Sovereign debt guru Layna Mosley discusses the key role of political philosophy in sovereign debt decisions. They explore reasons why political scientists study sovereign debt, the impact of elections and political institutions, and the influence of domestic politics on borrowing choices. The podcast also explores 'original sin' in developing countries' debt, determinants of government bond denomination, and the role of IMF and World Bank in the rise of local currency.
Left-leaning governments are more likely to issue bonds in domestic currency, highlighting their consideration of broader factors such as insulation from market pressures and policy flexibility.
Political scientists emphasize that political considerations and variation in politics play pivotal roles in understanding sovereign debt decisions, challenging the notion that borrowing decisions are solely based on cost of capital.
Deep dives
Government borrowing and the political economy of sovereign debt
Political scientists study how governments borrow and why sovereign debt is important in the context of fiscal policy. Governments borrow to enable them to fulfill their functions and achieve goals. Sovereign borrowing also involves the intersection between governments and markets, with creditors exerting leverage over governments. Political scientists are interested in how financial markets react to political institutions and events like elections, changes in government, civil conflicts, and the rule of law. They are also concerned with the role of international financial institutions and how politics affects conditional lending. Economists tend to dominate the field of sovereign debt research, but political scientists provide a different perspective, emphasizing the political and strategic considerations in borrowing decisions. There is occasionally frustration when economics "discovers" political science topics that have been studied for a long time. Political scientists care about issues like currency denomination, maturity structure, and the interest rate as part of the broader framework of understanding government borrowing.
Factors influencing currency denomination in government bonds
Political scientists, together with their co-authors, have conducted research on currency denomination in government bonds issued by non-OECD countries from 1990 to 2016. They found a shift towards a higher proportion of bonds being denominated in domestic currency rather than foreign currency, challenging the concept of original sin. Left-leaning governments are more likely than right-leaning or centrist governments to issue bonds in domestic currency. This suggests that governments, in addition to minimizing financing costs, consider broader factors such as insulation from market pressures and policy flexibility. These findings highlight the agency and decision-making power of governments in shaping their borrowing strategies. The research also indicates that politically independent central banks and those without recent crises are better able to pursue domestic currency denomination. Variation in borrowing practices may also occur based on electoral cycles and uncertainties.
Relationship between debt management offices and bond issuance strategies
Debt management offices play a significant role in government bond issuance strategies. The extent of their autonomy and decision-making authority varies across countries. However, political scientists have not extensively studied debt managers' decision-making processes and their relationship with governments. Debt managers are often responsible for obtaining capital at the lowest cost for their political bosses and constructing a yield curve for corporate entities in their countries. This suggests that their focus is on cost of capital rather than broader considerations such as insulation from market pressures. Yet, governments, particularly left-leaning ones, may have multiple long-term objectives, such as reducing reliance on foreign currency debt and gaining policy autonomy. Shifting bond profiles and reissuing debt in domestic currency can be a gradual process that requires significant reduction in foreign currency debt over time.
Role of international financial institutions and the impact on currency denomination
International financial institutions like the World Bank and IMF play a crucial role in shaping debt management practices and providing guidance to governments. Their efforts in promoting professional debt management offices and developing domestic capital markets have contributed to the shift towards domestic currency denomination. However, the extent of success and impact varies across countries. Governments make different choices in incentivizing the holding of their own bonds, such as privileging their debt in domestic regulations or privatizing pension systems. While international financial institutions have some influence on these outcomes, political factors and country-specific contexts significantly affect the degree to which governments adopt domestic currency denomination. Political scientists emphasize that political considerations and variation in politics play pivotal roles in understanding sovereign debt decisions.
Local v. Foreign Bonds?
One of the classic questions in sovereign debt is why and when do sovereigns choose to issue bonds under local parameters (e.g., currency and law) versus foreign ones. And the typical answer has been: It is all about the cost of capital, dummy! In a wonderful recent article, sovereign debt guru Layna Mosely and co authors give us a fresh and original perspective on this classic question by showing the key role that the borrower government’s political philosophy also plays. In this episode, we ask Layna about her new article and also about some broader and bigger questions about the field and the different roles that political scientists, lawyers, and economists play.
Producer: Leanna Doty
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