Redemption from Original Sin

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The latest Global Development Finance report from the World Bank indicates net private capital flows to developing countries reached a record high of $491 billion in 2005.

One factor for the rapid growth might be the taming of the so called ‘Original Sin’;

"When a country is hit by a piece of bad news or a bout of political uncertainty - as Brazil was recently - investors sell off their assets and the currency plummets. If this were all that happened, the main effect would be more competitive exports and the crisis would solve itself. But since so much of emerging-market debt is denominated in foreign currency, this produces a massive increase in debt-servicing costs. Fears of payment difficulties create a vicious circle.

The core of this phenomenon is that countries cannot borrow abroad in their own currency: external debt is overwhelmingly denominated in foreign currency. In the period 1999-2001 developing countries accounted for 8 per cent of the debt but less than 1 per cent of the currency denomination.

Some would say this is so because the policies and institutions of many countries lack credibility. But this phenomenon is not peculiar to developing countries with weak policies and institutions. It affects virtually all countries except the issuers of the five main currencies. It affects countries with low inflation, balanced budgets and a reliable rule of law. Since it is not clear what countries have done to bring this problem upon themselves, it is referred to as "original sin".

More on the report by Pablo and a podcast discussing the report.

See also the virtual book tour with Ricardo Hausmann on Other People's Money: Debt Denomination and Financial Instability in Emerging Market Economies

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This page contains a single entry by Paul published on May 31, 2006 1:13 AM.

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