Title : In Search of the Origin of Original Sin Dissipation

Author : Bada Han(BOK), Jangyoun Lee(Incheon National University), Taehee Oh(Incheon National University)

In this paper, we examine how emerging market economies have gained the ability to borrow abroad in local currency, as opposed to the ‘original sin’ hypothesis. We empirically analyze various economic variables in the association with local currency debt and identify three crucial conditions for the capacity to borrow in local currency: institutional quality, depth of the domestic bond market, and performance in inflation targeting. While trade and financial openness, as well as shares in JPMorgan Government Bond Index-Emerging Markets (GBI-EM) index, also appear to be influential, their associations with local currency debt are less clear compared to the aforementioned three factors. Additionally, we conduct a similar empirical analysis on portfolio equity, which represents a safer form of external liability than foreign currency debt, and verify that the depth of the equity market plays a key role in attracting foreign capital to domestic equity markets. Finally, we propose a simple portfolio model based on the inelastic market hypothesis to explain the positive correlation between capital market depth and the dissipation of original sin, which refers to the presence of more external liability in the form of equity or local currency debt. In essence, our analysis suggests that emerging market economies with reasonably strong fundamentals are not necessarily reliant on foreign currency debt.