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Original sin

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Centers (34 %) Total Debt issued by residents (93-98) Euroland (31%) Other Developed ... sin is a problem even for developed countries aside from financial centers. ... – PowerPoint PPT presentation

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Title: Original sin


1
Original Sin The Pain, the Mystery And the Road
to Redemption
Barry Eichengreen, Ricardo Hausmann Ugo
Panizza UC Berkeley, Harvard, and IDB
2
Motivation
  • Most countries cannot borrow abroad in their own
    currencies, a problem we referred to three years
    ago (Eichengreen and Hausmann, Exchange Rates
    and Financial Fragility, Kansas City Fed, ed.,
    New Challenges for Monetary Policy, 1999) as
    original sin
  • If a country has a net foreign debt, this creates
    an aggregate currency mismatch
  • This mismatch is associated with output and
    capital flow volatility
  • Monetary policies in such countries are rigid,
    while their central banks are unable to act as
    LLRs.
  • They are vulnerable to crises, of the
    self-fulfilling variety and otherwise.

3
Implications for Reform of the International
Financial Architecture
  • The conventional prescription of floating is
    problematic for countries with original sin
  • Inflation targeting is more difficult for such
    countries
  • Stabilizing capital flows is more difficult
  • Strengthening financial systems is more difficult
  • Avoiding financial crises is more difficult
  • All this raises the question of whether the
    architecture agenda can succeed without
    addressing original sin

4
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.
  • This leads us to a systemic explanation for the
    problem, which in turn leads us to an
    international proposal for its solution
  • (We will only touch on causes here Ugo Panizza
    will have more to say about them in a later
    session.)

5
Outline of the Paper
  • Original sin measurement
  • Incidence
  • Consequences
  • Causes
  • Learning from the outliers
  • The Road to redemption

6
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)

7
Table 1 International bonded debt by country
groups and currencies
2597.7

45

1773.6

61

3913.8

67.8

6
8.3

150.7

Euroland
1885.6

33

1071.5

37

1722.2

29.8

56.8

91.3


Other
477.6

8

45.9

2

89.9

1.6

9.6

18.8

Developed
Countries

Developing
434.0

8

11.6

0

47.4

0.8

2.7

10.9

Countries

International
378.4

7

0.0

0

0.0

0.0

0.0

0.0


Organizations

ECU

0.0

0

0.0

0

0.0

0.0

0.0

0.0

Total
5773.3

100

2902.5

100

5773.3

100.0

50.3

100.0



8
Total Debt issued by residents (93-98)
Developing (10)
Other Developed (14)
Major Financial Centers (34 )
Euroland (31)
Total Debt issued in own currency (93-98)
Developing (gt1)
Other Developed (9)
Major Financial Centers (64 )
Euroland (26)
9
Total Debt issued by residents (99-01)
International Organizations (7)
Other Developed (8)
Developing (8)
Euroland (33)
Major Financial Centers (45 )
Total Debt issued in own currency (99-01)
Other Developed (lt2)
Major Financial Centers (61 )
Euroland (37)
10
Things to Note
  • In 1993-8, Big 4 countries (financial centers
    US, UK, Japan, Switzerland) issued only 34 of
    global debt, but fully 68 of global debt was
    denominated in their currencies.
  • (By comparison, countries soon to become members
    of Euroland issued 31 of global debt but 24 was
    denominated in their currencies. For them,
    original sin was a problem, but only a small
    one.)
  • Other developed countries issued 14 but had only
    5 denominated in their own currencies.
    Evidently, original sin is a problem even for
    developed countries aside from financial centers.
  • Developing countries issued 10 of global debt
    but had only 1 in their own currencies.
  • Main difference after 1998 is growing importance
    of euro as a currency of denomination (relative
    to the legacy currencies).

11
Table 2 Cross-border bank claims

International Organizations

18

0.2

17

0.27

93.7

Unallocated

134

1.7

19

0.30

14.5

Total

7,808

100.0

6,344

100.00

81.3


12
Things to Note
  • In 1993-8, Big 4 countries (financial centers
    US, UK, Japan, Switzerland) issued only 34 of
    global debt, but fully 68 of global debt was
    denominated in their currencies.
  • (By comparison, countries soon to become members
    of Euroland issued 31 of global debt but 24 was
    denominated in their currencies. For them,
    original sin was a problem, but only a small
    one.)
  • Other developed countries issued 14 but had only
    5 denominated in their own currencies.
    Evidently, original sin is a problem even for
    developed countries aside from financial centers.
  • Developing countries issued 10 of global debt
    but had only 1 in their own currencies.
  • Main difference after 1998 is growing importance
    of euro as a currency of denomination (relative
    to the legacy currencies).

13
Measurement Issues
  • In constructing a measure of original sin, we
    would like to take into account both bank and
    bond market data.
  • We would like to acknowledge the fact that in
    some cases countries may be able to hedge their
    currency exposures
  • To this end, we measure original sin in several
    alternative ways.
  • It turns out that are key results emerge almost
    regardless of which of the following indices we
    use.

14
A First Measure Considering Only Bond Data (the
higher the value, the greater the sin)
i
i
currency
in

country
by

issued

Securities
-

OSIN
1
1
i
i
country
by

issued

Securities
15
A Second Measure (including loans as well as
securities)

i
currencies
major
in

country
by

issued

Loans

Securities

INDEXA
i

i
country
by

issued

Loans

Securities
16
A Third Measure (which accounts for the fact that
debt in currency i issued by other countries
creates an opportunity for country i to hedge)
i
currency
in

Securities
-

INDEXB
1
i
i
country
by

issued

Securities
17
A Fourth Measure (which eliminates negative
values, where there is more debt in currency i
than country i has in total, since countries
cannot hedge more debt than they issue)
ö
æ
currency
in

Securities
i

ç
-

0
,
1
max
3
OSIN

ç
i
country
by

issued

Securities
i
ø
è
18
  • Note that we consider yet additional measures in
    the paper.
  • But in Table 1, please focus on the columns for
    OSIN3, this last measure.
  • Note that we distinguish the periods before and
    after the advent of the euro.

19
Table 3 Measures of original sin by country
groupings

20
Graph 1 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
OSIN2
OSIN3
21
Graph 2 Measures of original sin by regions
(developing countries)
1
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
LAC
Middle East Africa
Asia Pacific
Eastern Europe
OSIN1
OSIN2
OSIN3
22
Things to Note
  • Lowest levels of original sin for the financial
    centers, followed by the Euroland countries
  • Note that the Euroland countries experience a
    major decline in original sin following the
    introduction of the euro
  • Other industrial countries have higher values.
  • Developing countries have still higher values.
  • Among developers, OS is lowest for accession
    economies, highest in Latin America.

23
Table 4 Countries with OSIN3 lt0.8, excluding
financial centers

Non Euroland


Euroland

Country

1993
-
98

1999
-
01

Country

1993
-
98

19
99
-
01

Czech Republic

0.0

0.00

Italy

0.00

0.00

Poland

0.82

0.00

France

0.23

0.12

New Zealand

0.63

0.05

Portugal

0.42

0.24

South Africa

0.44

0.10

Belgium

0.76

0.39

Hong Kong

0.72

0.29

Spain

0.59

0.42

Taiwan

1.00

0.54

Netherlands

0.64

0.47

Singapore

0.
96

0.70

Ireland

0.94

0.59

Australia

0.55

0.70

Greece

0.93

0.60

Denmark

0.80

0.71

Finland

0.96

0.62

Canada

0.55

0.76

Austria

0.90

0.68


24
Graph 3 OSIN3 in Euroland
0.96
1
0.94
0.93
0.9
0.9
0.76
0.8
0.68
0.7
0.64
0.62
0.6
0.59
0.59
0.6
0.47
0.5
0.42
0.42
0.39
0.4
0.3
0.24
0.23
0.2
0.12
0.1
0
0
0
Italy
France
Portugal
Belgium
Spain
Netherlands
Ireland
Greece
Finland
Austria
93-98
99-01
25
The Non-Euroland outliers are not all floaters
LYS 3
Fixers
3
Intermediate
2
Floaters
1
Australia
Canada
Poland
Czech Rep.
South Africa
Singapore
Denmark
Hong Kong
New Zealand
Average 1993 - 2001
26
Things to Note
  • The Euroland countries of course feature
    prominently
  • Accession economies and overseas regions of 19th
    century European settlement are also numerous.
  • Both fixed-rate Hong Kong and floating-rate
    Singapore and Taiwan appear on this list (raising
    questions about whether a particular exchange
    rate regime helps for eliminating original sin)

27
Original Sin is also Persistent
  • Table 5 in the paper classifies countries as
    issuing (gold) indexed debt or domestic currency
    debt in the mid-19th century. (Some cases are
    mixed.)
  • It shows a very strong and significant
    correlation with countries suffering from
    original sin (issuing foreign currency
    denominated or indexed debt) today.

28
Original sin is highly persistent

OSIN3 and Flandreau-Sussman classification circa
1850
29
The Pain of Original Sin
  • (The consequences)

30
Recall the Problem
  • If an original sin country has a net foreign debt
    and it is in foreign currency, then there is an
    aggregate currency mismatch
  • If no one else issues debt in its currency, then
    foreign exposures can then be passed around by
    residents like a hot potato, but foreign exposure
    cannot be hedged in the aggregate.
  • This can have important implications for exchange
    rate policy, capital flows, and output
    volatility, among other things. We explore these
    implications in turn, starting with the exchange
    rate.

31
Original sin and exchange rate flexibility
  • We use the Levy-Yeyati and Sturzenegger
    classification, M2/Reserves, and exchange rate
    variability/reserve variability as 3 measures of
    the dependent variable.
  • Note that there are good reasons to think that
    these things will be affected by original sin.
  • There are of course the theoretical reasons
    mentioned earlier. But there are also empirical
    reasons. Consider

32
Levels of Reserves
Reserves/M2
Singapore
0.879
0.637
Peru
Chile
0.485
0.446
Poland
Colombia
0.409
Greece
0.362
0.335
Indonesia
Czech. Republic
0.314
0.303
Guatemala
Mexico
0.302
Norway
0.287
Israel
0.262
Paraguay
0.259
0.253
Brazil
Jamaica
0.245
Korea
0.243
Philippines
0.242
Thailand
0.230
0.137
Sweden
India
0.133
0.105
Germany
Switzerland
0.094
Dominican Rep.
0.087
0.064
South Africa
Australia
0.062
0.058
Canada
New Zealand
0.057
Japan
0.048
0.021
United Kingdom
United States
0.013
0
0.2
0.4
0.6
0.8
1
33
Original sin and reserves over M2
34
Intervention using reserves
Relative Volatilities Exchange Rate and Reserves
Japan
30.454
.380
United States
United Kingdom
17.946
New Zealand
12.682
6.913
Australia
Thailand
6.617
3.369
Canada
Brazil
2.920
2.842
Germany
South Africa
2.466
2.324
Philippines
Switzerland
2.272
2.154
Indonesia
Dominican Rep.
1.583
Korea
1.345
Czech
1.260
India
1.215
0.976
Sweden
Colombia
0.926
Mexico
0.838
Israel
0.760
Singapore
0.690
Paraguay
0.615
Peru
0.506
0.424
Chile
Guatemala
0.417
0.416
Poland
Greece
0.390
0.362
Norway
Jamaica
0.272
0
5
10
15
20
25
30
35
std(dev)/std(res/m2)
35
Original Sin and relative volatility of exchange
and reserves
36
Multivariate Analysis
  • We control for GDP per capita, openness, and
    foreign debt/GNP, and focus on the coefficient of
    OSIN3.
  • We run weighted LS (weighted by share of
    securities in total debt) and also ordered probit
    for the LYS measure.
  • OS is negatively correlated with exchange rate
    flexibility using all 3 measures. (Time series
    and cross section evidence, and instrument
    variables regressions, support that this is not
    reserve causality.)
  • The effect is important eliminating OS is enough
    to move countries by a full category in the LYS
    classification.

37
Table 6 Original sin and exchange rate
flexibility

(1)

(2)

(3)


LYS

RESM2

RVER





OSIN3

0.984

0.248

-
0.801


(2.98)

(3.74)

(2.02)

LGDP_PC

0.268

-
0.053

0.026


(3.61)

(1.85)

(0.61)

OPEN

0.178

-
0.014

1.017


(1.85)

(0.41)

(2.88)

SHARE2

58.719

-
35.858

-
569.562


(0.46)

(0.66)

(2.36)

Constant

-
1.389

0.531

0.104


(1.79)

(1.73)

(0.17)

Observations

75

65

65

R
-
squared

0.22

0.37

0.62


38
Output and Capital Flow Volatility
  • Output volatility is measured as the SD of GDP
    growth.
  • Capital flow volatility is the SD of capital
    flow/domestic credit ratio
  • We control for level of development, openness,
    foreign debt, and terms of trade volatility.
  • Again, we run weighted least squares
  • Original sin account for more than ¼ of the
    difference in volatility between developed and
    developing countries.

39
Table 7 Original sin and volatility

(1)

(2)


VOL_GROWTH

VOL_FLOW




OSIN3

0.011

7.103


(1.96)

(3.58)

LGDP_PC

-
0.012

-
3.214


(2.14)

(2.56)

OPEN

-
0.001

-
4.181


(0.12)

(1.20)

VOL_TOT

-
0.000

0.223


(0.86)

(1.08)

SHARE2

-
1
4.287

147.265


(1.72)

(0.04)

Constant

0.135

32.825


(2.25)

(2.39)

Observations

77

33

R
-
squared

0.40

0.64


40
Original Sin Credit Ratings
  • Countries with original sin will have more
    volatile debt service ratios and deficits,
    because their service obligations will be more
    exchange-rate and interest-rate sensitive.
  • Greater fiscal volatility means lower credit
    ratings, other things equal.
  • This can explain, inter alia, why the correlation
    of credit ratings with debt and deficit variables
    is so low (as shown on the next slide).

41
The Weak Relationship Between Debt/GDP and Credit
Ratings
AUT
DEU
JPN
NOR
GBR
USA
19
BEL
CAN
DNK
SWE
AUS
ESP
FIN
ITA
PRT
CYP
ISL
SVN
rating foreign currency
CZE
ISR
EST
CHN
GRC
LVA
HUN
TUN
POL
TTO
PAN
IND
MEX
ARG
CRI
MAR
BRA
DOM
JOR
PRY
TUR
PAK
5
-.291965
1.13803
net_debt/gdp
42
Multivariate Analysis
  • We control for standard determinants of credit
    rates, public debt/GDP, public debt/tax revenues,
    and level of development.
  • Estimates are by weighted least squares and
    double censored Tobit.
  • Results, on next slide, suggest that eliminating
    original sin increases country credit rating by
    three notches.

43
Table 8 Original sin and credit ratings

(1)

(2)

(3)

(4)


RATING1

RATING1

RATING1

RATING1

DE_GDP2

-
1.553


-
1.815



(1.91)


(2.19)


DE_RE2


-
0.599


-
0.665



(1.40)


(1.52)

LGDP_PC

3.189

3.051

2.884

2.76
4


(8.54)

(7.59)

(6.47)

(5.68)

OSIN3

-
3.429

-
3.324

-
4.883

-
4.435


(3.85)

(3.49)

(3.49)

(3.11)

Constant

-
12.369

-
11.059

-
8.751

-
7.889


(3.16)

(2.60)

(1.89)

(1.57)

Observations

56

49

51

44

R
-
squared

0.82

0.81

0.81

0.80


44
Causes of original sin
  • Immaculate conception and the road to redemption

45
Miners canary or cause?
  • Is OS one more symptom of poor institutions, or
    is it a different kind of phenomenon?

46
Recent Theories
  • Underdevelopment of institutions and policies in
    general
  • Inadequate monetary credibility
  • Fiscal profligacy
  • Weak contract enforcement
  • Presence or absence of trade sanctions
  • Political economy stories
  • We will leave our discussion of these theories
    and evidence to Ugo tomorrow, but here we need to
    make one important point

47
Inadequacy of Conventional Explanations
  • None of a variety of measures of levels of
    development, monetary credibility, fiscal
    profligacy, strength of contract enforcement,
    trade dependence, or political economy have much
    traction.
  • Same is true for a variety of samples,
    specifications and econometric treatments.
  • Only robust correlates are country size and
    financial-center status (which is, in a sense,
    what we are trying to explain).

48
Why Might a Few Important Currencies So Dominate
the Global Portfolio?
  • Additional currencies add decreasing
    diversification benefits but constant
    transaction costs.
  • International transaction costs and heterogeneity
  • Network externalities may give a small number of
    vehicle currencies special attraction.
  • Countries seeking to add their currencies to the
    global portfolio thus face an uphill battle.
  • And each that succeeds makes life tougher for the
    others.

49
Bottom Line
  • 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 (given transactions costs, a
    world of heterogeneous countries, and network
    effects that lock in the status quo).
  • Redemption therefore requires international
    action to overcome the inertia in the system.

50
Lessons from outliers
  • Countries that have recently escaped original sin
    seem to have done so through non-nationals
    issuing debt in domestic currency
  • IFIs have played a major role in this process
  • Borrowers swap their obligations with residents

51
Our proposal
  • We propose an index based on an
    inflation-adjusted basket of EM currencies
  • Historically it shows trend appreciation, low
    volatility and negative correlation with
    industrial country consumption
  • We propose that the WB, other IFIs and C-5
    governments issue debt in this index and swap
    obligations with EMs

52
The seminar
  • Theoretical papers on consequences of OS
  • Cespedes, Chang and Velasco ask what are the
    consequences for domestic policies and for the
    ability to stabilize the economy
  • Jeanne and Zettelmeyer ask about the implications
    for the international financial architecture
  • Historical papers on the origin of OS
  • Bordo Meissner and Redish
  • Flandreau and Sussman

53
The seminar
  • Theoretical papers on causes of OS
  • Jeanne on poor monetary credibility
  • Corsetti on fiscal dynamics and crises
  • Chamon and Hausmann on the interaction between
    borrowers and CBs
  • EHP on the empirical mystery of OS
  • Redemption
  • Detailes outline of our proposal

54
Original Sin The Pain, the Mystery And the Road
to Redemption
Barry Eichengreen, Ricardo Hausmann Ugo
Panizza UC Berkeley, Harvard, and IDB
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