Relationships between exchange rate regime, real exchange rate volatility and currency structure of government bonds in emerging markets

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, h ps://doi.o g/10.2478/ e ecp-2020-0001 This Ve sion is a ailable a : h ps://hdl.handle.ne /10419/227538 S anda d-Nu zungsbedingungen: Die Dokumen e au EconS o dü en zu eigenen wissenscha lichen Zwecken und zum P i a geb auch gespeiche und kopie we den. Sie dü en die Dokumen e nich ü ö en liche ode komme zielle Zwecke e iel äl igen, ö en lich auss ellen, ö en lich zugänglich machen, e eiben ode ande wei ig nu zen. 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I he documen s ha e been made a ailable unde an Open Con en Licence (especially C ea i e Commons Licences), you may exe cise u he usage igh s as speci ied in he indica ed licence. h ps://c ea i ecommons.o g/licenses/by-nc-nd/3.0/ Re iew o Economic Pe spec i es – Ná odohospodářský obzo Vol. 20, Issue 1, 2020, pp. 3–22, DOI: 10.2478/ e ecp-2020-0001 © 2020 by he au ho s; licensee Re iew o Economic Pe spec i es / Ná odohospodářský obzo , Masa yk Uni e si y, Facul y o Economics and Adminis a ion, B no, Czech Republic. This a icle is an open access a icle dis ibu ed unde he e ms and condi ions o he C ea i e Commons A ibu ion 3.0 license, A ibu ion – Non Comme cial – No De i a i es. 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 . 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