Emerging Markets Interest Rates, International Reserves and Net Foreign Assets

Joseph Bitar and Martin Boileau

Journal of Globalization and Development, 2021, vol. 12, issue 2, 145-180

Abstract: In the context of a managed float regime, we adopt the portfolio balance view to show the effects of the net foreign assets of an economy and its gross international reserves level on interest rate differentials. We argue that the interest rate differential can be explained by three components, where the components are the expected depreciation of the domestic currency, a default risk premium, and a portfolio balance premium. Our theoretical analysis suggests that the interest differential is a convex function of the level of gross international reserves. In particular, the differential and gross reserves are inversely related at low levels of reserves, but positively at higher levels. We evaluate our framework for the case of Lebanon. We find that the differential is inversely related to both net foreign assets and gross international reserves. These findings are then confirmed with data from Indonesia and Mexico.

Keywords: emerging markets; interest rate parity; portfolio balance premium; Lebanon (search for similar items in EconPapers)
JEL-codes: E58 F30 F41 (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1515/jgd-2020-0079

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