Public debt sustainability and crises in emerging market countries: a presentation of the concepts and diagnostic tools

A. Bachellerie and B. Couillault

Financial Stability Review, 2005, issue 6, 63-80

Abstract: The growth of public debt in emerging market countries during the 1990s and recent financial crises have once again highlighted the risks associated with fragile public finances in these countries. The debt restructurings of the 1980s resulted from excessive debt vis-à-vis international banks. The 1990s saw a strong surge in financing on bond markets, which also brought risks with it and contributed to changing the nature and pattern of sovereign debt crises. The 1990s were marked by crises in investor confidence leading to sudden reversals in capital flows and sharp exchange rate movements, in turn sparking contagion phenomena between different economic sectors and countries. In this context, the government has a crucial role to play in limiting the impact of the drop in revenue. When public finances are fragile, doubts about the government’s ability to meet the financial cost of its intervention can contribute to prolonging the crisis or to triggering unsustainable debt dynamics. Emerging market countries that are heavily indebted in foreign currencies and subject to intermittent access to financial markets are particularly vulnerable to changes in international investor sentiment. Against this backdrop, the formulation of diagnoses making it possible to identify the risks weighing on public finances in emerging market countries is an important issue for the international community. In the light of recent experience, over the past few years the IMF has developed an analytical framework that should contribute to better account being taken of potential vulnerabilities in this area. This article begins by recalling that the rise in public debt in emerging market countries has gone hand in hand with the growth in debt financing and that “capital account crises” have had a significant impact on public finances. It reviews the traditional analysis of debt sustainability and the factors that may explain the instability of debt dynamics in emerging market countries. Lastly, it presents the methods for debt sustainability analysis used by the IMF and the difficulties involved in making diagnoses.

Date: 2005
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