The supply of general gross debt for advanced economies increased significantly over the past years compared to that of emerging economies, especially after the onset of the financial crisis as illustrated in the graph below:
The above general advanced economies debt supply has been absorbed by demand from both foreign and domestic investors, however, the demand composition of these investors has changed significantly for some countries compared to others since the onset of the financial crisis as evident in the graph below:
Indeed, notably the foreign demand has declined significantly during the euro sovereign crisis for higher spread euro sovereigns (Greece, Ireland, Italy, Portugal, and Spain, or so called “GIIPS”) as well as for other…show more content… (2009)) However, looking deeper, an increase, in particular, in the share of domestic banks in the investor base may threaten domestic financial stability and increase the sovereign-bank nexus, increasing borrowing costs and even in extreme cases leading to self-fulfilling debt crisis. (Adler, (2012); Acharya et. al. (2013))
Some studies show that a rising share of foreign investors in the investor base increases governments’ refinancing risk. In particular, foreign non-bank investors can be less stable source of funding for sovereigns because they can invest in broader pool of assets, thus can easily stop rolling over or can sell the debt in cases of sovereign shocks. (Arslanalp and Tsuda (2012)) Additionally, some advanced economies might be hit by sudden stops in foreign funding also as a result of global risk aversion shift. (Calvo and Talvi (2005))
Do foreign investors matter?
Indeed, the composition of the investor base matters, in particular a decline in foreign demand matters for both borrowing costs and refinancing risk. However, the interesting observation is that such foreign investor demand decline has had significant implications for some countries such as the high spread euro countries (GIIPS) while very little effect for other countries such as Switzerland, Australia, and US. This leads to the conclusion that some advanced economies (e.g. high spread euro economies) are more vulnerable to changes in the sovereign debt share by foreign