Ukraine on the financial front – the problem of Ukraine’s foreign public debt. OSW COMMENTARY NUMBER 178|05.08.2015

One of the key challenges that Ukraine is facing is the scale of its foreign debt (both public and private). As of 1st April it stood at US$ 126 billion, which is 109.8% of the country’s GDP. Approximately 45% of these financial obligations are short-term, meaning that they must be paid off within a year. Although the value of the debt has fallen by nearly US$ 10 billion since the end of 2014 (due to the private sector paying a part of the liabilities), the debt to GDP ratio has increased due to the recession and the depreciation of the hryvnia. The value of Ukraine’s foreign public debt is also on the rise (including state guarantees); since the beginning of 2015 it has risen from US$ 37.6 billion to US$ 43.6 billion. Ukraine does not currently have the resources to pay off its debt. In this situation a debt restructuring is necessary and this is one of the top priorities for the Ukrainian government as well as for the International Monetary Fund (IMF) and its assistance programme. Without this it will be much more difficult for Ukraine to overcome the economic crisis.

The Greek debt trap: an escape plan. Bruegel Policy Contribution 2012/19, 7 November 2012

Without corrective measures, Greek public debt will exceed 190 percent of GDP, instead of peaking at the anyway too-high target ratio of 167 percent of GDP of the March 2012 financial assistance programme. The rise is largely due to a negative feedback loop between high public debt and the collapse in GDP, and endangers Greek membership of the euro area. But a Greek exit would have devastating impacts both inside and outside Greece. A small reduction in the interest rate on bilateral loans, the exchange of European Central Bank holdings, buy-back of privately-held debt, and frontloading of some privatisation receipts are unlikely to be sufficient. A credible resolution should involve the reduction of the official lending rate to zero until 2020, an extension of the maturity of all official lending, and indexing the notional amount of all official loans to Greek GDP. Thereby, the debt ratio would fall below 100 percent of GDP by 2020, and if the economy deteriorates further, there will not be a need for new arrangements. But if growth is better than expected, official creditors will also benefit. In exchange for such help, the fiscal sovereignty of Greece should be curtailed further. An extended privatisation plan and future budget surpluses may be used to pay back the debt relief. The Greek fiscal tragedy highlights the need for a formal debt restructuring mechanism

Banking Union with a Sovereign Virus. The self-serving regulatory treatment of sovereign debt in the euro area. CEPS Policy Brief No. 289, 27 March 2013

In many eurozone countries, domestic banks often hold more than 20% of domestic public debt, which is an unsatisfactory situation given that banks are highly leveraged and that sovereign debt is inherently subject to default risk within the euro area. This paper by Daniel Gros finds, however, that the relative concentration of public debt on bank balance sheets is not just a result of the euro crisis, for there are strong additional incentives for banks in some countries to increase their sovereign. His contribution discusses a number of these regulatory incentives – the most important of which is specific to the euro area – and explores ways in which euro area banks can be weaned from massive investments in government bonds.

Sovereign debt and its restructuring framework in the Euro area. Bruegel Working Paper 2013/05, August 2013

To compensate for the inflexibility of fixed exchange rates, the euro area needs flexibility through a system of orderly debt restructuring. With virtually no room for macroeconomic manoeuvring since the crisis onset, fiscal austerity has been the main instrument for achieving reductions in public debt levels; but because austerity also weakens growth, public debt ratios have barely budged. Austerity has also implied continued high private debt ratios. And these debt burdens have perpetuated economic stasis. Economic theory,history, and the recent experience all call for a principled debt restructuring mechanism as an integral element of the euro area’s design. Sovereign debt should be recognised as equity (a residual claim on the sovereign), operationalised by the automatic lowering of the debt burden upon the breach of contractually-specified thresholds. Making debt more equity-like is also the way forward for speedy private deleveraging. This debt-equity swap principle is a needed shock absorber for the future but will also serve as the principle to deal with the overhang of ‘legacy’ debt.

The euro area's tightrope walk: debt and competitiveness in Italy and Spain. Bruegel Policy Contribution 2013/11, September 2013

Competitiveness adjustment in struggling southern euro-area members requires persistently lower inflation than in major trading partners, but low inflation worsens public debt sustainability. When average euro-area inflation undershoots the two percent target, the conflict between intra-euro relative price adjustment and debt sustainability is more severe. In our baseline scenario, the projected public debt ratio reduction in Italy and Spain is too slow and does not meet the European fiscal rule. Debt projections are very sensitive to underlying assumptions and even small negative deviations from GDP growth, inflation and budget surplus assumptions can easily result in a runaway debt trajectory. The case for a greater than five percent of GDP primary budget surplus is very weak. Beyond vitally important structural reforms, the top priority is to ensure that euro area inflation does not undershoot the two percent target, which requires national policy actions and more accommodative monetary policy. The latter would weaken the euro exchange rate, thereby facilitating further intra-euro adjustment. More effective policies are needed to foster growth. But if all else fails, the European Central Bank’s Outright Monetary Transactions could reduce borrowing costs.

Introducing more equity in the CAP: a difficult challenge. Egmont Paper #55, June 2012

[From the Introduction]. The main question addressed by this paper is how to reach a more equitable distribution of CAP’s payments pragmatically, politically and economically? Pragmatically, the CAP is a multi-functional policy, which has to combine different goals, i.e. to be more equitable, green and market-oriented. However, these objectives are not always compatible and require trade-offs. Politically, regarding the CAP’s significant share (40%) of the EU budget and the current public debt crisis, Member States are most likely to keep their attention on the juste retour calculations rather than the promotion of the European public interest in the EU negotiations. Economically, reaching a more equitable distribution of payments should be achieved without significant disruptive changes that could have serious consequences on the costs and benefits of the agricultural sector in the EU. Considering these elements, it is already clear that reaching a more equitable distribution of CAP’s payments represents a difficult challenge.

The austerity debate is beside the point for Europe. CEPS Commentary, 8 May 2013

In surveying the heated debate in the eurozone about austerity and the cost of high public debt, this CEPS Commentary suggests that the influential paper by Carmen Reinhard and Kenneth Rogoff misses the key point that public debt owed to foreigners is different from debt owed to residents.

Fiscal policy, banks and the financial crisis. National Bank of Belgium Working Paper No. 234, October 2012

This paper studies the effectiveness of Euro Area (EA) fiscal policy, during the recent financial crisis, using an estimated New Keynesian model with a bank. A key dimension of policy in the crisis was massive government support for banks—that dimension has so far received little attention in the macroeconomics literature. We use the estimated model to analyze the effects of bank asset losses, of government support for banks, and other fiscal stimulus measures, in the EA. Our results suggest that support for banks had a stabilizing effect on EA output, consumption and investment. Increased government purchases helped to stabilize output, but crowded out consumption. Higher transfers to households had a positive impact on private consumption, but a negligible effect on output and investment. Banking shocks and increased government spending explain half of the rise in the public debt/GDP ratio since the onset of the crisis.

Memo to Merkel: Post-election Germany and Europe. Bruegel Policy Brief 2013/05, 24 September 2013

Recent economic data points to the seeds of an economic recovery in the European Union. However, significant risks remain and bold policies are still needed. There are three central risks. Competitiveness adjustment is incomplete, casting doubt on the sustainability of public debt. Banking remains unstable and fragmented along national lines, resulting in unfavorable financial conditions, which further erode growth, job creation and competitiveness. Rising unemployment, especially among the young, is inequitable, unjust and politically risky. Germany has a central role to play in addressing these risks. The new German government should work on three priorities: Domestic economic policy should be more supportive of growth and adjustment, with higher public investment, a greater role for high-value added services, and more supportive immigration policy. Germany should support a meaningful banking union with a centralised resolution mechanism requiring a transfer of sovereignty to Europe for all countries including Germany. The establishment of a private investment initiative combined with a European Youth Education Fund and labour market reforms should be promoted. Building on these priorities, a significant deepening of the euro area is needed, with a genuine transfer of sovereignty, stronger institutions and democratically legitimate decision-making structures in areas of common policy.

The long haul: managing exit from financial assistance. Bruegel Policy Contribution Issue 2014/03, 20 February 2014

Countries can make a clean exit from financial assistance, or enter a new programme or a precautionary programme, depending on the sustainability of their public debt and their vulnerability to shocks. Ireland made a clean exit in December 2013, supported by significant budgetary and current-account adjustment and signs of economic recovery. But Irish debt sustainability is not guaranteed and prudence will be needed to avoid future difficulties. A clean exit for Portugal is not recommended when its programme ends in May 2014, because compared to Ireland it faces higher interest rates, has poorer growth prospects and has probably less ability to generate a consistently high primary surplus. A precautionary arrangement would be advisable. In case debt sustainability proves difficult to achieve later, some form of debt restructuring may prove necessary. It is unlikely that Greece will be able to exit its programme in December 2014. A third programme should be put in place to take Greece out of the market until 2030, accompanied by enhanced budgetary and structural reform commitments by Greece, a European boost to economic growth in the euro-area periphery and willingness on the part of lenders to reduce loan charges below their borrowing costs, should public debt levels prove unsustainable despite Greece meeting the loan conditions. Even assuming all goes well, the three countries will be subject to enhanced post-pro-gramme surveillance for decades. Managing such long-term relationships will be a key challenge.

The EMS Crisis of the 1990s: Parallels with the present crisis? CEPS Working Document No. 393, 28 March 2014

The EMS crisis of the 1990s illustrated the importance of a lack of confidence in price or exchange rate stability, whereas the present crisis illustrates the importance of a lack of confidence in fiscal sustainability. Theoretically the difference between the two should be minor since, in terms of the real return to an investor, the loss of purchasing power can be the same when inflation is unexpectedly high, or when the nominal value of government debt is cut in a formal default. Experience has shown, however, that expropriation via a formal default is much more disruptive than via inflation. The paper starts by providing a brief review of the EMS crisis, emphasising that the most interesting period might be the ‘post-EMS’ crisis of 1993-95. It then reviews in section 2 the crisis factors, comparing the EMS crisis to today’s euro crisis. Section 3 outlines the main analytical issue, namely the potential instability of high public debt within and outside a monetary union. Section 4 then compares the pressure on public finance coming from the crises for the case of Italy. Section 5 uses data on ‘foreign currency’ debt to disentangle expectations of devaluation/inflation from expectations of default. Section 6 concludes.

Europe's social problem and its implications for economic growth. Bruegel Policy Brief 2014/03, 1 April 2014

The European Union faces major social problems. More than six million jobs were lost from 2008-13 and poverty has increased. Fiscal consolidation has generally attempted to spare social protection from spending cuts, but the distribution of adjustment costs between the young and old has been uneven; a growing generational divide is evident, disadvantaging the young. The efficiency of the social security systems of EU countries varies widely. Countries with greater inequality tended to have higher household borrowing prior to the crisis resulting in more subdued consumption growth during the crisis. The resulting high private debt, high unemployment, poverty and more limited access to education undermine long-term growth and social and political stability. Policymakers face three main challenges. First, addressing unemployment and poverty should remain a high priority not only for its own sake, but because these problems undermine public debt sustainability and growth. Second, bold policies in various areas are required. Most labour, social and fiscal policies are the responsibility of member states, requiring national reforms. But better coordination of demand management at European level is also necessary in order to create jobs. Third, tax/benefit systems should be reviewed for improved efficiency, inter- generational equity and fair burden sharing between the wealthy and poor.

Determinants of Financial Development across the Mediterranean. MEDPRO Technical Report No. 29/February 2013

Casual observation shows that that the financial systems in the southern and eastern Mediterranean are unable (or unwilling) to divert the financial resources that are available to them as funding opportunities to private enterprises. Using a sample of both northern and southern Mediterranean countries for the years 1985 to 2009, this study empirically assesses the reasons underlying such conditions. The results show that strong legal institutions, good democratic governance and adequate implementation of financial reforms can have a substantial positive impact on financial development only when they are present collectively. Moreover, inflation appears to undermine banking development, but less so when the capital account is open. Government debt growth appears to weaken credit growth, which confirms that public debt ‘crowds out’ private debt. Lastly, capital inflows appear to primarily have an income effect, increasing income and thereby national savings, and thus increasing the availability of credit.