Winners and Losers from Sovereign Debt Inflows

Abstract

We study the transmission of sovereign debt inflow shocks on domestic firms. We exploit episodes of large sovereign debt inflows in six emerging countries which are due to the announcements of these countries’ inclusion in two major local currency sovereign debt indexes. We show that these episodes significantly reduce government bond yields and appreciate the domestic currency, and have heterogeneous spillovers on domestic firms. Financial and government-related firms experience positive abnormal returns in the days following the announcement episodes. Instead, companies operating in tradable industries exhibit negative abnormal returns after the episodes. We find that the former expansionary effect is more pronounced in countries where the government bond yields drop more in response to the announcement, while the latter recessionary effect is larger in countries where the domestic currency appreciates more. Also, we find that firms which rely more on external financing are positively affected by these events. Our findings shed novel light on the channels through which sovereign debt inflows affect firms in recipient countries. They suggest that these inflows can contribute to reshaping the domestic economy, by increasing the importance of the non-tradable sector at the expenses of the tradable one.