IMF Working Papers

Sovereign Defaults, External Debt, and Real Exchange Rate Dynamics

Author/Editor:

Tamon Asonuma

Publication Date:

February 25, 2016

Electronic Access:

Free Download. Use the free Adobe Acrobat Reader to view this PDF file

Summary:

Emerging countries experience real exchange rate depreciations around defaults. In this paper, we examine this observed pattern empirically and through the lens of a dynamic stochastic general equilibrium model. The theoretical model explicitly incorporates bond issuances in local and foreign currencies, and endogenous determination of real exchange rate and default risk. Our quantitative analysis replicates the link between real exchange rate depreciation and default probability around defaults and moments of the real exchange rate that match the data. Prior to default, interactions of real exchange rate depreciation, originated from a sequence of low tradable goods shocks with the sovereign’s large share of foreign currency debt, trigger defaults. In post-default periods, the resulting output costs and loss of market access due to default lead to further real exchange rate depreciation.

Series:

Working Paper No. 2016/037

Subject:

Consumption Currencies Depreciation External debt Foreign currency debt Foreign exchange Money National accounts Real exchange rates Yield curve