Since the early 2000s, local-currency debt (mostly traded in domestic markets) became a growing and important source of funding for several governments in emerging market economies. Despite their impressive growth, many domestic sovereign debt markets maintain a captive domestic audience that facilitates direct credit to government. This represents a form of financial repression 1, which can lead to a crowding out of private credit.
The degree of this form of financial repression depends crucially on government access to foreign credit. If there is a low presence of foreign investors in domestic sovereign debt markets, governments have to rely heavily on domestic financial institutions potentially worsening the crowding out of private credit. In turn, an increased presence of foreign investors might reduce financial repression, and free resources for the private sector. As a result local firms may be able to finance more investment projects and boost economic activity. Although intuitive, there is little evidence on this topic because of identification challenges.2 In a recent study (Williams, 2018), I use a quasi-natural experiment in Colombia and provide evidence on how the entrance of foreign investors into domestic sovereign debt markets reduces financial repression and increases domestic credit growth, boosting economic activity.
- Financial Sector