Governments have increasingly issued domestic debt in recent years, which reduces exchange rate mismatches and is welcome from a financial market development perspective. However, domestic debt often carries higher interest costs and specific risks. Countries where non-resident investors have a significant presence in the domestic debt market can be vulnerable to capital flight and associated exchange-rate pressures if non-resident investors with short-term investment horizons hold a significant amount of domestic debt and lose confidence in the Government’s solvency or economic policies. Moreover, fiscal stress can transmit to domestic financial systems to the degree that banks have invested in local government bonds.
The Addis Agenda specifically:
- Notes the increased issuance of sovereign bonds in domestic currency under national laws, and the possibility of countries voluntarily strengthening domestic legislation to reflect guiding principles for effective, timely, orderly and fair resolution of sovereign debt crises
Local currency debt has surged, with non-resident holdings continuing to grow in a handful of countries. In Ghana and Senegal, for example, foreign holdings have reached one third of domestic debt at times, while in other countries, their share has been increasing, albeit from a lower base.