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    Debt Problem & Development   26.10.2011   Kugonza & Emre Debt Problem & Development 26.10.2011 Kugonza & Emre Presentation Transcript

    • Debt Problem and Development Volkan EMRE Danald KUGONZA
    • Presentation Summary• Introduction• Overview of external debt• Origins of 1970’s – 1980’s External Debt Dilemma• Petrodollar Recycling and OPEC’s Absorption Problem• When is it prudent to borrow ?• Debt Sustainability• External borrowing, adjustment policies, and savings• 1980’ debt crisis• Longer term efforts to overcome the debt crisis• Debt overhang and future economic growth• Graphical Explanations• Conclusions
    • External Origins Petrodollar When IsOverview Borrowing of Recycling It Debt of Adjustment 1970s- & Prudent SustainExternal Policies 1980s OPEC’s To ability Debt & Debt Absorption Borrow Savings Dilemma Problem
    • Overview of External DebtWhat is an External Debt?It is the total private and public foreign debt owned by a country (Todaro).How is it paid ?Its usually paid by using foreign currency.Therefore a country should havesufficient foreign exchange for its servicing.Less Developed Countries can‘t borrow in their local currency-Original SinHow is it different from an internal debt?An internal debt is a borrowing owed to the citizens or institutions of acountry.Normally borrowed and paid in the local currency.Public DebtA Combination of external and internal debt.Why is an external debt a point of concern?Its payment is dependent on foreign exchange-recall currency mismatch &think of local curreny depreciation!
    • External Debt Stocks (% of GNI) in Developing Countries Graph 1 (1970 & 1982) Graph 2 Source: World Bank,World Bank Development Indicators, own calculations
    • Total External Debt in Developing Countries
    • External Debt Stocks (% of GNI) in Heavily Indebted Poor Countries (1970 & 1982) Mauritania Somalia Nicaragua Cote dIvoire Togo Guinea-Bissau Liberia Zambia Gambia, The Congo, Rep. Sudan Malawi Honduras Mali Comoros 1982 Bolivia Senegal 1970 Benin Madagascar Sierra Leone Niger Ethiopia Uganda Cameroon Congo, Dem. Rep. Ghana Central African Republic Chad Burkina Faso Rwanda 0 20 40 60 80 100 120 140 160 180 Source: World Bank,World Bank Development Indicators, own calculations
    • External Origins Petrodollar When IsOverview Borrowing of Recycling It Debt of Adjustment 1970s- & Prudent SustainExternal Policies 1980s OPEC’s To ability Debt & Debt Absorption Borrow Savings Dilemma Problem
    • Origins of 1970’s – 1980’s External Debt DilemmaWhy did nations continue to inccur external debts?  Needed to finance their current account deficitWhat caused their current account deficits?1. Arise in petroleum prices (External event)  During the above period, OPEC hiked Oil Prices  January 1973 = $ 2,59  November 1973 = $ 5,18  January 1974 = $ 11,65
    • Origins of 1970’s – 1980’s External Debt DilemmaBetween 1973 and 1981 Oil Prices Increased approximately by 500 %
    • Origins of 1970’s – 1980’s External Debt Dilemma2. Financing unproductive consumption e.g. military expenditures,repayment of the past external debts at the expense of productiveinvestments which would have generated or saved foreign exchange3.Problems and failures of internal economic policy that resulted in:  High levels of inflation  Over-valued exchange rates4.Failure of economies to successfully negotiate a series of‘’strategy switches’’ in economic policy that would have contributedto the necessary structural transformations on the path towards greaterindustrialisation and diversification of production e.g. Failed ISI
    • Origins of 1970’s – 1980’s External Debt DilemmaThe Remedy to a current account deficit would be : 1. A Surplus on Capital and Financial Account (say by borrowing externaly) 2. Reducing the Import Bill 3. Increasing Export EarningsHow did these economies respond ? 1. Reduced the Overall Volume of Imports moreso oil? 2. Increased export earnings? 3. Accumulated Further External Debt to Pay for More Expensive Oil and Other desired Imports ? 1. Dilemma !
    • External Petrodollar When Is Origins of BorrowingOverview Recycling It Debt 1970s- Adjustmentof External & Prudent Sustaina 1980s Policies Debt OPEC’s To bility Debt & Absorption Borrow Dilemma Savings Problem
    • Petrodollar Recycling and OPEC’s Absorption ProblemWhat exactly is Petrodollar Recycling ? Increased Export Deposited Excess Excess Deposits in Revenues Earnings in International Banks Amid LimitedAmid not enough Banks Clientsprojects to absorb Euro- Dollar or Euro Threatens profitablitythem thus the Currency Markets ( New of banks which brings‘‘absorption problem‘‘ York , London , Frankfurt, search for new Tokyo ) to earn interest markets Oil Price Hikes by OPEC Debt Serving•Promote Econ.Dev‘t in OPEC Creation of Sovereignthrough improving Borrowersinfrastructure,education,Technol Less developed oilogy,etc than spuring econ dev‘t payments in importing countries within the U.S,Europe & Japan current account deficits exchange for oil
    • Petrodollar Recycling and OPEC’s Absorption Problem• Petrodollar recycling is the circulation and recirculation of petroleum revenues from the oil-importing nations to the OPEC economies to the private international banks and then back again to the oil-importing nations in the form of loans, only to make the round again and again(Devlin 1989). Trade Balances for Oil Exporting and Importing Countries between 1973 & 1981(Billions of U.S dollars) Source: Cypher&Dietz, 2009
    • External Petrodollar When Is Origins of BorrowingOverview Recycling It Debt 1970s- Adjustmentof External & Prudent Sustaina 1980s Policies Debt OPEC’s To bility Debt & Absorption Borrow Dilemma Savings Problem
    • When is it Prudent to Borrow ?1. If it’s to finance what’s expected to be short-term current account deficit so as to avoid disruption of production and employment. i.e. smoothen out consumption of imports over a short term.2. And for Long-term, external debt accumulation must contribute to either foreign exchange savings or earnings-consider Import substitution and export promotion(recall, chapter 10)3. If external debt is to be directed towards productive investments that expand output of tradable goods and services that can generate foreign exchange required to pay borrowed funds-self liquidating.4. If its to finance infrastructure that can contribute to greater export earnings or import substitution production by lowering costs Key IssueThe undertaking should generate (exportation) or save (import substitution)foreign exchange sufficient to pay down both the principal and interest on theexternal loan over the its life time!
    • When is it Prudent to Borrow ?Betterstill,there is no guarantee of Transformation or achievement of theabove.Why?  Ineffective use of external debt.e.g military expenditure  World prices might fall-Mexican Dilemma!  Emergence of better exporters  Inefficiencies may arise-decline in labour productivity, increase in capital output ratios e.g. Incremental capital output ratios (ICOR) of countries which had borrowed either remained the same (South Korea) or rose substantially-Philippines, Argentina, and Morocco-World Bank!Caution• External borrowing should be approached consciously otherwise future growth and development prospects can be compromised• It should be based on conservative projections i.e. based on the assumption that future prices of exports & imports will be lower even lower than the current prices- Mexican Dilemma!Key issue: External borrowing should not be the wayforward!
    • External Petrodollar When Is Origins of BorrowingOverview Recycling It Debt 1970s- Adjustmentof External & Prudent Sustaina 1980s Policies Debt OPEC’s To bility Debt & Absorption Borrow Dilemma Savings Problem
    • Debt sustainabilityDebt sustainabilityIt is the ability of a debtor country to continue meeting its debtobligations on a continuous basis without going into default.Determinants of external debt sustainability1. Nominal interest rate on external debt2. Nominal growth in export earnings(foreign exhange)Circumstances under which the external debt is sustainable1. When the average nominal growth in foreign exchange earnings is greater than the nominal interest rate on the debt.2. Case of existence of a surplus on the capital and financial account.
    • External Petrodollar When Is Origins of BorrowingOverview Recycling It Debt 1970s- Adjustmentof External & Prudent Sustaina 1980s Policies Debt OPEC’s To bility Debt & Absorption Borrow Dilemma Savings Problem
    • External Borrowing, Adjustment Policies, and Savings ?The Twin Deficit and Productive Borrowing Assuming there is no central government deficit, and no debt accumulation S−I=X−M=0 If savings (S) equals investment (I) There will be no trade!!!! S = s(Y/L)L s: saving ratio L= Population Y/L = Per capita income Savings ratio (s) is likely to be smaller the lower per capita income, Y/L, which is typical with low-income countries and thus low levels of total domestic savings (I = Sd + Sf). Domestic savings augmented with foreign resources. And thus the 1st equation becomes: Sd − I = X − M < 0 since Sd − I = −Sf, which is negative for all Sf > 0
    • Debt Service Obligation: The Real Cost of Debt Repayment Debt Service Ratio and the Debt Burden
    • Current Account Deficits in Developing Countries- Source: World Bank,World Bank Development Indicators, own calculations
    • Debt 1980s Debt Longer Term Overhang1980s Crisis Efforts to & GraphicalDebt International Overcome Future ExplanationsCrisis Banking the Debt Economic Sector Crisis Growth
    • The 1980s Debt Crisis1980s Debt Crisis…• Originates from 1970s unsustainable debt accumulation• Debt Accumulation was based on availability of funds from OPEC• It started in August 1982 when Mexico anounced suspension of scheduled debt payment ( Moratorium) for which other countries followed.
    • The 1980s Debt CrisisWhat set off 1980 Debt Crisis that threatend the stability of the financial markets ?• By mid 1982 , the private international banks had dramatically begun reducing their lending (petro-dollar recyling) to sovereign borrowers. Why ? Slowdown in the growth rates of the international economy ( Inflation in the US and UK triggerd the application of stringent monetary policies and which led to recession) Recession resulted into declines in income and subsequently imports from Less Developed Countries Decline in export earnings of LDC’s ! Yet Less Developed Countries were using this money for debt repayment, import expenditure and very little for productive uses
    • The 1980s Debt Crisis – Causality and Reasons What exactly happened ? Loan window of the private Debtor nations faced with Without access to new loans banks closed because of a daunting foreign debtor nations were faced with recession related reasons exchange crisis difficult decissions Countries’ import Transformation would occur spending was now limited • Continuing to service pastprimarily by repressing import to the export earnings. debt spending . Yet exports could not be • Maintaining previous import expanded rapidly levels•Lower current living standards IMF and US Treasury forced Debtor countries declared large banks into involuntary•Lower GDP (Critical inputs for moratarium lending to avoid collapse ofdomestic industry affected bycutbacks) international financial system
    • Debt 1980s Debt Longer Term Overhang1980s Crisis Efforts to & GraphicalDebt International Overcome Future ExplanationsCrisis Banking the Debt Economic Sector Crisis Growth
    • The 1980s Debt Crisis – International Banking Sector Majority of total borrowed funds provided by private banksPeriod 1: Over-lending Higher interest rates Shorter repayment schedules Impending crisis !!Period 2: Under-lending Lower interest ratesLonger repayment schedulesInvoluntary lending with the assistance ofIMF and US TreasuryBridge loans for continued debtrepayment
    • The 1980s Debt Crisis – International Banking Sector Downgrade
    • Debt 1980s Debt Longer Term Overhang1980s Crisis Efforts to & GraphicalDebt International Overcome Future ExplanationsCrisis Banking the Debt Economic Sector Crisis Growth
    • Longer Term Efforts to Overcome Debt Crisis1) Involuntary Lending by private banks2) Lengthening maturities of commercial loans3) Reducing Interest Rates4) Capitalizing overdue payments by adding them to the principle value of loans5) Turning loans into long term bonds6)Debt Swaps • An indebted country trades something of value to a holder of its debt in return for a reduction or even a cancellation of some of the countries’ external debt  Debt for equity swap ( e.g giving a share in a SOE through privatization)  Debt for nature swap ( could be purchased in the secondary debt markets by NGO’s, e.g WWF)7) Writing Downs / Cancellation Multilateral (e.g., World Bank, IMF loans) and bilateral (e.g.,governmet-to-government ) loans were easier to reschedule or cancel
    • Debt 1980s Debt Longer Term Overhang1980s Crisis Efforts to & GraphicalDebt International Overcome Future ExplanationsCrisis Banking the Debt Economic Sector Crisis Growth
    • Debt Overhang and Future Economic Growth• Debt Overhang: A situation where a debt stock of a country exceeds its future capacity to repay it.• Countries accumulated a lot of debt with poor economic policy decissions compromising growth.  Many Countries in Latin America and Sub-Saharan Africa accumulated large external debt in the 1970s to finance unsustainable CA deficits (Lost Decade)• Debt overhang inversely effected investment decissions of both domestic and foreign investors, which led reduced economic growth (Expectations towards increased tax rates in the future)
    • Debt Overhang and Future Economic Growth• Debt overhang of accumulated external debt and its repayment blocked the transformation towards more sustainable ,productive, efficient economy  Hampers formation of human capital & technology acquisition capabilities• Countries like Korea and India managed to increase their investment rates thus increasing export revenues• Countries like Sudan, Tanzania and Zimbabwe do not have optimistic future to pay their debts despite the extraordinary efforts by the international community to delay repayments.
    • Debt Overhang and Future Economic Growth Debt burden Ratio (D/X)Despite the attempts , the debt ratio is still high
    • Debt 1980s Debt Longer Term Overhang1980s Crisis Efforts to & GraphicalDebt International Overcome Future ExplanationsCrisis Banking the Debt Economic Sector Crisis Growth
    • External Debt Stocks (% of GNI) in Developing Countries (1982 & 2009) Graph 1 Graph 2 Source: World Bank,World Bank Development Indicators, own calculations
    • External Debt Stocks (% of GNI) in Heavily Indebted Poor Countries (1982 & 2009) Mauritania Somalia Nicaragua Cote dIvoire Togo Guinea-Bissau Liberia Zambia Gambia, The Congo, Rep. Sudan Malawi Honduras Mali Comoros 2009 Bolivia Senegal 1982 Benin Madagascar Sierra Leone Niger Ethiopia Uganda Cameroon Congo, Dem. Rep. Ghana Central African Republic Chad Burkina Faso Rwanda 0 50 100 150 200 250 300 Source: World Bank,World Bank Development Indicators, own calculations
    • Current Account Balance (% GDP) in Developing Countries- 2010  Majority still have CA deficits Likeliness of continous external debt accumulation is high Source: World Bank,World Bank Development Indicators, own calculations
    • External Debt Stocks (% of GNI)- Source: World Bank Development Indicators, 2011
    • Interest Payments on External Debt (% of GNI) Source: World Bank Development Indicators, 2011-
    • Manufactured Exports (% of Merchandise exports) Source: World Bank Development Indicators, 2011-
    • Conclusions• The rapid build up of the debt was mostly due to OPEC‘s price hikes• Much of the external debt was owed to private commercial banks• Most economies borrowed for wrong reasons / unproductive use• Many economies continue to suffer from some degree of debt overhang and current account deficits• If countries have to borrow, a lot of conciousness and consertiveness need to be taken inorder not to hamper future growth of a country.Note:• Achieving development is more than External borrowing alone.It entails more complementary factors as discussed in the several chapters like education and moreso the political will by leaders and citizens of the respective countries to achieve development.
    • Thank you
    • ReferencesCypher&Dietz,2009, ‘’Debt Problem and Development’’ , The Process of Economic Development .Todaro & Smith,2009 ‘’ Economic DevelopementAn Examination of Banking Cases of the 1980s and early 1990s, Volume 1