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 percent. Is there reason to be concerned for 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 (2006). 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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Paper provided by Iowa State University, Department of Economics in its series Staff General Research Papers with number
12700.
Length: 42 pages Date of creation: 27 Nov 2006 Date of revision: Publication status: Forthcoming in Economia Mexicana Handle: RePEc:isu:genres:12700
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References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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Carmen M. Reinhart & Kenneth S. Rogoff & Miguel A. Savastano, 2003.
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NBER Working Papers
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[Downloadable!]
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