Emerging countries have not necessarily stood out through a significant increase in their public debt ratios in the 2000s. That said, over the last few years, some of them have seen a worrying rise in their debt ratio. This is true for South Africa in particular, but also Russia, whereas other countries have embarked on a much healthier trajectory (Turkey or the Philippines for example). Here, we intend to examine the factors that have contributed to the public debt dynamics of five countries with varied economic environments, presenting more or less credible budgetary objectives and with different exchange rate risk exposure (see graph 1).1
Health of the public finances: reflection of the quality of the institutions and the economic environment
Even more so than among developed countries, the accumulation over time of sovereign debt is the result of both the quality of the institutions and the underlying economic environment among emerging countries.
The trend in the debt ratio is obviously a reflection of the fiscal policy conducted by the countries via the structural component of the primary balance, which corresponds to the discretionary budgetary measures implemented by the country over time. However, even more so than among developed country peers, emerging countries are characterised by the less well-established credibility of fiscal policies, and the continuation of economic policies that may prove to be less important, especially for countries in a political and institutional transition phase. These characteristics result in higher risk premiums (reflected in the interest rates at which investors – particularly foreign investors – agree to lend, and therefore in the level of the debt burden). This risk premium effect is also increased among emerging countries due to the slower availability of macroeconomic data which is also sometimes less coherent, a shortcoming in the information system that can increase investors’ sentiment of mistrust.
Moreover, apart from the effects of discretionary action by governments, debt dynamics are also subjected to the effects of the economic environment. As in the case of developed countries, buoyant activity is at the origin, via the cyclical component of the primary balance, of higher public revenues and less expenditure (even if automatic stabilisers such as unemployment are less significant than among developed countries). Furthermore, buoyant activity will be favourable to the debt ratio dynamics via the denominator effect. However, even more so than in developed countries, emerging countries’ debt will also be the result of: i) on the one hand, the trend in the price of commodities (which constitute a substantial proportion of revenues for some producing countries whose economy is not sufficiently diversified); ii) on the other hand, exchange rate fluctuations (for countries particularly exposed in terms of the proportion of currency-denominated sovereign debt). In this respect, it is noticeable that there is a significant correlation for the mentioned countries between exchange rate fluctuations and sovereign debt exposure to foreign currencies, with the least exposed countries being precisely those whose currency has undergone substantial depreciation in recent years (Brazil and Russia are for example less exposed, in contrast to the Philippines which is more exposed but whose currency has tended to appreciate in recent years, see graph 2).
What are the factors explaining the debt dynamics among emerging countries?
Whereas for developed countries, the trend in the public debt is often presented as being the result of the primary balance, the interest rate/growth rate differential and stock-flow adjustments (or the difference in the debt stabilising balance and stock-flow adjustments), it is important, among emerging countries that are more exposed to exchange rate variations, to break down the debt burden into its components relative to debt denominated in local currency and in foreign currency. We therefore typically consider the trend in the debt ratio as:
Where it, gt, pbt and ƒt represent respectively the real interest rate, the real GDP growth, the primary balance and stock-flow adjustments (which correspond to the difference between public deficit and change in debt, in particular to acquisitions of financial assets, to loans2 or the realisation of contingent liabilities such as the call of debts guaranteed by the government). Among emerging countries in particular, negative stock-flow adjustments may primarily correspond to episodes of debt relief and positive stock-flow adjustments reflect the country’s intention to implement subsidies to the economy without however causing a deterioration in the public deficit (via capital injections for example).
For emerging countries, we can attempt to break down the interest rate, by considering that the interest rate at which a government finances itself is dependent on the allocation key between local and foreign currency denominated debt and the respective interest rates on these two types of debt. This breakdown leads to a debt ratio that is likely to evolve due to five terms: the debt burden denominated in local currency, the debt burden in foreign currencies (to which is added the change in the value of debt stock denominated in foreign currency due to changes in the exchange rate), the growth effect (i.e. the “denominator” effect), the effect of the primary balance (i.e. of the fiscal policy) and stock-flow adjustments. It is worth noting that, here, stock-flow adjustments are calculated as the difference between the total change in the debt ratio from one year to another and the contribution of the terms related to the debt burden, changes in the exchange rate, growth and the primary balance3 (i.e. as the residual).
Each sovereign debt has its specific features
Debt ratio dynamics have proved to be very disparate over the last five years for the countries on which we focus. Turkey and the Philippines (characterised by a primary balance surplus and very dynamic activity) have seen their debt ratio decline significantly, whereas South Africa, Russia and Brazil (more recently) have experienced a dynamic, significant upward trajectory driven by albeit different factors.
Turkey and the Philippines saw their debt ratio decline respectively from 42% to 32% of GDP and from 43% to 37% of GDP between 2010 and 2015. For both these countries, this decline can be explained mainly by substantial growth in GDP, which is at the origin of a favourable denominator effect on the debt ratio, and by a significant primary balance surplus. In addition, both these countries benefit from a relatively contained debt burden:
In contrast, South Africa, Brazil and Russia saw their debt ratio increase respectively from 35% to 50% of GDP, from 63% to 74% of GDP and from 11% to 18% of GDP between 2010 and 2015. However, this debt dynamic can be explained by different factors, specific to each of these countries:
Ultimately, it therefore emerges that the debt of these countries, and emerging countries generally, is the result of very different situations, depending not only on the economic situation within each country, but also the ability of these countries to implement both an effective fiscal policy and convince the markets of their credibility (in local or in foreign currency) but also control exchange rate fluctuations via a resolute monetary policy (to avoid the explosion of the debt burden in foreign currency, if the country is exposed to
1 For a prospective study presenting stochastic simulations of emerging countries' medium-term public debt trajectories, see "Which lever can enhance sustainability in emerging market countries ? A stochastic approach to better grasp public debt dynamics", Amundi Working Paper WP-53-2016.
2 These financial transactions result in an increase in gross public debt but are not considered as an expense since they are the counterpart of an increase in financial assets.
3 Accordingly, stock-flow adjustments do not include changes in the foreign currency debt value due to fluctuations in the exchange rate, since this term is isolated in this breakdown.