Domestic Bonds

Politics determine how developing countries borrow – Eurasia Review


Interest payments on bilateral public debt have been frozen in some of the world’s poorest countries this year and in 2020 to mitigate the economic impacts of COVID-19.

Yet among the 76 countries eligible for the freeze – known as the Debt Service Suspension Initiative – the debt structure varies widely, raising concerns about long-term debt sustainability.

Understanding how countries borrow is necessary to resolve debt crises and, for many developing countries, those choices are rooted in political ideologies, according to a new study co-authored by a researcher at Princeton University.

The article, published in the journal International organisation, is among the first to show a new trend: developing countries tend to borrow in national currencies when issuing sovereign bonds, a common way for governments to borrow to repay their debt. This can make it easier for them to act on their domestic policy preferences.

Political ideology plays a role: if developing countries have leftist governments, they tend to borrow in their own national currencies. If they have right-wing governments, they are more likely to borrow in foreign currencies, such as the US dollar.

These choices determine the types of pressure that creditors exert on governments, as well as the ease or difficulty in repaying these debts. For example, countries that largely borrow in foreign currencies will need to generate currencies to repay their debts, so they may be hit harder when their currencies depreciate. Countries that choose short-term borrowing will have to refinance their debt more frequently, exposing them to the risk of entering an unfavorable market.

“Our results go against the expectation that developing countries often cannot borrow in their own currencies. Some of these countries appear willing to pay the additional costs of borrowing in domestic currency in order to avoid exposure to currency risks or monetary policy constraints that could arise from borrowing in foreign currencies, ”the co-author said. Layna Mosley, professor of politics. and international affairs at the Princeton School of Public and International Affairs.

The “expectation” Mosley refers to is a concept economists call “original sin” to describe the sovereign borrowing of developing countries. For example, a country like Zambia – whose external debt has increased by 1000% over the past nine years – might be able to borrow in private capital markets, but it still needs to address creditors’ concerns about the debt. investment risk. One way to allay investor fears is to borrow in foreign currencies. This way, investors don’t have to worry about inflation or the depreciation of the currency. The logic of “original sin” claims that by virtue of their status as developing countries, Zambia and its developing country peers have little choice but to borrow in foreign currency. This logic has long suggested that international creditors are unwilling to buy government bonds in domestic currency.

Yet Mosley and his associates found the opposite. Borrowing in national currency has become much more common. To reach this conclusion, Mosley and colleagues investigated government bond issuance from 1990 to 2016 in 131 countries. This new data set included 240,000 new sovereign bonds.

Research shows it’s not just a matter of how much governments borrow or from what sources – like private bond markets, official bilateral creditors like the United States or China or the World Bank. The terms on which countries borrow play an important role in debt settlement. These conditions are determined not only by the preferences and demands of investors, but also by the national incentives of governments.

“To appreciate the challenges of sovereign debt and sovereign debt restructuring, we must consider the domestic policy incentives of debtor governments,” Mosley said. “And, at the international level, we must focus on the role of credible commitments, transparency and cooperation – all themes that are central to our study of international relations. “