ECONOMYNEXT – Gross Financing Need is one of the latest econometric measures applied by the International Monetary Fund to Latin American and other countries that default after severe currency crises in the hope of making debt sustainable or easier to manage and service.

The IMF uses stock and flow indicators to decide or claim that debt is “sustainable” or not.

Econometrics

A key indicator is debt to GDP ratio (a stock) and a GFN or the rollover of old debt and raising new debt in a given year under their Debt Sustainability Assessment.

Until floating rates, the debt to GDP ratio was the key indicator until floating rate countries started to survive with high levels of debt.

A high GFN is supposed to measure roll-over risk. Sri Lanka’s GFN is now over 30 percent of GDP.

The DDO, which involves extending the maturities of rupee debt, is aimed at reducing the roll-over risks of debt or the gross financing need (GFN) which the IMF believes will bring debt back to sustainability or make it manageable.

Sri Lanka has proposed re-structuring domestic debt as required under an International Monetary Fund program to make debt ‘sustainable’ according to some statistical requirements that the agency has devised.

Sri Lanka’s authorities have tried to minimize the fallout on domestic debt, in a debt re-structure. Sri Lanka has to do it, there is no choice.

In Sri Lanka GFN hit 34 percent and the debt to GDP ratio 128 percent after default and currency collapse. The aim is to bring GFN down to 13.5 percent and debt to 95 percent by 2030.

Like debt to GDP ratios and revenue to GDP there is a wide variation of GFN numbers among countries and also among defaulting countries.

In Ghana according to an IMF report in 2021, public debt to GDP was 83 percent and the IMF to be fair warned that debt was growing too rapidly, up from 57.9 percent in 2018.

Singapore according to the IMF had a GFN of 26 percent of GDP and debt to GDP ratio of 150 percent in 2020, amid Covid.

However, the country has monetary stability due to operating on currency board principles (no policy rate). Exchange rate depreciation is zero and interest rates are low.

And Singapore’s debt comes partly from the GIC, set up by Goh Keng Swee, the structure of which is too complicated to explain in this column. Regardless, that there is a balancing item abroad, the GFN is in the 20 percent levels, which has to be rolled over.

Due to the stability, it is easy to roll-over debt. And there is no real problem with repaying debt. As long as monetary stability is there, a government can raise money domestically (at a higher interest rate) reduce domestic investment, buy dollars and repay debt.

It is more difficult however with bullet repayment debt like sovereign bonds. Confidence matters here more than if a country had syndicated loans, which can be settled in installments.

If ISB holders lose confidence and start selling down debt, it will be difficult to roll-over debt. Countries with ISBs are especially vulnerable to default if the bond holders rightly or wrongly lose confidence.

In Ecuador, macro-economists or the International Monetary Fund cannot trigger monetary instability flexible policies because the country is dollarized. As with currency boards and dollarized countries, public debt to GDP was low.

But a socialist president, debt went up steeply including from China with cheap credit under Fed quantitative easing, shortly before Covid hit.

Still in 2019, the IMF framework did not find serious problems.

“Under the baseline projection, Ecuador’s public debt is on a sustainable path, thanks to the envisaged fiscal consolidation,” the IMF said in 2019.

“Debt is expected to peak in 2020 at around 50 percent of GDP and decline to below 40 percent of GDP by 2024. Gross financing needs are estimated at 8.1 percent of GDP in 2019 but are expected to decline to 5.2 percent of GDP in 2020 and further to 2.7 percent of GDP in the medium term. The debt profile is particularly vulnerable to unexpected and large terms of trade shocks and a sharp deceleration in growth though debt remains sustainable even under the stress scenarios.”

However, when Covid hit, and oil prices fell, ISB holders panicked and sold, pushing up yields.

ISB holders perhaps do not know the difference between a dollarized and non-dollarized Latin American country.

Public debt was around 50 percent of GDP and GFN was low.

Ecuador negotiated a re-structuring. The country serviced its debt up to the point of the debt exchange and then got some reductions as well.

The ISB holders had effectively hit an own goal.

There are two lessons in Ecuador. If a country has marketable sovereign debt (ISBs) a low GFN is not going to save it, if confidence takes a hit, rightly or wrongly.

The second lesson is that, like in the gold standard days, dollarization is a check on the debt to GDP ratio.

The discipline of markets came but people did not grow hungry because there was no dual anchor flexible inflation targeting the central bank to steal food from their mouths, like in Sri Lanka, Ghana or other countries like Laos.

The lenders took a hit, not the population. With an impotent central bank unable to engage in ‘monetary policy’, there was no ‘pain’ as seen in Sri Lanka.

So, confidence matters, particularly for countries with international sovereign bonds.

Cambodia

Another case in point is Cambodia which also had an exceptionally bad central bank and market-dollarized at 4000 local units to the US dollar.

Ecuador dollarized at 25,000 sucres to the dollar with a little official help, in a perhaps unusual situation.

It is not as if Cambodian politicians, and its leader Hun Sen is a paragon of fiscal virtue. Is this former Khmer Rouge fighter some genius reformer? He orchestrated a coup when the country’s currency was collapsing three decades ago.

Cambodia now also has a low debt to GDP ratio, in the same lines as Hong Kong and Bulgaria. Countries which are dollarized or are currency boards usually have debt to GDP ratios of around 30 percent of GDP.

Such countries also do not have big banking crises as there is no central bank to finance credit without deposits.

The lack of standing facilities at fixed rates, and the enhanced prudential lending protects such countries, even if the anchor currency country (the US) suffers a banking crisis.

These countries, which are unable to print money, engage in macro-economic policy have stability, low interest rates and low inflation.

If Sri Lanka prints money under flexible inflation targeting and output gap targeting, de-stabilizes money through flexible exchange rate, using policies prescribed by the IMF and which have been rejected in their home countries, nothing can save this country.

Nobody will say there was monetary instability which hit the debt.

That were exchange rate shocks from the currency crises from mis-targeted rates, that there was a growth shock and a concurrent a revenue shock and widened the deficit bloated the debt. And that frequent currency crises and depreciation led to high nominal rates.

Inflationist macro-economists write the narrative. Politicians will be blamed. The people will be blamed for electing the politicians.

Those who engage in discretionary flexible policy, which is destined to fail, not only in Sri Lanka, but in Argentina or Ghana where they are followed, will escape scrutiny and accountability.

People will go hungry as the flexible exchange rate collapses. It will be impossible to do reforms as the bottom falls out from under the home economy from depreciation.

Desperate voters will be blamed for asking for subsidies because currency depreciation and inflation robs their real salaries, making them vulnerable to economic charlatans and nationalists.

The usual suspects

The usual cracked record will be played. The politicians did not do the reforms.

There will be new twists now.

The debt restructure was not deep enough.

The GFN at 13.5 percent was not low enough, as well as that politicians did not do the reforms.

That domestic debt was rolled over, interest rates started to fall, with GFN at 30 percent when there was confidence in the currency and before open market operations began to destabilize the currency, would be forgotten.

Meanwhile, Singapore will have a GFN higher than 20 percent, Cambodia will make steady progress with weak policy making capacity but with neither the IMF nor other inflationists able to engage in ‘macro-economic policy’ to destabilize the country, drive out elected governments and keep out out foreign investors by scaring the living daylights out of them.

At least until de-dollarization is achieved and macro-economists get the power to destroy money through flexible policies.

Then Cambodia will also go back to the 1970s and 1980s like Argentina and Latin America do. Sri Lanka runs the same risk with flexible inflation targeting.