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How to make debt safer
Ugo Panizza
Debt and Finance Analysis Unit
DGDS
UNCTAD
http://upanizza.googlepages.com
How to make debt safer
• Keep debt low
– International policies (debt relief)
– Domestic policies
• Keep debt safer
– International policies
– Domestic policies
Outline
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Reducing debt
Managing debt
Domestic policies
International policies
Conclusions
A brief history of debt relief
• Negotiations in Paris with Argentina (1956)
• It started with UNCTAD (1967)
– A series of UNCTAD meetings in 1977-1979 led official
(bilateral) creditors to write off $6 billion of debt to 45
countries
• Brady Plan (1989)
– Private creditors
• HIPC (1996)
• Enhanced HIPC (1999)
• MDRI (2005)
– Multilateral official creditors
Domestic Policies
• Control the flow of debt
– Strengthen fiscal policies and institutions
• Fiscal rules
• Budget institutions
– Hierarchical rules
– Transparency Rules
– But this is never enough
Outline
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Reducing debt
Managing Debt
Domestic policies
International policies
Conclusions
Domestic Policies
• Manage the inherited stock of debt
– Improve debt structure (long-term, local
currency and contingent instruments)
– Self insurance (reserves, stabilization
funds)
– Develop local markets
In fact, several countries are
• Accumulating huge reserves
– But self insurance is a very inefficient way
to protect yourself
• Switching to the domestic market
– Currency mismatches are less likely
– Sudden Stops are less likely
Domestic debt is becoming more important
0.6
0.5
Debt to GDP Ratio
0.4
Domestic Public Debt
0.3
0.2
0.1
External Public
Debt
0
1994
1995
Source: Panizza (2007)
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Domestic debt is becoming more important
Share of Domestic Debt (weighted average)
1.00
94
4
99
9
05
0.90
0.80
0.70
0.60
0.50
0.40
0.30
0.20
0.10
0.00
EAP
Source: Panizza (2007)
ECA
LAC
MNA
SAS
SSA
All Countries
Can the switch to domestic debt eliminate all
vulnerabilities?
• To some extent, but…
– Need to be careful not to trade a currency
mismatch for a maturity mismatch
Can the switch to domestic debt
eliminate all vulnerabilities?
Domestic Original Sin in Latin America and Other Emerging Regions
1.0
Index of domestic original sin
0.9
LAC
0.8
0.7
0.6
Other EMs
0.5
0.4
0.3
Asia
0.2
0.1
0.0
1996
1997
1998
1999
2000
2001
2002
2003
Note : Original sin is measured as share of domesic debt which is short term, denominated in foreign currency, or indexed to prices or the interest rate. "Latin America" includes: Argentina, Brazil,
Chile, Colombia, Mexico, and Venezuela. "Asia" includes: China, India, Indonesia (from 1998), Korea, Malaysia, Philippines, and Thailand. "Other emerging markets" includes: Czech Republic,
Israel, Hungary, Poland, Russia, and Turkey.
Source : Authors' calculations based on Jeanne and Guscina (2006) data set.
Can the switch to domestic debt eliminate all
vulnerabilities?
• To some extent, but…
– The cost of borrowing needs to be evaluated carefully
• What happens if the currency appreciates
– Need to be careful not to "force" domestic institutional
investors and banks to assume "too much" government
debt
• Especially banks
– Domestic debt may be more difficult to restructure
– Externalities
Can the switch to domestic debt eliminate all
vulnerabilities?
• While the recent switch to more domestic borrowing
may have important positive implications for debt
management, policymakers should not be too
complacent.
– "The history of crisis modelling in international macroeconomics
reveals that each successive wave of crises exposes possibilities
for crisis that were overlooked in earlier analysis." (Krugman,
2006)
• As vulnerabilities are often identified after a financial
crisis starts to unravel, crisis prevention requires
detailed and prompt information on debt structure
• Yet, most research and DSA 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
Outline
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Reducing debt
Managing Debt
Domestic policies
International policies
Conclusions
International Policies
• Contagion risk
– “Emerging Market Fund” that support the
asset class at time of crisis
• Help develop new instruments
– Local currency
– Contingent debt instruments
• GDP index bonds
Why doesn’t the market develop
such financial innovations?
• Coordination problems and the need to
ensure “critical mass” for new instruments.
– The appeal of an innovation often depends on its
simultaneous adoption by many contracting
parties.
– Individual borrowers considering whether to issue
a new financial instrument will not take into
account the benefits for other borrowers and
investors that would result from establishing a new
asset class.
Why doesn’t the market develop
such financial innovations?
• The highly competitive structure of
financial markets.
– A private financial institution would have to
incur costs to develop a new type of
financial instrument but it may be unable to
maintain a monopoly over the provision of
this instrument for a long time
– Patents are still rarely used for financial
instruments, and imitation is relatively easy.
Why doesn’t the market develop
such financial innovations?
• The need for standards.
• The creation of a liquid secondary market
requires instruments with the same features
for all countries or all firms issuing them.
– For financial instruments where payments are due
when certain conditions are met, it is crucial to
have verifiable standards for whether those
conditions are met.
– For example, the market for credit default swaps
remained small for years but took off as soon as
the standards for a “credit event” were properly
defined and became broadly accepted
Why doesn’t the market develop
such financial innovations?
• Signaling.
– Individual countries may be reluctant to
issue new financial instruments or existing
instruments with new contractual features if
they fear that such innovations may be
misperceived as signs of weakness or lack
of commitment to good policies.
Why doesn’t the market develop
such financial innovations?
• So far, we assumed that these
instruments are just impossible or
too costly to develop
– … but, even if they are not too costly,
myopic politicians may not have the
right incentives
International Policies
• Dedollarize official lending
– The proposal for redemption from original Sin by
Eichengreen and Hausmann would reach two
objectives
• Create a market
• Lend in local currency
– This could also benefit low income countries if
multilateral lenders were to dedollarize their
concessional lending as suggested by Hausmann
and Rigobon
Outline
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Reducing debt
Managing Debt
Domestic policies
International policies
Conclusions
Summing up
• Two views on how to reduce
vulnerabilities
– Abstinence
• Borrow less
– Use “safer” debt
• Borrow in a smarter way
Borrow Less
• The status quo is an adaptation to deeper
problems, such as lack of credibility, and
weaknesses in domestic institutions. The
outcome may well be inefficient, but it cannot
be improved without addressing the underlying
problems…
• …and its going to take years
• See “Debt Intolerance” (Reinhart, Rogoff, and
Savastano)
Borrow in a smarter way
• Today’s array of instruments is inherited
from historical accident and has
persisted owing to inertia
• The existing structures can be changed,
though not without substantial effort,
through reforms involving coordination
among market participants
• I tend to share this view
How to make debt safer
Ugo Panizza
Debt and Finance Analysis Unit
DGDS
UNCTAD
http://upanizza.googlepages.com