Statistical analysis of public debt dynamics in transition economies

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Statistical analysis of public debt dynamics in transition economies

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Study of the dynamics of public debt

Statistical analysis of public debt dynamics in transition economies

We live in times when such terms as borrowings, credits and loans are widely used and became an essential part of our life. In our consumer-oriented society people all the time need to buy something: we take education loans in order to have possibilities to study, we take mortgages in order to buy place to live. Such lie of the land became normal and people all over the world live in debt. Here we speak about individual debt. But there also exists public debt. Let us find out what does the term public debt mean.

According to Economic Time definition, “public debt receipts and public debt disbursals are borrowings and repayments during the year, respectively, by the government” (Economic Times). In other words, public debt is how much money the government owes. Public debt appears when the government spends more than it takes in via taxes. In this case, public debt is a way to accumulate annual budget deficits. For short-long period this is a very good way to get extra funds and invest them in the country’s economy. If these funds are used directly on economic needs, they are probably to improve people’s living by building new roads, hospitals, improve health and education facilities. Unfortunately, in many countries the governments are used much more money than they could afford in order to raise voters’ loyalty.

The world statistics on this term says that “the global public debt is expected to skyrocket by $10.7 trillion and reach $62.7 trillion by the end of 2016” ( Daily Sabah, 2016). This is a very huge number that is caused by the fact that not every country has overcome effects of financial crisis 2008. According to IMF statistic for 181 countries, 84% of global debt reveals to 11 countries:

  • The U.S. – $20.1 trillion,
  • Japan – $11, 8 trillion
  • China – $5.3 trillion
  • Italy -$ 2.5 trillion
  • France, Germany and the U.K. – $2.4 trillion each
  • India – $1,5 trillion
  • Canada/Brazil – $1,4 trillion
  • Spain – $1.3 trillion.

Moreover, IMF predicts that by the end of 2016 public debt of 17 countries will exceed their GDP. These countries are: Japan (250, 4% of GDP), Greece ( 183,4%), Lebanon (143,9%), Italy, Portugal, Eritrea, Cape Verde, Jamaica, Mozambique, the U.S., Cyprus, Singapore, Belgium, Barbados, Bhutan, Libya and Spain. We have not mentioned the USA and China where public debt has been higher than GDP for many years.

Statistical analysis of public debt dynamics in transition economies

According to IMF classification, Table 1 illustrates the list of transaction economies in the world.

Table1 – Classification of transition economies.

Source: IMF, 2000.

Figure 1 shows the dynamics of public debt in some transition economies for the period 2004-2011. From this figure it is seen the steady growth trend of this indicator. Nevertheless, none of these countries reaches the critical level of 64% of debt-to-GDP ratio.

Figure 1 – Public Debt (% of GDP).

Source: Allen, 2015.

This figure illustrates one very important statement: for most of the depicted countries (Baltics, SEE, Croatia) 2008 was a crucial moment, since which a public debt began to grow. It means, that these countries felt terrible consequences of the world financial crisis of 2008. Transition economies are highly dependent on foreign investments and any commotion of advanced economies will be immediately reflected for transition economies in a negative way.

Table 2 gives the statistics of public debt dynamics for 2012-2015 period. The lowest debt-to-GDP ratio are observed in Russia and Estonia with 16,5% and 10,4% respectively for 2015. The situation in Russia can be explained by the political difficulties between the country and the USA together with EU. The existence of numerous sanctions for Russia makes this country almost at the position of closed economy. The highest level of debt-to-GDP ratio have such countries as Hungary (79,2%), Slovenia (75,6%) and Ukraine (73,4%). Once again, the situation with Ukraine can be explained with political issues. The revolution that took place in this country led to a change of political orientation in favor of the West. As a result, the public debt has showed the significant growth from 37,4% in 2012 to 73,4% in 2015. This data shows that only for four years Ukraine has almost doubled its public debt. This tendency cannot be named positive for any country and, on the contrary, tells about difficulties in the country’s economy. Such countries as Czech Republic and Poland show the tendency of decreasing of the public debt level. This tendency is rather slow but its existence underlines the positive changes that take place in these countries. For example, Poland is named the most dynamically developing economy in Europe.

Table 2 – Evolution of Public Debt, 2012–151 (Percent of GDP).

Source: Regional Economic Issues, 2014.

Figure 2 and Table 3 illustrate the latest statistics for the public debt data in some transition economies.

Figure 2 – Public debt dynamics for transition economies 2014-2016 (USD millions).

Table 3 – Public debt dynamics for transition economies 2014-2016 (USD millions).

2014Q2 2015Q2 2016Q2
Armenia

8,656

8,63

9,01

Bulgaria

51,856

40,588

39,59

China

1,673,200

1,364,529

Czech Republic

139,95

122,046

137,239

Estonia

25,905

22,164

21,628

Russia

732,779

555,632

520,219

Poland

393,406

343,497

343,81

From these sources of information it can be seen that highest level of public debt in USD millions has China. Its public debt is twice larger than its nearest ally – Russia. Its debt-to-DGP ration is almost 250% ( The Gardian, 16 June 2016). This ratio is almost the highest in the world (the USA has 331%). According to many economists, China is facing huge economic difficulties these days. “The country’s economy grew 6.9% last year, the slowest rate in a quarter of a century, and weakening economic figures have signaled the slowdown has continued this year” ( The Gardian, 16 June 2016). This fact puts in jeopardy China’s ability to pay off its debt and keep it at a sustainable level. In such situation, the government of China must implement steps to reduce its public debt level.

A simple model of overlapping generations

The model of overlapping generation (OLG model) was developed by French economist Maurice Allais in 1947. Since that time the OLG model was improved and further developed by many economists. According to this model, people live two different periods in their lives. The first period ends and the second period begins when people stop working. This model admits that while working people are completing two main tasks: earn money to satisfy their nowadays needs and save money for the future. It is obvious, that for the health society it is better two have more people who live in the first period than in the second – the more people earned for themselves, the less support will be needed from the government. We speak about overlapping generation model on the term of public debt because these two subjects are interconnected. If there is a large percentage of people in old period (who do not work), the pension burden on the government is increasing. A redistribution of state resources in favor of the payment of pensions takes place. In its term, this step leads to situation when such necessary spheres as health, education or agriculture suffers from the shortage of governmental funds. In such cases, the government has to find ways of budget replenishment that may cause the increase of public debt.

Determination and measurement of the rate of public debt

There are three main indicators for studying public debt:

  1. Vulnerability indicators – “risks over public debt that generated by current economic conditions” (ISSAI, 2010).
  2. Sustainability indicators – “the government’s ability to face upcoming contingencies considering certain expected circumstances” (ISSAI, 2010).
  3. Financial debt indicators – “the liabilities’ market performance” (ISSAI, 2010).

The vulnerability indicators became very important especially after the world financial crisis of 2008. After that, the IMF became to pay much attention on country’s vulnerability to such financial difficulties. Especially it refers to emerging economies “whose growth depends mostly on external financing and other capital flows, are particularly vulnerable to investors’ changes of attitude” (ISSAI, 2010).Vulnerability indicators include: indicators regarding GDP; Debt balance / domestic budgetary revenues; Debt service / domestic budgetary revenue; Current value / domestic budgetary revenue etc. One of the most important indexes is the public debt-to-GDP ratio. This index shows how many percentages of the debt in relation to GDP. In addition, it shows “how luckily the country can pay off its debt” (Amadeo, August 2016). A high ratio indicates that a country’s economy acts in the way that it will not be able to pay off its debt. A low ratio shows “there is plenty of economic output to make the payments” (Amadeo, September 2016). The World Bank has developed a study according to which a tipping point of debt-to-GDP ratio is 77% for developed countries and 64% for emerging economies. “Every percentage point of debt above this level will cost the country 1.7% and 2% in economic growth receptively” (Caner, Grennes,etc, 2010).

Debt sustainability is very important issue when we speak about the measurement of the rate of public debt. The main indictors here are: fiscal consistency indicator; Short term primary gap indicator; Macro-adjusted primary deficit etc. The most important one is Bagnai Indicator which aims “to keep the debt-to-GDP ratio (B/y) stable in time” (ISSAI, 2010). The formula looks like:

 < b = k []- {n – r (1 – τ)}Φ

Where: n is the population growth rate,

τ is the income tax,

s is the income proportion that is saved,

r is the real tax rate,

δ is the elasticity of savings related to the interest rate,

ε is the investment elasticity related to the interest rate,

η is the elasticity of consumption as a proportion of income,

k is the capital-to-GDP ratio,

φ is the elasticity of the product as a proportion of physical capital, which means the response of output to changes in the stock of the country’s infrastructure.

There are two main types of financial indicators: Market Risks and Credit Risks. The first type of financial indicator identifies possible losses that investor may face because if changes in interests rates, exchange rates etc. In its tern, Credit Risks defines possible losses due to default of terms and conditions of a deal. For example, one of the Credit Risks is Rating Agencies indexes. Such Agencies evaluate all the country’s financial information and assigns it a rating which influences country’s attractiveness to investors.

A state of equilibrium with zero debt

A state of equilibrium means that the economy reaches a balance between its spending and budget replenishments. It is obvious that it does not always mean that the level of public debt should be zero. The main feature of the equilibrium is to guarantee the possibility to pay off the debt. Moreover, it is necessary to say that there is no any country in the world with zero public debt. The approach to reduce public debt may have negative rather than positive influence on the economy. The good example is the depression of 1930th in the USA. One of the main reasons of which was the attempt of the USA government to reduce its public debt.

Let us give the mathematics meaning to zero debt.

d = (g-i)D*

where: “d – is the trend primary budget deficit as a percentage of GDP

D* – is the chosen trend in the ratio of public debt to GDP,

g – is the trend GDP growth rate of the economy,

i – is the average interest rate on public deb” (Aspromourgos).

If D* is zero, it means that d is also at a zero level – no budget deficit in this case.

Today we live in a globalized world where countries are interconnected with each other in such spheres as culture, economy and even policy. With the development and fast growth of transnational corporations this fact became especially true for the global economy. Nowadays there is no any prosperous country in the world that is closed to global influence. For any economy to be profitable it is necessary to be involved in international economic relations. In this case, we may say that zero debt is possible only if the economy is closed. Zero public debt means that the government spending and the level of taxes are very high in order to satisfy all the public needs. We have already mentioned that in our globalized world a zero public debt is an impossible situation. Here is the number of countries with the lowest debt-to GDP ration:

Wallis and Futuna 5.60

Azerbaijan 4.60

Oman 4.40

Equatorial Guinea 4.10

Libya 3.30” (Central Intelligence Agency)

While looking at this list of countires, it is once againg become clear that zero or low level of public debt usually means that a conutry’s economy is not efficient and even is below the poverty line.

Rather than speaking about zero buplic debt, tt is worth analyzing the equilibrium of public debt. Sustainable public debt is “the outstanding public debt and its projected path that are consistent with those of the government’s revenues and expenditures” (D’Erasmo, Mendoza, Zhang, 2015). Put simply, sustainably public debt is a debt that a government will be able to pay off. This can be illustrated as follows.

Gt + (1+it) B t-1 = Tt + Bt

it > 0 in period t – interest rate

Gt – Government spending for goods and services in period t

Tt – tax revenues in period t

Bt – government debt issued in period t” (Neck, Sturm, 2008).

According to this formula, the sustainable public debt is in direct dependent on government spending and interest rate. “The debt ratio increases if the government runs a deficit and, at the same time, the nominal interest rate exceeds nominal GDP growth” (Neck, Sturm, 2008). In order to archive public dent sustainability there should be meet next conditions:

  1. Real GDP growth;
  2. Low real interest rates;
  3. Stable and effective fiscal policy.

Analysis of qualitative function of public debt

The role of public debt for a county’s development may vary from country to country. As any other phenomena, public debt has both positive and negative impacts. One of the most important positive effects that public debt has is the support of the main sectors of the economy. The attraction of additional funding allows the state to maintain the stability and prosperity of the social and economic spheres of the country. Otherwise unreasonably high levels of debt lead to the impossibility of payment, tax increases and a decline in the overall economy. In this case, one of the most important points that must be taken into consideration when to speak about public debt is its sustainable level within one specific country’s condition. Public debt is a very important tool for transition economies as well as very risky. Transition economies are seeking for additional budget replenishment in order to provide blooming of their economies. At the same time, transition economies still do not reach their stability and resilience to shocks that is why the level of public debt must be closely monitored. The debt-to-GDP ratio is a good way to control public debt level and to ensure that it has not reached a critical point. It goes without saying that public debt plays significant role in economic growth but it must be used politically. “Debt would not be the main point on the political and academic agenda, if each economy possessed sufficient and structural mechanisms to deal with it” ( Afonso, Alves, 2014).

In conclusion I would like to say that the topic of public debt is of great interest nowadays because the financial crisis 2008 has shown that not all of the tools used by the governments are efficient – some of them (including public debt policy) must be improved. From this article we may make following conclusions:

  1. Public debt is how much money the government owes, is a way to accumulate annual budget deficits. It appears when the government spends more than it takes in via taxes.
  2. Transition economies with the highest level of public debt are the China and Russia in USD millions, China, Hungary and Slovenia in debt-to-GDP ratio.
  3. A model of overlapping generation shows the number of working people on who lays the tax obligation to pay off the debt.
  4. There exist a lot of measurements of public debt. The most widely used is debt-to-GDP ratio.
  5. There is no any country in the world with zero public debt. Moreover, zero or very low public debt refers to countries with unstable economy.
  6. Public debt has both positive and negative impact on the economy. The main purpose to any government is to maintain it on the sustainable level.

References

Economic Times. Definition of Public Debt. Retrieved form http://economictimes.indiatimes.com/definition/public-debt

Global public debt soars $11 trillion in 2016. (2016). Daily Sabah. Retrieved from http://www.dailysabah.com/economy/2016/10/20/global-public-debt-soars-11-trillion-in-2016

Amadeo, K. (August 2016). What Is the Public Debt? Pros, Cons, and How to Tell When It’s Too High. The Balance. Retrieved from https://www.thebalance.com/what-is-the-public-debt-3306294

Amadeo, K. (September, 2016). Debt-to-GDP Ratio: How to Calculate and Use It. When Does a Country Have Too Much Debt? The Balance. Retrieved from https://www.thebalance.com/debt-to-gdp-ratio-how-to-calculate-and-use-it-3305832

Carner, M., Grennes, T., Koehler-Geib, F. (2010). Finding the tipping point — when sovereign debt turns bad. The world Bank.

The International Standards of Supreme Audit Institutions, ISSAI. (2010). Debt Indicators. International Organization of Supreme Audit Institutions, INTOSAI. Retrieved from http://www.issai.org/media/13232/issai_5411_e.pdf

Central Intelligence Agency. The World Factbook: Country Comparison: Public Debt. Retrieved from https://www.cia.gov/library/publications/the-world-factbook/rankorder/2186rank.html

Aspromourgos, T. Is zero government debt desirable? EVATT Foundation. Retrieved from http://evatt.org.au/papers/zero-government-debt-desirable.html

D’Erasmo, P., Mendoza, E., Zhang, J. (2015). What is a Sustainable Public Debt? Volume 2 of the Handbook of Macroeconomics. Retrieved from https://bfi.uchicago.edu/sites/default/files/research/DErasmo-Zhang-Mendoza_HandbookDraft_0413.pdf

International Monetary Fund. (2000). Transition Economies: An IMF Perspective on Progress and Prospects. Retrieved from https://www.imf.org/external/np/exr/ib/2000/110300.htm

Allen, M. (2015). Progress in ReducingVulnerability of CEE Economies. From crisis to recovery: old and new challenges in Emerging Europe. Retrieved from http://www.imf.org/external/region/bal/rr/2011/070511.pdf

Regional Economic Issues. (2014). Central, Eastern, and Southeastern Europe Geopolitical Tensions Taking a Toll. IMF. Retrieved from http://www.imf.org/external/pubs/ft/reo/2014/eur/eng/pdf/erei1014.pdf

The Gardian. ( 16 June, 2016). China’s debt is 250% of GDP and ‘could be fatal’, says government expert. Retrieved from https://www.theguardian.com/business/2016/jun/16/chinas-debt-is-250-of-gdp-and-could-be-fatal-says-government-expert

Neck, R., Sturm, J.-E. (2008). Sustainability of Public Debt. The MIT Press.

Afonso, A., Alves, J. ( September, 2014). The Role of Government Debt in Economic Growth. WORKING PAPERS. Retrieved from http://pascal.iseg.utl.pt/~depeco/wp/wp162014.pdf

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