Why Don't Developing Countries Borrow in Their Own Currency from Abroad?

Most emerging markets do not often borrow in their own currency internationally, even though doing so could provide an attractive insurance mechanism. This phenomenon, commonly labeled as "the original sin" in international finance, has mostly been interpreted as evidence of the inability of developing countries to borrow in their domestic currency from abroad. A new working paper by Julien Bengui and Ha Nguyen provides a novel explanation for that phenomenon: It's not that they can't borrow this way, but they might not need to. That's because domestic and foreign lenders have different consumption baskets, the authors say. Domestic lenders largely keep their consumption basket in domestic currency, but all foreign lenders keep theirs in dollars. A depreciation of domestic currency, which tends to occur in bad times, is therefore less harmful to domestic savers than to foreign investors. It's not surprising that domestic lenders require a lower premium than foreign lenders do on domestic currency debt. For plausible calibrations, this consumption-basket effect can induce foreign investors to pull out of the domestic currency debt market.