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Public Debt, Fiscal Solvency and Macroeconomic Uncertainty in Latin America: the Cases of Brazil, Colombia, Costa Rica and Mexico.
The ratios of public debt as a share of gdp of Brazil, Colombia and Mexico
were 12 percentage points higher on average during the period 1996-2005 than in
the period 1990-1995. Costa Rica’s debt ratio remained stable but at a high level;
near 50 per cent. Is there reason to be concerned about the solvency of the public
sector in these economies? We provide an answer to this question based on the
quantitative predictions of a variant of the framework proposed by Mendoza and
Oviedo (2007). This methodology yields forward-looking estimates of debt ratios
that are consistent with fiscal solvency, for a government that faces revenue uncertainty
and can issue only non-state-contingent debt. In this environment, aversion
to a collapse in outlays leads the government to respect a “natural debt limit”
equal to the annuity value of the primary balance in a “fiscal crisis”. A fiscal crisis
occurs after a long sequence of adverse revenue shocks, and public outlays adjust
to their tolerable minimum. The debt limit also represents a credible commitment
to remain able to repay even in a fiscal crisis. The debt limit is not, in general, the
same as the sustainable debt, which is driven by the probabilistic dynamics of the
primary balance. The results of a baseline scenario question the sustainability of
current debt ratios in Brazil and Colombia, while those in Costa Rica and Mexico
are inside the limits consistent with fiscal solvency. In contrast, current debt ratios
are found to be unsustainable in all four countries for plausible changes to lower average growth rates or higher real interest rates. Moreover, sustainable debt ratios fall sharply when default risk is taken into account.
were 12 percentage points higher on average during the period 1996-2005 than in
the period 1990-1995. Costa Rica’s debt ratio remained stable but at a high level;
near 50 per cent. Is there reason to be concerned about the solvency of the public
sector in these economies? We provide an answer to this question based on the
quantitative predictions of a variant of the framework proposed by Mendoza and
Oviedo (2007). This methodology yields forward-looking estimates of debt ratios
that are consistent with fiscal solvency, for a government that faces revenue uncertainty
and can issue only non-state-contingent debt. In this environment, aversion
to a collapse in outlays leads the government to respect a “natural debt limit”
equal to the annuity value of the primary balance in a “fiscal crisis”. A fiscal crisis
occurs after a long sequence of adverse revenue shocks, and public outlays adjust
to their tolerable minimum. The debt limit also represents a credible commitment
to remain able to repay even in a fiscal crisis. The debt limit is not, in general, the
same as the sustainable debt, which is driven by the probabilistic dynamics of the
primary balance. The results of a baseline scenario question the sustainability of
current debt ratios in Brazil and Colombia, while those in Costa Rica and Mexico
are inside the limits consistent with fiscal solvency. In contrast, current debt ratios
are found to be unsustainable in all four countries for plausible changes to lower average growth rates or higher real interest rates. Moreover, sustainable debt ratios fall sharply when default risk is taken into account.