A large portion of external borrowing by emerging market economies is denominated in foreign currency---defining the so-called ``original sin’’ of these countries. Foreign currency borrowing itself is a source of economic vulnerability---it amplifies the depth of crises, as crises are typically associated with currency depreciation that exacerbates the burden of foreign currency debt. In the last decades, many emerging market economies have managed to raise the share of domestic-currency denominated debt. Nonetheless, on average, emerging market sovereigns still rely significantly on foreign currency borrowing, thereby exposing their balance sheets to currency mismatch. Over the period from 2004 to 2018, the average portion of external public debt denominated in foreign currency stands at approximately 80% (Lee 2022)
The project is structured around the long-standing questions in international macroeconomics, both positive and normative: why do emerging economies borrow substantially in foreign currency? how can an economy ``graduate from the original sin’’?
The project's trajectory involves acknowledging that debt denominations in emerging economies emerge from a nuanced interplay between sovereign risk and monetary policies. Economic modeling presents an opportunity to establish a viable analytical framework, serving as a coherent structure wherein these two components are addressed in distinct chapters within the same overarching agenda.
The project aligns with the fundamental objectives of the Keynes funds through a two-pronged approach. First, it investigates monetary regimes in the presence of ``original sin’’, with the aim of effectively reducing the occurrence and severity of financial crises. It examines how enhancing monetary credibility can lead to an increase in domestic currency borrowing, consequently mitigating the overall financial vulnerability of a nation. Second, it delves into the impact of default risk on financial markets and its influence on the cyclicality of emerging economies. Specifically, the project centers on identifying the key determinants of foreign currency borrowing in emerging economies and exploring the role of monetary policy in addressing the currency mismatch within a sovereign's balance sheet.
