Monday, 14 October 2013

Debt sustainability

The figure (click to enlarge) shows four high public debt experiences in the EU. Assessing the sustainability of government debt requires checking that the inter-temporal budget constraint of the government, holds. The relevant horizon is long by modern standards.  The conditions for sustainability have an objective dimension. These conditions are objective but linked and linked in an uncertain way. They are linked because a change in the path of deficits or surpluses affects both the growth rate of income and the interest rate on sovereign. They are linked in an uncertain way because the size of the effects appears to depend on the state of the economy. To complicate things, the conditions for sustainability are also subjective. Conditional on the uncertainty, the path of deficits and surpluses must be credible. The capacity of a government to control tax revenues and expenditure is key.
For Portugal the difference between the blue an red line in the last 3 years is caused by the item labeled "residuals". Residuals is a voice that includes change in deposits, support to financial sector, recognition of implicit contingent liabilities, reclassifications, unidentified financial transactions, and cash-accrual adjustments. In Portugal, for 2011, it included accumulation of deposits (6 percent of GDP) and BSSF funds (0.6 percent of GDP). For 2012, it included accumulation of BSSF funds (4.2 percent of GDP) and non-BSSF bank recapitalization (1.6 percent of GDP). In fact while debt to GDP increased by 40.7%  from 2010 to 2012, only 21.2 percentages points are caused by the deficits and the economy dynamics; 19.5 percentage points are caused by the Residuals, a very significant number.
The good news is that  for 2013 Residuals includes use of deposits (-5.9 percent of GDP) and acquisition of financial assets (0.3 percent of GDP), namely we are expecting that the residuals will improve the debt to GDP ratio in 2013 by 4.9%.