Debt sustainability is important in allowing lenders of funds to understand the risk profiles of the countries that they are lending. A country has debt sustainability if the government can meet all its current and future payment obligations without exceptional financial assistance or going into default. Read here to understand the significance of debt sustainability for a country.
A debt instrument is a financial claim that requires payment of interest, principal, or both by the debtor to the creditor at a future date.
Countries incur debt to a wide range of creditors, including private bondholders, banks, other countries and their official lending institutions, and multilateral lenders such as the World Bank.
Countries incur debt by borrowing. Borrowing can enable countries to finance important development programs and projects but, taken too far, the burden of debt repayment can overwhelm a country’s finances, at worst leading to default.
Also read: Public Debt: Overview
A country’s public debt is considered sustainable if the government can meet all its current and future payment obligations without exceptional financial assistance or going into default.
- The definition of public debt varies depending on its purpose. A commonly used narrow definition of public debt covers the budgetary central government.
- A broader definition is the general government (budgetary central government, state, and local government, extrabudgetary units, and social security funds).
To properly assess a country’s debt sustainability, it is important to cover all types of debt that pose a risk to a country’s public finances.
In advanced economies and emerging markets, debt sustainability analysis frequently focuses on the general government.
- However, in low-income countries nearly complete coverage of both public and publicly guaranteed debt is standard.
But sovereign credit rating agencies that focus on the risk of debt distress typically concentrate on market-based external public sector debt.
Debt sustainability analysis
The World Bank Group and the IMF work with low-income countries to produce regular Debt Sustainability Analyses, which are structured examinations of developing country debt based on the Debt Sustainability Framework.
This area of work has three goals:
- Ensure that countries that have received debt relief are on a sustainable development track.
- Allow creditors to better anticipate future risks and tailor their financing terms accordingly.
- Help client countries balance their needs for funds with the ability to repay their debts.
The objective of this analysis is to support efforts by low-income countries to achieve their development goals while minimizing their risk of experiencing debt distress.
- Debt crises are costly to debtors, creditors, and the international monetary and financial system.
- Debt sustainability analysis plays a critical role in guiding borrowing and lending decisions.
Also read: Budget Documents Made Simple
Challenges to Developing Country Debt Sustainability
Since the global financial crisis, economies around the world have become dependent on debt for their growth.
This has encouraged unprecedented global indebtedness, particularly in emerging markets and developing countries which have little control over global trends.
- Within the global financial system, developing countries have a limited number of choices, and proposals for regional and inter-regional monetary and financial cooperation and reliance on directed development banking are set out as a place to start.
- In recent years, developing countries have faced renewed financial stress due to increased and premature connectivity to international financial markets.
- The constraints imposed by a world with policy parameters shaped by unregulated international financial markets are particularly binding on developing countries.
- Unregulated capital inflows can lead to exchange rate appreciation, reducing the competitiveness of the domestic industry and hurting export earnings.
The challenge for the Governments of increasingly vulnerable economies is finding room to maneuver to manage debt sustainably while ensuring growth-inducing expenditure to enhance development.
What developing countries require most is long-term access to foreign demand, and thus reliable export markets to support their emergent domestic growth, and investment to repay external debt.
Developing countries have expanded and opened their domestic financial markets to non-resident investors, foreign commercial banks, and financial institutions prematurely
- They have also allowed their citizens to invest abroad and, many developing country Governments are engaged in raising finance in developed country financial markets.
India’s debt sustainability
The sustainability of public debt is one of the critical issues from the point of view of policymakers.
- Before Independence, the borrowing needs of Indian princely states were largely met by indigenous bankers and financiers.
- The concept of borrowing from the public was pioneered by the East India Company to finance the Anglo-French wars during the 18th century.
- The First World War saw a rise in India’s public debt due to the country’s contribution to the British exchequer.
- The provinces of British India were allowed to float loans for the first time in 1920 when the local government borrowing rules were issued under the Government of India Act, of 1919.
India’s public debt (combined liabilities of the Central and State governments) to gross domestic product (GDP), at constant prices, increased to a record high of 100.86 percent in 2020.
How to make public debt sustainable?
The following measures may be adopted by the government to make public debt sustainable in the medium to long term:
- The government may think of privatizing loss-making public sector undertakings (PSUs).
- The government may run any business if it is socially relevant, technologically feasible, environmentally friendly, economically viable, politically acceptable, legally unassailable, and ethically right.
- It is the government’s responsibility to control fiscal wastefulness and to achieve long-term macroeconomic sustainability through the effective conduct of monetary policy and prudential debt management in a transparent manner.
- As part of better fiscal deficit management, and maintaining enhanced transparency and accountability, the Public Financial Management System (PFMS) should be leveraged to the maximum.
- The government may think of the public-private partnership (PPP) model in social schemes.
- The government needs to focus on investment in infrastructure and human capital.
- GST needs to be harmonized and expanded to other areas to reach a national consensus to improve the tax-GDP ratio.
- The government should create an investor-friendly environment for additional sources of financing to replace the high public debt.
- The government should enhance the efficiency of public debt management by adhering to low cost, risk mitigation, and market development.
- Thrust on renewable energy can push the Indian economy to 5 trillion dollars by 2025. It is pertinent to reduce reliance on fossil fuels which will save foreign exchange.
The first G20 finance ministers and central bank governors (FMCBG) meeting concluded recently to address debt vulnerabilities.
The steps agreed upon at the meeting were:
- Straightening multilateral coordination by official bilateral and private creditors.
- Predictable and coordinated implementation of a Common framework for debt treatments beyond the Debt service suspension initiative of the world bank.
- To enhance macro policy cooperation and support the progress towards the 2030 Agenda for Sustainable Development.
- To develop a globally fair, sustainable, and modern international tax system fit for purpose for the 21st century.
Global growth remains slow, and downside risks to the outlook persist, including elevated inflation, a resurgence of the pandemic, and tighter financing conditions that could worsen debt vulnerabilities in many Emerging Market and Developing Economies (EMDEs).
The governments should make the public debt sustainable by carefully building their strategy in lines of growth achieved through financial stability.
The global focus should be to assist developing countries in attaining long-term debt sustainability through coordinated policies aimed at fostering debt financing, debt relief, and debt restructuring, as appropriate, and addressing the external debt of highly indebted poor countries to reduce debt distress.
Sustainable finance is critical in achieving sustainable, resilient, inclusive, and equitable economic growth which meets the needs of the present without compromising the ability of future generations to meet their own needs.
The need of the hour is for the international community to step up its efforts to effectively combat money laundering, terrorism financing, and proliferation financing to enhance the integrity and resilience of the international financial system.
-Article written by Swathi Satish