Dudzich, Vik a
A icle
Rela ionships be ween exchange a e egime, eal
exchange a e ola ili y and cu ency s uc u e o
go e nmen bonds in eme ging ma ke s
Re iew o Economic Pe spec i es
P o ided in Coope a ion wi h:
Masa yk Uni e si y, Facul y o Economics and Adminis a ion
Sugges ed Ci a ion: Dudzich, Vik a (2020) : Rela ionships be ween exchange a e egime, eal
exchange a e ola ili y and cu ency s uc u e o go e nmen bonds in eme ging ma ke s, Re iew
o Economic Pe spec i es, ISSN 1804-1663, De G uy e , Wa saw, Vol. 20, Iss. 1, pp. 3-22,
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Rela ionships be ween exchange a e egime, eal
exchange a e ola ili y and cu ency s uc u e o
go e nmen bonds in eme ging ma ke s
Vik a Dudzich
1
Abs ac : Public o eign cu ency bo owing is a common p oblem o eme ging
ma ke s. Schola s named i he o iginal sin o o eign deb . I has a p o en nega i e
in luence on economic g ow h and de elopmen , unde mining inancial s abili y, and
inc easing he p obabili y o mone a y c ises. The oo s o he o iginal sin o en lay in
eme ging ma ke s’ ins i u ional unde de elopmen , wi h low-quali y mone a y policy,
inapp op ia e exchange a e egime choice, and exchange a e mismanagemen being
s a ed among he mos impo an causes. This pape e alua es he in luence o he
exchange a e policy on he emission o o eign cu ency so e eign bonds in eme ging
ma ke s. The ela ionship is es ima ed using panel da a and GMM app oach, wi h
exchange a e egime ype (bo h de ju e and de ac o) and eal exchange a e ola ili y
se ing as explana o y a iables. The indings e eal ha ixed exchange a e egime and
high eal exchange a e ola ili y is p omo ing he o eign cu ency bo owing. Thus
coun ies ha wan o educe he bu den o he o iginal sin should lean owa ds a mo e
lexible exchange a e policy while main aining hei eal exchange a e s able.
Keywo ds: eme ging ma ke s, exchange a e egime, o iginal sin, eal exchange a e,
so e eign bonds.
JEL Classi ica ion: E62, F31, F34
Recei ed: 12 Oc obe 2019 / Accep ed: 26 Janua y 2020 / Sen o Publica ion: 12 Ma ch 2020
In oduc ion
Tigh ening global economic in eg a ion inc eases de eloping coun ies’ pa icipa ion on
in e na ional capi al ma ke s, wi h go e nmen bonds’ emission being he basic sou ce o
inancing o a conside able pa o so-called eme ging ma ke s (Eicheng een e al.,
2002; Claessens e al., 2002; Pa k e al., 2018). Bu nume ous deb c ises, which
occu ed in many less de eloped coun ies du ing he las 30 yea s, a e he eason why
oday’s global economic communi y is ho oughly s udying he e ec s o o eign deb on
na ional inancial and mac oeconomic s abili y. One o he mos discussed undamen al
p oblems is he ac ha a subs an ial pa o eme ging ma ke s’ o eign deb , including
ha om go e nmen bonds emission, is nomina ed in o eign ( o he deb o ) cu ency
1
Pos -g adua e s uden o Facul y o Finances and Accoun ing, Depa men o Mone a y Policy
and Theo y, Uni e si y o Economics, P ague, nms  Wins ona Chu chilla 1938/4 130 67 P aha
3 – iko , Czech Republic. Email: [email p o ec ed]
Re iew o Economic Pe spec i es
4
– mos ly in he U.S. dolla o eu o
2
(Eicheng een and Hausmann, 1999). Economis s
named his si ua ion he o iginal sin o o eign deb (Eicheng een and Hausmann, 1999).
Too high sha e o o eign cu ency on na ional deb may lead o disc epancy be ween
s a e’s o eign exchange e enues and expendi u es, pu s p essu e on he exchange a e,
wo sens he coun y’s c edi a ing and limi s he a ailabili y o inancing needed o
economic de elopmen (Eicheng een e al., 2002; Jeanne, 2003; O onello and Pe ez,
2019).
Today he si ua ion is changing o he be e . E en hough many de eloping coun ies
a e s ill unable o unwilling o issue local cu ency nomina ed bonds, o he s a e
expe iencing huge g ow h o domes ic bond ma ke s and o eign demand o local
cu ency nomina ed go e nmen bonds (Bo do e al., 2009; Pa k e al., 2018). Bu hose
changes apply only o ce ain coun ies, while many s ill ha e o ely on o eign cu ency
inancing. Thus, he de e mina ion o he ac o s in luencing he cu ency composi ion o
go e nmen bonds is becoming a c ucial esea ch opic – i may e eal he policy
implica ions o educing he cos s o he o iginal sin
3
.
Today’s con en ional wisdom sugges s ha mone a y policy o he de eloping coun ies
(o mo e speci ically, i s goals, quali y, and pe sis ence) is a signi ican de e minan o
he so e eign bonds’ cu ency s uc u e; wi h exchange a e egime ype being o
pa icula impo ance (Claessens e al., 2002; Cal o and Mishkin, 2003; Engel and Pa k,
2018). Recommenda ions on he igh choice o exchange a e egime ( he one limi ing
he o eign cu ency indeb ing) a e o en ambiguous. T adi ional easoning ha ixed
exchange a e s abilizes cu ency and so educes iskiness o local cu ency nomina ed
deb is p o en o be w ong in case o less de eloped coun ies wi h unc edible mone a y
au ho i ies and o en adminis a i ely limi ed cu ency con e ibili y (To nell and
Velasco, 1995). A he same momen , he loa ing exchange a e egime may be he sign
o mo e quali ied economic ins i u ions, which migh p omo e local cu ency deb
issuance (Eicheng een e al., 2002). A emp s o empi ical e i ica ion o his
ela ionship end o speak in a o o a lexible exchange a e (Eicheng een e al., 2002;
Claessens e al., 2002). Bu some academics a gue ha o icially announced exchange
a e egime may be o li le impo ance, wi h de ac o exchange a e egime ype
4
and he
ola ili y o exchange a e i sel being decisi e o he so e eign bonds cu ency (Cal o
and Mishkin, 2003).
This pape is analyzing and empi ically e i ying he exchange a e and exchange a e
egime’s in luence on he so e eign bonds cu ency composi ion in eme ging ma ke s.
This wo k is upda ing he esul s o pape s by Claessens e al., 2002; and Eicheng een e
al., 2002; which also deal wi h he exchange a e egime’s in luence on he o iginal sin
o o eign deb , hough hose pape s in es iga e a e y di e en (in e ms o deb
ma ke s’ de elopmen ) pe iod and highly he e ogenic se o coun ies. This pape ’s
2
E en hough oday he sha e o local cu ency on go e nmen deb o de eloping coun ies is
much highe han i was when he “classic” pape s on his opic (Eicheng een and Hausmann,
1999; Eicheng een e al., 2002) we e w i en, and o e all end may be seen as imp o ing (Pa k e
al., 2018).
3
Mos o iginal sin s udies apply o he imes when he cu ency s uc u e o go e nmen bonds
was much “wo se” (Eicheng een e al., 2002; Claessens e al., 2002), and as a as we know, he e
a e no pape s analyzing p esen -day si ua ion.
4
Such classi ica ion is p esen ed, o example, in Le y-Yeya i and S u zenegge (2016).
Volume 20, Issue 1, 2020
5
con ibu ion in o he analysis o he o iginal sin and exchange a e egimes lays in he
inclusion o b oad se o explana o y a iables – we use no only o mal de ju e
exchange a e egime ype, bu also se e al so s (based on di e en me hodology) o de
ac o exchange a e egimes; and eal exchange a e ola ili y.
This pape is s uc u ed as ollows. The i s chap e is e iewing he li e a u e ega ding
he cu ency s uc u e o go e nmen deb and so e eign bonds and i s in e ac ions wi h
economic de elopmen and mone a y policy o de eloping coun ies. The second
chap e discusses he in luence o he o iginal sin o o eign deb on economic and
ins i u ional de elopmen , acquain s he eade wi h he causes and e ec s o o eign
cu ency indeb edness. The hi d chap e analyzes he ole o he exchange a e egime in
de e mining he cu ency o de eloping coun ies’ so e eign bonds. Fou h chap e
e i ies and quan i ies he exchange a e egime ype’s in luence on he cu ency
s uc u e o eme ging ma ke s’ go e nmen bonds using panel da a o 13 coun ies and
applying Gene al Me hods o Momen s echnique. The las chap e concludes and also
p esen s implica ions o he analyzed coun ies’ exchange a e policy.
Re iew o li e a u e
Academic in e es in he cu ency composi ion o so e eign deb and eu obonds
emission by de eloping coun ies began o g ow in he las yea s o he 20 h cen u y
when many eme ging ma ke s expe ienced de as a ing o eign deb c ises. Thei causes,
besides o he s, laid in he disc epancy be ween go e nmen s’ o eign exchange e enues
and expenses and also exchange a e mismanagemen
5
(Eicheng een e al., 2002).
S a ing om ha pe iod, we can ind an abundance o esea ch pape s ocusing on he
nega i e impac o o eign cu ency deb on bo h eme ging ma ke s' economic
de elopmen and mone a y policy and discussing why hose coun ies can’ (o a e no
willing o) issue bonds o bo ow in local cu ency.
Claessens e al. (2002) analyze ac o s in luencing he cu ency s uc u e o de eloping
coun ies’ go e nmen bonds and conclude, ha low in la ion, banking sys em
de elopmen , and size o economy a e posi i ely (in he sense o la ge sha e o
domes ic cu ency on go e nmen deb ) a ec ing he cu ency o bonds’ emission. The
au ho s also emphasize he ole o ins i u ional de elopmen in explaining he
go e nmen deb cu ency s uc u e. The impac o he exchange a e egime is also
men ioned, wi h esul s ob ained indica ing ha coun ies wi h he lexible exchange a e
end o issue mo e bonds in local cu ency. The ole o policy and ins i u ions in
de e mining in which cu ency o bo ow is also highligh ed by Jeanne (2003), who
a gues ha coun ies wi h unde -de eloped ins i u ions and inconsequen ial economic
policy don’ in oke in es o s’ us in domes ic cu ency and so a e o ced o bo ow in
o eign cu ency. Ins i u ional “explana ion” can be ound in Bo do e al. (2009), which
5
In mos cases he p oblem was mone a y au ho i y’s e o o e ain he ixed a e, which
suppo ed o eign cu ency indeb edness du ing economic booms (Eicheng een and Hausmann
(1999) named i ixed a e mo al haza d), bu became a sou ce o mac oeconomic imbalance
accumula ion when o eign capi al lows slumped (Eicheng een and Hausmann, 1999). I ’s
impo an o men ion ha ha pe iod’s con en ional wisdom was ha ixed exchange a e egime
p o ided mo e iscal discipline, bu many esea che s didn’ ag ee wi h i e en be o e he s a o
Asian and Russian c ises o he end o he 90. ( o example, To nell and Velasco, 1995).
Re iew o Economic Pe spec i es
6
s a es ha o eign cu ency deb and poo economic policy combined a e he mos
equen causes o he de eloping coun ies’ mone a y c ises. In he same momen
coun ies ha can “a o d” o issue o eign cu ency bonds wi hou signi ican isks o
inancial s abili y, p e e no o do so as hei local cu ency is deemed as us wo hy
enough o o eign in es o s (Bo do e al., 2009). Simila opinions may be ound in Fuji
(2015), who emphasizes ha cu en accoun su plus and high o eign ese es do educe
he isks lowing om o eign cu ency so e eign deb , bu disco e s, ha hose less
isky coun ies also ha e a much smalle sha e o o eign cu ency on go e nmen deb .
Eicheng een e al. (2002) come wi h a complex analysis o he oo s o o iginal sin. The
au ho s accen ua e ha local cu ency bonds o de eloping coun ies a e associa ed wi h
high ansac ion cos s o in es o s, and hus eme ging ma ke s end o ha e unde -
de eloped local bond ma ke s. I is also highligh ed ha sou ces o he ansac ion cos s
lay in de eloping coun ies’ cu ency ola ili y (Eicheng een e al., 2002). The au ho s
disco e he posi i e ela ionship be ween exchange a e lexibili y deg ee and local
cu ency sha e on public deb , while also assume (based on Mussa, 1986) ha ixed
exchange a e egimes’ main sho coming lays in eal exchange a e ola ili y. The ac
ha exchange a e ola ili y ma e s mo e o o eign deb cu ency s uc u e han he
o icial exchange a e egime ype is also assumed by Cal o and Mishkin (2003). They
also expec mo e ins i u ionally de eloped coun ies o ha e less ola ile exchange a e
and a highe sha e o local cu ency on go e nmen deb ( ega dless o exchange a e
egime ype).
Model explana ion o why he o eign cu ency bo owing in de eloping coun ies is
some imes p e e ed is p esen ed in pape s by Du e al. (2016) and Engel and Pa k
(2018), who see he oo s o in es o s’ demand o o eign ( o he deb o ) cu ency deb
ins umen in high in la ion and hus low yield on local cu ency secu i ies (Du e al.,
2016); and in cons ain s pu on local cu ency deb by poo and no c edible mone a y
and iscal policy, which a ise om in es o s’ unwillingness o pu chase domes ic
cu ency ins umen s when hey begin o suspec ha he s a e may abandon in la ion
con ol ying o mone ize local cu ency deb (Engel and Pa k, 2018; deb mone iza ion
in de eloping coun ies is also s udied by O onello and Pe ez, 2019). The iskiness o
o eign cu ency so e eign bonds is also analyzed by Mello and Hussein (2001), which
de i e i om de eloping coun ies’ ine icien deb po olio managemen .
The e olu ion o de eloping coun ies’ public deb ’s cu ency composi ion (and in he
case o some coun ies - i s g adual imp o emen ) is desc ibed in P esbi e o e al., 2015;
Engel and Pa k, 2018. P esbi e o e al. (2015) s a e ha he numbe o de eloping
coun ies issuing bonds is cons an ly g owing, al hough local cu ency bonds emission is
“a ailable” only o hose mo e success ul bo h economically and ins i u ionally. Pa k e
al. (2018) p o e ha in de eloping coun ies’ local cu ency bond ma ke de elopmen
can boos inancial s abili y and limi exchange a e ola ili y, while his e ec being he
s onges in Sou heas -Asian coun ies, which end o ha e be e (compa ing o o he
eme ging ma ke s) iscal discipline and mo e quali ied mone a y au ho i ies.
The o iginal sin and so e eign bonds
As was men ioned, he oo s o o iginal sin lay in de eloping coun ies’ inabili y o
bo ow in local cu ency and, he e o e, cu ency misma ch o public e enues and

Volume 20, Issue 1, 2020
7
expendi u es. The nega i e e ec s o he o iginal sin a e bes obse ed du ing economic
u bulence, which, in de eloping coun ies, is almos always associa ed wi h cu ency
weakening. Empi ical esea ch shows ha oo much o eign cu ency in public deb
a ec s long- e m economic g ow h; enhances he p obabili y and he consequences o
inancial c ises; ceils he de elopmen o he local capi al ma ke and inancial sys em
(Bo do e al., 2009; Pa k e al., 2018; O onello and Pe ez, 2019).
The dynamics o so e eign deb cu ency composi ion and he o iginal sin i sel can be
bes obse ed in he case o so e eign bonds (Claessens e al., 2002; Pa k e al., 2018).
E en hough a subs an ial pa o many eme ging ma ke s’ public deb is composed o
o eign loans – ei he bila e al o hose om in e na ional ins i u ions – hese loans a e
and will be nomina ed in lende ’s cu ency (o some o he global cu ency). In he case
o local cu ency so e eign bonds’ emission is heo e ically cons ained only by he
absence o demand o such bonds. Bu i is s ill no comple ely clea why some
coun ies a e able o issue bonds in local cu ency while o he s ha e o ely on o eign
cu ency inancing.
I ’s e iden ha one o he easons is in local cu ency iskiness, which p oduces
ansac ion cos s o po en ial in es o s (Eicheng een e al., 2002). High p obabili y o
eme ging ma ke s’ cu ency weakening is implied by bo h speci ics o hei economic
de elopmen and hei go e nmen ’s and mone a y au ho i ies’ “ adi ional” beha io
(Jeanne, 2003; Bo do e al., 2009; Du e al., 2016).
A conside able sha e o de eloping coun ies has e y undi e si ied expo s’ s uc u e;
highly depends on p ice luc ua ions o expo ed mine al commodi ies; hea ily elies on
impo s o indus ial goods and o en doesn’ possess enough o eign ese es o enhance
he c edibili y o local cu ency (Bo do e al., 2009; Fuji, 2015). A he same momen ,
many o hose coun ies ha e some kind o pegged exchange a e egime (ei he de ju e
o de ac o), and i s p ese a ion may equi e cos ly cen al bank’s in e en ions (Cal o
and Mishkin, 2003; Le y-Yeya i and S u zenegge , 2016). Al hough hose ac o s speak
agains o eign cu ency bo owing (signaling p obable issues wi h deb epaymen in
case o un a o able economic de elopmen ), hey also unde mine he c edibili y o he
local cu ency, pu ing i unde dep ecia ing p essu e. In such cases local cu ency bonds
a e equi ed o o e e y s eep in e es a e o a ac in es o s, and such a e may be
disad an ageous du ing boom when local economy is g owing, and he cu ency is s able
and no equi ing in e en ions; and in he same ime hose bonds will be s ill isky due
o he possibili y o cu ency de alua ion ollowed by galloping in la ion, ha may u n
he yield in o nega i e (Du e al., 2016). F om he deb -holde s’ poin o iew local
cu ency dep ecia ion may be iewed posi i ely only in coun ies wi h ade su plus and
as -g owing expo s because o i s keen e ec on public inances and deb o ’s abili y o
pay – ei he high in e es in case o local cu ency deb o smalle one in case o o eign
cu ency (Fuji, 2015). While hose “expo ing” coun ies a e gene ally conside ed o be
less isky, hey usually ha e a la ge sha e o local cu ency on he o al ou s anding deb
amoun lowing om so e eign bonds
6
(Bo do e al., 2009; Fuji, 2015)
Ano he ma e cons aining he demand o eme ging ma ke s’ local cu ency bonds is
in es o s’ expec a ions ha mone a y au ho i ies, while holding he con ol o exchange
a e, may decide o ca y ou deb mone iza ion by allowing he cu ency o weaken, hus
6
While he undamen s may be “pe mi ing” hem o bo ow in o eign cu ency.
Re iew o Economic Pe spec i es
8
educing he eal amoun o so e eign deb
7
(Engel and Pa k, 2018). Ins i u ionally
unde -de eloped coun ies, which a e o en managed by poo ly quali ied o sho -sigh ed
poli icians, may be keen o e ase public deb by abandoning an i-in la iona y policy o
de aluing he local cu ency a he expense o bo h local popula ion and o eign
in es o s holding local cu ency bonds. Tha ’s why in es o s a e o en unwilling o
inance he go e nmen in local cu ency abo e a ce ain limi ; when ha limi (which is
e y subjec i e) is exceeded, he wo ies o possible deb mone iza ion g ow, and
lending shi s o o eign cu ency (Engel and Pa k, 2018). Because o ha go e nmen
can do no hing bu bo ow in o eign. This may be labeled as he ins i u ional cause o
public deb ’s cu ency imbalance (Jeanne, 2003; Engel and Pa k, 2018).
E en hough many ins i u ionally de eloped and mone a y s able coun ies s ill ha e a
la ge sha e o o eign cu ency on public deb and p e e (o ha e no o he op ion) o
issue o eign cu ency nomina ed bonds. Fu he causes may lay in lack o domes ic
in es o s’ (which would p e e local cu ency bonds – Bengui and Nguyen, 2016)
sou ces o unde -de elopmen o local bonds ma ke s (Pa k e al., 2018). The solu ion
may be ound in go e nmen suppo o bo h domes ic deb capi al ma ke s and he
demand o local cu ency ins umen s (Pa k e al., 2018).
Ye , s ill, he eme ging ma ke s’ so e eign bonds’ cu ency composi ion is g adually
be e ing (P esbi e o e al., 2015; Engel and Pa k, 2018; O onello and Pe ez, 2019).
Among he easons s a ed by schola s a e he imp o emen o de eloping coun ies’
ins i u ional en i onmen , mo e consis en and p o essional pe o mance o he mone a y
policy, inc ease o local cu ency c edibili y because o ixed exchange a e’s
abandoning – which educes he possibili y o deb mone iza ion (Engel and Pa k, 2018;
O onello and Pe ez, 2019). Al hough i ’s impo an o men ion ha his imp o emen
applies only o ce ain coun ies and egions (mainly Eas e n Eu opean EU-membe s and
some Eas -Asian s a es – Pa k e al., 2018), while o he s s ill ha e o s uggle wi h he
o iginal sin.
Exchange a e egime and he cu ency o so e eign deb
Fixed exchange a e egime is o en s a ed as one o he easons o de eloping coun ies’
o e - he- op o eign cu ency indeb edness and is conside ed o be he cause o deb
c ises occu ed in many La in Ame ican and Asian s a es in he second hal o he
nine ies (Eicheng een and Hausmann, 1999; Cal o and Reinha , 2002). Fixed a e may
c ea e an illusion o cu ency isks’ absence and hus s imula e domes ic demand o
o eign cu ency deb , and because du ing “good imes” ixed a e is pe cei ed as
sus ainable (and mone a y au ho i ies – as us wo hy and ha ing hings in con ol), he
use o o eign cu ency is widening (Eicheng een and Hausmann, 1999). Domes ic
liabili ies (bo h p i a e and public) end o dolla ize (Eicheng een and Hausmann, 1999).
Bu when o eign capi al lows o expo e enues a e dec easing, he s a e s ill has o
epay i s o eign cu ency obliga ions and in e ene o main ain he pegged a e. Such
si ua ions usually lead o cu ency de alua ions, which only deepen he p oblem o he
o eign cu ency nomina ed public deb (Cal o and Mishkin, 2003). Nume ous expe s
also conside ixed exchange a e egime o be he sign o less de eloped mone a y
policy pe se and ha pegged a e is usually ound in ins i u ionally poo coun ies,
7
The p obabili y o ha ises wi h lesse deg ee o mone a y au ho i ies’ independence.
Volume 20, Issue 1, 2020
9
which also a ec s local cu ency c edibili y, so e eign c edi a ing and coun ies’
abili y o issue local cu ency bonds (Velasco, 1999; Hausmann e al., 2002; Claessens e
al., 2002; Bo do e al., 2009).
On he o he hand, he lexible a e wasn’ always conside ed a good op ion o
de eloping coun ies (To nell and Velasco, 1995). Thei economic g ow h ola ili y and
nume ous c ises signaled ha hei cu ency would end o dep ecia e and hus keep bo h
in la ion and in e es a es high o he deg ee whe e i would decele a e economic
g ow h. Though i applied (and s ill applies) o ce ain coun ies, empi ical es s b ing
di e en esul s (Bo do e al., 2009). De eloping coun ies wi h lexible exchange a e
a e mo e poli ically and economically s able; end o ha e a quicke eac ion owa ds
ex e nal mac oeconomic h ea s; a e able o pe o m mo e consis en and high-quali ied
economic policy (Cal o and Reinha , 2002). I was also p o ed, ha coun ies wi h
loa ing exchange a e (bo h de eloped and de eloping) a e less a ec ed by he o iginal
sin p oblem (Hausmann e al., 2002; Claessens e al., 2002).
Nowadays de eloping coun ies a e going h ough g adual libe aliza ion o exchange
a e egime (Le y-Yeya i and S u zenegge , 2016; AREAER IMF Da abase, 2019). The
numbe o coun ies wi h pegged a e is dec easing,
8
al hough his egime is usually
abandoned as a esul o economic and cu ency c isis (Le y-Yeya i and S u zenegge ,
2016). The cos ly and economically des abilizing ixed a e emains p e oga i e o ei he
ich oil-expo ing coun ies, which can gua an ee he a e due o huge expo s e enues;
o less de eloped coun ies wi h weak economic ins i u ions. The exchange a e
libe aliza ion is also associa ed wi h de eloping coun ies’ g owing ac i i ies on global
deb capi al ma ke s (P esbi e o e al., 2015; Pa k e al., 2018).
Al hough i ’s impo an o men ion ha in he case o de eloping coun ies, he exchange
a e egime hey p oclaim o ha e is no always he egime hey ac ually ha e (Velasco,
1999; Cal o and Reinha , 2002). Nume ous o icially “ loa ing coun ies” s ill p ese e
some deg ee o con ol o e he exchange a e and in e ene when needed, o e en use
adminis a i e exchange a e es ic ions (Le y-Yeya i and S u zenegge , 2016). A
misma ch be ween de ju e and de ac o exchange a e egime is conside ed o be o
nega i e e ec on he o iginal sin (Eicheng een e al., 2002). A he same momen , he
de ju e exchange a e libe aliza ion is aking place much as e han he ac ual ixed- o-
loa ing shi (AREAER IMF Da abase, 2019).
The e a e e en opinions ha exchange a e egime’s (ei he de ac o o de ju e) impac
on de eloping coun ies’ iscal policy, and deb cu ency is highly o e es ima ed (Cal o
and Mishkin, 2003). In hese coun ies, exchange a e egime is jus an “ou pu ” o
gene al ins i u ional de elopmen and economic policymake s’ quali ica ion, while only
his o ical and expec ed ola ili y o na ional cu ency ( ega dless he exchange a e ype)
is signi ican in de e mining he deg ee o o iginal sin (Cal o and Mishkin, 2003). Gi en
ha de eloping coun ies’ cu encies a e no always mo e s able unde ixed exchange
a e han unde loa ing, eal exchange a e luc ua ions (meaning hose o nominal a e
and domes ic p ice le el – Mussa, 1986) and hus indi ec ly he luc ua ions o
go e nmen bonds’ yield a e de e mining i he local cu ency will be conside ed
us wo hy enough by o eign in es o s (Cal o and Mishkin, 2003). In he same
8
The ela ionship be ween exchange a e egime and o eign cu ency so e eign deb is insinua ed
by oday’s decline o de eloping coun ies’ o iginal sin (Pa k e al., 2018).
Re iew o Economic Pe spec i es
10
momen s able eal exchange a e esul s om e icien mone a y policy and is
encoun e ed mos ly in mo e ad anced and in e na ionally in eg a ed coun ies, which a e
able o issue local cu ency bonds and a e no subjec o o iginal sin (Ca e a and
Vule in, 2003).
Acco ding o he abo e-men ioned indings and es s’ esul s, we can assume ha he
exchange a e egime may be a c ucial de e minan o so e eign bonds’ emission
cu ency. Taking ha in o conside a ion, we see a necessi y o empi ical e i ica ion o
he ela ionship be ween he sha e o local/ o eign cu ency on he o al ou s anding
amoun o issued go e nmen bonds on he one hand; and ype o exchange a e egime
on he o he hand. Since he objec o his pape ’s analysis being eme ging ma ke s, i is
app op ia e o use no only de ju e exchange a e egime classi ica ion, bu also de ac o
one (see he nex chap e , such classi ica ion can be ound in Le y-Yeya i and
S u zenegge , 2016; o in IMF epo s). In eac ion o pape by Cal o and Mishkin
(2003) we also assume ha eal exchange a e luc ua ions a e o big in luence on
go e nmen ’s iscal policy and app oach o deb ’s cu ency; hus, he ela ionship
be ween eal exchange a e ola ili y and so e eign bonds’ cu ency composi ion should
also be examined.
Empi ical analysis and discussion
This chap e p esen s he econome ic es ima ion o he exchange a e egime’s and eal
exchange a e ola ili y’s in luence on so e eign bonds’ cu ency composi ion o
selec ed eme ging ma ke s. The es ima ion is conduc ed using panel da a o 13
coun ies.
9
The choice o he coun y sample was based on he ollowing condi ions:
• The coun ies should be classi ied as eme ging ma ke s ei he by IMF o EM Bond
Index and MSCI, which is ele an owa ds hei posi ion in he in e na ional bond
ma ke s.
• The coun ies should be ca ego ized as ei he high- o medium-income by he Wo ld
Bank classi ica ion.
• Selec ed coun ies should ha e a con e ible cu ency based on AREAER IMF
(2019) and be ac i e on in e na ional bond ma ke s as epo ed by he Bank o
In e na ional Se lemen s.
• The coun ies should be co e ed by he pas esea ch on his opic ound ei he in
Claessens e al. (2002) o Eicheng een e al. (2002).
• The e should be long enough ime se ies on hei bonds’ cu ency s uc u e,
co e ing a leas a pe iod om 2000 o 2018.
The analysis co e s he pe iod om 2000 o 2018 (annual da a we e used) and hus
conside ably upda es he wo ks by Claessens e al. (2002) and Eicheng een e al. (2002).
Me hodology, dependen , independen , and con ol a iables a e p esen ed below.
9
A gen ina, B azil, Chile, China, C oa ia, Hunga y, India, Indonesia, Is ael, Saudi A abia, Sou h
A ica, Sou h Ko ea, Thailand.
Volume 20, Issue 1, 2020
17
disp o es he assump ion ha highe ese es make he domes ic cu ency mo e c edible
and hus iable o local cu ency bonds’ emission. Lending in e es a e also p o ed o
be s a is ically signi ican , and i s sign indica es ha wi h he a es’ inc ease he coun ies
end o swi ch o o eign cu ency bo owing and subjec hemsel es o he o iginal sin.
The posi i e sign o iscal eedom in models 2 and 4 is in line wi h con en ional
wisdom. The o he ins i u ional index, which is signi ican ac oss he es ima ions, has a
sign ha is di icul o in e p e – he only explana ion may lay in he mo e economically
ee and ad anced coun ies’ be e abili y o handle o eign cu ency deb .
Table 4. Reg ession esul s
Va iable
Model 1
Model 2
Model 3
Model 4
Economic
openness
0,001554***
[14,92280]
0,001493***
[15,35895]
-0,000646***
[-3,577154]
0,001125***
[12,50731]
Log (GDP)
0,001554***
[23,79002]
0,077056***
[19,36152]
-0,027050***
[-4,326694]
0,049547***
[18,36383]
In la ion
1,23E-0,5
[0,048774]
0,000556**
[1,990660]
0,000298
[0,479941]
0,000552*
[1,858789]
Lending in e es
a e
-0,001730***
[-13,00697]
-0,002229***
[-26,44473]
-0,001197***
[-4,930028]
-0,001692***
[-14,09331]
FX ese es o
GDP
-0,043628***
[-3,635235]
-0,042668***
[-3,156194]
-0,027724
[-0,987294]
-0,046861***
[-4,080102]
Ec. eedom index
-0,001554***
[-12,14082]
-0,002302***
[-18,01679]
-0,004637***
[-9,853612]
-0,002376***
[-13,95463]
Fisc. eedom
index
-8,99E-05
[-0,505199]
0,000656***
[3,974075]
-0,000266
[-0,609449]
0,000340*
[1,907734]
De Ju e IMF
0,061089***
[9,382657]
De Fac o IMF
0,022366***
[10,59952]
De Fac o LYS
0,000895
[0,364324]
REER Vola ili y
-0,000976**
[-2,126149]
Numbe o
obse a ions
220
220
156
220
J-s a is ic
109,5810
112,7533
77,39262
119,9658
Pe iod dummy
a iable
Yes
Yes
Yes
Yes
Sou ce: au ho ’s own calcula ions.
No e: T-s a is ic in b acke : (*) 10% le el o signi icance, (**) 5% le el o
signi icance, (***) 1% le el o signi icance
The posi i e sign o explana o y a iables in models 1 and 2 shows ha coun ies wi h
lexible exchange a e egime (ei he de ju e o de ac o) ha e a la ge sha e o local
cu ency on issued so e eign bonds. These indings con i m he heo e ical explana ion
o exchange a e lexibili y’s posi i e in luence on he o iginal sin – ei he because o
lowe c edibili y o he ixed exchange a e in eme ging ma ke s; ei he due o, in

Re iew o Economic Pe spec i es
18
gene al, lowe quali y o mone a y policy in coun ies wi h ixed a e (see he p e ious
chap e ). The need o p ese e ixed a e is limi ing mone a y au ho i ies’ capabili ies o
s imula ing he economy in case o need and also equi es signi ican o eign exchange
expendi u es when he in lows dec ease ( o example, in case o expo ed commodi ies’
p ices dec ease, which is a common h ea o many analyzed coun ies). All his
inc eases he iskiness o domes ic cu ency and suppo s o eign cu ency bonds’
emission. On he o he hand, coun ies wi h a lexible exchange a e may be pe cei ed as
less isky because o he lexible a e’s abili y o es ic he mac oeconomic imbalance
accumula ion and while his egime may be an indica o o he go e nmen ’s us in o
he s a e’s own cu ency.
In model 4 we disco e ed a nega i e ela ionship be ween eal exchange a e ola ili y
and local cu ency’s sha e on o al deb om public bonds ( hus coun ies wi h less
ola ile eal exchange a e a e mo e success ul in o e coming he o iginal sin). The eal
exchange a e’s s abili y means ha cu ency weakening co esponds o he di e en ial
be ween domes ic and o eign in la ion, which makes he bonds’ eal yield mo e
pe sis en . I bo h ypes o he a iables (exchange a e egime and eal exchange a e
ola ili y) in luence he o iginal sin he way he eg ession disco e ed, i may be indi ec
suppo o Ca e a and Vule in’s (2003) indings, which disco e ha coun ies wi h
lexible exchange a e egime end o ha e less ola ile eal exchange a e. Based on ha ,
lexible exchange a e may be in luencing he o iginal sin ei he di ec ly o due i s’
s abilizing impac on eal exchange a e
15
, while ixed exchange a e egime (which, in
he same momen , can be a sou ce o eal exchange a e’s ola ili y) is damaging he
local cu ency’s a ac i i y o o eign in es o s and suppo s o eign cu ency
so e eign bonds emission.
The esea ch could be subjec ed o ce ain limi a ions a ising mos ly om he da a
a ailabili y, coun y sample, and employed me hodology. The analysis co e s only he
o eign deb om go e nmen bonds, wi h o al o eign cu ency deb being beyond he
each o his pape . Thus, he abo e-men ioned ecommenda ions on he exchange a e
policy and i s possible impac on he o iginal sin a e ele an only o he coun ies
bo owing on he bond ma ke s. As i was men ioned be o e, he bo owe usually can’
in luence he cu ency o he bila e al loans ecei ed, so he na ions elying on di ec
o eign inancing wouldn’ be able o bene i (in e ms o he o iginal sin) om he
exchange a e egime libe aliza ion o eal exchange a e s abiliza ion. The esea ch
co e s mo e de eloped na ions, so he inclusion o less de eloped coun ies, ha ha e
become mo e ac i e on he in e na ional bonds ma ke s as s a ed by P esbi e o e al.
(2015), could ha e changed he esul s
16
. Al hough se e al ecen pape s ( o example,
Pa k e al., 2018) s a e ha cu ency s abiliza ion, in gene al, is ied o local bond
ma ke s de elopmen , con en ional wisdom sugges s ha smalle and less de eloped
coun ies will s ill need a ixed a e o in oke us in hei lende s.
Al hough a s a is ically signi ican ela ion be ween exchange a e egime and so e eign
bonds’ cu ency was disco e ed, we should s ill pay a en ion o Cal o and Mishkin’s
15
Al hough, o cou se, his p esump ion would equi e an empi ical con i ma ion which is beyond
his pape ’s opic.
16
Once again, we we e dep i ed o his possibili y by oo sho ime se ies a ailable o a b oade
se o coun ies, bu u u e esea ch could make his issue clea .
Volume 20, Issue 1, 2020
19
(2003) hough s conce ning he limi ed impac o exchange a e egime on he exchange
a e s abili y and hus he o iginal sin. The model 4 disco e s he posi i e ela ion
be ween eal exchange a e s abili y and local cu ency bonds’ s ock, hus he pape ’s
indings may be pe cei ed no as “libe alize he exchange a e policy” bu “s abilize bo h
he exchange a e and p ice le el”, which is less achie able by adminis a i e means and
mone a y policy adjus men s; and mo e dependen on ex e nal ac o s.
Conclusion
Fo eign cu ency public deb is a common headache o less de eloped coun ies ha
don’ possess well-de eloped ins i u ions and economic policy while s uggling wi h he
mac oeconomic imbalance and local cu ency ola ili y. Academics labeled his issue as
he o iginal sin. The o iginal sin is p o ed o ha e a nega i e in luence on de elopmen
by inc easing economic g ow h’s ola ili y and equi ing cos ly hedging (Eicheng een e
al., 2002; O onello and Pe ey, 2019). In gene al, dealing wi h he o iginal sin equi es
an inc ease o he local cu ency’s c edibili y o make i mo e a ac i e as an in es men
ins umen . Thus, he demand o local cu ency nomina ed so e eign bonds should ise
(Eicheng een and Hausmann, 1999; Bo do e al., 2009).
Cu ency’s s abili y is highly in luenced by mone a y policy and exchange a e egime
(To nell and Velasco, 1995; Eicheng een and Hausmann, 1999), and in less de eloped
coun ies ixed exchange a e is pe cei ed as nega i e in e ms o he o iginal sin
(Claessens e al., 2002; Bo do e al., 2009). This pape is ying o e i y his pe cep ion
using ac ual da a.
We e alua ed he in luence o exchange a e egime on cu ency composi ion o 13
eme ging ma ke s’ so e eign bonds o he pe iod om 2000 un il 2018. Bo h o mal
and de ac o ypes (as classi ied by IMF and Le y-Yeya i and S u zenegge , 2016) o he
exchange a e egime we e used as explana o y a iables. Taking in o conside a ion
Cal o and Mishkin’s (2003) s a emen on exchange a e egime’s limi ed in luence on
iscal policy and cu ency s abili y in eme ging ma ke s, we employed eal exchange a e
ola ili y as an addi ional explana o y a iable.
We p o ed exis ence o he s a is ically signi ican posi i e ela ionship be ween
exchange a e lexibili y (bo h de ju e and de ac o as classi ied by IMF) and domes ic
cu ency’s sha e on o al so e eign deb ’s amoun lowing om bonds o he selec ed
coun ies – hose wi h lexible exchange a e a e less a ec ed by he o iginal sin. A he
same momen , we disco e ed a nega i e ela ionship be ween eal exchange a e
ola ili y and local cu ency bonds’ sha e. This con i ms heo e ical s a emen s abou he
low c edibili y o he ixed exchange a e egime in eme ging ma ke s, wi h he ixed
a e inc easing he local cu ency’s iskiness. As he ixed exchange a e is p e alen
among he coun ies wi h less quali ied mone a y au ho i ies (Ca e a and Vule in,
2003), we can assume ha swi ch o lexible exchange a e may be pe cei ed as a sign o
mo e “ma u e” economy and would ha e posi i e in luence on local cu ency’s
a ac i i y (as an in es men ins umen ). Abandoning o he ixed exchange a e and
enhancemen o mone a y policy (aiming o eal exchange a e s abiliza ion) should be
among he goals o coun ies pu suing he educ ion o o eign cu ency bo owing and
elimina ion o he o iginal sin. E en hough, i should be men ioned ha he esea ch
co e ed only mo e de eloped na ions wi h highe ac i i y on in e na ional bond ma ke s,
Re iew o Economic Pe spec i es
20
so i s indings may be i ele an o less ad anced na ions ha ha e s a ed o issue
so e eign bonds ecen ly. They may no be bene i ing om he exchange a e egime
libe aliza ion due o hei mone a y au ho i ies’ lack o quali ica ion and c edibili y. The
esea ch also doesn’ add ess he si ua ions when he o iginal sin’s oo s lay in loan-
based o eign cu ency bo owing, which is less common among he analyzed coun ies
bu can become ele an in case o economic u bulence hey may encoun e .
Funding: This wo k was suppo ed by p ojec IGA VŠE IG106017 “Mak o inančn
s abili a a inančn cyklus zemch s nega i n čis ou in es ičn pozic”.
Disclosu e s a emen : No po en ial con lic o in e es was epo ed by he au ho .
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