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ASSESSING FISCAL SUSTAINABILITY: A NEW APPROACH Enrique G. Mendoza Pedro Marcelo Oviedo Comments by: Andres F. Arias Ministerio de Hacienda y Crédito Público.

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Presentation on theme: "ASSESSING FISCAL SUSTAINABILITY: A NEW APPROACH Enrique G. Mendoza Pedro Marcelo Oviedo Comments by: Andres F. Arias Ministerio de Hacienda y Crédito Público."— Presentation transcript:

1 ASSESSING FISCAL SUSTAINABILITY: A NEW APPROACH Enrique G. Mendoza Pedro Marcelo Oviedo Comments by: Andres F. Arias Ministerio de Hacienda y Crédito Público Republic of Colombia

2 Probabilistic Model = ability to repay in crisis state where b* = stock of debt that government is able to repay in all states of nature  “Credible repayment commitment”

3 Very nice approach because… 1.Also captures stock of debt that government is “willing” to repay if lender chooses r so that b* reflects a rationing debt level that enforces the government’s participation constraint (i.e. constraint under which the government always finds it preferable to repay and maintain credit relationship)

4 Very nice approach because… 2.Incorporates the role of volatility of fiscal variables in determining ability to repay. Long-run method  A & B share the same sustainable debt ratio. Probabilistic method  A has a higher sustainable debt ratio than B. B A t B min =0.10 t A min =0.18 t mean =0.2 t f(t)

5 But…  Defines a “maximum” debt level and not a “target” debt level (to be achieved through policy adjustment).  Maximum debt level is not equilibrium or optimal debt level.

6 Is this a tool for governments or for Wall Street?  As a government, I discuss “optimal” indebtedness and strategic behavior (i.e. repayment/default) under different scenarios (critical and non- critical).  For instance, it may be optimal to issue b>b* and repay/default under different states of nature.

7  If so (and if markets buy b>b*) why do I care about b*? I already did when I defined my optimal strategy.  Does this mean that my debt is not sustainable?

8  Should governments (or firms and households) do debt sustainability analysis based on their capacity to repay under the worst case scenario (i.e. the crisis state)?  Will they ever do it?  If so, does this mean that Argentina never thought about the logic behind the probabilistic model?

9 Besides… How can we operationalize the probabilistic model? 1.Bail-outs  g min ? 2.Sudden stops/TOT shocks/Balance sheet effects  r, , g min ? 3.Inflation tax  t min ?

10 Colombia… The coefficient of variation in revenue is 7.3%, while expenditure cuts cannot exceed 5% of GDP because of budgetary inflexibilities (investment is the only item freely adjustable, 5% of GDP=60% of public investment)

11 Colombia… r = 6%  = 3.7% b* = -0.4% of GDP Does this mean that Colombia’s debt is (or is not) sustainable? of GDP 2002 (net of interests)

12 Colombia… In any case from the point of view of a sovereign debt issuer, the probabilistic model is very useful in suggesting that volatility of fiscal variables must be taken into consideration. This can be done with a series of tools…

13 Debt projections and sensibilities… Base Scenario Colombian medium-term debt path

14 This base projection may change… Due to shocks in variables such as r, , E, fiscal expenditure and contingencies.

15 Debt projections and sensibilities… Base Scenario Historical averages (96-02) for t>=2004 % GDP 1

16 Debt projections and sensibilities… Base Scenario 2 std dev shock in 2004 to % GDP 2

17 Debt projections and sensibilities… Base Scenario 2 std dev shock in 2004 to % GDP 3

18 Debt projections and sensibilities… Base Scenario 2 std dev shock in 2004 to (t-g) % GDP 4

19 Debt projections and sensibilities… Base Scenario 1 std dev shock in 2004 and 2005 to r,  and (t-g) % GDP 5

20 Debt projections and sensibilities… Base Scenario 30% devaluation in 2004 % GDP 6

21 Debt projections and sensibilities… Base Scenario Increase of 10 points in debt stock % GDP 7

22 Statistical significance of sensibilities… Sensibilities may be evaluated with p-values Year Base scenarioWorse scenario DebtP-valueDebtP-value Exercise

23 Financing needs… Interno 2.0%-0.9%-0.3%0.3%1.0%1.3%1.0%1.5% Externo 1.5%1.8%1.5%1.0%0.6%0.3%0.7%0.2% Total 3.5%1.0%1.2%1.3%1.6% 1.7% Source: Public Credit-MHCP Net Financing % GDP The NFPS deficit is financed through internal and external indebtedness

24 Future external indebtedness % NFPS 5.5%2.7%0.8%1.3%2.2%1.7% Source: IMF, Central Bank. Calculations DGPM. % of net capital inflows to developing countries absorbed by Colombia…

25 % GDP Consistent with financing strategy Source: Banco de la República- DGCP- Calculations DGPM Future internal indebtedness From forecast of real sector’s portfolio demand and with assumptions about M3 growth, I can deduce private sector’s demand for domestic government debt (TES) No signs of crowding out

26  Manasse, Roubini and Schimmelpfennig (2003)  Binary recursive tree analysis (sequence of rules) to determine if country is prone to fiscal crisis Default probability

27 1.¿Does total external debt exceed 50% of GDP?  NO (48,6%) 2.¿Is short-term external debt to reserves ratio greater than 1.34?  NO (0,98) In Colombia…

28 3.¿Is the public external debt to revenue ratio greater than 2.15?  NO (1) 4.¿Is the economy growth rate greater than -5.45?  YES (3.13)  Colombia is not crisis-prone (probability = 2.3%) In Colombia…

29 ASSESSING FISCAL SUSTAINABILITY: A NEW APPROACH Enrique G. Mendoza Pedro Marcelo Oviedo Comments by: Andres F. Arias Ministerio de Hacienda y Crédito Público Republic of Colombia


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