The objective of this report is to analyze the relationship between public debt, economic development, and macroeconomic stability. A clear understanding of these issues requires comparable cross-country data on the level and structure of public debt, but the problem is that good data on public debt are hard to find.

The ideal data set on public debt would cover the level of debt and break the data down according to the characteristics of the instruments of which it is composed. This data set would include figures for both net and gross debt at the levels of the general government, central government, and subnational governments.[1] However, data on the level of debt alone would not be enough, because different types of debt generate different types of vulnerabilities. For instance, short-term borrowing in foreign currency is likely to be more dangerous (albeit less expensive) than borrowing by issuing long-term domestic currency contingent debt (for a discussion of these issues, see Borensztein et al., 2004). Therefore, one would like to have data describing the composition of public debt. These data should separate domestic and external debt, and then divide each category according to maturity (long term and short term), currency of denomination (domestic and foreign), and type of indexation (nominal, indexed to prices, indexed to the interest rate). Finally, one would like to have information on both the face value of debt and its net present value.

This would be a complete data set. In reality, one might need to be less ambitious. Despite the importance of accurate measures of the level and composition of public debt for both policy and research purposes, until recently there existed no data set on the composition (in terms of both maturity and currency) of public debt, and even data on the level of government debt had gaps.

Two data sets assembled for this report, and a third one assembled by researchers at the International Monetary Fund, partly address these issues by increasing the country and time coverage of data on the level of central government debt, and by stressing for the first time information on the composition of debt for several Latin American, Caribbean, and emerging market countries.[2] These data sets (described in Boxes 2.1 and 2.2) will be the main source of data used in this report. With these data at hand, this chapter will describe and characterize the evolution and the structure of public debt in Latin America and the Caribbean and compare Latin America and the Caribbean with other regions of the world.

Public Debt in Latin America and the Caribbean[3]

Figure 2.1 provides a bird’s-eye view of the ratio of debt to GDP in the region and shows four different measures of aggregate indebtedness.[4] The dark bars report simple averages across countries and show that in the early 1990s, the region was characterized by very high levels of debt (above 100 percent of GDP). Debt decreased rapidly over the 1993–1997 period, bottoming out at 64 percent of GDP. The late 1990s and early years of this century were characterized by a wave of financial and debt crises (East Asia in 1997, Russia in 1998, Brazil in 1999, and Argentina in 2001), which led to a rapid increase in debt (from 64 to 80 percent of GDP over the 1998–2003 period). The unwinding of these crises was then associated with a decrease of approximately 12 percentage points during 2004 and 2005.

The declining trend of the early 1990s was mostly driven by debt reduction in a few countries with very high levels of debt. As a consequence, median values (the light bars) show a much less dramatic decline than the average values, decreasing from 62 to 49 percent of GDP over the 1991–1998 period. Over the 1998–2003 period, by contrast, median debt increased as rapidly as average debt.

The shaded area in Figure 2.1 reports a weighted average of the debt-to-GDP ratio. This gives relatively more importance to large countries because it is equivalent to computing the sum of total debt in Latin America and the Caribbean and dividing it by the total regional GDP. The weighted debt-to-GDP ratio, which reached a minimum of 40 percent in 1994, has been increasing since then, reaching 66 percent of GDP in 2003 and then dropping to 59 percent of GDP in 2005. The weighted-average data show two interesting patterns. First, the weighted average is always lower than the simple average, indicating that larger countries tend to have smaller debt.[5] Second, while the difference between the simple and weighted average was extremely large in the early 1990s, the two ratios have tended to converge in recent years because debt has been decreasing in small countries and increasing in large countries.

The last debt indicator reported in Figure 2.1 is the weighted debt-to-GDP ratio computed excluding Argentina from the sample (this is the solid dark line). This indicator isolates the aggregate measure from the influence of the sharp fluctuations in Argentina in the 2000s. The figure shows that dropping Argentina from the sample removes the local peak of 2003 and makes the pattern of debt smoother and more evident.

There are many ways to interpret the data reported in Figure 2.1. An optimistic observer would focus on the simple average measure and note that debt in 2005 is much lower than in 1991. This is likely to be a misreading of the data, however, because the large drop in debt is basically due to the behavior of two small countries (Guyana and Nicaragua) that in 1991 had debt levels above 500 percent of GDP and by 2005 had managed to bring debt down to the still considerable level of 150 percent of GDP. A more moderate optimist would focus on median values or the weighted averages and note that by 2005, debt was at about the same level as in 1991 and that these levels of debt compare well with those of several other regions (for instance, they are lower than those prevailing in the advanced economies). Such an optimist would think that this is a good outcome after a decade punctuated by a number of severe financial crises and high market volatility. This person’s optimism would be further fueled by the decline in debt in the last two years and favorable changes in the composition of debt, as well as the fact that part of the previous debt increase resulted from the privatization of pension systems, which will be discussed below.

A callous pessimist, however, would note that debt has been generally rising since 1995, squandering the gains from the significant debt reduction achieved in the early 1990s. Such an observer would also note that, while the 1990s were punctuated by several crises, the 1980s (often referred to as the “lost decade”) had been an even more traumatic period for Latin America and the Caribbean. The pessimist would also point out that part of the original debt reduction was due to the privatization process and that, having sold the family jewels, most Latin American and Caribbean countries are back where they were before privatization.[6]

Something on which optimists and pessimists are likely to agree, though, is that debt is still of significant magnitude in Latin America and the Caribbean and that good debt management must be a clear priority for the stability of a region which has been hit by devastating debt crises in the past.

One natural question is whether the patterns documented in Figure 2.1 are driven by valuation effects in the presence of foreign-currency-denominated debt. A way to partly address this issue is to adjust GDP for the currency composition of debt and isolate the changes in debt over GDP due to appreciations or depreciations of the real exchange rate.[7] Adjusting for valuation effects due to changes in the real exchange rate mitigates but does not change the upward trend in debt in the 1995–2005 period. This adjustment also shows that the recent slight decrease in debt is partly due to the real appreciation faced by several countries in the region (Figure 2.2).

The level of market access is an important dimension that may affect trends in the level of debt and its composition across countries, and the 24 countries used to compute the averages of Figure 2.1 can be divided into two subgroups. The first consists of emerging market countries with access to the international capital market, and the second consists of countries with no access or only limited access. The next sections discuss separately trends in those two groups.[8]

Emerging Market Countries

As the emerging market group comprises the largest countries in the region, the behavior of the weighted average of debt over GDP for these countries is basically identical to that of the weighted average for the whole sample of countries. Figure 2.3 describes the composition of total debt in emerging market countries, breaking it down into external debt owed to official creditors (such as the International Monetary Fund, the Inter-American Development Bank, the World Bank, and bilateral creditors), external debt owed to private creditors (bondholders and banks), and domestic debt.[9] It shows that official debt remained fairly stable at about 10 percent of GDP and that private external debt also remained more or less constant, ranging between 13 and 16 percent of GDP (with a spike of 18 percent of GDP in 2003). As a consequence, there is no clear trend in external debt.[10] The increasing trend in debt is entirely the result of the increase in domestic debt, which rose from 16 percent of GDP in 1994 to 37 percent of GDP in 2004.

Data on external debt are available for a longer period and show a visible downward trend in debt ratios, which fell from a peak of 42 percent in 1987 to 25 percent of GDP in 2004 (bottoming out at about 18 percent in 1997). Data on the composition of external debt show that lending by the IMF and other multilaterals has hovered around 5 percent of GDP (or 20 percent of external debt), with peaks during the Mexican, Brazilian, and Argentine crises (Figure 2.4). Bilateral lending has, instead, become progressively less important, falling from a peak of 6 percent of GDP in 1987 to 2 percent of GDP in 2004. Borrowing from private sources (comprising bank and bonded debt) has fallen sharply from a peak at 30 percent of GDP in 1987 to about 16 percent of GDP in 2004. The debt instruments shifted from mostly bank loans in the 1980s to mostly bonds in the 1990s, after the Brady Plan debt-restructuring operations resuscitated the market for emerging market bonds, which had largely died out in the interwar period (see Chapters 4 and 5). The result of a decreasing amount (in terms of GDP) of external debt owed to private lenders and a constant amount of external debt owed to official lenders is that the relative share of official debt has been increasing. While financing from international financial institutions represents a small fraction of international capital flows (including private borrowing and foreign direct investment), it still accounts for a significant share of the stock of external public debt in the largest Latin American countries.[11]

The currency composition of public debt appears to be especially important for this group of countries. The literature on “original sin,” liability dollarization, and currency mismatches has argued that countries with long-term domestic currency debt tend to have a safer debt structure than countries with short-term foreign currency debt (Box 2.3). Basically all external debt issued by Latin American and Caribbean emerging markets is denominated in foreign currency, while about two-thirds of domestic debt is denominated in nominal (i.e., not indexed to prices) domestic currency. Nevertheless, several local currency bonds have been issued in international markets over the past two years. While this is an interesting widening of financing options for Latin American and Caribbean countries, these issues are still too small to affect the aggregate figures, and it is not clear whether they are part of a developing trend or merely temporary factors (see Box 2.4). Those recent issues notwithstanding, there is a fairly close relationship for the time being between legal jurisdiction and the currency denomination of government debt issues.[12]

The recent evolution of debt in emerging Latin American and Caribbean economies shows a tendency towards “onshorization” (that is, substitution of domestic for external debt) and “dedollarization” (substitution of domestic currency debt for foreign currency debt), as depicted in Figure 2.5. This is in line with the correspondence between market of issuance and currency denomination noted above. For example, although there are important exceptions in individual cases, domestic debt in foreign currency is fairly small, and foreign debt in domestic currency is still insignificant as of 2004 for the aggregate of emerging Latin American and Caribbean economies. This onshorization process has resulted in a large increase in nominal (that is, nonindexed) local currency debt, which rose from 20 percent of GDP in 1996 to 30 percent of GDP in 2004, and also in debt indexed to the local CPI, which more than doubled over the 1996–2004 period to reach 6 percent of GDP.

While this switch towards more domestic currency debt is a positive development, the problem is that a large fraction of domestic debt issued in local currency tends to be either short term or indexed to the short-term interest rate. In 2003, only 15 percent of total domestic public debt was fixed rate, long term, and denominated in domestic currency (up from 9 percent in 1999), indicating that “domestic original sin” (as defined by Hausmann and Panizza, 2003) is still a problem in Latin America, and to an even larger degree than in the rest of the emerging world (Figure 2.6).

Countries with Limited Market Access

Countries that have limited access to the international capital markets are characterized by high levels of debt but do not show the increasing trend which the sample of emerging market countries has followed over the past 10 years. In fact, public debt in this group of countries decreased until 1997 and then remained stable at a level of about 80–90 percent of GDP (about 60 percent if the weighted average shown in Figure 2.7 is considered).

A decomposition of the evolution of total debt shows that over the 1991–2004 period, these countries halved their debt with official creditors (from 53 to 25 percent of GDP), maintained a low level of debt with private external creditors, and doubled the amount of debt issued in the domestic market (from 14 to 27 percent of GDP). Almost by definition, this group of countries has a composition of external debt which is very different from that of the emerging market group (Figure 2.8). On average, 80 percent of external debt is owed to official creditors, but there have been large swings in the share of debt held by private creditors. In the early 1980s, about one-third of external debt was owed to private creditors, mostly in the form of syndicated bank loans. The importance of this source of financing decreased substantially (both in relative and in absolute value) over the 1984–1997 period, reaching a minimum of 11 percent of total external debt (corresponding to 3.6 percent of GDP). Access to the international credit market picked up over the 2000–2004 period, however, and by 2004 about 25 percent of the external debt of this group of countries was owed to private creditors, mostly in the form of sovereign bonds in line with the evolution of global financial markets. There have also been large changes in the composition of official debt. Bilateral creditors were extremely important in the 1980s, but their share in total external debt continuously decreased over the 1990–2004 period, from 50 to about 20 percent of total external debt. Over the same period, the multilateral development banks became increasingly important and, by 2004, they accounted for more than 50 percent of the total external debt of this group of countries.

One important consideration is that the debt figures reported above are likely to grossly overstate the debt burden for several of the countries that are characterized by a large share of concessional debt. In the sample of countries with no market access, the net present value of total external debt was about 77 percent of book value; by 2004, the net present value had decreased to about 68 percent of book value.[13]

Gross versus Net Debt

Many countries compute a measure of net debt to obtain a more accurate measure of their level of indebtedness. Net debt measures subtract holdings of debt by some public entities, and sometimes they also deduct holdings of financial assets by the public sector. One problem with official statistics on net debt is that different countries use different methodologies to compute net debt. Although each of these different netting strategies is probably the most appropriate for the individual country that uses it, as a group they produce figures on net debt that are difficult to compare across countries (Box 2.5 describes the methodology used by the Brazilian authorities, which is clearly spelled out in various publications).

In order to obtain statistics on net debt that are comparable across countries, this report follows the methodology outlined in Cowan et al. (2006) and considers two definitions of net debt. The first definition (Net Debt 1) subtracts from gross debt the holdings of government debt by the central bank. As the central bank submits its profits to the government, interest payments by the treasury to the central bank will eventually return to the treasury. Thus, holdings of government paper by the central bank are not really a liability of the consolidated public sector.[14]

The second definition (Net Debt 2) is obtained by subtracting international reserves from Net Debt 1. Although widely done, the netting of reserves is conceptually more debatable. The main role of international reserves is to support the functioning of the foreign exchange system. In a fixed exchange rate system, central bank reserves need to be available for purchases by the private sector if there is net demand for them. Under such a system, if the private sector has a net external surplus, the resulting accumulation of international reserves will show up as a reduction in the government’s Net Debt 2 measure, when in fact it is simply the counterpart to the accumulation of assets by the private sector. In a (managed) floating exchange rate system, the central bank has more latitude to supply foreign reserves to the market, but in emerging market economies, central banks typically hold significant international reserves in order to intervene when market conditions require. Aggregate data show that over the 1991–2004 period, the difference between Gross Debt and Net Debt 1 averaged 3 percent of GDP, reaching a maximum of 6 percent of regional GDP in 1996. The difference between Gross Debt and Net Debt 2, however, is much larger. Over the 1991–2004 period, this difference averaged 11 percent of regional GDP. Reserves were lower in the early 1990s but increased rapidly in the mid-1990s, reaching a peak of 15 percent of regional GDP in 1996. Interestingly, the data show that there is no difference in reserve accumulation between small and large countries.

Implicit versus Explicit Debt: What Happens When Countries Privatize Their Pension Systems?

All measures of debt discussed so far have focused on explicit debt. Several countries, however, have unfunded public pension systems, which constitute a large implicit liability. In the past decade, many Latin American countries have transformed their social security systems from public, pay-as-you-go systems to private capitalization systems. The transition between these two types of systems typically involves an increase in explicit government debt, as the last generation of the pay-as-you-go system is still collecting pension payments, but younger generations have moved to the private system and do not contribute to the public social security system. Thus, the analysis of trends in public debt accumulation may net out the result of the pension system transition, although debt accumulated on account of the transition is conceptually indistinguishable from debt accumulated for any other reason. Ideally, one would like to have a measure of debt that includes pension obligations. However, the actual value of implicit liabilities is virtually impossible to assess, because the government maintains the option of diluting them by introducing legal changes such as reducing benefits or tightening eligibility conditions.

As an alternative to adding actual pension obligations to obtain a grand total for the debt level in every country, debt could be made comparable across countries by subtracting the value of the reduction in implicit liabilities in those countries which have privatized their pension systems. How can this be done? In the simplest case of pension system privatization, the pay-as-you-go system was completely shut down at the time of reform, with obligations to those who were participating in the system recognized by issuing bonds which were then deposited in private pension funds. Thus, the value of those compensation bonds would be a natural estimator of the reduction in the implicit liabilities faced by the government. Gross Debt would show a sizable increase at the time of the reform, which would be equal to the increase in assets managed by private pension funds, and a Net Debt measure could be constructed by subtracting pension fund holdings from Gross Debt.[15]

The treatment of pension reforms that did not change the status of current pensioners but only changed the relationship with the younger generations is more complicated. These reforms usually were implemented by eliminating the tax obligations on the current workers, who were then able to use those resources to build up private assets. As before, the question is, by how much does this pension reform reduce government liabilities at each point in time? If the cash flows into and out of the system are balanced, it seems reasonable to assume that what has been accumulated in pension funds is equivalent to the value of liabilities that will not have to be honored by the government in the future, and therefore this amount provides an estimate of the reduction in the government’s implicit liabilities resulting from the pension privatization scheme.[16]

This suggests another definition of net debt (Net Debt 3), this one being equal to Net Debt 2 minus assets of private pension funds. In the early 1990s, Net Debt 3 was basically identical to Net Debt 2, but after the pension reforms of the mid-1990s, private pension funds grew very rapidly. By 2004, assets of private pension funds were above 7 percent of regional GDP, generating a substantial wedge between Net Debt 2 and Net Debt 3. Correcting for pension privatization, however, does not alter the fact that Latin American public debt has been on an increasing trend since the mid-1990s.

While the netting methodology discussed above has some desirable properties, it is far from problem free. A first problem with the methodology is that if pension fund investments perform better than expected, the assets accumulated in the pension funds end up being greater than would have been necessary to guarantee the payments made by the old system, and this netting strategy will overcompensate for the drop in implicit liabilities brought about by the pension reform. This can be a sizable problem. Figure 2.9 decomposes Gross Debt into the three definitions of Net Debt discussed above and shows that the correction is substantial for countries with relatively large private pension systems (like Bolivia, Colombia, Peru, and El Salvador) and enormous in the case of Chile, where the assets of private pension funds are larger than Gross Debt, yielding a negative level of Net Debt (−40 percent of GDP).

A second issue is that the implicit future debt generated by public pay-as-you-go systems is of a different nature than the explicit debt issued to finance the transition. In particular, pension obligations are easier to dilute and are implicitly indexed to GDP, but explicit debt is often expressed in nominal or real terms (sometimes in foreign currency) and is more difficult to restructure in the event of insolvency.[17]

A third problem is that countries may differ in their systems for providing support to retired workers (Box 2.6). The example in Box 2.6 makes it clear why the most accurate measure would be for countries to report their implicit liabilities linked to unfunded pension obligations. Only in this case would debt levels be truly comparable both across countries and within countries across time. Given the complexities involved in estimating these liabilities, this is a possible area for technical assistance by the international financial institutions, which could help their member countries to develop and implement a standard methodology for calculating and reporting these liabilities.

How Do Latin America and the Caribbean Compare
with the Rest of the World?

Are the patterns documented in the previous section part of a global trend or are they limited to Latin America? Simple averages that include 94 countries show that Sub-Saharan Africa, the Middle East and North Africa, and South Asia are the regions with the highest levels of public debt. Latin American and Caribbean countries have intermediate levels of debt, which are not much higher than those of the advanced economies and higher than levels of public debt in East Asia and Eastern Europe and Central Asia (Figure 2.10). While public debt in Latin America displayed U-shaped behavior, public debt in East Asia increased substantially (going from 36 to 52 percent of GDP) between 1991 and 2005 (the period under observation in the figure). Public debt also increased (but at a slower pace) in South Asia and decreased in the Middle East and North Africa.

Weighted averages yield a different picture in terms of both levels and trends (Figure 2.11). As two large economies (Japan and Italy) have high levels of debt, weighting by GDP substantially increases the debt ratios of the advanced economies, which become similar to those of countries located in Sub-Saharan Africa. At the same time, weighting by GDP gives less importance to countries like Nicaragua and Guyana (small economies with high debt ratios) and reduces the average debt ratios for Latin America and the Caribbean. As a consequence, the weighted debt-to-GDP ratio in Latin America is much lower (by about 15 percentage points) than that of the advanced economies.

As East Asia, Eastern Europe and Central Asia, and Latin America were at the center of the main debt and financial crises of the late 1990s, it is interesting to compare the evolution of central government debt in these three regions (Figure 2.12). Eastern Europe, which started with high levels of debt (68 percent of GDP in 1993), showed a net decrease in debt over the 1993–1996 period, an increase in debt around the Russian crisis of 1998 (with another spike in 2001), and then a sustained decrease in debt, which reached 29 percent of regional GDP in 2005. East Asia shows the opposite trend. Debt was low and decreasing in the early 1990s (20 percent of GDP in 1991 and 17 percent in 1996) but increased rapidly after the crisis of 1997, reaching 34 percent of regional GDP in 2002. Since 2002, debt has been decreasing again, reaching 29 percent of regional GDP in 2005. In Latin America and the Caribbean, in contrast, debt has been constantly increasing over the 1997–2003 period. The resolution of the Argentine crisis and the current appreciation of several Latin American currencies have helped to reverse this trend since 2003, but debt still was 13 percent of GDP higher than in the other two regions as of 2005.[18] Even though debt in this region is now decreasing and it is hard to tell what will happen in the future, the series of crises that affected the region seem to have had a ratcheting effect, with debt stabilizing at a higher level after each crisis, a pattern that does not seem to characterize East Asia and Eastern Europe and Central Asia.

Latin America and the Caribbean is different from other emerging regions not only in terms of debt levels but also in terms of debt composition. Figure 2.6 presented some evidence in this direction by showing that Latin America is characterized by high levels of domestic original sin. Interestingly, the region does worse than the rest of the world in two of the three components of domestic original sin. Focusing on currency composition, while in Asia basically all domestic public debt is denominated in domestic currency, Latin America has high levels of domestic debt denominated in foreign currency (about twice as high as the levels prevailing in other non-Asian emerging market countries) (Figure 2.13). Focusing on maturity, Latin America has a larger share of short-term debt than Asia, and its share of short-term debt is only marginally smaller than that prevailing in other emerging market countries (Figure 2.14). Focusing on indexation, more than 60 percent of debt issued in Latin America is indexed either to prices or to the short-term interest rate, which is twice as high as the average for the non-Asian emerging market countries and about six times the Asian average (Figure 2.15).

The Cross-Country Picture

Latin America and the Caribbean is far from being a homogeneous region, and a better understanding of the level, evolution, and composition of public debt in the region requires a closer look at country-level data. Such a closer look immediately reveals that there is a large dispersion in the levels of debt (Table 2.1). Focusing on the 1990–2004 average, there were four countries with levels of public debt well below 40 percent of GDP and four countries with levels of debt that were 100 percent of GDP or higher. There are also large differences in the evolution of debt. Broadly speaking there are three groups of countries: (1) 11 countries in which debt over GDP in the 2000–2004 period was lower than in the first half of the 1990s;
(2) nine countries in which debt over GDP in the 2000–2004 period was higher than that prevailing in the early 1990s; and (3) three countries with constant debt ratios.[19]

The first group includes several small Central American countries and three of the seven largest countries in the region. Over the 1990–2004 period this group of countries had an average debt ratio close to 90 percent of GDP (this would drop to 60 percent of GDP if Nicaragua and Guyana were excluded from the sample) and, on average, reduced its debt by more than 30 percent. The second group includes most of the English-speaking countries located in the Caribbean and, like the first group, three of the seven largest countries in the region. Over the 1990–2004 period, this group of countries had an average debt ratio of approximately 60 percent of GDP and experienced a nearly 75 percent increase in debt. The third group of countries (which includes Bolivia, Costa Rica, and Mexico) also had an average level of debt close to 60 percent of GDP.

There is also a considerable degree of heterogeneity across countries in the composition of public debt. There are 7 countries in which more than 50 percent of public debt is issued domestically and 14 countries in which most public debt is external. Chile is the country with the largest share of domestic debt, and Belize, Paraguay, and Honduras are the countries with the highest shares of external debt (Figure 2.16). Interestingly, the share of domestic debt does not seem to be correlated with the overall level of financial development. Countries such as Uruguay and Chile have similar levels of financial development but large differences in the share of domestic public debt. There is instead a strong correlation between the share of domestic debt and income per capita (Figure 2.17), but here as well the correlation is far from perfect. Argentina and Uruguay are among the countries with the highest income per capita, but they also have intermediate levels of external debt. In fact, the relationship between the share of foreign currency debt and the level of development is driven in part by the behavior of several low-income countries that are characterized by a large share of official debt (which is all external). By contrast, market size as proxied by total GDP seems to be an important factor explaining the size of the domestic debt component of government liabilities (Figure 2.18).[20]

In regard to the creditor side, the data show that most of Latin America’s public debt is either official or bonded.[21] As a generalization, emerging market countries tend to borrow by issuing bonds, and countries that have limited market access tend to use official debt. But even these subgroups are far from being homogenous. In the emerging market group, the share of bonded debt goes from 38 percent (Peru) to 97 percent (Chile). At the same time, this group also includes countries with a substantial share of official debt; in 2004, for example, Peru, Ecuador, El Salvador, and Uruguay owed more than 40 percent of their debt to official creditors. In the group of countries with limited market access, the share of official debt ranges from 16 percent (Costa Rica) to 81 percent (Paraguay) of total debt.

Another source of heterogeneity is the currency and maturity composition of domestic debt. Almost 100 percent of external debt is in foreign currency (there have, however, been recent cases of issues in domestic currency, as described in Box 2.4), but there are large differences in the degree of “dollarization” of domestically issued public debt, ranging from less than 2 percent in Mexico and Nicaragua to 80 percent in Uruguay. Focusing on maturity, over the 2000–2004 period short-term debt (defined as debt with maturity shorter than one year) was particularly important in Brazil and Uruguay and less important in Colombia and Peru.

Data on maturity and currency composition can be combined to provide a global picture of public sector vulnerability. De la Torre and Schmukler (2004a) argue that dollarization and short-termism are alternative ways of coping with aggregate price risk. So, while several countries have made substantial progress in reducing their reliance on foreign-currency-denominated domestic debt, governments might be substituting short-term debt for dollarization (see Chapter 13 for a discussion of these issues).
Summing Up

In the past, most emerging market crises have been external debt crises. As a consequence, the analysis of emerging market sovereign finance has focused on the external component of public debt. That this component of debt is now lower than in the early 1990s is often mentioned in support of the fact that Latin American policymakers are now adopting more prudent fiscal policies and as a reason for the current optimism regarding the prospects of the Latin American and Caribbean economies. A different picture arises, however, when total debt (external plus domestic) is considered. While past analyses may have exaggerated the importance of the difference between debt issued abroad and debt issued domestically, globalization of international capital markets is making this distinction even less important. At the time of the Argentine crisis of 2001, for instance, it became clear that a large amount of debt issued under international law was in the hands of Argentine residents. At the same time, it is now becoming increasingly common for foreign investors to enter local markets and buy domestically issued debt directly. For instance, in 2004 foreign investors bought 80 percent of the domestic long-term bonds issued by the Mexican government (Castellanos and Martínez, 2006).

While the fact that several countries in the region are substituting domestically issued debt for external debt does not necessarily mean that the next crisis will be a domestic debt crisis, it does mean that policymakers and the international financial institutions ought to develop instruments to monitor potential new sources of vulnerability. This need notwithstanding, it is extremely hard to obtain timely data on the level and composition of domestic debt in Latin America, and the international financial institutions often overlook the role of domestic debt (until recently, most IMF Article IV consultation reports did not include any information on the level, let alone the composition, of domestic public debt). This chapter documents a first attempt to assemble a data set that can keep track of such vulnerabilities, but more work needs to be done in this direction. Fortunately, countries now realize that disseminating timely and accurate information can have positive effects on market confidence, lowering their borrowing costs and reducing the probability of sudden stop episodes and, hence, are taking actions aimed at improving their data dissemination strategies.[22] In this sense, the IDB-sponsored Group of Latin American and the Caribbean Debt Management Specialists (LAC Debt Group) is playing a key role in the development of a common platform for the dissemination of public debt data in the region.

A final message of this chapter has to do with the role of official debt (Chapter 6 discusses multilateral debt in greater detail). It is often claimed that the relative importance of official lending has declined markedly (see, for instance, Meltzer, 2000) and hence multilateral development banks are becoming irrelevant. This may be true if official lending is compared with total international private capital flows. However, in Latin America and the Caribbean official lending remains a significant component of sovereign finance. In 2004, 73 percent of external public debt and 40 percent of total public debt of Latin American and Caribbean countries with limited market access was owed to official creditors. But heavy reliance on official finance is not limited to this group of low-income countries. In the same year, 34 percent of external public debt and 14 percent of total public debt in Latin American and Caribbean countries with market access was owed to official creditors. These figures are higher than those prevailing in the early 1980s and similar to those prevailing in the early 1990s. This unambiguously indicates that official lending still plays an important role in Latin American and Caribbean sovereign finance.