There is a cure for the original sin

The headlines last week:

‘The rise of the dollar will punish borrowers in emerging markets’ (; ‘IMF fears emerging markets instability’ (

The head of the International Monetary Fund warned on Tuesday that emerging markets are set to face a renewed period of economic instability when US interest rates rise this year, forecasting a repeat of 2013’s damaging “taper tantrum” episode of capital flight and rapid currency depreciation.

In the past three months the dollar jumped by 11% and over the past year 22%, its fastest ascent in decades. Companies around the world, and especially in emerging markets, have been bingeing on dollar-denominated debt, seduced by the lower interest rates on offer compared with local-currency debt. The stock of dollar debts owed by non-financial borrowers outside America has grown by 50% since the financial crisis, according to the Bank for International Settlements. It now stands at $9 trillion. Emerging markets account for half of that amount, up from a third before the crisis. In China alone, dollar-denominated loans have vaulted from around $200 billion in 2008 to more than $1 trillion now. As the dollar rises, this debt becomes more expensive to service in local currency. And as the Fed starts to tighten, the interest rates charged on dollar debts—whether in bond markets or via banks—will rise in tandem. As a result, borrowers are at risk of a double whammy: a strengthening dollar and a rising cost of borrowing and refinancing.

Economist call this the “Original sin”: The original sin hypothesis was first defined as a situation “in which the domestic currency cannot be used to borrow abroad or to borrow long term even domestically” by Barry Eichengreen and Ricardo Hausmann in 1999. Based on their measure of original sin (shares of home currency-denominated bank loans and international bond debt), they showed that original sin was present in most of the developing economies. (

Over many decades we have seen the same story over and over again, (emerging) countries, companies and households (50% of the Hungarian mortgages are denominated in Swiss Franc or EURO’s) borrow in hard foreign currencies covered by income in local currencies. Why? The interest rate in hard foreign currencies is lower than the domestic rates.  This is called currency mismatch risk. When things are relatively stable for a while, people become overconfident that ‘this time it will be different’ and enjoy lower debt servicing costs until they get hit by a financial Tsunami. A massive depreciation of the local currency as result of an economic shock and the debt (expressed in local currency) is ballooning and…..they default.  We call this process Boom, Bust, Boom (see our website

What’s the solution? Well that’s pretty simple: local currency financing. Switching from foreign to local currency funding in emerging and frontier markets has important positive effects at the micro- and macro-economic levels.

If it’s so simple, why is it not happening? Most banks and Development Finance institutions (DFI’s) lent money only in hard currencies to their clients in emerging or frontier markets because they don’t have appetite to bear the currency risk. So they transfer currency mismatch risk to their clients and call it counterparty risk (this is the risk that the borrower is unable to repay the loan).

In 2007 the Dutch DFI FMO and Cardano came with a very simple but extremely effective financial innovation to help to solve the problem of the original sin: the launch of The Currency Exchange Fund (

The Currency Exchange Fund (TCX) provides OTC derivatives to hedge the currency and interest rate mismatch that is created in cross-border investments between international investors and local borrowers in frontier and less liquid emerging markets. The goal is to promote long-term local currency financing, by contributing to a reduction in the market risks associated with currency mismatches. To achieve this objective, TCX acts as a market-maker in currencies and maturities not covered by commercial banks or other providers, notably where there are no offshore markets, no long-term hedging, or, in extreme cases, no markets at all. This activity spans 70 currencies in Sub-Saharan Africa, Eastern Europe, the Middle East & North Africa, Central Asia, South East Asia, and Latin America. TCX is usually unable to hedge itself. The core risk management principle is the risk-reducing effect of running a globally diversified pool of currency exposures. This is supported by a conservative capital base provided by patient investors and donors. TCX’s investor base predominantly consists of development finance institutions and microfinance investment vehicles active in the long-term debt markets of emerging and frontier markets.

Since 2007, TCX has contributed to the reduction of currency mismatches on the books of emerging and frontier market borrowers by absorbing their currency risk through more than $1.5 billion in FX forwards and cross-currency swaps, spread across 400+ trades in 46 currencies.

By enabling international lenders to offer long-term debt in local currency, TCX helps reduce the excessive reliance on short-term debt that characterizes lending in frontier markets especially. This lowers the probability of self-fuelling rollover / liquidity crises, supports long-term financial inflows mainly from development finance institutions, contributes to an overall strengthening of the balance sheets of corporate and financial institutions, and enhances the resilience and growth potential of emerging and frontier economies.

Helping these markets to acquire the capacity to borrow long-term both locally and abroad in their own currencies should be a priority for officials striving to make the world a safer financial place, and seeking to quicken the pace, sustainability and resilience of growth. A noteworthy benefit is it creates more room for implementing macro-economic policy adjustments without adversely impacting growth and stability.  (Recommendation of the European Systematic Board of 21 September 2011 on lending in foreign currencies – ESRB/2011/1)

The cure for the original sin is local currency financing, the recipe for sustainable finance and resilience.


One thought on “There is a cure for the original sin

  1. Hello there. I would like to refer to the specific case of Hungary mentioned in the article. I was leading a business in Hungary at that time, in 2008, when the financial crisis happened. True that many – if not the vast majority – of loans were in CHF. It was just amazing, and I truly even wondered why people were borrowing so much in foreign currency or why they did not borrow in EUR for instance. Two lessons : on the long term it proved to be a good cure for Hungary. Fundamentals are now good in the economy, the HUF is relatively strong and stable, and people now borrow in their own currency with low interest rates and trust in their national currency. The other pending question is the role of banks once again, and the lack of information and ethics of some of them. Easy and short term money, with a population willing and pushed to consume always more… I remember some supermarkets were even offering credit on everything (even electric toothbrushes !). You name it.

    Who’s guilty then ?


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