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Samir Jahjah is an Economist in the African Department of the IMF, and Vivian Z. Yue is a graduate student of Economics at University of Pennsylvania. We are grateful to Gene Leon, Miguel Messmacher, Jacques A. Miniane, Amadou Sy, Etienne Yehoue and participants at the IMF Institute’s African division presentation for their suggestions and comments. The authors are responsible for all errors and omissions.
The amount of bonds issued by developing countries has risen to $61.47 billion in 2002 compared with $8.91 billion a decade ago. In 2001, the amount of newly issued sovereign bonds in developing countries peaked at $113.92 billion.
Among 65 developing countries that issue sovereign bonds, 30 have run into debt crisis at least once since the 1980s according to Standard & Poor’s.
Edwards and Levy Yeyati (2003) show empirical evidence that the terms of trade shocks have a larger effect on economic performance in countries with more rigid exchange rate regimes, than in countries with a flexible exchange rate regime.
J.P. Morgan’s EMBI global and EMBI+ are constructed for 23 countries starting in 1994 (or later depending on the countries). Data on primary bond markets start in 1980 and cover all developing countries that have issued sovereign bonds.
We also conducted the empirical analysis using the exchange rate regimes grouped into four classes: hard peg, conventional peg, intermediate and free floating. The inclusion of conventional peg as an individual group does not change the results. The estimation is available upon request.
Two adjustments are made to RR classification. A free falling regime is defined as one with monthly inflation rate greater than 40%. Because inflation is one regressor, we categorize this group (79 observations in our sample) using the secondary classification. Nine observations are in the dual-market regime. As no secondary classification is available, we discard these data. Our empirical analysis is robust to exclusion of these two groups.
Ratio of government deficit to GDP is also a common determinant of sovereign bond spreads. This ratio indicates the foreign borrowing needs. But it is found to be insignificant in both the bond issue equation and the spread equation in our study. The result is available upon request.
Eichengreen and Mody (1998) and Kamin and Kleist (1999) document such a relation between U.S. interest rates and bond issue/spreads. Eichengreen and Mody explain this result using a demand and supply argument. When the U.S. interest rate increases, there are fewer sovereign bond issuer countries in the market. Given the demand for bonds in emerging markets, the reduction in supply then lowers bond spreads.
Upon real external shock, the adjustment in equilibrium real exchange rate takes longer in countries with a fixed exchange rate. See Edwards and Levy Yeyati (2003).
Standard & Poor’s rates sovereign debt issuers as in default if a government fails to meet principal or interest payment on external obligations on the due date (including exchange offers, debt equity swaps, and buy back for cash).
In near-default, a country may face difficulties in servicing its debt even though the outright default was avoided through international financial support. Such episodes are not recorded among S&P debt crises, but they have a great impact on sovereign bond issuing and pricing.
In our sample with RR classification, there are 35 bond issues among the 93 observations during debt crises periods. This ratio is low compared with the full sample, which is 219 issuances out of 444 observations.
Unlike currency crises, debt crises usually last a long time. The average length of a debt crisis is 5 years. Therefore, there are sufficient observations in debt crises.
Eichengreen and Mody (1998) also find that much of change in bond spreads is due to changes in market sentiment. This empirical finding is consistent with theoretical studies with self-fulfilling debt crises. See Jahjah and Montiel (2002) for example.
Nominal exchange rate devaluation is expected to have a negative effect on bond spreads as an indicator of the willingness to adjust the exchange rate, but Edwards does not get a significant estimate on devaluation.
The political risk-ratings are from the PRS Group’s International Country Risk Guide (ICRG) risk-rating system, where 12 components of political risks are evaluated. The lower the total risk point, the higher the risk is.
The exchange rate policy variables are less significant, particularly in the spread determination estimation. The reason may be that more unstable political regimes are more likely to follow unsustainable policies such as more rigid exchange rate arrangements and appreciations of the exchange rate. Or unstable government use more rigid exchange rate arrangements as a commitment device.
See Poirson (2003).