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Assessing Debt Sustainability in Emerging Market Economies Using Stochastic Simulation Methods

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  • Philippe D Karam
  • Doug Hostland

Abstract

This paper applies stochastic simulation methods to assess debt sustainability in emerging market economies and provide probability measures for projections of the external and public debt burden over the medium term. The vulnerability of public debt to adverse shocks is determined by a number of interrelated factors, including the volatility of output, financial fragility, the endogenous response of the risk premium, and sudden stops in private capital flows. The vulnerability of external debt is sensitive to the determination of the exchange rate and to the pricing of traded goods. We show that fiscal policy can act in a preemptive manner to prevent the debt burden from rising significantly over the medium term. This requires flexibility in fiscal planning, which many emerging market economies lack. Emerging market economies therefore face a difficult trade-off between managing the risk of a debt crisis and pursuing other important fiscal policy objectives.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 05/226.

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Length: 36
Date of creation: 01 Dec 2005
Date of revision:
Handle: RePEc:imf:imfwpa:05/226

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Keywords: Debt sustainability; Emerging markets; Risk premium; Fiscal management; Capital flows; Economic models; public debt; external debt; debt burden; current account; primary fiscal balance; fiscal balance; debt service; fiscal policy; external debt burden; domestic currency; fiscal authority; debt service payments; debt burdens; fiscal policy rules; fiscal planning; debt crises; debt default; debt obligations; fiscal policy rule; debt intolerance; aggregate demand; debt crisis; budget balance; domestic debt; sovereign debt; currency crises; debt management; fiscal sustainability; debt dynamics; fiscal constraint; fiscal effort; fiscal developments; current account deficit; fiscal authorities; fiscal risk; debt accumulation; fiscal policy objectives; fiscal rule; balance of payment; current account balance; fiscal expenditures; account deficits; tax revenues; current account deficits; current account adjustment; fiscal constraints; current account adjustments; current account balances; foreign debt; fiscal adjustment; debt defaults; sovereign debt crises; fiscal variables; debt structure; sustainable fiscal policy; fiscal imbalances; level of debt service; fiscal surplus; reserve management; fiscal revenues; national debt; debtor reporting system; fiscal policy trade; debt rescheduling; fiscal vulnerability; fiscal policy response; fiscal balances; external debt sustainability; debtor reporting; sovereign defaults; balance sheet effects; debt stocks; taxes on growth; fiscal rules; increase in debt service; primary fiscal deficit; fiscal commitments; budget deficit; sovereign default; domestic debt markets; fiscal solvency; fiscal outlook; cyclical fiscal policy; market debt; tax rates; sovereign bond; maturity structure of debt; liquidity crisis; public debt crisis; external debt burdens; government budget; liquidity crises; serial defaulters; fiscal plan;

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References

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Citations

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Cited by:
  1. Charles Wyplosz, 2007. "Debt Sustainability Assessment: The IMF Approach and Alternatives," IHEID Working Papers 03-2007, Economics Section, The Graduate Institute of International Studies.
  2. Charles Wyplosz, 2011. "Debt Sustainability Assessment: Mission Impossible," Review of Economics and Institutions, Università di Perugia, vol. 2(3).
  3. Philippe D Karam & A. R. Pagan, 2008. "A Small Structural Monetary Policy Model for Small Open Economies with Debt Accumulation," IMF Working Papers 08/64, International Monetary Fund.
  4. Muhanji, Stella & Malikane, Christopher & Ojah, Kalu, 2013. "Price and liquidity puzzles of a monetary shock: Evidence from indebted African economies," Economic Modelling, Elsevier, vol. 33(C), pages 620-630.
  5. Philippe D Karam & Doug Hostland, 2006. "Specification of a Stochastic Simulation Model for Assessing Debt Sustainability in Emerging Market Economies," IMF Working Papers 06/268, International Monetary Fund.
  6. Paloma Acevedo & Enrique Alberola & Carmen Broto, 2007. "Local debt expansion... vulnerability reduction? An assessment for six crises-prone countries," Banco de Espa�a Working Papers 0733, Banco de Espa�a.
  7. Aleksandar Zdravkovic & Aleksandra Bradic-Martinovic, 2012. "Public Debt Sustainability in Western Balkan Countries," Book Chapters, Institute of Economic Sciences.
  8. Yýlmaz Akyüz, . "Global Rules and Markets: Constraints over Policy Autonomy in Developing Countries," Working Papers 2007/5, Turkish Economic Association.
  9. Alexis CRUZ-RODRÍGUEZ, 2014. "Assessing fiscal sustainability in some selected countries," Theoretical and Applied Economics, Asociatia Generala a Economistilor din Romania - AGER, vol. 0(6(595)), pages 7-22, June.
  10. Evan Tanner & Issouf Samaké, 2006. "Probabilistic Sustainability of Public Debt," IMF Working Papers 06/295, International Monetary Fund.
  11. Jafri, Sabina Khurram, 2009. "External Debt Sustainability Analysis for the Medium Term: A Case Study," Economia Internazionale / International Economics, Camera di Commercio di Genova, vol. 62(3), pages 363-382.
  12. Gabriel Di Bella, 2008. "A Stochastic Framework for Public Debt Sustainability Analysis," IMF Working Papers 08/58, International Monetary Fund.
  13. Akyüz, Yilmaz, 2008. "Global rules and markets : constraints over policy autonomy in developing countries," ILO Working Papers 420405, International Labour Organization.
  14. Jha, Shikha & Quising, Pilipinas & Camingue, Shiela, 2009. "Macroeconomic Uncertainties, Oil Subsidies, and Fiscal Sustainability in Asia," ADB Economics Working Paper Series 150, Asian Development Bank.
  15. E. H. Gardner & Julian di Giovanni, 2008. "A Simple Stochastic Approach to Debt Sustainability Applied to Lebanon," IMF Working Papers 08/97, International Monetary Fund.
  16. Paloma Acevedo & Enrique Alberola & Carmen Broto, 2008. "Local debt expansion and vulnerability reduction: an assessment for six crisis-prone countries," BIS Papers chapters, in: Bank for International Settlements (ed.), New financing trends in Latin America: a bumpy road towards stability, volume 36, pages 88-109 Bank for International Settlements.
  17. Muhanji, Stella & Ojah, Kalu, 2011. "External shocks and persistence of external debt in open vulnerable economies: The case of Africa," Economic Modelling, Elsevier, vol. 28(4), pages 1615-1628, July.
  18. Küçük, Ugur N., 2009. "Emerging Market Local Currency Bond Market, Too Risky to Invest?," MPRA Paper 21878, University Library of Munich, Germany.
  19. Carrera, Claudia Martínez & Vergara, Rodrigo, 2012. "Fiscal Sustainability: The Impact of Real Exchange Rate Shocks on Debt Valuation, Interest Rates and GDP Growth," World Development, Elsevier, vol. 40(9), pages 1762-1783.

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