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Overcoming the Original Sin: Gains from Local Currency External Debt

Ricardo Sabbadini

No 2017_27, Working Papers, Department of Economics from University of São Paulo (FEA-USP)

Abstract: Emerging markets increasingly rely on external debt denominated in local currency. In order to understand if this is a better situation than using US dollar denominated debt, I present a small open economy model with two sectors, and endogenous determination of both default risk and real exchange rate. Using a calibrated version of the model that replicates default frequency and debt level of emerging economies, I compare the two possibilities of debt denomination: local or foreign currency. I find that welfare gains from issuing debt in local currency derive from less frequent defaults, higher sustainable debt levels, and less volatile consumption and real exchange rates. However, even an economy issuing debt in local currency still faces counter-cyclical interest rate spread and real depreciations around default episodes.

Keywords: external debt; sovereign default; debt denomination; real exchange rate. (search for similar items in EconPapers)
JEL-codes: E43 F31 F34 F41 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac, nep-mon and nep-opm
Date: 2017-10-31
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