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To default or not? The crisis outcomes of sovereign defaults and IMF austerity programs

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Tuomas Malinen, University of Helsinki
Olli Ropponen, VATT Institute for Economic Research
Open Seminar, Eesti Pank, February 13 2017

Publicada em: Economia e finanças
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To default or not? The crisis outcomes of sovereign defaults and IMF austerity programs

  1. 1. Motivation Motivation Data and methods Results Robustness tests Conclusions To default or not? The crisis outcomes of sovereign defaults and IMF austerity programs Tuomas Malinen University of Helsinki Olli Ropponen VATT Institute for Economic Research Open Seminar, Eesti Pank, February 13 2017
  2. 2. Motivation Motivation Data and methods Results Robustness tests Conclusions IMF has pursued policies that in many cases not only failed to promote the stated objectives of enhancing growth and stability, but were probably counterproductive. -Joseph Stiglitz 2003 Indeed the efforts needed to avoid a default - which would be a catastrophe for Greece - are the responsibility of all political forces. -Comissioner Olli Rehn, 16th of June 2011
  3. 3. Motivation Motivation Data and methods Results Robustness tests Conclusions This study • Aims to shed some light on the question: is it beneficial for a country to default or enter into IMF program when facing an economic crisis?
  4. 4. Motivation Motivation Data and methods Results Robustness tests Conclusions This study • Aims to shed some light on the question: is it beneficial for a country to default or enter into IMF program when facing an economic crisis? • We estimate the outcomes of these actions on the growth of real GDP per capita of crisis countries after they have been implemented relative to other comparable countries. • We find that developing countries should in general avoid defaults and that IMF programs provide the most lenient crisis outcome.
  5. 5. Motivation Motivation Data and methods Results Robustness tests Conclusions Defaults • Sovereign defaults free government resources, which can be used on health care, education and for growth enhancing policies (e.g. public investments) • But, after a default, country is likely to remain outside international capital markets for an extended period of time. • This leaves the government with two options to cover its finances: • it either has to ’live by its means’, that is, cut expenditures so that they can be covered with diminished revenues, or • resort to monetization of budget deficits through central banks.
  6. 6. Motivation Motivation Data and methods Results Robustness tests Conclusions IMF programs • IMF programs provide emergency funding, technical and financial assistance and enforce unpopular but often necessary economic reforms during crises. • IMF offers four types of assistance programs for sovereign nations: • Stand-By Arrangements (since 1952) • Extended Fund Facilities (since 1974) • Structural Adjustment Facilities (since 1986) • Enhanced Structural Facilities / The Poverty Reduction and Growth Facilities (since 1988) • SBA’s are the most lenient of the arrangements, but all arrangements involve some form of conditionality.
  7. 7. Motivation Motivation Data and methods Results Robustness tests Conclusions Conditionalities of IMF programs • Even the earliest IMF programs imposed conditions on government behavior. Conditions demanded removal of subsidies and price controls from state economic enterprises (Krueger 2003). • Almost always there were also an agreement of ceiling on fiscal deficit and domestic redit. • Other conditions included the rescheduling of private and public debt, and the change or removal of the nominal exchange rate regime • The exact nature of conditions of IMF programs have changed (and continue to change), but some form of austerity has always been (and continue to be) a part of them
  8. 8. Motivation Motivation Data and methods Results Robustness tests Conclusions Data • We concentrate on three types of crises: finance, currency and inflation. • We use data on 45 countries for a period of 60 years (1951-2010) • Data are obtained from the IMF Staff Reports and Surveys, Penn World Tables, the World Bank, and from datasets of Bordo and Schwartz (2000), Ilzetzki et al. (2010), Przewoski et al. (2000) and Reinhart and Rogoff (2011). • In total we have 857 year-country crisis observations.
  9. 9. Motivation Motivation Data and methods Results Robustness tests Conclusions Descriptives Table: Descriptive statistics for countries in crisis, N=857 Categorical (dummy) variables YES NO Crises: Banking crisis 299 558 Currency crisis 540 317 Inflation crisis 534 323 Under at least 1 crisis 857 0 IMF program and sovereign defauts Under IMF program 404 453 Foreign default 274 583 Domestic default 66 791
  10. 10. Motivation Motivation Data and methods Results Robustness tests Conclusions Regressions • Our baseline growth model is given by growthcy = kUB ∑ k=kLB γk ∗ DOMdefkcy + kUB ∑ k=kLB δk ∗ FORdefkcy + + kUB ∑ k=kLB ηk ∗ IMFkcy + αc + βy + δxcy + cy . where growthcy is the change in the logarithmic real GDP per capita of crisis country c in year y, −2 ≤ k ≤ 5, and xcy are the control variables: growth of real gross capital formation, growth of real gross government consumption and change in trade openness.
  11. 11. Motivation Motivation Data and methods Results Robustness tests Conclusions Regressions • Our baseline growth model is given by growthcy = kUB ∑ k=kLB γk ∗ DOMdefkcy + kUB ∑ k=kLB δk ∗ FORdefkcy + + kUB ∑ k=kLB ηk ∗ IMFkcy + αc + βy + δxcy + cy . where growthcy is the change in the logarithmic real GDP per capita of crisis country c in year y, −2 ≤ k ≤ 5, and xcy are the control variables: growth of real gross capital formation, growth of real gross government consumption and change in trade openness. • The DID-estimations are performed by OLS-regressions, where the outcome variable is regressed on control variables (xcy), the year (βy ) and country (αc) dummies as well as on the dummies for an action(s) taken k years ago (DOMdefkcy , FORdefkcy , IMFkcy ).
  12. 12. Motivation Motivation Data and methods Results Robustness tests Conclusions The counterfactual • Identification: The counterfactual growth evolution of crisis country c in year y that has taken an action k periods ago follows that of those countries that have not taken a given action between −2 ≤ k ≤ 5 years ago, and who are also under at least one crisis.
  13. 13. Motivation Motivation Data and methods Results Robustness tests Conclusions The counterfactual • Identification: The counterfactual growth evolution of crisis country c in year y that has taken an action k periods ago follows that of those countries that have not taken a given action between −2 ≤ k ≤ 5 years ago, and who are also under at least one crisis. • That is, the counterfactual also includes observations of a country in crisis that has not taken a given action -2 to 5 years ago, but may have done so earlier (or later). • For example, Finland is in the counterfactual crisis country group in 1991-94 and in the IMF program crisis country group in year 1967 (-2 to 5 years).
  14. 14. Motivation Motivation Data and methods Results Robustness tests Conclusions Preselection and expectations • We pool observations around years of action into three periods: before, impact and after. We also measure overall outcome consisting of growth performance during impact and after periods.
  15. 15. Motivation Motivation Data and methods Results Robustness tests Conclusions Preselection and expectations • We pool observations around years of action into three periods: before, impact and after. We also measure overall outcome consisting of growth performance during impact and after periods. • It is possible that the time periods when countries default or enter into IMF programs have different characteristics than those periods when they do not. • We analyzed four main selection criteria from the literature: budget balance, public debt, foreign reserves and external debt. • They did not differ statistically between actions or between those periods when crisis countries took an action and when they did not.
  16. 16. Motivation Motivation Data and methods Results Robustness tests Conclusions Preselection and expectations • We pool observations around years of action into three periods: before, impact and after. We also measure overall outcome consisting of growth performance during impact and after periods. • It is possible that the time periods when countries default or enter into IMF programs have different characteristics than those periods when they do not. • We analyzed four main selection criteria from the literature: budget balance, public debt, foreign reserves and external debt. • They did not differ statistically between actions or between those periods when crisis countries took an action and when they did not. • We thus consider the difference in trends before actions, if any, to result from expectations not from preselection.
  17. 17. Motivation Motivation Data and methods Results Robustness tests Conclusions Growth evolution of different actions in crisis countries vs. the counterfactual −2 −1 0 1 2 3 4 5 −10−50510 Years after joining the IMF program Growth evolution after IMF IMF program begins −2 −1 0 1 2 3 4 5 −10−50510 Years after foreign default Growth evolution after foreign default Foreign default −2 −1 0 1 2 3 4 5 −10−50510 Years after domestic default Growth evolution after domestic default Domestic default
  18. 18. Motivation Motivation Data and methods Results Robustness tests Conclusions The role of debt • Although the level of sovereign or external debt does not seem to affect the selection process of countries to default or enter into IMF programs, they are likely to influence the outcomes of actions.
  19. 19. Motivation Motivation Data and methods Results Robustness tests Conclusions The role of debt • Although the level of sovereign or external debt does not seem to affect the selection process of countries to default or enter into IMF programs, they are likely to influence the outcomes of actions. • We analyze the role of sovereign and external debt using thresholds of 150% of GDP (sovereign debt) and 60% of GNI (external debt).
  20. 20. Motivation Motivation Data and methods Results Robustness tests Conclusions Growth evolution during an economic crisis in countries with high levels of public debt Dependent variable: growth of the real GDP per capita IMF Foreign Domestic Public debt < 150% of GDP Before (2y) 1.056* -1.226 -0.090 (0.521) (0.635) (1.056) Overall 0.280 -0.372 -1.661* (0.364) (0.376) (0.659) Impact (1y) 0.286 -1.695* 0.548 (0.645) (0.817) (1.227) After (5y) 0.307 -0.078 -2.240** (0.390) (0.408) (0.708) Interaction terms for public debt > 150% of GDP High debt ×before (2y) -6.061* -2.889 3.849 (2.466) (3.667) (3.485) High debt × overall 0.582 1.485 -2.178 (1.260) (1.273) (1.860) High debt × impact (1y) 3.295 2.476 -2.156 (2.516) (3.047) (4.646) High debt × after (5y) -0.478 1.472 -1.425 (1.331) (1.416) (1.965) countries 45 years 1951-2010 observations 857 * = p<.05, ** = p<.01, *** = p<.001.
  21. 21. Motivation Motivation Data and methods Results Robustness tests Conclusions Growth evolution during an economic crisis in countries with high levels of external debt Dependent variable: growth of the real GDP per capita IMF Foreign Domestic External debt < 60% of GNI Before (2y) 1.576* -1.366 -0.967 (0.737) (0.997) (1.315) Overall -0.136 -0.313 -0.339 (0.506) (0.575) (0.905) Impact (1y) -1.154 -0.094 0.308 (0.956) (1.303) (1.846) After (5y) 0.206 -0.379 -0.516 (0.558) (0.621) (0.991) Interaction terms for external debt > 60% of GNI High debt × before (2y) -1.311 0.767 1.048 (1.127) (1.477) (2.149) High debt × overall 0.558 -0.317 -3.017* (0.754) (0.810) (1.218) High debt × impact (1y) 1.752 -2.001 -1.282 (1.400) (1.852) (2.464) High debt × after (5y) 0.088 -0.008 -3.310* (0.812) (0.892) (1.345) countries 45 years 1951-2010 observations 857 * = p<.05, ** = p<.01, *** = p<.001.
  22. 22. Motivation Motivation Data and methods Results Robustness tests Conclusions The role of external debt • The result that external debt is more harmful in domestic default is likely to reflect the costs that it inflicts to the indebted domestic financial sector. • Financial companies of a country often hold a fairly large amount of domestic government bonds as collateral in their balance sheets. • When they also hold large amounts of external debt, haircuts to their collateral through cuts on the principal and/or interest payments of government bonds will cause insolvencies and force financial companies to default on their external debt. • This leads to diminution of credit in the economy and to bankruptcies in the private sector, which causes the GDP of a country to fall but with a lag.
  23. 23. Motivation Motivation Data and methods Results Robustness tests Conclusions Robustness checks • Few issues can affect our main findings. 1. The role of the IMF changed rather drastically during the currency crises of Latin American countries in the 1980s and after the fall of the Soviet Bloc that started in 1989. 2. The level of economic development. 3. Political crises.
  24. 24. Motivation Motivation Data and methods Results Robustness tests Conclusions Robustness checks • Few issues can affect our main findings. 1. The role of the IMF changed rather drastically during the currency crises of Latin American countries in the 1980s and after the fall of the Soviet Bloc that started in 1989. 2. The level of economic development. 3. Political crises. • We re-estimated our model using data from 1990 onwards. Results were qualitatively unchanged from those presented previously.
  25. 25. Motivation Motivation Data and methods Results Robustness tests Conclusions Growth evolution during an economic crisis in low- and high-income countries Dependent variable: growth of the real GDP per capita IMF Foreign Domestic countries obs. Developing countries Before (2y) 0.666 1.134 0.061 20 355 (0.915) (1.263) (2.183) Overall 0.262 -0.859 -3.198* (0.648) (0.802) (1.270) Impact (1y) -0.045 -3.871* -0.512 (1.195) (1.921) (2.546) After (5y) 0.328 -0.492 -3.746** (0.684) (0.827) (1.347) Developed countries Before (2y) 0.813 -0.238 -0.243 25 499 (0.454) (0.526) (0.860) Overall -0.127 -0.400 -0.731 (0.318) (0.304) (0.546) Impact (1y) -0.459 0.299 0.410 (0.558) (0.658) (1.055) After (5y) -0.033 -0.563 -1.027 (0.344) (0.333) (0.594) * = p<.05, ** = p<.01, *** = p<.001. The developing country group includes the poor and lower middle-income countries and the developed countries group includes the higher middle-income and rich countries based on the 2010 World Bank classification of countries.
  26. 26. Motivation Motivation Data and methods Results Robustness tests Conclusions Why developing economies seem to be more vulnerable to defaults? • In developing countries, the (few) large institutional investors and banks tend to hold large amounts of domestic debt as collateral. • Domestic default will affect negatively on their balance sheet, which is likely to be already under stress because of the crisis. • This will lead to private sector defaults and bankruptcies, diminution of credit and a fall in the output, with a lag (as the credit squeeze starts to bite).
  27. 27. Motivation Motivation Data and methods Results Robustness tests Conclusions Political crises Dependent variable: growth of the real GDP per capita IMF Foreign Domestic Government not in crisis Before (2y) 0.739 -0.941 -1.863 (0.551) (0.676) (1.177) Overall 0.441 -0.277 -1.791** (0.382) (0.388) (0.685) Impact (1y) 0.097 -2.334** 0.175 (0.689) (0.893) (1.324) After (5y) 0.545 0.141 -2.326** (0.414) (0.416) (0.746) Interaction terms for government in a crisis Gov. crises × before (2y) 0.283 0.234 2.505 (1.127) (1.233) (1.905) Gov. crises × overall -0.511 -0.678 -0.608 (0.786) (0.762) (1.201) Gov. crises × impact (1y) 0.888 3.838* -1.260 (1.482) (1.589) (2.452) Gov. crises × after (5y) -0.804 -1.850* -0.353 (0.839) (0.860) (1.304) countries 45 years 1951-2010 observations 857 * = p<.05, ** = p<.01, *** = p<.001.
  28. 28. Motivation Motivation Data and methods Results Robustness tests Conclusions Actions and outcomes in different crises • Above we have analyzed the outcomes of IMF programs and sovereign defaults using a dataset that pools all the crisis as one. • However, outcomes of IMF programs and defaults may differ between crises.
  29. 29. Motivation Motivation Data and methods Results Robustness tests Conclusions Growth evolution of different actions during a banking crisis −2 −1 0 1 2 3 4 5 −10−50510 Years after joining the IMF program Growth evolution after IMF, Banking crisis IMF program begins −2 −1 0 1 2 3 4 5 −10−50510 Years after foreign default Growth evolution after foreign default, Banking crisis Foreign default −2 −1 0 1 2 3 4 5 −15−10−5051015 Years after domestic default Growth evolution after domestic default, Banking crisis Domestic default
  30. 30. Motivation Motivation Data and methods Results Robustness tests Conclusions Growth evolution of different actions during a currency crisis −2 −1 0 1 2 3 4 5 −10−50510 Years after joining the IMF program Growth evolution after IMF, Currency crisis IMF program begins −2 −1 0 1 2 3 4 5 −10−50510 Years after foreign default Growth evolution after foreign default, Currency crisis Foreign default −2 −1 0 1 2 3 4 5 −10−50510 Years after domestic default Growth evolution after domestic default, Currency crisis Domestic default
  31. 31. Motivation Motivation Data and methods Results Robustness tests Conclusions Growth evolution of different actions during an inflation crisis −2 −1 0 1 2 3 4 5 −10−50510 Years after joining the IMF program Growth evolution after IMF, Inflation crisis IMF program begins −2 −1 0 1 2 3 4 5 −10−50510 Years after foreign default Growth evolution after foreign default, Inflation crisis Foreign default −2 −1 0 1 2 3 4 5 −10−50510 Years after domestic default Growth evolution after domestic default, Inflation crisis Domestic default
  32. 32. Motivation Motivation Data and methods Results Robustness tests Conclusions Conclusions • Developing countries should avoid defaulting, especially on domestic liabilities, as they lead to large fall in the real GDP per capita compared to developing countries in crisis that did not default. • Domestic default led to drop of more than -3% in the per capita output of a developing country.
  33. 33. Motivation Motivation Data and methods Results Robustness tests Conclusions Conclusions • Developing countries should avoid defaulting, especially on domestic liabilities, as they lead to large fall in the real GDP per capita compared to developing countries in crisis that did not default. • Domestic default led to drop of more than -3% in the per capita output of a developing country. • In addition, the level of external debt seems to be the dividing factor between outcomes of defaults. • Under high external debt, domestic default leads to drop of more than 3% in the per capita output, while there was no negative outcome under low external debt.
  34. 34. Motivation Motivation Data and methods Results Robustness tests Conclusions Conclusions • Developing countries should avoid defaulting, especially on domestic liabilities, as they lead to large fall in the real GDP per capita compared to developing countries in crisis that did not default. • Domestic default led to drop of more than -3% in the per capita output of a developing country. • In addition, the level of external debt seems to be the dividing factor between outcomes of defaults. • Under high external debt, domestic default leads to drop of more than 3% in the per capita output, while there was no negative outcome under low external debt. • IMF programs provide the most lenient crisis outcome, but they do not yield any statistically measurable economic benefits.
  35. 35. Motivation Motivation Data and methods Results Robustness tests Conclusions THANK YOU!

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