This powerpoint presentation summarizes a document analyzing the relationship between public debt, risk premium, and fiscal policies in emerging economies. It finds that higher public debt to GDP ratios are associated with higher risk premiums on government bonds. Primary budget surpluses and managing debt maturity levels were found to help reduce risk premiums. The results supported the idea that domestic economic factors mainly drive risk premiums in emerging markets, unlike some previous studies that found international variables were key drivers. The presentation concludes that maintaining primary budget surpluses is an effective mechanism for emerging economies to stabilize their economies and reduce bond risk premiums.

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. 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. 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. 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. 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. 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. 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. 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. 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. References
1. Public debt and risk premium An analysis from an emerging economy By Helder
Ferreira de Mendonca and Marcio Pereira Duarte Nunes
http://www.emeraldinsight.com/0144-3585.htm
2. Brazil Government Budget.
http://www.tradingeconomics.com/brazil/government-budget
3. INTERNATIONAL MONETARY FUND Strategies for Fiscal Consolidation in the PostCrisis World Prepared by the Fiscal Affairs Department
http://www.imf.org/external/np/pp/eng/2010/020410a.pdf

11. Farhad Hafez Nezami
ID : 5519582
Email : hafeznezami.farhad@gmail.com