This final paper aims to explain what the variable external debt really means and also to emphasize its importance. I have tried to explain in detail the meaning and significance of foreign debt and to understand what is the situation in several Member States of the European Union in this respect, the reasons for their current condition and the ways to a positive change. Initially, I chose this topic because of my interest in the current external debt crisis in the world and in this paper I wanted to find the reasons for its emergence, development and the ways to stop it.
What I discovered and confirmed is that the variable foreign debt is without doubt one the most important in the economic world. A variable, that not only gives much information about the financial situation of a country, but also for its specific economic position. No need even to mention that the ongoing crisis is perhaps the most discussed topic in recent times and will certainly continue to be so in the near future.
In my work I tried to analyze the situation in several specific countries like Portugal, Ireland, Greece, Spain (the PIGS), whose position is the worst in this respect and I tried to compare them with some of the well-developed economies like Germany. I have also given special attention to the case of Bulgaria and actually remained pleasantly surprised by the information that I found. It turned out that although it is one of the most underdeveloped countries in the European Union, perhaps even the most underdeveloped one, in terms of its foreign debt the state is in a stable condition.
The values that I found for 2011 are much better compared to the same period in 2010. Also, Bulgaria is the only European country that has managed to upgrade its credit rating last year. These news left me optimistic about the future of Bulgaria in respect of this concrete 3 variable. Moreover, compared to the above-mentioned countries, Bulgaria is thriving. The negligent and frivolous attitude of Greece, Portugal, etc. will not only deepen the crisis in these countries, but is likely to lead them to default on their debts, or even to bankruptcy.
I have tried to give suggestions for possible ways to resolve the crisis and stressed that unless tougher measures are taken, the situation of these countries will only get worse and unfortunately now all views are in favor of this claim. Hopefully, as I concluded in my paper, in the near future we will witness the positive development of this topic and the end of the debt crisis in the EuroZone. Gross external debt is defined as the amount of money borrowed by the residents of a country from non-residents of that same country and which requires payments of a principal and an interest by the borrower at a future point.
It is an important source of information about certain articles of the balance of payments and the international investment position of a country. In such a harsh environment as today’s, foreign debt is a key variable that allows us to understand not only the macroeconomic position of a country, but also the extent to which this country is influenced by the ongoing financial crisis. It is certainly the most discussed topic of the summer of 2011 and most probably will continue to be such in the following months or even years.
Foreign debt is one of the main attributes of the modern global economy and one of the mechanisms of its functioning. It is a concept, which indicates a commitment of a country or a government to lenders with different nationalities. The interest towards issues of debt is mainly caused by the interdependence between countries in terms of expanding trade relations and the development of financial markets. 4 As we see today, depending on the management of its foreign debt, a country can either prosper or fall into a crisis. The overriding aim of the external debt strategy is to ensure medium to long-term debt
sustainability, meaning the country can repay its current and future debt liabilities in full, without the need of a debt forgiveness or rescheduling and avoiding the accumulation of the debt, while managing to run their economy at an acceptable growth level. External debt is a key variable, because it gives an incredible amount of information about a country’s economy. It is not surprising that countries declare bankruptcy, fall into crisis or on the other hand have a steady financial situation just because of their foreign debt management. So undoubtedly, external debt is one of the most important factors for the goodwill of a country.
The amount of Bulgaria’s foreign debt and its servicing and refinancing costs have significant influence on the balance of payments as well as on the national budget, the banking system and the money market and thus its management policy is critical for maintaining macroeconomic stability and confidence in the currency board system. The purpose of this paper is to actually stress the importance of the variable “external debt”, as well as to examine key moments in its policy management, to outline the areas of influence of debt on the national economy and to analyze the effects of its restructuring.
Also to make a comparison between Bulgaria and other countries of the European Union, based on different ratios such as debt-to-gross domestic product, for example, in order to find exactly where Bulgaria stands on the issue of foreign debt. I will also try to reason about the current EuroZone debt crisis and its causes, the possible solutions and the way it influences European countries. The object of study is the size, structure and dynamics of the foreign debt of some European Union member states such as Greece, Portugal, Spain, etc. as well as the differences between their debt and that of Bulgaria.
5 According to the international definition, external debt is “the outstanding amount of those actual current, and not contingent, liabilities that are owed to non-residents by residents of an economy, and require payment(s) of principal and/or interest by the debtor at some point(s) in the future”1. The main criterion for inclusion of a liability to the amount of foreign debt is that it is issued by a resident and is due to non-residents and not whether it is issued on domestic or international financial markets. Similarly, the only transactions that are accounted for are those that occurred between resident and non-resident.
In calculating the debt only amounts actually disbursed are taken into account, not the agreed installments. The amount of liabilities is recorded at par rather than market value, even if there are marketable debt instruments. The Gross External Debt of Bulgaria in particular is reported in Euros. When compiling debt data, the distinction between short and long-term debt is based on original rather than the residual term to maturity. Long-term debt includes all liabilities with an original maturity of over 1 year and all liabilities to direct investments. Short-term includes those liabilities with maturity of 1 year or less. 1 http://www.censtatd. gov. hk/statistical_literacy/educational_materials/inte rnational_investment_position_external_debt/index. jsp 6.
The four principle components of the gross foreign debt classified by sectors are General Government, Banks, Monetary Authorities and Other Sectors. Within these sectors the foreign debt liabilities are classified by instruments and by maturity, being either short-term or long-term. In the General Government debt section are included: central government debt, debt of local governments, debt of social security funds and debt of all other non-market and non-profit institutions that are controlled and funded by the state.
Banks and other enterprises with more than 50% state ownership, which function as profit-making enterprises or socalled quasi-corporations are not included in the amount of debt of the general government sector and are appropriately allocated to banks or to other sectors. The General Government sector’s debt liabilities have a long-term maturity and are classified by instruments – Loans and Bonds and Notes. Those liabilities which do not involve the issue of tradable securities are recorded under Loans. Also recorded under Loans are the money borrowed by the central government from the International Monetary Fund.
The liabilities of the central government on securities that were issued on the international markets are written under Bonds and Notes, and this section includes the entire stock of the issue. The part of the issue that is held by residents is recorded with a negative sign in section Bonds and Notes at the end of the reporting period. The government securities that are issued on the domestic market by the government and are purchased by non-residents, are also recorded under the section Bonds and Notes. 7
According to the international methodology on external debt statistics this sector comprises all the external liabilities of the country’s Central Bank. Banks’ short-term liabilities include short-term loans of non-residents, non-residents’ deposits in local banks as well as other liabilities to nonresidents. In sub-item Deposits are included both deposits in foreign currencies and in Levas (for Bulgaria in particular) of non-residents in local banks. According to the manual “External Debt Statistics: Guide for Compilers and Users”, deposits related to contingent liabilities are not included in the foreign debt calculation.
Long-term debt includes loans and bonds and notes issued by the banks and held by non-residents. Other Sectors’ debt includes the external liabilities of commercial companies in the real sector (including loans for which government guarantees exist as well as loans of predominantly state-owned firms) and households. Short-term liabilities of commercial companies include shortterm loans received by residents, commercial loans and other liabilities to non-residents. Long-term liabilities include loans and bonds and notes issued by the companies and owned by non-residents.
In the presentation of gross external debt, those liabilities that are related to intercompany lending and those related to direct investment relationships are separately identified. Obligations in relation to equity (equity capital and reinvested revenue), except preferred shares, which are debt instruments, are not included in the foreign debt. 8 On the other hand, obligations under direct investment are included in long-term debt. Every country wants to be economically developed, to have a good infrastructure, well-maintained natural environment, perfect educating system, proper and cheap energy sources.
So how are countries able to fund all these extremely expensive projects? They do so by government bonds – basically, borrowing money from other more developed and financially stable countries. In order to seduce investors (countries in good financial condition) to actually lend them the money and finance their debt, countries in not such flawless economic shape have to offer a higher yield. In the past, such countries like Greece, Spain, Portugal, Italy, Ireland had to pay very high yields to be funded.
But after the creation of the EuroZone, each of these economically underdeveloped countries were given the right to borrow more easily and most importantly, for yields quite close to those of economically-advanced countries like France, for example. And actually this was the main purpose of the EuroZone – to give the opportunity to these lagging countries to catch up, to close the gap between them and the more powerful Germany and France by borrowing money cheaply and investing them responsibly in the abovementioned projects to develop economically.
In this manner, all of Europe would be able to prosper and grow stronger. But Greece, Spain, Portugal, 9 etc. did not act in the responsible manner in which they had promised to and invested the money foolishly and recklessly in projects with no real importance, instead of investing them in stabilizing their economy. No wonder this is the key topic of the summer, even the year, because until today these countries have issued so much debt, have spent so much money and have followed such an irresponsible fiscal policy that they cannot pay back all those loans.
And so they face default or even bankruptcy. A further problem for them is that if they now need to borrow more money to try and fix their economic situation, they will have to do that at a higher yield, since investors have raised it seeing their possible default on the loan. This is how the EuroZone debt crisis works, basically. And without the help of the European Union, these countries will have a hard time paying back the money they owe. Most probably, they would continue to borrow money, worsen even more their fiscal agendas and eventually declare bankruptcy.
This is why all their hopes are turned towards the European Union. There are countries in perfect financial situation, and then there are those like Portugal, Ireland, Greece and Spain, also known as the PIGS, whose public finances are far from being within the norms. In recent years economists are particularly focused on the fiscal situation of the PIGS and especially their indebtedness. There exist several reasons for their collapse, besides from their own irresponsibility and profligacy, and I will try to explain some of them.
First of all, however, I must point out the difference between the public debt and the foreign debt of these nations. Public or internal debt held by one nation is less risky and has less dangerous consequences, because the interest paid on it is actually 10 returned to the country’s domestic economy. On the other hand, the interest paid on external debt is received by non-residents of the country which means that the money for the interest payments flows out of the country. Having said this, the problem of Portugal, Ireland, Greece and Spain is exactly that an enormous part of their debt is foreign.
For example, in Greece 79% of the gross government debt is external and 40% of the budget deficit of the country is represented by interest payments on internal debt (Table 1). Italy is another case. It has an incredibly high amount of public debt – 115% of GDP, which is exactly the reason why it stands in a better financial situation than the PIGS, because the interest on this high public debt is paid back to Italians and part of it is received directly by the Italian government as taxes. In other words, the money stays in the country and benefits Italy’s own economy.
Table 1. Government debt, external debt, and Internal Investment Position at year-end 2009 (http://www. voxeu. org/sites/default/files/image/cabral_table1b. gif) 11 Every coin has two sides – on one stand the interest payments of the PIGS, on the other is the interest received by the wealthier nations that lend them the money. As I said before, the governments of countries like France or Germany get richer by earning tax revenues on the interest payments of Portugal, Greece, etc. which on their side have to periodically pay them the interest on the money borrowed.
In order to better understand the position of the indebted countries and the current crisis we can use the debt-to-GDP ratio, which is one of the main indicators of the health of an economy. Briefly explained, it is the size of the government debt of a country, represented as a percentage of its Gross Domestic Product (GDP). It indicates how quickly and smoothly a nation can pay back its foreign debt. If a debt-to-GDP ratio is low, this shows that the economy most probably produces products and services and thus revenues that are high enough to be able to pay back the debts without a problem.
This is why domestic governments aim at low debt-to-GDP ratios and can accept the risks involved in increasing their external debt as their economies have higher profit margins and GDP. This, however, is not the case with the PIGS. Their average net external debt-to-GDP ratio is around 30% higher than that seen in the countries shown in Table 2, during past external debt crisis. 12 Table 2. Government debt, external debt for selected past external debt crises (http://www. voxeu. org/sites/default/files/image/cabral_table2b. gif)
To reduce their net foreign debt-to-GDP ratios (Chart 1), Portugal, Ireland, Greece, Spain and even Italy would have to substantially improve their economic situation by increasing the amounts of their net exports and in the same time to maintain a fair growth rate of their nominal GDP. Otherwise they face further exposition to the crisis, because of the money compounded and paid as interests that leave their national economies. 13 Chart1. (http://upload. wikimedia. org/wikipedia/commons/3/39/Piiggs_balance_sheet_2009. png )
Extremely curious is the case of Ireland which has 144 billion Euros in GDP and well over a trillion Euros in external debt. It is the perfect way to demonstrate the death spiral which no one can escape from – debt is continuing to compound every second, without the country being able to pay it back. Neither Great Britain, nor Switzerland are much better than Ireland as a matter of fact and other countries in a better situation like Germany or the rest of the European Union will not be able to fix the ongoing crisis without some kind of a reform or restructuring, being it even default on the external debt of these nations.
Over a year ago rumor had it that Germany had plans to bail out Greece and if this had occurred the crisis would have worsened, since interest rates would have raised drastically making it virtually impossible for weak economies to borrow more money. But this is not the truly bad news. I 14 will shortly return to the Greece’s bailing out situation. The European Union must issue debt in the amount of more than 1. 5 trillion Euros this year and Greece is far from being the worst country facing the crisis – its economy is miniature with respect to those of Portugal, Italy and Spain.
And if Germany had bailed Greece out, this policy could have had the power to destroy the European Union over the next decade, because if a die is rolled once, afterwards it is rolled again and again, and after Greece, the really problematic countries would have waited to be bailed out. Germany would have certainly been unable to help all of them and the crisis in the European Union would have reached a new high-point. Thankfully, Germany did not engage in such actions. The European Union, jointly with the International Monetary Fund had the honor of doing so and partly saving Greece, Portugal and Ireland from defaulting.
However, this help will not be able to turn the situation around and end the crisis, since the countries have sunk so deeply, that it would take years to recover. With the purpose of further stressing how bad really the situation of the PIGS countries is, we should see Chart 2 which shows the government surplus/deficit of the problematic European countries against the European Union and the EuroZone. Today the deficit is at an even lower point and means that the purchases of goods and services and the net interest payments of these countries far exceed its tax revenues.
Thus the PIGS must further borrow money to finance the projects they desire to carry out, paying more and more interest and worsening more and more their fiscal agendas and their economy as a whole. 15 Chart2. (http://upload. wikimedia. org/wikipedia/commons/4/4b/Piiggs_surplus_2002-2009. png) In the beginning of 2010 in Greece there was already excessive anxiety about abnormally high national debt. On 23 April 2010, the Greek government requested that a bailout package proposed by the European Union, jointly with the International Monetary Fund be activated.
On 2 May 2010 the loan deal was reached between Greece, the other EuroZone countries, and the IMF. It was agreed that Greece would receive an immediate € 45 billion in loans to be provided in 2010 and more funds available later. The total of the financial help was decided to be €110 billion with an interest of 5% which is considered to be a high rate for any bailout loan. Without this bailout deal, however, there existed the possibility that Greece would prefer to default on some of its debt, because there was no way to repay it. As a condition to receive the loan, 16
Greece was required to bring its fiscal agenda into order. The financial politics of Greece is strictly supervised by the European Commission as well as the International Monetary Fund. In order to ensure that Greece restores at least part of its external competitiveness a fall in domestic wages and prices is required. There have been cases in the past that prove that Greece could be able to overcome the crisis. Though many believe that this can come only with a high price paid – some kind of restructuring, defaulting on part of the debt, for example.
However, the president of the European Central Bank Jean-Claude Trichet has stated numerous times that a default is not a solution to the problem and it is out of the question, but this only means that the indebtedness of the Mediterranean country will continue to rise and to suppress domestic economic activity through the interest payments to non-residents. Moreover, this strict supervision will probably depress the growth of nominal GDP and as a result, it would worsen the external debt dynamics of the country.
Another problem would be the large potential for development of the same situation in Spain, Portugal and Ireland, because the Greek bail-out deal was followed by a € 85 billion rescue package for Ireland in November, and a € 78 billion for Portugal in May 2011. Despite the supervision and numerous plans, Greece did not manage to bring its economy into shape during the last year and following weeks of market and political dynamics, on 21 July 2011 the leaders of the EuroZone countries decided for a new bailout for Greece. It was agreed that Greece will get a new loan, but this time with a lower interest rate of around 3.
5% and with a minimum of 15 years to pay it back. The total of the financial help amounts to approximately 109 billion Euros that would hopefully bring Greece’s debt crisis to an end or at least to a new, more acceptable level. 17 Past examples and the actual size of the required adjustments in the debt balances give us doubts that Portugal, Greece, Ireland and Spain will be able to reduce their foreign debt amount. The external indebtedness of these countries is by itself disastrous to their national government debt dynamics through the payment of interest to foreign lenders.
This is why many economists believe that some kind of restructuring is necessary, and since the current crisis is not a one-time event (it would most probably reoccur in the future) this restructuring must be firm and powerful to endure a further development. One solution to the problem of the PIGS’ net external liabilities could be bankruptcy or bank resolution. These policies would force the lenders of loans that took huge risks to cope with the losses and would partially reduce these countries’ foreign debt levels.
Another one would be if the governments of the creditor countries actually release the indebted countries from their liabilities and forgive them the debt. This solution, however, is not advisable due to high levels of the debt and more importantly due to moral hazard problems. The most preferable solution for the current situation would be debt restructuring and rescheduling, because it would have an immediate effect on the interest payment amounts to non-residents of the countries. In this option there is no risk of moral hazard, but the creditors would again suffer losses.
This solution is probably the best one since it would teach the lenders a lesson to correctly choose to who and when to give loans, and would set a signaling standard for any future debt crisis in the European Union. 18 The Economic and Monetary Union (EMU) is a term used to describe all the policies necessary for the conversion of the economies of all the members of the European Union which will allow the adoption of a single currency (the Euro) by all the members of the European Union. The term is extremely similar to the term EuroZone. Every state member of the European Union is obliged to participate in the European Monetary Union.
What is the importance of foreign debt in a monetary union? Portugal is the perfect example that external debt is a key variable, because although the fiscal agenda of the country is stable and is no worse than that of a more advanced economy like France, the risk premium on Portugal’s public debt increased dramatically until it had no other option, but to turn to the European Financial Stability Facility for urgent financing. However, the reason why markets are so disturbed about the country’s situation is different – its high foreign debt.
The sole fact that Belgium is not experiencing a crisis in spite of its weak fiscal situation is enough to show the importance of foreign debt the other way around. As we can see from Chart 3, the debt-to-GDP ratio of Belgium in 2009 and 2010 was around 100% and was well over the ratio of Portugal as was its risk premium. And despite the fact that the country was and as a matter of fact still is constantly shaken by political instability, Belgium’s economic position is numerous times better than that of Portugal and so is its reaction to the crisis.
19 Chart 3. (http://a1.citywirecontent. co. uk/images/2011/07/12/507595System__Resources_ _Big_Image-554978. gif) Is external debt more important than public debt? First of all, public debt is risk-free in a country with a proper currency, because if the country is close to a default on its government debt, it can always issue money and pay back the loans. This policy may raise interest rates, but it is certainly better than a default. In a monetary union, however, this is not possible, because of the common currency and the inability of members to freely issue new money when there is a need.
Secondly, even countries in a monetary union retain the right to define the policy of the taxation of its people and no other country or authority has the right to intervene. This is an important point, because even if a country faces a public debt crisis and cannot issue new money to pay it back, it can always impose an incredibly high tax on the loans. Thus, the government can always pay back a huge part of its public debt, using the revenue coming from the increased taxes.
This, of course, would be a kind of foolish policy, since issuing debt in the future would become harder, but at least the country would escape from a default. On the other hand, if the country is facing a default on its external debt, it cannot impose a higher 20 tax and repay the debt this way anymore, because the holder of the debt is a non-resident of the country and is not subject to its laws. As a consequence, every EuroZone country can always find a way to service its public debt, be it with issuing new money or increasing taxes, but it can’t repay its foreign debt as easily – on the contrary.
For this reason, it is external debt that is the more important variable. It is a main factor affecting the economy of the members of the European Union and is currently the most discussed topic in the economic world, because of the ongoing external debt crisis. In such tough times as today with the ongoing crisis, one often asks himself just how bad the situation with the major countries in the world is. The presumption would most certainly be that the smaller and undeveloped countries would be the most indebted, but in reality the contrary is true.
The country with greatest debt to the gross domestic product in the world is Japan, whose duties are 229 percent of its economy, amounting to nearly 14 trillion dollars. It is followed by Greece, whose debt of 487 billion dollars represents around 150 percent of gross domestic product (GDP). Jamaica has a debt of the modest at first sight $ 22 billion, but that is actually 137 percent of its economy. In Lebanon public debt represents 134 percent of GDP or 57 billion dollars. 21 Italy is next with duties of 127 per cent of GDP of 2.
7 trillion and Ireland with duties of $ 250 billion or 114% of the GDP. On the seventh position in this unprestigious ranking is Iceland with debt of 115 billion dollars, representing 14 per cent of GDP. After that comes the U. S. whose debt is 15 154 trillion, equivalent to 100 percent of GDP. With 501 billion dollars of debt Belgium follows and after that it is Singapore that has 255 billion dollars of commitments or 93 percent of GDP, Portugal with duties that amount to 91 per cent of GDP or 220 billion and France with 2. 483 trillion or 88% of GDP.
In the last three spots are Canada, Britain and Germany, whose duties represent 84%, 83% and 80% of GDP respectively, or 1. 472 trillion, 2. 066 trillion and 2. 904 trillion dollars. Currently, Bulgaria is stands 56th in the debt ranking with debt amounting to 47,150,000,000 $ or 36,014. 8 million Euros or 94. 3% of its Gross Domestic Product. For better understanding of the crisis throughout the world, Illustration 1 shows the debt as a percentage of GDP in every country and Illustration 2 shows a map of countries by external debt. Illustration 1. (http://upload. wikimedia.
org/wikipedia/commons/3/35/Public_debt_percent_gdp_world_map. PNG ) 22 Illustration 2. (http://upload. wikimedia. org/wikipedia/commons/e/ed/Debt. PNG) In April 2011 Bulgarian gross external debt amounted to 36,014,800,000 Euros, which is around 664,700,000 less compared to the end of 2010. The debt-to-GDP ratio of Bulgaria was 94. 3%, decreasing by 7. 5% compared to the same period. The liabilities of banks decrease by 592. 7 million Euros or 8. 6 percentage points. With respect to the end of April 2010 the gross external debt has decreased by 1,155,600,000 Euros 3.
1% of GDP. Long-term liabilities are 25,343. 4 million Euros, which is 70. 4% of total external debt and have increased by 168,900,000 million in comparison with the end of 2010. When compared to the end of April 2010 we see that they have decreased by 188. 2 million Euros. Short-term debt amounts to 10,671. 4 million Euros or 27. 9% of GDP and has decreased by 833. 5 million Euros with respect the end of 2010. The short-term liabilities of Banks have decreased by € 697. 4 million and the 23 short-term liabilities of Other Sectors have decreased by € 136. 1 million.
With respect to the end of April 2010, we see that short-term debt has decreased by € 967. 4 million or exactly 8. 3 percentage points. Chart 4. * General Government debt amounts to € 2,750. 5 million or 7. 2% of GDP and has decreased by € 122,500,000 compared t