Debt Burden and Fiscal Sustainability in the Caribbean Region

Debt Burden and Fiscal Sustainability in the Caribbean Region (24/02/2014) Pág. 1

1.- Introduction The main objective of the paper is to examine the issue of debt burden and fiscal sustainability in the Caribbean Region Together with government expenditures and taxes, public debt is an important fiscal policy tool. Tax Smoothing Golden Rule Pág. 2

1.- Introducción Although debt can be used as a tool to improve macroeconomic performance and promote walfare, excessive debt accumulation can lead to a fiscally unsustainable situation, with severe negative effects on: Macroeconomic Stability Economic Growth Pág. 3

1.- Introducción Reinhart and Rogoff (2009, 2011) document historical episodes of excessive debt accumulation for a large sample of countries Surges in public debt Wars Financial Crises Gradual debt buildups Tendency to Overspend Fiscal Illusion Pág. 4

2.-Debt Burden Indicators Gross Public Debt To GDP Ratio 1999-2011 Fourteen Countries IMF-WEO External Debt Indicators 1999-2011 Eight Countries WB-IDS Pág. 5

2.-Debt Burden Indicators Caribbean Countries. Classification According to Per capita Income (World Bank) and Main Economic Activity Country Income Classification (WB) Main Economic Activity Antigua and Barbuda Upper-middle ($4,036-$12,475) Tourism The Bahamas High (< $12,476) Tourism Barbados High (< $12,476) Tourism Belize Lower-middle ($1,026-$4,035) Tourism Dominica Grenada Guyana Upper-middle ($4,036-$12,475) Upper-middle ($4,036-$12,475) Lower-middle ($1,026-$4,035 Low (> $1,025) Tourism Tourism Commodity exporting Haiti Jamaica Upper-middle ($4,036-$12,475) Tourism St. Kitts and Nevis St. Lucia St. Vincent and the Grenadines Suriname Trinidad and Tobago Upper-middle ($4,036-$12,475) Upper-middle ($4,036-$12,475) Upper-middle ($4,036-$12,475) Upper-middle ($4,036-$12,475) High (< $12,476) Tourism Tourism Tourism Commodity exporting Commodity exporting Pág. 6

2.-Debt Burden Indicators Debt burden indicators try to capture the ability to pay. Critical debt levels are likely to vary from country to country, as well as over time (Chuhan, 2005) In principle, a thorough analysis of the debt burden issue must combine these indicators with an economic evaluation of each country. Reinhart and Rogoff (2009, 2011) propose an alternative approach based on the impact of debt on growth. They devide the data for the debt to GDP ratio in four intervals: 0 to 30%; 30 to 60%; 60 to 90%; over 90% Pág. 7

2.-Debt Burden Indicators Rogoff and Reinhart (2011) Thresholds For debt/gdp ratios above 90 percent, average growth falls considerably In emerging economies when external debt reaches 60%, average growth falls considerably Pág. 8

2.-Debt Burden Indicators Mendoza and Ostry (2007) Threshold Countries should avoid public debt ratios above the 50-60% range, as the ability of policy makers to maintain fiscal solvency through primary balances above this range appears to wane Pág. 9

2.-Debt Burden Indicators Based on Reinhart-Rogoff (2011), and Mendoza-Ostry (2007), we propose the following thresholds 0-30% 60-90% High Debt 30-60% 90% Plus Very High Debt Pág. 10

2.-Debt Burden Indicators a) Public Debt to GDP Gross Debt/GDP Caribbean Vs LAC (%) 90.00 80.00 70.00 60.00 50.00 Caribbean Avg. 72.32% LAC Avg. 51.77% In 2011 six countries had ratios between 60 and 90%; four countries were in the 90% plus range 40.00 30.00 20.00 10.00 0.00 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Caribbean LAC Pág. 11

2.-Debt Burden Indicators b) Total External Debt to GDP 80.00 70.00 60.00 External Debt Stocks % of GDP Caribbean Vs LAC Caribbean Avg. 61.07% LAC Avg.30.62% In 2011 three countries had ratios between 60 and 90%; one country was in the 90% plus range 50.00 40.00 30.00 20.00 10.00 0.00 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Caribbean LAC Pág. 12

2.-Debt Burden Indicators c) Total External Debt to Export of Goods and Services and Primary Income 250.00 200.00 150.00 External Debt Stocks % of Exports of Goods, Services and Primary Income Caribbean Vs LAC Caribbean Avg. 165.24% LAC Avg.136.85% Seven countries have average ratios above 100%; two countries show average ratios that exceed 200% 100.00 50.00 0.00 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Caribbean LAC Pág. 13

2.-Debt Burden Indicators d) External Debt Short-Term to Total Debt 18.00 16.00 14.00 12.00 10.00 External Debt Short-Term to Total Debt (%) Caribbean Vs LAC With the exception of St. Lucia and Guyana, excessive accumulation of short-term debt does not seem to be a serious problem 8.00 6.00 4.00 Caribbean Avg. 12.65% LAC Avg.14.63% 2.00 0.00 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Caribbean LAC Pág. 14

2.-Debt Burden Indicators e) Concessional Debt to Total Debt 60.00 50.00 40.00 30.00 20.00 External Debt Concessional to Total Debt (%) Caribbean Vs LAC Caribbean Avg. 45.09% LAC Avg.4.03% The strong participation of concessional debt on total external debt is a crucial element to understand how the Caribbean economies have been able to manage a high level of debt for a prolonged time. 10.00 0.00 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Caribbean LAC Pág. 15

2.-Debt Burden Indicators f) Total Debt Service to Export of Goods and Services and Primary Income 45.00 40.00 35.00 30.00 25.00 20.00 15.00 Total External Debt Service to Exports of Goods, Services and Primary Income (%) Caribbean Vs LAC Despite the important weight of concessional debt, the high debt to GDP ratio of the Caribbean generates a debt service burden similar to the observed in LAC since 2007 10.00 5.00 0.00 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Caribbean LAC Pág. 16

3.-Impact of Public Debt on Fiscal Variables a) Global Fiscal Balance Debt/GDP ratio average (%) 0-30 Average Global Fiscal Balance 1999-2011 (%) -1.57 30-60 -2.39 60-90 -3.29 90 Plus -6.31 Pág. 17

3.-Impact of Public Debt on Fiscal Variables b) Interest Payments Burden on Government Revenues and Expenditures Debt/GDP Ratio average (%) Average Interest/Revenues (%) Average Interest/Expenditures (%) 0 30 5.30 5.08 30-60 10.30 9.43 60 90 7.45 6.60 90 Plus 24.49 19.49 Pág. 18

3.- Impact of Public Debt on Fiscal Variables The impact of debt on fiscal variables increases substantially for countries with debt-gdp ratios above 90%. Following a simple rule suggested in Agénor (2000), however, not even the most indebted countries in the Caribbean fall in the high interest payments range (above 50%). This result may be related to the important participation of concessional external debt. Pág. 19

4.- The Relationship between Debt and Growth The empirical literature points to a non-linear relationship between government debt an economic growth: the relationship between government debt and real GDP growth is weak for debt/gdp ratios below a threshold of 90 percent of GDP. Above 90 percent, median growth rates fall by one percent, and average growth falls considerably more (Reinhart and Rogoff, 2011). Pág. 20

4.- The Relationship between Debt and Growth a) Total Public Debt and Growth Caribbean Countries Public Debt to GDP Ratio and per capita GDP Growth 6.00 0-30 5.00 60-90 Per capita GDP Growth 4.00 3.00 2.00 30-60 90 plus 1.00 0.00 0-30 30-60 60-90 90 plus GDP per capita 5.37 4.14 4.70 3.11 Debt/GDP ratio Pág. 21

4.- The Relationship between Debt and Growth a) Total Public Debt and Growth In the data for the Caribbean we do not perceive abrupt changes that indicates nonlinearity Therefore, we estimated a simple econometric linear panel data model that relates the growth rate of GDP per capita as the dependent variable, with the public debt/gdp ratio and a time trend variable. The coefficient of the debt to GDP ratio variable is negative, and statistically significant at standards levels. This result should be interpreted with caution due to the simplicity of the model. Pág. 22

4.- The Relationship between Debt and Growth Public Debt and Growth Dependent variable: growth rate GDP per capita Coef. Sta. Dev. t-statistic p-value const 8,00143 1,22369 6,5388 <0,00001 *** Public Debt/GDP (b) -0,031708 0,0167113-1,8974 0,05970 * time -0,246551 0,0950937-2,5927 0,01046 ** Number of obs. 165 Pág. 23

4.- The Relationship between Debt and Growth Public Debt and Growth Dependent variable: growth rate GDP per capita Coef. Sta. Dev. t-statistic p-value const 4.25537 1.92234 2.214 0.0285 ** Public Debt/GDP (b) -0,0300493 0.0165512-1.816 0.0716 * Investment/GDP 0.15523 0.0667602 2.325 0.0215 ** time -0.290032 0.100173-2.895 0.0044 *** Number of obs. 152 Pág. 24

4.- The Relationship between Debt and Growth b) Total External Debt and Growth Caribbean Countries External Debt to GDP Ratio and per capita GDP Growth(%) 6.00 5.00 4.00 Per capita GDP growthh 3.00 2.00 1.00 0.00 0-30 30-60 60-90 90 plus GDP per capita 4.54 3.98 4.98 Debt/GDP ratio Pág. 25

4.- The Relationship between Debt and Growth b) Total External Debt and Growth The graph indicate a weak relationship between external debt and growth. This result is confirmed by a simple linear panel data model that relates the growth rate of GDP per capita as the dependent variable, with the external debt/gdp ratio and a time trend variable. However, this result should be taken with caution given the simplicity of the econometric model, in addition to the reduced size of the sample used in the estimation. Pág. 26

4.- The Relationship between Debt and Growth External Debt and Growth Dependent variable: growth rate GDP per capita Coef. Sta. Dev t-statistic p-value const 7,85954 2,1079 3,7286 0,00035 *** External debt/gdp (be) -0,0310926 0,0260305-1,1945 0,23574 time -0,219831 0,119-1,8473 0,06831 * Number of obs. 91 Pág. 27

5.- Fiscal Sustainability a) Conventional Sustainability Analysis Conventional sustainability analysis is based on the government intertemporal budget constraint. Initial Stock of Debt (percentage of GDP) = Present Value of Future Primary Surpluses (percentage of GDP) Pág. 28

5.- Fiscal Sustainability r Long-run (i) (%) g Long-run Avg.1999-2011 (ii) (%) pb 2011 (iii) (%) b 2011 (iv) (%) pb* Infinite Horizon (v) (%) pb* b=60%; J=10 years (vi) (%) Country Antigua and Barbuda 6.03 1.51-1.0 93.41 4.15 6.9 The Bahamas 6.03 1.40-2.3 49.45 2.26 Barbados 6.03 0.97 0.08 76.90 3.86 5.2 Belize 6.03 4.85 2.33 83.60 0.94 3.2 Dominica 6.03 2.39-2.30 71.17 2.53 3.5 Grenada 6.03 2.73-2.30 103.71 3.34 7.1 Guyana 6.03 2.41-1.49 65.22 2.31 2.75 Jamaica 6.03 0.72 3.15 142.92 7.53 14.05 St. Kitts and Nevis 6.03 2.22 10.40 154.30 5.74 13.7 St. Lucia 6.03 2.23-4.40 70.12 2.61 3.5 St. Vincent and the Grenadines 6.03 2.50-1.88 68.14 2.35 3.0 Suriname 6.03 4.03 1.79 19.09 0.37 Trinidad and Tobago 6.03 5.55 2.20 31.14 0.14 Pág. 29

5.- Fiscal Sustainability b) Bohn s Fiscal Sustainability Test Bohn (Mendoza and Ostry, 2007) proposes an econometric test of fiscal sustainability that is based on the following idea: a sustainable fiscal policy should generate primary balances that respond positively and significantly to changes in the debt/gdp ratio. We apply Bohn s test to a sample of nine Caribbean countries for the period 1999-2011. We find that the their primary balances do not respond significantly to changes in the debt to GDP ratio. Caribbean countries included in the sample do not follow sustainable fiscal policies. This result is consistent with Mendoza and Ostry (2007): the high debt subgroup in the emerging market group in their study does not follow fiscally sustainable policies. Pág. 30

5.- Fiscal Sustainability Bohn s Fiscal Sustainability Test Dependent Variable: primary balance as share of GDP (pb) i ii iii Debt-GDP (b) ratio -0.0618*** -0.0331-0.0317 yvar 10.7965 ** 5.607 egvar 2.696 Number of observations: 105 Pág. 31

6.- Debt Burden and Fiscal Sustainability in the Caribbean: Zooming In RR Intervals WB Income Classification (i) Main Economic Activity (ii) Public Debt/GDP Ratio 2011 (iii) (%) Avg. GDP Growth 1999-2011 (iv) (%) Concessional Debt/Total External Avg. 1999-2011 (v) (%) pb*;b=60% J=10 years (vi) (%) Fiscal Effort; sp*-sp Avg. (vii) (%) 60-90% High Debt Barbados High Tourism 76.90 0.97 5.20 5.12 Belize Lower-middle Tourism 83.60 4.85 15.78 3.20 0.87 Dominica Upper-middle Tourism 71.17 2.39 51.94 3.50 5.80 Guyana Lower-middle Commodity exporting 65.22 2.41 69.64 2.75 4.24 St. Lucia Upper-middle Tourism 70.12 2.23 33.87 3.50 7.9 St. Vincent/Grenadines Upper-middle Tourism 68.14 2.50 48.79 3.0 4.88 90% Plus Very High Debt Antigua/Barbuda Upper-middle Tourism 93.41 1.51 6.90 7.90 Grenada Upper-middle Tourism 103.71 2.73 39.65 7.10 9.40 Jamaica Upper-middle Tourism 142.92 0.72 14.54 14.05 10.90 St. Kitts/Nevis Upper-middle Tourism 154.30 2.22 13.70 3.30 Pág. 33

7.- Concluding Remarks and Policy Recommendations The analyses conducted in this paper with aggregate data for the Caribbean region show clear signals of a situation of excessive debt burden and potential fiscal insolvency. Applying simple statistics and more elaborated econometric methods, we have presented evidence that the public debt burden of the Caribbean countries has a significant negative impact on economic growth. Implementation of Bohn s fiscal sustainability test indicates that the primary balances of the Caribbean countries do not respond significantly to changes in debt to GDP ratios. Fiscal policy is unsustainable. Pág. 34

7.- Concluding Remarks and Policy Recommendations Aggregate external debt of the Caribbean region is also very high, but with our limited data we could not detect a significant negative relationship between external debt and economic growth. A low ratio of external short-term debt to total and a high ratio of concessional debt to total, moderate considerably the burden of servicing the debt and its fiscal impact. The results obtained from the aggregate data reflect the fact that most countries in the Caribbean region exhibit excessive debt levels (beyond the 60% threshold). Pág. 35

7.- Concluding Remarks and Policy Recommendations Countries in the high public debt level interval (60-90%) include: Barbados, Belize, Dominica, Guyana, St. Lucia and St. Vincent and the Grenadines. All of these countries, except Belize, require a fiscal effort between 4.24-7.9% of GDP to achieve a debt target level of 60% in ten years. Countries in the very high debt level range (90% plus) include: Antigua and Barbuda, Grenada, Jamaica, and St. Kitts and Nevis. All of these countries, except St. Kitts and Nevis need a fiscal effort between 7.9-10.9% of GDP to accomplish a debt target level of 60% in ten years. Pág. 36

7.- Concluding Remarks and Policy Recommendations Analysis of the data at an aggregate level and on a country by country basis, suggests that an adequate combination of fiscal consolidation and debt restructuring/relief is crucial to attain a debt level compatible with fiscal sustainability. The Caribbean countries should attempt to negotiate and obtain the maximum debt restructuring/relief possible. Nevertheless, the excessive debt burden of most countries of the region makes impossible to achieve the deleveraging required without fiscal adjustment. Pág. 37

7.- Concluding Remarks and Policy Recommendations As documented in Reinhart, Rogoff, and Savastano (2003) for emerging-market countries, large public debt overhangs do not unwind quickly and seldom painlessly. In particular, debt-to-gdp ratios are seldom reduced entirely through consistent robust economic growth. More commonly, reducing debt levels significantly has relied on fiscal austerity, debt restructuring (sometimes outright default), or a combination of these (Reinhart and Rogoff, 2011). Pág. 38

7.- Concluding Remarks and Policy Recommendations The considerable magnitude of the fiscal effort necessary to attain debt levels consistent with solvency implies that, fiscal consolidation programs have to be carefully designed and implemented for several years. Policy makers should be convinced that the current excessive debt level of the region is severely limiting the use of fiscal policy, and affecting negatively economic growth. Achieving and maintaining fiscal sustainability is especially important for the Caribbean countries, given their vulnerability to natural disasters and scarcely diversified economic base. Pág. 39

Thank you http://www.sela.org sela@sela.org Pág. 40