Economic theory gives us an insight about the equations and indicators that relate the underlying concept of when in the developing country, the foreign debt is corroborative and when is it inordinate. Consorting to the IMF and the World Bank, the foreign debt property of a country is its skill to meet the present and future foreign debt service duties in complete acceptance, without refuge to debt rescheduling or aggregation of liability. This understanding of the property depicts the importance of the stake and reputation of the borrower, basically linking it to the willingness and ability of the borrower to repay the debt in full. It pays less attention towards the scope of settlement at the lenders end or anything that has to do with the cash flow of the lender and his other investment options. This implies that all the nations who get the foreign fund are in spot of excess debt.
On the other hand, if the credit providers ponder over some measures which would concern debt relief, then they need to constitute a maintainable debt level of the borrower by analysing the situation. This approach is, by first instance, is circumvent and it displays that the conventional idea of sustainability is whimsical. This is a direct consequence of the sovereign debt kinship (Epstein and Gintis, 1992).
In general, the foreign debt sustainability analysis is done in the background of medium-term premises. These scenes are the ones, which take into account, the prospects of conduct of economic variables and certain other citrons to ascertain the stipulations under which debt and other pointers would brace at acceptable levels, what are the major dangers that accompany the economy and of course the requirement and reach for amends and adaptability of the formed policies. In such types of mathematical procedures, macroeconomic anomalies such as the point of view for the current account, policy incertitude, such as for that of the fiscal and fiscal up gradations, incline to master the medium-term premises (Policy Paper, 2000, IMF, Debt and Reserve-Related Indicators of Foreign Vulnerability).
Foreign debt is an important concern for two primary reasons. First, while foreign debt can grow a nation's access to resources, local adoptions only channelize resources within the nation. Hence, only foreign debt gives rise to a "channel" problem (Keynes, 1929). Second, since regulatory banks in developing nations are not allowed to print the hard currency required to riposte foreign debt, foreign taking up is generally related with exposure that might lead to debt crisis.
Developing nations have orthodoxically acquired foreign capital in order to support local savings usable for investment so that it realises the economic potency and thereby improve the standard of living. For a long time, there has been no disagreement regarding this thing that there is a net flux of resources from the developed nations where industrialisation happened to come by earlier, significantly the OECD, to the struggling and developing countries, given the better ability of these nations to put the money for economic welfare and at the same time, their power to return the credits of the foreign nations at some projected time in future out of the development and enhancement of production which is made possible in the first place because of the money being borrowed by the external agencies. This import of foreign savings or the total inflow of potential through resources to these evolving nations is traditionally approximated by their debt on foreign current account.
Debt typography matters, but we have to consider everything that is well beyond the ordinary foreign/local debt decay. Excessive focus on the foreign/local decomposition can make us overlook the real causes of risks which are ripe period and currency disagreements and that the fall and break between local and foreign debt is of sense only if this disorder is a good anagram for moving forward on these perils.
The recent trend that governs the shift from foreign to local taking up will eventually end up as nations patronising another kind of vulnerability with each other. For example, nations that are switching from foreign to local debt could be patronising a currency counterpart for a maturity counterpart. Alternatively, the switch to local taking up could lead to stress on institutional investors and banks to engross a lot of central governing authority debt which may lead to a negative effect on fiscal equilibrium. Moreover, globalising the market for local government bonds can lead to positive responses for the corporate market of bonds domestically, yet there is the risk that the public sector may outnumber private issuers. Finally, there are reasons which are related to the political economy that may lead to unmanageable structuring of local debt. In fact, some highly indebted nations which used debt relief initiatives to resolve their foreign debt problems still suffer from high stakes of local debt. Correct evaluation of the cost of taking up in different currencies is equally important criteria for concern. Currently, when a number of evolving economies are seeded to appreciate via the US dollar, the dollar interest rate may end up being lower than in the local currency.
Even with these catchy postulates stated above, the normal thought remains that the current trends will effect on reducing the possibility of a debt crisis positively, and that policy-makers' think mode in using safer modes of finance is an appreciable development. However, the paper clarifies that we should not be too lenient and that the new embodiment of debt may lead to new and even higher risks. Safer debt can help in reducing risks and local and foreign notice makers can play a key role towards developing such deals. However, evolving nations should not cheat themselves by thinking that by reformulating the embodiment of sovereign debt, they will soon become developed.
In this report, we study about the various ways in which the foreign debt affects the developing economies. We go about studying various aspects, about the public debt in emerging economies, collecting and analysing the information on public debts, assessing the sustainability in external debts and then moving on the discuss the impact of all the factors on the economy of a developing country.
The debt crisis in early 80's which was a result of lack of confidence in the nations that borrowed money and an accompanying fall in commercial imparting, was activated by the fiscal cash flow crisis in Mexico, its inaccuracy to meet the due debt balance. It led to an afterthought of medium-term faces of the debt procedure alongside the efforts to locate and solve the trouble of payments which were due. This looked at - in particular on the economic issue of fiscal condition - on whether and how the debt saddle built up by the emerging nations can be taken care of and contained in time if the contiguous liquidity problems are dealt and what would be its cost. The fall in money inflows and the import adaptations forced on the debtor nations extended to retardation and in some cases a turnaround of the total flow of resources. Therefore, today some capitally weak debtor nations are at an extent of exporting local savings to the capital-rich nations who gave them credits, as displayed in excess on the present chronicle of balance of payments.
This reversal in the resources flux amongst various debtor and the developed nations has led to increment in the concern as to how growth can be reconstructed and maintained in the debtor nations. The efforts which reflect these concerns are evident in the proposal formulated for discussing and finding solution to the ascending problem - the Bankers Proposal. U.S. Treasury Secretary made the initial proposals at the IMF/World Bank 1985 Annual Meetings which has recognised and jotted down four major issues:
- Appropriate local mega economic and morphologic policies in the debtor nations formulated to for renewed and sustained growth;
- Increased imparting by many-sided development banks in support of structural adjustment policies which are growth oriented;
- Increased imparting by commercial-grade banks; and
- Policies in the developed nations aimed at continuing enough growth rates, keeping commercialized markets open to emerging-country exporters and promoting further decrement in interest rates.
The first point -the local policies needed to promote growth in emerging nations has not been discussed and wondered upon in this report. What is central to the paper are he implications brought upon by the following three points and what are their effects on the emerging countries. We then go on to discuss the trade-offs of the external debt and then conclude with what all can be done in order to bring the debt levels down at comfortable levels.
OBJECTIVE AND IMPORTANCE
It is widely acknowledged that "dangerous" forms of debt (especially short-term and/or foreign currency debt) make emerging market countries prone to crises and render these crises more difficult to manage. This raises the important policy question of how emerging market countries can develop debt structures more similar to the "safe" debt structures that prevail in advanced economies, such as long-term, domestic-currency debt.
As a contribution to the research on this question, this report presents a new data set on the structure of government debt in emerging market countries. It is the result of a data collection project that was pursued by the two authors in the Research Department of the International Monetary Fund in 2004-05. The report also presents—as a prelude to more extensive analysis— some stylized facts on debt structures, as well as preliminary evidence on their determinants.
1. THE DEBTOR GROUPS
In an attempt to build a understandable outlook of the debt billet, what is a unmanageable task- is to find a middle road between the contingent richness and pragmatism of case-by-case country analysis and the more manipulable and usual analysis of debtor nations in total. Studies that are focussed on case-by-case nations may take into account the singularity of each nation and can reflect on narrowed information displaying the economic and fiscal position of each nation. Such analysis must indicate the building block of certain fiscal plans. But generalised statements about the debt billet are unmanageable to make without some congregation. On the shallow side, congregation at high level - risks the different nations with rather unlike trade and fiscal traits being grouped together, thereby perplexing the rendition of compact trade and fiscal stats on the entire group. These countries have been chosen considering the size of their debt which is still not discharged, and then grouping them consorting to vernacular characteristics. While keeping the information pre-requisites within acceptable bounds, this sampling technique allows us to comment about the overall picture for several relatively alike groups.
The 12 debtor nations selected - Chile, Algeria, Thailand, Argentina, Indonesia, Malaysia, Mexico, Philippines, Brazil, South Korea, Nigeria and Venezuela - accounts for > 55 per cent of the foreign debt of the capital-borrowing emerging nations, but for < 40 per cent of their exports contribution to GDP. Two groups among these twelve are formed based on the financial strength and exports ability:
- Trade structure - are these nations energy exporters or not
- Fiscal position - these nations reschedule or not;
The fiscal criteria take into picture the aspect that whether that particular nation has ever rescheduled or in other words - defaulted on their foreign debt or not. Those which have done so are put under "problem debtors", whereas the other 5 are categorised as "stable debtors".
The trade structure criteria is another one on basis on which the classification is made considering the goods and services that the nation is exporting. Here again, two different classes are formulated on the basis of exports - ones that export oil and earn their major revenue from oil itself, and the other which have a more diversified export unit, and their revenues which they earn from exports are not solely dependent on the oil or any specific good.
The next page goes on to picture the groups that are formed on the basis of the above mentioned classes.
2. EVOLUTION OF DEBT RATIOS
The debt scenario is generally evaluated by concentrating on certain fiscal stats, frequently ratios of payments of interest and export debts and Gross Domestic Product. Ascending ratios are understandably unsustainable indefinitely. It is not evident whether there is distinctive limens level, the fiscal activities to be maintained just below these threshold levels. Nevertheless, improvement in the current situation has been equated with the fall in these ratios, and a devolve to the degrees of these proportions has been granted for as extending the hypothesis that voluntary commercial grade bank loaning may be restarted. The ups and downs of the various fiscal ratios have been humongous.
Now, what has been even more dynamic and volatile in comparison to the debt to export ratio is the interest to exports ratio which has been a result of swinging interest rates in the developed nations which lend the money, which has changed because of the indebt of various emerging economies. The rendering of ratios and their projections have always played a crucial role in the discussions of whether the debt crisis be christianise as the issue of illiquidity or the matter of bad financial condition also termed as the insolvency (e.g. Cline, 1984). Although this difference cannot be brought out accurately, because there are two key issues that should be addressed when we talk about the insolvency and economic condition of financial trouble wherein there are cases when the countries don't have enough money to pay back the debt they are in. Firstly, is it this that the debt crisis is just about mainly an unfitness to conform to obligations at the required time? The second is whether the issue is not just the one of timing but a bit more rudimentary, with the opening that debtors could not or would not sustain debt payment they have to do over the longer period in time, implying that losses to lenders may be delayed but cannot be avoided for long. The difference between unbalanced cash flow and poor financial conditions is not full proof. For one thing, a sensed situation of insolvency can give rise to the issues of insolvency because of the unwillingness of the lenders to roll over maturity. Moreover, it would be incorrect to bring out a close similarity with the post of the private firm, which may be completely dissolved in the procedures of bankruptcy; nations go on, with debtor and lender countries continuing to have relations and trades.
3. THE DEBT MODEL
The structure of the debt accounting model is a set of simple behavioural equations and identities that yield projections of export revenues, debt and interest due as functions of OECD growth, trade prices, the effective dollar exchange rate and interest rates. The model is summarised in the two accompanying panels. The key element is the assumption that import volumes respond to changing circumstances in such a way that the current account net of investment income remains constant. Changes in the overall current account are thus due entirely to changes in debt interest. This assumption is relaxed in one set of simulations where import growth is allowed to increase in such a way that the current balance net of investment income is zero by the end of the projection period (1990).
The determination of imports in this way, effectively as a residual, is one of several ways in which the system could be closed. The rationale for this particular assumption is as follows. The recent, post- 1982 crisis surpluses on current account net of interest payments represent a transfer from debtors to creditors. By sustaining these transfers, borrowing countries have avoided the disruption of their commercial affairs that might otherwise have followed and have made a contribution to the stability of the international financial system. They have sought thereby to enhance their prospects for once again having access to private credits. But these transfers are costly to countries in the short run as they limit foreign exchange available for current imports. There is no optimal level of transfer to work out debt problems, either from the point of view of the borrower or the lender. Rather than attempt to project the future course of such transfers, which will be determined by the interplay of economic, financial and political considerations, they are held constant in the simulations of the debt model. This allows one to examine how other indicators of tension - debt ratios, reflecting liquidity and solvency, and imports of borrowing countries - could evolve, holding the transfers at 1985 levels. Whether the resulting simulations are regarded as realistic depends partly on how the various ratios turn out using this assumption and partly on an interpretation of the political situation in the debtor countries. The behaviour of the banks and multinational agencies involved as the creditors in the system will also affect the outcome.
The model building blocks are presented in the two panels in the logical order entailed by the import assumption. The first panel presents the modelling of trade developments, culminating in the determination of imports in such a way that the current balance net of investment income remains unchanged. The second panel then takes this as given and works through the implications for the debt position and the development of debt ratios through time.
4. EXPORT VOLUMES AND OECD GROWTH
CASE STUDIES: COMPARISION BETWEEN VARIOUS DEVELOPING COUNTRIES
Trade prices from another link between OECD economies and debtor countries. The division of goods exports into three categories - primary commodities, energy, and manufactured goods - brings out the situation of the different debtor groups. The recent weakness of primary commodity and energy prices versus the relative strength of manufactured goods prices has had the most negative impact upon export revenues of the problem and oil-exporting groups. The terms of trade of the problem and oil-exporting groups deteriorated every year from 1982 to 1985 with the exception of 1984, while they improved for the other groups. Primary commodities (defined as SlTC sections 0 to 4 excluding energy) make up an important part of the exports of all the groups except the oil-exporting group. Thus movements in commodity prices strongly affect debtor country export revenues, especially in cases where a country depends on a single commodity or a small number of commodities for a large share of its export receipts. Supply and demand interact to determine commodity prices, but for the present model it is changes in demand which are the main focus. As OECD countries account for a large share of consumption for many primary commodities, demand developments in the OECD have a strong effect on commodity prices. Hence studies of primary commodity prices have concentrated on OECD demand-side factors such as changes in OECD activity and inflation, exchange rates and interest rates (as, for example, in Chu and Morrison, 1984; Hartman, 1985 and Holtham et al., 1985).
Single equation estimates of real commodity price equations explain a relatively small part of aggregate commodity price movements, although a range of studies are in broad agreement on the magnitudes of the effects of several key variables on commodity price movements:
- an elasticity with respect to OECD activity of about 2;
- an elasticity with respect to the effective dollar exchange rate which is negative and less than one;
- an elasticity with respect to real interest rates which is negative and small but often with insignificant coefficients.
In the debt model, OECD GDP growth and the effective dollar exchange rate are used as explanatory variables with coefficients taken from a variety of studies.
The two other trade prices included in the model -energy prices and manufactured goods prices - are taken as exogenous. Manufactured goods export prices are largely determined by cost developments in the OECD, and it is assumed that non-OECD manufacturers follow competitors' prices. It should be noted, however, that in particular circumstances prices of developing country manufactured exports may rise or fall relative to prices of competitors. For example, in 1986 the depreciation of the dollar vis-i-vis the yen and the major European currencies has been followed by a number of developing country exporters of manufactured goods. As a result, their prices have declined against the average prices of OECD country manufactured exports. Oil prices expressed in dollars are subject to a wide range of influences, of which exchange rate changes among OECD countries is one. But the uncertainty and instability of the effects, which involve a broad range of interactions, suggest that it is more illuminating to treat oil prices as exogenously given.
The amount of interest paid by debtor countries is a function of movements in interest rates, which are largely determined in the OECD economies, but there are other factors to be considered. The first is the share of debt which is subject to fixed rates of interest as compared with floating rates of interest. For non-oil developing countries in total, about half of liabilities and about three-quarters of assets were at floating rates at the end of 1984 (OECD, 1986a1, but for the major debtors of this study the proportion of liabilities at floating rates was much higher, ranging from about 50 per cent to 90 per cent depending upon the country. The share of floating-rate debt in total debt is much higher now than it was in 1978, especially for the problem debtors, but the share has been fairly steady for the last couple of years. The second factor is the spread over LIBOR charged by commercial banks to non-oil developing countries, which has fallen over the past couple of years [the absolute amount of the spread fell in 1985 to its lowest level since 1979 (IBRD, 198611. As
Dornbusch (1985) points out, there are actually two "spreads" involved here - one, a spread between a "risk-free" rate like the U.S. Treasury bill rate and LIBOR, and, secondly, a spread between LIBOR and the rate actually charged on debtor-country loans including fees and commissions. The debt accounting model assumes a constant proportional spread between the risk-free rate and the rate charged to debtor groups, thus abstracting from changing country risk (actual rate minus LIBOR) and OECD financial market developments (LIBOR minus risk-free rate).
However, data on spreads and fees should be interpreted carefully, since new syndicated market loans have been shrinking in recent years and since rescheduling fees are charged on debt relief operations. Among problem debtors, the variable interest rate portion of debt has declined slightly in recent years as new commercial bank lending has slowed particularly sharply. Among the stable debtors, Algeria, Malaysia, South Korea and Thailand had bond issues in 1984-85 (OECD, 1986b) that reduced the dependence on new commercial loans, although the amounts involved were generally small in relationship to total outstanding commercial loans.
In the model of debt determination, it has been important to take note of the share of debt which is denominated in dollars as well as the share which is at floating rates. In the first half of the 1980s dollar interest rates were normally higher than interest rates on other major international currencies. This is less the case in 1986, but as the dollar has depreciated, the valuation of non-dollar-denominated debt has grown. For most of the problem debtors, the share of non-dollar-denominated debt is small, so dollar depreciation does little to the value of debt outstanding. This is not the case, however, for Nigeria and a number of the stable debtors, which have a significant share of liabilities in non-dollar-denominated trade and other credits.
In 1984, total developing country debt was about 60 per cent dollar-denominated. For the debtor country groups in this study, the share was higher, in the 60 to 90 per cent range. Other things being equal, the recent fall in both dollar interest rates and the exchange rate for the dollar will help to improve the ratios most for those borrowers who have debt portfolios that are heavily weighted towards floating-rate dollar-denominated instruments: namely, the problem debtors as a group. This shows up in the projected ratios as an offset to the negative effects of the oil price decline suffered by several of the problem debtors. The share of debt denominated in dollars changes as the dollar changes in value and is endogenous in the debt accounting model. The currency composition of additions or reductions to debt is assumed to match the distribution of outstanding debt.
TRENDS IN DOMESTIC AND FOREIGN DEBT
Domestic public debt is not a new phenomenon for developing countries. Guidotti and Kumar (1991) study the case of 15 emerging market countries and show that their domestic public debt-to-GDP ratio went from 10 per cent in 1981 to 16 per cent in 1988. They also point out that, while the ratio of domestic debt to total public debt remained more or less constant over the period (at about 30 per cent), there were important differences in the process that led to the accumulation of domestic and external debt. The increase in domestic debt was mainly due to new borrowing and that of external debt was due to accumulation of arrears. This suggests that if emerging market countries had not been shut down from the international capital market, they would have probably accumulated more external and less domestic debt. This view is consistent with the one put forward by Borensztein, Cowan, Eichengreen and Panizza (2007), who find that crises play a key role for the development of the domestic bond market. Christensen (2005) shows that also low income countries have a tradition of domestic borrowing (in his sample of sub-Saharan African countries, domestic public debt was about 10 per cent of GDP in 1980). Most of the domestic debt issued by low income sub-Saharan African countries is held by commercial banks and has short maturity (average maturity is ten months and the majority of bonds have a 3-month maturity). In a study of 17 West African countries, Beaugrand, Loko and Mlachila (2002) found that most medium term debt was not issued at market conditions and consisted of securitization of arrears. However, they found that Mali, Benin, and Senegal did place some medium term bonds at market rates. Abbas (2007) and Abbas and Christensen (2007) show that bank-holdings of domestic public debt in low income countries were about 5.5 per cent of GDP in the 1975-1985 period and increased to 8.4 per cent of GDP in the 1996-2004 period. The increase was particularly large in emerging market countries, where bank-holdings of public debt went from 7.8 to 14.3 per cent of GDP.
As in the case of emerging market countries, also in low income countries external factors are among the main drivers of the accumulation of domestic public debt which, somewhat paradoxically, can be driven by either too little foreign aid or too much foreign aid.8 Countries that run a budget deficit which is not fully matched by donor flows often issue domestic debt because the standard policy advice of the international financial institutions is to limit external borrowing at commercial rate. In fact, for countries that have an IMF programme, there are explicit limits on external borrowing at commercial rate. In order to understand how this can happen, it is useful to classify what a country can do with aid flows. It can:
- absorb and spend the aid flows;
- not absorb and not spend the aid flows;
- absorb but not spend; and
- spend and not absorb.
In the first case, the government spends all the aid flows by buying either foreign or domestic goods. This results in no net accumulation of assets or liabilities and often leads to an appreciation of the real exchange rate. In the second case, all aid is transformed into international reserves. This contributes to reserve build up and increases the net wealth of the beneficiary country but has no other effect on the economy. In fact, if one excludes the reserve build up, this strategy is equivalent to not receiving aid. In the third case, the government uses the aid flows to reduce its deficit without changing its expenditure and hence reduces its public debt. In the fourth case, the government widens its budget deficit but does not use the external aid flows (that remain locked in the central banks in form of international reserves). This is equivalent to a fiscal expansion in absence of aid and may be driven by the government's decision of sterilizing aid inflows. A government that decides to spend and not absorb can either print money or issue domestic debt. It is in this sense that aid can translate into an increase of domestic debt. While this latter policy may look like an odd choice, case studies show that this is not an infrequent strategy among countries that are attempting to avoid an appreciation of the real exchange rate (Aiyar, Berg and Hussain, 2005). The above discussion suggests that, traditionally, developing countries used the domestic debt market only when they did not have access to external resources (or to sterilize aid flows). What is new in the current situation is that the increase in domestic financing (both in relative and absolute terms) is happening in a period during which most emerging market countries do have access to the international capital market. The top panel of table 2 shows that over the 1994-2005 period domestic public debt increased slightly going from 19 to 23 per cent of developing countries' GDP. This happened while average debt levels were decreasing (going from 75 to 64 per cent of developing countries' GDP). As a consequence, the share of domestic debt over total public debt went from 30 to 40 per cent. The bottom panel of table 2 reports weighted averages and shows that the switch to domestic borrowing is even more important in larger countries. In this case, the domestic debt-to-GDP ratio went from 22 to 27 per cent, and the share of domestic debt over total debt went from 48 to 69 per cent. Some emerging market countries have been particularly aggressive in retiring external debt. In Mexico, for instance, the share of domestic debt went from 60 per cent of total public debt in 2004 to 73 per cent of public debt in 2007. In Brazil, the public sector substituted its net external debt with net external assets equal to approximately 3 per cent of GDP.
Figure 1 plots the evolution of public debt in the developing world and shows a net decrease in total debt which is mostly driven by lower external debt. Figure 2 shows the evolution of the simple average of the share of domestic debt over total debt in 6 regions. The share of domestic debt increased in most regions of the world. Only in sub-Saharan Africa the share of domestic debt decreased slightly over 1999-2005, but also in this region domestic debt went from 25 per cent of total public debt in 1994 to 30 per cent of total public debt in 2005. Figure 3 uses weighted averages and also shows a net increase in the share of domestic debt. Again, the only region where domestic debt has become less important is sub-Saharan Africa. It is interesting to note, however, that when we use weighted averages, we find that sub-Saharan Africa has a high level of domestic debt (second only to East Asia). This is due to the fact that the largest economy in the region (South Africa) has a large market for domestic debt.
The international capital market can provide a large amount of funds and developing countries have used external public borrowing to supplement scarce domestic savings and thus finance public deficits without crowding out lending to the private sector or recurring to inflationary finance. Moreover, in developing countries where private firms do not have access to the international capital market the state often plays the role of financial intermediary by either guaranteeing private external debt or by borrowing abroad and then using the external resources to lend domestically to the private sector. The devastating financial crises that hit several emerging market countries in the second half of the 1990s made policymakers well aware of these risks and there is now widespread belief that issuing in the domestic market reduces the risks of sovereign finance. There is some truth in this view. Domestically issued debt has often the advantage of being denominated in the domestic currency and hence may reduce currency mismatches (but note, what matters is the currency in which the debt is denominated and not whether the debt is domestic or external) and may count on a more stable investor base. As a consequence, policymakers who are trying to reduce the risk of sovereign finance by limiting excessive foreign borrowing and by developing the required infrastructure and institutional set up for a well working domestic debt market should be applauded and encouraged.
However, the switch to domestic borrowing could entail important trade-offs and policymakers should not be too complacent. In deciding the optimal structure of public debt, debt managers should consider the trade-offs between the cost and risk of alternative forms of financing and the role of possible externalities.
Broadly speaking, long-term domestic currency debt reduces maturity and currency mismatches and hence tends to be safer (from the borrower's point of view) than short-term foreign currency debt. This is important for the choice between external and domestic borrowing because most developing countries are unable to issue domestic currency debt (either short or long-term) in the international market (Eichengreen, Hausmann and Panizza, 2005a). However, while most emerging market countries do issue domestic currency bonds in their own market, few of them are able to issue longterm domestic debt at a reasonable interest rate, those that cannot may face a trade-off between a maturity and a currency mismatch. It is not clear what types of policies are necessary to escape this potential trade-off.
In low income countries there is no trade-off between issuing safer and cheaper debt. In this group of countries, external debt tends to have concessional rates and long-maturity. Hence, even if external borrowing carries a potential currency mismatch, it tends to be cheaper (both ex-ante and ex-post) than domestic borrowing.14 For instance, in the sample of 65 low income countries studied by IMF (2006) domestic debt is approximately 21 per cent of total debt but it absorbs 42 per cent of the total interest bill.
The government is a big player and the presence of a large and liquid market for government bonds can promote the development of the corporate bond market by building the required minimum size, supplying a benchmark yield curve, and providing the necessary trading infrastructure. Moreover, the availability of a well-working market for domestic debt can provide domestic savers with an alternative to investing abroad and thus reduce capital flight and can convince domestic agents to bring their savings back into the formal financial system generating large benefits in terms of financial depth and reduction of the black economy (Abbas and Christensen, 2007).
ANALYSIS OF RESULT
The choice of the optimal debt structure involves important trade-offs and, as weakness with the current system are often identified after a financial crisis starts to unravel (Krugman, 2006), policymakers should be aware of possible new vulnerabilities. Hence, crisis prevention requires detailed and prompt information on debt structure. Yet, most research and analysis focuses on external borrowing and prompt and detailed information on the level and composition of domestic public debt is often not available to policymakers and analysts. This situation is made even worse by the fact that standard debt sustainability analyses of public debt use a definition of "external" debt which does not reflect what it is supposed to measure.
Donors can play a major role in helping developing countries to improve their capacity to record and disseminate information on the structure of total public debt. The creation of the Programme on Debt Management and Financial Analysis System (DMFAS) in UNCTAD and the Debt Management Programme of the Commonwealth Secretariat were important steps in this direction, but more resources and continuous support are needed. It is also encouraging that the IMF is implementing technical cooperation pilot programmes aimed at improving the collection of debt statistics in several countries (IMF, 2006).
CONCLUSION AND RECOMMENDATION
This report suggests that the traditional dichotomy between external and domestic debt does not make much sense in a world characterized by open capital accounts and that, although the recent switch to domestic borrowing has important positive implications for debt management, policymakers should not be too complacent.
Better data are necessary because debt sustainability analysis should focus on total debt and study the implication of debt structure. IMF (2006) reports that about two thirds of the recent joint IMF/WB debt sustainability analyses discuss vulnerabilities linked to total public debt and IMF (2003, 2007) states that debt sustainability analysis in both low and middle income countries should always include a module on total public debt. However, few of these exercises have data on the composition (maturity, currency, type of holders) of total public debt, and most of the policy conclusions are based on vulnerabilities arising from "external" debt. The standard justification for this approach (besides data availability) is that different types of debt have different default risk (for instance, domestic currency debt can be diluted with inflation) and hence external and domestic public debt cannot be simply added to each other to form a single indicator of total public debt. While it is true that simply summing external and domestic debt would be misleading, with better data it would be possible to build an aggregate debt ratio where "riskier" types of debt have a higher weight than safer type of debt. Of course, such an indicator would be an imperfect measure of the risk of total debt, but it would be superior to the current practice of assigning a weight of one to all types of external debt (independently from maturity, currency composition, and type of holder) and a weight of zero to all other types of debt. Better information on debt structure could help us in building such an indicator and at doing a better job at tracking the risks of sovereign borrowing.
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- External Debt Histories of Ten-Low Income Developing Countries: Lesson from their experience. (1998). Retrieved on March 30, 2010 from www.imf.org/external/pubs/ft/wp/wp9872.pdf
- Imed Drine and Sami Nabi. (n.d.). Public External Debt, Informality and Production Efficiency in Developing Countries. Retrieved on March 30, 2010 from www.ecomod.org/files/papers/893.pdf
- Pushpa Kumari. (1996). External Debt, Foreign Exchange Constraint and Economic Growth in Developing Countries. Retrieved on March 30, 2010 from www.iif.edu/data/fi/journal/Fi102/FI102Abs3.pdf
- Debt Relief Initiative for poor countries faces challenges. (2000). Retrieved on March 30, 2010 from www.gao.gov/new.items/ns00161.pdf
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