Leverage in emerging market economies (EMEs) has become highly dollarized in recent decades. This trend presents a significant challenge to EMEs’ sovereign debt sustainability, particularly in the face of U.S. monetary policy tightening. We construct a two-country monetary general equilibrium model to evaluate the effects of debt restructuring of EMEs.Our findings suggest the benefit of equilibrium sovereign default: we demonstrate that the role of the nominal exchange rate and state-contingent monetary policy in absorbing shocks is limited in a dollarized environment because of the trade-off between relieving the external debt burden and maintaining domestic growth, whereas sovereign debt restructuring can effectively help EMEs smooth consumption both across states and time, stabilize nominal exchange rates, and reduce the level of dollar-denominated debt. Ourempirical evidence further supports these theoretical findings.