Debt Sustainability in Emerging Markets: A Critical Appraisal
By Yilmaz Akyüz

Summary

Until recently, debt sustainability analyses in the Bretton Woods Institutions (BWIs) concentrated on low-income countries, primarily in the context of the HIPCs initiative. The analysis has been confined largely to an external transfer problem because public debt in these countries is identified with external sovereign bor­rowing. Attention has turned increasingly towards debt sustainability in emerging market economies in the past few years after a series of crises, notably in Argentina.

In these countries the identity between public and external debt does not hold because of the growing importance of public domestic debt and private external debt. On average, domestic debt now accounts for more than half of total public debt in emerging market economies while the share of the private sector in total external debt matches or exceeds that of the public sector in many countries. Thus public and external debt sustainability needs to be addressed as two separate, though interrelated, issues. The Fund has, in fact, developed a framework for this purpose, focusing on pub­lic sector solvency in the former respect and balance-of-payments stability in the latter.

The framework applied by the BWIs for assessing the sustainability of low-income countries’ exter­nal debt has been subject to an intense debate in the context of official debt initiatives in recent years. How­ever, with few notable exceptions, much less attention has been paid to the adequacy of the standard frame­work used for the assessment of sustainability of public and external debt of emerging market economies. This paper aims at contributing towards filling this gap.

This paper critically assesses the standard IMF analytical framework for debt sustainability in emerging markets. It focuses on complementarities and trade-offs between fiscal and external sustainability, and interactions and feedbacks among policy and endogenous variables affecting debt ratios. It examines current fragilities in emerging markets and notes that domestic debt is of concern. Despite favourable conditions, many governments are unable to generate a large enough primary surplus to stabilize public debt ratios. Worsening global financial conditions may create difficulties for budgetary transfers, posing greater challenges to government debt management since restructuring often is more difficult for domestic than external debt.

This paper is published as a United Nations Department for Economic and Social Affairs (UN DESA) Working Paper No. 61 in November 2007. It is reproduced here with permission.

Debt Sustainability in Emerging Markets: A Critical Appraisal