Question

b) The use of debt by countries to finance national budget has engaged the attention of economists,

tax practitioners and the ordinary man in the interest regarding its impact on the economy. While

some prefer domestic debt, others are making a case for foreign debts as part of government’s fiscal

policy.

Required:

Present a report on the benefits to a government for going in for a foreign debt as opposed to going in

for domestic debt as a support to revenue base from taxes.

Answer 1

i i i i i i i i i i i i i i i i i iSovereign idebt imanagement iis ithe iprocess iof iestablishing iand iexecuting ia istrategy ifor imanaging ithe igovernment's idebt iin iorder ito iraise ithe irequired iamount iof ifunding, iachieve iits irisk iand icost iobjectives iand ito imeet iany iother isovereign idebt imanagement igoals ithe igovernment imay ihave iset, isuch ias ideveloping iand imaintaining ian iefficient imarket ifor igovernment isecurities.

i i i i i i i i i i i i i i i i i i i i i i i i i i i i i iIn ia ibroader imacroeconomic icontext ifor ipublic ipolicy, igovernments ishould iseek ito iensure ithat iboth ithe ilevel iand irate iof igrowth iin itheir ipublic idebt iis ifundamentally isustainable, iand ican ibe iserviced iunder ia iwide irange iof icircumstances iwhile imeeting icost iand irisk iobjectives. iSovereign idebt imanagers ishare ifiscal iand imonetary ipolicy iadvisors' iconcerns ithat ipublic isector iindebtedness iremains ion ia isustainable ipath iand ithat ia icredible istrategy iis iin iplace ito ireduce iexcessive ilevels iof idebt. iDebt imanagers ishould iensure ithat ithe ifiscal iauthorities iare iaware iof ithe iimpact iof igovernment ifinancing irequirements iand idebt ilevels ion iborrowing icosts. i

i i i i i i i i i i i i i i i i i i i i i i i iPoorly istructured idebt iin iterms iof imaturity, icurrency, ior iinterest irate icomposition iand ilarge iand iunfunded icontingent iliabilities ihave ibeen iimportant ifactors iin iinducing ior ipropagating ieconomic icrises iin imany icountries ithroughout ihistory. iThis ihas ileft igovernment ibudgets iseriously iexposed ito ichanging ifinancial imarket iconditions, iincluding ichanges iin ithe icountry's icreditworthiness, iwhen ithis idebt ihas ito ibe irolled iover. iForeign icurrency idebt ialso iposes iparticular irisks, iand iexcessive ireliance ion iforeign icurrency idebt ican ilead ito iexchange irate iand/or imonetary ipressures iif iinvestors ibecome ireluctant ito irefinance ithe igovernment's iforeign-currency idebt. iBy ireducing ithe irisk ithat ithe igovernment's iown iportfolio imanagement iwill ibecome ia isource iof iinstability ifor ithe iprivate isector, iprudent igovernment idebt imanagement, ialong iwith isound ipolicies ifor imanaging icontingent iliabilities, ican imake icountries iless isusceptible ito icontagion iand ifinancial irisk.

i i i i i i i i i i i i i i i i i i i i i i i i i iA igovernment's idebt iportfolio iis iusually ithe ilargest ifinancial iportfolio iin ithe icountry. iIt ioften icontains icomplex iand irisky ifinancial istructures, iand ican igenerate isubstantial irisk ito ithe igovernment's ibalance isheet iand ito ithe icountry's ifinancial istability. iAs inoted iby ithe iFinancial iStability iForum's iWorking iGroup ion iCapital iFlows, i"recent iexperience ihas ihighlighted ithe ineed ifor igovernments ito ilimit ithe ibuild-up iof iliquidity iexposures iand iother irisks ithat imake itheir ieconomies iespecially ivulnerable ito iexternal ishocks." iTherefore, isound irisk imanagement iby ithe ipublic isector iis ialso iessential ifor irisk imanagement iby iother isectors iof ithe ieconomy i"because iindividual ientities iwithin ithe iprivate isector itypically iare ifaced iwith ienormous iproblems iwhen iinadequate isovereign irisk imanagement igenerates ivulnerability ito ia iliquidity icrisis." iSound idebt istructures ihelp igovernments ireduce itheir iexposure ito iinterest irate, icurrency iand iother irisks. iMany igovernments iseek ito isupport ithese istructures iby iestablishing, iwhere ifeasible, iportfolio ibenchmarks irelated ito ithe idesired icurrency icomposition, iduration, iand imaturity istructure iof ithe idebt ito iguide ithe ifuture icomposition iof ithe iportfolio.

i i i i i i i i i i i i i i i i i i i i i i i i i i iSeveral idebt imarket icrises ihave ihighlighted ithe iimportance iof isound idebt imanagement ipractices iand ithe ineed ifor ian iefficient iand isound icapital imarket. iAlthough igovernment idebt imanagement ipolicies imay inot ihave ibeen ithe isole ior ieven ithe imain icause iof ithese icrises, ithe imaturity istructure, iand iinterest irate iand icurrency icomposition iof ithe igovernment's idebt iportfolio, itogether iwith isubstantial iobligations iin irespect iof icontingent iliabilities ihave ioften icontributed ito ithe iseverity iof ithe icrisis. iEven iin isituations iwhere ithere iare isound imacroeconomic ipolicy isettings, irisky idebt imanagement ipractices iincrease ithe ivulnerability iof ithe ieconomy ito ieconomic iand ifinancial ishocks. iSometimes ithese irisks ican ibe ireadily iaddressed iby irelatively istraightforward imeasures, isuch ias iby ilengthening ithe imaturities iof iborrowings iand ipaying ithe iassociated ihigher idebt iservicing icosts i(assuming ian iupward isloping iyield icurve), iby iadjusting ithe iamount, imaturity, iand icomposition iof iforeign iexchange ireserves, iand iby ireviewing icriteria iand igovernance iarrangements iin irespect iof icontingent iliabilities.

i i i i i i i i i i i i i i i i i i i i i i i iRisky idebt istructures iare ioften ithe iconsequence iof iinappropriate ieconomic ipolicies--fiscal, imonetary iand iexchange irate- ibut ithe ifeedback ieffects iundoubtedly igo iin iboth idirections. iHowever, ithere iare ilimits ito iwhat isound idebt imanagement ipolicies ican ideliver. iSound idebt imanagement ipolicies iare ino ipanacea ior isubstitute ifor isound ifiscal iand imonetary imanagement. iIf imacroeconomic ipolicy isettings iare ipoor, isound isovereign idebt imanagement imay inot iby iitself iprevent iany icrisis. iSound idebt imanagement ipolicies ireduce isusceptibility ito icontagion iand ifinancial irisk iby iplaying ia icatalytic irole ifor ibroader ifinancial imarket idevelopment iand ifinancial ideepening. iExperience isupports ithe iargument, ifor iexample, ithat ideveloped idomestic idebt imarkets ican isubstitute ifor ibank ifinancing i(and ivice iversa) iwhen ithis isource idries iup, ihelping ieconomies ito iweather ifinancial ishocks.