IDB study provides recommendations for countries to reduce debt
A new flagship report by the Inter-American Development Bank recommends that Latin American and Caribbean countries decrease debt to prudent levels to increase economic growth, allow constructive investment, and reduce the possibility of a debt catastrophe (IDB).
The IDB said that overall debt in Latin America and the Caribbean had increased to US$5.8 trillion, or 117% of GDP, from under US$3 trillion in 2008. According to “Dealing with Debt: Less Risk for More Growth in Latin America and the Caribbean,” part of the IDB’s Development in the Americas series, COVID-19 fiscal packages, fewer revenues, and a recession increased public debt from 58 percent in 2019 to 72 percent in 2020.
The IDB said high debt levels can hamper development because investors seek greater yields, squeezing out private investments and pushing governments to allocate scarce resources to interest payments instead of infrastructure and public services.
High debt levels diminish a country’s ability to respond to future economic shocks to help people and enterprises and increase crisis risk. The pandemic, Russian invasion of Ukraine, high inflation, rising interest rates, low world growth, and huge debt make the region vulnerable.
In response, the IDB recommended that governments in the region cut public debt ratios from an average of 70% to a reasonable range of 46-55 percent of GDP, stressing that each country’s range will differ depending on its peculiarities. Countries with variable commodities revenues should reduce debt.
“Well-managed and sustainable debt may help unlock Latin America and the Caribbean’s vast growth potential,” said Inter-American Development Bank Chief Economist Eric Parrado. Our hallmark report promotes growth by turning debt into an engine. It offers regional governments extensive policy proposals to strengthen macro-fiscal institutions, reduce public debt, and encourage firm financing.”
The paper examines measures to reduce government debt and increase debt sustainability.
Stronger fiscal institutions can help governments halt overspending in good times, provide a cushion for difficult times, and give credible budgetary guidance to lower public debt. Fiscal regulations provide transparent budget and macroeconomic aggregate goals, which hold governments accountable. Poor rule drafting caused Latin American and Caribbean counties to meet only 57% of the targets.
Effective fiscal regulations have solid legal underpinnings, credible enforcement mechanisms, shock flexibility, and well-defined escape clauses. Independent fiscal councils monitor the application of budgetary rules and promote prudent policies.
The study shows that better growth, effective public spending, and appropriate public revenues without sacrificing growth are the greatest ways to reduce debt.
Countries, especially those with high expenditure and taxes as a proportion of GDP, should improve revenue collection and spending efficiency. Public investment can be improved throughout the project cycle, transfer payments should be targeted to those who need them, and tax monitoring can be improved. In low-revenue countries, expanding the tax base and raising public sector revenues could boost public investment and growth.
Reforms to minimize labor informality include decreasing tax incentives for enterprises to hire informal labor and moving advantages from labor taxes to general taxation.
The report also recommends countries focus on debt management. Debt composition requires efficient organizations like Debt Management Offices and novel debt products. Countries must actively control amortization schedules as pre-pandemic debt composition improvements stagnated. Above half of the region’s countries have debt payment of over 2.5 percent of GDP, and a quarter more than 5 percent—similar to education spending.
Countries should use multilateral development banks and other official lenders for competitive long-term funding. Development banks assist countries manage risks with technical expertise and cheaper rates and longer tenors than private markets.
The paper suggests a regional forum for debt restructuring cooperation. This would supplement present international initiatives on low-income countries.
Pre- and post-pandemic private debt increased. A quarter of countries have domestic credit more than 100% of GDP, and domestic banking sectors have grown. Credit remains below 50% of GDP for another quarter. Households, SMEs, and female-led firms lack access.
Demand for regional SME funding exceeds availability by $1.8 trillion. Access was crucial to companies surviving the pandemic, even with efforts to keep credit open.
Internationally, regional household indebtedness is low. Household debt in the region is 22% of GDP, substantially lower than in other emerging economies (35%) and developed countries (77 per cent). The report includes regional household credit data. The research advises governments to keep improving consumer and SME credit availability.
The paper suggests that governments target potential enterprises that require support with a wider range of vehicles, including stock or quasi equity, to avoid adding debt.
