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Debt Sustainability Myths and Fallacies Vardan Aramyan Deputy Minister of Finance Armenia

Debt Sustainability Myths and Fallacies Vardan Aramyan Deputy Minister of Finance Armenia Ministry of Finance 2013. OUTLINE Stylized Facts Debt Dynamics Debt Sustainability Analysis (DSA) Concluding Remark. Stylized facts.

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Debt Sustainability Myths and Fallacies Vardan Aramyan Deputy Minister of Finance Armenia

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  1. Debt Sustainability Myths and Fallacies VardanAramyan Deputy Minister of Finance Armenia Ministry of Finance 2013

  2. OUTLINE Stylized Facts Debt Dynamics Debt Sustainability Analysis (DSA) Concluding Remark

  3. Stylized facts Countries' International experience on debt crises reveals some facts: • All debt crises episodes were external debt crises – internal debt always have an option of seniorage • No multilateral or bilateral debt crises experience- there is always room for maneuver • Different debt levels during the crises (Russia (1998) external debt/GDP ratio 38.5%, Chile (1982) 71.2%, etc., Argentina (2002) 142%) • What does it mean for Sovereigns? Golden Rule – Not only debt levels matter but whether the new debt accumulation creates new value added in the economy and sufficient cash flows in the future to guarantee solvency and liquidity for the government.

  4. Debt Dynamics

  5. 2. Debt Dynamics

  6. DEBT DYNAMICS-Structure of Current Public Debt

  7. DEBT DYNAMICS-Structure of Current Public Debt

  8. DSA FRAMEWORK

  9. 3. DSA Models Overview Government of Armenia currently exercises 3 models for Debt Sustainability. DSA long-term model developed by the joint IMF-World Bank, which is the workhorse tool used by developing and transition countries to assess the sustainability of their debt level FSA GAP (ST, MT) models suggested by Willem H. Buiter and Olivier Blanchard. PVBC (Present Value Budget Constraint) model

  10. 3. Debt Sustainability Analysis (DSA) Methodological Framework and Models • 1st DSA model is a standardized forward-looking analysis of debt and debt service dynamics • long horizon (20 years) to reflect long grace period and maturity • An assessment of external debt sustainability in relation to indicative country-specific debt burden thresholds that depend on the quality of policies and institutions- assessed by WB CPIA • present value not face value to capture the concessionality • The analysis comprises projections under: • a baseline scenario (most likely outcome), • alternative scenarios (that discipline the projections under the baseline), • standardized stress test based on a country’s historical vulnerability to shocks • country-specific stress tests if the vulnerabilities are not duly captured by the standard tests

  11. 3. Debt Sustainability Analysis (DSA) Methodological Framework and Models: The three pillars of the DSA. External debt sustainability in relation to indicative country-specific debt burden thresholds

  12. 3. Debt Sustainability Analysis (DSA) Methodological Framework and Models • A risk of external debt distress classification that takes into consideration this threshold assessment, as well as other country specific factors Low risk • Debt indicators are well below debt-burden thresholds • Stress tests do not lead to significant breaches of thresholds Moderate risk • Baseline scenario does not indicate a breach of thresholds • Stress tests show a significant rise in debt service ratios or a breach of debt thresholds High risk • Baseline indicates a breach of debt or debt service thresholds In debt distress • Current debt and debt service ratios are in significant or sustained breach of thresholds

  13. 3. Debt Sustainability Analysis (DSA) Methodological Framework and Models: Structure of the External Template r + r d g d ( 1 g ) d - - - t t 1 t t 1 t t t 1 - = - + - - + d d c nfdi z - t t 1 t t t + + r + r + + r + r + + r + r 1 g g 1 g g 1 g g t t t t t t t t t t t t Change in Real GDP Changes in price nominal growth and exchange rate interest rate Evolution of the nominal debt-to-GDP ratio

  14. 3. Debt Sustainability Analysis (DSA) Methodological Framework and Models:Macroeconomic assumptions

  15. 3. RESULTS OF DSA: INDICATORS OF PUBLIC AND PUBLICLY GUARANTEED EXTERNAL DEBT 2013-2033

  16. 4. RESULTS OF DSA: INDICATORS OF PUBLIC AND PUBLICLY GUARANTEED EXTERNAL DEBT 2013-2033

  17. 4. RESULTS OF DSA: INDICATORS OF PUBLIC AND PUBLICLY GUARANTEED EXTERNAL DEBT 2013-2033

  18. 3. RESULTS OF IMF’s DSA:

  19. 3. Results of dsa: Indicators of Public and Publicly Guaranteed Fiscal Debt under Alternatives Scenarios, 2013-2033 Most extreme shock MLT GDP growth

  20. 3. RESULTS OF IMF’s DSA:

  21. 3. Results of dsa Based on the model 1 DSA, Armenia is assessed to be at a low risk of debt distress, with all indicators below the country specific indicative thresholds under the baseline scenario. The public sector DSA suggests sustainability. Armenia is considered at low level of debt distress, based on external debt burden indicators. The public sector DSA suggests that Armenia’s overall public sector debt dynamics are sustainable in light of the current size of the debt stock.

  22. 3. Results of dsa: (continued) External sustainability analyses highlight for PV of debt-to-GDP ratio and PV of debt-to-revenue ratios the most extreme shock is under less favorable terms of new public sector loans. Fiscal sustainability analyses highlight for all fiscal sustainability the most extreme shock is permanently lower GDP growth. -IMF WB findings coincide with MOF findings (better revenue performance, 30% depreciation most extreme scenario for debt to GDP ratio….)

  23. Fiscal Sustainability Models (2 and 3)

  24. Fiscal Sustainability “Fiscal sustainability is defined as non increasing debt-to-GDP ratio. The models calculate primary deficit and/or tax revenues needed to keep debt-to-GDP ratio constant /stabilize/” • Primary Gap • Tax (Revenue) Gap • PVBC –Present Value Budget Constrain

  25. 3. Fiscal Sustainability Theoretical Framework: Primary Gap The difference between the required and the actual primary surpluses-to-GDP ratio is the primary gap. d *- dt = (gt–rt) * bt-1 - dt Shows the average correction to be made to the primary surplus-to-GDP ratio over the N-period time interval starting in period t, in order to achieve /stabilize/ the debt-GDP targetby the target date. d*t = (gt – rt) * bt-1 Where` d*t–estimated required primary surplus-GDP ratio (deficit-GDP) gt–GDP real growth rate rt–debt interest rate b t-1–debt-GDP ratio (previous year) dt–primary surplus-GDP ratio (deficit-GDP)

  26. 3. Fiscal Sustainability Theoretical Framework: Tax Gap Tax ratio gap methodology is based on the permanent tax-to-GDP ratio necessary to stabilize the debt ratio: t t– t* = t t + (gt – rt) * bt-1- Gt t* = Gt - (g t – rt) * b t-1 where` t*- estimated revenue-GDP ratio t- revenue-GDP ratio Gt- expenditure-GDP ratio /excluding interest payments/ gt- GDP real growth rate rt - debt interest rate b t-1 - debt-GDP ratio (previous year) Medium term gap model is forward looking and requires a projection of future spending. It measures how much the tax ratio needs to rise over the next N years to stabilize the debt-to-GDP ratio given current and expected future spending policies

  27. 3. Results of FSA: Primary Gap

  28. 3. Results of FSA: Tax Gap

  29. 3. Fiscal Sustainability Theoretical Framework: (PVBC-present value budget constraint) PVBC is the benchmark against which solvency is determined In the debt sustainability analysis models as a starting point should be satisfied two conditions: i) intertemporal budget constraint and ii), a static budget constraint (in every period) Static budget constraint B t+1= RtB t+D t 30

  30. 3. Fiscal Sustainability Theoretical Framework (PVBC-present value budget constraint) where` Rt = 1+rt Rt- discount factorfor tandt+1periods rt - government debt interest rate Bt -debt-GDP ratio (beginning period stock of government debt) D t- primary fiscal deficit (i.e., it excludes interest payments) Sustainability (or solvency) requires: the present value of future primary surpluses to exceed the present value of future primary deficits by a sufficient amount to cover the difference between the initial debt stock and the present value of the terminal debt stock. ∞ Bt = - ΣDt+j *(1+r t, t+j)-1 + lim t - ∞ (1+r t, t+j)-1 * Bt+j+1 j=0 31

  31. 3. Results of FSA: PVBC-present value budget constraint 32

  32. 3. Results of FSA: GAP and PVBC Gap models show that current sustainability indicators are in place after 2012 In terms of PVBC, fiscal sustainability requires that for future debt services more emphasis on revenue performance must be put. The PVBC considers additional increase of revenue to GDP ratio on average 0.8 percentage points more for 2013-2023 period.

  33. 4. ConcludingRemark - Debt Sustainability indicators show that Armenia is low risk country in terms of meeting future debt obligations. - Debt sustainability is sensitive the level of economic growth and new borrowing conditions • If deterioration of new borrowing conditions is inevitable than more emphasizes must be paid to the debt management capacities in terms of well managing future cash flows. • Issuance of 5-10 years Eurobonds that will allow bullet payment will ease cash flow needs for upcoming 5-10 years, conditioned that Russian loan will be repaid not allowing deterioration of debt profile. • More emphasis on revenue performance is needed

  34. THANK YOU

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