Financial Crises: Lessons from the Past, Preparation for the Future

Chapter 4. Sovereign Debt in Developing Countries with Market Access: Help or Hindrance?

 Sovereign Debt in Developing Countries with Market Access Help or Hindrance? 4 Sovereign debt can help developing countries. It enables their governments to facilitate growth take-offs by investing in a critical mass of infrastructure projects and in the social sectors when taxation capacity is limited or the alternative would be to print money and compromise macroeconomic stability. Debt also facilitates tax smoothing and countercyclical fiscal policies, essential for reducing the volatility of output, and it permits an equitable alignment of benefits and costs for long-gestation projects by shifting taxation away from current generations. This is what theory tells us. There is every reason to believe that governments that borrow and spend prudently will reap these benefits in practice, but we also know that there was a profusion of costly macroeconomic crises during the 1990s, with public debt either being a central cause (for example , Russia in 1998 and Argentina in 2001) or else absorbing the brunt of the impact (for example, Indonesia, Korea, Malaysia, and Thailand during 1997–98). Moreover, the external debt crisis of the 1980s and the nowindermit gill brian pinto The authors thank Joshua Aizenman, Amar Bhattacharya, Nina Budina, Craig Burnside, Christophe Chamley, Ajay Chhibber, Gautam Datta, Norbert Fiess, 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. They are particularly indebted to James Hanson for encouraging them to write this paper and making numerous suggestions for improvement. 1. There are varying definitions of both numerator and denominator across countries. Turkey reports debt ratios as a share of GNP, and Brazil and Turkey both report public debt net of central bank assets. 2. Lebanon remains an enigma. In spite of being an outlier in its ratio of public debt to GDP, it did not suffer a debt default or financial system crisis, but its exchange rate collapsed during 1986–87 and 1992 as a result of domestic credit–financed expansions in government spending, which depleted reserves, akin to a first-generation crisis (see box 4-1). It also benefited from a pubic debt reprofiling under the auspices of the Paris II conference held in November 2002 (Ministry of Finance, Republic of Lebanon, 2003). controversial financial liberalization of the early 1990s have raised questions about the benefits of market-based external finance for developing countries with access to the international capital markets, called market access countries. These are the countries we look at in this chapter. Table 4-1 lists the top ten market access countries in terms of public debt (external plus domestic)—Argentina, Brazil, China, India, Indonesia, Korea, Mexico, Poland, Russia, and Turkey. In 2002 their combined public debt was $2.2 trillion, or more than two-thirds of total market-access-country public debt. These countries also accounted for about $1.4 trillion in external debt—that is, public plus private debt held by external creditors. When public debt is expressed as a ratio of GDP, the top eleven market-accesscountry debtors in 2002 were Argentina, India, Indonesia, Jamaica, Jordan, Lebanon, Morocco, Pakistan, the Philippines, Turkey, and Uruguay, with ratios ranging between 90 and 180 percent.1 All but three countries had higher ratios of public debt to GDP than a decade earlier in 1992, the year by which the Brady Plan resolution of the 1980s debt crisis had been implemented for the major participating countries. In the three exceptions— Jamaica, Jordan, and Morocco—the ratio of public debt to GDP was exceptionally high in 1992 and had declined only modestly by 2002. Of the seventeen countries in table 4-1, China was the only one not to experience a debt or balance-of-payments crisis during the 1980s or later.2 This chapter pays special attention to many of the countries listed in the table. In the face of concern that access to the international capital markets and high and rising public debt are enhancing vulnerability rather than growth, this chapter attempts to answer three questions: —What are the chances of a new debt crisis? —Is public debt constraining economic growth? —What should be done about public debt in developing countries?     What Is the Likelihood of Another Debt Crisis? What are the risks of another debt crisis as in the early 1980s or in the latter half of the 1990s? This chapter offers the following answer: Such...