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The Role of International Reserves and FDI in Offsetting External Debt Risk

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  • Juan Jose Battaglia

Abstract

This paper investigates the relationship between sovereign spreads and external assets and liabilities. To address potential endogeneity concerns, we employ a panel VAR model within a generalized method of moments (GMM) framework on a sample of 59 countries, encompassing 18 advanced economies and 41 emerging markets, over the period from 1996 to 2021. The findings reveal that a positive shock to international reserves (IIRR) assets (measured as a ratio to GDP) leads to a significant decrease in sovereign spreads. Conversely, a positive shock to the external debt to GDP ratio leads to a significant increase in sovereign spreads. Both effects are stronger in emerging markets. The responses of spreads to shocks in foreign direct investment (FDI) liabilities are less clear, highlighting that not all foreign liabilities have the same effect on the cost of international credit. We corroborate the robustness of the results using the local projection method and a variety of additional tests.

Suggested Citation

  • Juan Jose Battaglia, 2024. "The Role of International Reserves and FDI in Offsetting External Debt Risk," Working Papers REM 2024/0355, ISEG - Lisbon School of Economics and Management, REM, Universidade de Lisboa.
    • Handle: RePEc:ise:remwps:wp03552024
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    More about this item

    Keywords

    Sovereign spread; External asset and liabilities; Panel VAR.;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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