presentation external debt sustainability

8/6/2019 Presentation External Debt Sustainability

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External debtand

sustainability

Mihai Copaciu

Outline

External debt

CA/debtsustainabilityDenitionDeterminantsMain indicators

IMFmethodology -in detail

Materials

External debt and sustainability

Mihai Copaciu

December 15, 2010
http://find/http://goback/


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External debtand

sustainability

Mihai Copaciu

Outline

External debt



Materials

1 External debt

2 CA/debt sustainabilityDenitionDeterminantsMain indicators

3 IMF methodology - in detail

4 Materials


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External debt

andsustainability

Mihai Copaciu

Outline

External debt



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Denition

Gross External Debt , at any given time, is the outstanding amount of those actual current, and not contingent, liabilities

that require payment(s) of principal and/or interest by the debtor at some point(s) in the future and that are owed to nonresidents by residents of an economy.

VIP!!! : You will see references also to Total Gross ExternalDebt .Total Gross External Debt = Gross external debt + Direct investment intercompany lending.


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External debt

andsustainability

Mihai Copaciu

Outline

External debt



Materials

More on denition

Gross debt is dened in terms of liabilities. A concept of netdebt can be derived by subtracting the stock of external assetsfrom gross liabilities. Although such a notion might be usefulin countries that are both debtors and creditors (ex. Russia),there are a number of practical difficulties in dening net debt:

it is unclear which assets should offset liabilities for example,should only official assets be used, or should bank and nonbankassets also be included;

a net debt total would mask important differences in the

maturity structure, currency composition, and risk features of liabilities and assets;

linking debt servicing to net debt may disguise the seriousnessof a countrys debt problem if assets broadly offset liabilities.


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External debt

andsustainability

Mihai Copaciu

Outline

External debt



Materials

Dt = Dt-1 + Bt - At, where:Dt: Stock of the outstanding debt at the end of a given period;

Dt-1: Stock of the outstanding debt at the end of the previuosperiod;

Bt: Disbursements of new loans (the placing of nancial resources atthe disposal of a borrower) during time period t ;

At: Amortization of debt (repayment of principal) during period t .

Basically this law of motion provides the connection between the gross

external debt and the debt creating ows from the capital and nancial accounts from the BOP . Please take into account that the interest component is found in the current account (under Incomes balance,debits).


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External debt

andsustainability

Mihai Copaciu

Outline

External debt



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Why the earlier formula is just an approximation

debt stocks are subject to valuation adjustments owing tothe fact that debt is contracted in various currencies. The

stock of debt, measured (for example) in euros, maychange because the value of debt denominated in anothercurrency (such as dollars), changes in euro terms when theeuro depreciates or appreciates against that currency;Interest is sometimes capitalized, adding to the stock of debt any unpaid interest obligations (interest arrears);Outstanding debt is sometimes canceled or written off.


7/25

External debt

andsustainability

Mihai Copaciu

Outline

External debt



Materials

Look at:

maturity structureshort term: original maturity of less than 1 year;medium term: original maturity between 1-5 years;long term: original maturity greater than 5 years;

sectorspublic: general government, monetary authority andeventually public owned commercial banks;private: private banks and non-banking sectors;

types of instruments: loans, currency and deposits, bonds,

trade credits, etc.original versus residual maturity;publicly guaranteed or not;foreign and domestic currencies;

interest rate type, etc.


8/25

External debt

andsustainability

Mihai Copaciu

Outline

External debt



Materials

What is meant by intertemporal solvency, liquidityand sustainability?

Intertemporal solvencyImplies that the present discounted value of future primary current accountbalances (=current account excluding interest payments) is sufficient torepay the accumulated debt (strong condition) or maintain debt-to-GDPratio constant (weak condition);

if a country is a net debtor it must run primary current account surpluses(in case of strong condition);requires forecasting of future current account balances and assumptionsabout future policies.

Liquidity

ability to meet or roll over the maturing obligations;

Sustainability

solvency+liquidity+no expectation of unrealistically largeadjustment.


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External debt

andsustainability

Mihai Copaciu

Outline

External debt



Materials

Main determinants affecting CA/debt sustainability

Economic growth

Is GDP growth rate above the world interest rate?Investment-Saving gap

Is CA decit caused mainly by lower savings or higherinvestment?

Openess and trade pattern

large size and diversication of exports sector strenghten

sustainability;outward-oriented trade policy and a well diversied exportsector can deal easier with external shocks;


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External debt

andsustainability

Mihai Copaciu

Outline

External debt



Materials


Size and composition of external liabilities

Maturity structure and currency composition of externalliabilities are relevant to the risk of suffering a liquiditycrisis;

Financial structureFinancial sector weaknesses undermine sustainability (e.g.Asian crisis, current crisis);missmatch between assets and liabilities denominated inforeign currency increase vulnerability to external shocks;

Other factorspolitical instability and uncertainty;policy credibility;market expectations;

contagion;


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External debt

andsustainability

Mihai Copaciu

Outline

External debt



Materials


Exchange rate and monetary policy

Fiscal policy

countercyclical policy is recommended;Capital ows

excessive capital inows, resulting in excess domesticdemand, ination in nontradables, loss of monetarycontrol and real exchange rate appreciation;


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External debt

andsustainability

Mihai Copaciu

Outline

External debt



Materials

Main indicators to assess vulnerability/sustainability

CA/GDP;

FDI/GDP and FDI/CA;REER;

GDP growth;

public decit;

CDS spreads (credit default swaps spreads);


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External debt

andsustainability

Mihai Copaciu

Outline

External debt



Materials

Main indicators to assess vulnerability/sustainability

external debt/GDP (NPV and current);

external debt/exports (NPV and current);

short term debt (remaining maturity)/reserves;

interest payments/GDP, interest payment/exports;

external debt service payment/reserves;

external debt service payment/exports;

reserves/imports, reserves in months of imports;

reserves/short term debt by remaining maturity;maturity structure of liabilities, public versus private, guaranteedversus not guaranteed;


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External debt

andsustainability

Mihai Copaciu

Outline

External debt



Materials

What are CDS?

A credit default swap (CDS) is a swap contract in which the buyer of theCDS makes a series of payments to the seller and, in exchange, receives apayoff if a credit instrument (typically a bond or loan) goes into default(fails to pay).

The (premium) spread of a CDS is the annual amount the protection buyermust pay the protection seller over the length of the contract, expressed asa percentage of the notional amount.

For example, if the CDS spread of Romania is 50 basis points, or 0.5% (1basis point = 0.01%), then an investor buying 10 millions USD worth of protection from AAA-Bank must pay the bank 50,000 USD per year.These payments continue until either the CDS contract expires or Romaniadefaults (adapted from http://en.wikipedia.org/wiki/Credit default swap).


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External debt

andsustainability

Mihai Copaciu

Outline

External debt



Materials

More on CDS spreads

CDS spreads depends on the expected default risk of the respectivecountry and thus are an indicator of the markets current perceptionof sovereign risk.

CDS spreads also depend on the global nancial environment likeglobal risk appetite.

Spreads derived from the CDS market are more reliable duringsovereign debt crises since, while the bond market liquidity decreasesduring a crisis, the demand for insurance against the default riskincreases for the troubled countries.

Very interesting paper: Euro-area sovereign risk during the crisis , SilviaSgherri, Edda Zoli.Summary available at: http://www.voxeu.org/index.php?q=node/4217


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External debt

andsustainability

Mihai Copaciu

Outline

External debt



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More on CDS spreads

Source: Bloomberg


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External debt

andsustainability

Mihai Copaciu

Outline

External debt



Materials

Which values are considereddangerous?

One way: take some benchmark values used by others/impliedby the ratio itself.Some examples:

CA/GDP 5%;short term debt(remaining maturity) / reserves 1;reserves in months of imports 3;

Give special attention to the dynamics and to the direction of change.


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External debt

andsustainability

Mihai Copaciu

Outline

External debt



Materials

Which values are considereddangerous?

Another way: look at some values for leading indicators indifferent time periods and get info on the current stance.Lets see an example from Manasse and Roubini (2005).


19/25

External debt

andsustainability

Mihai Copaciu

Outline

External debt



Materials

Lets look at the IMF methodology

CAB t +1 + KAB t +1 + FAB t +1 + NEO t +1 = 0You can rewrite this (why?) as:

CAB t +1 + NDCF t +1 + NNDCF t +1 + R t +1 + NEO t +1 = 0

CAB

t +1

r t +1

D t + NDCF t +1 + NNDCF t +1 + R t +1 + NEO t +1 = 0NDCF t +1 = CAB

t +1 + r t +1 D t NNDCF t +1 R t +1 NEO t +1NDCF t +1 = CAB

t +1 + r t +1 D t NNDCF t +1 + RES t +1

where:

CAB - current account balance; KAB - capital account balance;FAB - nancial account balance;

NEO - net errors and ommisions;r - nominal effective interest rate on external debt;

D - stock of external debt;

NDCF - net debt creating ows;

NNDCF - net non-debt creating ows;

NEO - net errors and omissions;

R

change in the foreign reserve assets and other assets held by residents abroad ;RES = - R NEO ;


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External debt

andsustainability

Mihai Copaciu

Outline

External debt



Materials


We assume that all variables are in USD. The debt accumulation equationyou had earlier in the slides can be written as:

D t +1 D t = B t +1 At +1 = NDCF t +1

Now, replace the expression for NDCFt+1 with the one derived on theprevious slide:

D t +1 D t = CAB

t +1 + r t +1 D t NNDCF t +1 + RES t +1Now, divide everything with nominal GDPt+1:

D t +1GDP t +1

= (1 + r t +1 ) D t

GDP t +1

CAB t +1GDP t +1

NNDCF t +1

GDP t +1+

RES t +1GDP t +1


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External debt

andsustainability

Mihai Copaciu

Outline

External debt



Materials


You can rewrite the last equation as (lower case shows ratios in GDP):

d t +1 =(1 + r t +1 )

(1 + g t +1 ) (1 + t +1 ) d t cab

t +1 nndcf t +1 + res t +1

The change in debt debt is:

d t +1 d t =(1 + r t +1 )

(1 + g t +1 ) (1 + t +1 ) 1 d t cab

t +1 nndcf t +1 + res t +1

where:

g - real GDP growth rate;

change in domestic GDP deator in USD terms


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External debt

andsustainability

Mihai Copaciu

Outline

External debt



Materials

A note on the nominal effective interest rate

Lets assume that:you still want to have your debt expressed in USD terms;you have foreign debt issued on dollars and national currency.

Then, the nominal effective interest rate for the USD denominated debt is:

1 + r t +1 =

(1 + r domestic

t +1 )

(1 + e t +1 ) + (1

)

(1 + r foreign

t +1 )where:

e change in the nominal exchange rate . + shows anappreciation of the domestic currency against the dollar ;

= e t D domestic t

D t share of foreign debt issued in domestic currency

(and expressed in dollars) in total external debt (in USD );

1- = D foreignt D t

share of foreign debt issued in USD in total external debt (in USD);rforeign , r domestic interest rates on foreing and domestic denominated

foreign debt .

Now let us analyse this You have it also on the


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External debtand

sustainability

Mihai Copaciu

Outline

External debt



Materials

Now, let us analyse this. You have it also on theYahoo group/email (IMF aggrement)

NBR-Debt data: www bnro ro - BNR - Comunicate


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External debtand

sustainability

Mihai Copaciu

Outline

External debt



Materials

NBR Debt data: www.bnro.ro BNR Comunicatede presa - Tipuri de comunicate - Balanta de Plat i


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External debtand

sustainability

Mihai Copaciu

Outline

External debt



Materials

Materials

On the Yahoo group/email you have:This presentation;The rst(sept. 2009) and the last (sept. 2010) reviews of the IMF Stand-By Agreement with Romania;

presentation external debt sustainability

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