Debt Sustainability and Debt Composition

1. Debt Sustainability and Debt Composition UNCTAD Paper by Heiner Flassbeck and Ugo Panizza

2. Introduction • Problems with DSA exercises • Often mix the concept of external sustainability with that of fiscal sustainability • Trend to focus on the level of debt without considering its composition

3. Outline • Disentangling Concepts of Sustainability • External Sustainability and Fiscal Sustainability • Interactions/Linkages • Debt Decomposition analysis • Debt composition • Proposed composite debt indicator • Determinants of debt crises

4. Different concepts of sustainability tied to different types of debt • External sustainability focuses upon the Transfer Problem: • ability to generate foreign exchange • Fiscal sustainability focuses upon the Budgetary Problem: • ability to increase or broaden the tax base to generate revenue

5. External Debt Indicators • Standard external debt sustainability indicators: • Debt to GDP ratio • Debt to revenues ratio • Debt to export ratio • Weaknesses of these indicators • These indicators are problematic if import growth outpaces export growth. • Unless the external debt is issued in domestic currency, the foreign exchange needed will only result from a current account surplus. • Not all types of debt carry the same risk features

6. Fiscal Sustainability & Budgetary Problem • Public debt has an external and domestic component. • Fiscal sustainability analyses focus on adjustments to the level and composition of tax revenue or primary expenditures • Both public debt (domestic vs. external) and fiscal sustainability lack clear definitions • Formal fiscal sustainability tests are problematic and are demanding in terms of data. • The tests do not establish any necessary conditions for long-run sustainability

7. Fiscal Sustainability Indicators • Common Rule of Thumb: Δd = (r – g) d – ps, where • d is the debt to GDP ratio • r is the steady state real interest rate • g is the long run growth rate of real GDP • ps is the primary surplus to GDP • Problems: • No well specified definition of sustainability or of the necessary conditions for LR sustainability • Requires many assumptions on growth, interest rates, government expenditures and revenues • These variables tend to be endogenous and correlated with one another

8. Considerations for Developing Countries Fiscal sustainability indicator does not account for the fact that developing countries often: • Have a limited capacity to raise taxes • Have a volatile revenue base • Are subject to large external shocks (real and financial) that increase the volatility of GDP growth • Have high levels of liability dollarization

9. Tradeoffs between External and Fiscal Sustainability • Consider a real devaluation: • Positively impacts external sustainability through increased export competitiveness and FOREX earnings • Negatively impacts fiscal sustainability if a large share of public debt is denominated in foreign currency, results in a jump in the debt-to-GDP ratio.

10. These interactions highlight the need for domestic debt to be included in DSA exercises. • Broad shift towards a greater proportion of domestic debt in developing countries • Domestic debt has been excluded from DSA exercises thus far because • Domestic debt has different risk characteristics • Not appropriate to sum debt of different risk characteristics together • Data are scarce

11. Important Considerations • Any attempt of measuring debt sustainability requires a thorough analysis of the causes of indebtedness • Analysis purely based on debt levels and on the forecast of some macroeconomic variables will lead to nowhere.

12. In a perfect world • Construct a composite debt indicator • Decompose external and public debt by: • Maturity and currency characteristics • Type of lender • Type of borrower • Authors propose categorization of external debt across 12 different levels of risk. • Assigning different weights to different risk categories to calculate a composite risk measure

13. Back to reality… empirical study • Empirical study examines how debt level and composition affect the probability of a debt crisis • Estimate a probit model on an unbalanced panel of 78 developing countries for the 1980-2006 period • Explanatory variables: GDP growth; international reserves to GDP, trade openness; undervaluation of the exchange rate; growth rate of private credit; fiscal and CA balance; inflation; corruption

14. Total external debt is decomposed into four components: • Total short term external debt • Long-term private external debt • Long-term public external debt to private creditors • Long-term public debt to official creditors (bilateral and multilateral)

15. Empirical findings • Examining separate components of total external debt, authors find evidence that debt composition matters • Find significant evidence that crises are positively correlated with long term public debt owed to private creditors • Find evidence suggesting that the relationship between default risk and debt with private creditors is more sensitive to external shocks than between default risk and debt with official creditors. • Find evidence that there is less risk associated with borrowing abroad in their own currency.

16. Conclusions • Different types of debt may be ranked by risk: • External public debt with private creditors in a foreign currency (highest risk) • Domestic public debt • External public debt with official creditors (lowest risk) • The evidence wrt private debt does not yield consistent evidence

17. Remaining Obstacles Data availability International agreement to provide better and comparable data on debt statistics

18. Thank You