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Public Debt, Fiscal Solvency and Macroeconomic Uncertainty in Latin America The Cases of Brazil, Colombia, Costa Rica and Mexico

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  • Enrique G. Mendoza

    ()
    (Professor, Department of Economics, University of Maryland, and Research Associate, National Bureau of Economic Research (NBER))

  • P. Marcelo Oviedo

    ()
    (Assistant Professor, Department of Economics, Iowa State University.)

Abstract

The ratios of public debt as a share of gdp of Brazil, Colombia and Mexico were 12 percentage points higher on average during the period 1996-2005 than in the period 1990-1995. Costa Rica’s debt ratio remained stable but at a high level; near 50 per cent. Is there reason to be concerned about the solvency of the public sector in these economies? We provide an answer to this question based on the quantitative predictions of a variant of the framework proposed by Mendoza and Oviedo (2007). This methodology yields forward-looking estimates of debt ratios that are consistent with fiscal solvency, for a government that faces revenue uncertainty and can issue only non-state-contingent debt. In this environment, aversion to a collapse in outlays leads the government to respect a “natural debt limit” equal to the annuity value of the primary balance in a “fiscal crisis”. A fiscal crisis occurs after a long sequence of adverse revenue shocks, and public outlays adjust to their tolerable minimum. The debt limit also represents a credible commitment to remain able to repay even in a fiscal crisis. The debt limit is not, in general, the same as the sustainable debt, which is driven by the probabilistic dynamics of the primary balance. The results of a baseline scenario question the sustainability of current debt ratios in Brazil and Colombia, while those in Costa Rica and Mexico are inside the limits consistent with fiscal solvency. In contrast, current debt ratios are found to be unsustainable in all four countries for plausible changes to lower average growth rates or higher real interest rates. Moreover, sustainable debt ratios fall sharply when default risk is taken into account.

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Bibliographic Info

Article provided by in its journal Economia Mexicana NUEVA EPOCA.

Volume (Year): XVIII (2009)
Issue (Month): 2 (July-December)
Pages: 133-173

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Handle: RePEc:emc:ecomex:v:18:y:2009:i:2:p:133-173

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Keywords: fiscal sustainability; public debt; sovereign default; default risk; sovereign debt.;

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  16. Enrique G. Mendoza & P. Marcelo Oviedo, 2006. "Fiscal Policy and Macroeconomic Uncertainty in Developing Countries: The Tale of the Tormented Insurer," NBER Working Papers 12586, National Bureau of Economic Research, Inc.
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Cited by:
  1. Oya Celasun & Xavier Debrun & Jonathan David Ostry, 2006. "Primary Surplus Behavior and Risks to Fiscal Sustainability in Emerging Market Countries," IMF Working Papers, International Monetary Fund 06/67, International Monetary Fund.
  2. Lassila, Jukka & Valkonen, Tarmo & Alho, Juha M., 2011. "Fiscal sustainability and policy rules under changing demographic forecasts," Discussion Papers, The Research Institute of the Finnish Economy 1265, The Research Institute of the Finnish Economy.
  3. Flores Prieto, Pedro & Fullerton, Thomas M., Jr. & Andrade Olivas, Cesar, 2007. "Evidencia empirica sobre deuda externa, inversion, y crecimiento en Mexico, 1980-2003
    [Empirical evidence on foreign debt, investment, and growth in Mexico, 1980-2003]
    ," MPRA Paper 9497, University Library of Munich, Germany, revised Apr 2007.
  4. Lassila , Jukka & Valkonen, Tarmo, 2008. "Population ageing and fiscal sustainability in Finland: a stochastic analysis," Research Discussion Papers, Bank of Finland 28/2008, Bank of Finland.
  5. Evan Tanner & Kevin Joseph Carey, 2005. "The Perils of Tax Smoothing," IMF Working Papers, International Monetary Fund 05/207, International Monetary Fund.
  6. Garcia, Carlos J. & Restrepo, Jorge E. & Tanner, Evan, 2011. "Fiscal rules in a volatile world: A welfare-based approach," Journal of Policy Modeling, Elsevier, Elsevier, vol. 33(4), pages 649-676, July.
  7. Paolo Mauro & Marcos Chamon, 2005. "Pricing Growth-Indexed Bonds," IMF Working Papers, International Monetary Fund 05/216, International Monetary Fund.
  8. Viviane Luporini, 2014. "Sustainability Of Brazilian Fiscalpolicy, Once Again: Corrective Policy Response Over Time," Anais do XL Encontro Nacional de Economia [Proceedings of the 40th Brazilian Economics Meeting], ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Grad 064, ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Graduate Programs in Economics].
  9. Evan Tanner & Issouf Samaké, 2006. "Probabilistic Sustainability of Public Debt," IMF Working Papers, International Monetary Fund 06/295, International Monetary Fund.
  10. Enrique G. Mendoza & P. Marcelo Oviedo, 2006. "Fiscal Policy and Macroeconomic Uncertainty in Developing Countries: The Tale of the Tormented Insurer," NBER Working Papers 12586, National Bureau of Economic Research, Inc.
  11. Nazim Belhocine & Salvatore Dell'Erba, 2013. "The Impact of Debt Sustainability and the Level of Debt on Emerging Markets Spreads," IMF Working Papers, International Monetary Fund 13/93, International Monetary Fund.
  12. E. H. Gardner & Julian di Giovanni, 2008. "A Simple Stochastic Approach to Debt Sustainability Applied to Lebanon," IMF Working Papers, International Monetary Fund 08/97, International Monetary Fund.
  13. Diego Valderrama, 2005. "Fiscal sustainability and contingent liabilities from recent credit expansions in South Korea and Thailand," Economic Review, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, pages 29-41.
  14. Safdar Ullah Khan & Omar Farooq Saqib, 2007. "An Analysis of Pakistan s Vulnerability to Economic Crisis," The Pakistan Development Review, Pakistan Institute of Development Economics, Pakistan Institute of Development Economics, vol. 46(4), pages 597-610.

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