Public debt and risk premium: An analysis from an emerging economy


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This Slide is based on a paper which studies the public debt to GDP ratio, the economic policies which can stabilize it and the role of this ratio in controlling the risk premium of treasury bill and finally stabilizing the whole economy and avoiding the economic crisis to happen. It studies the economy of Brazil and takes it as a good sample of developing country which uses Inflation targeting as the monetary policy and has been having budget surplus rather than budget deficit for a very long time.

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Public debt and risk premium: An analysis from an emerging economy

  1. 1. Public debt and risk premium: An analysis from an emerging economy by Helder Ferreira de Mendonça , Marcio Pereira Duarte Nunes[1] This powerpoint presentation is done by “Farhad Hafez Nezami” Assumption University of Thailand
  2. 2. Outline • Introduction – Fiscal policies,Public debt and Risk Premium, Introduction – Literature review – Conceptual framework • Models and method – Methodology – Results • Conclusion – Implication and Recommendation – Conclusion • References
  3. 3. Fiscal policies,Public debt and Risk Premium, Introduction • Definition- What is Public Debt ? • In economics, the debt-to-GDP ratio is one of the indicators of the health of an economy. • Importance of Public debt / GDP ratio : IMF is concerned about high Public debt and suggests the governments to lower the public debt/GDP ratio even if higher public debt is a mechanism to stimulate the economy after the crisis. • Government Bonds , Risk Premium, Refinancing Risk & Bond maturity, Wealth effect. • Brazil as a Model (a member of BRIC, performing Inflation Targeting). • Brazil as a sample and model has tried for a budget surplus rather than deficit even at the time of crisis. (Historically, from 1998 until 2011, Brazil Government Budget averaged 2.06 Percent of GDP) [2]
  4. 4. Literature Review • • • • According to Giavazzi and Pagano (1990) there exists a negative relation between average maturity of public debt and the determination of the interest rate. (Approved according to this paper also) According to Calvo et al. (1993) and Calvo (2002) the risk premium in emerging economies is a result of the behavior of international variables. (Not approved accrding to this paper at least for Emerging Economies) IMF strongly warns the governments about The crisis and associated increases in fiscal deficits [3]. According to this paper, risk premium is cause by domestic variables. Also it suggests that applying a fiscal surplus and efficient management of public debt leads to reduction of risk premium and stablizing the economy.
  5. 5. Conceptual framework Public debt Departure of inflation from target International variables Output Gap No effect GDP Long term Debt Short term Debt Ratio Treasury risk premium low Stabilizing the economy High Refinancing risk Crisis Budget surplus
  6. 6. Methodology according to the fact that the fiscal authorities cannot increase the public debt over time in growing rates because of the risk of entering on an explosive path, there is a constraint imposed by the private demand for Treasury bonds, that is: is the maximum private demand for Treasury bonds at t is the amount of Treasury bonds held by private sector
  7. 7. Research result • unit-root tests : As this study is based on time series, the first step is to verify if the series have unit root (Augmented Dickey-Fuller – ADF and Phillips-Perron PP). • Result : Except for the public debt/GDP ratio that is I(1), all series are I(0). • • • • Both exchange rate and risk premium are exogenous. In regard to the risk premium the outcome is sensitive to the number of lags applied. Hence an ADL model is estimated to find the elasticities. Hausman test is performed with the objective of testing the exogeneity of the variables. Our set of data : Public debt/GDP ratio (D), is the country risk, Primary surplus (S), Exchange rate (Ex), output gap, Departures of inflation - – IPCA (official price index). Result : – The highest elasticity belongs to the public debt/GDP ratio (average elasticity is close to 0.13). – The items “departure of inflation from target” and “ouput gap” also lead to lower risk premium with a lower elasticity (average is close to 0.02 in both cases). – The result of Exchange rate is not significant to the risk premium.
  8. 8. Implication and Recommendation With regard to this paper and the results, we understand the importance of Public debt to GDP ratio and the effect of lower ratio in reducing the Premium Risk of treasury bill. This is exactly what IMF is very much concerned about, a higher debt to GDP ratio leads to higher Premium Risk of Government Bonds, and can be a major reason to another crisis. But there are 2 main factors in this paper : 1- this research and the results are based on emerging economies like Brazil which can be applied to developing countries as well. But for industrialized country the results might be different 2- the high amount of government debt is not a big deal but it must be compared to the GDP amount. Countries can focus on Managing their budget and fiscal policies to have surplus rather than deficit although it may be in order to stimulate the economy to get out of the crisis. But however the Brazil successful case shows that fiscal surplus can be effective to high extent.
  9. 9. Conclusion • In this study treasury risk premium is defined as a measure of credibility of fiscal policies to stabilize the economy. • The theoretical model developed in the paper shows that the risk premium is determined by public debt, primary surplus, departures of inflation from its target and the output gap. • This paper almost rejects the arguments of Calvo et al. (1993) and Calvo (2002) about the effect of international variables affecting the risk premium. • The paper approves the findings of Giavazzi and Pagano (1990) that there is a negative relation between average maturity of public debt and the determination of the interest rate. • According to the findings, paper suggests that the use of primary surplus targets is an adequate mechanism to reduce the Treasury bond risk premium.
  10. 10. References 1. Public debt and risk premium An analysis from an emerging economy By Helder Ferreira de Mendonca and Marcio Pereira Duarte Nunes 2. Brazil Government Budget. 3. INTERNATIONAL MONETARY FUND Strategies for Fiscal Consolidation in the PostCrisis World Prepared by the Fiscal Affairs Department
  11. 11. Farhad Hafez Nezami ID : 5519582 Email :