Does Sovereign Risk in Local and Foreign Currency Differ?
Frank Packer and
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Frank Packer: Bank for International Settlements, Hong Kong (E-mail: firstname.lastname@example.org)
Jimmy Shek: Bank for International Settlements, Hong Kong (E-mail: email@example.com)
No 18-E-01, IMES Discussion Paper Series from Institute for Monetary and Economic Studies, Bank of Japan
Historically, sovereign debt in local currency has been considered safer than debt in foreign currency. The literature offers scant theoretical or empirical guidance as to why such a gap has existed or why it appears to have slowly and steadily diminished for all regions over the past two decades, as expressed in the credit ratings widely used by global investors and regulators to assess credit risk. We suggest and empirically test five hypotheses. We find the assessed differences between local and foreign currency credit risk to not be driven by changes in inflation. The banking sector fs vulnerability to sovereign debt problems is a significant determinant of the gap, but does not account for the declining spread over time. Instead, the surge in global reserves, and to lesser extent the declining dependence on foreign currency borrowing overseas (decline of original sin), as well as lower global volatility, appear to have diminished the gap. In case of a trend reversal of these variables, there could be a widening of the gap going forward.
Keywords: Sovereign risk; local currency debt; foreign currency debt; credit ratings (search for similar items in EconPapers)
JEL-codes: F31 F33 F34 F41 H63 (search for similar items in EconPapers)
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Working Paper: Does sovereign risk in local and foreign currency differ? (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:ime:imedps:18-e-01
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