Emerging markets should be aware of their debt intolerance

Carmen and Vicent Reinhart a timely piece on fiscal stimulus and its impact on developing/emerging markets.  The summary is:

Developed economies are implementing massive fiscal stimulus packages. Should emerging economies? This column warns them that fiscal multipliers are not certain, financing budget deficits will not be easy, the risk of default looms, and central bank independence may be eroded.

I was just discussiing this with a journalist friend the other day.  Seeing advanced econs pass such large fiscal stimulus, there is a serious danger that the emerging econs see this as fashionable and again slips into irresponsible fiscal regimes.

This short note says there are 3 issues with emerging econs:

1.  Fiscal multipliers: North and South
Although there is little consensus in academic and policy circles on their magnitudes, the discussion of fiscal multipliers in most OECD countries is at least informed by existing analytical and empirical studies. For emerging markets, however, a comparable literature does not exist. Thus, any statement about fiscal multipliers for emerging markets (and developing countries) as a class has to be interpreted with care.

2. Emerging markets and global crowding out
Figure 2 highlights that public debt typically explodes in the years following a systemic financial crisis. On average, public debt nearly doubles three years after the crisis. Recessions lead to major revenue losses and fiscal spending expands, as the bailout of the banking sector proves costly and stimulus packages find favour.

It is noteworthy that the last time the world experienced a crisis of this proportion (the Great Depression), governments in the advanced economies were able to continue borrowing (Figure 3), as recovery remained elusive for nearly a decade. Debt rises by 44% in the first three years and by another 40% during the next three years. By contrast, the public debt of emerging markets remained frozen after the third year. This was not the result of rebounding revenues balancing the budget – in a number of cases it was the result of sovereign defaults.

3. Above all – remember debt intolerance! 
Historically, emerging market defaults have taken place at levels of debt that would appear to be safe and even conservative by advanced economy standards. The defaults of Mexico in 1982 and Argentina in 2001 were not exceptions. Table 1 shows that external debt exceeded 100% of GNP in only 16% of the default or restructuring episodes, that more than one-half of all defaults occurred at levels below 60% – which would have satisfied the Maastricht criteria – and that defaults took place against debt levels that were below 40% of GNP in nearly 20% of the cases.

The last point is very important as we often see complacency in emerging markets. The policymakers often say our debt levels are much lower than the others/developed economies and hence not a crisis at all. The findings are based on this paper written by Carmen along with Rogoff and Savastano. This is a problem with India as well.

 

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