Financial Deregulation, Private Foreign Borrowing and the Risk of Sovereign Default: A Political-Economic Analysis

Abstract

It is often argued that financial liberalization and large external borrowing by the private sector bode ill for sovereign creditworthiness. In this paper, we highlight a channel through which financial liberalization reduces the risk that a developing country’s government defaults on its foreign debt. We present a simple model in which a deregulation-induced surge in private borrowing raises the political costs of default and reduces a government’s incentive to deny repayment.

Keywords: International Investment, Sovereign Risk

JEL Classification: F34, O16