Essays in International Finance No. 156). Retrieved from https://ies.princeton.edu/pdf/E156.pdf
• Edwards, S. (1984b). LDC foreign borrowing and default risk: An empirical investigation, 1976-1980. American Economic Review, 74(4), 726-734. https://doi.org/10.3386/w1172
• Edwards, S. (1986). The pricing of bonds and bank loans in international markets: An empirical analysis of developing countries’ foreign borrowing. European Economic Review, 30(3), 565-589. https://doi.org/10.1016/0014-2921(86)90009-7
• Eichengreen, B. and Hausmann, R. (1999). Exchange rates and financial fragility (NBER Working Paper No. 7418). Retrieved from https://www.nber.org/system/files/working_papers/w7418/w7418.pdf
• Elgin, C. and Uras, B.R. (2013). Public debt, sovereign default risk and shadow economy. Journal of Financial Stability, 9(4), 628-640. https://doi.org/10.1016/j.jfs.2012.09.002
• Favero, C., Pagano, M. and Von Thadden, E.L. (2010). How does liquidity affect government bond yields? Journal of Financial and Quantitative Analysis, 45(1), 107-134. https://doi.org/10.1017/S0022109009990494
• Folkerts-Landau, D. (1985). The changing role of international bank lending in development finance. (International Monetary Fund Staff Papers, 32(2)), 317-363. https://doi.org/10.2307/3866843
• Fouquin, M. and Hugot, J. (2016). Two centuries of bilateral trade and gravity data: 1827-2014 (CEPII Working Paper No. 2016-14). Retrieved from http://www.cepii.fr/PDF_PUB/wp/2016/wp2016-14.pdf
• Hansen, L.P. (1982). Large sample properties of generalized method of moments estimators. Econometrica: Journal of The Econometric Society, 50(4), 1029-1054. https://doi.org/10.2307/1912775
• Hilscher, J. and Nosbusch, Y. (2010). Determinants of sovereign risk: Macroeconomic fundamentals and the pricing of sovereign debt. Review of Finance, 14(2), 235-262. https://doi.org/10.1093/rof/rfq005
• Holtz-Eakin, D., Newey, W. and Rosen, H.S. (1988). Estimating vector autoregressions with panel data. Econometrica: Journal of the Econometric Society, 56(6), 1371-1395. https://doi.org/10.2307/1913103
• Ilzetzki, E., Reinhart, C.M. and Rogoff, K.S. (2019). Exchange arrangements entering the twenty-first century: Which anchor will hold? The Quarterly Journal of Economics, 134(2), 599-646. https://doi.org/10.1093/qje/qjy033
• Judson, R.A. and Owen, A.L. (1999). Estimating dynamic panel data models: A guide for macroeconomists. Economics Letters, 65(1), 9-15. https://doi.org/10.1016/S0165-1765(99)00130-5
• Kalemli-Özcan, Ṣ. (2019). US Monetary policy and international risk spillovers (NBER Working Paper Series No. 26297). Retrieved from https://www.nber.org/system/files/working_papers/w26297/w26297.pdf
• Longstaff, F.A., Pan, J., Pedersen, L.H. and Singleton, K.J. (2011). How sovereign is sovereign credit risk? American Economic Journal: Macroeconomics, 3(2), 75-103. https://doi.org/10.1257/mac.3.2.75
• Min, H.G. (1998). Determinants of emerging market bond spread: Do economic fundamentals matter? (World Bank Policy Research Working Paper No. 1899). Retrieved from: https://documents1.worldbank.org/curated/en/281041468764417283/109509322_20041117180532/additional/multi0page.pdf
• Nickell, S. (1981). Biases in dynamic models with fixed effects. Econometrica: Journal of the Econometric Society, 49(6), 1417-1426. https://doi.org/10.2307/1911408
• Obstfeld, M. and Zhou, H. (2022). The global dollar cycle (NBER Working Paper Series No. 31004). Retrieved from https://www.nber.org/system/files/working_papers/w31004/w31004.pdf
• Palić, P., Posedel Šimović, P. and Vizek, M. (2017). The determinants of country risk premium volatility: Evidence from a panel VAR model. Croatian Economic Survey, 19(1), 37-66. https://doi.org/10.15179/ces.19.1.2
• Pan, J. and Singleton, K.J. (2008). Default and recovery implicit in the term structure of sovereign CDS spreads. The Journal of Finance, 63(5), 2345-2384. https://doi.org/10.1111/j.1540-6261.2008.01399.x
• Reinhart, C., Rogoff, K. and Savastano, M. (2003). Debt intolerance (NBER Working Paper Series No. 9908). Retrieved from https://www.nber.org/system/files/working_papers/w9908/w9908.pdf
• Sgherri, S. and Zoli, E. (2009). Euro Area sovereign risk during the crisis (IMF Working Paper No. 09/222). Retrieved from https://www.elibrary.imf.org/view/journals/001/2009/222/001.2009.issue-222-en.xml
• Sims, C.A. (1980). Macroeconomics and reality. Econometrica: Journal of the Econometric Society, 48(1), 1-48. https://doi.org/10.2307/1912017