Abstract
This paper analyzes the development of 49 local bond markets. The main finding is that policies and laws matter: countries with stable inflation rates and strong creditor rights have more developed local bond markets and rely less on foreign-currency-denominated bonds. The results suggest that “original sin” is a misnomer. Emerging economies are not inherently dependent on foreign currency debt. Rather, by improving policy performance and strengthening institutions, they may develop local currency bond markets, reduce their currency mismatch, and lessen the likelihood of future crises.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
Notes
See also Krugman (1999), Jeanne and Zettelmeyer (2002), Schneider and Tornell (2004), and Aghion, Bacchetta and Banerjee (2004). The literature on currency mismatches, and by extension our work, also has a link to the vast literature on dollarization. For example, Goldstein and Turner (2004) note that a currency mismatch could ultimately force an emerging economy to dollarize.
For example, Jeanne and Zettelmeyer (2002) start from a situation of original sin and examine solutions that involve international lending.
For the particular global solution proposed by EHP, see Eichengreen and Hausmann (2002).
The rule of law variable is, as reported in LLSV, an average over 1982–95 of the International Country Risk Guide assessment of law and order tradition. We supplement this source with 2000 data from Gwartney, Lawson, and Emerick (2003) for five other countries: China, Czech Republic, Hungary, Iceland, and Poland. Creditor rights, also from LLSV, aggregates the various rights that secured creditors have in liquidation and reorganization. Fiscal balance data are from the World Bank’s World Development Indicators database, with data from Hong Kong SAR and Taiwan Province of China obtained from Organization for Economic Cooperation and Development data and the IMF’s International Financial Statistics.
In even-numbered columns, we lose one country that does not have 10 years of historical GDP (Czech Republic) and seven that do not have data on creditor rights (China, Hungary, Iceland, Luxembourg, Morocco, Poland, and Venezuela).
Tables with these robustness checks are available from the authors upon request.
These results are available from the authors upon request. A direct test of whether larger bond markets lead to better inflation performance would involve lagged bond market development. However, data on bond market development across a range of countries are available only from 1994. We found no evidence (regression results available upon request) that 1994 bond market development is associated with subsequent inflation performance.
To be sure, the debate is moving in various directions. Levine (2002) discusses the financial services view that stresses not bank-based versus market-based systems, but the financial arrangements that arise in the economy, and a special case, the law and finance view of La Porta, Lopez-de-Silanes, Shleifer, and Vishny (1998).
References
Aghion, P., P. Bacchetta, and A. Banerjee, 2004, “A Corporate Balance-Sheet Approach to Currency Crises,” Journal of Economic Theory, Vol. 119 (November), pp. 6–30.
Beck, T., and R. Levine, 2004, “Stock Markets, Banks, and Growth: Panel Evidence,” Journal of Banking and Finance, Vol. 28 (March), pp. 423–42.
Beck, T., A. Demirgüc-Kunt, and R. Levine, 1999, “A New Database on Financial Development and Structure,” Policy Research Working Paper No. 2146 (Washington: World Bank).
Claessens, S., D. Klingebiel, and S. Schmukler, 2003, “Government Bonds in Domestic and Foreign Currency: The Role of Macroeconomic and Institutional Factors,” CEPR Discussion Paper No. 3789 (London: Centre for Economic Policy Research).
Cukierman, A., G. Miller, and B. Neyapti, 2002, “Central Bank Reform, Liberalization and Inflation in Transition Economies—An International Perspective,” Journal of Monetary Economics, Vol. 49 (March), pp. 237–64.
Cukierman, A., S. Webb, and B. Neyapti, 1992, “Measuring the Independence of Central Banks and Its Effect on Policy Outcomes,” World Bank Economic Review, Vol. 6, No. 3, pp. 353–98.
Eichengreen, B., and R. Hausmann, 1999, “Exchange Rates and Financial Fragility,” NBER Working Paper No. 7418 (Cambridge, Massachusetts: National Bureau of Economic Research).
—, 2002, “How to Eliminate Original Financial Sin,” Financial Times, November 22.
Eichengreen, B., and P. Luengnaruemitchai, 2004, “Why Doesn’t Asia Have Bigger Bond Markets?” NBER Working Paper No. 10576 (Cambridge, Massachusetts: National Bureau of Economic Research).
Eichengreen, B., R. Hausmann, and U. Panizza, 2002, “Original Sin: The Pain, the Mystery, and the Road to Redemption,” paper presented at the Inter-American Development Bank conference, “Currency and Maturity Matchmaking: Redeeming Debt from Original Sin,” Washington, November.
Goldstein, M., and P. Turner, 2004, Controlling Currency Mismatches in Emerging Markets (Washington: Institute for International Economics).
Gwartney, J., and R. Lawson, with N. Emerick, 2003, Economic Freedom of the World: 2003 Annual Report (Vancouver: The Fraser Institute). Available via the Internet: http://www.freetheworld.com/book.html
Impavido, G., A. Musalem, and T. Tressel, 2003, “The Impact of Contractual Savings Institutions on Securities Markets,” Policy Research Working Paper No. 2948 (Washington: World Bank).
International Monetary Fund (IMF), 2002, “Emerging Local Bond Markets,” in Global Financial Stability Report, September 2002, World Economic and Financial Surveys (Washington).
Jeanne, O., 2003, Why Do Emerging Economies Borrow in Foreign Currency?” IMF Working Paper 03/177 (Washington: International Monetary Fund).
—, and J. Zettelmeyer, 2002, “‘Original Sin,’ Balance Sheet Crises, and the Roles of International Lending,” IMF Working Paper 02/234 (Washington: International Monetary Fund).
Krugman, P., 1999, “Balance Sheets, The Transfer Problem, and Financial Crises,” in International Finance and Financial Crises: Essays in Honor of Robert P. Flood, Jr., ed. by P. Isard, A. Razin, and A. Rose (Norwell, Massachusetts: Kluwer Academic).
La Porta, R., F. Lopez-de-Silanes, A. Shleifer, and R. Vishny, 1997, “Legal Determinants of External Finance,” Journal of Finance, Vol. 52 (July), pp. 1131–50.
—, 1998, “Law and Finance,” Journal of Political Economy, Vol. 106 (December), pp. 1113–55.
Levine, R., 2002, “Bank-Based or Market-Based Financial Systems: Which Is Better?” Journal of Financial Intermediation, Vol. 11 (October), pp. 398–428.
Merrill Lynch, 2002, The Size and Structure of the World Bond Market: 2001.
Mihaljek, D., M. Scatigna, and A. Villar, 2002, “Recent Trends in Bond Markets,” in The Development of Bond Markets in Emerging Economies, BIS Paper No. 11 (Basel: Bank for International Settlements).
Rousseau, P., and R. Sylla, 2003, “Financial Systems, Economic Growth, and Globalization,” in Globalization in Historical Perspective, ed. by M. Bordo, A. Taylor, and J. Williamson (Chicago: University of Chicago Press/National Bureau of Economic Research), pp. 373–413.
Schneider, M., and A. Tornell, 2004, “Balance Sheet Effects, Bailout Guarantees and Financial Crises,” Review of Economic Studies, Vol. 71 (July), pp. 883–913.
Author information
Authors and Affiliations
Additional information
The authors thank Thomas Jans and Denis Petre for invaluable assistance with data and Jillian Faucette, Sara Holland, and Alex Rothenberg for research assistance. We also thank for helpful comments an anonymous referee, Morris Goldstein, Bill Helkie, Olivier Jeanne, Steve Kamin, Ross Levine, Ugo Panizza, Vincent Reinhart, Charles Thomas, Joachim Voth, Jon Wongswan, and seminar participants at the Berkeley Workshop on Global Balances and Asian Financial Markets, Centre for Economic Policy Research/Gerzensee Conference on International Capital Flows, Darden Conference on Investing in Emerging Markets, the Federal Reserve Board’s International Finance Workshop, IMF Research Seminar, Loyola College, Towson University, Trinity College International Bond and Debt Market Integration Conference, and University of North Carolina. John Burger acknowledges support from the Sellinger School Junior Sabbatical Program.
