Public Debt Dynamics and Intra-Year Exchange Rate Fluctuations

IMF Working Papers, November 20, 2020

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The paper examines how converting foreign currency denominated flows and stocks into local currency using average and end-of-period exchange rates, respectively, produces an identifiable stock-flow adjustment term due to intra-year exchange rate fluctuations.
Inclusion of this stock-flow adjustment term is critical to accurately project public debt levels and related indicators used to assess the risk of debt distress.
Using a novel dataset covering 82 countries during 2008–19, the paper finds the stock-flow adjustment term can be sizable in episodes of large exchange rate depreciations.

The stock-flow adjustment term arising from intra-year exchange rate fluctuations affects public debt accumulation and debt-to-GDP ratios.
In countries experiencing large exchange rate depreciations (namely above the 99th percentile of the full sample), the stock-flow adjustment term can reach 1.2 percent of GDP.
Measurement of policy-related concepts is affected by intra-year exchange rate fluctuations in non-negligible ways, including:
- Interest rate-growth differentials.
- Debt stabilizing primary balances.

Debt projections that omit the intra-year stock-flow adjustment term may misstate public debt levels and misinform assessments of debt distress risk.
Accurate measurement of interest rate-growth differentials and debt stabilizing primary balances requires accounting for intra-year exchange rate fluctuations to avoid distortions.

Sample: 82 countries.
Period covered: 2008–19.
Analysis focuses on episodes of heightened exchange rate volatility and nominal exchange rate depreciation.