Financial globalization forces, financial sector development and country risk premium in leading emerging and developing countries

Abstract

Purpose This paper aims to examine whether financial globalization forces and financial sector development impact country risk premiums in leading emerging and developing economies (EDEs). Design/methodology/approach The study collected panel data for 35 EDEs from 2000 to 2021. Based on the pre-estimation test conducted on the panel data, the seemingly unrelated regression technique, which can handle cross-sectional dependence, was used to estimate the baseline models. For robustness checks, the two-step system generalized method of moments (2S-GMM), which addresses endogeneity, autocorrelation and the dynamism of econometric variables, was also employed in the study. Findings The empirical analysis reveals that financial sector development can significantly reduce country risk premiums and can alter the effect of external debt on country risk premiums. Financial globalization forces have varying influences: foreign direct investment has a negative but insignificant effect on country risk premiums, whereas external debt significantly exacerbates them. Among the control variables, it is shown that inflation strongly contributes to country risk premiums in EDEs. Conversely, economic growth, current account balance, favourable credit ratings, foreign reserves and political stability ameliorate country risk premiums. Originality/value First, the study provides empirical evidence to corroborate the financial market liberalization and debt overhang theories. Second, this study reveals that financial sector development can alter the influence of financial globalization forces on the country risk premium in the EDEs. This implies that a well-developed financial sector can reduce reliance on external debt. This empirical issue was not addressed in previous studies.