External debt management, classification of external debt ...

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External Debt Management , External Debt Management , Classification of External Debt Classification of External Debt Crises. and Indicators Crises. and Indicators -first presentation- -first presentation- Aug 30, 2005 Aug 30, 2005 Dr. Sayuri SHIRAI Dr. Sayuri SHIRAI http://www.paw.hi-ho.ne.jp/~sshirai http://www.paw.hi-ho.ne.jp/~sshirai 1

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Transcript of External debt management, classification of external debt ...

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External Debt Management ,External Debt Management ,Classification of External Classification of External

Debt Crises. and IndicatorsDebt Crises. and Indicators

-first presentation--first presentation-Aug 30, 2005Aug 30, 2005

Dr. Sayuri SHIRAIDr. Sayuri SHIRAIhttp://www.paw.hi-ho.ne.jp/~sshiraihttp://www.paw.hi-ho.ne.jp/~sshirai

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Two Main External Debt Two Main External Debt IssuesIssues   

1. Economic Crises in Low-income developing countries1. Economic Crises in Low-income developing countries IMF and World Bank as a provider of concessionary loaIMF and World Bank as a provider of concessionary loa

ns (PRGF, IDA)ns (PRGF, IDA) Main issue: macroeconomic problems together with the Main issue: macroeconomic problems together with the

quality of governance and institutionsquality of governance and institutions Millennium Development Goals, HIPCs, Debt reliefMillennium Development Goals, HIPCs, Debt relief

22. . Economic Crises in Emerging Market Economies (East AsEconomic Crises in Emerging Market Economies (East Asia of 1997-99, Russia in 1998, Brazil in 1999, Argentinia of 1997-99, Russia in 1998, Brazil in 1999, Argentina in 2001)a in 2001)

IMF and World Bank provide non-concessionary loans IMF and World Bank provide non-concessionary loans Regional initiatives in Asia (AMF, New Miyazawa InitiativRegional initiatives in Asia (AMF, New Miyazawa Initiativ

e)e) Main issue: severity of crises, contagion of crisesMain issue: severity of crises, contagion of crises

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Various External Debt Crises Various External Debt Crises Since the 1990sSince the 1990s

Current Account Crisis (developing Current Account Crisis (developing countries)countries)

Capital Account Crisis (emerging market Capital Account Crisis (emerging market economies)economies)

Commonality: Commonality: Fixed Exchange Rate Regime Fixed Exchange Rate Regime Large Current Account Deficit Large Current Account Deficit Substantial External Debt Substantial External Debt 3

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Recent Crises in Emerging Recent Crises in Emerging Market and Developing Market and Developing

CountriesCountries••Mexican Crisis of 1994-1995Mexican Crisis of 1994-1995

••East Asian Crisis of 1997-1998East Asian Crisis of 1997-1998

••Russian Crisis of August 1998Russian Crisis of August 1998

••Brazilian Crisis of January 1999Brazilian Crisis of January 1999

••Argentina Crisis of December 2001 Argentina Crisis of December 2001 4

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Classification of External Debt Classification of External Debt Crises is ImportantCrises is Important

Different policy prescriptions are necessaryDifferent policy prescriptions are necessary

Understanding IMF criticism and better international finUnderstanding IMF criticism and better international financial architecture to prevent crises ancial architecture to prevent crises

=> massive, immediate financial support and banking se=> massive, immediate financial support and banking sector soundness (SRF, CCL, CACs, SDRM)ctor soundness (SRF, CCL, CACs, SDRM)

=> better poverty-oriented development strategies (PRS=> better poverty-oriented development strategies (PRSP, donor coordination over ODA increase and external dP, donor coordination over ODA increase and external debt relief, MDGs) ebt relief, MDGs)

Different external debt management skills are necessaDifferent external debt management skills are necessary (private debt versus sovereign debt)ry (private debt versus sovereign debt)

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Types of External Debt CrisesTypes of External Debt Crises

Capital AccountCrisis(East Asia)

Current Account Crisis (Developing Countries)

Russia, Brazil Argentina

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New Environment Related to New Environment Related to the East Asian Crises of 1997-the East Asian Crises of 1997-

9898(1) Liberalization of domestic financial market (e.g., interest (1) Liberalization of domestic financial market (e.g., interest rate deregulation, entry deregulation) + Liberalization of rate deregulation, entry deregulation) + Liberalization of international capital flows + Technology development + international capital flows + Technology development + New Financial Assets New Financial Assets

=> Market-determined interest rates=> Market-determined interest rates(2) Borrowers: Public (fiscal deficit, small domestic savings) (2) Borrowers: Public (fiscal deficit, small domestic savings)

=> Private => Contingent liability=> Private => Contingent liability

(3) Creditors: Public => Private (syndicate) => Private (3) Creditors: Public => Private (syndicate) => Private (investors)(investors)

(4) New risk: (a) Shortened debt maturity (private) => volatile (4) New risk: (a) Shortened debt maturity (private) => volatile and speculative capital flows => frequent speculative and speculative capital flows => frequent speculative currency attacks; (b) Enlarging asset price volatility + currency attacks; (b) Enlarging asset price volatility + excessive excessive

risk-taking => balance sheets of banks and firmsrisk-taking => balance sheets of banks and firms 7

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Capital Account CrisisCapital Account Crisis New type of crises driven by capital New type of crises driven by capital

flowsflows

Good macroeconomic performanceGood macroeconomic performance

Massive capital Inflows => accumulation Massive capital Inflows => accumulation of foreign reserves (BOP surplus)of foreign reserves (BOP surplus)

Investors’ sentiment matters Investors’ sentiment matters 8

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Current Account CrisisCurrent Account Crisis Inappropriate Macroeconomic PoliciesInappropriate Macroeconomic Policies Fiscal Deficit => Monetization + External DebtFiscal Deficit => Monetization + External Debt=> Inflation + Current Account Deficit => Inflation + Current Account Deficit

(S-I)g + (S-I)p = Current Account < 0(S-I)g + (S-I)p = Current Account < 0 oror(Income – Absorption) = Current Account < 0(Income – Absorption) = Current Account < 0

=> Foreign Reserves Shortage + Real => Foreign Reserves Shortage + Real AppreciationAppreciation

=> IMF rescue with conditionality=> IMF rescue with conditionality 9

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For a Country Prone to the For a Country Prone to the Current Account Crisis, Current Account Crisis,

(Domestic and foreign) public debt management(Domestic and foreign) public debt management is very important because:is very important because:

(1) Government debt portfolio tends to be the (1) Government debt portfolio tends to be the largestlargest

(2) Public sector default often leads to a sharp (2) Public sector default often leads to a sharp curtailment of capital flows, while that of the curtailment of capital flows, while that of the private sector does not necessarily indicate an private sector does not necessarily indicate an external crisis external crisis

(3) Public debt problems often generate substantial (3) Public debt problems often generate substantial risk not only to the government’s balance sheet, risk not only to the government’s balance sheet, but also to the country’s financial stabilitybut also to the country’s financial stability 10

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Purpose of Public Debt Purpose of Public Debt ManagementManagement Public debt management = the process of establishing and executing a stratePublic debt management = the process of establishing and executing a strate

gy for managing the government’s (external and domestic) debt to gy for managing the government’s (external and domestic) debt to (1) raise the required amount of funding, (1) raise the required amount of funding, (2) achieve its risk and cost objectives, and possibly, (2) achieve its risk and cost objectives, and possibly, (3) develop an efficient market for government securities(3) develop an efficient market for government securities

In a macroeconomic context, the level and rate of growth in public debt should In a macroeconomic context, the level and rate of growth in public debt should be be sustainable and can be servicedsustainable and can be serviced under various circumstances, while meeti under various circumstances, while meeting cost and risk objectives. ng cost and risk objectives.

A country should adopt and maintain a A country should adopt and maintain a crediblecredible debt strategy to reduce exces debt strategy to reduce excessive levels of debt and be aware of the impact of government financing requiresive levels of debt and be aware of the impact of government financing requirements and debt levels on borrowing costsments and debt levels on borrowing costs

Public debt covers both marketable debt and non-market debt (concessional fiPublic debt covers both marketable debt and non-market debt (concessional financing); domestic and foreign currency borrowings; and off-balance sheet clainancing); domestic and foreign currency borrowings; and off-balance sheet claims, including contingent liabilitiesms, including contingent liabilities

In many developing countries, external debt management is more In many developing countries, external debt management is more important than domestic oneimportant than domestic one

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Public Debt Management and Public Debt Management and Macroeconomic PolicyMacroeconomic Policy

Sound public debt management cannot be a substitute for Sound public debt management cannot be a substitute for sound macroeconomic policiessound macroeconomic policies

Sound public debt management is not enough to ensure Sound public debt management is not enough to ensure that a country is well insulated from economic and financial that a country is well insulated from economic and financial shocksshocks

Macroeconomic policy framework covers appropriate Macroeconomic policy framework covers appropriate exchange rate regime, a monetary policy framework, a exchange rate regime, a monetary policy framework, a sound external position, a well-supervised financial systemsound external position, a well-supervised financial system

Sound macroeconomic policy is essential to foster Sound macroeconomic policy is essential to foster confidence among financial market participants so that they confidence among financial market participants so that they are willing to invest in government securities with a are willing to invest in government securities with a minimum of uncertaintyminimum of uncertainty

However, having sound public debt management is closely However, having sound public debt management is closely associated with her ability to absorb various shocksassociated with her ability to absorb various shocks

Risky debt management practices increase the vulnerability Risky debt management practices increase the vulnerability of the economy to economic and financial shocksof the economy to economic and financial shocks 12

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Solvency and LiquiditySolvency and Liquidity An entity is An entity is solventsolvent if the present discounted value (PDV) if the present discounted value (PDV)

of its current and future primary expenditure (E) is no of its current and future primary expenditure (E) is no greater than the PDV of its current and future path of greater than the PDV of its current and future path of income (Y), net of any initial indebtedness. income (Y), net of any initial indebtedness.

An entity is An entity is illiquidilliquid if (regardless of whether it satisfies the if (regardless of whether it satisfies the solvency condition) its liquid assets and available financing solvency condition) its liquid assets and available financing are insufficient to meet or roll-over its maturing liabilitiesare insufficient to meet or roll-over its maturing liabilities

The distinction between solvency and liquidity is The distinction between solvency and liquidity is ambiguous because illiquidity may be manifested in rising ambiguous because illiquidity may be manifested in rising interest rates which eventually calls into question the interest rates which eventually calls into question the entity’s solvency. entity’s solvency. 13

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Sustainability and Sustainability and VulnerabilityVulnerability

It is useful to define sustainability and vulnerability instead of It is useful to define sustainability and vulnerability instead of solvency and liquiditysolvency and liquidity

An entity’s liability is An entity’s liability is sustainablesustainable if it satisfies the present value if it satisfies the present value budget constraint without a major correction of income and budget constraint without a major correction of income and expenditure given the costs of financingexpenditure given the costs of financing

Debt sustainability rules out any of the following:Debt sustainability rules out any of the following:(a)(a) A debt restructuring is already needed (or expected to be needed); A debt restructuring is already needed (or expected to be needed); (b)(b) A borrower keeps on indefinitely accumulating debt faster than its A borrower keeps on indefinitely accumulating debt faster than its

capacity to service these debts is growing;capacity to service these debts is growing;(c)(c) A borrower lives beyond its means by accumulating debt in the A borrower lives beyond its means by accumulating debt in the

knowledge that a major retrenchment will be needed to service knowledge that a major retrenchment will be needed to service these debtsthese debts

The interest rate is a factor influencing debt accumulation and The interest rate is a factor influencing debt accumulation and sustainabilitysustainability

Sustainability incorporates the concepts of solvency and of Sustainability incorporates the concepts of solvency and of liquidity, without making a sharp demarcation between themliquidity, without making a sharp demarcation between them

VulnerabilityVulnerability refers to the risk that the liquidity or solvency refers to the risk that the liquidity or solvency conditions are violated and the borrower enters a crisisconditions are violated and the borrower enters a crisis

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Fiscal SustainabilityFiscal Sustainability Assessment of a variety of measures of the fiscal deficit and public Assessment of a variety of measures of the fiscal deficit and public

sector debt, as well as ratios such as public debt-to-GDP ratiossector debt, as well as ratios such as public debt-to-GDP ratios e.g. overall deficit excluding net interest payments (called the e.g. overall deficit excluding net interest payments (called the

primary fiscal balanceprimary fiscal balance) /GDP, revenue/GDP, and expenditure/GDP, ) /GDP, revenue/GDP, and expenditure/GDP, (primary balance-unrequited grants-privatization receipts)/GDP(primary balance-unrequited grants-privatization receipts)/GDP

Debt dynamics equation: Debt dynamics equation: => The debt (D) at t+1 period is defined as the difference between => The debt (D) at t+1 period is defined as the difference between

debt at t period plus interest minus net debt creating component debt at t period plus interest minus net debt creating component of fiscal deficit (TB).of fiscal deficit (TB).

=> When this equation is rewritten in terms of GDP, it would be => When this equation is rewritten in terms of GDP, it would be expressed by expressed by

Rearranging the equation yields the next equation for the change Rearranging the equation yields the next equation for the change in the net debt ratio. in the net debt ratio.

where g= real GDP growth, P=inflation, d=GDP ratio, and tb= the debt creating component of the fiscal deficit/GDP 15

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Medium-term projections are also important in the assessment Medium-term projections are also important in the assessment of fiscal sustainabilityof fiscal sustainability

Realistic set of assumptions Realistic set of assumptions e.g., revenue elasticities, revenus from natural resourcese.g., revenue elasticities, revenus from natural resourcese.g., primary expenditure projectionse.g., primary expenditure projections

Projected changes in revenue/expenditure should be based on rProjected changes in revenue/expenditure should be based on revenue/expenditure measures or tangible changes in the enviroevenue/expenditure measures or tangible changes in the environment, not on efficiency gains in tax administration or expenditunment, not on efficiency gains in tax administration or expenditure or revenue windfallsre or revenue windfalls

Financing amounts from each source should be projected with aFinancing amounts from each source should be projected with associated risksssociated risks

Financing plans should be consistent with medium-term monetaFinancing plans should be consistent with medium-term monetary and external sector projections ry and external sector projections

Domestic banking financing should be consistent with movemenDomestic banking financing should be consistent with movements of money demand, deposit growth, and financing needs of prits of money demand, deposit growth, and financing needs of private sectorvate sector

The impact of real exchange rate changes on public debt should The impact of real exchange rate changes on public debt should be a part of the sensitivity testbe a part of the sensitivity test 16

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Financial Sector StabilityFinancial Sector Stability The financial sector is associated with public and external The financial sector is associated with public and external

debt debt The government acts as the ultimate guarantor of the The government acts as the ultimate guarantor of the

financial sector => potentially large contingent liabilities financial sector => potentially large contingent liabilities An unsustainable stock of government debt could cause An unsustainable stock of government debt could cause

broader financial instability because government broader financial instability because government securities often constitute a large share of the assets of securities often constitute a large share of the assets of banksbanks

The importance of financial sector stabilityThe importance of financial sector stability Lowering double mismatches Lowering double mismatches Improving the soundness of the banking sectorImproving the soundness of the banking sector e.g., reducing directed credits to government-targeted e.g., reducing directed credits to government-targeted

industries, overly generous bailing-out of insolvent banks, industries, overly generous bailing-out of insolvent banks, connected lending to associated family firmsconnected lending to associated family firms

e.g., strengthening prudential and supervisory regulations e.g., strengthening prudential and supervisory regulations in terms of CAMEL (Capital adequacy, Asset quality, in terms of CAMEL (Capital adequacy, Asset quality, Management competence, Earnings, and Liquidity) Management competence, Earnings, and Liquidity) 17

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Risks Related to Debt Risks Related to Debt ManagementManagement

Market RiskMarket Risk: Risks associated with changes in market : Risks associated with changes in market prices (such as interest rates, exchange rates, commodity prices (such as interest rates, exchange rates, commodity prices) on the cost of the government’s debt servicingprices) on the cost of the government’s debt servicing

Rollover Risk:Rollover Risk: Risks that debt has to be rolled over at an Risks that debt has to be rolled over at an

unusually high cost or, in extreme cases, cannot be rolled unusually high cost or, in extreme cases, cannot be rolled over over

Liquidity RiskLiquidity Risk: Two types of liquidity risk: Two types of liquidity risk(1)(1) One refers to the cost investors face in trying to exit a One refers to the cost investors face in trying to exit a

position because of the lack of depth of a particular marketposition because of the lack of depth of a particular market(2)(2) Second refers the risk for a borrower when the volume of Second refers the risk for a borrower when the volume of

liquid assets diminish quickly in the face of unanticipated liquid assets diminish quickly in the face of unanticipated cash flow obligations or a difficulty in raising cash through cash flow obligations or a difficulty in raising cash through borrowingborrowing

Credit RiskCredit Risk: Risks of non-performance by borrowers on : Risks of non-performance by borrowers on loansloans 18

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Settlement RiskSettlement Risk: Potential loss that the government suffer : Potential loss that the government suffer as a result of failure to settle by another counterpartyas a result of failure to settle by another counterparty

Operational RiskOperational Risk: Including transaction errors in the : Including transaction errors in the various stages of executing and recording transactions; various stages of executing and recording transactions; inadequacies or failures in internal controls, or in systems inadequacies or failures in internal controls, or in systems and services; reputation risk; legal risk; security breaches; and services; reputation risk; legal risk; security breaches; or natural disasters that affect business activity or natural disasters that affect business activity

=> => Developed countriesDeveloped countries generally focus primarily on generally focus primarily on market riskmarket risk

=> => Emerging market economiesEmerging market economies tend to give higher priority tend to give higher priority to rollover risk. to rollover risk.

=> => Developing countriesDeveloping countries with little access to foreign capital with little access to foreign capital markets and limited domestic debt market tend to raise markets and limited domestic debt market tend to raise funds mainly from governments in advanced countries or funds mainly from governments in advanced countries or international developing financial organizations => thus, international developing financial organizations => thus, their concerns are placed not so much on the afore-their concerns are placed not so much on the afore-mentioned risks, but on the continuation and regularity of mentioned risks, but on the continuation and regularity of flows of concessionary loans and grants.flows of concessionary loans and grants. 19

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Two External Vulnerability Two External Vulnerability IndicatorsIndicators

Indicators of Foreign Reserve Adequacy:Indicators of Foreign Reserve Adequacy:

(1) Ratio of Reserves to Short-term External Debt(1) Ratio of Reserves to Short-term External Debt:: =>Most important indicator of reserve adequacy in countries with =>Most important indicator of reserve adequacy in countries with

significant but uncertain access to capital marketssignificant but uncertain access to capital markets => Positive relationship between this indicator and crisis index=> Positive relationship between this indicator and crisis index => IMF view: the ratio of foreign reserves to economy-wide short-=> IMF view: the ratio of foreign reserves to economy-wide short-

term debt should be 1term debt should be 1

(2) Ratio of Foreign Reserves to Imports(2) Ratio of Foreign Reserves to Imports::=> A useful measure of reserve needs for countries with limited => A useful measure of reserve needs for countries with limited

access to capital marketsaccess to capital markets

(3) Ratio of Foreign Reserves to Broad Money(3) Ratio of Foreign Reserves to Broad Money:: Measures the potential impact of a loss of confidence in the Measures the potential impact of a loss of confidence in the

domestic currency, leading to capital flight by residentsdomestic currency, leading to capital flight by residents Useful if the banking sector is weak and/or credibility of the Useful if the banking sector is weak and/or credibility of the

exchange rate regime remains to be establishedexchange rate regime remains to be established20

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External Debt-Related IndicatorsExternal Debt-Related Indicators(1) Ratio of External Debt to Exports(1) Ratio of External Debt to Exports: : A useful indicator of trend in debt that is closely related to the A useful indicator of trend in debt that is closely related to the

repayment capacityrepayment capacity For the larger emerging market economies, this ratio has positively For the larger emerging market economies, this ratio has positively

impact interest spreads on sovereign bonds. impact interest spreads on sovereign bonds.

(1)’ Ratio of External Debt Service to Exports(1)’ Ratio of External Debt Service to Exports:: Another possible indicator of economy-wide debt sustainabilityAnother possible indicator of economy-wide debt sustainability Debt service includes principal payments and interest paid on both Debt service includes principal payments and interest paid on both

long- and short-term debt. In practice, this ratio often excludes long- and short-term debt. In practice, this ratio often excludes amortization payments on short-term debt from debt service, as a amortization payments on short-term debt from debt service, as a common practice.common practice.

Government and guaranteed debt service is a useful indicator of Government and guaranteed debt service is a useful indicator of government debt sustainability government debt sustainability

(2) Ratio of External Debt to GDP(2) Ratio of External Debt to GDP This stock-based indicator is a useful supplementary indicator of This stock-based indicator is a useful supplementary indicator of

relating to resource base (reflecting the potential of shifting relating to resource base (reflecting the potential of shifting production to exports or import substitutes so as to enhance production to exports or import substitutes so as to enhance repayment capacity). Tax revenue could be also used in exchange of repayment capacity). Tax revenue could be also used in exchange of GDP. These indicators are useful when public debt is predominant, GDP. These indicators are useful when public debt is predominant, since they relate debt to the underlying source of repayment or the since they relate debt to the underlying source of repayment or the country’s tax base.country’s tax base.

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(3) Average Interest Rate on External Debt(3) Average Interest Rate on External Debt A useful indicator of borrowing termsA useful indicator of borrowing terms The indicators (1) (2) suffer from drawbacks (e.g., a single snapshot in time)The indicators (1) (2) suffer from drawbacks (e.g., a single snapshot in time) Useful to report and analyze the average interest rate on the debt alongside Useful to report and analyze the average interest rate on the debt alongside

with the above indicators, as an indicator of concessionality of debt and to awith the above indicators, as an indicator of concessionality of debt and to analyze the impact of changing interest rates on the real debt burdennalyze the impact of changing interest rates on the real debt burden

(4) Average Maturity on External Debt(4) Average Maturity on External Debt: : Useful for homogenous categories such as nonconcesssional public sector dUseful for homogenous categories such as nonconcesssional public sector d

ebt, to track shortening of maturities or efforts to limit future vulnerabilitiesebt, to track shortening of maturities or efforts to limit future vulnerabilities The maturity structure of debt has a profound impact on liquidityThe maturity structure of debt has a profound impact on liquidity Adequately focused measures, such as average maturity by sector and by deAdequately focused measures, such as average maturity by sector and by de

bt category, can usefully be compared over time.bt category, can usefully be compared over time.

(5) Share of Foreign Currency External Debt in Total External Debt(5) Share of Foreign Currency External Debt in Total External Debt: : Useful indicator of the impact of exchange rate changes on debt Useful indicator of the impact of exchange rate changes on debt The balance sheet effects of a depreciating exchange rate vary with the extenThe balance sheet effects of a depreciating exchange rate vary with the exten

t to which the debt is denominated in foreign currencyt to which the debt is denominated in foreign currency If sharp changes occur in the exchange rates in which debt is denominated, If sharp changes occur in the exchange rates in which debt is denominated,

but these are not offset by similar changes on the inflow side (such as exportbut these are not offset by similar changes on the inflow side (such as exports), significant income effects may results), significant income effects may result

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External Debt-Related Indicators for Public, Financial and External Debt-Related Indicators for Public, Financial and Corporate SectorsCorporate Sectors

(1) Public Sector(1) Public Sector:: => Public debt management must ensure that external debt is => Public debt management must ensure that external debt is

serviced while minimizing costs serviced while minimizing costs => Indicators that capture the solvency and liquidity risks associated => Indicators that capture the solvency and liquidity risks associated

with external public debt: public sector debt service ratio, public with external public debt: public sector debt service ratio, public debt/ GDP (and to tax revenue), the average interest rate, various debt/ GDP (and to tax revenue), the average interest rate, various maturity indicators, foreign-currency-denominated or indexed debt , maturity indicators, foreign-currency-denominated or indexed debt , the share of overall short-term and longer-term floating rate the share of overall short-term and longer-term floating rate external debtexternal debt

(2) Financial Sector(2) Financial Sector:: Financial sector vulnerability is a cause for concern as regards Financial sector vulnerability is a cause for concern as regards

external vulnerabilityexternal vulnerability Financial sector is vulnerable because highly leveraged, exposed to Financial sector is vulnerable because highly leveraged, exposed to

maturity mismatch, operate in markets with asymmetric maturity mismatch, operate in markets with asymmetric information, and subject to moral hazard through explicit or implicit information, and subject to moral hazard through explicit or implicit deposit insurance and limited liabilitydeposit insurance and limited liability

Financial sector is vulnerable to the balance sheet effects of Financial sector is vulnerable to the balance sheet effects of changing exchange rates, withdrawal of foreign currency deposits or changing exchange rates, withdrawal of foreign currency deposits or credit lines by foreign banks credit lines by foreign banks

The appropriate prudential indicators include the followingsThe appropriate prudential indicators include the followings(1)(1) Open foreign exchange positionOpen foreign exchange position(2)(2) Foreign currency maturity mismatchesForeign currency maturity mismatches

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(3) Corporate Sector(3) Corporate Sector Individual firm failures should be addressed through Individual firm failures should be addressed through

bankruptcy and resolution systemsbankruptcy and resolution systems However, the organization of the corporate sector However, the organization of the corporate sector

and its financial structure can impact external and its financial structure can impact external vulnerability. vulnerability.

E.g., Overextension of foreign currency financing to E.g., Overextension of foreign currency financing to the corporate sector can lead to widespread the corporate sector can lead to widespread corporate nonpayment corporate nonpayment

Key indicators are the followings:Key indicators are the followings:(1)(1) Net foreign currency cash flow as a ratio to overall Net foreign currency cash flow as a ratio to overall

cash flowcash flow(2)(2) Net foreign currency debt over equityNet foreign currency debt over equity(3)(3) Traditional indicators—such as the coverage of Traditional indicators—such as the coverage of

interest payments by operational cash flow, leverage, interest payments by operational cash flow, leverage, the ratio of short-term to overall debt, returns on the ratio of short-term to overall debt, returns on assets (ROA before tax and interest), and the ratio of assets (ROA before tax and interest), and the ratio of domestic currency versus foreign currency debtdomestic currency versus foreign currency debt 24