Our discussion, hitherto, has been predicated on the
assumptionthatgovernmentsdonotdefault,atleastonlocal
currency borrowing. There are many emerging market
economies where this assumptionmight not be viewed as
reasonable. Governmentsinthesemarkets areperceivedas
capableofdefaultingevenwhentheyborrowintheirlocal
currencies.Whenthisperceptioniscoupledwiththefactthat
manygovernmentsdonotissuelong-termbondsdenominated
inthelocalcurrency,therearescenarioswhereobtaininga
risk-freerateinthatcurrency,especiallyforthelong term,
becomesdifficult.Inthesecases,therearecompromisesthat
yield reasonable estimates of the risk-free rate.
- Lookatthelargestandsafestfirmsinthatmarketand
use the rate that they pay on their long-term
borrowingsinthelocalcurrencyasabase.Giventhat
thesefirms,in spiteoftheirsizeand stability,still
have default risk, you would use a rate that is
marginally lower
7 than the corporate borrowing rate. - If there are long-term dollar-denominated forward
contractsonthecurrency,youcanuseinterest rate
parityandtheTreasurybondrate(orrisklessratein
anyotherbasecurrency)toarriveatanestimateof
the local borrowing rate.
8 - You could adjust the local currency government
borrowingratebytheestimateddefaultspreadonthe
bondtoarriveatarisklesslocalcurrencyrate.The
default spread on the government bond can be
estimated using the local currency ratings
9 thatareavailableformanycountries.Forinstance,
assumethat theBraziliangovernment bondrate,in