Download The national accounting in an indebted open economy

MIBE
The economics of emerging economies
The role of Finance in economic
development and the emerging economies
Gianni Vaggi, April 2014
Finance 3-3
National accounting in an
indebted open economy
The national accounting in an indebted open
economy
Suppose D0 = 100 to be repaid in 10 years and i = 5%,
each year:
 iD
interest payments = 5
 ΔD
principal repayment = 10
iD + ΔD = DS
Debt Service
The national accounting in an indebted open
economy
Remember:


FA = NCF = Net Capital Flows = (Inflows – Outflows)
FA = [(Inflows - Other Outflows) -ΔD] = dD/dt
•
ΔD<0
in an indebted economy ΔD is an outflow because
debt must be repaid
•
dD/dt
is the change of the debt stock during the year,
which depends also on inflows and other outflows in
the FA.
CA = [(X-M) + (NPI – iD) + NSI]
The national accounting in an indebted open
economy
CA+FA = 0

Suppose an indebted economy where there are only foreign debt related
flows:
(Inflows - Other Outflows) = 0

and no other item in NPI and NSI other than –iD
[(X-M) - iD]
- ΔD = 0
(X-M) = iD + ΔD = DS
Take the example: DS = 5 +10 = 15
The national accounting in an indebted open
economy
IF
the trade balance is 15 and exactly covers the debt service, then the
overall debt decreases by ΔD = D0 - D1 , according to the original
scheduled payments or:
-ΔD = 90 -100 = -10 = -dD/dt
IF
the trade balance is 5 and covers interests only, then ΔD = 0 and the
overall debt does not change:
dD/dt=0
IF
the trade balance is less than 5 and, then the overall debt increases:
dD/dt=>0
The Current Account Balance
Now suppose there are other financial flows in the CA
In the BoP the Current account balance (CA) is the sum of
three items:
 Trade balance (X-M)
 Net income transfers (interest payments, dividends,
etc.;)= Net Primary Income = NPI
 Net unilateral transfers (remittances, international aid,
etc.)= Net Secondary Income = NSI
The national accounting in an indebted open
economy
 Net primary income:
 Interests on foreign debt
 Dividends (on portfolio investments);
 Earnings of FDIs, profit repatriation
 Rents on land and natural resources;
 Compensation of employees (cross-border workers).
 Net secondary income:
 Personal transfers (i.e. remittances);
 Current) International cooperation,ODA
The national accounting in an indebted open
economy
Consider the following flows:
-iD
are outflows in NPI = -5
Compensation of employees are often included in remittances
NSI
includes
-remittances
-international aid , ODA
The national accounting in an indebted open
economy
Remember:
[(X-M) + NPI + NSI] = CA Current Account Balance
and CA + FA = 0
[(X-M) - iD + NSI] + (-ΔD) = 0
[(X-M) + NSI] = iD + ΔD = DS = 15
Debt sustainability - 1
 D = overall foreign debt
 Y = GDP
 gn = (dY/dt)/Y is the nominal growth rate
 Thresholds
 d(D/Y)/dt < 0
The latter: Domar 1944
Debt sustainability - 2
By total differentiation of D/Y:
d(D/Y)/dt = [ (dD/dt)*Y - (dY/dt)*D ]/ Y2
= (dD/dt)Y - [ (dY/dt)/Y ] * (D/Y)
= (1/Y) [dD/dt - gn * D ]
But
dD/dt = [inD - (X – M)]
Debt sustainability - 3
d(D/Y)/dt = inD/Y - gnD/Y - (X - M)/Y
i = (in - dp/dt) and g = (gn - dp/dt)
dp/dt inflation rate on debt
d(D/Y)/dt = (i - g)D/Y - (X - M)/Y
i, g
are the real interest rate and the GDP growth rate
Debt sustainability - 4
But there are also other financial flows:
Current Account (CA)= [(X-M) + NPI + NSI ]
NICA = [CA – iD] = Non-Interest Current Account
NICA = [CA – iD] = [(X-M) + NPI + NSI] - iD
NICA
largely depends on the trade balance, but not only.
Debt sustainability - 5
The correct sustainability formula is
d(D/Y)/dt = (i - g)D/Y - NICA/Y
Debt sustainability – 6- and
national public debt
NICA is the equivalent for foreign debt of the concept of
Primary surplus (net of interests) for domestic(public)
debt
(T – G)
= Primary surplus
[(T – G) – iD] (<0)
= overall Fiscal Deficit = FD
FD/Y
must not exceed 3%