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Although the paper may benefit from the inclusion of country case studies, such amplification is best left to a later longer study.
Generally, nonresident retail investors will not be interested or accessible for emerging market sovereign issues.
Some residents think in terms of the domestic currency and markets (“resident domestic”); others have access to foreign currency and perhaps also to foreign markets, and so have different opportunity costs (“resident international”); while accessible nonresident investors will tend to think in terms of the international markets (“nonresident international”).
For example, some foreign investors may only want to take on sovereign risk and not foreign exchange risk. To hedge against the latter, they may use forward markets (though this still involves counterparty risk) or repo, borrowing from domestic banks to finance the government debt. Some international investors will not participate in a developing market domestic currency issues if they cannot use these hedging instruments simply.
Sometimes defaults on a domestic obligation may trigger a default on international issues due to cross-default provisions.
It is difficult to assess the risk preferences of different types of investor’s ex-ante; but discussions with major (and potential) investors, together with market pricing, can provide useful information.
The level of central bank bills issued, denominated in local currency, will have to exactly match the government’s borrowing to fully sterilize the effect of liquidity injection.
The central bank can also choose to sterilize the excess liquidity by raising non-renumerated reserve requirement. This, however, simply passes part of the government’s funding cost to the commercial banks as a form of increased domestic taxation.
Assuming the government spends the domestic currency its obtains from the central bank.
Either directly or through the central bank (when it is the banker for the government).
This information asymmetry was illustrated by the tequila crisis during which Mexican residents exited the domestic currency before foreign investors.
On the other hand, excessive short-term domestic currency denominated government debt positions may constrain the authorities’ ability to raise interest rates to prevent an excessive depreciation of the domestic currency.
Increased confidence in the domestic currency is more still likely to come from evidence of sound fiscal and macroeconomic policies and strong net reserves.
It may be more effective for the government to borrow on behalf of the central bank; but in this case, the central bank’s liability should be a debt to the government rather than an increased government cash balance, which could be disbursed. Otherwise, the central bank would need to sterilize the domestic monetary creation.
Borrowing whose interest and principal payments are tied to the exchange rate.