ANALYZING THE RELATIONSHIP BETWEEN PUBLIC AND EXTERNAL DEBT SUSTAINABILITY: CASE STUDY ROMANIA

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1 ANALYZING THE RELATIONSHIP BETWEEN PUBLIC AND EXTERNAL DEBT SUSTAINABILITY: CASE STUDY ROMANIA Campeanu Emilia Academy of Economic Sudies Buchares, Faculy of Finance, Insurance, Banking, and Sock Exchanges, Pia a Roman, No. 6, Room 4, Buchares, Romania, Zip Code 374, emilia.campeanu@fin.ase.ro, Miricescu Emilian Academy of Economic Sudies Buchares, Faculy of Finance, Insurance, Banking, and Sock Exchanges, Pia a Roman, No. 6, Room 4, Buchares, Romania, Zip Code 374, miriemil@yahoo.com, Absrac: The exernal vulnerabiliy became an imporan issue as a resul of recen financial crises. The debaes focused on he exernal and public deb susainabiliy in order o idenify he relaionship beween hese wo variables in order o invesigae he degree of vulnerabiliy of a counry from he poin of view of is inernaional financial posiion and inernal sabiliy. So, he recen increase of exernal deb in Romania conduc o he necessiy o analyze he deb susainabiliy for he exernal posiion and for he domesic deb. The aim of his paper is o invesigae he relaionship beween public and exernal deb susainabiliy in Romania. Using monhly daa from 992 o 27 we find evidence for weak form of Romanian deb susainabiliy. Key words: public deb, exernal deb, susainabiliy.. Inroducion The exernal vulnerabiliy became an imporan issue as a resul of recen financial crises. The debaes focused on he exernal and public deb susainabiliy in order o idenify he relaionship beween hese wo variables and o invesigae he degree of vulnerabiliy of a counry from he poin of view of is inernaional financial posiion and inernal sabiliy. So, exernal deb is susainable if a counry is expeced o mee is curren and fuure exernal debservice obligaions in full, wihou recourse o deb relief, rescheduling of debs, or he accumulaion of arrears, and wihou unduly compromising growh 4. This definiion reveals he complexiy of his concep which is analyzed using differen variables and echniques in order o ensure long erm deb susainabiliy wihou affecing he counry s capaciy o service exernal deb on long run. These variables ha are aken ino he consideraion are economic growh, expor, impor and fiscal revenue. So, considering he relevance of exernal deb susainabiliy in relaion wih public deb susainabiliy, we find useful he invesigaion of his issue for Romanian case. The sudy is srucured as follow. Afer a brief presenaion of he Romanian public and exernal deb (Secion II) we invesigae he lieraure on deb susainabiliy (Secion III). Secion IV highlighs he resuls of he empirical ess o analyze he relaionship beween Romanian public and exernal deb susainabiliy. Secion V discusses he policy implicaions of hese findings. 2. Romanian exernal and public deb Exernal deb is he resul of he counry financial liabiliies ha is owed o crediors ouside he counry. In Romania, exernal deb has an increasing rend over he period as a resul o exernal indebedness of public auhoriies and privae eniies. Bu public exernal deb has a decreasing rend saring wih 24, when he raio of public deb o exernal deb became less hen 5 percen. This raio varies beween 94.9 percen in Ocober 992 and 3 percen in December 27, and shows he exernal vulnerabiliy caused by privae debors (figure ). 4 IMF, 997, pp

2 Jan92 Jun92 Nov92 Apr93 Sep93 Feb94 Jul94 Dec94 May95 Oc95 Mar96 Aug96 Jan97 Jun97 Nov97 Apr98 Sep98 Feb99 Jul99 Dec99 May Oc Mar Aug 2Jan 2Jun 2Nov 3Apr 3Sep 4Feb 4Jul 4Dec 5May 5Oc 6Mar 6Aug 7Jan 7Jun 7Nov DE mil RON dpe/ de Source: daa are from Naional Bank of Romania. Figure Exernal deb and exernal public deb, Review of seleced lieraure Susainabiliy of exernal deb is based on he ineremporal budge consrain which expresses aggregae income of he economy as a funcion of oal expendiure, as follows: Y B + TR = A + rb + N ( i ) N ] or TB B + TR = rb + N ( i ) N ] ( 42 ) + [ + + [ + where: Y GDP during period; B change of gross exernal deb; TR ne ransfer receips; Aoal expendiure of domesic residens on goods and services; r nominal ineres rae; N foreign currency reserves of cenral bank; i ineres rae in hese reserves; TB rade balance. These variables can be expressed as raio of GDP or in real erm. If i is considered he expecaion operaor, he ineremporal budge ideniy became: S j B = E (2 43 ) j j= + = ( + r + i ) So, he exernal deb a ime is equal o he presen value of fuure ne surpluses which is equivalen wih BN exernal deb susainabiliy if: E lim = (3 44 ) N N j= ( + r + j ) Invesigaion of exernal deb susainabiliy may also ake ino he consideraion: (i) curren accoun susainabiliy focused on he composiion of CA and on he mehods used o finance he CA defici hrough foreign direc invesmens or oher. In his conex i is useful he ne exernal posiion (NEP) of a counry (Lane and Milesi Ferrei, 25); (ii) domesic public deb underlined how i undermines he susainabiliy arge for exernal deb (Abbas, 25). Presbiero and Arnone (26) analyze he exernal susainabiliy using domesic public deb because i became an imporan par of he indebedness level and ineres raes 42 Gülcan and Uku, 26, pp Gülcan and Uku, 26, pp Gülcan and Uku, 26, pp

3 on domesic deb consrained he governmen spending and invesmen; (iii) economic growh (Bhaacharya, Clemens, 24; Presbiero, 25); (iv) fiscal deficis and economy (such as consumpion, invesmen) (Agenor, 24). Exernal deb susainabiliy and i s incidence on oher variables are invesigaed using differen echniques and variables. The procedures are: (i) uni roo es for exernal deb and rade balance or curren accoun; (ii) coinegraion regressions among exernal deb and rade balance or curren accoun, or expors, impors, GDP, and ineres raes (Hamilon, Flavin, 986; Sawada, 994); (iii) reacion funcion for exernal deb expressed by oher explanaory variables. Uni roo and coinegraion ess are useful o analyze he implicaion of he ineremporal consrain on long run in order o idenify if a governmen can susain is domesic and exernal deficis wihou major adjusmens imposed by ineremporal budge ideniy. Such empirical invesigaion begin wih he sudy of Hamilon and Flavin (986), and exended by Wilcox (989), Trahan and Walsh (99), Hakkio and Rush (99), Buier and Pael (992), Tanner and Liu (994), Liu and Tanner (995), Tanner (995), Wu (998). As a resul of he empirical sudies, invesigaion of exernal deb susainabiliy can be done by using accouning approach (Cuddingon, 997; Agenor, 24; Burnside, 25) and presen value consrain approach. According o his las mehod he deb is susainable when NPV of deb (public and publicly guaraneed) o expors raio and he deb service o expor raio are below cerain counry specific arge levels wihin ranges of 225 percen and 225 percen respecively 45. These sandard levels for differen deb raio are: (i) public exernal deb is 5 percen of GDP, 2 percen of expors and 25 percen of consolidaed general budge revenue; (ii) public exernal deb service is 2 percen of expors, 25 percen of consolidaed general budge revenue; (iii) ineres on public exernal deb is percen of expors and 5 percen of consolidaed general budge revenue. 4. Relaionship beween public and exernal deb susainabiliy: evidence for Romania In order o invesigae he relaionship beween public and exernal deb susainabiliy in Romania we use uni roo, coinegraion and OLS regression for exernal deb and public exernal deb. The variables used are exernal deb (ED), public exernal deb (PED), expor (EX), impor (IM), rade defici (TB) and curren accoun defici (CA) from January 992 o December 27. Uni roo ess show ha hese variables are I() according o PhillipsPerron (able ). As a resul we may say ha susainabiliy of exernal deb and exernal public deb is weak as a resul of he equilibrium relaionship on long run beween exernal deb or public exernal deb and rade or curren accoun defici over he enire sample. ariable Saisic % level Tes criical values 5 % level % level PhillipsPerron (PED) (ED) (EX) (IM) (TB) (CA) Table Resuls of uni roo ess 45 IMF, 997, pp

4 The resuls of our ess are: (i) exernal deb deermines impor and expor bu here is a weak relaionship beween hem; (ii) public exernal deb causes impor and expor and i is influenced by expor. So, he regressions resuls are: ED PED = ED.3557EX IM ε, wih Rsquared = = PED.24882EX IM ς, wih Rsquared =9824 Invesigaion of public exernal deb and exernal deb using he sandard level recommended by World Bank and Inernaional Moneary Fund shows ha Romanian public exernal deb is susainable because hese raios are below arges. For example we presen hese resuls, for 2526, in able Sandard level Public exernal deb (% of GDP) Public exernal deb service (% of GDP) Public exernal deb (% of expor) Public exernal deb service (% of expor) Ineres of public exernal deb (% of expor) 2 Public exernal deb (% of consolidaed general budge revenue) Public exernal deb service (% of consolidaed general budge revenue) Ineres of public exernal deb (% of consolidaed general budge revenue) Source: Romanian Minisry of Economy and Finance Table 2 Public exernal deb indicaors Anoher way o invesigae deb susainabiliy is o use he IMF mehodology using sensiiviy ess for differen macroeconomic perspecive such as economic growh, GDP deflaor, real ineres rae on public deb, primary defici and gross financing need. The resuls of hese invesigaions for auomaic deb dynamics 46 are presened in figure 2 and Relaions and daa are from IMF, Romanian Counry Repor No. 4/22 and No. 7/29. Auomaic public deb dynamics is deerminae using equaion [(rp(+g)g+ae(+r)]/(+g+p+gp)) imes previous period deb raio, wih r = ineres rae; p = growh rae of GDP deflaor; g = real GDP growh rae; a = share of foreigncurrency denominaed deb; and e = nominal exchange rae depreciaion (measured by increase in local currency value of U.S. dollar). Auomaic exernal deb dynamics is derived as [rg r(+g)+ea(+r)]/(+g+r+gr) imes previous period deb sock, wih r = nominal effecive ineres rae on exernal deb; r = change in domesic GDP deflaor in US dollar erms, g = real GDP growh, e = nominal appreciaion (increase in dollar value of domesic currency), and a = share of domesiccurrency denominaed deb in oal exernal deb. 5

5 conribuion from real ineres rae conribuion from exchange rae depreciaion conribuion from real GDP grow h Figure 2 Auomaic public deb dynamics conribuion from nominal ineres rae conribuion from price and exchange rae changes conribuion from real GDP grow h Figure 3Auomaic exernal deb dynamics Auomaic public deb dynamics had posiive value in 999 and 2 as a resul of he conribuion from exchange rae depreciaion, and negaive for 222. These negaive value express al so he decreasing pah of public deb a.6 percen of GDP in 22 according o he IMF projecions. For exernal deb, he auomaic dynamics is negaive for he enire sample especially as he resul of price and exchange rae changes which will conduc o a level of exernal deb of 32.3 percen of GDP in Conclusions The exernal vulnerabiliy became an imporan issue as a resul of recen financial crises. The debaes focused on he exernal and public deb susainabiliy in order o idenify he relaionship beween hese wo variables in order o invesigae he degree of vulnerabiliy of a counry from he poin of view of is inernaional financial posiion and inernal sabiliy. So, he recen increase of exernal deb in Romania conduc o he necessiy o invesigae he deb susainabiliy for he exernal posiion and for he domesic deb. In heoreical and empirical sudies on his issue are developed many echniques in order o analyze he deb susainabiliy regarding he exisence and he ype of susainabiliy, and he incidence of economic variables on deb susainabiliy. These variables can be used o influence he dynamics of public and exernal deb in order o ensure he ineremporal budge consrain. Saring wih hese mehods we find ha Romanian deb susainabiliy is weak and here are evidences for long erm equilibrium beween deb and curren accoun. 52

6 References. Abbas, S. M. Ali, Public deb susainabiliy and growh in SubSaharan Africa (poshipc): The role of domesic deb, GDN Projec on Macroeconomics of Low Income Counries, February Agenor, PierreRichard, The Economics of Adjusmen and Growh, Harvard Universiy Press, Cambridge, Bhaacharya, Rina; Clemens, Benedic, Calculaing he Benefis of Deb Relief, Finance & Developmen, December 24, pp Buier, W.H.; Pael, U.R., Deb, Deficis, and Inflaion: an Applicaion o he Public Finances of India, Journal of Public Economics 47, 992, pp Burnside, Craig, Fiscal Susainabiliy in Theory and Pracice: A Handbook, Washingon, DC: The World Bank Publicaions, Cuddingon, John T., Analysing he Susainabiliy of Fiscal Deficis in Developing Counries, Working Paper No. 97, 997, Georgeown Universiy, Economic Deparmen 7. Gülcan, Önel; Uku, Ukulu, Modeling he LongRun Susainabiliy of Turkish Exernal Deb wih Srucural Changes, Economic Modelling 23, 26, pp Hakkio, C.S.; Rush, M., Is he Budge Defici oo Large?, Economic Inquiry 29, 99, pp Hamilon, J.D; Flavin, M.A., On he Limiaions of Governmen Borrowing: a Framework for Empirical Tesing, American Economic Review 76 (4), 986, pp Inernaional Moneary Fund, Deb Relief for Low Income Counries and he HIPC Iniiaive, WP/97/24, 997. Inernaional Moneary Fund, The Enhanced HIPC Iniiaive and he Achievemen of Long Term Exernal Deb Susainabiliy, prepared by he Saffs of he World Bank and he Inernaional Moneary Fund, April Inernaional Moneary Fund, Romanian Counry Repor No. 4/22, Inernaional Moneary Fund, Romanian Counry Repor No. 7/29, Lane, Philip; MilesiFerrei, Gian Maria, A Global Perspecive on Exernal Posiions, IMF Working Paper 5/6, Liu, P.; Tanner, E., Ineremporal Solvency and Breaks in he U.S. defici process: a Maximum Likelihood Coinegraion Approach, Applied Economics Leers 2, 995, pp Presbiero, Andrea F., The Deb Growh Nexus: a Dynamic Panel Daa Esimaion, Deparmen of Economics Working Paper No. 243, Presbiero, Andrea F.; Arnone, Marco, Exernal deb susainabiliy and domesic deb in Heavily Indebed Poor Counries, MPRA Working Papers No. 396, May Sawada, Y., Are he Heavily Indebed Counries Solven?: Tess of Ineremporal Borrowing Consrains, Journal of Developmen Economics 45, 994, pp Tanner, E., Ineremporal Solvency and Indexed Deb: Evidence from Brazil, 97699, Journal of Inernaional Money and Finance 4 (4), 995, pp Tanner, E; Liu, P., Is he Budge Defici oo Large : Some Furher Evidence, Economic Inquiry 32, pp Treahan, B,; Walsh, C.E, Tesing Ineremporal Budge Consrains: Theory and Applicaions o U.S. Federal Budge and Curren Accoun Deficis, Journal of Money, Credi and Banking 23 (2), 99, pp Wilcox, D.W., The Susainabiliy of Governmen Deficis: Implicaions of Presen Value Borrowing Consrain, Journal of Money, Credi and Banking 2 (3), 989, pp Wu, J.L., Are Budge Deficis oo Large? Evidence from Taiwan, Journal of Asian Economics 9 (3), 998, pp