Download Original sin

The Pain and the Mystery of
Original Sin
Barry Eichengreen
Ricardo Hausmann
Ugo Panizza
1
Outline and Summary

Definition and Facts

Most countries do not borrow abroad in their own
currencies, a problem we refer to as “original sin”

If a country has a net foreign debt, this creates an aggregate
currency mismatch


Pain


Of course a country can decide not to have a mismatch by not
borrowing or holding a lot of reserves
We show that original sin is associated with limited
XR flexibility, high volatility, low credit ratings
Mystery

We show that standard explanations based on poor
policies or institutions do not do a good job at
explaining original sin
2
Work on Original Sin

First papers on the topic:




Original Sin book:


Eichengreen and Hausmann (1999)
Hausmann, Panizza, and Stein (2001)
Hausmann and Panizza (2003)
Cespedes, Chang and Velasco, Corsetti and
Mackowiak, Jeanne, Jeanne and Zettelmeyer,
Flandreau and Sussman, Bordo, Meissner and Redish,
Chamon and Hausmann
Critics:




Goldstein and Turner (2003)
Burger and Warnock (2003)
Reinhart, Rogoff, and Savastano (2003)
Eichengreen, Hausmann, and Panizza (2003)
3
Definition


Eichengreen and Hausmann (1999) definition: “a
situation in which the domestic currency is not
used to borrow abroad or to borrow long term
even domestically”
Here we mostly focus on “international original
sin”



Better data on international original sin
Domestic original sin seems easier to solve and some
countries are doing progress in this direction
However, we also try to say something on
“domestic original sin”
4
A first look at the problem:
Distribution of international debt by issuers
and currencies (1999-2001)
1
0.9
Debt by
currency
0.8
Debt by
country
0.7
$5.6 trillion
0.6
$4.5 trillion
0.5
0.4
0.3
USA
Euroland
Japan
UK
Switzerland Canada
Australia 5
Is this because countries do their local
currency funding on the home market
and foreign currency funding abroad?
100
90
80
Debt by
currency
$632 billion
70
60
$473 billion
50
40
30
20
10
0
Debt by
country
USA
EURO
JAPAN
CANADA
UK
6
Measurement




Measuring original sin is not straightforward
In principle, we want to measure external
liabilities in own currency as a share of total
external liabilities
We use data gathered by the BIS on the currency
denomination of bonds and money market
instruments
We also consider BIS data on cross-border bank
lending, although the data are less complete
(both in country coverage and currency
breakdown)
7
Main index used in the paper


Securities in currency i
OSIN 3i = max1 ,0 
 Securities issued by country i 
It captures opportunities for hedging through swaps
It recognizes that you cannot hedge more than 100
percent of your debt
8
Alternative indexes
OSIN1= 1 -
securities in currency i issued by country i
securities issued by country i
OSIN2
Uses bank loans
OSIN3b
Like OSIN3 but can take negative values
9
1
Measures of original sin by
country groupings
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
Financial Centers
Euroland
OSIN1
Other Developed
Developing
OSIN3
10
Original Sin in Developing
Countries
1
0.95
0.9
0.85
0.8
0.75
LAC
ASIA&PAC
1993-1998
ME&AFR
ECA
1999-2001
11
Original sin is highly persistent:
OSIN and Flandreau-Sussman classification
(circa 1850)
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
Gold
Clauses
Mixed
Clauses
Domestic
Currency
12
The Pain of Original Sin
(The consequences)

Exchange rate flexibility

Output and capital flow volatility

Credit ratings
14
Original Sin and Exchange Rate
Flexibility



If an original sin country has a net foreign debt,
then there is an aggregate currency mismatch.
Movements in the RER will have an aggregated
wealth effect
This renders the CB less willing to let the
exchange rate move (fear of floating, Calvo and
Reinhart, 2002)
As a consequence, the CB holds more reserves
and uses them, together with the interest rate, to
intervene in the foreign exchange market
(Hausmann, Panizza, Stein, 2001)
15
Original Sin and Exchange Rate
Flexibility
(1)
OSIN3
(2)
LYS
RESM2
1.503
0.248
(3.56)*** (3.74)***
(3)
RVER
-0.801
(2.02)**
GDP_PC
0.302
(2.89)***
-0.053
(1.85)*
0.026
(0.61)
OPEN
0.198
(0.92)
0.290
(0.96)
-2.188
(1.94)*
75
-0.014
(0.41)
-0.036
(0.66)
0.531
(1.73)*
65
0.37
1.017
(2.88)***
-0.570
(2.36)**
0.104
(0.17)
65
0.62
EXD/GDP
Constant
Observations
R-squared
(4)
(5)
(6)
Dropping Financial Centers
LYS
RESM2
RVER
1.112
0.339
-0.598
(2.45)** (3.10)***
(1.33)
0.285
(2.77)**
*
0.153
(0.72)
0.297
(0.98)
-1.644
(1.46)
71
-0.052
(1.81)*
0.025
(0.56)
-0.014
(0.41)
-0.030
(0.54)
0.435
(1.35)
62
0.34
1.021
(2.93)***
-0.544
(2.29)**
-0.084
(0.13)
62
0.65
16
Original Sin and Exchange Rate
Flexibility


The results are generally robust to alternative
definitions of original sin, to dropping weights,
and to augmenting the regressions with a
developing country dummy
Causality is a big issue (Burnside, Eichenbaum,
and Rebelo, 2001)

IV regressions confirm the results but instrument
(SIZE) is lousy



We tried to go in the other direction. OSIN on the left
and LYS on the right instrumented with openness. We
found no correlation between LYS and OSIN
Using lagged OSIN in a panel confirms the results
Devereux and Lane (2003)
17
Original Sin, Output and Capital
Flow Volatility




Original sin limits the scope and effectiveness of
counter-cyclical policies (Cespedes, Chang and
Velasco, 2003)
Original Sin limits the CB ability of acting as a
LOLR (Chang and Velasco, 2000)
Dollar liabilities are likely to increase the cost of
a currency crisis
Dollar liabilities could be associated with Sudden
Stops in capital flows (Calvo, Izquierdo and
Mejia, 2003)
18
Original Sin, Output and Capital
Flow Volatility
OSIN3
LGDP_PC
OPEN
VOL_TOT
SHARE2
Constant
Observations
R-squared
(1)
(2)
VOL_GROWTH
0.011
(1.96)*
-0.012
(2.14)**
-0.001
(0.12)
-0.000
(0.86)
-0.014
(1.72)*
0.135
(2.25)**
77
0.40
VOL_FLOW
7.103
(3.58)***
-3.214
(2.56)**
-4.181
(1.20)
0.223
(1.08)
0.147
(0.04)
32.825
(2.39)**
33
0.64
(3)
(4)
Dropping Financial Centers
VOL_GROWTH
VOL_FLOW
0.015
7.498
(2.45)**
(2.69)**
-0.012
-3.322
(2.09)**
(2.40)**
-0.000
-4.333
(0.08)
(0.83)
-0.000
0.223
(0.89)
(1.02)
-0.015
0.949
(1.51)
(0.14)
0.131
33.282
(2.15)**
(2.22)**
73
29
0.40
0.62
19
Original Sin and Credit Ratings

If a country’s debt is denominated in foreign currency, its
capacity to pay will not be related to its LCU GDP but to
its dollar GDP



Original Sin makes the real exchange rate matter for debt
service
This is important because in developing countries the
volatility of dollar GDP is much higher than the volatility
of LCU GDP, and sudden drops of dollar GDP are usually
associated with much smaller drops in real GDP
Other things equal, countries with Original Sin should be
riskier than countries that borrow in own currency
20
Original Sin and Credit Ratings
OSIN3
DE_GDP
(1)
RATING
(2)
RATING
-5.845
(4.08)***
-2.421
(2.50)**
-5.644
(4.01)***
DE_RE
LGDP_PC
SHARE2
Constant
Observations
2.916
(8.48)***
2.187
(1.43)
-8.058
(2.12)**
56
-0.999
(2.49)**
2.670
(6.16)***
2.787
(1.52)
-5.962
(1.28)
49
(3)
(4)
RATING
RATING
Dropping Financial
Centers
-5.214
-4.955
(3.31)***
(3.21)***
-2.285
(2.32)**
-0.975
(2.39)**
2.976
2.729
(8.36)***
(5.97)***
1.810
2.405
(1.09)
(1.18)
-9.119
-7.037
(2.29)**
(1.44)
53
46
21
The Mystery of Original Sin
(the causes)
Key Question from this Point of
View


Does the inability to borrow internationally in
domestic currency reflect problems with
country policies and institutions or systematic
problems?
We argue that the problem is too pervasive
(and too weakly correlated with country
characteristics) to be entirely explicable on
the first set of grounds.
23
Five possible explanations





Underdevelopment of institutions and
policies in general
Inadequate monetary credibility
Fiscal profligacy
Weak contract enforcement
Political economy stories
24
Original Sin and the Level of
Development
LGDP_PC
SIZE
FIN_CENTER
EUROLAND
OTH_DEVELOPED
Constant
Observations
(1)
OSIN3
-0.141
(1.59)
-0.310
(3.37)***
-0.680
(1.99)*
-0.126
(0.62)
0.007
(0.03)
2.522
(3.39)***
75
(2)
OSIN3
-0.128
(1.43)
-0.310
(3.33)***
(3)
OSIN3
-0.170
(2.99)***
-0.415
(4.51)***
-0.152
(0.74)
-0.021
(0.10)
2.414
(3.24)***
71
2.833
(5.46)***
75
25
Original Sin and Monetary
Credibility


Lack of monetary credibility is the true cause of
Original Sin (Jeanne, 2002)
The government has an incentive to inflate away
domestic currency debt held by foreigners, and
the presence of foreign currency debt can act as
commitment device and improve credibility
(Tirole, 2002, Calvo and Guidotti, 1990)

Why don’t we observe inflation indexed debt?
(Chamon, 2002)
26
Original Sin and Monetary
Credibility
AV_INF
(1)
(2)
(3)
(4)
OSIN3
0.306
(1.19)
OSIN3
OSIN3
0.436
(0.69)
-0.116
(0.23)
OSIN3
AV_INF2
MAX_INF
FIN_CENTER
EUROLAND
OTH_DEVELOPED
Constant
Observations
(6)
OSIN3
0.083
(1.07)
-0.318
(3.50)***
0.175
(2.08)**
-0.503
(5.75)***
-0.318
(2.21)**
-0.213
(1.57)
1.347
(13.46)***
70
1.358
(13.41)***
74
0.067
(0.95)
INF
SIZE
(5)
Dropping
Financial
Centers
OSIN3
-0.318
(3.57)***
-0.866
(2.88)***
-0.304
(2.12)**
-0.199
(1.47)
1.277
(10.87)***
74
-0.318
(3.54)***
-0.897
(2.99)***
-0.329
(2.31)**
-0.224
(1.67)*
1.310
(11.60)***
74
-0.316
(3.52)***
-0.857
(2.83)***
-0.296
(1.99)*
-0.192
(1.37)
1.259
(8.83)***
74
0.085
(1.09)
-0.318
(3.55)***
-0.881
(2.93)***
-0.315
(2.21)**
-0.211
(1.56)
1.346
(13.56)***
74
27
Original Sin and Monetary
Credibility
e( OSIN3 | X)
.363081
KOR
MEX
IND
SWE
THA
TUR
NOR
SGP
AUT
ISR
IDN
FIN
PHL
CHL
COLVEN
HUN
BEL
PAK
GRC
MAR
DNK
SVN
TUN
POL BGR
URY
DOM
LKA
OMN GTM
NET
CRI
JOR
SLV
ESP ECU
BHR
ZWE
ISL
SVK
CYP
JAM
EST LVA
MLT
BOL
MUS CAN
PNG
BHS
AUS
BRB MDA
RUS
ARG
UKR
ROM
PER
NIC
GBR
SUR
FRA
ZAF
PRT
TTO
USA
JPN
DEU
ITA
CHE
-.893699
CZE
LUX
- .246179
1.48963
e( AV_INF | X )
28
Original Sin and Monetary
Credibility



Low inflation seems to be a necessary but not
sufficient condition for escaping Original Sin
Results are robust to longer lags (1970s)
They are robust to instrumenting inflation with
an index of CB independence
29
Original Sin and Fiscal Solvency


A government with weak fiscal accounts has an
incentive to debase its currency in order to
erode the value of its real obligations (Lucas and
Stokey, 1983)
Corsetti and Mackowiack (2002) find that there
is a vicious circle in which, in the presence of
weak public finances, a large stock of foreign
currency debt limits the ability to borrow in
domestic currency
30
Original Sin and Fiscal Solvency
DE_GDP
(1)
OSIN3
-0.073
(0.50)
DEFICIT
(2)
OSIN3
(3)
OSIN3
(4)
OSIN3
(5)
OSIN3
-0.025
(0.30)
-0.024
(0.28)
0.014
(0.24)
FISC
DE_GDP*DEV
-0.342
(3.42)***
-0.839
(2.66)**
-0.348
(2.48)**
-0.272
(2.01)**
1.382
(12.04)***
-0.348
(2.46)**
-0.272
(1.99)*
1.385
(11.93)***
0.247
(0.88)
-0.186
(1.13)
-0.330
(3.60)***
-0.645
(2.01)**
-0.155
(0.84)
-0.094
(0.53)
1.260
(8.00)***
57
54
64
DE_GDP*IND
FIN_CENTER
EUROLAND
OTH_DEVELOPED
Constant
Observations
(7)
OSIN3
0.050
(0.31)
1.777
(0.92)
DE_RE
SIZE
(6)
OSIN3
-0.350
(3.71)***
-0.825
(2.72)***
-0.344
(2.61)**
-0.275
(2.18)**
1.426
(11.99)***
-0.327
(3.52)***
-0.926
(3.09)***
-0.361
(2.66)***
-0.215
(1.54)
1.311
(11.46)***
64
74
-0.354
(3.51)***
-0.816
(2.57)**
-0.327
(2.22)**
-0.245
(1.73)*
1.370
(10.06)**
*
57
-0.345
(3.40)***
-0.555
(5.92)***
1.374
(11.66)***
64
31
Original Sin and Contract
Enforcement



Investors are reluctant to lend in countries where the
institutions designed to enforce their claims are weak
Chamon (2002) and Aghion, Bacchetta and Banerjee
(2001) show that if depreciation and default risk are
correlated and, if in case of default, assets are divided
among creditors in proportion to their nominal claims,
domestic currency market will disappear
This problem could be solved if courts could enforce
complicated contracts that distinguish among creditors of
different seniority
32
Original Sin and Contract
Enforcement
RULEOFLAW
SIZE
FIN_CENTER
EUROLAND
OTH_DEVELOP
ED
Constant
Observations
(1)
OSIN3
-0.050
(0.46)
-0.323
(3.53)***
-0.883
(2.65)**
-0.326
(1.81)*
-0.203
(2)
OSIN3
-0.053
(0.49)
-0.322
(3.48)***
(1.03)
1.388
(13.17)***
75
(1.01)
1.390
(13.08)***
71
(3)
OSIN3
-0.182
(2.33)**
-0.480
(5.32)***
-0.325
(1.79)*
-0.201
1.486
(12.33)***
75
33
Original Sin and Political Economy


Original sin could be due to the absence of a
domestic constituency of local currency debtholders prepared to penalize a government that
debase the currency
Tirole (2002) suggests that Original Sin may
arise from the government’s inability to commit
to protect the rights of foreigners
34
Original Sin and Political Economy
DC_GDP
FOR_DOM
(1)
(2)
(3)
(6)
OSIN3
OSIN3
OSIN3
OSIN3
-0.332
(1.49)
-7.289
(2.15)**
SIZE
-0.290
-0.360
(3.22)*** (4.02)***
FIN_CENTER
-0.753
-0.843
(2.40)** (3.02)***
EUROLAND
-0.226
-0.301
(1.37)
(2.34)**
OTH_DEVELOPED -0.224
-0.223
(1.75)*
(1.86)*
Constant
1.521
1.431
(10.13)*** (13.76)***
Observations
74
73
-0.554
(2.99)***
7.224
(0.86)
-0.399
-0.323
(3.72)*** (4.47)***
-0.895
(3.23)***
-0.299
(2.42)**
-0.254
(2.16)**
1.636
1.291
(11.15)*** (11.32)***
74
72
35
Digression on Domestic Original Sin


It may be the case that the previous
regressions do not yield any result
because we are not able to measure the
“real” size of the domestic local currency
market
This would require building a measure of
domestic original sin and looking at how it
relates to international original sin
36
Digression on Domestic Original Sin

We were able to build such a measure for
a small sample of 21 developing countries
FC + DST + DLTII
DSIN =
FC + DST + DLTII + DLTIP + DLT
37
Digression on Domestic Original Sin
ARG
IDN
MYS
VEN
TUR
DSIN=0.25+0.37*OSIN3
p value on slope coefficient 0.11
R2=0.13 N= 21
1
BRA
MEX
EGY
.75
HKG
DSIN2
CZE
CHL
.5
POL
PHL
HUN
ISR
SGP
.25
THA
SVK
ZAF
IND
TWN
0
0
.25
.5
OSIN3
.75
1
38
Digression on Domestic Original Sin
LGDP
(1)
DSIN
0.134
(1.63)
LGDP_PC
(2)
DSIN
(3)
DSIN
(4)
DSIN
(5)
DSIN
(6)
DSIN
0.134
(2.16)**
RULEOFLAW
0.176
(1.73)
0.215
(3.75)***
-0.142
(1.59)
DC_GDP
-0.638
(1.94)*
-0.263
(0.60)
CAPCONTR
Observations
R-squared
(8)
DSIN
0.029
(0.36)
AV_INF
Constant
(7)
DSIN
-0.064
(0.17)
21
0.09
0.335
(0.49)
21
0.01
0.217
(1.09)
21
0.15
0.607
0.906
(6.38)*** (4.39)***
20
18
0.08
0.18
0.218
(0.43)
18
0.28
-0.069
-0.140
(1.18)
(3.24)***
0.576
0.008
(7.48)*** (0.04)
21
21
0.07
0.37
39
Digression on Domestic Original Sin
TUR
ARG
IDN
MYS
VEN
1
CC=0.50
BRA
Not significantly different
MEX
EGY
.75
CZE
DSIN2
CC=0.69
HKG
CHL
.5
CC=0.45
POL
PHL
HUN
ISR
SGP
.25
THA
SVK
ZAF
IND
TWN
0
0
.25
.5
OSIN3
.75
1
40
Digression on Domestic Original Sin


There is some (weak) evidence that
capital controls may help in reducing
domestic original sin
However, it looks as if capital controls are
bad for for international original sin
41
Back to International Original
Sin
Putting Everything Together
SIZE
GDP per cap
AV_INF
DE_GDP
RULE of LAW
DC_GDP
FIN_CENTER
EUROLAND
OTH_DEVEL.
Constant
Observations
(1)
OSIN
-0.302
(3.32)***
-0.262
(2.08)**
0.288
(0.89)
-0.003
(0.02)
0.305
(1.88)*
-0.313
(1.05)
-0.492
(1.45)
0.032
(0.15)
-0.053
(0.24)
3.506
(3.54)***
63
(2)
OSIN
-0.325
(3.48)***
-0.127
(1.31)
0.150
(0.4 9)
-0.102
(0.60)
-0.173
(0.59)
-0.453
(1.31)
0.010
(0.04)
0.030
(0.14)
2.505
(3.22)***
63
(3)
OSIN
-0.326
(3.50)***
0.070
(0.29)
0.044
(0.26)
0.091
(0.70)
-0.403
(1.38)
-0.680
(2.06)**
-0.220
(1.18)
-0.299
(1.55)
1.516
(7.66)***
63
(4 )
OSIN
-0.352
(3.88)***
-0. 248
(2.30)**
0.274
(0.88)
-0.002
(0.01)
0.255
(1.61)
-0.291
(1.25)
(5 )
OSIN
-0.374
(4.05)***
-0. 113
(1.82)*
0.099
(0.36)
-0.062
(0.37)
3.437
(4.03)***
63
3.437
(4.03)***
63
-0.269
(1.14)
43


SIZE always significant
When we include one variable at a time, we find that:



If we control for country groups there is no other variable
that is significantly correlated with Original Sin
If we do not control for country groups, GDP per capita,
inflation, rule of law, and size of the financial system are
correlated with Original Sin
When we jointly test all the hypotheses, we find that:


When country groups are included, only SIZE is robustly
correlated with Original Sin
When country groups are dropped, GDP per capita is
marginally significant
44





Original sin is not merely a problem of country
policies (one need not deny the relevance of these,
of course)
It is also a problem with the operation of the
international system
In a world with transaction costs and decreasing
returns to diversification, the global portfolio may
have a limited number of currency
If larger countries offer better opportunity for
diversification, country size will matter in the choice
of the global portfolio
Redemption therefore requires international action
to overcome the inertia in the system
45
Lessons from outliers

An interesting fact about the international issuance
of bonds in exotic currency is that it is mostly done
by non-residents who then swap the debt-service
obligation back to US dollar
46
Share of local currency international
debt issued by non-residents
1
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
Czech
Republic
South
Africa
New
Poland Hong Kong Denmark Canada Singapore Australia
Zealand
47
Lessons from outliers


An interesting fact about the international issuance
of bonds in exotic currency is that it is mostly done
by non-residents who then swap the debt-service
obligation back to US dollar
They do this to reduce cost of funding



But, why is this complex operation cheaper than
borrowing directly in dollar?
A possibility is that the market values the
possibility of separating currency and credit risk
The IFIs have a natural hedge and could play
a role in expanding this market
48
Conclusions


Original Sin is a widespread phenomenon
It has costs






Limits the ability to conduct monetary policy
Increases volatility
Increases credit risk
It cannot be easily explained by weak policies or
institutions
Country size seems to be important
The IFIs could play a role in reducing Original Sin
49
The Pain and the Mystery of
Original Sin
Barry Eichengreen
Ricardo Hausmann
Ugo Panizza
50
Original Sin and Credit Ratings
(1)
RATING
(2)
RATING
4.814
(2.30)**
-8.627
(4.96)***
-2.659
(1.24)
-3.671
(2.34)**
-9.027
(5.78)***
(3)
RATING
(4)
RATING
5.783
(3.10)***
-9.207
(5.85)***
-1.511
(0.83)
-4.438
(3.36)***
8.917
(6.60)***
Original Sin
Debt/GDP advanced
Debt/GDP developing
Developing
Debt/GDP high rating
Debt/GDP low rating
High rating
GDP per capita
Ex Debt/GDP
Constant
13.999
19.757
14.138
11.028
(15.60)***
(15.27)***
(17.51)***
(15.03)***
Observations
61
61
61
61
DEG_DEV=DEG_ADV F(1,59)=41.31 F(1,58)=0.14 F(1,59)=62.7 F(1,58)=1.69
DEG_HR=DEG_LR
P=0.000
P=0.705
P=0.000
P=0.199
(5)
RATING
-5.100
(3.38)***
-1.553
(1.31)
-3.557
(2.66)**
(6)
RATING
-4.751
(3.32)***
-2.451
(2.05)**
-2.475
(1.84)*
-3.004
(2.38)**
2.663
(6.71)***
2.252
(1.50)
-6.314
(1.58)
56
1.936
(4.00)***
1.751
(1.22)
1.606
(0.32)
56
51