debt indicators. content 1.introduction 2.financial indicators 3.vulnerability indicators 4....

DEBT INDICATORS

DEBT INDICATORS

Content

1. Introduction

2. Financial Indicators

3. Vulnerability Indicators

4. Sustainability Indicators

5. Final Consideration

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Three groups of indicators

DEBT INDICATORS 1.-Introduction

Risk of current conditions’ impact on debt status

Government’s ability to

address future contingencies

Liabilities’ performance

as market variables

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DEBT INDICATORS 1.-Introduction

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Analyzing and describing the most accepted vulnerability, sustainability and financial indicators, along with their implementation scope within public debt management and auditing policies.

Aim of Work

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Risk Classification

DEBT INDICATORS 2- Financial Indicators

Market risk

Credit risk

Reputation risk

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Risk Classification Market Risk

Most accepted indicators :

1. Interest Rates and Yield Curve

These are the gain measure for those who decide to

save. Capital markets provide an efficient mechanism to

transfer capital between economic agents.


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1. Position and Slope of the Yield Curve


Slope Market Expectations Theory

Liquidity Preferences Theory

Market Segmentation Theory

Positive Short-term rates are expected to rise

Positive price to liquidity

Excessive supply regarding long-term demand

Negative Short-term rates are expected to decrease

Negative price (punishment) to liquidity

Excessive supply regarding short-term demand

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1. Position and Slope of the Yield Curve


Slope Market Expectations Theory

Liquidity Preferences Theory

Market Segmentation Theory

Horizontal Short-term rates are expected to remain the same

Absence of liquidity price

Equilibrium between supply and demand in all terms

Concave Short-term rates are expected to rise and subsequently decrease

Positive price to liquidity followed by a negative price to liquidity

Excess of supply regarding mid-term demand

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2. Weighted Average Maturity and Duration

These statistics measure the average time in which

issuers must face debt’s service.

The weighted average maturity term possesses a

limited use because it only considers payment dates

of the principal, while the duration additionally takes

into account the interests payment dates.


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3. Modified Duration

It is used to measure the risk of a bonus. It indicates

the impact on the bonuses’ prices resulting from

interest rates’ variations.


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4. Standard Deviation

It indicates the average detachment between a data

set and its average value.


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5. Risk-Adjusted Yield (RaR)

It indicates the way in which an expected interest

rate associated to an issue, could cover the expected

loss due to an increase in such interest rate.

This indicator shows the number of times that the

loss expectations surpass the expected earnings.


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6. Amortization Profile

It is used for distributing on a timeline payments to

capital.

The main idea is creating a regular series of

amortizations intended to minimize the risk of

refinancing large portions of debt if unfavorable

market conditions arise.


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7. Risk Cost (CaR)

Together with the term and the amortization profile,

CaR is used for risk-management purposes in a debt

portfolio.

This indicator allows assessing the cost-related

consequences resulting from different issue

strategies.


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Risk Classification Credit Risk

CONCEPT

The potential loss resulting from noncompliance of a party in a financial transaction, or noncompliance with the terms and conditions of a transaction.

It is conceived as the weakening of a party’s credit quality, or the weakening of an originally agreed guarantee or collateral.


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Risk Classification Credit Risk

1. Credit default Swap (CDS)

CDS provide an insurance against bankruptcy risk from any entity used as reference .

The seller of the protection is obliged to purchase the referred bonus at its par value in case of a credit event.

The purchaser periodically makes payments to the seller during the term of the contract or until a credit event occurs, whatever happens first.


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Risk Classification Reputation Risk

CONCEPT

Reputation Risk refers to losses resulting from untaken

financing opportunities, due to issuer’s bad reputation

resulting from failure in payment or from a damaged fiscal

situation.


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1. Credit Ratings

This indicators represents the private agents’ perception of a country’s debt situation.

Rating Agencies


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2 A. Country Risk Indicators

They measure the degree of risk operating within a country for foreign investments.

Investors seek for earnings’ maximization and take risk into consideration, i. e., the possibility of less than expected earnings, or loss occurrence.


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2 B. Country-Risk Indicators

The country-risk index equals the over-rate that a

country pays for its bonuses related to the rate paid by

the Treasury of the United States.


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2 C. Country-Risk Indicators

The more damaged the country-risk rating is, the

larger it will be the cost of debt, and the lesser

economic policies can be handled; hence, the risk of

noncompliance will be bigger.


DEBT INDICATORS 3.- Vulnerability Indicators

Monetary crisis effectsEmerging market

economies

The 90´s

Main issue of economic policy:

Analysis and research on fiscal vulnerabilities and their link to debt.

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Emerging market economies

• They are vulnerable to variation of investors’ attitude

• Special attention was placed on this group of countries and their vulnerability assessment work

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Vulnerability analysis

• Data’s quality and transparency

• Availability of timely and detailed data on international stocks, external debt and capital flows

• Definition of critical values

• Conduction of strain tests

• Applying early-warning system models

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Vulnerability indicators encompass:

• Public sector

• Financial sector

• Households

• Enterprises

When economies are under strain, one sector’s problems spread to others.

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DEBT INDICATORS 3.- Vulnerability indicators


These are useful indicators to define debt’s evolution and payment capability.

They offer certain signals about the worsening or improvement of the government’s position.

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Most accepted indicators by international institutions and governments and the academic sector:

1. Debt’s balance / domestic budgetary revenue

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2. Debt’s service / domestic budgetary revenue

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3. Current value / domestic budgetary revenue

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4. Interests / GDP

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5. Interests / domestic budgetary revenue

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Frequently used indicators in a cross-cutting way with the aforementioned :

6. Foreign debt / exports

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Vulnerability indicators


7. Net International reserves / foreign debt

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8. • Amortization / external debt disbursements

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Minimal suggested levels for emerging countries, provided by two different international organizations.

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Minimal Suggested Levels

Vulnerability Indicator

International Debt Relief *

International Monetary Fund**

Debt Service /income

28%-63% 25%-35%

Debt VP /income

88%-127% 200%-300%

Interest/income 4.6%-6.8% 7%-10%

Debt/GDP 20%-25% 25%-30%

Debt/Income 92%-167% 90%-150%

* Debt Relief International: “Key Aspects of Debt Sustainability Analysis”, 2007

** International Monetary Fund, Foreign Affairs Department: Technical Note “Vulnerability Indicators”, April 30, 2003 and several research documents.


Fiscal sustainability indicators

Public debt and the corresponding interest payment

became a structural problem in countries showing

persistent deficits.

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DEBT INDICATORS 4.- Sustainability indicators


Fiscal sustainability indicators seek to describe public

finances’ inter-temporal aspects, based on year-to-year

available information.

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Systematic fiscal imbalances will mean future pressures

concerning interest expenditure, which will in turn

contribute to new debt accumulation.

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Main indicators

1 A. Fiscal Consistency Indicator

It takes into consideration the consistency of the current tax policy, while keeping the debt-to-GDP ratio constant.

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Main indicators

1 B. Fiscal Consistency Indicator

wheretn* is the fiscal burden stabilizing, in a period of

(n) years, the debt-to-GDP ratio in level d*, g being the expenditurer being the interest rate, and q being the GDP’s growth rate.

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tdqrn

g

tt

n

n

*)(*


Main indicators

2 A. Buiter’s Indicator

It calculates the gap between the sustainable primary balance and the primary effective balance.

The sustainability condition is defined starting from a wider net wealth concept than the one implicit in the ratio debt / GDP.

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Main indicators

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2 B. Buiter’s Indicator

whereb* is the ratio debt / sustainable GDP, b is the ratio debt / GDP,wt is the net / real government wealth value as a

GDP proportion,r is the interest rate, andq is the GDP increase rate.

ttt bwqrbb )(*


Main indicators

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2 C. Buiter’s Indicator

A tax policy is defined as sustainable by this indicator if

the net government wealth is kept steady, in a ex-ante

sense.


Main indicators

3 A. Short-term primary gap indicator

It provides the primary balance level needed to stabilize debt as a proportion of the GDP.

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Main indicators

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3 B. Short-term primary gap indicator

whereBP* is the primary balance needed to stabilize

debt, BP is the prevailing primary balancer the real interest rate trendn is the population growth’s rate, andb is the ratio debt / GDP.

BPbnrBPBP tt )(*


Main indicators

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3 C. Short-term primary gap indicator

If the permanent primary balance exceeds the current primary balance, the primary path is positive. This means that the fiscal policy is not sustainable.

On the contrary, when the permanent primary balance is lower than the current primary balance, the fiscal policy tends to reduce the debt level regarding the GDP.


Main indicators

4 A. Macro-adjusted primary deficit

This indicator was created due to the high volatility of macroeconomic variables, which leads deficit in a specific moment to be different from the one that would appear within normal macroeconomic conditions.

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Main indicators

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4 B. Macro-adjusted primary shortage

wherer is the real interest rate, g represents the analyzed year’s real growth

is the primary macro-adjusted balance

Mtt

Mt db

g

grI

11

)(

Mtd


Main indicators

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4 C. Macro-adjusted primary shortage

The inconvenience of this indicator lies within the need of establishing what a “normal economy

condition” is.

DEBT INDICATORS 4.- Sustainability Indicators

Main indicators

5 A. Sustainable fiscal position indicator

It considers a historical methodology which explicitly assess the tax authority reaction in face of changes in those variables defining debt’s sustainability in time.

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Main indicators

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5 B. Sustainable fiscal position indicator

where β is the relation between the real

interest rate (r) and the GDP’s growth rate (g)

λ is the function of fiscal policy’s reaction, defined as the ratio between the primary effective balance gap (BP) related to the primary sustainable balance or goal (BP*), and the current gap between the ratio debt / GDP from the last period (b) respect to the ratio debt / sustainable GDP or goal (b*).

*1

*

1

1)(

bb

BPBP

g

rI

t

t

t

ttt

PFSt


Main indicators

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5 C. Sustainable fiscal position indicator

If the ratio debt / GDP of the last period is higher than the goal, it will converge to b* if, and only if

| βt - λt | <1.


Main indicators

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5 D. Sustainable fiscal position indicator

In static terms, an indicator value superior or equal to 1, is an evidence that the fiscal authority maintains an inconsistent fiscal policy with the convergence of the ratio debt/sustainable GDP levels.

An indicator value minor than 1 indicates that the fiscal position is consistent with the conditions

required to ensure sustainability.


Main indicators

6 A. Currency availability indicator

The initial assumption is that volatility of capital flows’ variables is higher than that of macroeconomic variables.

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Main indicators

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6 B. Currency availability indicator

This indicator compares the proportion of external debt related to internal debt with the proportion of tradable goods related to the non-tradable goods in economy:


Main indicators

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6 C. Currency availability indicator

where b is the ratio debt / GDP,B is the debt in terms of non-tradable

goods,e is the type of real exchange,B* is the debt in terms of tradable goods,y the GDP of non-tradable goods, and y* the GDP of tradable goods.


**

eyyeBB

b )(a

Main indicators

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6 D. Currency availability indicator

When

The debt’s composition and the production are perfectly consistent.

When this condition occurs, the variations in the exchange rate have no effects in fiscal sustainability holding the ratio debt / constant GDP.

1

*

*

eyyeBB

(b)


Main indicators

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6 E. Currency availability indicator

When the value is closer to 0 instead of 1, the fiscal position becomes highly sensitive to variations of the real exchange rate.


Main indicators

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6 F. Currency availability indicator

Thus, to estimate indicator (a) it is necessary to determine (b) and, therefore, the indicator to be estimated is:

I

eyyeBB

*

* )10( I


Main indicators

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7 A. Fiscal Sustainability Indicators with Long-Term Restrictions

Debt and fiscal sustainability indicators fail when no long-term budgetary restrictions are

represented by them.


Main indicators

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7 B. Fiscal Sustainability Indicators with Long-Term Restrictions

In order to try to cover these possible upcoming events, Bagnai (2003) presents two indicators consistent with these restrictions, in order to keep debt sustainability.


In the mid- and long-term,

generations from a country will act as a

governmental funding source regarding debt

(financial markets) and tax payment

(macroeconomic).

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ObjetiveTo keep the debt /

GDP ratio (B/y) stable in time.

7 C. Indicators that consider the budgetary restrictions - Bagnai, 2003. First case


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Dynamic fiscal stability will be reached only when the following two conditions are met:

(a)

(b)

)1(1

)1(~

rn

nkb

y

B

0)1(

)1(

)1()1(1

s

r

ns

7 D. Indicators that consider the budgetary restrictions - Bagnai, 2003


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where n is the population growth rate, is the income tax, s is the income proportion that is saved, r is the real tax rate is the elasticity of savings related to the interest rate, is the investment elasticity related to the interest rate,

is the elasticity of consumption related to income,k is the ratio capital GDP, and is the elasticity of the product related to capital.

7 E. Indicators that consider the budgetary restrictions - Bagnai, 2003


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If debt exceeds the level, the economic system turns dynamically unsustainable and debt will respond to any exogenous shock, acquiring an explosive trajectory.

b~

7 F. Indicators that consider the budgetary restrictions - Bagnai, 2003


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7 G. Indicators that consider the budgetary restrictions - Bagnai, 2003. Second case

Inter-temporal restrictions

The equilibrium’s steadiness depends on the provisions regulating

fiscal and monetary policies


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7 H. Indicators that consider the budgetary restrictions - Bagnai, 2003. Second case

When a monetization coefficient is zero and public expenditure endogenously vary with the strengthening

of debt, then the necessary condition to achieve a dynamic equilibrium is the following:

(a)0)1()1(1

ryB

yL

Lwr


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7 I. Indicators that consider the budgetary restrictions - Bagnai, 2003. Second case

Formula:

where y is GDP, is the income proportion by the total income

capital,L represents currency, L1 is the first derivate of the former variable

respect to the real interest rate, and w is the wealth as a proportion of the GDP.

0)1()1(1

ryB

yL

Lwr


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7 J. Indicators that consider the budgetary restrictions - Bagnai, 2003. Second case

Public debt balance in real terms B

where elasticity of money’s demand related to the interest rate

r

rwb

y

B

1*

0)1( 1 LrL


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7 K. Indicators that consider the budgetary restrictions - Bagnai, 2003. Second case

When an expansive fiscal policy is funded through

deficit, the interest rate needs to be increased in order

to induce the economic agent to reallocate its balance

portfolio to the new debt.


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DEBT INDICATORS 5.- Final consideration

These three main indicators groups:

financial

vulnerability

sustainability

aim understanding the public debt phenomena from

different angles, with the objective of allowing

governments to control and manage public debt based

on sound credit practices.

debt indicators. content 1.introduction 2.financial indicators 3.vulnerability indicators 4....

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