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The role of international reserves in sovereign debt restructuring under fiscal adjustment

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  • Tavares, Tiago

Abstract

Highly indebted developing economies commonly also hold large external reserves. This behavior seems puzzling given that governments borrow with an interest rate penalty to compensate lenders for default risk. Although reducing external debt to the same extent as international reserves would reduce the interest payment burden, reserves can have additional insurance benefits during default crises. Moreover, reserves can also be used to improve lenders recovery rates upon default, thus decreasing the interest rate penalty in non-defaulting times. A standard model of sovereign default risk, augmented with distortionary tax policies and debt restructuring, can replicate quantitatively the observed data patterns on external debt and reserves holdings.

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  • Tavares, Tiago, 2025. "The role of international reserves in sovereign debt restructuring under fiscal adjustment," Journal of Economic Dynamics and Control, Elsevier, vol. 174(C).
    • Handle: RePEc:eee:dyncon:v:174:y:2025:i:c:s0165188925000466
    DOI: 10.1016/j.jedc.2025.105080
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    Keywords

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    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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