Orthodox and heterodox option of debt reduction for EMDEs
Debt in emerging market and developing economies (EMDEs) is at its highest level in half a century. In this paper Kose et al. suggest orthodox as well as heterodox options for EMDEs to lower the debt burden.
Orthodox options include:
Fiscal consolidation by cutting budget deficits and privatizing a broad array of government assets. Interestingly enough, they argue for raising wealth taxes mainly on the rich so that deficit cutting policies don’t impact adversely low- and middle-income citizens. Relying on rapid growth to reduce debt has not been a successful strategy in the past at the exception of episodes when debt ramped up quickly after one-off shocks such as wars and was then followed by a rapid growth period.
Heterodox options include:
Inflation as a reduction strategy would mostly be useful for a one-off reduction in high debt levels, but if high debt levels are the result of persistent spending pressures or revenue weakness, a bout of surprise inflation cannot reduce elevated debt levels in a lasting manner. Financial repression, is another option especially since many EMDEs have already implemented interest rate controls during the pandemic. Finally, there is the option of default which of course imposes long-term costs.
The Aftermath of Debt Surges
Authors: M. Ayhan Kose, Franziska Ohnsorge, Carmen Reinhart, Kenneth Rogoff
From: World Bank, Harvard University
Caught between a rock and a hard place
As the Fed is contemplating rate increases, EMDEs with high public and private debt, foreign exchange exposures, and lower current-account balances saw already larger movements of their currencies relative to the US dollar. As a result, some have already started to adjust monetary policy and are preparing to scale back fiscal support to address rising debt and inflation. Danninger et al. in this policy brief, also suggest allowing their currencies to depreciate while raising their own interest rates despite the fact that such measures make supporting a weak domestic economy more difficult.
Emerging Economies Must Prepare for Fed Policy Tightening
By: Stephan Danninger, Kenneth Kang, Hélène Poirson – IMF
