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Şenay Ağca, George Washington University; Oya Celasun, International Monetary Fund, respectively. The authors would like to thank Simon Johnson and Alessandro Prati for encouragement in the early stages of the project, and the seminar participants at the George Washington University and IMF for useful comments. Patricio Valenzuela, Fernando Balderrama, Manzoor Gill, and Morris Mitler provided excellent research assistance. Ağca acknowledges a research grant from the School of Business at the George Washington University. Celasun acknowledges a research grant from the IMF’s Research Department.
A large literature has addressed the different question of whether public debt raises interest rates on public, as opposed to private, debt. Much of this work has focused on the United States or other OECD countries. See for instance Ardagna, Caselli, and Lane (2006), Engen and Hubbard (2004), and Laubach (2009). Akitoby and Stratmann (2008) investigate the effect of total (public and private) external debt on sovereign spreads in the secondary market.
The syndicates providing the loans are predominantly composed of foreign banks.
There is wide agreement that sovereign debt crises are strongly associated with currency crises (see, for instance, Herz and Tong, 2008), but the literature is not conclusive on whether a higher level of external debt necessarily raises the risk of a currency crisis. For instance, Jeanne and Rancière (2006) find that a sudden stop of capital flows is more likely when the ratio of total gross external liabilities to GDP is high, while Frankel and Wei (2004) find no significant association between external debt and the likelihood of a currency crisis.
In Cespedes, Chang, and Velasco (2004), a real depreciation would also shift aggregate demand towards domestically produced goods, thereby improving profits. Cowan and Bleakley (2008) find that the negative balance-sheet effects of a depreciation on Latin American firms holding dollar debt are offset by the larger competitiveness gains of these firms. Such a channel from real depreciations to improved profits could partially alleviate the riskiness of sovereign debt for domestic firms, in particular those in the tradables sector. We therefore investigate, in robustness checks, how the results differ between the tradables and nontradables sectors.
Eichengreen and Mody (2000) estimate yield spread equations for a pooled sample of public as well as private borrowers and do not include public external debt as a separate explanatory variable. Qian and Strahan (2007) and Bae and Goyal (2009) investigate the role of contractual environment on loan terms for private borrowers.
This bias can be avoided if the determinants of loan demand can be fully controlled for in the regressions.
Eichengreen and Mody (2000) argue that increases in U.S. Treasury rates increase spreads on emerging market bonds less than proportionately because high-risk borrowers are discouraged from coming to the market.
There is a slightly higher number of loans in the database, but we discard those loans issued by firms in countries that do not have a measure of sovereign credit risk. As a result, we end up with 3223 usable observations.
Dealogic classifies borrowers as being public or private sector entities. The public sector comprises the sovereign, public sector enterprises, and enterprises issuing debt under public guarantees.
In estimating the determinants of yield spreads, Eichengreen and Mody (2000) also use the “sovereign risk residual” from a first step regression of sovereign credit ratings on macroeconomic variables that are included in the spread equation.
Time varying global factors affecting all countries are largely captured by the year dummies. U.S. high yield corporate and five year U.S. Treasury yields are meant to capture the within-year variation in global factors.
In columns 3 and 6, we use two-step Heckman regressions as the maximum likelihood procedure does not converge in the joint Heckman specification. As it can be observed from the inverse Mill’s ratio (lambda), there is no sample selectivity when we control for firm level variables. However, sample selectivity is not rejected when we do not control for firm levels variables (column 6). Chi-square statistics for the full Heckman regressions support these arguments.
Qian and Strahan (2007) investigate the role of legal origin, creditor rights, the availability of public and private registries, and indices of legal formalism and enforcability of contracts on a host of loan terms and characteristics, including yield spreads. Among these legal variables, they only find creditor rights and legal origin to matter for yield spreads. We also do not find a significant effect of registries, legal formalism and enforceability on the effects of sovereign debt on corporate loan yield spreads.
These additional controls are also included as explanatory variables when obtaining the residuals of sovereign credit ratings and EMBIG spreads from public external debt, real GDP growth, and political risk.
Jeanne and Guscina (2006) provide data on public debt issued domestically, and international public debt, i.e. debt issued under a foreign jurisdiction. This is different from the concept of public external debt used in the rest of this paper (from the Global Development Finance database), where the criterion is the residency of the debt holder, and where the coverage extends to publicly guaranteed as well as public debt.
Firms in the agriculture, forestry, fishing, mining and manufacturing sectors are classified as tradables. We control for sectoral dummies in all regressions, so the level effect of the issuer being in the tradables sector is accounted for.