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Debt Sustainability and
Debt Composition
UNCTAD Paper by
Heiner Flassbeck and Ugo Panizza
Introduction

Problems with DSA exercises
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Often mix the concept of external sustainability
with that of fiscal sustainability
Trend to focus on the level of debt without
considering its composition
Outline
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Disentangling Concepts of Sustainability
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External Sustainability and Fiscal Sustainability
Interactions/Linkages
Debt Decomposition analysis
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Debt composition
Proposed composite debt indicator
Determinants of debt crises
Different concepts of sustainability tied
to different types of debt

External sustainability focuses upon the Transfer
Problem:

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ability to generate foreign exchange
Fiscal sustainability focuses upon the Budgetary
Problem:

ability to increase or broaden the tax base to generate
revenue
External Debt Indicators
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Standard external debt sustainability indicators:
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Debt to GDP ratio
Debt to revenues ratio
Debt to export ratio
Weaknesses of these indicators
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These indicators are problematic if import growth
outpaces export growth.
Unless the external debt is issued in domestic currency,
the foreign exchange needed will only result from a
current account surplus.
Not all types of debt carry the same risk features
Fiscal Sustainability & Budgetary
Problem
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Public debt has an external and domestic component.
Fiscal sustainability analyses focus on adjustments to
the level and composition of tax revenue or primary
expenditures
Both public debt (domestic vs. external) and fiscal
sustainability lack clear definitions
Formal fiscal sustainability tests are problematic and
are demanding in terms of data.

The tests do not establish any necessary conditions for
long-run sustainability
Fiscal Sustainability Indicators
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Common Rule of Thumb:
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d
r
g
ps
Δd = (r – g) d – ps, where
is the debt to GDP ratio
is the steady state real interest rate
is the long run growth rate of real GDP
is the primary surplus to GDP
Problems:
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No well specified definition of sustainability or of the
necessary conditions for LR sustainability
Requires many assumptions on growth, interest rates,
government expenditures and revenues
These variables tend to be endogenous and correlated with one
another
Considerations for Developing
Countries
Fiscal sustainability indicator does not account
for the fact that developing countries often:
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Have a limited capacity to raise taxes
Have a volatile revenue base
Are subject to large external shocks (real and
financial) that increase the volatility of GDP
growth
Have high levels of liability dollarization
Tradeoffs between External and Fiscal
Sustainability

Consider a real devaluation:
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Positively impacts external sustainability through
increased export competitiveness and FOREX earnings
Negatively impacts fiscal sustainability if a large share of
public debt is denominated in foreign currency, results in
a jump in the debt-to-GDP ratio.
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These interactions highlight the need for domestic
debt to be included in DSA exercises.
Broad shift towards a greater proportion of domestic
debt in developing countries
Domestic debt has been excluded from DSA
exercises thus far because
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Domestic debt has different risk characteristics
Not appropriate to sum debt of different risk
characteristics together
Data are scarce
Important Considerations
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Any attempt of measuring debt sustainability
requires a thorough analysis of the causes of
indebtedness
Analysis purely based on debt levels and on
the forecast of some macroeconomic variables
will lead to nowhere.
In a perfect world
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Construct a composite debt indicator
Decompose external and public debt by:
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Maturity and currency characteristics
Type of lender
Type of borrower
Authors propose categorization of external debt
across 12 different levels of risk.
Assigning different weights to different risk
categories to calculate a composite risk measure
Back to reality… empirical study
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Empirical study examines how debt level and
composition affect the probability of a debt crisis

Estimate a probit model on an unbalanced panel of 78
developing countries for the 1980-2006 period
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Explanatory variables: GDP growth; international
reserves to GDP, trade openness; undervaluation of
the exchange rate; growth rate of private credit; fiscal
and CA balance; inflation; corruption
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Total external debt is decomposed into four
components:
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Total short term external debt
Long-term private external debt
Long-term public external debt to private
creditors
Long-term public debt to official creditors
(bilateral and multilateral)
Empirical findings
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Examining separate components of total external
debt, authors find evidence that debt composition
matters
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Find significant evidence that crises are positively
correlated with long term public debt owed to private
creditors
Find evidence suggesting that the relationship between
default risk and debt with private creditors is more
sensitive to external shocks than between default risk and
debt with official creditors.
Find evidence that there is less risk associated with
borrowing abroad in their own currency.
Conclusions
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Different types of debt may be ranked by
risk:
1.
2.
3.
4.
External public debt with private creditors in
a foreign currency (highest risk)
Domestic public debt
External public debt with official creditors
(lowest risk)
The evidence wrt private debt does not yield
consistent evidence
Remaining Obstacles
Data availability
International agreement to provide better and
comparable data on debt statistics
Thank You