Sovereign Borrowing: Global Dollar Cycle Transmission via Heterogeneous Corporate Balance Sheets

Emerging market firms have extensively borrowed in dollars and engaged in severe currency mismatches over the past decade. I find that this liability dollarization of nonfinancial corporate generate unintended consequences to sovereigns, and helps explain the cross-country heterogeneous transmission of the Global Dollar Cycle (Jiang, Krishnamurthy and Lustig (2021)) to EM governments' borrowing behaviors. Particularly, sovereigns tend to accumulate more dollar debt and currency composition of external public debt is tilted towards dollar during global flight-to-dollar-safety episodes, especially when their corporate sector is heavily indebted in dollar. The presence of dollar debts on corporate balance sheets can be especially disruptive during times of global flight-to-dollar-safety when the dollar strengthens. Consequently, governments increase their financing needs to make debt repayment facing with falling tax revenue stemming from decreased output and corporate performance. Moreover, surge in global demand for dollar-denominated safe assets also encourages governments to issue more debt in dollar than in home currency from abroad and increase the dollar share in external public debt so to exploit dollar funding premium.