Natural Resources and Sovereign Risk in Emerging Economies: A Curse and a Blessing

RePEc Short ID: pre260
ORCID iD: 0000-0002-1481-051X

Hamann, Franz; Mendez-Vizcaino, Juan Camilo; Mendoza, Enrique G.; Restrepo-Echavarria, Paulina

doi:10.20955/wp.2018.032

Working Paper Revision

Natural Resources and Sovereign Risk in Emerging Economies: A Curse and a Blessing

Abstract: Emerging economies that are large oil producers have sizable external debt, their sovereign risk rises when oil prices fall, and many of them have defaulted in the past. Interestingly, oil output reduces country risk on impact and in the long-run,but oil reserves increase it in the long-run and reduce it only marginally on impact. We propose a model of sovereign default and oil extraction and derive analytic and quantitative findings consistent with these observations. The sovereign manages oil reserves strategically to make default less painful, and hence its sustainable debt falls. Reserves rise in the run-up to a default and the co-movement of reserves and country risk in response to oil-price shocks switches from negative initially to positive afterwards. These results extend to a setup with rare, large and uncertain oil discoveries. Defaults occur with less severe drops in GDP and oil prices but after long dry spells in discoveries.

JEL Classification: E44; F4; F34; G12; H63; L72;

https://doi.org/10.20955/wp.2018.032