Domestic versus External Borrowing and Fiscal Policy in Emerging Markets

Abstract

This paper presents a model of an emerging market sovereign that can selectively default on its domestic or external creditors. The two classes of creditors have different ways of punishing the government in the event of default, which in turn creates a differential in the sovereign's incentives to default on its domestic versus foreign creditors. We explore the extent to which the possibility of differential treatment of creditors affects the composition of debt. We find that a country characterized by volatile output, sovereign risk, and costly tax collection will want to borrow in domestic as well as in international markets. Copyright � 2010 Blackwell Publishing Ltd.

Political, Institutional, and Economic Factors Underlying Deficit Volatility

“…This suggests that deficit volatility should be negatively correlated to the country's income. For instance, Vasishtha () develops a model in which, because of different ways of punishing the government in case of default, countries characterized by costly tax collection, sovereign risk, and volatile output will borrow from both domestic and foreign creditors. Inflation (IFS) We include this variable in order to test the prediction that the higher the level of inflation is, the higher the budget deficit volatility will be. In fact, when the inflation rate is high, the level of economic uncertainty is large and both government spending and revenue are highly volatile, therefore, making it difficult to plan the fiscal budget. Openness (WDI) This variable is computed as the log of the ratio of national trade to GDP.…”

Distributional Incentives in an Equilibrium Model of Domestic Sovereign Default

“…4 See Panizza, Sturzenegger, and Zettelmeyer (2009), Aguiar and Amador (2014), and Tomz and Wright (2012) for recent reviews of the sovereign debt literature. Some studies in this area have examined models that include tax and expenditure policies, as well as settings with foreign and domestic lender, but always main-taining the representative agent assumption (e.g., Cuadra, Sanchez, and Sapriza (2010), Vasishtha (2010) and more recently Dias, Richmond, and Wright (2012)) have examined the benefits of debt relief from the perspective of a global social planner with utilitarian preferences.…”

Distributional Incentives in an Equilibrium Model of Domestic Sovereign Default

“…Panizza et al (2009), Aguiar andAmador (2014), and Tomz and Wright (2012) for recent reviews of the sovereign debt literature. Some studies in this area have examined models that include tax and expenditure policies, as well as settings with foreign and domestic lenders, but always maintaining the representative agent assumption (e.g., Cuadra et al 2010;Vasishtha 2010;and more recently Dias et al 2012) have examined the benefits of debt relief from the perspective of a global social planner with utilitarian preferences. Basu 2009;Broner et al 2010;Broner and Ventura 2011;Brutti 2011;Di Casola and Sichlimiris 2014;Gennaioli et al 2014;Guembel and Sussman 2009;Mengus 2014).…”

“…Some studies in this area have examined models that include tax and expenditure policies, as well as settings with foreign and domestic lenders, but always maintaining the representative agent assumption (e.g., Cuadra et al. ; Vasishtha ; and more recently Dias et al. ) have examined the benefits of debt relief from the perspective of a global social planner with utilitarian preferences.…”