The Credibility Cost of Redemption: Local Currency Debt and Central Bank Communication

Does the currency composition of sovereign debt determine who believes the central bank? We argue that the shift toward foreign-held local currency debt creates a time-inconsistency problem that undermines monetary policy communication. In our signaling framework, high foreign ownership amplifies the sovereign’s incentive to dilute liabilities via inflation, causing investors to discount hawkish signals as cheap talk. We test this prediction using a transformer-based NLP model (FOMC-RoBERTa) to score central bank speeches in 15 emerging economies, measuring credit risk via the local currency spread. We find that while hawkish communication reduces spreads by roughly 60 basis points in the baseline, this credibility vanishes as foreign participation rises, disappearing entirely when foreign ownership exceeds 77%. These results highlight an underappreciated trade-off: redeeming Original Sin stabilizes balance sheets but constrains the central bank’s ability to manage risk premia.