Why Can't Developing Countries Borrow from Abroad in Their Currency?

30 Pages Posted: 5 Dec 2002

See all articles by Marcos Chamon

Marcos Chamon

International Monetary Fund (IMF) - Research Department

Date Written: May 2003

Abstract

This paper analyzes the different implications of denominating foreign debt in a tradable or in a nontradable good, analogous to foreign currency and a local price index respectively. While the price of tradables is exogenous to a small open economy, the price of nontradables reacts to the shocks it experiences, being high (low) following a good (bad) shock. Since defaults are correlated with large real depreciations, debt denominated in the tradable good will have a relatively higher face-value in those states. If there are large deviations from strict creditor seniority enforcement, a nontradable denominated debt holder's claim on a borrower's bankrupt firm can be expropriated through additional borrowing denominated in the tradable good. This dilution mechanism is an inefficient expropriation technology, whose cost is borne by the borrower in equilibrium. That discourages the use of nontradable denominated instruments, even though they can improve international risk sharing and help prevent financial crises.

Keywords: Financial Indexation, Dollarization, International risk sharing

JEL Classification: F30, F32, F34

Suggested Citation

Chamon, Marcos, Why Can't Developing Countries Borrow from Abroad in Their Currency? (May 2003). Available at SSRN: https://ssrn.com/abstract=320001 or http://dx.doi.org/10.2139/ssrn.320001

Marcos Chamon (Contact Author)

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-5867 (Phone)

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