The COVID-19 crisis shows once again how currency depreciation can rapidly makes debt burdens unsustainable, especially in the poorest countries.
In this light, Ugo Panizza and Filippo Taddei produced timely research: a paper documenting how foreign currency borrowing poses risks to debt sustainability. To improve the allocation of currency risk, the authors discuss various options, including multilateral development banks (MDBs) handing out loans indexed to local currencies and then using risk markets and TCX to manage the currency risks.
TCX works with many development finance institutions (DFIs) and MDBs to successfully implement such an approach for private sector lending; TCX is also working on a pilot project with IDA for sovereign loans. Currency risks should be and can be shifted away from borrowers and allocated at the level at which they can best be managed and sustained. The COVID-19 crisis has shown that our current development finance approach, which allocates currency risk with borrowers, can be improved.
Please find the paper by clicking on this link: Local Currency Denominated Sovereign Loans – A Portfolio Approach to Tackle Moral Hazard and Provide Insurance.