Why are there serial defaulters? Quasi-experimental evidence from Constitutions

Presidential democracies were 4.9 times more likely to default on external debts between 1976 and 2000 than parliamentary democracies. This paper argues that the explanation to the pattern of serial defaults among a number of sovereign borrowers lies in their constitutions (on serial defaults see Reinhart, Rogoff and Savastano (2003) and Reinhart and Rogoff (2004)). Ceteris paribus, parliamentary democracies are less likely to default on their liabilities as the confidence requirement creates a credible link between economic policies and the political survival of the executive. This link tends to strengthen the repayment commitment when politicians are opportunistic. I show that this effect is large and statistically significant in the contemporary world even when comparison is restricted to countries that are twins in terms of colonial origin, geography and economic variables. Moreover, the result persists if Latin American and/or OECD democracies are excluded from the sample. Since the form of government of a country is typically chosen at the time of independence and highly persistent over time, constitutions can explain why debt policies in developing countries are related to individual histories.

Why are there serial defaulters? Quasi-experimental evidence from Constitutions

Presidential democracies were 4.9 times more likely to default on external debts between 1976 and 2000 than parliamentary democracies. This paper argues that the explanation to the pattern of serial defaults among a number of sovereign borrowers lies in their constitutions (on serial defaults see Reinhart, Rogoff and Savastano (2003) and Reinhart and Rogoff (2004)). Ceteris paribus, parliamentary democracies are less likely to default on their liabilities as the confidence requirement creates a credible link between economic policies and the political survival of the executive. This link tends to strengthen the repayment commitment when politicians are opportunistic. I show that this effect is large and statistically significant in the contemporary world even when comparison is restricted to countries that are twins in terms of colonial origin, geography and economic variables. Moreover, the result persists if OECD democracies are excluded from the sample. Since the form of government of a country is typically chosen at the time of independence and highly persistent over time, constitutions can explain why debt policies in developing countries are related to individual histories.

Estimating Exchange Market Pressure and Intervention Activity

Using the index proposed by Weymark (1995) for small open economies, the paper computes exchange market pressure and intervention indexes for Chile in the period from 1990 to 1998. This statistics can be used to assess timing and scale of currency crises, as they include exchange rate and reserves variations in one single indicator. The index is suited for intermediate exchange rate policies, since it gives due consideration to the possibility of accommodating exchange market pressures through changes in domestic credit. The monetarist model developed suggests low effectiveness of controls in affecting the exchange rate level, when the interest rate-elasticity of money demand is low. Substantial appreciative pressure on the Chilean peso is found over the period, with exception of isolated quarters following the introduction of the reserve requirement and following the outset of the Asian crisis.

Sovereign risk: constitutions rule

This paper models the executive's choice of whether to reschedule external debt as the outcome of an intra-governmental negotiation process. The executive's necessity of a confidence vote from the legislature is found to provide the rationale for why some democracies may not renegotiate their foreign obligations. Empirically, parliamentary democracies are indeed less prone to reschedule their foreign liabilities or accumulate arrears on them. Most of the democracies that have been able to significantly reduce their debt/GNP ratio without a 'credit incident' were parliamentary. Moreover, countries with stronger political checks on the executive and lower executive turnover have a lower rescheduling propensity. These results suggest that North and Weingast's account of the evolution of institutions in 17th century England gives substantial mileage in understanding the international debt markets in the contemporary developing world

Debt bailouts and constitutions

A demand based theory of sub-national debt bailouts is presented. It is shown that revenue sharing (RS) arrangements alter the demand for bailouts among politicians with regional constituencies as a bailout usually implies a shift of taxation to the federal tier. Automatic RS may lead to the formation of pro-bailout coalitions formed by indebted states and states that are net recipients of the RS arrangement. Also, RS can act as a commitment device for compensating payments among state representatives, making a bailout politically rational. The model shows that the state debt bailouts approved by the Brazilian Senate prior to the enactment of the Fiscal Responsibility Act were fully consistent with politicians that maximize the proceeds accruing to their constituencies

International Liquidity Swaps : Is the Chiang Mai Initiative Pooling Reserves Efficiently ?

We analyze the network of bilateral liquidity swaps (BSAs) among the ASEAN+3 countries. We find that the network has taken the correlation of capital flows in the region into account, in the sense that countries with lower correlation of reserve growth have engaged in larger BSAs. All else equal, a decimal point increase in the correlation of international reserve growth decreases the size of a bilateral swap agreement between 18 and 27%. Moreover, we find that the approximatedly $ 60bn of BSAs have had a limited impact, if any, on government bond spreads so far. Finally, we identify potential gains from inter-regional BSAs.insurance ; international reserves ; liquidity ; sovereign risk ; swaps

Domestic vs. external sovereign debt servicing: an empirical analysis

This paper analyzes the incidence of domestic and external debt crises for a sample of 53 emerging economies between 1980 and 2005. Even though there is substantial time variation in the default rates during the period, sovereign default rates for domestic debts are typically lower than those for external debts. The incidence of both types of defaults is explained by means of the estimation of independent and simultaneous limited-dependent variable models. The results show that while there is considerable evidence that external defaults trigger domestic defaults, evidence for the reverse link disappears when default propensities are estimated in a simultaneous equation model

A Sovereign Debt Model with Trade Credit and Reserves

This paper analyzes sovereign debt in an economy in which the availability of short-term trade credit reduces international trade transaction costs. The model highlights the distinction between gross and net international reserve positions. Borrowed reserves provide net wealth and liquidity services during a negotiation, as long as they are not fully attachable by creditors. Moreover, reserves strengthen the bargaining position of a country by shielding it from a cut-off from short-term trade credits thereby diminishing its degree of impatience to conclude a negotiation. We show that competitive banks do lend for the accumulation of borrowed reserves, which provide partial insurance

On Risk Aversion in the Rubinstein Bargaining Game

We derive closed-form solutions for the Rubinstein alternating offers game for cases where the two players have (possibly asymmetric) utility functions that belong to the HARA class and discount the future at a constant rate. We show that risk aversion may increase a bargainers payoff. This result - which contradicts Roth’s 1985 theorem tying greater risk neutrality to a smaller payoff - does not rely on imperfect information or departures from expected utility maximization.

Pessimistic Foreign Investors and Turmoil in Emerging Markets: the case of Brazil in 2002

Using survey data, we document that foreign-owned institutions became more pessimistic than locally owned institutions about the strength of the Brazilian currency around the 2002 presidential elections. As a result of their relative pessimism, foreign-owned institutions made larger forecast errors. Consistent with the emergence of their relative pessimism, foreign investors heavily sold Brazilian stocks and the Brazilian currency in futures markets ahead of the 2002 elections. Periods of stronger foreign sell-off were associated with larger equity price declines and larger depreciation of the Brazilian Real in spot and futures markets. These results are consistent with foreign investors’ relative lack of knowledge of Brazilian institutions contributing to the sharp depreciation of the Brazilian currency and stock market ahead of the 2002 presidential elections.