Quick Economics Question

CFA Level III Economics
#1

For some reason, I think panic of the exam has set in and the simplest things are starting to not make sense - please could someone help in understanding the following statement:

“Most emerging market debt is denominated in a non-domestic currency, which increases its default risk.”

I understand that EM debt has more default risk, but I thought the point of denominating it in a non-dom currency was to reduce its riskiness (so for example, the EM country doesn’t have the power to inflate its currency to reduce the value of the debt).

Thanks!

#2

Most of the EM countries do not have enough USD reserve. Thus, increase the defaut risk when the Bond is demoniated in USD.

#3

Thanks!

#4

First, to reduce the value of its debt, a country would _ deflate _ its currency (e.g., by printing more), not inflate its currency.

Second, that’s exactly the point: if a country’s debt is denominated in another country’s currency, it cannot print its way out of default, so it’s more likely to default.

#5

Hi S2000magician,

Thanks for your response. Could you please further explain why it would be deflation not inflation? I thought it the currency value inflation reduces the value of the currency (e.g. hyperinflation in Zim)? I am sure you are right, but I’m missing a piece of the puzzle here. Or I’m just being stupid!

#6

You’re correct, just from the opposite perspective: The currency deflates, and thus inflation of goods & services occurs. (Hyperinflation in Zimbabwe occured because the currency was becoming worthless)

#7

What Louter said.