Private Sector Share of External Debt and Financial Stability: Evidence from Bank Loans.

Abstract

Since the 1990s, the private sector in developing countries has contracted a substantially larger share of foreign-currency debts (external debts). In this paper, I empirically examine the effect of private sector external debts on bank loan prices. I find that, in general, the private sector share of external debts negatively and significantly impacts the price of bank loans, affecting public sector and private sector borrowers alike. This result demonstrates that private sector debts constitute a factor of international financial stability compared with public sector debts. Further analysis reveals that this impact is mitigated by the existence of a fixed foreign exchange regime showing that the private sector is still able to take advantage of potential market distortions and may subsequently become a factor of financial instability. Moreover, the private sector share of external debts has a positive impact on economic growth and lender monitoring. These additional results explain the gain in financial stability associated with the private sector.