Who Owns Sovereign Debt

The influence of foreign investors on emerging markets

By: Dan Rasmussen with Lulu Patterson

Foreign governments and domestic banks own the majority of outstanding sovereign debt. But a new paper has found that private investors drive most of the volatility in government borrowing costs, and higher shares of private investor ownership can make countries more prone to capital flight during periods of economic stress.
 
Three researchers out of the National Bureau of Economic Research, Xiang Fang, Bryan Hardy and Karen K. Lewis, analyzed data from 95 countries over a 20-year period and compared three different types of sovereign debt holders: domestic banks, non-bank private investors, and official creditors.
 
They found that, although non-bank private investors only hold an average of 46% of sovereign debt holdings, when debt levels rise, non-bank private investors hold a disproportionate 69% of debt. And non-bank private investor ownership is correlated with yields: the higher the yield on a government’s bonds, the higher the percentage of private investor ownership, their research suggests.
 
Emerging markets, which issue higher-yielding bonds, also have a higher percentage of private investors. The below graph shows these differences. Illustrated in beige and blue is the study’s main finding that non-bank private investors (both domestic and foreign) are key marginal investors in sovereign debt. Additionally, advanced economies see higher levels of involvement by central domestic banks and low levels of debt holdings for domestic banks. This is in contrast to emerging markets, where domestic bank debt holdings are greater and domestic central bank are lesser.
 
Figure 1: Marginal Holders by Country Group

Note: AE stands for advanced economies, and EM stands for emerging markets.
Source: Fang, Hardy, and Lewis, “Who Holds Sovereign Debt and Why it Matters.”

This investor composition creates a problem for emerging markets. The researchers found that during recessions foreign non-bank investors and domestic banks dramatically reduce their holdings.

Figure 2: Marginal Holders in Emerging Markets

Source: Fang, Hardy, and Lewis, “Who Holds Sovereign Debt and Why it Matters.”

The capital flight from these marginal lenders can magnify the impacts of economic shocks. Foreign investors rush into and out of these countries as their yields and economic health varies, and the volatility of this capital can create a significant crash risk, as we’ve discussed in our previous work on emerging market currencies.

Acknowledgment: This article was co-authored by Lulu Patterson. Lulu is a rising junior at Harvard studying cognitive neuroscience. Lulu’s interests are at the intersection of science and business.