Abstract
Over the past 25 years, significant levels of public debt and external finance are more likely to have enhanced macroeconomic vulnerability than economic growth in developing countries. This conclusion applies not just to countries with a history of high inflation and past default, but also to those in East Asia, with a long tradition of prudent macroeconomic policies and rapid growth. We examine why with the help of a conceptual framework drawn from the growth, capital flows and crisis literature for developing countries with access to the international capital markets ('market access countries' or MACs). We find that, while the chances of another generalized debt crisis have receded since the turbulence of the late 1990s, sovereign debt is indeed constraining growth in MACs, especially those with debt sustainability problems. Several prominent MACs have sought to address the debt and external finance problem by generating large primary fiscal surpluses, switching to flexible exchange rates and reforming fiscal and financial institutions. Such country-led initiatives completely dominate attempts to overhaul the international financial architecture or launch new lending instruments, which have so far met with little success. While the initial results of the countries' initiatives have been encouraging, serious questions remain about the viability of the model of market-based external development finance. Beyond crisis resolution, which has received attention in the form of the proposed sovereign debt restructuring mechanism, the international financial institutions may need to ramp up their role as providers of stable long-run development finance to MACs instead of exiting from them.
Highlights
We know that in practice, there has been a profusion of costly macroeconomic crises during the 1990s with public debt either being a central cause, e.g., Russia 1998 and Argentina 2001, or else absorbing the brunt of the impact, e.g., Indonesia, Korea, Malaysia, and Thailand during 1997-98
For MACs with debt sustainability problems and which rule out default, the government’s intertemporal budget constraint is most likely to be helped by fiscal effort, flexible exchange rates, and institutional reform
4.2 What Are Countries Doing to Lower Vulnerability?. Vulnerable countries such as Brazil, Turkey and Jamaica are running primary fiscal surpluses of unprecedented magnitude—and these have persisted for lengths of time that would have been considered politically impossible only a few years ago. This “revealed policy preference” may be the outcome of a realization that debt levels are too high and are hurting development; and that repeated defaults and restructurings are too costly in a long-term development sense
Summary
Blanchard and Giavazzi (2003) argue that if the EMU’s Stability and Growth Pact targets of a fiscal deficit of 3 percent of GDP and public debt of 60 percent of GDP are achieved by cutting public investment, this would reduce long-run growth and eventually lead to rising fiscal deficits and debt—as observed in key EMU countries Their point is that the pact “puts no pressure on EMU members to reduce current government spending, so as to lower tax rates and make room for higher public investment”. The implicit assumptions are that there is no waste in government current spending, that borrowing is only for worthwhile public investment projects (economic ROR exceeds the interest rate) and that any investment subsidy required (difference between the interest rate and the net financial ROR) comes strictly from taxation Meeting these conditions is likely to require higher public saving. The last section concludes and questions the viability of market-based development finance
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