Optimal debt levels depend on the development of countries’ institutions and the quality of governance
What is a “safe” and optimal debt level? How does rising debt affect economic growth? The COVID-19 pandemic has forced countries around the world to reconsider these issues facing the reality wherein the budgetary stimulus accompanied by government debt accumulation became principal instruments used to curtail shocks. The current EFSD Working Paper “Optimal Debt and the Quality of Institutions” indicates that, in countries with strong institutions, the debt threshold is above 55% of GDP, while economies with weaker political institutions feature a 37-38% debt-to-GDP threshold. Hence, the quality of institutions is one of the key factors for economic and debt sustainability and an efficient debt policy.
Moscow, 30 November 2020
The Eurasian Fund for Stabilization and Development, administered by the Eurasian Development Bank, published a Working Paper WP20/04 “Optimal Debt and the Quality of Institutions”.
Amid the COVID-19 pandemic policymakers now face the dilemma of whether to stimulate infrastructure development by raising debt, which may reduce future flexibility, or to strengthen their fiscal positions. In order to shed light on this issue, the present study analysed an optimal debt level, taking into account countries’ institutional characteristics.
The key findings on the debt–GDP relationship reveal monotonic increase of the debt threshold from less institutionally developed countries to more developed ones. While economies with weak political institutions feature a 37% debt-to-GDP threshold, in countries with strong institutions the debt threshold rises above 55% of GDP. This distribution of debt thresholds stresses the greater resilience of the advanced economies to growing debt burdens compared to their less institutionally sustainable peers.
Russia and Kazakhstan are in a comfortable position of low public debt (below 20% of GDP), which does not exceed a 37-38% debt-to-GDP threshold. Concurrently, other EDB and EFSD countries have to be cautious about their debt positions given their uneven development of institutions. Nevertheless, our findings suggest that above a threshold value of 37–38% of GDP, growing public debt still features a very small positive effect on economic growth of Armenia, while the study does not indicate statistically significant negative effect for Belarus, the Kyrgyz Republic and Tajikistan.
We stress that the debt–growth nexus depends on a wide range of countries’ features, which should be considered carefully with regard to their policy implications. In developing economies, there is a number of other factors, which underline a possibility to raise debt without materially jeopardizing the country’s debt position, e.g. access to concessional financing. “In general, our research does not suggest that countries have to reduce their actual debt levels to the estimated threshold, – stresses the EDB and EFSD Chief Economist Evgeny Vinokurov. – Rather, it implies that, above a certain debt level, the countries may need to access carefully whether an additional debt financing would stimulate their economic activity or rather impose unnecessary risks to their budget sustainability”.
The full text of the working paper is available online.
The working paper will be presented at the First Eurasian Congress
The Eurasian Development Bank (EDB) is an international financial institution founded by Russia and Kazakhstan in January 2006 with the mission to facilitate the development of market economies, sustainable economic growth, and the expansion of mutual trade and other economic ties in its member states. The EDB's charter capital totals US $7 billion. The member states of the Bank are the Republic of Armenia, the Republic of Belarus, the Republic of Kazakhstan, the Kyrgyz Republic, the Russian Federation, and the Republic of Tajikistan.
The Eurasian Fund for Stabilization and Development (EFSD) amounting to US$8.513 billion was established on June 9th, 2009 by the governments of the same six countries. The EFSD assists its member states in overcoming the consequences of the global financial crisis, ensuring their economic and financial stability, and fostering integration in the region. The EFSD member countries signed the Fund Management Agreement with Eurasian Development Bank giving it the role of the EFSD Resources Manager.
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