Why Do Emerging Economies Borrow in Foreign Currency?

IMF Working Papers, September 1, 2003

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Why Do Emerging Economies Borrow in Foreign Currency?

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Bibliographic details

• Authors: Olivier D Jeanne
• Published: September 1, 2003
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781451858891.001

Summary

• Explores the hypothesis that the dollarization of liabilities in emerging market economies is the result of a lack of monetary credibility.
• Presents a model in which firms choose the currency composition of their debts so as to minimize their probability of default.
• Decreasing monetary credibility can induce firms to dollarize their liabilities, even though this makes them vulnerable to a depreciation of the domestic currency.
• The channel is different from the channel studied in the earlier literature on sovereign debt, and it applies to both private and public debt.
• The paper presents some empirical evidence and discusses policy implications.

Model and Mechanism

• Firms choose currency composition of debt to minimize probability of default.
• Reduced monetary credibility increases the incentive for firms to denominate debt in foreign currency (dollarize liabilities).
• Dollarization lowers default risk under certain monetary credibility scenarios but increases vulnerability to domestic currency depreciation.
• The mechanism described applies to both private and public debt and is distinct from channels in earlier sovereign-debt literature.

Empirical Evidence

• The paper presents some empirical evidence consistent with the model’s hypothesis (details of empirical tests are contained in the full paper).

Policy Implications

• Monetary credibility influences firms’ currency-denomination choices for liabilities.
• Restoring or strengthening monetary credibility can reduce incentives for liability dollarization.
• Implications apply to policy design concerning exchange-rate arrangements, monetary policy credibility, and debt composition for both private and public sectors.

Publication and Metadata

• Author: Olivier D Jeanne
• Date: September 1, 2003
• Series: Working Paper No. 2003/177
• Issue: 177
• Volume: 2003
• Pages: 38
• DOI: https://doi.org/10.5089/9781451858891.001
• Stock No: WPIEA1772003
• ISBN: 9781451858891
• ISSN: 1018-5941
• Subjects: Conventional peg, Currencies, Domestic debt, External debt, Foreign currency debt, Foreign exchange, Labor, Money, Public debt, Self-employment
• Keywords: Conventional peg, Currencies, currency composition, currency peg, debt contract, debt structure, dollar debt, Domestic debt, exchange rate, foreign currency, Foreign currency debt, Liability Dollarization, long-term debt, Monetary Credibility, monetary policy, results from a lack, Self-employment, short-term debt, Southeast Asia, WP

IMF Working Paper: "Why Do Emerging Economies Borrow in Foreign Currency?" by Olivier D Jeanne (Working Paper No. 2003/177, September 1, 2003).

Content in this bundle

• Why Do Emerging Market Economies Borrow in Foreign Currency? - WP/03/177
  • Why Do Emerging Market Economies Borrow in Foreign Currency? - WP/03/177 (Markdown version)
  • Why Do Emerging Market Economies Borrow in Foreign Currency? - WP/03/177 (PDF)