Missing Link: Volatility and the Debt Intolerance Paradox

Abstract

This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. A striking feature of sovereign lending is that many countries with moderate debt-to-income ratios systematically face higher spreads and more stringent borrowing constraints than others with far higher debt ratios. Earlier research has rationalized the phenomenon in terms of sovereign reputation and countries' distinct credit histories. This paper provides theoretical and empirical evidence to show that differences in underlying macroeconomic volatility are key. While volatility increases the need for international borrowing to help smooth domestic consumption, the ability to borrow is constrained by the higher default risk that volatility engenders.

Assessing Debt Sustainability In Emerging Market Economies Using Stochastic Simulation Methods

“…A number of studies that have stressed that output growth has been much more volatile in emerging market economies than in advanced economies Sutton 2002, Catão andKapur, 2004;Kaminsky, Reinhart, and Végh, 2004). Calculations reported by Catão and Kapur (2004) indicate that real GDP growth in a sample of 26 emerging market economies has a standard deviation of 4.5%, roughly double that for OECD countries.…”

“…Calculations reported by Catão and Kapur (2004) indicate that real GDP growth in a sample of 26 emerging market economies has a standard deviation of 4.5%, roughly double that for OECD countries. 22 Kaminsky, Reinhart, and Végh, (2004) report similar results-the standard deviation of real GDP growth in high-middle income countries over the period 1960-2003 is about double that in OECD countries (5.9% versus 3.1%).…”

“…Empirical studies by Catão and Sutton (2002) and Catão and Kapur (2004) indicate that countries with more volatile output and terms of trade and destabilizing macro policies are more likely to default on their sovereign debt. The terms of trade and output are much more volatile in emerging market economies than in advanced economies.…”

“…4 Catão and Kapur (2004) argue that macroeconomic volatility is a key determinant of default risk and can help explain the debt intolerance question posed by Reinhart, Rogoff and Savastano.…”

A new country risk index for emerging markets: A stochastic dominance approach

“…The latter typically include solvency indicators such as the ratio of debt to GDP, GDP growth, the real exchange rate, liquidity indicators and the level of international reserves. Several recent papers, such as Reinhart (2002), Catao and Sutton (2002), Reinhart et al (2003), Van Rijckeghem and Weder (2004), Kruger and Messmacher (2004), Catao and Kapur (2004), have included other institutional and political variables, debt history, financing needs indicators and macroeconomic volatility. Some studies investigate the effects of macroeconomic fundamentals on sovereign credit spreads, under the view that a higher yield spread reflects higher risk.…”