UNCTAD project : «Capacity building for debt sustainability in developing countries» ****** ALTERNATIVE APPROACHES TO DEBT SUSTAINABILITY.

Transcription

1 1 UNCTAD projec : «Capaciy building for deb susainabiliy in developing counries» ALTERNATIVE APPROACHES TO DEBT SUSTAINABILITY Noe by An-Nga Tran-Nguyen and Albi Tola UNCTAD DRAFT (please do no quoe) Ocober 2006

2 2 INTRODUCTION Deb susainabiliy as become a key policy issue in e discussion on deb in differen fora. Te concep of deb susainabiliy iself is difficul o define in pracice. Wen is a cerain level of deb deemed oo ig and unsusainable? How imporan is deb susainabiliy for developmen? Sould i be a major objecive and economic policies be adjused accordingly? Oerwise, sould developmen be pu before deb susainabiliy objecive and wa does i mean in erms of policies? On e oer and, one canno go wiou e oer: a is, deb susainabiliy and developmen are igly inerconneced? Answers o ese quesions are no sraigforward. Te lieraure on deb susainabiliy offers a wide range of analyses on e issue from differen angles. Te purpose of is noe is o summarize e analyical approaces o deb susainabiliy, wic are ofen discussed or applied in deb managemen. Te basic elemens of eac approac are igliged, as well as eir pracicaliy or relevance for dealing wi developing counries deb. Four main approaces are idenified in is noe: - Te presen value approac; - Te financing gaps approac; - Te indicaors of deb crisis; - Te olisic policy-based approac. Te analyical underpinnings of ese approaces are linked, bu e focus on paricular aspecs of e deb problems may be differen. Te las srand of analysis, as illusraed by e framework developed by Professor E. Fizgerald for is projec, aemps o address differen concerns wiin a compreensive macroeconomic and policy-based model. I. THE PRESENT VALUE APPROACH How can deb susainabiliy be defined? Deb being generally incurred o finance invesmen, an analogy wi e micro-level analysis of invesmen projecs can be made. A e micro level, deb susainabiliy is deermined by e condiion a e presen value of fuure income sreams (ne of expendiures) derived from invesmen projecs sould be a leas equal o e nominal value of deb used o finance ese projecs. Tere are wo ways o obain e presen value of fuure income sreams. Te presen value can be compued by discouning e sreams of income by e ineres rae of e deb. Anoer way is o compue e expeced rae of reurn, defined as e rae of discoun applied o fuure income, wic would equal e presen value of income wi e nominal value of deb. In e second case, deb susainabiliy is assured if e expeced rae of reurn is a leas equal o e ineres rae of deb.

3 3 Wen is presen value approac o deb susainabiliy is applied o e deb of a counry, many difficul problems of definiion firs arise. On e one and, e invesmen projecs financed by deb are e sum of privae and public projecs wi differen raes of reurn (e laer may include projecs addressing social needs), and e income generaed by invesmen can be denominaed in foreign currency (in e case of expors) or in local currency. Furermore, exernal deb someimes is used o smoo ou cyclical canges in consumpion (wic does no generae any income), deb being incurred during imes of depression and repaid during ig grow periods. On e oer and, deb can carry concessional or marke ineres raes and ave differen mauriies and grace periods, wic make e coice of e discoun rae a complicaed issue. Nowisanding ese difficulies, aemps ave been made o apply e presen value approac o e deb of a counry. Te IMF implicily uses is concep of e presen value in eir approac o deb susainabiliy (see IMF, 2002a). I defines deb susainabiliy as a siuaion in wic a borrower is expeced o be able o coninue servicing is debs wiou an unrealisically large fuure correcion o e balance of income and expendiure. 1 Underlying is definiion of susainabiliy are conceps of solvency and liquidiy, wic are defined on e basis of e presen value approac. Solvency is secured wen e presen value of a debor s curren and fuure primary expendiure (E) is no greaer an e presen value of is curren and fuure pa of income (Y), ne of any iniial indebedness (D): i i= 0 j= 1 E + i (1 + r + j ) i i= 0 j= 1 Y + i (1 + r + j (1 + r ) D ) 1 Liquidiy crisis occurs wen a debor s liquid asses and available financing are insufficien o mee or roll-over is mauring liabiliies, regardless of weer e solvency condiion is me. Susainabiliy is reaced wen a debor s liabiliy posiion saisfies e presen value budge consrain wiou a major correcion in e balance of income and expendiure, given e coss of financing i faces in e marke. Te pracicaliy of suc a noion of solvency is called ino quesion. Firs, e ime orizon is infiniy, wic makes any planning or ime framing of governmen s budge an 1 Susainabiliy, according o e IMF, rules ou : - deb resrucuring ; - Ponzi game (e borrower keeps on indefiniely accumulaing deb faser an is capaciy o service deb is growing); - moral azard (wereby e borrower lives beyond is means by accumulaing deb in e knowledge a a major deb service reducion will be needed).

4 4 impossible ask. Furermore, e coice of e discoun rae is no clear: any cange in e discoun rae auomaically canges e presen value. Te presen value approac is also applied o e analysis of e primary balance of e governmen budge or of e curren accoun of e balance of paymens. Based on e naional accoun ideniies (wic will be developed in e nex secion), e primary balance (P), a is e difference beween revenue and expendiure, excluding ineres paymens, is grossly equal o e cange in deb (D) plus ineres paymens: D = ( 1 + r) D + 1 P 1 Assuming consan ineres rae, aking e presen value of is expression gives: D P D n + j + 1 = + j+ 1 n+ 1 j= 0 (1 + r) (1 + r) If n ends o infiniy, e second erm on e RHS ends o zero. Tis means a e presen value of deb in e indefinie fuure converges o zero, as lenders would presumably no be willing o allow e debor o perpeually pay eir curren ineres obligaions merely by borrowing more. Hence: D = j= 0 P + j (1 + r) j+ 1 In oer words, all deb mus evenually be paid back, and e primary balance deficis will be more an compensaed by e primary balance surplus in e fuure in order o repay e deb. Tis observaion leads o an ineresing conclusion: e abiliy o generae a primary surplus is a precondiion for deb susainabiliy. In e case of e curren accoun of e balance of paymens, is condiion means a e debor counry sould be able o expor and earn enoug foreign excange receips o produce a rade surplus o repay deb (e well known ransfer problem). Te IMF Ne Presen Value of Deb In e case of low-income counries a receive loans on concessional erms, crediors apply e concep of Ne presen Value 2 (NPV) of loans o calculae e real burden 2 Te erm «Ne Presen Value» (NPV) is wrongly used ere. In e corporae finance jargon, NPV is e difference beween e presen values of income and cos of e invesmen projec. In fac, e correc erm o be used ere is e presen value (PV).

5 5 of deb, arguing a e deb service on concessional loans sould be discouned a e marke rae of ineres, o reflec e rue opporuniy cos of ese loans. Tis NPV concep was firs applied in e conex of Paris Club resceduling on concessional erms, en in e conex of e Iniiaive for e Heavily Indebed Poor Counries (HIPC). Te IMF reains is applicaion o e low-income counries in is new deb susainabiliy analysis framework (IMF, 2003, May 23). Te argumen supporing e use of NPV was a discouning e sream of fuure debservice paymens by an appropriae marke ineres rae provides an aggregae measure of e effecive deb-service burden implied by a given deb sock. As seen a e beginning of is secion, in order o gauge weer e debor can service is deb, e fuure sream of income as o be discouned, eier a e rae of ineres of e loan wic as been conraced, or a e rae of reurn of e invesmen projec. Te NPV does no, erefore, reflec e debor s capaciy o pay, because, if anying, is capaciy is aken ino accoun wen concessional erms are graned o low-income counries. Te NPV is raer a credior s concep, used o measure e gran elemen of aid. I can also be useful as a means o deermine comparable opporuniy coss for donors for burden saring purpose in deb relief operaions. II. THE FINANCING GAPS APPROACHES Te ree naional accoun ideniies relaed o e balance of paymens, domesic invesmen and savings, and governmen budge, sow links of exernal deb o differen financing gaps and idenify e needs a are filled by deb. Te balance of paymens ideniy is saed as follows: E E E ( D D 1) = E P M P X + i D 1 FDI ( R R 1) were E D exernal deb sock nominal excange rae E P foreign prices M impor volume P domesic prices X expor volume i foreign ineres rae FDI ne flow of foreign direc invesmen, including long erm porfolio equiy invesmen sock of foreign excange reserves R

6 6 I is, us, sown a e new deb-creaing capial inflow serves o fill e curren E accoun defici ( EP M P X + i D 1 ), besides e financing derived from FDI and cange in e sock of reserves. Te invesmen-savings ideniy is derived from e naional income ideniy, wic is defined as: Y = C + S = C + I + ( P X P E M ) or: S I = P X E P M Combining e balance of paymens and e domesic invesmen-savings ideniy gives anoer equaion for exernal deb: ( D E D E E 1 ) = ( I S ) + i D 1 FDI R Te governmen budge ideniy is saed as: DG = D D + DG E = i D + i DG D E 1 1 P were D D is governmen's domesic deb and P is primary surplus: P = T + ET G + IG + DT ) were T ET G IG DT ( governmen revenue exernal ransfers o governmen governmen consumpion governmen capial formaion and domesic ransfers and subsidies. Te ree ideniy equaions are used as e basis o derive a dynamic pa of deb a will deermine e susainabiliy of deb. Two paricular approaces are menioned ere. Te firs approac define a dynamic equaion for deb accumulaion in erms of eier e foreign excange gap or e savings gap and idenify e condiions of sabiliy of e dynamics of deb. Te second uses medium erm projecions of income and expendiure including deb service paymens o assess e grow dynamics of deb. Tis is e approac adoped by e IMF and e World Bank in eir deb susainabiliy analysis (DSA). Finally, e financing gaps equaions are used o deermine e role of rade and grow in deb accumulaion, and, in urn, e conribuion of deb o grow.

7 7 1. Te sabiliy of deb dynamics Te role of foreign capial in e developmen process as firs been analyzed in e conex of e wo-gap models, wereby deb or capial inflow elps in filling e resource gap resuling from sorage of savings or of foreign excange earnings. Deb, us, conribues o grow and over ime follows a cycle a e end of wic deb is repaid. Te resource gap is gradually narrowed and owards e end of e cycle, e debor counry will ave enoug surpluses in resources o repay is deb. Te dynamic ineracions beween deb on one and and income grow and expor grow on e oer and, would deermine e condiions under wic e deb accumulaion process can be conrolled. Tis dynamic analysis considers a level of deb (in relaion wi income or expors) a a saring poin, and en deermines e condiions under wic a process of deb accumulaion is susainable. Assuming a e supply of loans is no consraining, e condiions for deb o be susainable are deermined by e ineres rae, e grow rae and e rae of grow of expors. Te basic model 3 sown below illusraes suc deb dynamics roug beavioral ineracions of some macro-economic variables. To begin wi, e accumulaion of deb (D) is used o finance e resource gap, defined ere as e difference beween impors and expors (M-X) and e ineres paymens on earlier deb (id). dd (1) = M X + id d Te increase in oupu is simply e produc of invesmen (I) and e inverse of e incremenal capial-oupu raio (1/k): dy 1 (2) = I d k Te savings gap (e difference beween invesmen I and domesic savings S) and e foreign excange gap (e difference beween impors M and expors X) are equal ex pos: dd (3) I S = M X = id d Consider e savings gap firs. I sould be noed a ne exernal deb would increase eier because invesmen increases over e curren level of domesic savings, or because savings decrease. In e firs case, exernal deb would serve o finance an increase in invesmen, wile in e second insance, exernal deb would be used o finance an increase in domesic consumpion (as domesic savings decrease). In e laer case, as ere is no increase in invesmen, oupu grow would also be nil. 3 Noe a e model is in real erms, i.e all variables are divided by e GDP deflaor.

8 8 Te savings funcion simply saes a savings are e produc of e marginal propensiy o save and domesic produc: (4) S = sy As saed, equaion 4 implicily assumes a e marginal savings rae is equal o e average savings rae. Oer specificaions can be added o is basic model. For example, impors can be broken down ino impors of capial goods and impors of consumpion goods. Expors can be specified o grow exogenously or o depend on e invesmen rae. Using e savings gap (I - S) and rearranging e erms, deb accumulaion can be se in funcion of e oupu grow rae (g), invesmen (gk) and savings (s) raes: d( D / Y ) D (5) = ( i g) + ( gk s) d Y Equaion 5 saes a e cange in e raio of deb o domesic produc depends on e curren level of is raio, as well as e difference beween e ineres rae and e grow rae, and e difference beween e invesmen rae and savings rae. Te soluion o is differenial equaion will deermine e condiion of sabiliy of e deb process: D gk s D0 gk s ( i g ) (6) = + e Y g i Y0 g i were D 0 /Y 0 is e value of D/Y a ime = 0. From equaion 6 i can be seen a deb can be susained only if e rae of grow is iger an e ineres rae, in wic case e raio D/Y will decrease and reac an asympoic limi. If e ineres rae is iger an e rae of grow, deb will grow a an ever-increasing rae and will reac an exploding amoun a canno be serviced and susained. Tus, e rajecory of D/Y can be exponenially ascending or descending, depending on weer e grow rae g is greaer or smaller an e ineres rae i. Referring o e remark made above in case exernal deb is used o finance domesic consumpion, e grow rae g would be small. Terefore, e probabiliy a i would exceed g is ig, leading o an explosion of deb accumulaion. Wi g>i, e asympoic value of e deb-income raio is: Lim D/Y [(gk s)/(g i) ]

9 9 Te maximum amoun of D/Y is deermined by e difference beween e marginal invesmen rae (gk) and savings rae (s). Alernaively, using e rade gap (M - X) and rearranging e erms, deb accumulaion can be se in funcion of e ineres rae (i) and e rae of grow of expors (x). (7) d( D / X ) d D M X = ( i x) + X X were D/X is e deb-o-expor raio. Equaion 7 saes a e cange in e raio of deb o expor depends on e curren level of is raio muliplied by e difference beween e ineres rae and e rae of grow of expors, as well as e curren rade gap divided by e curren level of expors. Te soluion o is differenial equaion gives e following ime pa of e deb-expor raio: (8) X D + X X e D 1 M X 0 1 M X ( i x) X = x i 0 x i were D 0 /X 0 = deb-expor raio a ime = o. Here, e condiion for deb o be susainable is a e ineres rae sould be lower an e rae of grow of expors (i < x). Te rajecory of D/X can be exponenially ascending or descending, depending on weer x is greaer or smaller an i. Wi i < x, e asympoic value of D/X is: Lim D/X [1/(x-i)] [(M X)/X] As e limi of e deb-o-expor raio depends on e rade gap, is limi can be very ig if e rade gap is very large. As e limi is reaced a infinie ime, is i realisic o say a a counry can be "permanenly" indebed wile is counry does no service deb from is own resources? Finally, aking ino consideraion e fiscal gap, as derived from e governmen budge ideniy (and assuming a e governmen incurs only exernal deb and does no ave domesically conraced deb), applying e same procedure as above yields e following equaion: (9) d( D / Y ) d D = ( i g) + Y PB Y PB is e primary defici of e governmen budge. Tis ime e sabiliy condiion is a g exceeds i.

10 10 Based on e ree gaps, e sabiliy condiions a g and x sould exceed i can, us elp o sabilize deb raios in e sor erm, before ey grow o unsusainable level. I would be unrealisic o assume a ese condiions old over e very long run. Deb would coninue o grow as long as lenders are willing o lend. Te quesion is weer lenders would be willing o lend over a prolonged period, knowing a deb is no going o be repaid. 2. Te IMF and World Bank Deb Susainabiliy Analysis framework Te framework consiss of wo emplaes, one relaed o e exernal deb susainabiliy and e oer o e fiscal susainabiliy of e public secor. Tese wo DSA are briefly summarized below. Te exernal deb susainabiliy emplae analyzes e deb incurred exernally by domesic residens (bo e public and e privae secor). Using e balance of paymens ideniy as e poin of deparure, and rearranging e erms derived from e algebraic ransformaions of is ideniy, e exernal deb dynamics can be decomposed as follows: d 1 1 d = ( r g ρ(1 + g) + εα (1 + r)) d (1 + g + ρ + gρ) + b + 1 were d is e deb-o-gdp raio, α is e sare of domesic-currency deb in oal exernal deb, ε is e cange in e excange rae expressed in US dollar per local currency uni, b is e non-ineres curren accoun balance in per cen of GDP, ρ is e cange in e domesic GDP deflaor expressed in US dollar, g is e real GDP grow rae, r is e ineres rae. Tis equaion allows decomposing e cannels affecing e evoluion of e deb raio: e non-ineres curren accoun defici b, r e ineres rae conribuion d ( 1+ g + ρ + gρ), e conribuion of real GDP grow g d ( 1+ g + ρ + gρ) ρ(1 + g) + εα (1 + r) a of price and excange rae canges d (1 + g + ρ + gρ) Te ree las effecs are regrouped under e erm of endogenous deb dynamics. Te fiscal susainabiliy emplae analyzes e beavior of e deb-o-gdp raio, wi all variables expressed in domesic currency. Using e governmen budge ideniy as e

11 11 poin of deparure and rearranging e erms derived from e algebraic ransformaions of is ideniy, e dynamics of e public deb raio can be decomposed as follows: 1 d d = ( rˆ π(1 + g) g+ εα(1 + rˆ)) d pb (1 + g+ π + gπ) were d is e deb-o-gdp raio, pb is e primary balance, ˆr is a weiged average of domesic and foreign ineres raes, α is e sare of foreign-currency denominaed public deb, π is e cange in e domesic GDP deflaor, and g e real GDP grow rae. Canges in e excange rae (local currency per U.S. dollar) are denoed by ε, wi ε > 0 indicaing a depreciaion of e local currency. Tis equaion allows idenifying differen cannels a conribue o e evoluion of e deb-o-gdp raio: e primary defici pb, r π (1 + g) e conribuion of e real ineres rae is d (1 + g + π + gπ ), e conribuion of e real grow rae is g d ( 1+ g + π + gπ ) εα (1 + r) a of an excange rae depreciaion is d (1 + g + π + gπ ). Again, e ree las effecs are regrouped under e erm of endogenous deb dynamics. By idenifying differen facors conribuing o e grow of e deb raios, e emplaes ipso faco indicae e cannels roug wic deb can be reduced, if e level is oo ig. Noe a e real GDP grow rae and expor grow rae are exogenously given, so a ere is only one-way relaionsip: from GDP and expor grow o deb accumulaion. Te sorcoming, erefore, is e lack of reverse relaionsip beween deb and grow, i.e. e conribuion of deb o GDP and expor grow, wic over ime could dampen e dynamics of deb grow. Te above equaions describe e dynamics of deb, racing e evoluion of e deb o GDP raio over ime, resuling from canges in projeced values of e independen variables. 4 If e deb raio is on e growing rend, i canno be susainable. Tis analysis of deb dynamics leaves open e quesion of e appropriae level of deb around wic deb as o be sabilized. As will be discussed in e following secion of 4 Noe a in pracice, fuure exernal deb pa can also be derived simply by using e framework of e curren accoun and e projecions of eac iem of e curren accoun (i.e. impors, expors, non-deb creaing flows, ineres paymens and oer income remiances, grans ).

12 12 is paper on deb indicaors, e deerminaion of e susainable level of deb is muc a maer of empirical or inuiive findings. In e conex of e IMF/World Bank deb susainabiliy analysis framework for lowincome counries, e indicaive resolds for e raios of NPV of deb o GDP, o expors and o governmen revenue are se (in a muc inuiive way) a differen levels, according o e policy performance of borrowing counries as measured by e Counry Policy and Insiuional Assessmen (CPIA) Index. Te following able illusraes ese resolds: Indicaive Exernal Deb Burden Indicaors 1/ (in per cen) Qualiy of Policies and Insiuions 2/ Poor Medium Srong NPV of deb in per cen of: Expors GDP Revenue 3/ Deb service in per cen of: Expors Revenue 3/ / See IDA and IMF "Operaional Framework for Deb Susainabiliy Assessmens in Low-Income Counries - Furer Consideraions", / Counry's wi a CPIA below or equal o 3.25 are defined o ave a poor qualiy of policies and insiuions, wile a CPIA above 3.75 indicaes srong insiuional 3/ Revenue defined exclusive of grans. 3. Deb, rade and grow Te analysis reviewed above poin o e imporance of rade and grow in deb dynamics. Tis inerlinkage beween rade, grow and deb can be sown more direcly by rearranging e balance of paymens ideniy as follows (see appendix for e algebraic ransformaions): d d 1 = m x + ( i f p f ) d 1 ( co + g) d 1 All variables are expressed in domesic currency: d = raio of exernal deb o GDP m = raio of impors o GDP x = raio of expors o GDP i f = foreign ineres rae p f = rae of cange of foreign price index co = e + p f p = rae of cange of e erms of rade

13 13 e = rae of cange of e excange rae (domesic currency per uni of foreign currency) p = domesic price index Ignoring e effec real foreign ineres rae, is equaion is esed empirically, roug a panel regression 5 of daa of seven counries (Argenina, Banglades, Bolivia, Kenya, Korea, Malaysia, and Uganda) over e period Te resuls are repored below ( saisics are in pareneses): d d -1 = (x m ) fdi g co (6.07) (5.54) (2.30) (1.68) (0.66) R 2 (wiin) = Were fdi = raio of ne flows of FDI o GDP Te variables repored on e rig-and side explain rougly 18 per cen of e variaions in deb raios, aloug e regression coefficiens are significan (a leas a e 10 per cen level, in e case of grow), excep for e coefficien of e erms of rade cange. Undersandably, e rade balance plays a significan role in deb accumulaion: rade defici adds o deb, wile rade surplus reduces deb. FDI and grow end o reduce deb accumulaion. 4. Role of deb in GDP grow Wile grow conribues o reduce deb, wa is e conribuion of deb o grow? In order o assess is relaionsip, e balance of paymens ideniy is rearranged again o sow e relaionsip beween grow, as a dependen variable, and deb flows, expor grow (or world economy grow) and erms of rade (see appendix for e algebraic ransformaions). Tis relaionsip is refleced in e following equaion 6 dy (1 + λη+ ψ)( dp/ P de/ E dp = Y e e / P ) + (1 λ)( d( D )/ D ) + λεdy π Were λ represens e iniial raio of expors o impors ψ is e price elasiciy of impors π is e income elasiciy of impors η is e price elasiciy of expors w / Y w 5 Te equaion is esimaed by a panel regression, using e fixed effec model a consiss of running OLS on deviaions from e means (i.e. wiin groups). Tis ype of panel regression as consan slopes and inerceps a are differen beween groups/counries. In order o accoun for e possible presence of eeroskedasiciy, a regression is also run using e robus esimaor of e variance, e so-called Huber/Wie/sandwic esimaor. Te second regression did no sow resuls wic are very differen from e firs simple panel regression and, erefore, is no sown in e paper. 6 Tirwall and Hussain (1986) produced a similar equaion, expressing grow in erms of e volume effec of relaive price canges, e erms of rade, world economy grow and grow of capial flows.

14 14 ε is e income elasiciy of expors D e = ne exernal deb flows P = expor price index P = impor price index E = excange rae Y w = world income A panel regression, covering e same counries and e same period as above, is run o esimae is relaionsip. Two equaions are sown below, esimaing grow in funcion of exernal facors. (i) g = d co x (10.75) (5.25) (2.00) (1.91) R 2 (wiin) = 0.25 were g = real GDP grow d = cange in e raio of exernal deb sock o GDP co = rae of cange of e erms of rade (UNCTAD index of erms of rade) x = grow rae of consan US$ expors All coefficiens are significan. Noe a e sign of e coefficien of deb is negaive, wic means a an increase in e deb o GDP raio reduces grow. Te second equaion replaces deb sock by a variable measuring e raio of ne exernal resource flow o GDP ( f) : (ii) g = f co x (8.05) (2.22) (3.23) (1.46) R 2 (wiin) = 0.11 Were f = nd + fdi + oda nd = raio of ne ransfer on deb o GDP. Ne ransfer on deb is ne flows of deb (ne of amorizaion) minus ineres paymens fdi = raio of ne flows of FDI o GDP oda = raio of grans o GDP f = f - f -1 Te exernal variables as illusraed in is equaion explain only 11 per cen of GDP grow, and e coefficiens, excep a of expor grow, are significan. Tis ime exernal deb as included in e variable represening ne exernal resource flows as a posiive impac on grow.

15 15 A ird equaion esimaes separaely e effec of ne ransfer on deb, fdi and oda, ogeer wi cange in e erms of rade and expor grow. Te coefficiens obained ave e same signs bu are no significan, and e equaion is no reproduced ere. Te resuls sown above seem o indicae a, a leas for e counries included in e sample and for e period under consideraion, an increase in e sock of deb as a negaive impac on grow, wile an increase in e ne resource flows ave a posiive impac on grow. Tis may sugges a an increasing rend of e deb sock may exer a derimenal effec on grow, in conformiy wi e deb overang ypoesis. III. DEBT INDICATORS In e aferma of major financial and deb crisis, some economiss concenraed effors o idenify early warning indicaors wic would signal in advance e probabiliy of occurrence of a currency or deb crisis, us conribuing o preven crisis by encouraging debor counries o ake correcive measures. One suc indicaor a sould elp signal e even of a deb crisis is unsusainable curren accoun defici associaed wi low GDP grow. Ta was e case in 1980s deb crisis. On e oer and, a counry can susain a curren accoun defici as long as is GDP increases faser a e real ineress rae (see secion II.1 on sabiliy condiion of deb dynamics). If is is e case, counries sould no ave o worry abou an increasing foreign deb as long as is raio of foreign deb-o-gdp is no increasing. However, access o credi can be abruply sopped if crediors become worried abou e increasing deb. In addiion, ig grow raes of GDP, accompanied by capial inflows, can induce ig inflaion, wic will pu pressure on e excange rae o appreciae. Tus, counries will lose eir compeiiveness and eir curren accoun will deeriorae even furer. Anoer imporan indicaor of deb susainabiliy is e size of expors, wic enance e debor s abiliy o generae foreign currency revenues needed o service e deb. However, an imporan expor secor will make e counry vulnerable o erms of rade and foreign demand socks. In fac, as i is sown by Corsei e al (December 1998), Sou Eas Asian expors suffered from significan negaive erms of rade socks in 1996 following e fall in e prices of semiconducors and oer expors, e increasing compeiion of ceaper goods from Cina and decreasing demand from Japan due o long sagnaion of is economy. Radele and Sacs (02/1998) poined ou a invesmens financed by exernal borrowing can conribue o grow if ey are canneled o producive aciviies, bu over-reliance on exernal financing can be e source of macroeconomic insabiliy, insofar as i induces an appreciaion of e real excange rae. Moreover, in Sou Eas Asia, a par of ese invesmens was direced o non-raded goods and purcase of real esae, wic do no generae foreign excange revenue.

16 16 Radele and Sacs (02/1998) also idenify e increasing fragiliy of financial secor as a sign of an upcoming deb crisis. As credi o e privae secor increased rapidly, in order o keep up wi e demand for new loans banks borrowed offsore, as an opening of e capial accoun allowed suc sor-erm borrowing. Mos of ese loans were no used for producive invesmens, bu for speculaive purposes in e real esae marke. Banks were exposed in wo ways: firs o e excange rae risk since ey were borrowing in foreign currency and lending in domesic currency and second o e risk of mauriy mismac since ey borrowed sor and len long. I was fel a radiional warnings indicaors suc as a slowing down of expors, deerioraing curren accoun defici and overvalued excange rae were no enoug o aler marke paricipans and governmens abou e possibiliy of a crisis. Researc as erefore inensified following e Mexican and Eas Asian crises o refine early warning sysems (EWS), in paricular o predic e probabiliy of a currency crisis. Berg e al (03/2004) describe e feaures of wo EWS models, respecively Kaminsky, Lizondo and Rienar (KLR) 7 and IMF Developing Counries Sudies Division (DCSD). Bo models inended o predic a currency crisis. Te indicaor used is "e excange marke pressure index", a weiged average of one-mon canges in excange rae and foreign excange reserves. If e value of is index exceeds is mean by more an ree sandard deviaions, en ere was evidence a is currency is under risk o be devalued. Aloug ese models use differen economeric ecniques, ey are similar in e sense a bo ry o esimae e probabiliy a an "even" will appen, given differen indicaors. DCSD model indicaors include real excange devaluaion, canges in foreign reserves, raio of sor erm-deb o foreign excange reserves wile KLR model uses addiional indicaors as e domesic credi grow, cange in money muliplier, raio of foreign excange reserves o M2 ec. Given a currency crises were preceded by deb crisis, in lig of Argenina deb crisis of January 2002, wic preceded e peso devaluaion, e sor-erm deb o reserves raio was used o assess e possibiliy of deb crisis. In fac, an IMF 8 sudy sows a is indicaor is more appropriae o measure liquidiy raer an exernal solvency problem. Aloug Argenina ad a beer liquidiy posiion compared o Turkey in , is deb-service o curren receips indicaor was wice as large and is anicipaed e solvency problems one year laer. Te same IMF sudy proposes e inclusion of counry risk models and sovereign risk indices in e EWS, indicaing an economeric model by Eicengreen and Moody (2000) as a possible candidae. Tese auors esimae e deerminans of emerging marke deb spread and produce e sample forecass. Teir resuls sow a deb service o expor raio was igly correlaed wi e level of spreads and in e case of Argenina, e firs raio was ree imes bigger en e average. 7 Kaminskyl, Lizondo and Rienar, (1998) 8 IMF (2002b)

17 17 Differen auors 9 ave sudied e performance of EWS models and eir verdic is a ese models ave mixed success in predicing crises. Wile ey perform beer an non-model based indicaors suc as sovereign spreads, sovereign raings or markes survey, many imes ey signaled false alarms. On e oer and, ese models consider a large number of macroeconomic and financial variables across a large number of counries and for a long period. As suc, ey can bring invaluable informaion abou e vulnerabiliy of a counry compared o oers. Te performance of ese models can be improved if feaures of counry risk models menioned above as well as oer radiional indicaors of exernal posiion and macroeconomic siuaion of e economy are included 10. Liquidiy and solvency problems A liquidiy problem may arise because of a buncing of deb obligaion a a paricular ime, wic canno be fully serviced as e debor may experience a sorfall in revenues. Te deb can be repaid in full if eier recourse o exernal funding is available on a emporary basis, or if e deb is resrucured in erms of e sream of deb obligaions so a ey beer mac e debor's flow of revenues. In case of insolvency, owever, e incapaciy of e debor o pay in full is deb obligaions is no due o a emporary sorfall of is revenues, bu resuls from a more srucural problem of raising enoug revenue in e long erm o service is deb. In eory, a counry is solven even if i runs a uge curren accoun defici as long as i produces curren accoun surpluses in e fuure and a e sock of is exernal deb increases a a slower rae an e ineres rae paid on is deb. In addiion, as seen in secion 2, e deb dynamics sow a as long as GDP grows faser an real ineres rae, a counry is solven even if e raio of foreign deb o GDP keeps growing. Te same applies for fiscal deb: if e discouned value of e sum of fuure fiscal surpluses is equal o iniial deb, e governmen is solven. In pracice, ese conceps ave sown o be no very realisic, as poined ou by differen auors. Roubini (2001) considers a e main problem wi ese eories lies wi e fac a a governmen canno credibly commi o run uge primary balances in e fuure, because i will ave o follow a igly disorionary ax policy (ig marginal ax raes in e long run make up for low marginal ax raes in e sor run). Te same problem will persis if governmens ry o run primary surpluses in e fuure by cuing is spending in e long run o allow excessive spending in e sor run. Tis auor proposes e use of foreign deb o GDP raio as an indicaor of solvency and susainabiliy. If is raio is growing, en a larger rade surplus will be required o mainain e solvency and is surplus need o be even iger if e real ineres rae is bigger an GDP grow. 9 See Berg e al (03/2004) for example 10 See Berg and Paillo (2000) for a more deailed descripion of ese indicaors

18 18 Oer sudies deermine empirically e deb resolds beyond wic a deb crisis (or solvency problems) will develop. Te deb crisis is generally defined as an even in wic ere are arrears of principal or ineres on exernal obligaions, or in wic e counry rescedules or resrucures is exernal deb. I is generally found 11 a deb crisis occurs ypically a deb o GDP raios below per cen. However, in e conex of exernal deb, e ransfer problem implies a a counry mus generae rade surplus o service is deb. Tis implies a e expor o GDP raio, (or e deb o expor raio or e deb service o expor raio), will be relevan as well. Te IMF (May 2002) repored observaions of deb crisis wic sowed a a expor raios below 20 per cen, ree quarers of observed cases run a deb crisis a a deb o GDP raio below 60 per cen of GDP, a expor raios beween 20 and 40 per cen of GDP, e corresponding deb o GDP raio is beween 60 and 80 per cen. Liquidiy is a concep a is very closely relaed o solvency. Te main indicaors used o measured i are e raio of foreign excange reserves o impors (ow many mon of impors a counry can be covered wi is foreign excange reserves), e raio of foreign excange reserves o sor erm deb, e sare of sor erm deb o oal deb and ineres paymens o foreign excange reserves. Aloug a counry can be solven, i risks a deb defaul if i does no ave enoug liquidiy o service is sor erm deb or wen i suffers from a mauriy buncing of loans mauring a a paricular poin in ime. Tis mig appen during a financial panic were sor-erm crediors decide no o renew eir loans o debors and ask for a repaymen. Even oug a counry is solven, e fac a e does no ave enoug liquidiy o mee e crediors demand on e spo can cause a deb crisis. Ta is wy debor counries sould be careful wi eir mauriy srucure and make sure a ey ave enoug sor-erm asses o cover eir sor-erm liabiliies. As e process of assessing e solvency and e liquidiy of a counry is a dynamic process, one sould ake ino accoun differen socks a mig reduce is capaciy o service e deb. Tese socks can come in e form of a drop in expor earning, due o a fall in demand or price, unfavorable movemens in erms of rade, as well as increase in oil prices. Te DSA emplaes provide e framework o include ese socks in e process of assessing e deb susainabiliy. Roubini (2001) draws e aenion on wa e calls "self-fulfilling solvency raps". Tis is were a ig (bu no necessarily insolven) exernal or public deb will be considered by e markes as a risky siuaion wi a ig possibiliy of defaul and so e spreads of e ineres raes will increase. As a resul, debor counries will pay more ineres and will accumulae deb more rapidly. Tis is anoer case were a liquidiy crisis may urn ino a solvency crisis. As we see, liquidiy and solvency conceps are inerlinked and i is very difficul o disinguis beween e wo. A oroug analysis of evens counry by counry is needed. Te case of Argenina 2001 crisis is aken ofen as an example. By e end of 1998, e 11 Te findings of e empirical sudies on deb resold indicaors, as repored in is secion, are reviewed in an IMF publicaion of May 2002 on Assessing Susainabiliy, p

19 19 raio of exernal deb o GDP was a around 50% level, wic is no ig enoug o rigger a deb crisis. However, oer indicaors sowed a ere were reasons o worry. Te raio of deb o expor and deb service o expor, wic measure e capaciy of counry o generae income in foreign currency o repay e deb, indicaed a e repaymen capaciies were no keeping up wi e increasing deb. Tings go worse in 1999, were e raio of deb service o expors was 75.5 %, wic mean a pracically ree quarers of expors were going o service exernal deb and is, combined wi a very low domesic savings rae, forced e counry o borrow more o finance is impors. In addiion, e low level of rade openness reduced e posiive effec a currency devaluaion ad for Argeninean expors, wic was muc smaller an e negaive effec a devaluaion ad roug e rise of e value of exernal deb expressed in local currency. In pracice, erefore, e disincion beween illiquidiy and insolvency problems is no easy o make. Tis is because i is ofen difficul o deermine weer incapaciy o pay is emporary or permanen. Te fuure is difficul o predic and someimes problems of illiquidiy can urn ino solvency if ey are no ackled in ime. IV. A HOLISTIC POLICY-BASED APPROACH TO DEBT SUSTAINABILITY Te above discussion sows a ere is a diversiy of approaces o deb susainabiliy analysis. Eac approac as a paricular focus and serves differen purposes: deb managemen, crisis prevenion, deb relief I is also noed a ecnical indicaors sould be supplemened by policy consideraions and sysemic analysis, in order o assis counries in managing eir exernal deb in a susainable way. Wiin is broad conex, UNCTAD projec proposes a olisic approac o deb susainabiliy. Te quesion of deb susainabiliy is no viewed only from a narrow perspecive of reducing an excessive and unsusainable curren level of deb, bu raer deb susainabiliy is inegraed in e overall developmen sraegy of a counry, insofar as deb sould be managed in suc a way as o maximise is conribuion o e susainable developmen of debor counries. Te approac aken in is projec is based on e view a exernal indebedness canno be susainable in e long run, if e developmen sraegy does no lead o an increase in foreign excange earnings above e level of domesic resource requiremens in order o repay e deb. Te poin of deparure of a susainable deb sraegy is, erefore, a clear vision by e governmen of e counry's developmen rajecory. Te governmen will gear is developmen rajecory by encouraging economic acors (including public agens) o use exernal deb in an efficien way, balancing e coss and benefis of deb over ime. Incurring exernal deb by iself increases e exposure of e domesic economy o exernal influences. Consequenly, debor counries sould pay aenion o e impac of exernal financial flows on eir economies and o e adequae macroeconomic managemen of ese flows, according o eir specific circumsances and level of

20 20 developmen. Some counries, especially e low-income counries, are igly vulnerable o exernal socks wile aving a narrow producive base. Tese counries need o ake ino accoun suc vulnerabiliies in managing eir deb, ofen wi e assisance of eir developmen parners. Developmen is ofen no a smoo process and no counry can be selered from e rea of a deb or financial crisis. Counries could more effecively adjus o deb crisis if ey can foresee e even of a crisis riggered by some exernal or inernal socks. Te approaces and indicaors reviewed in e preceding secions of is paper, aloug imperfec, provide eac one some assessmen of paricular aspecs of e deb problems facing individual counries. Tey could be referred oo by counries o assess forerunner signs of paymens difficulies. Taking early adjusmen measures, were possible, could in some cases elp o miigae e graviy of e crisis and soren is duraion. In oer cases, deb resrucurings or renegoiaions, or even deb relief, are necessary. Counries sould be aware of e coss and benefis of deb renegoiaions and any sorcomings of deb renegoiaion frameworks. Prevening a deb crisis is a crucial policy concern in a susainable deb sraegy. Ulimaely, exernal deb crisis prevenion inges on one condiion, a e deb paymen capaciy of debor counries is fully suppored by is expor capaciy. Tis brings us o e poin of deparure: exernal deb as o be repaid in foreign excange, ence rade plays a criical role. Debor counries sould also build and improve eir insiuional framework for deb managemen. Wiin is framework, i is imporan o assign specific roles and responsibiliies o differen governmen eniies: e minisry of finance, e cenral bank and e deb managemen agency. Tis framework sould be adaped o e adminisraive capaciy of eac debor counry. Agains is background, e objecive of e projec is o idenify policy measures a e naional and inernaional level, and o srengen e policy-making and managerial capaciy in developing counries in e following areas: To analyse e macroeconomic and srucural requiremens for deb susainabiliy; To analyse e conceps underlying e definiion and use of deb indicaors, aking ino accoun e inerdependence beween rade, finance, invesmen and deb; To acieve and mainain susainable levels of deb, including roug effecive paricipaion in inernaional deb negoiaions; To enance e economic cooperaion among developing counries and srengen regional and inernaional effors owards acieving deb susainabiliy in low- and middle-income counries.

21 21 A compreensive deb sraegy sould be inegraed wiin e broader developmen sraegy of a counry, on e basis of wic differen financing opions would be idenified, and e coss and reurns of borrowing evaluaed agains e financial consrains faced by e governmen (foreign excange, or savings or fiscal consrains). Te panoply of policies accompanying is deb sraegy would aim a addressing differen siuaions: policies o enance an efficien use of deb, in line wi developmen objecives, policies o adjus o socks, in order o avoid deb paymen crisis, policies o deal wi deb crisis and o resore grow. Tis approac could be viewed as a grow-oriened policy approac o deb susainabiliy. Noe a i does no exclude policy consideraions o reduce a level of deb wic can be oo ig o be susainable. In addiion, an effecive insiuional se-up for deb managemen is essenial for e implemenaion of a susainable deb sraegy. Furermore, in an inerdependen world, prevenion of a deb crisis ofen requires acions a e inernaional level, based on a consrucive inernaional cooperaion o ensure adequae ransfer of resources for developmen and rading opporuniies for debor counries. Te elemens of a olisic approac are capured in an analyical framework proposed by Professor Fizgerald. I is supplemened by oer sudies on specific aspecs of deb susainabiliy and by counry case sudies.

22 22 References Berg, Andrew and Caerine Paillo, July 2000, "Te Callenges of Prediciong Economic Crises", IMF Economic Issues No. 22. Berg, Andrew, Eduardo Borenszein, and Caerine Paillo, Marc 2004, "Assesing Early Warning Sysems: How Have Tey Worked in Pracice?", IMF Working Paper, WP/04/52. Corsei, Giancarlo, Paolo Peseni and Nouriel Roubini, December 1998, "Wa Caused e Asian Currency and Financial Crisis, NBER Working Papers w6833 Eicengreen, Barry and Asoka Mody, January 2000, "Would Collecive Acion Clauses Raise Borrowing Coss?," NBER Working Papers 7458 Inernaional Moneary Fund, May 2002a, "Assessing Susainabiliy", prepared by e Policy Developmen and Review Deparmen Inernaional Moneary Fund, 2002b, "Early Warning Sysem Models: Te Nex Sep Forward" in Global Financial Sabiliy Repor (Marc) (Wasingon, IMF).

23 23 Inernaional Moneary Fund, May 2003 "Deb Susainabiliy in Low-Income Counries: Towards a Forward-Looking Sraegy", prepared by e Policy Developmen and Review Deparmen Inernaional Developmen Associaion and Inernaional Moneary Fund, 2005, "Operaional Framework for Deb Susainabiliy Assessmens in Low-Income Counries: Furer Consideraion" (IDA/R ) Kaminsky, Graciela, Saul Lizondo and Carmen Rienar, 1998, "Leading indicaors of Currency Crises", IMF Saff Papers, Vol. 47, Issue 0, pp Radele, Seven and Jeffrey Sacs, February 1998, "Te Onse of e Eas Asian Financial Crisis", mimeo Roubini, Nouriel, December 2001, "Deb Susainabiliy: How o Assess Weer a Counry is Insolven". Tirwall, A.P. and Nureldin Hussain, M., Te balance of paymens consrain, capial flows and grow rae differences beween developing counries, OxfordEconomic Papers, November 1982.

24 24 APPENDIX I. Deb, rade and grow From e Balance of Paymens ideniy: 1) P X EP M i ED + EF = 0 f f were: X are real expors (or volume of expors), wic can be expressed as funcion of relaive prices and world demand, 2) X P = E P η ( Y w ) ε were η (η <0) and ε represen respecively price and income elasiciy of demand for expors, bo assumed consan M are real impors (or volume of impors), wic can be expressed as funcion of relaive prices and real domesic GDP 3) M E P = P ψ ( Y R ) π were ψ (ψ <0) and π represen respecively price and income elasiciy of demand for impors, bo assumed consan P P f is domesic price index is foreign price index E is nominal excange rae ED is exernal deb expressed in foreign currency EF are exernal flows a include new deb and Ne FDI flows expressed in foreign currency. i f is foreign ineres rae

25 25 We assume a ere are no canges in inernaional reserves. Dividing all variables by nominal GDP, ED EF 4) x m i f + = 0 P Y P Y were P X x =, P Y deb relaed so Le s define P Y we ge: EPf M m = and for simpliciy assume a all exernal flows are P Y dd F = d ED d = and P Y f = EF P Y Differeniae e expression for d : dd d = ( EdD + DdE ) P Y ED ( dpy + 2 ( PY ) P dy ) = EdD + DdE ED( dp Y + P dy) 2 P Y ( P Y ) = EdD + DdE EDdP P Y P 1 P Y EDdY Y 1 P Y = = EdD + DdE EDp P Y P Y ED EDg P Y [( dd / D + de / E) p g] P Y We can rewrie e above expression as: dd d were: ED F = d( e p g) + = d( e p g) + f P Y D e rae of cange of excange rae p rae of cange of domesic prices

26 26 g real GDP grow rae (dy/y) Finally, we replace f wi e above expression in equaion 2: x m i or f dd d ( e p g) d + = 0 d dd 5) = m x + ( i f + e p g) d d Furer, we can rewrie equaion 3 as: dd d were or dd d rade. = m x + i f d + ( e + p f p g p f ) d p f represens e rae of cange of foreign prices = m x + ( i p ) d ( co + g d were co is e rae of cange of erms of f f ) II. Conribuion of deb and capial flows o grow Firs, e balance of paymens ideniy: e e e 6) D D ) = E P M P X + i D FDI ( R R ) ( D e is expressed in domesic currency.

27 27 For simpliciy, we will assume a all capial inflows are deb relaed and so included ino ( R = 0 ). Ten: D + P X = E P M e e D and a e foreign excange reserves are uncanged aking logs on bo sides: e ln( D + P X ) = ln( P Differeniaing: E M ) d( D D e e + P X ) + P X = dp P + de E + dm M Since e d ( P X ) = dp X + P dx and D + P X = E P M we can rewrie is expression as: P X P E M dp P dx + X P e e D d( D ) dp = e E M D P + + de E + dm M Replacing P X by λ and P E M P D e E M by 1 λ we ge. 7) e d( D ) dp dx de dp ( 1 λ ) + λ = + e + D P X E P + dm M were λ represens e iniial raio of expors o impors and is weiging e conribuion of expor receips and capial inflows in covering e impor expendiures. Taking e raes of cange of expression 2) and 3), respecively dx / X / = η ( dp / P de / E dp / P ) + ε dy w Y w and dm / M = ψ ( dp / P + de / E dp / P) + πdy / R Y R

28 28 subsiuing em o expression 7) and solving for Y dy, we ge: 8) dy (1 + λη+ ψ)( dp/ P de/ E dp = Y e e / P ) + (1 λ)( d( D )/ D ) + λεdy π w / Y w On e RHS of is expression, we see a e balance-of-paymen-consrained grow rae of real GDP depends on: combined effec of price elasiciy of impors and expor and relaive price canges ( η +ψ )( dp / P de / E dp / P ) rae of cange of erms of rade ( dp / P de / E dp / P ) rae of cange of deb-relaed foreign capial inflows, d( e D ) / D e grow rae of foreign income