External debts sustainability, imf policies effect and turkey sample

AuthorFaik Çelk/Yaman Ö. Erzurumlu
Pages136-149

Faik Çelk- /Kocaeli University-Turkey1

Yaman Ö. Erzurumlu /Dou University-Turkey2

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External3 borrowing is a core element in nearly all developing countries' development strategies. Foreign loans can be used to finance public spending aimed at increasing growth, development, and security.

1. Introduction

Throughout their history developing countries have been subject to repeated economic crises, with serious consequences for their long-term growth prospects. The links of these crises to the external sector performance, including the problems of external debt and its sustainability, have been the subject of prolonged debate. While the issue of debt was always present, particularly in relation to the increased availability of investable resources, the relevance of this topic has been heightened in recent years. Increasing capital mobility and greater use of market borrowing by emerging economies may well have helped to improve economic performance and growth prospects, but with low levels of bilateral and multilateral lending the vulnerability of the developing countries' economies has increased.

As developing countries became more integrated into the world economy and a wider universe of private investors have come into the picture, the volatility of capital flows has risen sharply and aggravated the effects of both internal and external shocks. More dramatically, developing countries have seen their debt burden remain high as a proportion of

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GDP with the possible exception of East Asia; and their rate of growth has lagged behind that of the industrialized world, most dramatically in Latin America and Sub-Saharan Africa. The high debt burden, low growth rates, and considerable resource outflows has put in serious doubt the premise that foreign borrowing on current terms is an appropriate mechanism to enhance growth (Loser 2004). The amount of developing countries external debt in 2004 was 2.5 millions of millions of dollars, this amount represents 34 per cent of the Third World Gross National Product (GNP). Taking into account that in 1968 the Third World debt represented nearly 50 thousand millions dollars, the amount has increased by 50 times.(Choike 2008)

2. Literature review

In some countries, debt places such a burden on the economy that it cannot correctly function. Some see this as an argument against maintaining such a debt. In this context, most heavily debated topic is sustainable deficit, keeping deficits at some acceptable level. In an incidence that current deficits exceed sustainable deficit, revising budgetary targets or undertaking alterations in fiscal policy is required. The theoretical literature emphasizes the intertemporal budget constraint as well as the flow-budget constraint of the government, and focuses on whether current fiscal policy can be continued into the distant future without threatening government solvency. Yet, at the level of empirical policy analysis, the term "fiscal sustainability" remains highly controversial, and each empirical study often develops its own definition of the concept and derive its conclusions accordingly. (Voyvoda and Yeldan 2005)

Theoretical discussions of external sustainability reference is often made to the trade balance as the key determinant of the evolution of the external debt ratio, in practice, the relevant variable is the primary current account balance, including current transfers and non- interest net income payments.

External sustainability refers to the ability of a country to meet the current and future external obligations of both private and public sectors without running into arrears, recourse to debt-rescheduling and eventually a -drastic balance-of-payments adjustment. In theory the conditions for external sustainability are analogous to those for fiscal sustainability. (Akyuz 2007). Although external debt provides additional source during the term they were acquired, it requires the transfer of a part of import income as principal and interst payment at the following terms. Moreover, since external debt is acquired in foreign currency, it poses serious impact on the balance of payments. During the period of repayments, the quantity of foreign exchange reserves plays a key role on the balance of foreign deficit. In economies that such balance could not be achieved, additional borrowing becomes necessary for debt- rescheduling. At such situations, domestic debt seems to be easier to reschedule since it usually is much easier to manage old domestic debt with new domestic debt acquired (Özkan 2006).

The rationale behind the creation of a domestic market for government securities in poor countries is that it could stimulate the development of deep and liquid internal financial markets and protect countries from adverse external shocks. When a country is heavily indebted, the prospect of a decline in net inflows, and a possible net resource outflow makes the management of the economy very demanding, as it transfers the cost of lower aid to the borrowing country, and hampers growth.

A rising external debt tends to weaken the economy. First, foreign borrowing increases vulnerability to external conditions. When debt is contracted at a floating rate, higher foreign interest rates lead to an increase in debt-servicing costs. This raises budgetary outlays, which may translate into a larger deficit or a reduction of nondebt outlays. Likewise, a depreciation

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of the currency leads to increased debt servicing (in domestic currency terms), and has the same effects as those mentioned earlier. Second, when the government borrows to cover a growing deficit, foreign borrowing leads to an unsustainable level of debt, an excessive share of debt service in overall government expenditure, and substantial use of foreign exchange to service the debt. In the long run, this may lead to a debt crisis (Bcaugrand etal. 2002). Moreover, the recent literature on debt intolerance emphasizes that developing countries historically have run into problems at much lower debt-to-output ratios than advanced countries. (IMF 2004)

Critics of the practical point in this argument question whether or not unpayable debt truly exists, since governments can refinance their debt via the IMF or World Bank, or come to a negotiated settlement with their creditors. However, this international debt problem has become such a crisis that many poor countries pay more money to the World Bank and the IMF each year than they receive in loans. The World Bank's own figures indicate that the IMF extracted a net US$1 billion from Africa in 1997 and 1998 more than they loaned to the continent.

The problem has been greatly increased by the multilateral institutions' conditionalities, since the IMF determines the creditworthiness of countries: i.e., until the IMF gives its stamp of approval (which usually requires adherence to the economic policies it recommends), poor countries generally cannot get credit or capital from other sources. In the last few years, the World Bank and the IMF have agreed to help countries that are heavily suffering from major debt burdens by creating the Heavily Indebted Poor Countries (HIPC) Initiative of 1996. This facility seeks debt reduction by official creditors, including multilateral agencies, in the context of comprehensive programs of structural reform monitored by the IMF and the IBRD. However, even for the poor countries, the debt burden still remains high at some 50 percent of GDP and 180 percent of exports (Loser 2004). Even after qualifying for HIPC, a country must complete three years under an IMF-designed Structural Adjustment Program. Even after that hurdle, the country must fulfil a further three years bound by another SAP before relief is granted on its multilateral debt. The cruel paradox here is that the SAP requires them to cut spending on health care, food subsidies, and education.

3. External debt and sustainability
3.1. Sources of vulnerability

This section covers the principles involving the sustainability of external debt, and the implications for debt management. External sustainability refers to the ability of a country to meet the current and future external obligations of both private and public sectors without running into arrears, recourse to debt-rescheduling and eventually a drastic balance-of- payments adjustment. In theory the conditions for external sustainability are analogous to those for fiscal sustainability (Akyuz 2007).

A common practice in evaluating debt sustainability is to focus on (gross or net) government debt as a share of the country's GDP. A sustainable government debt is one in which that debt ratio is stable or falling over time; a rising debt ratio denotes unsustainability. To determine what the debt ratio will be next year, the analyst makes (year ahead) projections for the economy's real growth rate, the real interest on the debt, and the noninterest component of the government budget expressed as a share of GDP (the so-called "primary surplus" or primary deficit).

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Sustainability will depend among others on developments in the domestic economy and those related to the external environment, as well as the initial level and structure of external debt. The path to...

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