MIBE The economics of emerging economies The role of Finance in economic The role of Finance in economic development and the emerging development and the emerging economies economies Gianni Vaggi, April 2014 Finance 3-3 Finance 3-3 National accounting in National accounting in an an indebted indebted open economy open economy
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MIBE The economics of emerging economies The role of Finance in economic development and the emerging economies development and the emerging economies.
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MIBEThe economics of emerging economies
The role of Finance in economicThe role of Finance in economic
development and the emerging development and the emerging economieseconomies
Gianni Vaggi, April 2014
Finance 3-3Finance 3-3
National accounting in an National accounting in an indebtedindebted open economy open economy
The national accounting in an indebted open economy
Suppose D0 = 100 to be repaid in 10 years and i = 5%,
each year:
iD interest payments = 5
ΔD principal repayment = 10
iD + ΔD = DS Debt Service
The national accounting in an indebted open economy
Remember: FA = NCF = Net Capital Flows = (Inflows – Outflows)
FA = [(Inflows - Other Outflows) -ΔD] = dD/dt
• ΔD<0 in an indebted economy ΔD is an outflow because debt must be repaid
• dD/dt is the change of the debt stock during the year, which depends also on inflows and other outflows in the FA.
CA = [(X-M) + (NPI – iD) + NSI]
The national accounting in an indebted open economy
CA+FA = 0
Suppose an indebted economy where there are only foreign debt related flows:
(Inflows - Other Outflows) = 0
and no other item in NPI and NSI other than –iD
[(X-M) - iD] - ΔD = 0
(X-M) = iD + ΔD = DS
Take the example: DS = 5 +10 = 15
(X-M) - iD = ΔD
The national accounting in an indebted open economy
IF IF the trade balance is 15 and exactly covers the debt service, thenthen the overall debt decreases by ΔD = D0 - D1 , according to the original scheduled payments or:
-ΔD = 90 -100 = -10 = -dD/dt
IF IF the trade balance is 5 and covers interests only, thenthen ΔD = 0 and the overall debt does not change:
dD/dt=0
IF IF the trade balance is less than 5 and, thenthen the overall debt increases:
dD/dt=>0
The Current Account Balance
Now suppose there are other financial flows in the CA
In the BoP the Current account balance (CA) is the sum of three items:
Trade balance (X-M)
Net income transfers (interest payments, dividends, etc.;)= Net Primary Income = NPI
Net unilateral transfers (remittances, international aid, etc.)= Net Secondary Income = NSI
The national accounting in an indebted open economy
Net primary income: Net primary income: Interests on foreign debt
Dividends (on portfolio investments);
Earnings of FDIs, profit repatriation
Rents on land and natural resources;
Compensation of employees (cross-border workers).
Net secondary income:Net secondary income:
Personal transfers (i.e. remittances);
Current) International cooperation,ODA
The national accounting in an indebted open economy
Consider the following flows:
-iD are outflows in NPI = -5
Compensation of employees are often included in remittances
NSI includes -remittances
-international aid , ODA
The national accounting in an indebted open economy
Remember:
[(X-M) + NPI + NSI] = CA Current Account Balance
and CA + FA = 0
[(X-M) - iD + NSI] + (-ΔD) = 0
[(X-M) + NSI] = iD + ΔD = DS = 15
Debt sustainability - 1
D = overall foreign debt
Y = GDP
gn = (dY/dt)/Y is the nominal growth rate
Thresholds d(D/Y)/dt < 0< 0
The latter: Domar 1944
Debt sustainability - 2
By total differentiation of D/Y:
d(D/Y)/dt = [ (dD/dt)*Y - (dY/dt)*D ]/ Y2
= (dD/dt)Y - [ (dY/dt)/Y ] * (D/Y)
= (1/Y) [dD/dt - gn * D ]
But dD/dt = [inD - (X – M)]
Debt sustainability - 3
i = (in - dp/dt) and g = (gn - dp/dt)
dp/dt inflation rate on debt
d(D/Y)/dt = (i - g)D/Y - (X - M)/Yd(D/Y)/dt = (i - g)D/Y - (X - M)/Y
i, g are the real interest rate and the GDP growth rate
d(D/Y)/dt = inD/Y - gnD/Y - (X - M)/Y
Debt sustainability - 4
But there are also other financial flows:
Current Account (CA)= [(X-M) + NPI + NSI ]
NICA = [CA – iD] = Non-Interest Current Account
NICA = [CA – iD] = [(X-M) + NPI + NSI] - iD
NICA largely depends on the trade balance, but not only.
Debt sustainability - 5
The correct sustainability formula is
d(D/Y)/dt = (i - g)D/Y - d(D/Y)/dt = (i - g)D/Y - NICANICA/Y/Y
Debt sustainability – 6- and national public debt
NICA is the equivalent for foreign debt of the concept of Primary surplus (net of interests) for domestic(public) debt