Debt Sustainability and Debt Composition

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Debt Sustainability and Debt Composition

• UNCTAD Paper by
• Heiner Flassbeck and Ugo Panizza

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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

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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

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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

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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

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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

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Fiscal Sustainability Indicators

• Common Rule of Thumb ?d (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

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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

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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.

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• 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

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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.

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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

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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

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• 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)

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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.

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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

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Remaining Obstacles

• Data availability
• International agreement to provide better and
  comparable data on debt statistics

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Thank You