IMF Working Papers

In Search of the Origin of Original Sin Dissipation

By Bada Han, Jangyoun Lee, Taehee Oh

January 26, 2024

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Bada Han, Jangyoun Lee, and Taehee Oh. In Search of the Origin of Original Sin Dissipation, (USA: International Monetary Fund, 2024) accessed October 13, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

In this paper, we examine how, contrary to the ‘original sin’ hypothesis, emerging market economies have gained the ability to borrow abroad in their local currency. We empirically analyze the relationship of various economic variables with local currency debt and identify three crucial conditions for the capacity to borrow in local currency: institutional quality, sufficient depth in the domestic bond market, and adequate performance in inflation targeting. While shares in JPMorgan Government Bond Index-Emerging Markets (GBI-EM) index also appear to be influential, the associations with local currency debt is less clear. We conduct a similar empirical analysis on portfolio equity, which represents a safer form of external liability than foreign currency debt, and verify that the depth of the equity market plays a key role in attracting foreign capital to domestic equity markets. Finally, we propose a simple portfolio model based on the inelastic market hypothesis to explain the positive correlation between capital market depth and the dissipation of original sin, which refers to the presence of more external liability in the form of equity or local currency debt. In essence, our analysis suggests that emerging market economies with reasonably strong fundamentals are not necessarily reliant on foreign currency debt.

Subject: Currencies, Currency crises, Currency markets, External debt, Financial crises, Financial markets, Local currency debt, Money, Securities markets

Keywords: Annex C. optimal portfolio, Currencies, Currency crises, Currency markets, Emerging Markets, Equilibrium portfolio determination, Equity original sin dissipation indices, Equity portfolio investment, FX Market liquidity, Global, Growth regression, Local Currency Debt, Original Sin, Securities markets

Publication Details

  • Pages:

    49

  • Volume:

    ---

  • DOI:

    ---

  • Issue:

    ---

  • Series:

    Working Paper No. 2024/018

  • Stock No:

    WPIEA2024018

  • ISBN:

    9798400264634

  • ISSN:

    1018-5941