Comments to S. Gopinath, Y. Akyüz, and A. Réz

1. Comments to S. Gopinath, Y. Akyüz, and A. Réz Ugo Panizza UNCTAD Workshop on Debt, Finance, and Emerging Issues in Financial Integration London, 6-7 March 2007

2. - = DEBT DEBT DEFICIT - 1 t t t D = ´ - - + p ´ d i d pb ( g ) d The Unexplained Part of Debt • The “Economics 101” debt dynamics equation tells us that the change in the stock of debt is equal to the budget deficit • This equation can be used to decompose the growth rate of the Debt-to-GDP ratio

3. - = + DEBT DEBT DEFICIT SF - 1 t t t D = ´ - - + p ´ + d i d pb ( g ) d SF The Unexplained Part of Debt • The “Economics 101” debt dynamics equation tells us that the change in the stock of debt is equal to the budget deficit • This equation can be used to decompose the growth rate of the Debt-to-GDP ratio

4. The Unexplained Part of Debt Decomposition of Debt Growth in LAC7 24 Inflation UNEXPLAINED PART Interest expenditure Primary balance GDP growth 12 Percentage of GDP 0 -12 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Source: Campos, Jaimovich, and Panizza (2006).

5. The Unexplained Part of Debt 15 10 5 INFLATION GDP GROWTH 0 UNEXPLAINED PART INTEREST EXPENDITURE PRIMARY DEFICIT -5 -10 -15 IND EAP ECA MNA LAC SSA Source: Campos, Jaimovich, and Panizza (2006).

6. The Unexplained Part of Debt • What explains the “Unexplained part of debt” • Skeletons • Fiscal policy matters! • Banking Crises • Balance Sheet Effects due to debt composition • Debt Structure Matters…

7. …sometimes more than debt level Public Debt and Sovereign Rating (1995-2005) Germany United Kingdom Switzerland France Austria Norway AAA Australia Spain Finland Denmark Canada United States Ireland Belgium New Zealand Luxembourg Portugal Japan Italy Sweden Netherlands AA- Iceland Cyprus Saudi Arabia Malta Botswana Slovenia Israel Chile Czech Republic Korea, Rep. Standard & Poor's Sovereign Rating A- Qatar Bahamas Bahrain Barbados Malaysia Estonia Latvia Investment grade Thailand China Hungary Poland Tunisia Oman Trinidad and Tobago South Africa Slovak Republic Egypt, Arab Rep. Lithuania BBB- Mexico El Salvador Panama Croatia Colombia Kazakhstan Peru India Morocco Uruguay Costa Rica Guatemala Philippines BB- Bulgaria Jordan Brazil Senegal Bolivia Russian Federation Mongolia Belize Benin Ghana Ukraine Papua New Guinea Grenada Paraguay Jamaica Venezuela, RB Indonesia Turkey Argentina Pakistan B- Ecuador 0 10 20 30 40 50 60 70 80 90 100 110 Public Debt as Percent of GDP : Jaimovich and Panizza (2006) and Standard and Poor's Source

8. Volatility is another source of risk

9. As answer to these vulnerabilities, several countries are: • Accumulating huge reserves (well above GG rule) • But self insurance is a very inefficient way to protect yourself • Switching to the domestic market • Currency mismatches are less likely • Sudden Stops are less likely

10. Switch to Domestic Market Public Debt Composition in Developing Countries (share of GDP) 0.5 0.45 0.4 0.35 DOMESTIC 0.3 0.25 0.2 EXTERNAL 0.15 0.1 0.05 0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

11. Switch to Domestic Market Composition of Public Debt in 2004 Composition of Public Debt in 1994 DOMESTIC EXTERNAL 39% 41% EXTERNAL DOMESTIC 61% 59% Source: Jaimovich and Panizza (2006) and GDF

12. Can the switch to domestic debt eliminate all vulnerabilities? • To some extent, but… • Need to make sure not to trade a currency mismatch for a maturity mismatch • In the past debt structure has mutated very rapidly

13. Can the switch to domestic debt eliminate all vulnerabilities? Domestic Original Sin in Latin America and Other Emerging Regions 1.0 0.9 LAC 0.8 0.7 0.6 Index of domestic original sin Other EMs 0.5 0.4 0.3 Asia 0.2 0.1 0.0 1996 1997 1998 1999 2000 2001 2002 2003 Note : Original sin is measured as share of domesic debt which is short term, denominated in foreign currency, or indexed to prices or the interest rate. "Latin America" includes: Argentina, Brazil, Chile, Colombia, Mexico, and Venezuela. "Asia" includes: China, India, Indonesia (from 1998), Korea, Malaysia, Philippines, and Thailand. "Other emerging markets" includes: Czech Republic, Israel, Hungary, Poland, Russia, and Turkey. Source : Authors' calculations based on Jeanne and Guscina (2006) data set.

14. Can the switch to domestic debt eliminate all vulnerabilities? • To some extent, but… • The cost of borrowing needs to be evaluated carefully • What happens if the currency appreciates • Need to be careful not to "force" domestic institutional investors and banks to assume "too much" government debt • Especially banks • Domestic debt may be more difficult to restructure • Externalities to corporate bond market • Positive (market creation, yield curve) • Negative (crowding out)

15. Can the switch to domestic debt eliminate all vulnerabilities? • While the recent switch to more domestic borrowing may have important positive implications for debt management, policymakers should not be too complacent. • "The history of crisis modelling in international macroeconomics reveals that each successive wave of crises exposes possibilities for crisis that were overlooked in earlier analysis." (Krugman, 2006) • As vulnerabilities are often identified after a financial crisis starts to unravel, crisis prevention requires detailed and prompt information on debt structure • Yet, most research and DSA focuses on external borrowing and prompt and detailed information on the level and composition of domestic public debt is often not available to policymakers and analysts

16. The Development of Local Currency bond Markets: The Indian Experienceby Shyamala Gopinath • A remarkable feature of the Indian experience is the ability of financing large deficits without issuing external debt with private creditors • Could have this been possible with an open capital account and fully convertible currency?

17. The Development of Local Currency bond Markets: The Indian Experienceby Shyamala Gopinath • In the second phase of reforms, foreign institutional investors were given access to the primary and secondary markets • Did they come in? • If not, why didn’t they come in?

18. The Development of Local Currency bond Markets: The Indian Experienceby Shyamala Gopinath • The 16.9 years of average maturity of G-Bonds is impressive • But the figure could be misleading. • More than 50% of the bonds are in the hands of banks and this may shorten their de facto maturity • If there is a banking crisis, long term bonds held by banks may soon become overnight!

19. Debt Sustainability in EM Economies: A Critical Appraisalby: Yilmaz Akyüz • One key question asked in the paper is what is a sustainable level of debt • I am not a big fan of the “debt intolerance” approach. • I like: “No debt threshold is right for all countries or at all times” • What about the CPIA approach? • I am not a big fan of that either • What are the consequence of adopting the MDG approach for future access to financing?

20. Debt Sustainability in EM Economies: A Critical Appraisalby: Yilmaz Akyüz • Capital controls may be a good idea if introduced during tranquil times, but there may be a timing issue • What would happen if Turkey were to introduce CC right now?

21. Debt Sustainability in EM Economies: A Critical Appraisalby: Yilmaz Akyüz • The paper raises the issue that fiscal adjustments often go through cuts in public investment • Should expenditure in public investments removed from fiscal targets in IMF programs? • What are the pros and cons?

22. Debt Sustainability in EM Economies: A Critical Appraisalby: Yilmaz Akyüz • I am moderately pessimistic on spreads

23. Will the good times last? 1400 1200 Actual Spreads 1000 800 600 400 Predicted Spreads 200 0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

24. Predicted Spreads would be higher with average external conditions 1400 1200 1000 800 600 400 200 0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Spread for average External Conditions Actual Spreads

25. Public Debt Management and ALM: The Case of Hungaryby: Andràs Réz • I liked the discussion on the importance of having an independent and well working DMO but also the possible obstacles to policy-making that come from having independent institutions • I was intrigued by the availability of data on non-residents’ holdings of domestic public debt • ..but how can you be sure that they are non-residents?

26. Public Debt Management and ALM: The Case of Hungaryby: Andràs Réz • Is it always the case that if one focuses on the PV of tax revenues, the logical outcome is to have all debt in domestic currency? • What about the role of the tradable sector • What are the tradeoffs • Cost • Maturity

27. Public Debt Management and ALM: The Case of Hungaryby: Andràs Réz • The paper states that the size of foreign currency reserves should be limited at the optimal level • But what determines the optimal level? • Greesnpan-Guidotti • Size and solidity of the banking system • Openness (Import/Exports) • Need to stabilize the XR • Would the optimal level of reserves be lower with a better International Financial Architecture and a better IMF?

28. Comments to S. Gopinath, Y. Akyüz, and A. Réz Ugo Panizza UNCTAD Workshop on Debt, Finance, and Emerging Issues in Financial Integration London, 6-7 March 2007