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Sovereign Defaults, External Debt, and Real Exchange Rate Dynamics

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  • Mr. Tamon Asonuma

Abstract

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.

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  • Mr. Tamon Asonuma, 2016. "Sovereign Defaults, External Debt, and Real Exchange Rate Dynamics," IMF Working Papers 2016/037, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:2016/037
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    Cited by:

    1. Aguiar, M. & Chatterjee, S. & Cole, H. & Stangebye, Z., 2016. "Quantitative Models of Sovereign Debt Crises," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 1697-1755, Elsevier.
    2. Burger, John D. & Warnock, Francis E. & Warnock, Veronica Cacdac, 2018. "Currency matters: Analyzing international bond portfolios," Journal of International Economics, Elsevier, vol. 114(C), pages 376-388.
    3. Mehak Ejaz & Kalim Hyder, 2019. "A Fan Chart Approach to Debt Sustainability in Pakistan," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, vol. 24(2), pages 1-23, July-Dec.
    4. Di Letizia, Gerardo & De Lucia, Caterina & Pazienza, Pasquale & Cappelletti, Giulio Mario, 2023. "Forest bioeconomy at regional scale: A systematic literature review and future policy perspectives," Forest Policy and Economics, Elsevier, vol. 155(C).
    5. Kaas, Leo & Mellert, Jan & Scholl, Almuth, 2020. "Sovereign and private default risks over the business cycle," Journal of International Economics, Elsevier, vol. 123(C).
    6. Fisera, Boris & Workie Tiruneh, Menbere & Hojdan, David, 2021. "Currency depreciations in emerging economies: A blessing or a curse for external debt management?," International Economics, Elsevier, vol. 168(C), pages 132-165.
    7. Senanu Kwasi Klutse & Judit Sági & Gábor Dávid Kiss, 2023. "The role of COVID‐19 in worsening the debt sustainability in developing economies – The case of Ghana and Kenya," Regional Science Policy & Practice, Wiley Blackwell, vol. 15(6), pages 1259-1275, August.
    8. Arellano, Cristina & Bai, Yan & Mihalache, Gabriel, 2018. "Default risk, sectoral reallocation, and persistent recessions," Journal of International Economics, Elsevier, vol. 112(C), pages 182-199.
    9. Moumita Basu & Rilina Basu & Ranjanendra Narayan Nag, 2022. "A Dependent Economy Model of Employment, Real Exchange Rate and Debt Dynamics: Towards an Understanding of Pandemic Crisis," Foreign Trade Review, , vol. 57(1), pages 85-113, February.
    10. Ricardo Sabbadini, 2017. "Overcoming the Original Sin: Gains from Local Currency External Debt," Working Papers, Department of Economics 2017_27, University of São Paulo (FEA-USP).
    11. Popov, Sergey V. & Wiczer, David G., 2009. "Equilibrium sovereign default with endogenous exchange rate depreciation," MPRA Paper 18854, University Library of Munich, Germany.
    12. Kikkawa, Ayumu Ken & Sasahara, Akira, 2020. "Gains from trade and the sovereign bond market," European Economic Review, Elsevier, vol. 124(C).
    13. Mr. Tamon Asonuma & Mr. Marcos d Chamon & Akira Sasahara, 2016. "Trade Costs of Sovereign Debt Restructurings: Does a Market-Friendly Approach Improve the Outcome?," IMF Working Papers 2016/222, International Monetary Fund.
    14. Patrycja Chodnicka-Jaworska & Piotr Jaworski, "undated". "Countries Credit Ratings And Exchange Rates €“ The Impact Of Economic Development," Review of Socio - Economic Perspectives 201608, Reviewsep.
    15. Sandro C. Andrade & Vidhi Chhaochharia, 2018. "The Costs of Sovereign Default: Evidence from the Stock Market," The Review of Financial Studies, Society for Financial Studies, vol. 31(5), pages 1707-1751.
    16. Daniel Hansen, 2023. "The democratic (dis)advantage: The conditional impact of democracy on credit risk and sovereign default," Economics and Politics, Wiley Blackwell, vol. 35(1), pages 356-410, March.

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    More about this item

    Keywords

    WP; exchange rate; foreign currency; Sovereign Defaults; External Debt; Real Exchange Rate; Currency Composition of Debt; Bond Spreads; default probability; default choice; exchange rate depreciation; default period; GDP ratio; meaning appreciation; tradable goods; business cycle; Real exchange rates; Consumption; Depreciation; Currencies; Foreign currency debt; Global;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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