A New Index of External Debt Sustainability

26 Pages Posted: 16 Nov 2017

See all articles by Olivier J. Blanchard

Olivier J. Blanchard

National Bureau of Economic Research (NBER); Peter G. Peterson Institute for International Economics

Mitali Das

International Monetary Fund (IMF)

Date Written: November 14, 2017

Abstract

Debt sustainability is fundamentally a probabilistic concept: Debt is rarely sustainable with probability one. We propose an index of external debt sustainability that reflects this uncertainty. Namely we construct the index as the probability that, at the current exchange rate, net external debt is equal to or less than the present value of net exports. Constructing this index involves three steps: (1) deriving the distribution of the present value of net exports at the current exchange rate; (2) deriving the distribution of exchange rates associated with the condition that, for each realization, the present discounted value of net exports is at least equal to the value of current net debt; and (3) assessing where the current exchange rate stands in the distribution of exchange rates and thus the probability that debt is sustainable. Having shown how this can be done, we then compute the index for two countries, the United States and Chile. Our main conclusion is the large degree of uncertainty implied by the presence of large gross asset and liability positions, together with uncertainty about rates of return on these assets and liabilities. The size of the distribution of exchange rate adjustments implies that one should be careful in concluding that debt is or is not sustainable at the current exchange rate and that strong measures are potentially needed to reestablish sustainability. Exchange rates that appear overvalued in the baseline may still imply a reasonably high probability that debt is sustainable at the current exchange rate; symmetrically, exchange rates that appear undervalued in the baseline may still come with a reasonably low probability that debt is unsustainable at the current exchange rate.

Keywords: Sustainability, External Debt, Capital Gains, Gross Assets, Gross

JEL Classification: F32, F34

Suggested Citation

Blanchard, Olivier J. and Das, Mitali, A New Index of External Debt Sustainability (November 14, 2017). Peterson Institute for International Economics Working Paper No. 17-13. Available at SSRN: https://ssrn.com/abstract=3070980 or http://dx.doi.org/10.2139/ssrn.3070980

Olivier J. Blanchard (Contact Author)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Peter G. Peterson Institute for International Economics ( email )

1750 Massachusetts Avenue, NW
Washington, DC 20036
United States

Mitali Das

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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