Local Currency or Foreign Currency Debt?

Patrick Artus

Revue économique, 2003, vol. 54, issue 5, 1013-1031

Abstract: We consider whether it is better for an emerging country to have its (public and private, domestic and foreign) debt in foreign currency (i.e. in this paper dollars) rather than in local currency. We introduce the possibility that the authorities opt for devaluation if the economic situation deteriorates. A foreign currency debt reduces the probability of devaluation as this increases the debt servicing related to borrowers? default risk, which encourages the authorities to devalue less often. However, the default probability is heightened when the debt is in foreign currency as the devaluation does not improve the borrowers? situation. It is therefore possible to have both a lower devaluation risk and a higher interest rate when the debt is in foreign currency.

Date: 2003
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