Hiding Public Debt

Abstract

This paper examines the determinants of hidden public debt-that is, government financial commitments and contingent liabilities that do not receive official recognition and explicit budgetary allocations, but are later on assumed by the government as additional debt outside the normal budget. Hidden debts are large in many countries and can cause major fiscal and macroeconomic instability. We show that the forces that raise the demand for public expenditure, such as fractionalization and division in the government, also motivate the politicians to resort to disguised expenditure and debt as a means of alleviating constraints on explicit borrowing. The tightness of such constraints also adds to the incentive to hide debt, as do factors that reduce the costs of arranging off-budget debts. We find that these costs decline with the extent of government intervention in the economy, especially when the economy is more developed and interventions allow the politicians to tap on larger resources. We also examine the role of IMF standby programs, which impose limits on explicit spending and borrowing while intensifying the monitoring of fiscal operations to curb disguised liability creations. We find that the latter function is strong enough to ensure that hidden debts decline towards the end of standby programs.

Keywords: Hidden public debt, fiscal policy, borrowing constraint, IMF standby programs

JEL Classification: H63, H62, H11