POVERTY POVERTY THE WORLD BANK REDUCTION REDUCTION AND ECONOMIC MANAGEMENT MANAGEMENT NETWORK (PREM) NETWORK (PREM) Economic Premise JULY 2010 · Number 23 JUNE 2010 · Number 18 Debt Management: Now the Difficult Part 55829 Trade and the Competitiveness Agenda Sudarshan Gooptu and Carlos A. Primo Braga1 José Guilherme Reis and Thomas Farole The first years of the 21st century were characterized by more prudent macroeconomic policies in the developing world, the positive impact of debt relief on low-income countries (LICs), and positive growth trends for the world economy, despite the puncturing of the high-tech "bubble" in OECD The global economic the financial crisis, a major rethinking of the respective roles of governments and markets in the countries. Until the eve of crisis has forced many emerging economies were able to reduce the vulnerabilities of their debt portfolios and debt management was being carried out under favorable circumstances. Average maturities increased, reflecting increases in the maturities of new debt processes of trade and growth. Indeed, industrial policy seems to be back in fashion--or, at least, talking about it is. issuances, and rollover risks declined. Moreover, the increased availability of local currency financing, reflecting the development of domestic capi- But a renewed "activism" by government in the trade and growth agenda need not mean a return to old-style tal markets, and the globalization of the corporate sector in emerging economies underscored the changing landscape of development financing. policies of import substitution and "picking winners." Instead, it may mean a stronger focus on competitiveness by unlocking the constraints to private sector­led growth. This note discusses the renewed role of government in trade and growth policy from the competitiveness angle, and some priorities for the new competitiveness agenda. The current global financial crisis is changing this landscape it suggests Interestingly enough, for the first time in over 40 years, con- once again. Since 2007, the world economy has slowed signifi- cerns about debt sustainability seem to be concentrated in cantly: global output declined 0.6 percent (a 3.2 percent con- high-income economies. It is true that developing economies traction in advanced economies) in 2009, and although the entered this crisis in a much stronger financial position, reflect- global economy is expected to return to a positive growth path Export-Led Growth, the Crisis, and the End ing better macroeconomic policies, improved debt manage- pacts of the crisis on the policy environment regarding trade of an (4.2 in 2010Era percent), future prospects remain uncertain ment practices, becoming more apparent. Indeed, in addi- and growth wereand, in the case of heavily indebted poor coun- (World Bank 2010). Moreover, advanced economies are ex- tries, debt relief. Still, over the global commitment growing tion to raising concernsthe severity of the crisis and the to trade The dramatic expansion in global trade interest rates, and pected to face large public debts, rising real over recent decades tensions in public debt markets in to some serious rethink- liberalization, the crisis has also ledOrganisation for Economic slower growth. The International Monetary Fund (IMF), forand has contributed significantly to diversification, growth, Co-operation and Development (OECD) countries emphasize ing of some of the conventional wisdom regarding the poverty projects that annual gross domestic product (GDP) example, reduction in many developing countries. This period that agenda--the most important result of which is the growththere is no room for complacency. This note documents potential growth rates in advanced countries will be about a of rapid export growth has been enabled by two critical evolving that governments and identifies some of the emerg- likelihood debt and fiscal trendswill play a much more activist half percentage point less, on average, than precrisis levels if structural changes in global trade: (1) the vertical and spatial ing challenges faced by debt managers in developing markets. role in the coming years. There are three principal reasons public debt is not lowered (IMF 2010a). fragmentation of manufacturing into highly integrated why governments are likely to be more actively involved in There is broad consensus that many dangers lie ahead in Emerging Issues "global production networks," and (2) the rise of services industrial and trade policy in the coming years. terms of the sustainability of the recovery, including challenges trade and the growth of "offshoring." Both of these, in turn, First, 1 captures debt and fiscal variables for selected discred- Figure the crisis has undone faith in markets andadvanced in implementing exit strategies from the massive government were made possible by major technological revolutions; and and emerging countries in 2007, rely simply before the onset ited laissez-faire approaches that immediately on trade policy interventions that have taken place since 2008 (Primo Braga they were supported by of attenuation of the crisis reforms 2010). Despite the first signsmultilateral trade policyin the liberalization. Instead, governments and local markets have of the current financial crisis. As illustrated by the location of a and broad liberalizations in domestic trade and to signifi- third quarter of 2009, economic indicators still point investment been "rediscovered." In this sense, the demand for activist large number of economies in the right quadrant of the graph-- environments worldwide. cant levels of unemployment and social distress around the with fiscal is likely and debt-to-GDP ratios below 60 percent-- government surplusesto go well beyond financial markets and The global economic crisis came crashing into the middle world. This crisis has not yet evolved into a systemic sovereign many countries were able the policy environment in a posi- regulation, and it will affectto respond to the crisis from which of this long-running rapid accumulation party during 2008 debt crisis,2 however, theexport-led growthof public debt and tion of industrial strategies are designed. trade and strength. Figure 2 shows that by the end of 2009, the and 2009. Between the last quarter of 2007 and the second growing fiscal imbalances in many countries, as well as histori- Second, the crisis significantly, with many countries now dis- picture had changedhas highlighted the critical importance quarter of 2009, global the possibility cannot 36 percent. cal precedent, suggest that trade contracted by be ignored. But playing fiscal deficits of more than 5 percent and debt-to-GDP of diversification (of sectors, products, and trading partners) as the recovery started to strengthen in 2010 (at least until in reducing the risks of growth volatility. The recent era of the clouds began to form over Europe), the longer-term im- globalization contributed to substantial specialization of 1 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise 1 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise Figure 1. General Government Balance and General Government Gross Debt, 2007 (% of GDP) 200 Japan G20: advanced G20: emerging general government debt (as % of GDP) non-G20 150 Italy Greece 100 India Argentina Germany Brazil Hungary Canada Portugal France Austria 50 United States Spain United Kingdom Mexico Korea, Rep. of Turkey Indonesia Saudi Arabia Venezuela, R. B. de Ireland S. Africa China Bulgaria Russian Federation Latvia Chile 0 Estonia Australia -15 -10 -5 0 5 10 15 overal government balance Source: Authors' calculations based on IMF 2010a. Note: Debt measures for República Bolivariana de Venezuela are external debt (all other countries are measured in general government gross debt). Figure 2. General Government Balance and General Government Gross Debt, where existing social entitlements and low productivity 2009 (% of GDP) growth prospects make debt-to-GDP reduction exercises 250 quite difficult. Confidence in the strength of the recovery of advanced Japan economies remains a question and the process of delever- G20: advanced aging of the private sector in many OECD countries is on- 200 G20: emerging going. Accordingly, although the debate about the proper general government debt as % of GDP non-G20 timing to unwind public interventions remains fierce (see, for example, Hannoun [2009]); it was clear by May 2010 150 that developments in European markets had increased the Greece need for credible plans for fiscal consolidation. Italy Given the growing levels of debt, several questions 100 emerge, including: What if the fiscal stimulus programs United India Canada Hungary States Portugal Germany were to continue for two to four years more than currently France Ireland Austria Brazil projected? What will happen to public debt if there is no United Kingdom Spain Argentina adjustment to the primary fiscal balances in the medium 50 Turkey Mexico Indonesia Korea, Rep. of term? What is the degree of fiscal adjustment necessary for Latvia S. Africa China Australia countries to either reduce their public debt stock to his- Venezuela, R. B. de Saudi Arabia Russina Federation Bulgaria torical average levels or stabilize it around a certain fiscally Chile Estonia 0 sustainable target? If the adjustment is deemed too large to -15 -10 -5 0 5 be feasible from a political economy standpoint, what will overall government balance be the effect of a more gradual adjustment on debt sustain- Source: Authors' calculations based on IMF 2010a. ability? While this paper does not aim to answer these im- Note: Debt measures for República Bolivariana de Venezuela are external debt (all other portant questions, some preliminary findings have already countries are measured in general government gross debt). started to appear in the literature. A recent study conduct- ed on a sample of 20 middle-income countries (MICs), for ratios well above 60 percent. In other words, the scope for fur- example, shows that the fiscal policy responses in 2008 and ther expansionary interventions, be it on the monetary or on 2009 and the related external financing packages have contrib- the fiscal fronts, is now much more limited. The situation is par- uted to higher public and external debts in several countries ticularly complex in some of the countries in the eurozone, (figure 3; Van Doorn, Suri, and Gooptu forthcoming). 2 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise Figure 3. Increased External and Public Debt Levels in MICs (% of GDP) 140 external and public debt as percent of GDP 120 100 80 60 40 20 0 India Hungary Egypt, Arab Rep. of Brazil Argentina Malaysia Poland Philippines Turkey Mexico Thailand Colombia Ukraine South Africa Indonesia Peru China Nigeria Russian Federation Chile end-2009 gross public debt* end-2009 total external debt** end-2007 gross public debt* end-2007 total external debt** Sources: Van Doorn, Suri, and Gooptu forthcoming; IMF 2010b. Hypothetical scenarios that were examined in this study-- Meanwhile, the surge in gross borrowing needs of advanced to assess the staying power of the fiscal stimulus programs in economies--from US$9 trillion in 2007 to roughly US$16 tril- the sample countries--suggest that if a growth recovery is not lion in 2009, with an expected similar level for 2010--is add- sustained in advanced countries and the global outlook re- ing to the financial stress under which public debt is being mains fragile, the primary balances that most of these coun- managed (Blommestein and Gok 2009). If general govern- tries will need to run in the medium term will be significantly ment debt ratios in advanced economies are to be brought higher than what they have carried in the recent past. More- back to the precrisis average of 60 percent of GDP by 2030, it over, if the prolonged downturn leads to even more debt accu- will require an 8 percent swing in the fiscal balance from an mulation, if rising international interest rates, foreign exchange average deficit of 4 percent in 2010 to a fiscal surplus of 4 per- risk, and a continuous repricing of risk of sovereign credits cent by 2020 and then maintenance of this surplus for the en- characterize the new postcrisis reality, it will become more dif- suing decade (Lipsky 2010). The growing level of public debt ficult for several countries to reach their respective debt targets suggests that the spread between long-term and short-term in- (figure 4). terest rates is likely to increase over time, even though quantita- In the case of LICs, the global financial crisis has also impact- tive easing may delay such a trend. For developing countries, ed their debt positions and associated vulnerabilities. This this is likely to imply higher borrowing costs and shortening group of countries is likely to face tighter external financing-- maturities on new borrowings. Developing countries will be dwindling foreign direct investment, commercial lending, and impacted by these developments not only through the cost of (potentially) smaller aid flows--and contractions in export in- capital and reduced global economic dynamism, but also be- come. Several of the LICs have increased their reliance on do- cause the massive public interventions of the last two years--in mestic debt to close their widening fiscal financing needs. A the absence of an orderly unwinding--will foster asset bubbles recent joint World Bank and IMF study reviewed debt sustain- and speculative waves. Exchange rate misalignments can also ability analyses (DSAs) for 32 LICs for which pre-and postcrisis contribute to the tensions in the financial system. Speculative DSAs were available. Like the MICs, the external and fiscal fi- attacks against currencies in highly leveraged economies can nancing requirements of LICs also increased after the global add to risks by further contributing to the deterioration of pri- crisis (World Bank and IMF 2010). In addition, their future lev- vate sector balance sheets and may evolve into sovereign debt els of GDP, exports, and fiscal revenues are expected to be per- crises. All of these risks need to be managed on a continuous manently lower as a result of this global shock. The World Bank basis, and risk management should be accompanied by credi- and IMF (2010) conclude that, on average, LIC debt ratios are ble, medium-term debt management practices and financing also expected to deteriorate in the near term, particularly for strategies to support the fiscal spending and postcrisis recovery public debt. efforts. 3 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise Figure 4. Required Postcrisis Primary Balances Diverge Significantly from Historical Levels (% of GDP) 10 adjustment in primary balance required under scenario 1 primary balances as % of GDP 8 adjustment in primary balance required under scenario 2 6 4 2 0 -2 -4 Hungary Egypt, Arab Rep. of India Malaysia Poland Argentina* Brazil* Ukraine China Colombia* Peru Mexico Russian Federation* Thailand Philippines Turkey* Chile* Indonesia* South Africa Nigeria* Sources: Van Doorn, Suri, and Gooptu forthcoming; IMF 2010b. Note: Assumptions: debt target is 40 percent of GDP by 2020 if the country's gross public debt was above 40 percent of GDP at end-2009, or to stabilize debt at its end-2009 level if debt was below 40 percent of GDP at end-2009. Adjustment is the difference between the required primary balance to reach the debt target under the two hypothetical scenarios and the country-specific historical primary balance (that is, average of 1996­2001 for countries marked with an asterisk; average of 2002­07 for all other countries). For Chile, Indonesia, South Africa and Nigeria the historical primary balance is larger than the required primary balance, so, in principle, no unprecedented fiscal adjustment will be needed in these countries. Adopting a Sovereign Balance Sheet The ability of governments to make payments on their debt Approach obligations (domestic and external) and minimize future risks to their public finances can be enhanced by implementing a This review of debt and fiscal paths underscores the impor- credible, medium-term debt management strategy and creat- tance of refocusing on sovereign debt management. The tradi- ing an institutional capability to monitor and manage contin- tional, external DSAs will continue to be an important ingredi- gent liabilities. To this end, a sovereign balance sheet approach ent of the analytical toolkit, but they need to be complemented to debt management will be useful in managing the financial by a closer examination of public debt (encompassing both do- and credit risks associated with carrying out regulatory and mestic and external debt) and medium-term fiscal sustainabil- macroeconomic functions. This approach focuses on the risk ity analyses by the respective authorities on a regular basis. Spe- characteristics of the assets and obligations that the govern- cial attention will now need to be given to managing not only ment manages, and the types of financial flows associated with the composition of sovereign debt portfolios, but also the ex- them. In practice, this entails an examination of the cash flows panding array of contingent liabilities incurred by government generated by the key assets (or asset classes) of the government responses to the crisis. and monetary authorities to see how sensitive they are to Conventional DSAs for low- and middle-income countries changes in real interest rates, currency movements, and shifts highlight country-specific characteristics, focusing on the na- in terms of trade (Wheeler 2004, chapter 4). ture and size of shocks that affect a country's debt and debt service profile, and the potential for fiscal response to these Conclusion shocks, given fiscal space at any point in time. However, the les- sons from the East Asian financial crisis of the late 1990s and The coordination of exit policies from the massive fiscal inter- the current global financial crisis emphasize the need for DSAs ventions of the last few years will pose major challenges for gov- to consider the wider liabilities of the public sector. Countries ernments around the world. While simultaneous fiscal expan- with high sovereign debt ratios, large fiscal deficits, and growing sion helped thwart the global economic slowdown of 2008­9, contingent liabilities are especially at risk of contagion because the story is more complicated when it comes to unwinding heightened market uncertainties in international capital mar- these fiscal programs and moving toward a path of fiscal con- kets lead to a flight to quality. Investors are wary of rising inter- solidation. Simultaneous fiscal consolidation is likely to con- est rates across countries and the prospect of stringent fiscal strain the dimensions of economic recovery, at least in the ini- consolidation that lies ahead. tial stages of fiscal retrenchment. If the fiscal consolidation is 4 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise focused on stabilizing entitlement spending­to-GDP ratios (a Notes must for countries facing demographic pressures) and letting 1. This paper relies extensively on Primo Braga (2010) and Van discretionary interventions expire, the required adjustment Doorn, Suri, and Gooptu (forthcoming). can be achieved. However, the difficulties of dealing with enti- 2. There is extensive literature on the correlation between tlement reforms (for example, pension and health reforms) banking crises and sovereign debt crises. See, for example, Rein- and the temptation to postpone adjustment because of contin- hart and Rogoff (2009). ued weaknesses in the private sector (reflecting the ongoing deleveraging process) exacerbate the challenges of fiscal con- About the Authors solidation. Markets will be closely monitoring the evolution of fiscal po- Sudarshan Gooptu is acting director and sector manager in the sitions around the world, and economies that are not able to Economic Policy and Debt Department and Carlos Alberto Primo implement consolidation plans will face increasing difficulties Braga is acting vice president and corporate secretary of the World in financing their debts. In this context, international coordina- Bank Group, Washington, D.C. tion (and monitoring) can play a positive role in helping en- References hance the credibility of national strategies and by giving "am- Blanchard, Olivier, Giovanni Dell'Ariccia, and Paolo Mauro. 2010. "Rethinking munition" to financial authorities to resist short-term pressures Macroeconomic Policy." International Monetary Fund Staff Position Note, associated with political cycles. SPN/10/03, Washington, DC Finally, because of the increasing importance of public infra- Blommestein, Hans J., and Arzu Gok. 2009. "The Surge in Borrowing Needs of OECD Governments: Revised Estimates for 2009 and 2010 Outlook." structure spending in renewing the growth process through the OECD Journal: Financial Market Trends (2). issuance of sovereign guarantees and/or by the reliance on pub- Hannoun, Hervé. 2009. "Unwinding Public Interventions after the Crisis." lic-private partnerships, the role of contingent liabilities re- Speech delivered at the IMF High Level Conference, "Unwinding Public quires renewed attention. Contingent liabilities may pose sub- Interventions--Preconditions and Practical Considerations," December 3, Washington, DC. stantial balance sheet risks for governments, as demonstrated Horton, Mark, Manmohan Kumar, and Paolo Mauro. 2009. "The State of Pub- by the East Asian financial crisis in 1997. When contingent li- lic Finances: A Cross-Country Fiscal Monitor." International Monetary abilities are realized, they become a potential source of future Fund Staff Position Note, SPN/09/21, Washington, DC. call on tax revenues and can be a major factor in the build-up of IMF (International Monetary Fund). 2010a. Fiscal Monitor: Navigating the Challenges Ahead. Fiscal Affairs Department. public sector debt. Experience shows that contingent liabilities ------. 2010b. World Economic Outlook. April, Washington, DC. associated with capital injections into the banking system or in Lipsky, John P. 2010. "Fiscal Policy Challenges in the Post-Crisis World." the recapitalization of public sector enterprises are particularly Speech delivered at the China Development Forum, March 21, Council important (Wheeler 2004, chapter 6). The rapid build-up of on Foreign Relations publication, www.cfr.org/publication/21712/imf. html. public debt that has occurred in advanced countries, and is Primo Braga, Carlos A. 2010. "The Great Recession and International Policy now occurring in MICs, is highly correlated with these "hidden Coordination." Paper prepared for the First International Research Con- deficits." ference of the Reserve Bank of India, "Challenges to Central Banking in the Context of Financial Crisis," Mumbai, February 12­13. Experiences of many countries, such as Colombia, Hunga- Reinhart, Carmen M., and Kenneth S. Rogoff. 2009. This Time Is Different: Eight ry, New Zealand, South Africa, and Sweden, suggest that a gov- Centuries of Financial Folly. Princeton, NJ: Princeton University Press. ernment's exposure to contingent liabilities can be substantial- Van Doorn, Ralph, Vivek Suri, and Sudarshan Gooptu. Forthcoming. "Do ly reduced through better, more complete monitoring and Middle-Income Countries Continue to Have the Ability to Deal with the Global Financial Crisis?" World Bank Staff Policy Research Working Paper. reporting; better risk-sharing arrangements; improved gover- Wheeler, Graeme. 2004. Sound Practice in Government Debt Management. nance and regulatory regimes; and sound economic policies Washington, DC: World Bank. that minimize the possibility of these contingent liabilities World Bank. 2010. Global Monitoring Report: The MDGs after the Crisis. Wash- from being realized in the first place. Debt managers around ington, DC. World Bank, and IMF (International Monetary Fund). 2010. "Preserving Debt the world will have to pay close attention to the evolution of Sustainability in Low-Income Countries in the Wake of the Global Crisis." contingent liabilities and their impact on public debt to avoid Washington, DC, http://www.imf.org/external/np/pp/eng/2010/04011 surprises. 0.pdf. The Economic Premise note series is intended to summarize good practices and key policy findings on topics related to economic policy. They are produced by the Poverty Reduction and Economic Management (PREM) Network Vice-Presidency of the World Bank. The views expressed here are those of the authors and do not necessarily reflect those of the World Bank. The notes are available at: www.worldbank.org/economicpremise. 5 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise