Original Sin (Economics)

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As Original Sin ( English original sin ) is called in economics , a situation, a country on the capital market is not in its own currency can borrow and therefore loans in foreign currency must accept. Such a situation arises when market participants do not have sufficient confidence in the country or its currency. Original Sin is particularly a problem in emerging and developing countries and causes, among other things, for the countries concerned. And enormous costs .

trigger

The metaphorical term "original sin" suggests that Original Sin obviously had triggers that are very ancient.

The capital market theory explains supply and demand for securities through the price - in this case the interest . The situation that a potential debtor can not find a potential creditor on the market is therefore explained by the too unattractive interest rate. From this it can be concluded that every borrower from a certain (possibly very high) interest rate also finds an investor who is willing to do business with him.

For countries that are affected by the phenomenon of the Original Sin, this is exactly the problem: You will not find a lender at affordable interest rates in their own currency. This is explained by the fact that the interest rate offered is obviously not a sufficient risk premium in terms of protection against impending defaults (two risks in particular: interest is not paid in full on time and the loan itself is not paid back in full on time). An 'Original Sin' is therefore implicitly based on a situation with a relatively high risk.

The sources of this risk can be twofold:

• the country risk : the potential investors do not consider the borrower to be trustworthy enough.
• the currency risk : The potential investors are afraid of a possible devaluation of the currency in which the loans are denominated. A devaluation of the currency during the investment period would result in a direct loss of value for the investor.

The case of a too high country risk alone is not important for an Original Sin, since the country risk has an equal impact on debt in domestic and foreign currency. For the Original Sin, on the other hand, the currency risk is of much greater importance, since a country whose currency is subject to a high risk of devaluation will hardly be able to take out loans in its own currency, but will be able to borrow relatively easily in a foreign reserve currency .

Effects

Original Sin poses enormous problems , especially in developing countries with poor capital . Many of these countries urgently need foreign capital inflows in order to be able to make the investments necessary for economic development . However, due to the original Sin, they can only take out the necessary loans in foreign currency ( US dollars , euros , ...). Although they pay far lower interest rates for this than for debt in domestic currency, the currency risk is transferred to them as a result: If the currency of the indebted country devalues ​​in the course of the lending business, the amount to be repaid increases in domestic currency on - so the country's debts are increasing.

This is very problematic for the countries concerned, as such a situation has a strong procyclical effect: Even a small causal devaluation can lead to a noticeable increase in national debt (and thus, due to the loss of confidence, to a further devaluation and thus a further increase in national debt). At the end of this process, there is often a national bankruptcy , which, due to the original Sin, can be triggered by a comparatively small impulse.

As a result, an original sin not only brings with it the inability to borrow in domestic currency, but also risks of national debt in foreign currencies. The high currency risk makes it difficult for the country to access foreign capital and makes it difficult for this country to achieve economic growth .

Measures against original sin

Because of its enormous economic consequences, the Original Sin is feared by developing and emerging countries. Scientists (especially economists ) name a number of measures:

1. Since Original Sin is almost always (partly) triggered by a high level of national debt, renouncing extensive national debt is a way out of the Original Sin problem in a double sense: Firstly, a country without high national debt does not suffer from Original Secondly, Sin and cannot be affected by an appreciation of its foreign debt. However, this proposed solution includes the state's implicit waiver of foreign capital and is therefore only viable to a limited extent.
2. As a second way out of the original Sin trap, economists are increasingly demanding greater state transparency on the part of the borrower. This is justified by the fact that precisely the lack of transparency , uncertainty and risk on the part of the capital provider is answered with high interest rates (and consequently the original sin). However, greater transparency is more of a long-term way of avoiding the problem than a short-term approach. In addition, z. B. after elections or a coup, drastically change a country's politics.
3. A third strategy often used by developing countries to bypass the original Sin is to fix the exchange rate . If a country succeeds in a credible way (e.g. via a currency board ) in pegging its currency to a foreign anchor currency , the lender can come to the conclusion that the currency risk has decreased significantly for it. Not least for this reason, developing countries are attested to have a massive fear of floating (a fear of exchange rate fluctuations ). However, fixed exchange rates, other economic problems entail .