Transcript Sovereign Debtors in Distress -- Who is Vulnerable? Jeffrey Frankel Waterloo, Ontario, Canada, Feb.

Sovereign Debtors in Distress
-- Who is Vulnerable?
Jeffrey Frankel
Waterloo, Ontario, Canada, Feb. 24-26, 2012
(1) Vulnerability to Sovereign Debt Crises
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Vulnerability is high now.
My guess: Greece will make it past March 20,
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but then will default within a year.
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with usual 3-part formula of bail-out + conditionality + PSI ;
Greece cannot get back to a sustainable debt path
by austerity, as has been clear for awhile.
When it succeeds in eliminating its primary budget deficit,
it will have no more incentive to keep servicing debt.
Risk of contagion is high
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not just to rest of periphery, but rest of euro;
and rest of world.
Country creditworthiness is now inter-shuffled
“Advanced” countries
AAA Germany, UK
AA+ US, France
AA
Belgium
AA- Japan
A+
A
Spain
ABBB+ Italy
BBB- Iceland, Ireland
BB+
BB
Portugal
B
CC
Greece
(Formerly) “Developing” countries
Singapore
Chile
China
Korea
Malaysia, South Africa
Brazil, Thailand, Botswana
Colombia
India
Indonesia, Philippines
Costa Rica, Jordan
Burkina Faso
S&P ratings, Feb.2012 domestic currency
(2) What Determines Country Vulnerability?
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Fundamentally: Quality of institutions.
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This does not mean “tough” rules –
like SGP, debt ceiling or BBA – which lack enforceability.
Better would be structural budget targets (Swiss)
with forecasts from independent experts (Chile).
One third of developing countries since 2000 have
graduated from pro-cyclical spending to countercyclical,
even while US, UK & euro countries have forgotten
how to run countercyclical fiscal policy,
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and instead enact fiscal expansion in booms
& contraction after recessions.
Correlations between Govt. Spending & GDP
1960-1999
Adapted from Kaminsky, Reinhart & Vegh, 2004, “When It Rains It Pours”
procyclical
Pro-cyclical spending
countercyclical
Countercyclical
spending
G always used to be pro-cyclical
for most developing countries.
Correlations between Govt. Spending & GDP
2000-2009
procyclical
Frankel, Vegh & Vuletin (2011)
countercyclical
In the last decade,
about 1/3 developing countries
switched to countercyclical fiscal policy:
Negative correlation of G & GDP.
(3) It’s not so much the level
of debt/GDP that matters
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as the risk of getting stuck on an explosive path,
with ever-rising debt/GDP
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because of high primary deficit or interest rates
(or low growth), or risk of a sudden deterioration.
Early Warning indicators:
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composition of capital inflows
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Fx-denominated, ST, bank loans vs.
FDI, equity & contracts with automatic adjustment provisions.
Plus real currency overvaluation, fx reserves
Fiscal capacity.
(for peggers)…