Key Public Debt Issues in Selected Transition Economies

In a recent article we examined the fiscal performance of the Czech Republic, Hungary, Poland, Russia, Turkey, and South Africa during 1998-2001. We noted that, with the exception of Russia since 2000, all countries have run budget deficits over the entire previous four-year period. [1] The factors behind this performance varied widely across countries, and included: the costs of banking sector clean-up (the Czech Republic); pension reform and a weak economy (Poland); and a prolonged period of fiscal mismanagement involving large commitments to the state banks (Turkey). In this article – the first of a two-part series – we look more closely at public debt issues, with particular reference to the external component of the public debt.

Turkey’s total public debt has risen quickly in the recent past; fr om under 60% of GDP at end-1999 to over 90% of GNP at end-2001; debt service payments last year exceeded 21.5% of GNP, by far the heaviest debt burden of all the countries in the emerging Europe region. Indeed, this ratio is higher than the sum total of the corresponding debt service ratios for all the other countries listed in the table below. While much of the rise in the stock of public debt is associated with the recapitalisation of the state banks and the incorporation into the budget of several quasi-fiscal operations previously unaccounted for (including, for instance, the cost of interest rate subsidies associated with state support to agriculture), the external debt burden has also been growing quickly, from around 25% of GNP in 1998 to 34% of GNP at the end of 2001. Although part of the reason is the fall in the value of the Turkish lira, the sharp rise in indebtedness to the IMF has also played a role. Furthermore, efforts on the part of the authorities in 2001 to facilitate the roll-over of domestic debt by issuing high-yielding dollar-denominated instruments to domestic investors has boosted hard currency debt (by 8.5% of GNP in 2001 alone); this is not included in the external debt numbers in the table below which uses a residency classification criteria.

Emerging Europe: Fiscal indicators Percent of GDP		Emerging Europe: Total Public Debt, 2001 Percent of GDP

The above developments raise questions about the debt-carrying capacity of Turkey over the medium- to longer-term. While the maturity profile of Turkey’s external debt is considerably better than that of lira-denominated obligations (almost 50% of which fall due within the next 12 months) it remains the case that the economy is still relatively closed. Exports of goods and services in relation to GNP are equivalent to about 25%, compared to 37% in Russia and 65-70% in the case of Hungary and the Czech Republic.

Furthermore, Turkey’s terms of trade are unfavourable and likely to remain so. Its biggest export (comprising almost 40% of the total) are textiles and clothing, the prices of which are on the decline and are likely to fall further following China’s entry into the WTO.

Moreover, IMF generosity towards Turkey is a double-edged sword, facilitating short-term debt management while the money flows in but imposing onerous future claims on the budget. Assuming that the Fund lends an additional $10bn this year, Turkey will owe the Fund around $30bn by the middle of next year (close to 20% of next year’s GNP), payable within the next 5-7 years. Unlike Russia, which benefited from massive terms of trade gains in the last three years which boosted FX reserves to record levels, we judge it unlikely that Turkey will be able to fulfill its obligations to the Fund without additional “refinancing” packages (from the Fund). Being under IMF tutelage for the foreseeable future is likely to involve other costs for Turkey as well, including a dampening of FDI inflows.

In sum, Turkey’s rising external debt burden is a major source of concern. The only solution is to enhance the long-term hard currency earning capacity of the economy. That would mean a dramatic increase in FDI, a sharp turnaround in foreign capital inflows and an improvement in export earnings. These require an acceleration of structural reforms to enhance the long-term productive capacity of the economy.

The other country with a significant share of public sector external indebteness is Russia; indeed, following the restructuring of domestic obligations which took place in 1998, ruble denominated debt has fallen to under 6% of GDP, compared to close to 43% of GDP for the external component. While these levels are somewhat higher than in Turkey, Russia is in a much better position to service these obligations. The maturity of this debt is longer (the bulk of the eurobonds are 30-year instruments resulting from the London Club restructuring which took place in early 2000; a large chunk of the rest is Paris Club Soviet-era debt with a long maturity schedule) and, more importantly, the claims that total debt service obligations make on the budget are quite modest: 2.9% of GDP in 2001, compared to over 21% of GDP in Turkey. Indeed, Russia’s total debt stock has been falling quickly, from 80% of GDP at end-1999, to under 44% at end-2001. While the real appreciation of the ruble has helped to boost dollar GDP, two other key factors have been the resumption of economic growth and the fact that the country has not accessed the capital markets since the summer of 1998; debt management in Russia has largely consisted of making debt repayments, including some ahead of schedule in late 2001.

External debt management has not been a serious policy concern in either the Czech Republic, Hungary, Poland or South Africa. In the Czech Republic the government is scaling back already modest plans to issue foreign debt, as privatisation inflows are resulting in currency appreciation. Poland plans to issue some ?2.0 bn this year, to ease the burden on local markets and the impact this could have on domestic interest rates. Private sector external debt has grown rapidly in recent years although it remains relatively low, around 12% of GDP, compared to the Czech Republic, wh ere it is high at some 37% of GDP. Hungary’s debt management has benefited from a tougher approach to fiscal consolidation and the market has rewarded the authorities in terms of debt spreads. The South African authorities have continued to follow a cautious fiscal policy as well, and public external debt remains quite low.

[1] See “The Fiscal Policy Stance”, Global Weekly Economic Monitor, 18 January 2001.