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Why Do Emerging Economies Borrow in Foreign Currency?

Why Do Emerging Economies Borrow in Foreign Currency?

(p.190) 7 Why Do Emerging Economies Borrow in Foreign Currency?
Other People's Money
Olivier Jeanne
University of Chicago Press

This chapter addresses the following question: Why is it that emerging-market borrowers find it more difficult or less desirable to issue long-term debt denominated in domestic currency? To put it succinctly, the hypothesis proposed in this chapter is that “original sin” is the result of the lack of credibility in domestic monetary policy. Unpredictable monetary policy makes borrowers unsure about the future real value of their domestic-currency debts, and may induce them to dollarize their liabilities. This is so even though foreign currency debt is itself dangerous, especially in the event of a large depreciation. The chapter illustrates this point with a model of a fixed currency peg in which increasing the probability of devaluation induces domestic firms to borrow in foreign currency. Somewhat paradoxically, an increase in the devaluation risk may lead domestic borrowers to take less insurance against this risk.

Keywords:   borrowers, long-term debt, domestic currency, original sin, monetary policy, foreign currency, debt, fixed currency, devaluation

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