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National accounting in an indebted open economy. Gianni Vaggi April 2014. The national accounting in an indebted open economy. Suppose D 0 = 100 to be repaid in 10 years and i = 5%, each year: iD interest payments = 5 Δ D principal repayment = 10 - PowerPoint PPT Presentation
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National accounting in an indebted open
economy
Gianni Vaggi
April 2014
The national accounting in an indebted open economy
Suppose D0 = 100 to be repaid in 10 years and i = 5%,
each year:
iD interest payments = 5
ΔD principal repayment = 10
iD + ΔD = DS Debt Service
The national accounting in an indebted open economy
Remember: FA = NCF = Net Capital Flows = (Inflows – Outflows)
FA = [(Inflows - Other Outflows) -ΔD] = dD/dt
• ΔD<0 in an indebted economy ΔD is an outflow because debt must be repaid
• dD/dt is the change of the debt stock during the year, which depends also on inflows and other outflows in the FA.
CA = [(X-M) + (NPI – iD) + NSI]
The national accounting in an indebted open economy
CA+FA = 0
Suppose an indebted economy where there are only foreign debt related flows:
(Inflows - Other Outflows) = 0
and no other item in NPI and NSI other than –iD
[(X-M) - iD] - ΔD = 0
(X-M) = iD + ΔD = DS
Take the example: DS = 5 +10 = 15
(X-M) - iD = ΔD
The national accounting in an indebted open economy
IF IF the trade balance is 15 and exactly covers the debt service, thenthen the overall debt decreases by ΔD = D0 - D1 , according to the original scheduled payments or:
-ΔD = 90 -100 = -10 = -dD/dt
IF IF the trade balance is 5 and covers interests only, thenthen ΔD = 0 and the overall debt does not change:
dD/dt=0
IF IF the trade balance is less than 5 and, thenthen the overall debt increases:
dD/dt=>0
The Current Account Balance
Now suppose there are other financial flows in the CA
In the BoP the Current account balance (CA) is the sum of three items:
Trade balance (X-M)
Net income transfers (interest payments, dividends, etc.;)= Net Primary Income = NPI
Net unilateral transfers (remittances, international aid, etc.)= Net Secondary Income = NSI
The national accounting in an indebted open economy
Net primary income: Net primary income: Interests on foreign debt
Dividends (on portfolio investments);
Earnings of FDIs, profit repatriation
Rents on land and natural resources;
Compensation of employees (cross-border workers).
Net secondary income:Net secondary income:
Personal transfers (i.e. remittances);
Current) International cooperation,ODA
The national accounting in an indebted open economy
Consider the following flows:
-iD are outflows in NPI = -5
Compensation of employees are often included in remittances
NSI includes -remittances
-international aid , ODA
The national accounting in an indebted open economy
Remember:
[(X-M) + NPI + NSI] = CA Current Account Balance
and CA + FA = 0
[(X-M) - iD + NSI] + (-ΔD) = 0
[(X-M) + NSI] = iD + ΔD = DS = 15
Debt sustainability - 1
D = overall foreign debt
Y = GDP
gn = (dY/dt)/Y is the nominal growth rate
Thresholds d(D/Y)/dt < 0< 0
The latter: Domar 1944
Debt sustainability - 2
By total differentiation of D/Y:
d(D/Y)/dt = [ (dD/dt)*Y - (dY/dt)*D ]/ Y2
= (dD/dt)Y - [ (dY/dt)/Y ] * (D/Y)
= (1/Y) [dD/dt - gn * D ]
But dD/dt = [inD - (X – M)]
Debt sustainability - 3
i = (in - dp/dt) and g = (gn - dp/dt)
dp/dt inflation rate on debt
d(D/Y)/dt = (i - g)D/Y - (X - M)/Yd(D/Y)/dt = (i - g)D/Y - (X - M)/Y
i, g are the real interest rate and the GDP growth rate
d(D/Y)/dt = inD/Y - gnD/Y - (X - M)/Y
Debt sustainability - 4
But there are also other financial flows:
Current Account (CA)= [(X-M) + NPI + NSI ]
NICA = [CA – iD] = Non-Interest Current Account
NICA = [CA – iD] = [(X-M) + NPI + NSI] - iD
NICA largely depends on the trade balance, but not only.
Debt sustainability - 5
The correct sustainability formula is
d(D/Y)/dt = (i - g)D/Y - d(D/Y)/dt = (i - g)D/Y - NICANICA/Y/Y
Debt sustainability – 6- and national public debt
NICA is the equivalent for foreign debt of the concept of Primary surplus (net of interests) for domestic(public) debt
(T – G) = Primary surplus
[(T – G) – iD] (<0) = overall Fiscal Deficit = FD
FD/Y must not exceed 3%