Borrowing in the Shadow of China

Emerging economies' debt to China is large, non-marketable, and opaque. We study the impact that such borrowing from China{which is almost completely official debt-has on the equilibrium quantities and prices for marketable sovereign debt. We do so by using a standard sovereign debt model with long-term debt augmented with subsidized Chinese loans that are subject to rollover risk. We find that following a positive inflow from China our model economy chooses to re-balance its debt portfolio by deleveraging from market debt. In the process it pays lower spreads and faces less volatile consumption. On the other hand, when facing a capital outflow vis-a-vis China, the economy taps international debt markets, levers up on defaultable debt, and ends up paying higher and more volatile spreads in equilibrium. These model predictions are consistent with our panel-data evidence from emerging and low-income economies. Finally, we use the model to discuss the welfare gains from having access to Chinese loans and find that they are positive but smaller when default risk is material.

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