What drives emerging market and developing economies’ local currency sovereign yields? A comparative approach!

Recently, benign global liquidity conditions and low interest rate atmosphere in advanced economies have led to elevated interest among investors in emerging market sovereign debt markets. Local currency bond markets in emerging markets grown in dimensions following a global financial trouble, greater than doubling in nominal terms between 2011 and 2018 (IMF and World Bank 2020).1 Comprehending the factors that determine yields on marketable debt might help shape government policy in important ways, including making enhancements towards the way sovereign debts are issued and managed. A much better functioning and much more efficient sovereign debt market can, consequently, result in less expensive of funding for that sovereign over time.

Methodological framework

Our recent paper describes an easy and versatile analytical framework for analyzing the determinants of local currency sovereign borrowing costs of the country in accordance with comparable peer countries.

The framework includes quantitative empirical analysis and qualitative country situation studies. The previous enables for any quantitative comparison of the country’s sovereign yields with comparable countries poor a multitude of different determinants (figure 1). We explore domestic macroeconomic and financial market factors, exterior factors, along with other political and institutional factors. The second situation studies use the reform encounters of selected peer countries in developing their local currency sovereign debt market. The situation studies complement the quantitative analysis by searching at key elements that aren’t easily taken within an empirical analysis for technical reasons.

Within our empirical framework, we trace the evolution of excess yields the nation of great interest pays in accordance with peers once we consider different specifications/explanatory variables. A panel data set composed of the reasonably lengthy time-series for those relevant variables for that country of great interest and several peer countries was put together.

However, a big share of variation inside a country’s yields in accordance with peers may remain inexplicable through the quantitative analysis. To deal with challenges within the domestic government bond market, several emerging markets have carried out reforms to enhance the functioning of the government bond market, aligned with worldwide best practice. These policy encounters and training learned offer a number of different potential policy pathways and complement the paper’s empirical analysis.

Figure 1. Potential factors influencing sovereign yields within an emerging market economy

A table showing Figure 1: Potential factors influencing sovereign yields within an emerging market economy

Illustrative example

We produce an illustrative use of our analytical framework using Indonesia. Between 2009 and 2019, Indonesia experienced persistently greater yields in accordance with regional peers along with other comparable emerging markets concentrating on the same observable market features and credit profiles. We apply this framework to review the potential reasons for the surplus yields Indonesia pays in accordance with peers (the “Indonesia premium”) inside a panel regression setting utilizing a sample of 11 emerging markets and developing economies (Indonesia and 10 regional (ASEAN-5 and global peers) between 2009Q1 and 2019Q2 as well as in selected country situation studies.

We discover that strong macroeconomic fundamentals along with a liquid and stable forex market lead to lowering the price of sovereign borrowing. Holding other activities constant, a lesser policy rate, a solid idea of lower sovereign default risk (as measured through the sovereign credit default swap spread), as well as an improvement in the present balance reduce the price of sovereign borrowing. Additionally, a noticable difference in forex market liquidity and a rise in foreign reserve adequacy are located in lowering the price of borrowing.

However, beyond macroeconomic fundamentals, additional factors, like the functioning from the sovereign debt market and it is condition of development, might also explain area of the “Indonesia premium.” After controlling for those macro-financial variables and forex market variables, the “Indonesia premium” narrows considerably, however it remains positive generally (figure 2). It is really an indication that additional factors could boost the functioning of presidency debt markets in Indonesia and lead to lowering sovereign yields.

Figure 2. The “Indonesia Premium” after controlling for macro and financial market variables

A bar chart showing Figure 2. The “Indonesia Premium” after controlling for macro and financial market variables

Note: This figure is definitely the yield premium Indonesia pays in accordance with peer countries for the sample period before (blue) after (orange) controlling for potential explanatory factors. An optimistic number implies that Indonesia pays a greater yield. Error bars represent 95% confidence times from the point estimates.

We use four qualitative situation studies from the encounters of 4 regional and global peers to enhance the quantitative analysis. Previous reform encounters in emerging market peers (Colombia, Hungary, the Philippines, and Poultry within this study) highlight important areas for market development reform, specifically in places that barriers to advance still stay in the Indonesian government debt market. Included in this are the main dealers system, issuance policies, competition policies, and depth from the domestic investor base.


Our paper outlines an easy, tractable, and versatile framework for analyzing a country’s local currency sovereign yield in accordance with several peer countries and offers significant policy recommendations. This framework enables a rustic to evaluate a multitude of potential determinants from the sovereign price of borrowing and enables for straightforward and simple comparison with peer countries. The assessment and comparison could indicate significant policy areas that may be a noticable difference to aid the efficiency and functioning from the local currency sovereign debt market.

We highlight the significance of mixing rigorous empirical analysis with situation studies of country-specific encounters. Econometric analysis inside a panel setting enables for any rigorous and knowledge-driven assessment of (1) the relevance of a multitude of potential determinants of sovereign yield, (2) the way a country’s yield compares with what peer group, and (3) the way the determinants and also the comparison communicate with another. However, econometric analysis alone is frequently insufficient. This kind of analysis is frequently complicated because of insufficient data and identification challenges. Qualitative country situation studies offer an invaluable complement to the framework, particularly in highlighting factors which are important although not easily taken within an econometric analysis.

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