Original sin

1
The Pain and the Mystery of Original Sin
Barry Eichengreen Ricardo Hausmann Ugo Panizza
2
Outline and Summary

• Definition and Facts
• Most countries do not borrow abroad in their own
  currencies, a problem we refer to as original
  sin
• If a country has a net foreign debt, this creates
  an aggregate currency mismatch
• Of course a country can decide not to have a
  mismatch by not borrowing or holding a lot of
  reserves
• Pain
• We show that original sin is associated with
  limited XR flexibility, high volatility, low
  credit ratings
• Mystery
• We show that standard explanations based on poor
  policies or institutions do not do a good job at
  explaining original sin

3
Work on Original Sin

• First papers on the topic
• Eichengreen and Hausmann (1999)
• Hausmann, Panizza, and Stein (2001)
• Hausmann and Panizza (2003)
• Original Sin book
• Cespedes, Chang and Velasco, Corsetti and
  Mackowiak, Jeanne, Jeanne and Zettelmeyer,
  Flandreau and Sussman, Bordo, Meissner and
  Redish, Chamon and Hausmann
• Critics
• Goldstein and Turner (2003)
• Burger and Warnock (2003)
• Reinhart, Rogoff, and Savastano (2003)
• Eichengreen, Hausmann, and Panizza (2003)

4
Definition

• Eichengreen and Hausmann (1999) definition a
  situation in which the domestic currency is not
  used to borrow abroad or to borrow long term even
  domestically
• Here we mostly focus on international original
  sin
• Better data on international original sin
• Domestic original sin seems easier to solve and
  some countries are doing progress in this
  direction
• However, we also try to say something on
  domestic original sin

5
A first look at the problem Distribution of
international debt by issuers and currencies
(1999-2001)
1
0.9
Debt by
currency
0.8
Debt by
country
0.7
5.6 trillion
0.6
4.5 trillion
0.5
0.4
0.3
USA
Euroland
Japan
UK
Switzerland
Canada
Australia
6
Is this because countries do their local currency
funding on the home market and foreign currency
funding abroad?
100
90
Debt by currency
632 billion
80
70
60
473 billion
50
40
30
Debt by country
20
10
0
USA
EURO
JAPAN
CANADA
UK
7
Measurement

• Measuring original sin is not straightforward
• In principle, we want to measure external
  liabilities in own currency as a share of total
  external liabilities
• We use data gathered by the BIS on the currency
  denomination of bonds and money market
  instruments
• We also consider BIS data on cross-border bank
  lending, although the data are less complete
  (both in country coverage and currency breakdown)

8
Main index used in the paper
ö
æ
currency
in

Securities
i

ç
-

0
,
1
max
3
OSIN

ç
i
country
by

issued

Securities
i
ø
è
It captures opportunities for hedging through
swaps It recognizes that you cannot hedge more
than 100 percent of your debt
9
Alternative indexes
i
i
country
by

issued

currency
in

securities
-

OSIN1
1
i
country
by

issued

securities
Uses bank loans
OSIN2
Like OSIN3 but can take negative values
OSIN3b
10
Measures of original sin by country groupings
1
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
Financial Centers
Euroland
Other Developed
Developing
OSIN1
OSIN3
11
Original Sin in Developing Countries
12
Original sin is highly persistent OSIN and
Flandreau-Sussman classification (circa 1850)

13
The Pain of Original Sin

• (The consequences)

14

• Exchange rate flexibility
• Output and capital flow volatility
• Credit ratings

15
Original Sin and Exchange Rate Flexibility

• If an original sin country has a net foreign
  debt, then there is an aggregate currency
  mismatch. Movements in the RER will have an
  aggregated wealth effect
• This renders the CB less willing to let the
  exchange rate move (fear of floating, Calvo and
  Reinhart, 2002)
• As a consequence, the CB holds more reserves and
  uses them, together with the interest rate, to
  intervene in the foreign exchange market
  (Hausmann, Panizza, Stein, 2001)

16
Original Sin and Exchange Rate Flexibility

(1)

(2)

(3)

(4)

(5)

(6)





Dropping Financial Centers


LYS

RESM2

RVER

LYS

RESM2

RVER

OSIN3

1.503

0.248

-
0.801

1.112

0.339

-
0.598


(3.56)
(3.74)

(2.02)

(2.45)

(3.10)


(1.33)


GDP_PC

0.302

-
0.053

0.026

0.285

-
0.052

0.025


(2.89)
(1.85)

(0.61)

(2.77)
(1.81)

(0.56)




OPEN

0.198

-
0.014

1.017

0.153

-
0.014

1.021


(0.92)

(0.41)

(2.88)

(0.72)

(0.41)

(2.93)

EXD/GDP

0.290

-
0.036

-
0.570

0.297

-
0.030

-
0.544


(0
.96)

(0.66)

(2.36)

(0.98)

(0.54)

(2.29)

Constant

-
2.188

0.531

0.104

-
1.644

0.435

-
0.084


(1.94)

(1.73)

(0.17)

(1.46)

(1.35)

(0.13)

Observations

75

65

65

71

62

62


R
-
squared


0.37

0.62


0.34

0.65

17
Original Sin and Exchange Rate Flexibility

• The results are generally robust to alternative
  definitions of original sin, to dropping weights,
  and to augmenting the regressions with a
  developing country dummy
• Causality is a big issue (Burnside, Eichenbaum,
  and Rebelo, 2001)
• IV regressions confirm the results but instrument
  (SIZE) is lousy
• We tried to go in the other direction. OSIN on
  the left and LYS on the right instrumented with
  openness. We found no correlation between LYS and
  OSIN
• Using lagged OSIN in a panel confirms the results
• Devereux and Lane (2003)

18
Original Sin, Output and Capital Flow Volatility

• Original sin limits the scope and effectiveness
  of counter-cyclical policies (Cespedes, Chang and
  Velasco, 2003)
• Original Sin limits the CB ability of acting as a
  LOLR (Chang and Velasco, 2000)
• Dollar liabilities are likely to increase the
  cost of a currency crisis
• Dollar liabilities could be associated with
  Sudden Stops in capital flows (Calvo, Izquierdo
  and Mejia, 2003)

19
Original Sin, Output and Capital Flow Volatility

(1)

(2)

(3)

(4)




Dropping Financial Centers


VOL_GROWTH

VOL_FLOW

VOL_GROWTH

VOL_FLOW

OSIN3

0.011

7.
103

0.015

7.498


(1.96)

(3.58)

(2.45)

(2.69)

LGDP_PC

-
0.012

-
3.214

-
0.012

-
3.322


(2.14)

(2.56)

(2.09)

(2.40)

OPEN

-
0.001

-
4.181

-
0.000

-
4.333


(0.12)

(1.20)

(0.08)

(0.83)

VOL_TOT

-
0.000

0.223

-
0.000

0.223


(0.86)

(1.08)

(0.89)

(1.02
)

SHARE2

-
0.014

0.147

-
0.015

0.949


(1.72)

(0.04)

(1.51)

(0.14)

Constant

0.135

32.825

0.131

33.282


(2.25)

(2.39)

(2.15)

(2.22)

Observations

77

33

73

29

R
-
squared

0.40

0.64

0.40

0.62


20
Original Sin and Credit Ratings

• If a countrys debt is denominated in foreign
  currency, its capacity to pay will not be related
  to its LCU GDP but to its dollar GDP
• Original Sin makes the real exchange rate matter
  for debt service
• This is important because in developing countries
  the volatility of dollar GDP is much higher than
  the volatility of LCU GDP, and sudden drops of
  dollar GDP are usually associated with much
  smaller drops in real GDP
• Other things equal, countries with Original Sin
  should be riskier than countries that borrow in
  own currency

21
Original Sin and Credit Ratings

(1)

(2)

(3)

(4)


RATING

RATING

RATING

RATING




Dropping Financial
Centers

OS
IN3

-
5.845

-
5.644

-
5.214

-
4.955


(4.08)

(4.01)

(3.31)

(3.21)

DE_GDP

-
2.421


-
2.285



(2.50)


(2.32)


DE_RE


-
0.999


-
0.975



(2.49)


(2.39)

LGDP_PC

2.916

2.670

2.976

2.729


(8.48)

(6.16)

(8.36)

(5.97)

SHARE2

2.187

2.
787

1.810

2.405


(1.43)

(1.52)

(1.09)

(1.18)

Constant

-
8.058

-
5.962

-
9.119

-
7.037


(2.12)

(1.28)

(2.29)

(1.44)

Observations

56

49

53

46


22
The Mystery of Original Sin

• (the causes)

23
Key Question from this Point of View

• Does the inability to borrow internationally in
  domestic currency reflect problems with country
  policies and institutions or systematic problems?
• We argue that the problem is too pervasive (and
  too weakly correlated with country
  characteristics) to be entirely explicable on the
  first set of grounds.

24
Five possible explanations

• Underdevelopment of institutions and policies in
  general
• Inadequate monetary credibility
• Fiscal profligacy
• Weak contract enforcement
• Political economy stories

25
Original Sin and the Level of Development

(1)

(2)

(3)


OSIN3

OSIN3

OSIN3

LGDP_PC

-
0.141

-
0.128

-
0.170


(1.59)

(1.43)

(2.99)

SIZE

-
0.310

-
0.310

-
0.415


(3.37)

(3.33)

(4.51)

FIN_CENTER

-
0.680




(1.99)



EUROLAND

-
0.126

-
0.152



(0.62)

(0.74)


OTH_DEVELOPED

0.007

-
0.021



(0.03)

(0.10)


Constant

2.522

2.414

2.833


(3.39)

(3.24)

(5.46)

Observations

75

71

75


26
Original Sin and Monetary Credibility

• Lack of monetary credibility is the true cause of
  Original Sin (Jeanne, 2002)
• The government has an incentive to inflate away
  domestic currency debt held by foreigners, and
  the presence of foreign currency debt can act as
  commitment device and improve credibility
  (Tirole, 2002, Calvo and Guidotti, 1990)
• Why dont we observe inflation indexed debt?
  (Chamon, 2002)

27
Original Sin and Monetary Credibility

(1)

(2)

(3)

(4)

(5)

(6)






Dropping

Financial
Centers


OSIN3

OSIN3

OSIN3

OSIN3

OSIN3

OSIN3

AV_INF

0.306


0.436





(1.19)


(0.69)




AV_INF2



-
0.116







(0.23)




MAX_INF


0.067







(0.95)





INF




0.085

0.083

0.175





(1.09)

(1.07)

(2.08)

SIZE

-
0.318

-
0.318

-
0.316

-
0.318

-
0.318

-
0.503


(3.57)

(3.54)

(3.52)

(3.55)

(3.50)

(5.75)

FIN_CENTER

-
0.866

-
0.897

-
0.857

-
0.881




(2.88)

(2.99)

(2.83)

(2.93)



EUROLAND

-
0.304

-
0.329

-
0.296

-
0.315

-
0.318



(2.12)

(2.31)

(1.99)

(2.21)

(2.21)


OTH_DEVELOPED

-
0.199

-
0.224

-
0.192

-
0.211

-
0.213



(1.47)

(1.67)

(1.37)

(1.56)

(1.57)


Constant

1.277

1.310

1.259

1.346

1.347

1.358


(10.87)

(11.60)

(8.83)

(13.56)

(13.46)

(13.41)

Observations

74

74

74

74

70

74


28
Original Sin and Monetary Credibility

.363081


RUS

ARG

UKR


P
ER
ROM




NIC
e( OSIN3 X)
-
.893699

-
.246179

1.48963

e( AV_INF X )

29
Original Sin and Monetary Credibility

• Low inflation seems to be a necessary but not
  sufficient condition for escaping Original Sin
• Results are robust to longer lags (1970s)
• They are robust to instrumenting inflation with
  an index of CB independence

30
Original Sin and Fiscal Solvency

• A government with weak fiscal accounts has an
  incentive to debase its currency in order to
  erode the value of its real obligations (Lucas
  and Stokey, 1983)
• Corsetti and Mackowiack (2002) find that there is
  a vicious circle in which, in the presence of
  weak public finances, a large stock of foreign
  currency debt limits the ability to borrow in
  domestic currency

31
Original Sin and Fiscal Solvency

(1)

(2)

(3)

(4)

(5)

(6)

(7)


OSIN3

OSIN3

OSIN3

OSIN3

OSIN3

OSIN3

OSIN3

DE_GDP

-
0.073






0.050


(0.50)






(0.31)

DEFICIT


1.777








(0.92)






DE_RE



0.014








(0.24)





FISC




-
0.025

-
0.024







(0.30)

(0.28)



DE_GDPDEV






0.247








(0.88)


DE_
GDPIND






-
0.186








(1.13)


SIZE


32
Original Sin and Contract Enforcement

• Investors are reluctant to lend in countries
  where the institutions designed to enforce their
  claims are weak
• Chamon (2002) and Aghion, Bacchetta and Banerjee
  (2001) show that if depreciation and default risk
  are correlated and, if in case of default, assets
  are divided among creditors in proportion to
  their nominal claims, domestic currency market
  will disappear
• This problem could be solved if courts could
  enforce complicated contracts that distinguish
  among creditors of different seniority

33
Original Sin and Contract Enforcement

(1)

(2)

(3)


OSIN3

OSIN3

OSIN3

RULEOFLAW

-
0.050

-
0.053

-
0.182


(0.46)

(0.49)

(2.33)

SIZE

-
0.323

-
0.322

-
0.480


(3.53)

(3.48)

(5.32)

FIN_CENTER

-
0.883




(2.65)



EUROLAND

-
0.326

-
0.325



(1.81)

(1.79)


OTH_DEVELOP
-
0.203

-
0.201


ED


(1.03)

(1.01)


Constant

1.388

1.390

1.486


(13.17)

(13.08)

(12.33)

Observations

75

71

75


34
Original Sin and Political Economy

• Original sin could be due to the absence of a
  domestic constituency of local currency
  debt-holders prepared to penalize a government
  that debase the currency
• Tirole (2002) suggests that Original Sin may
  arise from the governments inability to commit
  to protect the rights of foreigners

35
Original Sin and Political Economy

(1)

(2)

(3)

(6)



OSIN3

OSIN3

OSIN3

OSIN3


DC_GDP

-
0.332




-
0.554


(1.49)




(2.99)

FOR_DOM


-
7.289

7.224




(2.15)

(0.86)












SIZE

-
0.290

-
0.360

-
0.323

-
0.399


(3.22)

(4.02)

(3.72)

(4.47)

FIN_CENTER

-
0.75
3

-
0.843

-
0.895



(2.40)

(3.02)

(3.23)


EUROLAND

-
0.226

-
0.301

-
0.299



(1.37)

(2.34)

(2.42)


OTH_DEVELOPED

-
0.224

-
0.223

-
0.254



(1.75)

(1.86)

(2.16)


Constant

1.521

1.431

1.291

1.636


(10.13)

(13.76)

(11.15)

(11.32)

Observations

74

73

72

74


36
Digression on Domestic Original Sin

• It may be the case that the previous regressions
  do not yield any result because we are not able
  to measure the real size of the domestic local
  currency market
• This would require building a measure of domestic
  original sin and looking at how it relates to
  international original sin

37
Digression on Domestic Original Sin

• We were able to build such a measure for a small
  sample of 21 developing countries

38
Digression on Domestic Original Sin
DSIN0.250.37OSIN3 p value on slope
coefficient 0.11 R20.13 N 21
ARG
IDN
MYS
TUR
VEN
1
BRA
MEX
EGY
.75
HKG
CZE
CHL
.5
DSIN2
PHL
POL
HUN
ISR
SGP
.25
THA
SVK
ZAF
IND
TWN
0
0
.25
.5
.75
1
OSIN3
39
Digression on Domestic Original Sin





(1.18)

(3.24)

Constant

-
0.064

0.335

0.217

0.607

0.906

0.218

0.576

0.008


(0.17)

(0.49)

(1.09)

(6.38)

(4.39)

(0.43)

(7.48)

(0.04)

Observations

21

21

21

20

18

18

21

21

R
-
squared

0.09

0.01

0.15

0.08

0.18

0.28

0.07

0.37


40
Digression on Domestic Original Sin
TUR
ARG
IDN
MYS
1
VEN
CC0.50
BRA
Not significantly different
MEX
EGY
.75
CC0.69
HKG
CZE
CHL
.5
DSIN2
CC0.45
PHL
POL
HUN
ISR
SGP
.25
THA
SVK
ZAF
IND
TWN
0
0
.25
.5
.75
1
OSIN3
41
Digression on Domestic Original Sin

• There is some (weak) evidence that capital
  controls may help in reducing domestic original
  sin
• However, it looks as if capital controls are bad
  for for international original sin

42
Back to International Original Sin
43
Putting Everything Together

(1)

(2)

(3)

(
4
)

(
5
)


OSIN

OSIN

OSIN

OSIN

OSIN

SIZE

-
0.302

-
0.325

-
0.326

-
0.352

-
0.374


(3.32)

(3.48)

(3.50)

(3.88)

(4.05)

GDP
per cap

-
0.262

-
0.127


-
0.
248

-
0.
113


(2.08)

(1.31)


(2.30)

(1.82)

AV_INF

0.288

0.150

0.070

0.274

0.099


(0.89)

(0.4
9)

(0.29)

(0.88)

(0.36)

DE_GDP

-
0.003

-
0.102

0.044

-
0.002

-
0.062


(0.02)

(0.60)

(0.26)

(0.01)

(0.37)

RULE of LAW

0.305


0.091

0.255


(1.61)


(1.88)


(0.70)


-
0.291

DC_GDP

-
0.313

-
0.173

-
0.403

-0.269

(1.25)


(1.05)

(0.59)

(1.38)

(1.14)

FIN_CENTER

-
0.492

-
0.453

-
0.680



(1.45)

(1.31)

(2.06)


EUROLAND

0.032

0.010

-
0.220




(0.15)

(0.04)

(1.18)




OTH_DEVEL.

-
0.053

0.030

-
0.299





(0.24)

(0.14)

(1.55)



Constant

3.506

2.505

1.516

3.437

3.437


(3.54)

(3.22)

(7.66)

(4.03)

(4.03)

Observations

63

63

63

63

63


44

• SIZE always significant
• When we include one variable at a time, we find
  that
• If we control for country groups there is no
  other variable that is significantly correlated
  with Original Sin
• If we do not control for country groups, GDP per
  capita, inflation, rule of law, and size of the
  financial system are correlated with Original Sin
• When we jointly test all the hypotheses, we find
  that
• When country groups are included, only SIZE is
  robustly correlated with Original Sin
• When country groups are dropped, GDP per capita
  is marginally significant

45

• Original sin is not merely a problem of country
  policies (one need not deny the relevance of
  these, of course)
• It is also a problem with the operation of the
  international system
• In a world with transaction costs and decreasing
  returns to diversification, the global portfolio
  may have a limited number of currency
• If larger countries offer better opportunity for
  diversification, country size will matter in the
  choice of the global portfolio
• Redemption therefore requires international
  action to overcome the inertia in the system

46
Lessons from outliers

• An interesting fact about the international
  issuance of bonds in exotic currency is that it
  is mostly done by non-residents who then swap the
  debt-service obligation back to US dollar

47
Share of local currency international debt issued
by non-residents
1
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
Czech
South
New
Poland
Hong Kong
Denmark
Canada
Singapore
Australia
Republic
Africa
Zealand
48
Lessons from outliers

• An interesting fact about the international
  issuance of bonds in exotic currency is that it
  is mostly done by non-residents who then swap the
  debt-service obligation back to US dollar
• They do this to reduce cost of funding
• But, why is this complex operation cheaper than
  borrowing directly in dollar?
• A possibility is that the market values the
  possibility of separating currency and credit
  risk
• The IFIs have a natural hedge and could play a
  role in expanding this market

49
Conclusions

• Original Sin is a widespread phenomenon
• It has costs
• Limits the ability to conduct monetary policy
• Increases volatility
• Increases credit risk
• It cannot be easily explained by weak policies or
  institutions
• Country size seems to be important
• The IFIs could play a role in reducing Original
  Sin

50
The Pain and the Mystery of Original Sin
Barry Eichengreen Ricardo Hausmann Ugo Panizza
51
Original Sin and Credit Ratings

(1)

(2)

(3)

(4)

(5)

(6)


RATING

RATING

RATING

RATING

RATING

RATING

Original Sin





-
5.100

-
4.751






(3.38)

(3.32)

Debt/GDP advanced

4.814

-
2.659



-
1.553

-
2.451


(2.30)

(1.24)



(1.31)

(2.05)

Debt/GDP developing

-
8.627

-
3.671



-
3.557

-
2.475


(4.96)

(2.34)



(2.66)

(1.84)

Developing


-
9.027




-
3.004



(5.78)




(2.38)

Debt/GDP high rating



5.783

-
1.511






(3.10)

(0.83)



Debt/GDP low rating



-
9.207

-
4.438






(5.85)

(3.36)



High rating




8.917







(6.60)



GDP per capita





2.663

1.936






(6.71)

(4.00)

Ex Debt/GDP





2.252

1.751






(1.50)

(1.22)

Constant

13.999

19.757

14.138

11.028

-
6.314

1.606


(15.60)

(15.27)

(17.51)

(15.03)

(1.58)

(0.32)

Observations

61

61

61

61

56

56

DEG_DEVDEG_ADV

F(1,59)41.31

F(1,58)0.14

F(1,59)62.7

F(1,58)1.69



DEG_HRDEG_LR


P0.000

P0.705

P0.000

P0.199