The determinants of "domestic" original sin in emerging market economies

This paper explains why domestic debt composition in some emerging economies is risky. To this end, it carries out a systematic analysis of the determinants of the so-called domestic original sin, which refers to the inability of emerging economies to borrow domestically in local currency, at long maturities and fixed interest rates. As such, the latter is a measure of financial vulnerabilities arising from domestic debt composition, which encompasses maturity mismatches, rollover risk and interest payment contingency. The paper builds on a large dataset compiled by the authors from national sources. It finds that domestic original sin is particularly severe when inflation is lofty, the debt service-to-GDP ration high, the slope of the yield curve inverted and the investor base narrow. These results suggest that sound macroeconomic policies, attractive long-term yields and policies aimed at widening the investor base are instrumental to overcome domestic original sin, reduce domestic debt riskiness and tilt its composition towards safer, long-term, unindexed, local currency instrumentsOriginal sin, domestic debt, emerging economies

Do China and oil exporters influence major currency configurations?

This paper analyses the impact of the shift away from a U.S. dollar focus of systemically important emerging market economies (EMEs) on configurations between the U.S. dollar, the euro and the yen. Given the difficulty that fixed or managed U.S. dollar exchange rate regimes remain pervasive and reserve compositions mostly kept secret, the identification strategy of the paper is to analyse the market impact on major currency pairs of official statements made by EME policy-makers about their exchange rate regime and reserve composition. Developing a novel database for 18 EMEs, we find that such statements not only have a statistically but also an economically significant impact on the euro, and to a lesser extent the yen against the U.S. dollar. The findings suggest that communication hinting at a weakening of EMEs' U.S. dollar focus contributed substantially to the appreciation of the euro against the U.S. dollar in recent years. Interestingly, EME policy-makers appear to have become more cautious in their communication more recently. Overall, the results underscore the growing systemic importance of EMEs for global exchange rate configurations.Foreign exchange rates ; Monetary policy ; International finance ; Financial markets

Uncovered interest parity at distant horizons: evidence on emerging economies & nonlinearities

This paper tests for uncovered interest parity (UIP) at distant horizons for the US and its main trading partners, including both mature and emerging market economies, also exploring the existence of nonlinearities. At long and medium horizons, it finds support in favour of the standard, linear, specification of UIP for dollar rates vis-à-vis major floating currencies, but not vis-à-vis emerging market currencies. Moreover, the paper finds evidence that, not only yield differentials widen, but that US bond yields do react in anticipation of exchange rate movements, notably when these take place vis-à-vis major floating currencies. Last, the paper detects signs of nonlinearities in UIP at the mediumterm horizon for dollar rates vis-à-vis some of the major floating currencies, albeit surrounded by some uncertainty. JEL Classification: E43, F31, F41distant horizon, emerging economies, Nonlinearities, Uncovered interest parity

The determinants of ‘domestic’ original sin in emerging market economies

This paper explains why domestic debt composition in emerging economies is risky. It carries out an analysis of the determinants of ‘domestic’ original sin, which refers to the inability of emerging economies to borrow domestically in local currency, at long maturities and fixed interest rates. The latter is a measure of financial vulnerabilities arising from domestic debt composition, which encompasses maturity mismatches, rollover risk and interest payment contingency. The paper builds on a large dataset compiled by the authors from national sources. It finds that domestic original sin is severe when inflation is lofty, the debt service-to-GDP ratio high, the slope of the yield curve inverted and the investor base narrow. These results suggest that sound macroeconomic policies, attractive long-term yields and policies aimed at widening the investor base are instrumental to reduce domestic debt riskiness and tilt its composition towards safer, long-term, unindexed, local currency instruments. JEL Classification: F34, F41, G15domestic debt, emerging economies, Original sin

Domestic Debt Structures in Emerging Markets : New Empirical Evidence

This paper explains why public domestic debt composition in emerging economies can be risky, namely in foreign currency, with a short maturity or indexed. It analyses empirically the determinants of these risk sources separately, developing a new large dataset compiled from national sources for 33 emerging economies over 1994-2006. The paper finds that economic size, the breadth of the domestic investor base, inflation and fiscal soundness are all associated with risky public domestic debt compositions, yet to an extent that varies considerably in terms of magnitude and significance across sources of risk. Only inflation impacts all types of risky debt, underscoring the overarching importance of monetary credibility to make domestic debt compositions in emerging economies safer. Given local bond markets' rapid development, monitoring risky public domestic debt compositions in emerging economies becomes increasingly relevant to global financial stability.Public domestic debt, composition, risk, emerging economies.

China's dominance hypothesis and the emergence of a tri-polar global currency system

This paper assesses whether the international monetary system is already tripolar and centred around the US dollar, the euro and the Chinese renminbi (RMB). It focuses on what we call China’s “dominance hypothesis”, i.e. whether the renminbi is already the dominant currency in Asia, exerting a large influence on exchange rate and monetary policies in the region, a direct reference to the old “German dominance hypothesis” which ascribed to the German mark a dominant role in Europe in the 1980s-1990s. Using a global factor model of exchange rates and a complementary event study, we find evidence that the RMB has become a key driver of currency movements in emerging Asia since the mid-2000s, and even more so since the global financial crisis. These results are consistent with China’s dominance hypothesis and with the view that the international monetary system is already tri-polar. However, we also find that China’s currency movements are to some extent affected by those in the rest of Asia. JEL Classification: F30, F31, F33, N20China, euro, Exchange Rates, German dominance hypothesis, international monetary system, renminbi, tri-polarity, US dollar

Does the euro make a difference? Spatio-temporal transmission of global shocks to real effective exchange rates in an infinite VAR

This paper provides evidence on whether the creation of the euro has changed the way global turbulences affect euro area and other economies. Specifically, it considers the impact of global shocks on the competitiveness of individual euro area countries and assesses whether their responses to such shocks have converged, as well as to what pattern. Technically, the paper applies a newly developed methodology based on infinite VAR theory featuring a dominant unit to a large set of over 60 countries' real effective exchange rates, including those of the individual euro area economies, and compares impulse response functions to the estimated systems before and after EMU with respect to three types of shocks: a global US dollar shock, generalised impulse response function shocks and a global shock to risk aversion. Our results show that the way euro area countries' real effective exchange rates adjust to these shocks has converged indeed, albeit to a pattern that depends crucially on the nature of the shock. This result is noteworthy given the apparent divergence in competitiveness indicators of these countries in the first ten years of EMU, which suggests that this diverging pattern is unlikely to be due to global external shocks with asymmetric effects but rather to other factors, such as country-specific domestic shocks. JEL Classification: C21, C23euro, High-Dimensional VAR, Identification of Shocks, Real Effective Exchange Rates, Weak and Strong Cross Sectional Dependence

The international role of the euro - evidence from bonds issued by non-euro area residents

This paper analyses the main features of the market for euro-denominated bonds issued by non-euro area residents on the basis of a new database. It shows that large private corporations from mature economies have contributed significantly to the internationalisation of the euro since 1999, more than sovereigns in transition and emerging economies, whose part was initially expected to be stronger. It confirms that the euro’s international role is characterised by a strong regional focus, being most prominent in countries located in the immediate vicinity of the euro area. In particular, the paper provides ample evidence that the City of London plays a key role in the market for euro-denominated bonds issued by non-euro area residents, be it on the supply side, the demand side or as an intermediary. When it comes to demand, the paper shows that the euro’s reach in the rest of the world has been more limited thus far, notwithstanding some recent interest in Asia. Finally, the paper finds evidence that the international role of the euro has, to some extent, been driven by the euro area itself, with euro area investors being significant purchasers of euro-denominated bonds issued by non-euro area residents.

How have global shocks impacted the real effective exchange rates of individual Euro area countries since the Euro's creation?

This paper uncovers the response pattern to global shocks of euro area countries' real effective exchange rates before and after the start of Economic and Monetary Union (EMU), a largely open ended question when the euro was created. We apply to that end a newly developed methodology based on high dimensional VAR theory. This approach features a dominant unit to a large set of over 60 countries' real effective exchange rates and is based on the comparison of two estimated systems: one before and one after EMU. ; We find strong evidence that the pattern of responses depends crucially on the nature of global shocks. In particular, post-EMU responses to global US dollar shocks have become similar to Germany's response before EMU, i.e. to that of the economy that used to issue Europe's most credible legacy currency. ; By contrast, post-EMU responses of euro area countries to global risk aversion shocks have become similar to those of Italy, Portugal or Spain before EMU, i.e. of economies of the euro area's periphery. Our findings also suggest that the divergence in external competitiveness among euro area countries over the last decade, which is at the core of today's debate on the future of the euro area, is more likely due to country-specific shocks than to global shocks.Economic and Monetary Union ; Vector autoregression

The yield curve as a predictor and emerging economies

This paper investigates the extent to which the slope of the yield curve in emerging economies predicts domestic inflation and growth. It also examines international financial linkages and how the US and euro area yield curves help to predict. It finds that the domes-tic yield curve in emerging economies contains in-sample information even after control-ling for inflation and growth persistence, at both short and long forecast horizons, and that it often improves out-of-sample forecasting performance. Differences across countries are seemingly linked to market liquidity. The paper further finds that the US and euro area yield curves also contain in- and out-of-sample information for future inflation and growth in emerging economies. In particular, for emerging economies with exchange rates pegged to the US dollar, the US yield curve is often found to be a better predictor than the domes-tic curves and to causally explain their movements. This suggests that monetary policy changes and short-term interest rate pass-through are key drivers of international financial linkages through movements at the low end of the yield curve.emerging economies; yield curve; forecasting; international linkages