Is declining public debt ratio a reason for complacency?

Transcription

1 Is declining public debt ratio a reason for complacency? Arief Ramayandi Asian Development Bank June 2013 A. Ramayandi (ADB) June / 20

2 Trend in public debt ratio: Indonesia Debt has been declining sharply since 2000 The trend has slowed somewhat lately, but is expected to continue Can we a ord to be complacent? A. Ramayandi (ADB) June / 20

3 Is it a reason to be complacent? Debt sustainability and scal risks Baseline scenario is based on what is known Assessment of the quantitative impact of scal risk (known unknowns) Alternative scenarios di erentiated by risk Uncertainties (unknown unknowns) Debt sustainability Growth, interest rate & other macro variables Central government nances Local government nances Contingencies NPLs/Banks vulnerability SOEs Fuel subsidies Other guarantees (explict/implicit) A. Ramayandi (ADB) June / 20

4 On contigencies and hidden liabilities... I don t have analysis on Indonesia, but the case of PRC may shed some lights Government debt, including hidden liabilities, could reach RMB 39.8 trillion or 96% of GDP in The worst case is a pretty large-scale nancial crisis around The slowdown would last at least two years and maybe longer. (Professor Victor Shih, Northwestern University, Reported by Bloomberg on March 3, 2010) A. Ramayandi (ADB) June / 20

5 What should be counted as government debt? The case for including all hidden liabilities as part of debt is not strong Total gross debt consists of all liabilities that are debt instruments. A debt instrument is de ned as a nancial claim that requires payment(s) of interest and/or principal by the debtor to the creditor at a date, or dates, in the future (Public Sector Debt Statistics, 2011, p3). The case for including LIC debt in particular as part of debt is compelling Special purpose entities undertaking scal and/or quasi- scal activities and not bearing the risk associated with (their) assets and liabilities are part of general government (Public Sector Debt Statistics, 2011, p16). As is the case for including liabilities of the Ministry of Railways General government entities with individual budgets not covered by the general budget are considered extra-budgetary (Public Sector Debt Statistics, 2011, p.10). Extra-budgetary entities are part of general government. Other hidden liabilities should be thought of as contingent liabilities that are a source of scal risk. The operations to which they relate may or may not have future scal implications. Fiscal policy should be designed and implemented taking scal risk into account. A. Ramayandi (ADB) June / 20

6 On macro-risks... A. Ramayandi (ADB) June / 20

7 Under the baseline, negative IRGD as the main driver for declining debt ratio A. Ramayandi (ADB) June / 20

8 Issues A negative IRGD is not a stable condition and is inconsistent with what required to securing stable long-run equilibrium The "modi ed golden rule" (Blanchard and Fischer, ) postulates that IRGD should turned positive for an economy close to steady state. No ground for complacency as IRGD may turn positive and reverse the trend in public debt ratio. Case of Spain: 1 Blanchard, O., and Fischer, S. (1989), Lectures on Macroeconomics, Cambridge, MA: MIT Press. A. Ramayandi (ADB) June / 20

9 How does IRGD a ects public debt dynamics? Not much analytical explanation found in the literature To provide insights, I exploit: The standard debt dynamic equation based on the government s intertemporal budget constraint. Basic scal reaction function (Bohn, ), which often used for testing the bahavior of scal management A reduced form equation explaining the behavior of IRGD 2 Bohn, H. (1998), The Behavior of US Public Debt and De cits, Quarterly Journal of Economics, 113(3): A. Ramayandi (ADB) June / 20

10 Dynamics of public debt ratio Consider a stylized economy where the debt dynamics is governed by the following simple equation: ḋ (t) = θ (t) d (t 1) s (t) ; where θ (t) = r (t) g (t) 1 g (t) d = public debt ratio, r = interest rate, g = rate of GDP growth, s = primary budget surplus Given the simpli ed speci cation, acceleration/deceleration of public debt ratio can be expressed as: d (t) = d (t 1) 1 g (t) θ ġ (t) d (t 1) (t) + [1 g (t)] 2 θ (t) ṡ (t) A. Ramayandi (ADB) June / 20

11 The behavior of IRGD The level of interest-growth di erential is governed by many di erent factors that a ect the overall state of the aggregate economy, covering both internal and external aspects of development in the nancial and the real sectors Of particular interest here, IRGD is a ected by scal policy (s) which I separate out from the set of all other a ecting factors (Z) for simplicity: θ (t) = f [s (t), Z (t)] The e ect of s on θ is not straightforward: Higher primary de cits, for example, tend to push interest rate higher as more funding is required to nance the expenditures and hence increasing r Higher expenditures, however, can act as a factor that improves growth (by enhancing aggregate demand) and hampers growth (by crowding out the private sector) at a same time A. Ramayandi (ADB) June / 20

12 The behavior of IRGD The interest rate e ect seems to dominate empirically. See for example: Feldstein and Eckstein (1970) 3, Escolano, et. al (2011) 4 Assuming that the interest rate e ect dominates, f s primary surplus led to a drop in θ : θ (t) = f f _ ṡ (t) + Z (t) s Z < 0; higher 3 Feldsein, M. and O. Eckstein (1970), The Fundamental Determinants of the Interest Rates, The Review of Economics and Statistics, 52(4): Escolano, J., A. Shabunina, and J. Woo (2011), The Puzzle of Persistently Negative Interest Rate Growth Di erentials; Financial Repression or Income Catch Up? IMF Working Paper, WP/11/260, Washington, DC: IMF. A. Ramayandi (ADB) June / 20

13 Fiscal reaction function Movements in scal policy are not entirely exogenous as primary balance dynamics are often governed by a scal policy rule: s (t) = ρd (t) + µ (t) Bohn (1998) 5 demonstrates that 0 < ρ < 1 is su cient for scal sustainability Ferrarini and Ramayandi (2012) 6 suggests that the condition holds on average in Developing Asia Changes in primary budget surplus can then be expressed as follows ṡ (t) = ρḋ (t) + µ (t) 5 Bohn, H. (1998), The Behavior of US Public Debt and De cits, Quarterly Journal of Economics, 113(3): Ferrarini, B. and A. Ramayandi (2012) Public Debt Sustainability Assessments for Developing Asia, in B. Ferrarini, R. Jha and A. Ramayandi (eds), Public Debt Sustainability in Developing Asia, Routledge. A. Ramayandi (ADB) June / 20

14 System dynamics governing changes in debt ratio and IRGD d (t) θ (t) = " h d (t 1) + f ġ (t)d (t 1) 1 g (t) s 1 ρ [1 g (t)] 2 f s " ρ 0 d (t 1) f d (t 1) f 1 g (t) Z 1 g (t) s 1 f Z h i d (t 1) f 1 g (t) s 1 ρ < 0, if ρ > 0; or > 0, if ρ < 0 f s ρ < 0, if ρ > 0; or > 0, if ρ < 0 i f s # ḋ (t) θ (t) # _ Z (t) µ (t) ġ (t)d (t 1) [1 g (t)] 2 < 0, if ġ < 0; or > 0, if ġ > 0; or = 0, if ġ = 0 A. Ramayandi (ADB) June / 20

15 Assessing the system s stability Let A = " h d (t 1) f 1 g (t) s 1 Three interesting cases emerges: i ρ ġ (t)d (t 1) [1 g (t)] 2 f s ρ 0 1 The system is globally stable if ρ > 0, ġ > 0 as the roots are negative 2 Saddle point stability if: 1 ρ > 0, ġ < 0, or 2 ρ < 0, ġ > 0 as the roots have opposite signs for both cases # A. Ramayandi (ADB) June / 20

16 Phase diagrams A. Ramayandi (ADB) June / 20

17 Paths for public debt ratio under case 1 A. Ramayandi (ADB) June / 20

18 Concluding remarks Declining trend in public debt ratio that is driven by negative IRGD provides no room for complacency as the IRGD may reverse due to many di erent factors A negative interest-growth di erential is not a stable condition and is inconsistent with what required to securing a stable long-run equilibrium of an economy It leads to a low-and-stable debt equilibrium under a debt-stabilizing-consistent scal management, given that growth is accelerating However, it could also be destabilizing if growth is decelerating or if the scal sector is managed otherwise The analytical framework presented here provides some useful features for understanding di erent cases of public debt related issues A. Ramayandi (ADB) June / 20

19 Concluding remarks Contingent liabilities are sources of scal risk and scal policy should be designed and implemented by appropriately taking this risk into account To guarantee sustainable public debt ratio, scal should be managed in a "Bohn s sustainable" manner while maintaining growth momentum A. Ramayandi (ADB) June / 20

20 Thank you A. Ramayandi (ADB) June / 20