In Search of the Origin of Original Sin Dissipation

Bada Han, Jangyoun Lee and Taehee Oh

No 2024/018, IMF Working Papers from International Monetary Fund

Abstract: In this paper, we examine how, contrary to the ‘original sin’ hypothesis, emerging market economies have gained the ability to borrow abroad in their local currency. We empirically analyze the relationship of various economic variables with local currency debt and identify three crucial conditions for the capacity to borrow in local currency: institutional quality, sufficient depth in the domestic bond market, and adequate performance in inflation targeting. While shares in JPMorgan Government Bond Index-Emerging Markets (GBI-EM) index also appear to be influential, the associations with local currency debt is less clear. We conduct a similar empirical analysis on portfolio equity, which represents a safer form of external liability than foreign currency debt, and verify that the depth of the equity market plays a key role in attracting foreign capital to domestic equity markets. Finally, we propose a simple portfolio model based on the inelastic market hypothesis to explain the positive correlation between capital market depth and the dissipation of original sin, which refers to the presence of more external liability in the form of equity or local currency debt. In essence, our analysis suggests that emerging market economies with reasonably strong fundamentals are not necessarily reliant on foreign currency debt.

Keywords: Original Sin; Local Currency Debt; Emerging Markets; FX Market liquidity; annex C. optimal portfolio; equity original sin dissipation indices; equity portfolio investment; equilibrium portfolio determination; growth regression; Securities markets; Currency markets; Currencies; Currency crises; Global (search for similar items in EconPapers)
Pages: 49
Date: 2024-01-26
New Economics Papers: this item is included in nep-fdg, nep-ifn and nep-inv
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