Template-Type: ReDIF-Paper 1.0
Author-Name: Boris Hofmann
Author-X-Name-First: Boris 
Author-X-Name-Last: Hofmann
Author-Name: Nikhil Patel
Author-X-Name-First: Nikhil 
Author-X-Name-Last: Patel  
Author-Name: Steve Pak Yeung Wu
Author-X-Name-First: Steve Pak Yeung 
Author-X-Name-Last: Wu
Title: Original sin redux: a model-based evaluation
Abstract: Many emerging markets (EMs) have graduated from "original sin" and are able to borrow from abroad in their local currency. Using a two-country model, this paper shows that the shift from foreign currency to local currency external borrowing does not eliminate the vulnerability of EMs to foreign financial shocks but instead results in "original sin redux" (Carstens and Shin (2019)). Even under local currency borrowing from foreign lenders, a monetary tightening abroad is propagated to EM financial conditions through a tightening of foreign lenders' financial constraints. Moreover, local currency borrowing does not eliminate currency mismatches, but shifts them from the balance sheets of EM borrowers to the balance sheets of financially constrained global lenders, so that amplifying financial effects of exchange rate fluctuations remain. We provide empirical evidence in line with this prediction of the model using data on currency composition of external debt of emerging and advanced economies. Our model-based analysis further suggests that foreign exchange intervention and capital flow management measures can mitigate the adverse effects of capital flow swings in the short run and that a larger domestic investor base can reduce the vulnerability to such swings in the longer run.
Length: 59 pages
Creation-Date: 2022-02
File-URL: https://www.bis.org/publ/work1004.pdf
File-Format: Application/pdf
File-Function: Full PDF document
File-URL: https://www.bis.org/publ/work1004.htm
File-Format: text/html
Number: 1004
Keywords: emerging market, capital flows, exchange rate, currency mismatch.
Classification-JEL: E3, E5, F3, F4, F6, G1.
Handle: RePEc:bis:biswps:1004