Consumption Baskets and Currency Choice in International Borrowing

Consumption Baskets and Currency Choice in International Borrowing

Most emerging markets do not borrow much internationally in their own currency, although doing that has been argued as an attractive insurance mechanism. This phenomenon, commonly labeled "the original sin", has mostly been interpreted as evidence of the countries' inability to borrow in domestic currency from abroad. This paper provides a novel explanation for that phenomenon: not that countries are unable to borrow abroad in their currency, they might not need to do so. In the model, the small prevalence of external borrowing in domestic currency arises as an equilibrium outcome, despite the absence of exogenous frictions or limits on market participation. The equilibrium outcome is driven by the fact that domestic and foreign lenders have differential consumption baskets. In particular, a large part of domestic lenders' consumption basket is denominated in domestic currency whereas all of foreign lenders' is in dollars. A depreciation of domestic currency, which tends to occur in bad times, is therefore less harmful to domestic savers than to foreign investors. This makes domestic lenders require a lower premium than foreign lenders on domestic currency debt. For plausible calibrations, this consumption basket effect can induce foreign investors to pull out of the domestic currency debt market.

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Bibliographic Details
Main Authors: Bengui, Julien, Nguyen, Ha
Language:English
Published: 2011-11-01
Subjects:ACCELERATOR, AGGREGATE CONSUMPTION, ASSET POSITION, ASSETS, BAILOUT, BALANCE SHEET, BENCHMARK, BILL, BOND, BOND HOLDERS, BOND MARKET, BOND MARKETS, BOND RETURN, BONDS, BORROWING COUNTRY, BUDGET CONSTRAINT, BUDGET CONSTRAINTS, BUSINESS CYCLE, CAPITAL ACCUMULATION, CAPITAL FLOWS, CASH HOLDINGS, CLAIMANTS, COMPETITIVE MARKET, CONSUMPTION BASKET, CONSUMPTION BASKETS, CONSUMPTION DECLINE, COUNTRY RISK, CREDIT MARKETS, CURRENCY, CURRENCY COMPOSITION, CURRENCY EXPOSURES, CURRENT ACCOUNT, CURRENT ACCOUNT IMBALANCES, DEBT, DEBT DENOMINATION, DEBT MARKET, DEPRECIATION, DEVALUATIONS, DEVELOPING COUNTRIES, DEVELOPING COUNTRY, DEVELOPMENT POLICY, DOLLAR BOND, DOLLAR BONDS, DOLLAR DEBT, DOLLAR PRICE, DOMESTIC CREDIT, DOMESTIC CURRENCIES, DOMESTIC CURRENCY, DOMESTIC ECONOMY, DOMESTIC MARKET, DOMESTIC MONETARY POLICY, DOMESTIC WORKERS, ECONOMIC CONDITIONS, ECONOMIC RESEARCH, ELASTICITY, ELASTICITY OF SUBSTITUTION, EMERGING ECONOMIES, EMERGING MARKET, EMERGING MARKET ECONOMIES, EMERGING MARKETS, EMPLOYMENT, EQUATIONS, EQUILIBRIUM, EQUILIBRIUM CONDITIONS, EXCESS RETURN, EXCHANGE RATE, EXCHANGE RATES, EXOGENOUS RATE, EXPENDITURES, EXTERNAL BORROWING, EXTERNAL DEBT, EXTERNALITIES, EXTERNALITY, FINANCIAL CRISES, FINANCIAL EXCHANGE, FINANCIAL FRAGILITY, FINANCIAL INSTABILITY, FOREIGN CURRENCY, FOREIGN DEBT, FOREIGN INCOME, FOREIGN INVESTOR, FOREIGN INVESTORS, FOREIGN LENDERS, FOREIGN MARKETS, GDP, HEDGES, HOLDING, HOLDINGS, IMPLICIT CONTRACT, IMPLICIT CONTRACTS, IMPORTS, INCOME SHOCKS, INCOMPLETE MARKETS, INFLATION, INSTRUMENT, INSURANCE, INSURER, INTEREST RATE, INTERNATIONAL BANK, INTERNATIONAL BORROWING, INTERNATIONAL CAPITAL, INTERNATIONAL CAPITAL FLOWS, INTERNATIONAL CURRENCY, INTERNATIONAL DEBT, INTERNATIONAL DEBT MARKETS, INTERNATIONAL DIVERSIFICATION, INTERNATIONAL ECONOMICS, INTERNATIONAL FINANCE, INTERNATIONAL PRICE, LABOR DEMAND, LABOR MARKET, LABOR SUPPLY, LACK OF CREDIBILITY, LEVY, LOAN, LOAN MARKET, LOCAL CURRENCIES, LOCAL CURRENCY, MACROECONOMICS, MARKET STRUCTURES, MIDDLE INCOME COUNTRIES, MONETARY POLICY, MONEY HOLDING, MONEY HOLDINGS, MONEY SUPPLY, MORAL HAZARD, MUTUAL FUNDS, NEGATIVE SHOCK, NOMINAL WAGE, OPEN ECONOMY, POLITICAL ECONOMY, PORTFOLIO, PORTFOLIO CHOICE, PORTFOLIO CHOICES, PORTFOLIO HOLDINGS, PORTFOLIOS, PRIVATE CREDIT, PRODUCTION FUNCTION, PRODUCTION FUNCTIONS, PRODUCTION STRUCTURE, PRODUCTIVITY, RANDOM VARIABLES, REAL EXCHANGE RATE, REAL SHOCK, REAL SHOCKS, REAL WAGES, REPAYMENTS, RETURN, RISK AVERSE, RISK PREMIUM, RISK SHARING, SHARE OF CAPITAL, SMALL COUNTRIES, SMALL COUNTRY, SMALL ECONOMY, SOCIAL RISKS, SOURCE OF UNCERTAINTY, STANDARD DEVIATION, STANDARD DEVIATIONS, STEADY STATE, STEADY STATE LEVEL, STICKY PRICES, STICKY WAGES, SUPPLIERS, SUPPLY SHOCK, TOTAL OUTPUT, TRADABLE GOOD, TRADABLE GOODS, UTILITY FUNCTION, VOLATILITIES, VOLATILITY, WAGES, WEALTH, WORLD DEVELOPMENT INDICATORS, WORLD INTEREST RATE,
Online Access:http://www-wds.worldbank.org/external/default/main?menuPK=64187510&pagePK=64193027&piPK=64187937&theSitePK=523679&menuPK=64187510&searchMenuPK=64187283&siteName=WDS&entityID=000158349_20111103142914
https://hdl.handle.net/10986/3636
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Summary:Most emerging markets do not borrow much internationally in their own currency, although doing that has been argued as an attractive insurance mechanism. This phenomenon, commonly labeled "the original sin", has mostly been interpreted as evidence of the countries' inability to borrow in domestic currency from abroad. This paper provides a novel explanation for that phenomenon: not that countries are unable to borrow abroad in their currency, they might not need to do so. In the model, the small prevalence of external borrowing in domestic currency arises as an equilibrium outcome, despite the absence of exogenous frictions or limits on market participation. The equilibrium outcome is driven by the fact that domestic and foreign lenders have differential consumption baskets. In particular, a large part of domestic lenders' consumption basket is denominated in domestic currency whereas all of foreign lenders' is in dollars. A depreciation of domestic currency, which tends to occur in bad times, is therefore less harmful to domestic savers than to foreign investors. This makes domestic lenders require a lower premium than foreign lenders on domestic currency debt. For plausible calibrations, this consumption basket effect can induce foreign investors to pull out of the domestic currency debt market.

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