Debt Unsustainability Research Articles

Excess capacity and hysteresis in EU Countries. A structural approach

We develop a structural method to estimate the rate of capacity utilization in 12 EU countries that consists of identifying the structural parameters of a Leontief production function, using a parsimonious theoretical specification. Parameters are correctly identified, stable and robust to alternative specifications. Our results provide evidence of persistent excess capacity and hysteresis in the rate of capacity utilization in many EU countries, especially after the 2008′s global financial crisis, thereby supporting the claim that larger fiscal deficits would have contributed to absorb excess capacity without producing persistent inflationary pressures or debt unsustainability. Despite the simplicity of our model, the method allows more complex macroeconomic specifications for country-specific applications.

Бюджетні дефіцити і державний борг України під впливом шоків пандемії та повномасштабної агресії

Introduction. The extraordinary conditions for the government’s functioning during the pandemic and warfare provoked a strong respose of the state institutions, as a result of which the size of budget deficit in Ukraine over 2022-2023 exceeded a lot the historical values and averages for the different country groups as most indicators of the debt burden worsened, generating the danger of debt unsustainability. Problem Statement. Identification of the nature of Ukraine’s fiscal policy through the lens of past and contemporary global phenomenon, identification of macro-financial factors impacting he state of debt sustainability under the extreme conditions, analysis of debt burden indicators and fiscal risks in order to outline the ways of solving the fiscal and debt problems in Ukraine. Purpose. To reveal the global patterns and national features of the expansive fiscal policy conduct and public debt accumulation in emergency conditions which are connected with the pandemic and military actions , to investigate the factors of Ukrainian government’s solvency deterioration and to assess the relevant risks, as well as to define the tools of public debt management in the medium run. Methods. General scientific and special methods are applied: analysis and synthesis, description and comparison, historical method, method of theoretical generalization and abstract-logical method. Results. It has been found that the impact of operations of the general government on aggregate demand in Ukraine was positive in 2020, 2021 and 2022, and this situation was in sharp contrast to the period of 2015-2019, when fiscal policy produced restrictive effects. Fiscal policy in Ukraine was of pro-cyclical nature in 2014-2018 and turned to countercyclical stance only in 2020 with sustaining this course until 2023. It has been proven that in Ukraine the debt sustainability criteria are violated across major part of debt burden indicators , that signal the high solvency risks and liquidity risks for general government; moreover, relative to 2019, the dynamics of most indicators in 2020 and 2022-2023 were unfavorable. Computations conducted indicate that refinancing risks, foreign exchange and interest rate risks inherent to the structure of public debt have increased significantly with the start of hostilities in Ukraine. Conclusions. In the post-war period, contraction of budget deficit and well-balanced restructuring of the external public debt should become the main levers for debt reduction. Effective management of public debt with consideration of existing risks are important for securing macro-financial stability and active government’s involvement in the post-war reconstruction of the country.

Pakistan’s External Debt Unsustainability and the Required Approach

The paper traces financial and non-financial variables that prompt external debt distress in Pakistan. It explains that the economic vulnerability emanates from macroeconomic imbalances and structural problems. The macroeconomic imbalances deeply connect with global oil crisis, the Russia-Ukraine war and non-compliance with mutually agreed International Monetary Fund (IMF) conditionalities in the short run. However, the structural reasons are rising oil expenses, growing domestic political scandals, increasing terrorist attacks, and high spending on military imports. The paper recommends formulating a publicly available blueprint i.e. theory of change to resolve Pakistan’s increased reliance on transnational lenders, including the IMF. It should include innovative policies to initiate the green revolution that could replace intermittent nonrenewable resources to incrementally lower oil imports. Moreover, to increase growth in the non-military sector employing non-kinetic means and engaging transnational governance entities to resolve geopolitical conflicts would reduce reliance on military sector. The paper concludes that undergoing policy innovation for environmental and economic sustainability, is inevitable for gaining benefits from global renewable energy transition and avoiding debt distress.

External Debt in Developing Countries in The Period of 2001 to 2020: Reality and New Manifestations

Recently, external debt (ED) in developing countries (DCs) has increased rapidly because domestic finance is not able to meet their high capital needs. Debt has certain benefits when it comes to providing capital for economic development. However, the debt burden also creates risks for an economy. The main objective of this paper is to assess the situation of ED and determine its new manifestations in DCs in the period of 2001 to 2020 through indicators such as debt size, debt solvency as well as fluctuations in debt. The results show that the size of debt increased rapidly, but there was no sign of the unsustainability of debt during this period. The indicators, which were studied, showed a contradiction in the growth trend of debt solvency and debt size. In addition, the large share of short-term debt and private debt in total debt has also shown that debt payment pressure is growing in these DCs. Therefore, these economies are currently facing their own difficulties in financial potential along with general difficulties caused by the Covid-19 pandemic. Similar to other economic experts’ comments, the study shows that the reality of ED in DCs is going in a bad direction and therefore these economies are likely to fall into a new debt crisis.

Sources of Macroeconomic Instability: Implications on Foreign Direct Investment Inflow in Sub-saharan Africa, A PMG/ARDL Approach

This study investigates the short and long run effect of diverse sources of macroeconomic instability on the inflow of foreign direct investment (FDI). The stability of the business environment of a host country will determine the extent to which these economies will absorb shocks and make the economy attractive to foreign investors. We evaluate the role played by macroeconomic instability conditions in determining the inflow of FDI in Sub-Saharan African (SSA) economies, where FDI inflow have been relatively low and macroeconomic instability variables like inflation, external debt and exchange rate has persistently shown volatile trends as compared to other regions in the world. This study employs the Pooled Mean Group (PMG), Mean Group (MG) and Dynamic fixed effect (DFE) autoregressive distributive lag (ARDL) estimation approaches which account for both non-stationarity and heterogeneity effects, in a panel of 31 SSA countries and covers the period 1990 to 2017. We equally employ first and second generation panel unit root test, cross sectional dependence test and cointegration test. The Hausman test is used to select the most efficient estimation technique between the MG, PMG and DFE techniques. The results reveal a negative but insignificant effect of inflation on FDI both in the short and long run. Equally, a positive but insignificant effect of external debt and a negative but insignificant effect of exchange rate are observed in the short run. In the long run, external debt significantly crowds out FDI while exchange rate significantly crowds in FDI in the sub-Saharan African sub region. Based on the findings, we recommend that debt contracted in the sub region should be channeled to productive use like road infrastructure and renewable energy, while currency depreciation should be encouraged in order to render investors within this region more competitive. The used of monetary and fiscal policies should be employed to tackle macroeconomic uncertainty. Capital account regulation should equally be adopted to ensure a competitive real exchange rate. Equally, the debt carrying capacity of each economy should be identified in order to avoid debt unsustainability or payment and servicing default.

Borrowing Beyond the European Stability Mechanism: Arranging Additional Facilities

Since its arrival in late spring 2018 the Italian Government has presented a series of measures capable of questioning the sustainability of the Italian public debt. The key point is that, in the absence of a steady economic growth, spending measures may involve an increase in interest rates and a downgrade of public debt. In this case, without a significant correction, market access can be lost and debt burden might become unsustainable. In order to avert this scenario, Italy would be obliged to require assistance to the ESM machinery. Nevertheless, such possibility has brought to light that the ESM machinery may be unavailable for some reasons: disagreement on conditionality, unsustainability of debt and insufficiency of resources. Additional resources may come from the OMT programme, but its operation is subject to some constraints, like the market access status of the requesting country. In this context, it is useful to investigate whether and to what extent financial assistance may be sought elsewhere. A first route may be for the Euro countries to establish a borrowing facility within the ESM, but this must take into account the borrowing limits of the ESM. A second route may be for Euro countries to establish a parallel mechanism outside the ESM that may overcome some requirements of the ESM assistance. A third route may be for non-Euro countries to establish a lending facility, provided that conditionality is respected. A fourth route may be for Euro and non-Euro countries alike to establish a facility in the case of withdrawal from the monetary union with the purpose of preserving the stability of the EU.

INTEREST RATE TARGETS AND SPECULATIVE ATTACKS ON PUBLIC DEBT

The application of exchange rate target zones modeling to interest rates allows interpreting the puzzles that emerged with the public debt euro area crisis, namely the nonlinear behavior of the interest rates and the fact that some stand-alone countries, not belonging to the euro area, have not been subject to speculative attacks in spite of equally large public debt-to-gross domestic product (GDP) ratios. As a matter of fact, this model shows that in the case of a noncredible upper threshold for the interest rate (that may be due to both the lack of room for increasing further the required government primary surplus and/or the absence of a monetary authority acting as a lender of last resort), the resulting public debt unsustainability determines an interest rate nonlinearity and makes the crisis possible for public debt levels that would be stable in the presence of a credible interest rate target.

Bayesian Modelling of Kenya Extreme Debt with Correction for Budgetary Leakage

Total public debt levels in Kenya are exponentially increasing due to rising budget deficit, poor public fund management as well as movement of various macro-economic indicators such as balance of payments, inflation, Gross Domestic Product, exchange rates, and grants leading to worries on whether or not the high debt levels would be sustainable in future. The major concern is that a huge portion of the country’s revenue is committed to debt repayment and budgetary leakage strains the repayment efforts, thereby accelerating the country's debt unsustainability. This study sought to model extreme debt in Kenya with correction for budgetary leakage using a Bayesian approach to Extreme Value Theory (EVT) the main aim being to estimate the maximum debt tolerable for the country. A non-stationary Generalized Pareto Distribution (GPD) model is used for modeling the public debt extremes which depend on some covariates (macro-economic indicators) and Bayesian methods used to directly estimate the threshold and the GPD parameters. A major contribution of this study is the introduction of a compensator to allow for possible leakage due budgetary leakage through corruption, tax evasion, money laundering, and other forms of financial fraud, modelling it as a function of budget deficit. The established debt threshold is approximately KShs. 2 trillion which is the standard amount that should be borrowed, beyond which values are considered extremes. The results indicate that the movements in the macro-economic debt indicators significantly affect total public debt levels, and that budgetary leakage reduces Kenya's debt tolerance. The research concluded that the current debt level of around KShs. 5 trillion is still sustainable but high budgetary leakage may accelerate the country's long-run debt unsustainability. For further work, it is recommended to use a time-varying threshold to capture seasonality of the public debt series.

The Growth of Debt and the Debt of Growth: Lessons from the Case of Argentina

Argentina's case is a ‘game changer’ in the discussion about sovereign debt across the globe, particularly regarding debt restructuring. This article reviews Argentina's sovereign debt and economic growth process over the last 25 years and draws lessons from the country's trajectory. Alternating austerity and heterodox economic policies resulted in different outcomes throughout this period. One lesson, in particular, stands out: sustainable debt has been a necessary condition for sustainable growth. Conversely, austerity policies combined with a lax approach toward debt have led to economic recession and debt unsustainability alike. Argentina's case underscores that the only way to overcome the debt‐recession trap is a timely and big‐enough debt restructuring that provides an economy with a fresh start. Neither austerity policies nor debt roll‐overs have done the job. That is why an orderly, predictable, fair, and balanced sovereign debt restructuring system is such a relevant – still pending – component of the international financial architecture.

Risk Management Optimization for Sovereign Debt Restructuring

Abstract Debt restructuring is one of the policy tools available for resolving sovereign debt crises and, while unorthodox, it is not uncommon. We propose a scenario analysis for debt sustainability and integrate it with scenario optimization for risk management in restructuring sovereign debt. The scenario dynamics of debt-to-GDP ratio are used to define a tail risk measure, termed conditional Debt-at-Risk. A multi-period stochastic programming model minimizes the expected cost of debt financing subject to risk limits. It provides an operational model to handle significant aspects of debt restructuring: it collects all debt issues in a common framework, and can include contingent claims, multiple currencies and step-up or linked contractual features. Alternative debt profiles – obtained by maturity rescheduling, interest payment concessions or nominal value haircuts – are analyzed for their expected cost-risk tradeoffs. With a suitable re-calculation of the efficient frontier, the risk of debt un-sustainability of alternative risk profiles can be ascertained with a given confidence level. The model is applied to Greece sovereign debt crisis analyzing the suitability of various proposals to restore debt sustainability.

Risk profiles for re-profiling the sovereign debt of crisis countries

Purpose– This paper aims to use a risk management approach for re-profiling of sovereign debt. It develops profiles that trade off expected cost of financing alternative debt structures against their risk. The risk profiles are particularly informative for countries facing sovereign debt crisis, as they allow us to identify, with high probability, debt unsustainability. Risk profiles for two eurozone countries with excessive debt, Cyprus and Italy, were developed. In addition, risk profiles were developed for a proposal to impose debt sanctions in the Ukrainian crisis and it was shown that the financial impact could be substantial.Design/methodology/approach– Using scenario analysis, a risk measure of the sovereign’s debt – Conditional Debt-at-Risk – was developed, and an optimization model was then used to trade off expected cost of debt financing against the Conditional Debt-at-Risk. The model is applied to three diverse settings from current crises.Findings– The methodology traces informative risk profiles to identify sustainable debt structures. Interesting, although tentative, conclusions are drawn for the countries where the methodology was applied. Cyprus’s debt sustainability hinges on current International Monetary Fund (IMF) projections about gross domestic product growth and small deviations can push debt into unsustainable territory. For Italy, our analysis provides evidence of debt unsustainability. Common assumption of debt by eurozone member states could restore sustainability for Italy. Finally, it is shown how a proposal to impose debt sanctions against Russia for the Ukrainian crisis could have significant financial impact for Ukraine.Research limitations/implications– Additional work is needed to calibrate the simulation models for each country separately. Nevertheless, the direction of the results is such that more careful calibration will most likely not alter the conclusions but make them stronger instead.Practical implications– The results provide significant insights for the management of sovereign debt for Cyprus and Italy. They also show the significant positive impact on Ukrainian public finances from debt sanctions. However, the most important practical implication is to show how the proposed methodology provided a decision support tool for restructuring and rescheduling sovereign debt for crisis countries.Social implications– There is widespread acceptance that debt restructuring has been too little and too late in recent crises failing to re-establish market access in a durable way. How to develop risk profiles for alternative debt structures has been illustrated. Debt profiles that are unsustainable can be identified, with high probability, and alternative structures proposed that restore sustainability. The methodology proposed in this paper is providing a useful tool of analysis. The topic of debt relief is currently debated widely at policy circles by the IMF and the United Nations, and the analysis of this paper provides some insightful input to the debate.Originality/value– The use of scenario analysis for sovereign debt modeling and the use of an optimization model developed by the authors in previous research provide empirical analysis for three current problems in sovereign debt management. Useful insights are obtained for three important real-world cases for Cyprus, Italy and Ukraine.

Risk Management Optimization for Sovereign Debt Restructuring

Debt restructuring is one of the policy tools available for resolving sovereign debt crises and, while unorthodox, it is not uncommon. We propose a scenario analysis for debt sustainability and integrate it with scenario optimization for risk management in restructuring sovereign debt. The scenario dynamics of debt-to-GDP ratio are used to define a tail risk measure, termed conditional Debt-at-Risk. A multi-period stochastic programming model minimizes the expected cost of debt financing subject to risk limits. It provides an operational model to handle significant aspects of debt restructuring: it collects all debt issues in a common framework, and can include contingent claims, multiple currencies and step-up or linked contractual features. Alternative debt profiles -- obtained by maturity rescheduling, interest payment concessions or nominal value haircuts -- are analyzed for their expected cost-risk tradeoffs. With a suitable re-calculation of the efficient frontier, the risk of debt unsustainability of alternative risk profiles can be ascertained with a given confidence level. The model is applied to Greece sovereign debt crisis analyzing the suitability of various proposals to restore debt sustainability.