The Relationship Between Sovereign Spreads and International Reserves: Does the Exchange Rate Regime Matter?

Abstract

International reserves have been put forward as an important factor affecting sovereign spreads in the literature. This article empirically analyzes whether the relationship between international reserves and sovereign spreads depends on exchange rate policy in emerging markets. The analysis is carried out using exchange rate classifications based on both the officially declared regimes and the actual exchange rate behavior. The results show that international reserves reduce sovereign spreads for all levels of exchange rate flexibility using both classifications. Reserves have a similar effect on spreads for all exchange rate categories, except for hard pegs, under which the effect is larger.

KEY WORDS:

• international reserves
• sovereign spreads
• exchange rate regimes
• emerging markets

Notes

1. The sovereign spread is measured as the spread on foreign currency denominated debt so that it does not reflect the premium paid on local currency debt due to exchange rate risk.

2. See Aizenman and Marion (2003), Mendoza (2004), García and Soto (2006), Aizenman and Lee (2007), Jeanne and Rancière (2011).

3. See Edwards (1984), Haque et al. (1996), Min et al. (2003), Baek et al. (2005), Barajas et al. (2008), Levy Yeyati (2008), Hilscher and Nosbusch (2010), Gumus (2011), Baldacci et al. (2011), and Martinez et al. (2013).

4. Since 1998 the classifications in AREAER have been adjusted to reflect the actual exchange rate behavior and do not correspond to the de jure classification directly. In most cases where there is a discrepancy between the declared regime and the actual behavior, however, this has been stated. Therefore, the de jure classification used in this article has been adjusted to reflect this information and diverges from the IMF classification when it has been stated that the de jure classification is different.

5. The results do not change when the crisis dummy is constructed using the crisis dates from only Kaminsky (2006) or only Laeven and Valencia (2008).