Debt Sustainability

liberatomilo
May 5
2 min read

Introduction

We know that governments have three main ways of financing their expenditures: taxes, monetary issuance, and the issuance of public debt. But there are limits to all of them, and abusing their use can lead to severe problems. Uncontrolled monetary issuance can generate inflation, too high a tax burden can deteriorate the economic activity of the private sector, and a heavy debt burden can become unpayable, leading the State to default, defaulting on contracts and also generating social losses.

A debt in singular? or many debts?

While we usually speak of “debt” as if all government liabilities were one and the same thing, in reality there are many ways to account for and classify public debt. For example, one can count the debt of the Treasury (or the “central administration”, which is the most frequently used indicator), or include the liabilities of other public agencies such as the Central Bank, social security funds, or public enterprises. When all areas of the State are incorporated, we speak of the “consolidated public sector”.

The distinction according to the creditor may also be relevant: the State may owe resident citizens, foreign investment funds, or multilateral organizations, and each of these may imply different characteristics and conditionalities.

How much debt is “too much” debt?

Debt sustainability analysis seeks to account for a government's ability to meet its current and future obligations without the need for exceptional financial assistance or default (IMF, 2020). The most frequent indicator to analyze whether a public debt is sustainable is the percentage it represents of the Gross Domestic Product, although each country may have its own limits according to: among the main factors they include, the long-term growth path (a higher growth perspective contributes to sustainability); the fiscal path (higher future surpluses make the same level of debt more sustainable); and the ease of access to credit by the State, including the development of a robust local capital market and low interest rates.

At the same time, countries should take care not to generate a currency mismatch that could make debt repayment unsustainable when the debt is denominated in a currency other than the local one. This is especially relevant for emerging economies.

What then?

In an increasingly financialized global economy, it is important for the state and policy makers to keep in mind the relevance of debt sustainability. If a problematic level of debt has been reached, some of the mechanisms that can contribute to making debt more sustainable include: