Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
External Debt Management and the HIPCs Livingstone, Zambia 10-21 April 2006 Thorvaldur Gylfason Debt: Good or bad? It depends If foreign credit is used well, to finance profitable investments, etc., then borrowing may be a good thing Many countries have developed rapidly with the aid of external loans This is how the US built its railways and how Korea managed to develop so rapidly from the 1960s onwards Both countries paid back their debts Debt: Good or bad? Many other countries have fared less well with their external debt strategies because ... ... they did not use their foreign loans well Too often, countries have borrowed to finance consumption, not investment Consumption does not increase the ability of indebted countries to service their debts, nor does low-quality investment But high-quality investment does Too much debt can hurt growth Conceptual framework If the world interest rate is lower than the domestic interest rate, it pays to be a borrower in world financial markets Domestic firms will want to borrow at the lower world interest rate Domestic households will reduce their saving because the domestic interest rate moves down to the level of the world interest rate Conceptual framework Real interest rate Saving Domestic equilibrium World equilibrium Borrowing 0 Domestic saving Domestic investment World interest rate Investment Saving, investment Conceptual framework Real interest rate Saving A Domestic equilibrium World equilibrium B C D Borrowing World interest rate Investment 0 Saving, investment Conceptual framework Real interest rate Consumer surplus before borrowing Saving A Domestic equilibrium World equilibrium 0 B C Producer surplus before borrowing Investment Saving, investment Conceptual framework Real interest rate Consumer surplus after borrowing A Domestic equilibrium World equilibrium B C D Borrowing Producer surplus after borrowing 0 Saving World interest rate Investment Saving, investment Conceptual framework Before borrowing After borrowing Change Consumer surplus A A+B+D + (B + D) Producer surplus B+C C -B A+B+C A+B+C+D +D Total surplus The area D shows the increase in total surplus and represents the gains from borrowing Gains from borrowing: Three main conclusions Borrowers are better off and savers are worse off Borrowing raises the economic wellbeing of the nation as a whole because the gains of borrowers exceed the losses of those who save If the world interest rate is above the domestic interest rate, savers are better off and borrowers are worse off, and nation as a whole still gains External debt: Key concepts Debt stock Usually measured in dollars or other international currencies because debt needs to be serviced in foreign currency Debt ratio Ratio of external debt to GDP Ratio of external debt to exports More useful for some purposes, because export earnings accrue in foreign currencies and reflect the ability to service the debt External debt: Key concepts Debt burden Also called debt service ratio Equals the ratio of amortization and interest payments to exports A rD q X F q = debt service ratio A = amortization r = interest rate DF = foreign debt X = export earnings External debt: Key concepts Interest burden Ratio of interest payments to exports Amortization burden Also called repayment burden Ratio of net amortization to exports F rD b X A a X q=a+b External debt: Magnitude and composition Magnitude of the debt Debt should not become too large How large is too large? Measurement of the debt Gross or net? May subtract foreign reserves in excess of three months of imports Composition of the debt FDI vs. portfolio equity Long-term vs. short-term loans External debt: Magnitude and composition Composition of the debt Foreign direct investment Least likely to flee, most desirable Portfolio equity Long-term loans Short-term loans Most volatile, least desirable As a rule, outstanding short-term debt should not exceed foreign reserves of the central bank External debt: Numbers How can we figure out a country’s debt burden? Divide through definition of q by income F A D r Y Y q X Y Now we have expressed the debt service ratio in terms of familiar quantities: the interest rate r, the debt ratio DF/Y, and the export ratio X/Y as well as the repayment ratio A/Y Numerical example Suppose r = 0.06 DF/Y = 0.50 A/Y = 0.05 X/Y = 0.20 Here we have a country that has to use 40% of its export earnings to service its external debt F A D r Y q Y X Y 0.05 0.06 0.5 0.08 q 0.4 0.2 0.2 Numerical example Suppose r = 0.06 DF/Y = 1.50 A/Y = 0.05 X/Y = 0.20 Here we have a country that has to use 70% of its export earnings to service its external debt F A D r Y q Y X Y 0.05 0.06 1.5 0.08 q 0.7 0.2 0.2 Numerical example Suppose r = 0.06 DF/Y = 1.50 A/Y = 0.05 X/Y = 0.20 Here we have a country that has to use 45% of its export earnings just to pay interest on its external debt F A D r Y q Y X Y 0.05 0.06 1.5 0.08 q 0.7 0.2 0.2 MEFMI countries: External debt 2003 (present value, % of exports) Rwanda Malawi Zambia Uganda Kenya Tanzania Mozambique Angola Lesotho Swaziland Botswana 0 200 400 600 800 MEFMI countries: External debt 2003 (present value, % of GNP) Zambia Malawi Angola Rwanda Lesotho Kenya Mozambique Uganda Swaziland Tanzania Botswana 0 50 100 150 MEFMI countries: External debt service 2003 (% of exports) Zambia Kenya Angola Rwanda Lesotho Malawi Uganda Mozambique Tanzania Swaziland Botswana 0 5 10 15 20 25 30 MEFMI countries: Exports 2003 (% of GDP) Swaziland Angola Botswana Lesotho Namibia Malawi Kenya Zimbabwe Mozambique Zambia Tanzania Uganda Rwanda 0 20 40 60 80 100 MEFMI countries: Current account balance 2002-2003 (% of GDP) Namibia Botswana Kenya Angola Swaziland Uganda Tanzania Rwanda Malawi Mozambique Lesotho -20 -15 -10 -5 0 5 10 MEFMI countries: Gross foreign reserves 2003 (months of imports) Botswana Tanzania Uganda Mozambique Lesotho Rwanda Kenya Malawi Namibia Swaziland Zambia Angola 0 5 10 15 20 MEFMI countries: Short-term debt 2003 (% of foreign reserves) Angola Zambia Kenya Malaw i Sw aziland Mozambique Tanzania Rw anda Uganda Botsw ana Lesotho Namibia 0% 50% 100% 150% 200% 250% 300% External debt dynamics Debt accumulation is, by its nature, a dynamic phenomenon A large stock of debt involves high interest payments which, in turn, add to the external deficit, which calls for further borrowing, and so on Debt accumulation can develop into a vicious circle How do we know whether a given debt strategy will spin out of control or not? To answer this, we need a little arithmetic External debt dynamics Balance of payments equation: BOP = X – Z + F where F = capital inflow = DF where DF = foreign debt Capital inflow, F, involves an increase in the stock of foreign debt, DF, or a decrease in the stock of foreign claims (assets) So, F is a flow and DF is a stock External debt dynamics Now assume Then, it follows that BOP = X – Z + DF = 0 so that DF = rDF Z = ZN + rDF Z = total imports ZN = non-interest imports rDF = interest payments Further, assume X = ZN BOP = 0 In other words: ΔD r F D F A flexible exchange rate maintains equilibrium in balance of payments at all times External debt dynamics So, now we have: ΔD r F D F Now subtract growth rate of output from both sides: ΔD ΔY r -g F D Y F Y g Y External debt dynamics But what is ΔD F ΔY F D Y ? This is proportional change in debt ratio: DF Δ F Y ΔD ΔY F DF D Y Y This is an application of a simple rule of arithmetic: %(x/y) = %x - %y Proof z = x/y log(z) = log(x) – log(y) log(z) = log(x) - log(y) But what is log(z) ? dlog(z) dz 1 Δz Δlog(z) dt dt z z So, we obtain Δz Δx Δy z x y Q.E.D. Debt, interest, and growth We have shown that Δd rg d Debt ratio rg where F D d Y r=g rg Time What can we learn from this? It is important to keep economic growth at home above – or at least not far below – the world rate of interest Otherwise, the debt ratio keeps rising over time External deficits can be OK, even over long periods, as long as external debt does not increase faster than output and the debt burden is manageable to begin with A rising debt ratio may also be OK as long as the borrowed funds are used efficiently Once again, high-quality investment is key Debt dynamics: Another look Let us now study the interaction between trade deficits, debt, and growth Two simplifying assumptions: Dt = aYt (omit the superscript F, so D = DF) Y Exponential growth Trade deficit is constant fraction a of output Yt = Y0egt Output grows at constant rate g per year t Pictures of growth Y log(Y) g 1 time time Exponential growth implies a linear logarithmic growth path whose slope equals the growth rate Debt as the sum of past deficits T DT ΔD t dt 0 at time T Debt as the sum of past deficits T DT ΔD t dt at time T 0 T T 0 0 DT ΔD t dt aY0egt dt Debt as the sum of past deficits T DT ΔD t dt at time T 0 T T 0 0 DT ΔD t dt aY0egt dt 1 gt DT ΔD t dt aY0e dt aY0 e g 0 0 T T gt Evaluate this integral between 0 and T Debt as the sum of past deficits T DT ΔD t dt at time T 0 T T 0 0 DT ΔD t dt aY0egt dt So, as T goes to infinity, Dt becomes infinitely large. But that may be quite OK in a growing economy! 1 gt DT ΔD t dt aY0e dt aY0 e g 0 0 T T gt Evaluate this integral between 0 and T 1 gt 1 gT DT ΔD t dt aY0e dt aY0 e aY0 e 1 g g 0 0 T T gt Debt as the sum of past deficits D T a Y0 e gt Y0 YT g YT Debt as the sum of past deficits D T a Y0 e gt Y0 YT g YT DT a Y0egt Y0 a Y0 1 YT g YT g YT Debt as the sum of past deficits D T a Y0 e gt Y0 YT g YT DT a Y0egt Y0 a Y0 1 YT g YT g YT DT a Y0egt Y0 a Y0 a 1 1 e gT YT g YT g YT g Debt as the sum of past deficits D T a Y0 e gt Y0 YT g YT DT a Y0egt Y0 a Y0 1 YT g YT g YT DT a Y0egt Y0 a Y0 a 1 1 e gT YT g YT g YT g So, as T goes to infinity, DT/YT approaches the ratio a/g lim T DT a YT g Numerical example Suppose Debt ratio 3 Trade deficit is 6% of GNP a = 0.06 Growth rate is 2% per year Time g = 0.02 Then the debt ratio approaches d = a/g = 0.06/0.02 = 3 This point will be reached regardless of the initial position ... ... as long as a and g remain unchanged What to conclude? Must adjust policies Must either Reduce trade deficit by stimulating exports or by reducing imports, or Increase economic growth Otherwise, the debt ratio will reach unmanageable levels, automatically No country can afford an external debt equivalent to three times annual output And why not? Because the debt burden then becomes unbearable Recall our earlier numerical example Where we looked at the relationship between the debt ratio and the debt burden Korea is a case in point Its export-oriented growth strategy reduced the numerator and increased the denominator of the debt ratio, thereby quickly reducing the country’s debt burden An import-substitution strategy would reduce both numerator and denominator with an ambiguous effect on the debt burden Numerical example, again Here we have a Suppose country whose entire export r = 0.06 (as before) earnings do not D/Y = 3 (our new number) suffice to service its debts A/Y = 0.05 (as before) X/Y = 0.20 (as before) A DF r Y q Y X Y 0.05 0.06 3 q 1.15 0.2 Numerical example, again Suppose that r = 0.06 (as before) D/Y = 2 (our new number) A/Y = 0.05 (as before) X/Y = 0.20 (as before) A DF r Y q Y X Y 0.05 0.06 2 q 0.85 0.2 Numerical example, again Suppose that r = 0.06 (as before) D/Y = 1 (new number) A/Y = 0.05 (as before) X/Y = 0.20 (as before) A DF r Y q Y X Y 0.05 0.06 1 q 0.55 0.2 Numerical example, again Suppose that r = 0.06 (as before) D/Y = 0.4 (new number) A/Y = 0.05 (as before) X/Y = 0.20 (as before) A DF r Y q Y X Y 0.05 0.06 0.4 q 0.37 0.2 Numerical example, again Suppose that r = 0.06 (as before) D/Y = 0.4 (as before) A/Y = 0.05 (as before) X/Y = 0.30 (new number) A DF r Y q Y X Y 0.05 0.06 0.4 q 0.25 0.3 MEFMI countries: External debt 2003 (present value, % of exports) Rwanda Malawi Zambia Uganda Kenya Tanzania Mozambique Angola Lesotho Swaziland Botswana 0 200 400 600 800 MEFMI countries: External debt service 2003 (% of exports) Zambia Kenya Angola Rwanda Lesotho Malawi Uganda Mozambique Tanzania Swaziland Botswana 0 5 10 15 20 25 30 Debt relief and the HIPCs Borrowers often renegotiate the terms of their loans in mid-stream so as to Delay repayments, that is, extend the maturity of the loans, or to Reduce interest payments by replacing high-interest loans by loans with lower interest Debt rescheduling vs. debt forgiveness Rescheduling of concessional terms involves an element of debt forgiveness But debt relief is not a substitute for sound and sustainable economic policies Debt relief and the HIPCs HIPC initiative from 1996 and 1999 Aims to bring debt to sustainable levels, thus eliminating the need for continued debt relief, rescheduling, and arrears Requires demonstrated capacity to put debt relief provided to good use Objective: Bring net present value of debt down to 150% of exports, and 250% of government revenue if Exports exceed 30% of GDP Revenues exceed 15% of GDP Floating completion points Tied to key structural reforms These slides will be posted on my website: www.hi.is/~gylfason In conclusion External borrowing is a necessary and natural part of economic development This requires countries that borrow to invest the funds borrowed in high-quality capital This is necessary to be able to service the debt If debt burden becomes too heavy, must either reduce deficit or spur growth It is always desirable anyway to do everything possible to encourage economic growth Rapid growth allows more foreign borrowing without making the debt burden unmanageable