Sovereign Debt in Developing Countries with Market Access: Help or Hindrance? Indermit Gill and Brian Pinto The World Bank “The Financial Sector Post-Crisis:

Sovereign Debt in Sovereign Debt in Developing Countries with Developing Countries with

Market Access: Market Access: HelpHelp or or HindranceHindrance??

Indermit Gill and Brian PintoThe World Bank

“The Financial Sector Post-Crisis: Challenges and Vulnerabilities”

April 26-27, 2005

Acknowledgements

•We thank Joshua Aizenman, Amar Bhattacharya, Nina Budina, Craig Burnside, Christophe Chamley, Ajay Chhibber, Gautam Datta, Norbert Fiess, Jim Hanson, Olivier Jeanne, Himmat Kalsi, Homi Kharas, Gobind Nankani, Vikram Nehru, Anand Rajaram, Luis Serven, John Williamson, Holger Wolf, and many others for useful comments or contributions. All errors are ours. The opinions expressed in this paper are entirely those of the authors and should not be attributed to the World Bank, its Executive Directors, or the countries the represent.

In Principle:

• Government borrowing should facilitate growth by permitting investments in infrastructure and social sectors – Debt often superior to taxing money or output

• Free capital flows should augment resources in developing countries and accelerate growth and convergence.

In Practice:•1980s: widespread external debt crisis, took a decade to resolve •Early 1990s

– Brady Plan -18 countries, restructured $200 billion of bank loans into $154 billion in bonds

– Financial liberalization

•After mid-1990s: – Another round of crises– Two new generations of crisis models

Things haven’t gone too well with sovereign debt and capital account openness.

• What are the chances of another 1980s-type debt crisis?

• Is public debt constraining growth?• What is being done about sovereign debt?

Focus: Market Access Countries

Objective- Answer three questions:

Table 1. Sovereign Debt -Ten Big MACs and Ten Debt Majors

Total Public Debt ($ Billions) Public Debt to GDP (%) 1992 2002 1992 2002 India 156 380 Lebanon 70 177 China 68 366 Argentina 26 126 Brazil 165 284 Uruguay 48 109 México 118 280 Jordan 167 100 Korea 61 232 Turkey 40 94 Turkey 65 173 India 74 81 Indonesia 56 149 Pakistan 81 90 Russia 12 118 Morocco 102 90 Argentina 59 117 Philippines 81 89 Poland 44 72 Indonesia 40 86 Notes: Public and publicly guaranteed external debt and domestic public debt.

Approach

•Survey the literature to develop a conceptual framework– Growth theory– External capital flows– Macroeconomic crises

There’s not much theory linking sovereign debt and growth. Empirical studies are few and fraught with measurement and econometric problems.

•Answer the three questions.Debt issues are very country-specific, difficult to generalize.

Findings from the Literature Survey

• MACs do not appear to have used sovereign debt well.

• External capital flows are more likely to have enhanced vulnerability than growth

Why Such Negative Findings?

• Debt intolerance vs. Original Sin

• Paucity of suitable instruments

• Fiscal Space – IFI macro framework is wrong

• Political economy explanations more convincing than pure economic theory, which rules out crises by construction.

Table 3. Main Factors Underlying Debt Reduction, 1990-2003

Country, Time Period Initial level Total Change

% of GDP % of GDP GDP Growth Primary Balance Exchange Rate

Chile, 1990-1998 42.7 -30.2 -15.6 -11.5Indonesia, 2001-2003 90.3 -22.3 -9.5 -8.3 -4.8Lebanon, 1990-1993 98.4 -48.5 -33.4 15.8Malaysia, 1990-1996 91.4 -41.4 -37.3 -32.3Mexico, 1990-1993 50.2 -22.8 -3.9 -12.9 -5.9Pakistan, 2001-2003 113.5 -18.3 -10.2 -6.0 -6.2Philippines, 1993-1997 93.5 -25.3 -15.1 -22.4 -7.5Poland, 1992-2000 86.7 -42.8 -25.5 -9.0Russia, 1999-2003 88.7 -55.2 -15.4 -16.7 -19.3Turkey, 2001-2003 95.0 -21.3 -11.3 -10.2 -8.2

Unweighted Average 85.0 -32.8 -17.7 -10.5 -6.1

Main Contributing Factors (% of GDP)

Based on Budina, Fiess and others (2004)

Debt Reduction Episodes

• All episodes involve GDP growth as one of the main contributing factors.

• Two-thirds involve significant primary surpluses; in only one episode, Lebanon 1991-93, were debt ratios reduced while running a primary deficit.

• Two-thirds of the episodes involve real exchange rate appreciation.

Table 4. Main Factors Underlying Debt Increases, 1990-2003

Based on Budina, Fiess and others (2004)

Country, Time Period Terminal Level Total Change

% of GDP % of GDP Primary Balance Interest Rate Exchange Rate Other FactorsArgentina, 2000-2003 146.1 95.3 5.5 41.7 53.0Brazil, 1998-2003 58.7 16.5 -18.5 23.7 11.0 -7.5India, 1997-2003 87.0 21.8 20.0 20.0 Indonesia, 1997-2000 94.6 70.8 8.2 64.4Jamaica, 1997-2003 152.7 74.8 -56.4 51.6 78.6Korea, 1996-1998 43.5 31.0 4.3 4.8 20.6Lebanon, 1994-2003 177.9 128.1 39.4 115.5 Malaysia, 1997-2001 70.6 19.9 -32.0 17.2 26.2Mexico, 1994-1998 56.6 29.3 -23.9 23.3 5.9 26.6Pakistan, 1995-2001 87.6 27.9 -4.5 20.6 20.2 8.5Philippines, 1998-2002 89.1 20.9 -5.2 10.3 12.1 15.9Russia, 1997-1999 88.7 34.0 40.4 -4.1Turkey, 1998-2001 95.1 51.3 -5.3 32.5 7.7 7.9

Unweighted Average 96.0 47.8 -6.3 24.6 11.7 22.3

Main Contributing Factors (% of GDP)

Debt Increase Episodes

• All episodes involve real interest or exchange rate changes or both as significant factors

• Most episodes involve "other factors" such as financial sector bailouts

• In more than half the cases, the countries ran primary surpluses during these debt run-ups; only in three cases did countries run primary deficits.

• Economic growth collapses did not play an important part

Public Debt and Economic Growth),(

)()( FDgg

)()(

gfg

normalcrisis ggg ,,

g

- optimal debt

SR - sovereign (or default) risk

*d

g - GDP growth

- Inflation

FD - fiscal deficit

)),(,()()(

* gSRgdd

Output volatility

(1)

(2)

(3)

(4)

Sustainability and Solvency

• “Sustainability” problem means mix of primary fiscal balances, real interest rates and growth rates is untenable. – Market final arbiter of sustainable debt level for

MACs.

• “Solvency” problem means discounted sum of future primary fiscal surpluses less than initial debt.– Insolvency implies unsustainability.

Let’s Get Real!• No objective measure of sustainability.

– Example: primary deficits and r>g but low debt-to-GDP; or temporary.

• On the other hand:– government may be unhappy -- too much revenue

going for interest, short maturities

– market may be signaling high default and devaluation risk.

• “Unsustainable debt dynamics” inextricably tied up with market perceptions and political economy.

Possible Responses to Unsustainability

• Procrastinate (Russia, Argentina)

• Inflate away debt (Russia, Argentina)

• Default and restructure (Russia, Argentina)

• Increase primary surplus, move to flexible exchange rates, reform fiscal and other institutions (E. Asia, Brazil, Turkey).

Chances of Another Big Crisis

• Never say never. But crisis risks have receded since late 1990s.– Low international interest rates, encouraging

movements in market spreads– Moral hazard likely to be lower after Russia

Argentina– Significant countries running large primary

fiscal surpluses, flex exchange rates, move towards domestic debt.

Table 6. Economic Indicators Before and After Crisis in Four Big MACs

Net Resource Transfers % of GDP % of GDP US$ bln 1st year = 100

before after before after before after before after

Argentina 0.1 0.8 3.4 7.3 7.0 -8.1 97.5 57.5Brazil 0.5 3.8 7.0 8.1 19.4 4.7 89.2 54.8Russia -3.2 4.6 5.0 3.8 6.3 -3.6 111.0 72.4Turkey 0.1 5.2 18.7 19.8 2.8 -0.4 98.1 84.9

Notes: 1. Real exchange rate is bilateral with respect to US$, period average

2. Argentina: before 1998-2000, after 2001-2003; Brazil: before 1996-1999, after 2000-2003; Russia: before 1995-1998, after 1999-2002; Turkey: GNP is used, instead; before 1998-2000, after 2001-2003. 3. Net resource transfers are calculated as a net resource flows minus interest on long-term debtand profit remittances on FDI Data are not available for 2003Source: Staff estimates, Global Development Finance, various issues

Primary Surplus Interest Payment Real Exchange Rate

Growth Being Constrained?

• Easy answer: yes, based on debt thresholds established by existing studies

• Yes, if debt sustainability problems (Argentina, Brazil, Jamaica, Lebanon, Turkey)

• Yes, if debt intolerant and volatile.

• Yes, if leads to an adverse spending composition (India)

What is Being Done?

• Numerous initiatives, little concrete progress– SDRM on hold, CACs appear to be taking off– Chance of new instruments remote

• Most significant: what countries themselves are doing.

Some Conclusions

• MACs need to pay more attention to the government’s inter-temporal budget constraint (different mindset)

• If debt sustainability problems, negative impact on growth very likely (don’t assume you’ll grow out of the debt problem)

• Fiscal space a valid point, but approach cautiously• Fiscal and institutional reform key• Vexing problem: How can IFIs help MACs?

Thank you!