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DEBT SUSTAINABILITY IN EMERGING MARKET ECONOMIES Yilmaz Akyüz

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.

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DEBT SUSTAINABILITY IN EMERGING MARKET ECONOMIES Yilmaz Akyüz

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  1. DEBT SUSTAINABILITY INEMERGING MARKET ECONOMIESYilmaz 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.

  2. 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 non- stationary

  3. 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

  4. 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.

  5. 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

  6. 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.

  7. 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.

  8. 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.

  9. 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

  10. Optimistic • 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.

  11. 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.

  12. 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.

  13. 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

  14. 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

  15. Debt Workouts: Options and Constraints • Domestic debt: Keynes solution • Official debt: Evian approach – more promises. • Commercial debt: Orderly sovereign debt workouts – not again?

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