Fiscal Debt Sustainability

In my 25 years of interaction with multilateral financial institutions on fiscal issues, I have repeatedly made the following points (which remain valid till today): 1) That the simple rule that growth rate must be more than the real interest rate is a good guide to ensuring that debt GDP ratio declines over time. (2) Theory does not tell us what level of the debt-GDP ratio is optimal. A number of factors are important for judging whether this level is too high. Among these are, (a) The asset owned or the net debt-GDP ratio. In other words a country with a lower debt, net of assets, can sustain a higher gross debt-GDP ratio.  Given the financial innovation over the last 25 years, it is also necessary to emphasise that the liquidity, maturity structure and uncertainty/risk associated with the assets also matters! A further implication is that debt incurred for investment is more sustainable than if used for consumption and transfers. (b) The manner of financing of the debt, in particular the proportion financed by domestic as against foreign capita/savings.  Thus countries with higher private domestic saving rates can sustain a higher level of debt to GDP and vice versa! (c) The demand conditions in the economy relative to potential supply.  An economy sufferring from lack of effective demand (virtually all advanced economies today), need to balance policy measure to ensure medium-long run debt reduction, with investment in public and quasi public goods in the short run to ensure effective demand.  If this is not done, growth will suffer and debt-GDP ratios will end up higher than they could be!  However, in economies suffering from excess demand (several Emerging economies today) and inflation, immediate fiscal (expenditure) contraction can allow a more relaxed monetary policy that will sustain growth and accelerate debt reduction.