Costs and benefits of government borrowing in foreign currency: is it a major source of risk for EU member states outside the Euro?

Abstract

This paper discusses the costs and benefits of government borrowing in foreign currency. While discussing the main costs, such as increased exposure to currency and rollover risks, and limited capacity to respond to financial crises, this paper also identifies two benefits of foreign currency borrowing. The paper also explores to what extent governments of non-euro area EU member states rely on foreign currency borrowing and whether they have sufficient capacity to preserve currency stability in the event of adverse shocks. The analysis suggests that the public finances of these countries are not heavily exposed to currency risk. Exceptions to this are Bulgaria and Croatia, whose government debt is mainly denominated in euros, and who also suffer from high loan and deposit euroization. It is therefore not surprising that they are the first two among the remaining non-euro area EU member states to take steps towards the introduction of the euro.