Does sovereign risk in local and foreign currency differ?

Abstract

Sovereign debt in local currency has been considered safer than in foreign currency. The literature offers scant guidance as to why such a gap existed, or why it has slowly and steadily diminished over the past two decades. We suggest and empirically test five hypotheses. We find FX reserves, and original sin (greater financing in local currency) to consistently be robust determinants of the gaps in local and foreign currency ratings. As for why the gap has declined, we identify as important factors the surge in global reserves, and to a lesser extent the decline of original sin.