Abstract
Recently, there has been an increasing tendency for switching external debts into domestic borrowings in many developing countries. In this paper, we develop a simple general equilibrium model to determine the optimal share for domestic and external government debts in Indonesia. We emphasise the important role of demand in forming the optimal structure of government debts. We found that both domestic and external government debt markets are linked from both the perspectives of demand and supply. In addition, the back testing simulation suggests that the Indonesian government has to reduce the level of its external debt. Through a dynamic recursive simulation, it is suggested that, in the long run, the government must not hold any external debt while the debt-to-GDP ratio is at the 16%-17% level.
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