## _wp05212

## Source details

**Canonical URL:** [_wp05212](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2005/_wp05212.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2005/_wp05212.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2005/_wp05212.pdf.json)

---

### Introduction and purpose
- Study examines the impact of global financial conditions in recent years on emerging market fiscal performance for 40 emerging markets.
- Focus on two empirical questions:
  - The benefits that these countries derived from the benign global environment.
  - The impact of a potential reversal in these conditions over the next few years.
- Key conclusion: most countries’ budgets have benefited substantially from the decline in global interest rates and spreads, dollar depreciation, and high commodity prices.
- Also finds synergies between fiscal reforms pursued by many countries and the benefits from global financial integration and benign financial market conditions.

### Analytical framework (Sections II and formal model)
- Uses a standard fiscal accounting relationship linking the debt ratio to the primary balance and automatic debt dynamics; starting point is equation (1) relating change in public debt-to-GDP to the primary deficit, automatic dynamics of foreign and domestic debt, depreciation, growth, and stock-flow adjustments (SFA).
- Primary deficit equivalence: P = B − A (equation (2), where B is borrowing and A is amortization).
- Analysis focuses on external (foreign currency) debt and isolates effects of:
  - exchange rate changes,
  - global base interest rates (r),
  - spreads (s),
  - share of foreign currency debt at variable rates (v) versus fixed rates (r0),
  - share p of foreign currency debt owed to private creditors subject to a fixed spread s0.
- Key derived expressions include:
  - Impact on debt service from exchange rate changes and amortization (equation (5)).
  - Impact from changes in variable-rate interest on foreign debt (equation (6)).
  - Cumulative effect of changes in fixed base interest rates and spreads on borrowing from private creditors (equation (7)).
  - Combined total effect of changes in financial conditions between reference period t* and current period t (equation (8)).
- Notes on application:
  - For quantifying fiscal impact of future changes, the framework accounts for gradual replacement of existing debt with new debt at prevailing conditions.
  - Domestic debt portion is disregarded in the core empirical exercise due to data problems and cross-country transmission variability; however, if domestic rates respond to global rates, domestic debt effects would go in the same direction as external debt.

### Financial integration and budgetary costs of external financing (Section III)
- Financial globalization accelerated since the early 1990s, with rapid increases in net capital flows to emerging markets.
- Structural changes observed:
  - Investor base for emerging-market assets broadened and deepened; emerging-market assets increasingly identified as a separate asset class.
  - Shift in external debt composition: nominal public external debt stock grew markedly over the 1990s and particularly since 2000 for the 40 countries studied.
  - The 40 countries increased their public external debt roughly by US$ 70 billion (1 percent of GDP) both in 2004 and 2005—the highest nominal increase since 1998.
  - Debt owed to official creditors stabilized over the 1990s.
  - Debt owed to private creditors excluding bonds (largely commercial banks and trade financing) has fallen significantly.
  - Bond debt has grown rapidly in the 1990s and now makes up a much larger share of developing countries’ external debt than at any point in the past three decades.
- Implications and risks:
  - Bond financing indicates rising investor confidence but is more susceptible to sharp movements in pricing conditions and risk perceptions than long-term bank lending.
  - Despite rising nominal debt and a shift to potentially riskier sources, debt-to-GDP ratios have trended down recently in many emerging markets.
- Explanations reconciling higher nominal debt with lower debt-to-GDP:
  1. Exchange rate movements: U.S. dollar weakness since 2002 produced a revaluation effect on debt stock (about 60 percent of emerging market external debt is denominated in U.S. dollars).
  2. Strong global activity and high commodity prices boosted emerging market growth and debt-service capacity.
     - World output expanded at rates above the long-term average in 2003–05, with growth in 2004 the highest since 1976.
     - Commodity prices reached record levels over the period.
     - Debt over noncommodity GDP shows debt ratios trending down on average, though with heterogeneity across countries.
  3. Decline in interest burden:
     - Between 2001 and 2005, interest payments on public external debt declined by about half a percentage point of GDP in the median country in Asia Pacific and Emerging Europe and more than that in the median country of Africa/Middle East; in Latin America interest payments have kept up, but less than they would have under less benign conditions.
     - Decline in interest burden attributed to:
       - Lower industrial country interest rates.
       - Decline in emerging market spreads.
     - Tentative evidence: market volatility and global liquidity account for about three-fourths of the decline in spreads during recent years, while fundamentals account for about one-fourth.

### Fiscal performance under benign global conditions (Section IV)
- Empirical approach:
  - Compares actual financial conditions in 2002–05 (U.S. dollar exchange rates, global interest rates, and spreads) to those prevailing in 2001 as the reference period.
  - Calculates fiscal balance over noncommodity GDP to indicate commodity-price effects on denominators.
- Estimated gross fiscal savings from benign global financial environment (regional medians, 2002–05 relative to 2001):
  - Asia Pacific: about 0.9 percent of GDP.
  - Africa/Middle East: about 1.8 percent of GDP.
  - Emerging Europe: about 1.9 percent of GDP.
  - Latin America: about 1.9 percent of GDP.
- Evolution over time (median estimated gross savings in 2005, relative to 2001 benchmark):
  - Asia Pacific: 0.4 percent of GDP in 2005 (median).
  - Africa/Middle East: 0.7 percent of GDP in 2005 (median).
  - Emerging Europe: 0.9 percent of GDP in 2005 (median).
  - Latin America: 0.8 percent of GDP in 2005 (median).
- Detailed median components (2005):
  - Median interest rate effect on variable rate debt (2005):
    - Asia Pacific: 0.2 percent of GDP
    - Africa/Middle East: 0.3 percent of GDP
    - Emerging Europe: 0.4 percent of GDP
    - Latin America: 0.3 percent of GDP
  - Median interest rate effect on new borrowing (2005):
    - Emerging Europe and Latin America: about 0.3 percent of GDP
    - Asia Pacific and Africa/Middle East: about 0.2 percent of GDP
  - Median spread effect on new borrowing (2005):
    - Less than 0.1 percent of GDP in all regions (median); some countries experienced up to 0.5 percent of GDP savings in 2005 from declining spreads
  - Median exchange rate effect on debt service (2002–05):
    - Asia Pacific: virtually zero
    - Africa/Middle East and Emerging Europe: 0.1–0.2 percent of GDP
    - Latin America: negative, median country paid extra 0.2–0.3 percent of GDP (in 2002 and 2005) to 0.6–0.7 percent of GDP (in 2003–04)
  - Total (gross) estimated fiscal savings (medians, 2002–05 annual numbers summed as TT 2/):
    - Asia Pacific: 0.85 percent of GDP (TT 2/)
    - Africa/Middle East: 1.77 percent of GDP (TT 2/)
    - Emerging Europe: 1.05 percent of GDP (TT 2/)
    - Latin America: 1.92 percent of GDP (TT 2/)
- Memorandum items (medians by vulnerability quartiles, TT 2/):
  - Least vulnerable (first quartile) totals: Asia Pacific 0.69; Africa/Middle East 1.32; Emerging Europe 0.34; Latin America 0.77 (percent of GDP)
  - Most vulnerable (third quartile) totals: Asia Pacific 1.93; Africa/Middle East 4.11; Emerging Europe 1.05; Latin America 2.86 (percent of GDP)
- Fiscal performance adjusted for savings and commodity booms (2002–05):
  - Median adjusted deficits (2005, over noncommodity GDP, augmented by savings on interest expenditure):
    - Asia Pacific: 4½ percent of GDP
    - Africa/Middle East: 3½ percent of GDP
    - Emerging Europe: 4.9 percent of GDP
    - Latin America: 3.1 percent of GDP (adjusted) versus 1.9 percent of GDP (headline)
  - Observations:
    - The combined median impact of savings from benign global financial conditions was substantially larger than the median impact of high commodity prices over 2002–05.
    - In median countries of Asia Pacific, Africa/Middle East, and Emerging Europe, fiscal deficits rose over 2002–05 when adjusted for savings and commodity exports (increases since 2001 of 0.2, 0.7, and 0.8 percentage points respectively).
    - In Latin America, median fiscal performance improved since 2003 even when adjusted for exogenous factors, but adjusted deficits remain high by 1990s standards.
    - Conclusion: savings from the benign global environment were largely spent in many countries instead of being used to reduce fiscal deficits; heterogeneity across countries is substantial.

### Fiscal risks from a reversal in global financial conditions
- Drivers of risk:
  - Rising global long-term interest rates, widening yield spreads, and pronounced exchange rate movements.
  - Potential partial unwinding of the “global savings glut.”
- Channels affecting public finances:
  - Increased cost of servicing existing variable rate debt.
  - Higher interest rates on new debt commitments (effect increases over time as cheaper old debt is rolled over).
- Simulation assumptions (2006–07):
  - Global interest rate increases simulated: 100 to 300 basis points relative to end-2004.
  - Assume each 100 basis points increase in U.S. short-term rates entails an extra 50 basis points increase in spreads on emerging market debt.
  - Yield curve slope for emerging market financing assumed unchanged.
  - U.S. dollar exchange rate changes simulated: 10–20 percent relative to the 2005 estimated average exchange rate from IMF (2005a).
- Simulated fiscal impacts (medians, Table 2):
  - Global interest rates rise by 200 basis points (additional fiscal burden in 2006 and 2007, medians) (percent of GDP):
    - Asia Pacific: 0.13 (2006), 0.17 (2007)
    - Africa/Middle East: 0.24 (2006), 0.30 (2007)
    - Emerging Europe: 0.30 (2006), 0.35 (2007)
    - Latin America: 0.30 (2006), 0.39 (2007)
  - Global interest rates rise by 300 basis points:
    - Asia Pacific: 0.20 (2006), 0.26 (2007)
    - Africa/Middle East: 0.37 (2006), 0.45 (2007)
    - Emerging Europe: 0.45 (2006), 0.52 (2007)
    - Latin America: 0.45 (2006), 0.58 (2007)
  - US$ appreciation/depreciation by 10 percent (impact on medians in 2006/2007):
    - Asia Pacific: 0.11 (2006), 0.10 (2007)
    - Africa/Middle East: 0.13 (2006), 0.13 (2007)
    - Emerging Europe: 0.10 (2006), 0.08 (2007)
    - Latin America: 0.28 (2006), 0.26 (2007)
  - US$ appreciation/depreciation by 20 percent (impact on medians in 2006/2007):
    - Asia Pacific: 0.22 (2006), 0.19 (2007)
    - Africa/Middle East: 0.27 (2006), 0.25 (2007)
    - Emerging Europe: 0.20 (2006), 0.16 (2007)
    - Latin America: 0.56 (2006), 0.51 (2007)
- Combined scenarios and vulnerability:
  - Most highly indebted emerging markets: fiscal impact of a 300 basis points hike could be in the region of 1½ percent of GDP in 2006–07 and rising.
  - For the most vulnerable (third quartile) of the 40 emerging markets: up to 1.1 percent of GDP impact from a 300 basis points interest rate increase combined with a 20 percent depreciation of national currencies against the U.S. dollar.
  - A more benign scenario (200 basis points hike with 10 percent depreciation) yields about 0.8 percent of GDP impact for the most vulnerable countries.
  - Regional median ranking of vulnerability: Latin America (greatest), Africa/Middle East, Emerging Europe, Asia Pacific (smallest).
- Robustness:
  - Estimates do not change much under a downside GDP growth scenario assuming real GDP growth in 2006–07 is half the baseline value.

### Policy implications and recommendations
- Emerging markets face substantial fiscal risks if benign global financial conditions reverse; risks increase if reversal coincides with slowing global activity and lower commodity prices.
- Key recommended actions:
  - Aim for consolidation of underlying fiscal positions.
  - Press ahead with fiscal reforms to preserve benign financing conditions even if global conditions deteriorate.
  - Strengthen debt management: lengthen average maturity, prepay unfavorable debt, broaden investor base, deepen local bond markets (electronic trading platforms, direct trading systems).
  - Improve fiscal institutions and transparency to bolster investor confidence and lock in favorable financing conditions.

### Reform of fiscal institutions and financing conditions: empirical evidence
- Fiscal transparency index:
  - Index bounded between zero and one; covers 20 desirable institutional fiscal features.
- Correlations:
  - Fiscal transparency is positively correlated with sovereign ratings (R-squared = 0.5051 in univariate cross-section).
  - Fiscal transparency is negatively correlated with EMBI spreads (R-squared = 0.4101 in univariate cross-section).
- Ratings evidence:
  - Hameed (2005) cross-section (31 developing countries): a 0.1 improvement in the fiscal transparency index improves the rating on average by 0.82 notches.
  - In 2005, a one-notch rating upgrade could be expected to lower spreads by about 40 basis points.
  - For a country with median public external debt ratio of 25 percent of GDP (2005), a one-notch upgrade implies expected fiscal savings of 0.1 percent of GDP (25 percent of GDP times 40 basis points).
- Spreads regression (cross-section of 20 emerging market countries, 2005) — coefficients (Table 3):
  - Constant: 569.46 (Std. Error 132.50; t-Statistic 4.2978; P-Value 0.0006)
  - Fiscal Transparency: –399.05 (Std. Error 213.02; t-Statistic –1.8733; P-Value 0.0794)
  - Income per Capita at PPP: –0.0109 (Std. Error 0.0033; t-Statistic –3.3166; P-Value 0.0044)
  - Real GDP Growth Rate: –20.735 (Std. Error 9.2459; t-Statistic –2.2426; P-Value 0.0394)
  - Notes: R-squared = 0.57. Observations for fiscal transparency date from various years.
- Interpretation: adding two fiscal transparency practices (≈0.1 increase in index) is associated with an average spread reduction of about 40 basis points (holding other controls constant).

### Conclusions
- Financial globalization has significantly affected fiscal positions in many emerging markets, both via external environment changes and via policy improvements associated with integration.
- Countries with sound policies have benefited most from integration; there is potential for a virtuous cycle of prudent policies → better integration → improved performance → greater policy discipline.
- Given looming uncertainties, countries that relied mainly on the benign external environment and may have increased underlying vulnerabilities should use current favorable conditions to strengthen fiscal positions and institutions.

*Source document: _wp05212 - REFERENCES*

### References .............................................................................................................

### _wp05212 - References .............................................................................................................

### Tables
- 1. Estimated Fiscal Savings from Benign Global Financial Conditions, 2002/2005 .............. 13
- 2. Estimated Fiscal Impact of Changes in Interest Rates and the U.S. Dollar, 2006–07 ........ 19
- 3. Fiscal Transparency and Spreads ........................................................................................ 22

### Figures
- 1. Net Capital Inflows, 1970–2005............................................................................................ 7
- 2. Stock of Public and Publicly Guaranteed External Debt, 1990–2005................................... 9
- 3. Public External Debt Indicators, 40 Emerging Markets, 1990–2005.................................. 10
- 4. Global Financial Conditions, 1990–2005............................................................................ 11
- 5. Estimated Fiscal Impact of Low Interest Rates and Spreads, U.S. Dollar Depreciation,  
and High Commodity Prices in 40 Emerging Markets, ...................................................... 16
- 6. Fiscal Transparency and Financing Conditions .................................................................. 21

* _wp05212 - References ............................................................................................................. *

### Appendix Tables

### _wp05212 - Appendix Tables

### Introduction and purpose
- Study examines the impact of global financial conditions in recent years on emerging market fiscal performance for 40 emerging markets.
- Focuses on two empirical questions:
  - The benefits that these countries derived from the benign global environment.
  - The impact of a potential reversal in these conditions over the next few years.
- Key conclusion: most countries’ budgets have benefited substantially from the decline in global interest rates and spreads, dollar depreciation, and high commodity prices.
- Also finds synergies between fiscal reforms pursued by many countries and the benefits from global financial integration and benign financial market conditions.

### Analytical framework (Sections II and formal model)
- Uses a standard fiscal accounting relationship linking the debt ratio to the primary balance and automatic debt dynamics; starting point is equation (1) in the source that relates change in public debt-to-GDP to the primary deficit, automatic dynamics of foreign and domestic debt, depreciation, growth, and stock-flow adjustments (SFA).
- Primary deficit equivalence: P = B − A (equation (2), where B is borrowing and A is amortization).
- Analysis focuses on external (foreign currency) debt and isolates effects of:
  - exchange rate changes,
  - global base interest rates (r),
  - spreads (s),
  - share of foreign currency debt at variable rates (v) versus fixed rates (r0),
  - share p of foreign currency debt owed to private creditors subject to a fixed spread s0.
- Key derived expressions include:
  - Impact on debt service from exchange rate changes and amortization (equation (5)).
  - Impact from changes in variable-rate interest on foreign debt (equation (6)).
  - Cumulative effect of changes in fixed base interest rates and spreads on borrowing from private creditors (equation (7)).
  - Combined total effect of changes in financial conditions between reference period t* and current period t (equation (8)).
- Notes on application:
  - For quantifying fiscal impact of future changes, the framework accounts for gradual replacement of existing debt with new debt at prevailing conditions.
  - Domestic debt portion is disregarded in the core empirical exercise due to data problems and cross-country transmission variability; however, if domestic rates respond to global rates, domestic debt effects would go in the same direction as external debt.

### Financial integration and budgetary costs of external financing (Section III)
- Financial globalization accelerated since the early 1990s, with rapid increases in net capital flows to emerging markets.
- Observed structural changes:
  - Investor base for emerging-market assets has broadened and deepened; emerging-market assets increasingly identified as a separate asset class.
  - Shift in external debt composition: nominal public external debt stock grew markedly over the 1990s and particularly since 2000 for the 40 countries studied.
  - The 40 countries increased their public external debt roughly by US$ 70 billion (1 percent of GDP) both in 2004 and 2005—the highest nominal increase since 1998.
  - Debt owed to official creditors stabilized over the 1990s.
  - Debt owed to private creditors excluding bonds (largely commercial banks and trade financing) has fallen significantly.
  - Bond debt has grown rapidly in the 1990s and now makes up a much larger share of developing countries’ external debt than at any point in the past three decades.
- Implications and risks:
  - Bond financing indicates rising investor confidence but is more susceptible to sharp movements in pricing conditions and risk perceptions than long-term bank lending.
  - Despite rising nominal debt and a shift to potentially riskier sources, debt-to-GDP ratios have trended down recently in many emerging markets.
- Three explanations reconciling higher nominal debt with lower debt-to-GDP:
  1. Exchange rate movements: U.S. dollar weakness since 2002 produced a revaluation effect on debt stock (about 60 percent of emerging market external debt is denominated in U.S. dollars).
  2. Strong global activity and high commodity prices boosted emerging market growth and debt-service capacity.
     - World output expanded at rates above the long-term average in 2003–05, with growth in 2004 the highest since 1976.
     - Commodity prices reached record levels over the period.
     - Debt over noncommodity GDP (noncommodity GDP defined as nominal GDP minus commodity exports) shows debt ratios trending down on average, though with heterogeneity across countries.
  3. Decline in interest burden:
     - Between 2001 and 2005, interest payments on public external debt declined by about half a percentage point of GDP in the median country in Asia Pacific and Emerging Europe and more than that in the median country of Africa/Middle East; in Latin America interest payments have kept up, but less than they would have under less benign conditions.
     - Decline in interest burden attributed to:
       - Lower industrial country interest rates (reflecting accommodative monetary policies and lower inflation expectations).
       - Decline in emerging market spreads (reflecting improving fundamentals, high investor risk appetite, and structural shifts in industrial-country investor asset allocations).
     - Tentative evidence cited: market volatility and global liquidity account for about three-fourths of the decline in spreads during recent years, while fundamentals account for about one-fourth.

### Fiscal performance under benign global conditions (Section IV)
- Empirical approach:
  - Compares actual financial conditions in 2002–05 (U.S. dollar exchange rates, global interest rates, and spreads) to those prevailing in 2001 as the reference period.
  - Also calculates fiscal balance over noncommodity GDP to indicate commodity-price effects on denominators.
- Estimated gross fiscal savings from benign global financial environment (regional medians, 2002–05 relative to 2001):
  - Asia Pacific: about 0.9 percent of GDP.
  - Africa/Middle East: about 1.8 percent of GDP.
  - Emerging Europe: about 1.9 percent of GDP.
  - Latin America: about 1.9 percent of GDP.
- Evolution over time (median estimated gross savings in 2005, relative to 2001 benchmark):
  - Asia Pacific: 0.4 percent of GDP in 2005 (median).
  - Africa/Middle East: 0.7 percent of GDP in 2005 (median).
  - Emerging Europe: 0.9 percent of GDP in 2005 (median).
  - Latin America: 0.8 percent of GDP in 2005 (median).
- Distributional/heterogeneity notes:
  - Size of effects varies considerably within country groups.
  - For the most vulnerable countries (third quartile), total estimated savings in 2005 amounted to:
    - Asia Pacific: 0.7 percent of GDP (third quartile).
    - Africa/Middle East: 1.6 percent of GDP (third quartile).
  - (Analysis continues in the source beyond the excerpt provided.)

*Italic source: _wp05212 - Appendix Tables*

### 1.4 percent of GDP in Emerging Europe, and 1.1 percent of GDP in Latin America. This is

### _wp05212 - 1.4 percent of GDP in Emerging Europe, and 1.1 percent of GDP in Latin America. This is

### Estimated fiscal savings from benign global financial conditions (2002–05)
- Median interest rate effect on variable rate debt (2005):
  - Asia Pacific: 0.2 percent of GDP
  - Africa/Middle East: 0.3 percent of GDP
  - Emerging Europe: 0.4 percent of GDP
  - Latin America: 0.3 percent of GDP
- Median interest rate effect on new borrowing (2005):
  - Emerging Europe and Latin America: about 0.3 percent of GDP
  - Asia Pacific and Africa/Middle East: about 0.2 percent of GDP
- Median spread effect on new borrowing (2005):
  - Less than 0.1 percent of GDP in all regions (median); some countries experienced up to 0.5 percent of GDP savings in 2005 from declining spreads
- Median exchange rate effect on debt service (2002–05):
  - Asia Pacific: virtually zero
  - Africa/Middle East and Emerging Europe: 0.1–0.2 percent of GDP
  - Latin America: negative, median country paid extra 0.2–0.3 percent of GDP (in 2002 and 2005) to 0.6–0.7 percent of GDP (in 2003–04)
- Total (gross) estimated fiscal savings (medians, 2002–05 annual numbers summed as TT 2/):
  - Asia Pacific: 0.85 percent of GDP (TT 2/ column in Table 1)
  - Africa/Middle East: 1.77 percent of GDP (TT 2/)
  - Emerging Europe: 1.05 percent of GDP (TT 2/)
  - Latin America: 1.92 percent of GDP (TT 2/)
- Memorandum items (medians by vulnerability quartiles, TT 2/):
  - Least vulnerable (first quartile) totals: Asia Pacific 0.69; Africa/Middle East 1.32; Emerging Europe 0.34; Latin America 0.77 (percent of GDP)
  - Most vulnerable (third quartile) totals: Asia Pacific 1.93; Africa/Middle East 4.11; Emerging Europe 1.05; Latin America 2.86 (percent of GDP)
- Note: 1/ Gross total savings exclude negative effects. 2/ Simple sum of the 2002–05 annual numbers that is not adjusted for GDP growth.

### Fiscal performance adjusted for savings and commodity booms (2002–05)
- Median adjusted deficits (2005, over noncommodity GDP, augmented by savings on interest expenditure):
  - Asia Pacific: 4½ percent of GDP
  - Africa/Middle East: 3½ percent of GDP
  - Emerging Europe: 4.9 percent of GDP
  - Latin America: 3.1 percent of GDP (adjusted) versus 1.9 percent of GDP (headline)
- Observations:
  - The combined median impact of savings from benign global financial conditions was substantially larger than the median impact of high commodity prices over 2002–05.
  - In median countries of Asia Pacific, Africa/Middle East, and Emerging Europe, fiscal deficits rose over 2002–05 when adjusted for savings and commodity exports (increases since 2001 of 0.2, 0.7, and 0.8 percentage points respectively).
  - In Latin America, median fiscal performance improved since 2003 even when adjusted for exogenous factors, but adjusted deficits remain high by 1990s standards.
  - Conclusion: savings from the benign global environment were largely spent in many countries instead of being used to reduce fiscal deficits; heterogeneity across countries is substantial.

### Fiscal risks from a reversal in global financial conditions
- Drivers of risk:
  - Rising global long-term interest rates, widening yield spreads, and pronounced exchange rate movements.
  - Potential partial unwinding of the “global savings glut.”
- Channels affecting public finances:
  - Increased cost of servicing existing variable rate debt.
  - Higher interest rates on new debt commitments (effect increases over time as cheaper old debt is rolled over).
- Simulation assumptions (2006–07):
  - Global interest rate increases simulated: 100 to 300 basis points relative to end-2004.
  - Assume each 100 basis points increase in U.S. short-term rates entails an extra 50 basis points increase in spreads on emerging market debt.
  - Yield curve slope for emerging market financing assumed unchanged.
  - U.S. dollar exchange rate changes simulated: 10–20 percent relative to the 2005 estimated average exchange rate from IMF (2005a).
- Simulated fiscal impacts (medians, Table 2):
  - Global interest rates rise by 200 basis points (additional fiscal burden in 2006 and 2007, medians):
    - Asia Pacific: 0.13 (2006), 0.17 (2007) percent of GDP
    - Africa/Middle East: 0.24 (2006), 0.30 (2007)
    - Emerging Europe: 0.30 (2006), 0.35 (2007)
    - Latin America: 0.30 (2006), 0.39 (2007)
  - Global interest rates rise by 300 basis points:
    - Asia Pacific: 0.20 (2006), 0.26 (2007) percent of GDP
    - Africa/Middle East: 0.37 (2006), 0.45 (2007)
    - Emerging Europe: 0.45 (2006), 0.52 (2007)
    - Latin America: 0.45 (2006), 0.58 (2007)
  - US$ appreciation/depreciation by 10 percent (impact on medians in 2006/2007):
    - Asia Pacific: 0.11 (2006), 0.10 (2007)
    - Africa/Middle East: 0.13 (2006), 0.13 (2007)
    - Emerging Europe: 0.10 (2006), 0.08 (2007)
    - Latin America: 0.28 (2006), 0.26 (2007)
  - US$ appreciation/depreciation by 20 percent (impact on medians in 2006/2007):
    - Asia Pacific: 0.22 (2006), 0.19 (2007)
    - Africa/Middle East: 0.27 (2006), 0.25 (2007)
    - Emerging Europe: 0.20 (2006), 0.16 (2007)
    - Latin America: 0.56 (2006), 0.51 (2007)
- Combined scenarios and vulnerability:
  - Most highly indebted emerging markets: fiscal impact of a 300 basis points hike could be in the region of 1½ percent of GDP in 2006–07 and rising.
  - For the most vulnerable (third quartile) of the 40 emerging markets: up to 1.1 percent of GDP impact from a 300 basis points interest rate increase combined with a 20 percent depreciation of national currencies against the U.S. dollar.
  - A more benign scenario (200 basis points hike with 10 percent depreciation) yields about 0.8 percent of GDP impact for the most vulnerable countries.
  - Regional median ranking of vulnerability: Latin America (greatest), Africa/Middle East, Emerging Europe, Asia Pacific (smallest).
- Robustness:
  - Estimates do not change much under a downside GDP growth scenario assuming real GDP growth in 2006–07 is half the baseline value.

### Policy implications and recommendations
- Emerging markets face substantial fiscal risks if benign global financial conditions reverse; risks increase if reversal coincides with slowing global activity and lower commodity prices.
- Key recommended actions:
  - Aim for consolidation of underlying fiscal positions.
  - Press ahead with fiscal reforms to preserve benign financing conditions even if global conditions deteriorate.
  - Strengthen debt management: lengthen average maturity, prepay unfavorable debt, broaden investor base, deepen local bond markets (electronic trading platforms, direct trading systems).
  - Improve fiscal institutions and transparency to bolster investor confidence and lock in favorable financing conditions.

### Reform of fiscal institutions and financing conditions: empirical evidence
- Fiscal transparency index:
  - Index bounded between zero and one; covers 20 desirable institutional fiscal features.
- Correlations:
  - Fiscal transparency is positively correlated with sovereign ratings (R-squared = 0.5051 in univariate cross-section).
  - Fiscal transparency is negatively correlated with EMBI spreads (R-squared = 0.4101 in univariate cross-section).
- Ratings evidence:
  - Hameed (2005) cross-section (31 developing countries): a 0.1 improvement in the fiscal transparency index improves the rating on average by 0.82 notches.
  - In 2005, a one-notch rating upgrade could be expected to lower spreads by about 40 basis points.
  - For a country with median public external debt ratio of 25 percent of GDP (2005), a one-notch upgrade implies expected fiscal savings of 0.1 percent of GDP (25 percent of GDP times 40 basis points).
- Spreads regression (cross-section of 20 emerging market countries, 2005):
  - Coefficients (Table 3):
    - Constant: 569.46 (Std. Error 132.50; t-Statistic 4.2978; P-Value 0.0006)
    - Fiscal Transparency: –399.05 (Std. Error 213.02; t-Statistic –1.8733; P-Value 0.0794)
    - Income per Capita at PPP: –0.0109 (Std. Error 0.0033; t-Statistic –3.3166; P-Value 0.0044)
    - Real GDP Growth Rate: –20.735 (Std. Error 9.2459; t-Statistic –2.2426; P-Value 0.0394)
  - Notes: R-squared = 0.57. Observations for fiscal transparency date from various years.
  - Interpretation: adding two fiscal transparency practices (≈0.1 increase in index) is associated with an average spread reduction of about 40 basis points (holding other controls constant).
- Conclusion: suggestive empirical evidence that improving fiscal institutions (fiscal transparency) can lower spreads and improve financing conditions, providing an additional rationale for fiscal reforms.

### Conclusions (paper’s main takeaways)
- Financial globalization has significantly affected fiscal positions in many emerging markets, both via external environment changes and via policy improvements associated with integration.
- Countries with sound policies have benefited most from integration; there is potential for a virtuous cycle of prudent policies → better integration → improved performance → greater policy discipline.
- Given looming uncertainties, countries that relied mainly on the benign external environment and may have increased underlying vulnerabilities should use current favorable conditions to strengthen fiscal positions and institutions.

*Sources: Global Development Finance, IMF country reports, JP Morgan Chase & Co./Datastream, WEO, United Nations Conference on Trade and Development, FAD Fiscal Transparency Database, and authors’ calculations.*

### REFERENCES

### _wp05212 - REFERENCES

### References
- Arora, Vivek, and M. Cerisola, 2000, “How Does U.S. Monetary Policy Influence Sovereign Spreads in Emerging Markets?” International Monetary Fund Staff Papers, Vol. 48, No. 3, pp. 474–98.
- Ferrucci, Gianluigi, 2003, “Empirical Determinants of Emerging Market Economies’ Sovereign Bond Spreads,” Working Paper No. 205 (London: Bank of England).
- Hameed, Farhan, 2005, “Fiscal Transparency and Economic Outcomes,” forthcoming IMF Working Paper (Washington: International Monetary Fund).
- Hauner, David, 2005, “A Fiscal Price Tag for International Reserves,” IMF Working Paper No. 05/81 (Washington: International Monetary Fund).
- Hauner, David, and Manmohan S. Kumar, 2005, “Interest Rates and Fiscal Policy,” forthcoming IMF Working Paper (Washington: International Monetary Fund).
- IMF, 2003, “Assessing and Promoting Fiscal Transparency: A Report on Progress” (Washington: International Monetary Fund), available at http://www.imf.org/external/np/pdr/sac/2003/030503s2.htm.
- IMF, 2004a, Global Financial Stability Report, April (Washington: International Monetary Fund).
- IMF, 2004b, Global Financial Stability Report, September (Washington: International Monetary Fund).
- IMF, 2005a, World Economic Outlook, April (Washington: International Monetary Fund).
- IMF, 2005b, Global Financial Stability Report, September (Washington: International Monetary Fund).
- Kamin, Steve B., and Karsten von Kleist, 1999, “The Evolution of Emerging Market Credit Spreads in the 1990s,” BIS Quarterly Review (November), pp. 36–44.
- Kumar, Manmohan S., and Avinash Persaud, 2002, “Pure Contagion and Investors' Shifting Risk Appetite: Analytical Issues and Empirical Evidence,” International Finance, Vol. 5, No. 3, pp. 401–36.
- Min, Hong G., 1998, “Determinants of Emerging Market Bond Spread: Do Economic Fundamentals Matter?” World Bank Policy Research Paper No. 1899 (Washington: World Bank).
- Poterba, James M., and Jürgen von Hagen, 1999, Fiscal Institutions and Fiscal Performance (Chicago: University of Chicago Press).
- World Bank, 2005, Global Development Finance (Washington: World Bank).
- Zoli, Edda, 2004, “Credit Rationing in Emerging Economies’ Access to Global Capital Markets,” IMF Working Paper No. 04/70 (Washington: International Monetary Fund).

### Data Sources and Estimates (Table A1) — variables, acronyms, and descriptions
- f_t D — Public sector external debt  
  - GDF (DTDODDPPGCD); 2004–05 based on IMF country reports.
- total_t L — Total long-term external debt  
  - GDF (DTDODDLXFCD)
- t L — Public sector long-term external debt  
  - GDF (DTDODPUBSCD); 2004–05 proxied)/(
    20032003
    ff
    tt
    DDLL⋅=.
- USD_t d — US$-denominated share in public sector external debt  
  - Proxied by US$-denominated share in total long-term debt from GDF (DTCURUSDLZS); assumed constant after 2003. All the remaining debt is assumed to be denominated in euros.
- t v — Variable-rate share in public sector long-term external debt (percent)  
  - Proxied by variable-rate share in total long-term debt from GDF (DTDODVTOTCD); assumed constant after 2003.
- t S — Total service of public sector external debt  
  - GDF (DTTDSDPPGCD), where ttt IAS+=.
- total_t A — Amortization of total long-term external debt  
  - GDF (DTAMTDLXFCD). Note on GDF projections: projected amortization are based on loan commitments; amortization profile follows first and final payment dates and frequency; irregular future payments require a schedule. Projected debt service obligations are converted into U.S. dollars using end-December 2003 exchange rates and interest rates as of end-December 2003 for variable interest rate debt.
- f_t A — Amortization of public sector long-term US$ denominated external debt  
  - GDF (DTAMTDPPGCD), 2004–07 proxied by )/(
    200320032003
    totalUSDtotal
    t
    f
    t
    LLdAA⋅⋅=.
- f_t I — Interest payments on public sector external debt  
  - GDF (DTintDPPGCD), 2004–05 proxied by assuming same change in average interest rate since 2003 as for total external debt as reported in IMF (2005a).
- f_t i — Average interest rate on public sector external debt  
  - f_t f_t f_t DII/=.
- f_t B — New commitments of public sector external debt  
  - GDF (DTCOMDPPGCD), 2004–07 calculated based on the estimated equation [R2 = 0.49]  
    t C= 1,182,084,666 [t=13.8]+ 0.547 [t=33.3] * total_t A, assuming that the currency split of new commitments is as for the existing stock, and that all external debt is denominated either in U.S. dollars or in euros.
- pf_t B — New commitments of public sector external debt, private creditors  
  - GDF (DTDISPRVTCD)
- f_t r — Treasury bill rate (aop)  
  - IFS (line 60C), the German rate is used for the Euro Area.
- t s — Interest rate spread (aop)  
  - Average of daily EMBI+ spreads from JP Morgan Chase & Co (regional composite for 11 countries with no own index). Note: individual country spreads are compared; medians used by regional grouping.
- t Y — Nominal GDP  
  - WEO (NGDPD)
- t X — Commodity exports  
  - Fuel, ores, and metal exports (World Development Indicators)
- t G — General government balance  
  - WEO (GGB), central government where not available.
- USD_t a — National currency per USD (aop)  
  - WEO (ENDA)
- USD_t e — National currency per USD (eop)  
  - IFS (..AE.ZF...), June=December assumed for 2005.

- Source statement from table: "Source: Authors. Notes: GDF ... World Bank Global Development Finance, IFS ... IMF International Financial Statistics, WEO ... IMF World Economic Outlook Database."

### Country Groups (Table A2)
- Asia Pacific: Bangladesh, China, India, Indonesia, Malaysia, Philippines, Sri Lanka, Thailand, Vietnam
- Africa/Middle East: Algeria, Côte d'Ivoire, Egypt, Lebanon, Morocco, Nigeria, Pakistan, South Africa, Tunisia, Turkey
- Emerging Europe: Bulgaria, Croatia, Czech Republic, Hungary, Poland, Romania, Russia, Slovak Republic, Ukraine
- Latin America: Argentina, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, El Salvador, Mexico, Peru, Uruguay, Venezuela

### Public and Publicly Guaranteed External Debt — tables overview (Tables A3 and A4)
- Table A3 provides country-level series of "Public and Publicly Guaranteed External Debt in Billions of U.S. Dollars" for 1994–2003. (Example entries shown in the source include numbers for selected countries and years, e.g., Algeria: 67.0, 74.4, 66.6, 59.6, 59.1, 53.0, 42.9, 38.0, 38.2, 32.7 for 1994–2003 row.)
- Table A4 provides the corresponding series expressed as "Public and Publicly Guaranteed External Debt in Percent of GDP" for 1994–2003 (country-year percent values are presented in the source tables).

- Source for the tables: "Source: Global Development Finance and WEO."

*Italic: Source document: _wp05212 - REFERENCES*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2005/_wp05212.pdf_