DEBT SUSTAINABILITY IN
EMERGING MARKET ECONOMIES
Yilmaz Akyüz
• So far focus on LICs. Debt seen as an external transfer
problem. Fiscal dimension an afterthought.
• Now greater attention to EMs; and to both fiscal and
external sustainability – but more on FS than on ES.
• Public debt no longer consists of external debt.
Domestic debt is a growing part of total public debt.
• Private external debt is a rising proportion of total
external debt.
1
Theoretical Notion of Sustainability
Solvency: present value budget constraint
• Problems
– No specific constraints over debt and deficits at any
point in time.
– Uncertainty: Key parameters are nonstationary
2
The Standard Framework: Debt
Stabilization
• Conditions for public debt stabilization
• Problems with thresholds; more serious than
HIPC because of unstable lender behaviour
• ES: Same framework. Transfer of resources
• Evolution of external and public debt in the
course of development
3
Shortcomings
Neglect of endogeneities and feedbacks:
• Treatment of key parameters as if they are
independent – growth, fiscal and current account
balances, debt levels, risk premium and interest
rates, exchange rates.
• Neglect of cumulative interactions; vicious and
virtuous circles.
4
Neglect of links between FS and ES:
• FS: an internal transfer problem only?
• No distinction between domestic and
external debt; neglect of forex constraints
• But external imbalances and BOP crises
alter key parameters effecting FS.
• Socialization of private debt
5
• ES : An external transfer problem?
• Public and private surpluses
• Importance of the division of external debt
between public and private sectors
• Internal transfer problems leading to BOP
difficulties: LA in the 1980s.
6
Trade offs Between FS and ES
• Asymmetric effects of growth and exchange
rate shocks on budget and current account
• Conditions favouring FS but causing external
fragility and vice versa.
7
The Fund’s Approach
• Standard framework; same shortcomings.
• FS:
– Stabilization of the debt ratio, no threshold
– Baseline scenarios; debt projections
– Stress tests
• ES
– BOP and external projections
– 40% threshold, used with discretion.
8
Optimistic Projections
• Invariably projects falling debt ratios; more
optimistic for external than public debt
• Misses by large margins
• Greater optimism for countries with Fund
programs
9
• Optimism about private investment and growth→
misses fiscal targets → misses debt projections.
• Stress tests almost meaningless: translates
falling to stable debt ratios.
• Early warnings: cannot predict if simulated
shocks could actually occur or lead to crises.
• Analytical difficulties yes.
• But also faults in economic thinking. Too much
confidence in the policies promoted.
10
Capital Flows and Sustainability
• Still believes in Lawson Doctrine? Little attention to external
imbalances if driven by free capital flows and floating.
• Lessons: Debt crises often follow currency crises. Need to
check surges in arbitrage inflows and external fragility.
• IMF aversion to control over inflows even when monetary
policy is powerless to stabilize the currency.
• Has the Fund really learned on capital account issues? Is
there a new paradigm, as claimed by the IEO?
• Policy advice. Turkey versus Argentina and Thailand.
11
Current Vulnerabilities
• Favourable global conditions. Debt ratio fell by 8%.
• Currency appreciations contributed 6%.
• Significant fiscal savings from low spreads/rates.
• Strong commodity prices and growth added to revenues.
• Liquidity and risk appetite more important than
fundamentals.
• And the debt ratio is still 60%: far above estimates of
“safe” debt, including by the IMF itself.
12
Public Debt and Fiscal Space
• Fiscal policy has not been serving growth and
development.
• First price stabilization, now debt stabilization
• Burden fell on investment; from 8-10% to 4-5% of GDP
• Large infrastructure gaps, reducing potential growth
• Interest payments almost twice the share of investment
• Public debt distorting income distribution: regressive
taxation, concentrated debt holdings
13
How to Generate Fiscal Space?
• BWIs: fiscal space is what is left after servicing debt.
• Raise efficiency and revenues, attract grants, borrow more
• Debt relief is not an option unless “granted” by creditors.
• IMF aversion to restructuring. Primacy of debt service
• Why then promote CACs?
• UN approach: sustain and service debt subject to MDGs.
• US Chapter 9: Primacy of social objectives over debt
14
Debt Workouts: Options and Constraints
• Domestic debt: Keynes solution
• Official debt: Evian approach – more
promises.
• Commercial debt: Orderly sovereign debt
workouts – not again?
15