Devaluation, Debt, and Default in Emerging Economies

SSRN Electronic Journal, 2000

Emerging countries experience real exchange rate depreciations around defaults. In this paper, we examine this observed pattern empirically and through the lens of a dynamic stochastic general equilibrium model. The theoretical model explicitly incorporates bond issuances in local and foreign currencies, and endogenous determination of real exchange rate and default risk. Our quantitative analysis, using the case of Argentina's default in 2001, replicates the link between real exchange rate depreciation and default probability around defaults and moments of the real exchange rate that match the data. Prior to default, interactions of real exchange rate depreciation, originated from a sequence of low tradable goods shocks with the sovereign's large share of foreign currency debt, trigger defaults. In post-default periods, the resulting output costs and loss of market access due to default lead to further real exchange rate depreciation. .

2016

Emerging countries experience real exchange rate depreciations around defaults. In this paper, we examine this observed pattern empirically and through the lens of a dynamic stochastic general equilibrium model. The theoretical model explicitly incorporates bond issuances in local and foreign currencies, and endogenous determination of real exchange rate and default risk. Our quantitative analysis replicates the link between real exchange rate depreciation and default probability around defaults and moments of the real exchange rate that match the data. Prior to default, interactions of real exchange rate depreciation, originated from a sequence of low tradable goods shocks with the sovereign’s large share of foreign currency debt, trigger defaults. In post-default periods, the resulting output costs and loss of market access due to default lead to further real exchange rate depreciation. JEL Classification Numbers: E43; F32; F34; G12

2004

A lo largo del año 2001 el PIB de Argentina cayó un 20% y el ratio de inversión sobre el PIB decreció más de un 20%. El gobierno realizo diversos anuncios de cambios en la política de tipos de cambio para ayudar a la recuperación de la economía. Al mismo tiempo, la balanza comercial tuvo un fuerte superávit y la ratio deuda externa sobre el PIB se incrementó tanto que obligó al gobierno argentino a suspender pagos tras devaluar el peso un 40%. Exploramos la relación entre la suspensión de pagos y la expectativa de devaluación. Encontramos que dependiendo del nivel de deuda y dada una expectativa de devaluación, dos tipos de crisis pueden ocurrir: si el nivel de deuda es bajo el gobierno devalúa pero no suspende pagos; para un nivel de deuda más alto el gobierno devalúa y suspende pagos para cancelar el coste futuro de pagar la deuda. Hemos calibrado el modelo para recoger las principales características de la crisis Argentina y mostramos que el ratio de la deuda externa sobre PIB se encontraba en la zona de crisis donde para el gobierno era óptimo devaluar y suspender pagos internacionales.

The collapse of Argentina's currency board provides further evidence that fiscal profli- gacy (whether financed by domestic money creation or foreign debt) is incompatible with the maintenance of any fixed exchange rate regime. In this paper we analyze a dynamic general equilibrium model with a mixture of fiscal deficits, stochastic endowment, and sovereign debts. It oers an environment in which a loss of confidence in the sustain- ability of the government's fiscal position creates an environment for exchange rate crises. The evidence provided demonstrates that the Argentine government's decision to abandon the peg in 2002 - following the default on its international debts, was a self-fulfilling out- come of agent's expectations based on the underlying economic environment. Moreover, we also show that in an essentially identical economic framework - where the equilibrium probability of default is low, the optimal action for the government would be to maintain th...

Total public debt in most emerging markets grew before and after the pandemic with a sizable share in foreign currency. Along this trend, interest payments increased even in the presence of active fiscal rules in some countries. How should debt management of public debt be set under a fiscal rule? This document studies how optimal currency composition reduces the cost of debt and facilitates fiscal rule compliance but increases budget risk. Using a small open economy model, we provide evidence that optimal foreign currency holdings in Chile, Colombia, and Mexico depart considerably from observed; remaining low (high) in periods of favorable (adverse) external or domestic macroeconomic and financial conditions.

2010

In this paper we study the Argentine and Uruguayan crisis of 2001-2002 with emphasis in the role played by the exchange rate and fiscal policies followed by the two countries. We find that in both cases the crisis can be understood as the result of an adverse external shock in a vulnerable environment. This environment was characterized by a perverse combination of fixed exchange rate, a fiscal policy not sustainable in a strong sense, and a great de facto dollarization. The Uruguayan peg was more flexible which facilitated a more gradual adjustment of the real exchange rate. Uruguay enjoyed better credit conditions during recession which derived in a different public debt dynamics. By testing cointegration between government expenditures and revenues we find that fiscal policy was not sustainable in a strong sense in Argentina and Uruguay which favored the speculative attacks suffered by the public debt of both countries. We find no clear difference in terms of fiscal sustainabilit...

2002

Journal of International Development, 2008

Latin American countries have been in the eye of economic and financial storms several times in recent years. Advice from the International Monetary Fund has consistently highlighted the need for sound fiscal policies and lower debt levels. But is public debt relevant? Following a brief discussion of the theoretical issues involved, this paper examines empirically the relationship between public indebtedness and pressures in the foreign exchange market. Alternative measures are used to capture the latter and the analysis controls for a de facto classification of exchange rate regimes. Estimations of static and dynamic panels for 28 Latin American and Caribbean (LAC) countries report substantial fiscal effects.

Economic Theory, 2013

We characterize optimal debt policy in a dynamic stochastic general equilibrium model of defaults and devaluations in which self-fulfilling crises can arise. When the government cannot commit to repay its debt and cannot commit to maintain the exchange rate, consumers' expectations of devaluation make the safe level of government debt very low. We show that, when the debt is in the crisis zone-where self-fulfilling crisis can occur-the government finds it optimal to reduce the debt in order to exit the zone. The lower the probability that consumers assign to devaluation, however, the greater is the number of periods that the government will choose to take to exit the crisis zone. We argue that this was the case in Argentina in 2001-2002.

2003

The rise and fall of Argentina's currency board shows the abandonmenlt of the currency board and a sovereign debt extent to which the advantages of hard pegs have bcen default. The crisis can be best interpreted as a bad overstated. The currency board did provide nomilinal outcome of a high-stakes strategy to overcome a weak stability and boosted financial intermediation, at the cost currency problem. To increase the credibility of the hard of endogenous finaicial dollarization, but did not foster peg, the government raised its exit costs, which deepened monetary or fiscal discipline. The failure to adequately the crisis once exit could no longer be avoided. But some address the currency-growth-debt trap into whichi alternative exit strategies would have been less Argentina fell at the end of the 1990s precipitated a run destructive than the one adopted. on the currency and the banks, followed by the This paper-a product of Macroeconomics and Growth, Development Research Group-is part of a larger effort in the group to understand 1ow currency regimes work. Copies of the paper are available free from the World Bank,