The Emerging Debt Problems of Small States

image of The Emerging Debt Problems of Small States
In recent years there has been a significant rise in the indebtedness of small states. However, unlike major debtors and the Heavily Indebted Poor Countries (HIPCs), the emerging debt problems of small, mainly middle income, states have received little international recognition and attention.

Thirteen small middleincome Caribbean economies are amongst the most indebted thirty emerging market economies in the world. Similar conditions apply in a number of other small economies in Africa, the Indian Ocean and the Pacific.

Dinesh Dodhia examines the history of this indebtedness, its likely causes in different economies, and prospects for dealing with the debt problem in the future. He argues that there is a need for a comprehensive international framework to deal with it, covering:

• fiscal discipline in small states themselves

• improved debt recording and debt management

• insurance and grant financing mechanisms that respond to the challenges posed by natural disasters

• continued grant and concessional financing for small states

• adequate compensation for preference erosion, and

• support for the efforts of small states to promote private investment for diversification and growth.

This is the first substantial investigation of a newlyrecognised international problem.



Future Debt Prospects

It is now standard practice for the IMF to carry out public and external debt sustainability analysis (DSA) as an addendum to the regular Article IV consultations. These provide a baseline, in addition to some alternative scenarios based on various assumptions (e.g. growth, GDP deflator and interest rate) and adjustment (fiscal) efforts. Baseline or active scenarios generally assume a significant fiscal effort and improved growth prospects, although not all baseline scenarios would do so taking the current government reform effort as given. Alternative scenarios either assume key variables at historical averages (historical scenario) or that primary balances are held constant (no policy change scenario, also referred to as a passive scenario). Sensitivity tests are also carried out on the basis of shocks which can be either permanent or temporary. Usually six such stress or bound tests are carried out, including an interest rate shock, a growth shock, a primary balance shock, a combined shock of the above three, an exchange rate shock (usually taken as 30 per cent depreciation of the currency) and a contingent liability shock (usually taken as a 10 per cent increase in debt creating flows). Some countries have also included a natural disaster scenario.


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