Fiscal Policy, Leverage, and Foreign Holdings of Sovereign Debt: What Role Do Aspects of Geopolitical Risk Play?
‘…[C]omprehensively measures a country’s overall institutional quality. The higher the ICRG rating, the level of domestic bond yields tends to decrease.’
These words, from a very interesting and recently published IMF Working Paper, analyzes the interaction of fiscal policy with banking sector leverage and foreign investor holdings for government debt.
The findings?
A one percentage point increase in expected primary deficits results in a persistent increase in 10-year domestic bond yield by around 36 basis points over 2.5 years, with larger effects observed during the COVID-19 pandemic. This contrasts with external bond spreads which are more sensitive to external and global risk factors. The greater the reliance on domestic banks for deficit financing, the stronger the impact of loose fiscal policy on domestic bond yields.
Have a look: (https://www.imf.org/en/Publications/WP/Issues/2025/03/28/Fiscal-Determinants-of-Domestic-Sovereign-Bond-Yields-in-Emerging-Market-and-Developing-565661)
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