Crude credit: The political economy of natural resource booms and sovereign debt management

Abstract

Oil, gas, and minerals have notoriously adverse effects on institutional quality. But when global liquidity is high, risk-tolerant investors are more willing to lend to all borrowers, even resource-rich countries with low-quality institutions. Despite the availability of cheaper credit during commodity booms, we argue that countries do not increase current borrowing to mitigate future revenue shortfalls during commodity busts. Instead, they rely on resource windfalls to meet their current financing needs, fearing they would otherwise forfeit national policy discretion to global financial markets. We leverage primary evidence from extensive field research across five Latin American countries to show that national economic officials (i.e. finance ministers and central bank governors) are wary of high indebtedness, after past commodity booms ended in cycles of lofty spending, borrowing, and default. For sovereign borrowers, high bond market indebtedness often reduces government discretion over economic policy, whereas windfalls increase it; all else equal, governments will favor the latter. Using data on 22 Latin American and Caribbean countries from 1996 to 2020, we find that governments issue bonds less frequently, in smaller amounts, as their oil and gas production or GDP share from resource rents increases. These findings make an important contribution to our understanding of how commodity cycles affect global capital markets: sovereign borrowers do not fully leverage commodity booms to expand their fiscal space to finance more spending over time.