Bibliography
Annex 3. Estimated Fiscal Impact of the Principal Tax Measures, 2001–05
II. Debt Sustainability
erate. Close to 20 percent of outstanding Paris Club debt to be refinanced in the market between 2005 and 2009 has been prepaid with the proceeds of long-term paper, half of which was issued in local currency. As a result of the exchange referred to above and the replacement of external debt, the average maturity of the domestic debt portfolio increased from 5.9 years to 8.9 years (BCRP 2005).
The debt management strategy has also significantly reduced interest rate risk.
On the one hand, prefinancing and substituting short-term maturing Paris Club loans with long-term, fixed-rate bonds has reduced the share of debt that will be repriced in the next few years. On the other hand, there is a consistent drive to increase the share of fixed-rate debt, not only using new borrowing, but also through interest rate swaps on existing debt.9The percentage of fixed-rate debt increased from 47 percent in 2002 to 59 percent in 2005.
Key Issues for Debt Sustainability, Debt Management, and Debt Market Development
Following from the above discussions, a number of key questions can be asked from a policy maker’s standpoint: (i) Taking into account the potential impact of a down-turn in the economy driven by the end of the current external boom,is the debt fis-cally sustainable under the current fiscal policy stance?(ii) Given the potential for higher funding needs (end of current external boom), and the market’s limited capacity to absorb domestic debt,how can debt management practices contribute to improving debt sustainability?(iii) Taking into account that the domestic debt market is relatively small and illiquid and that macroeconomic or financial shocks may result in a debt market squeeze, what can be done to ensure the government has sustained and increasing access to funding in local currency in the domestic market?The following sections attempt to answer these questions.
impact has declined with the slowing of the privatization program after 2000. Other factors captured by the residual of the model accounted for a 3.5 percent decrease and a 5.6 percent decrease in 2005 and 1997, respectively, and could be attributed to the reduction of the Paris Club debt in September 2005 and the restructuring of Brady Plan debt in 1997.
Table 3. Peru: Debt Determinants (as a percent of GDP)
1995– 1999– 2001–
98 2000 05 2001 2002 2003 2004 2005
Change in public
sector debt 8.7 4.7 7.6 0.3 1.2 0.7 3.3 6.5
Interest payments 10.4 4.9 11.0 2.3 2.2 2.2 2.1 2.2
Primary deficit
(a surplus) 5.2 1.7 2.7 0.2 0.1 0.4 1.0 1.6
Growth effect 7.6 1.6 8.6 0.1 2.1 1.7 2.1 2.7
Inflation effect 0.8 0.4 0.8 0.1 0.0 0.2 0.4 0.1
Revaluation effect 0.7 1.5 5.4 2.0 1.4 0.3 3.9 0.5
Privatization 7.1 1.6 1.8 0.6 0.8 0.1 0.2 0.1
Predicted change
in debt 11.0 4.5 8.4 0.3 0.7 0.4 5.5 3.0
Residual
(other factors) 4.1 0.2 0.8 0.6 0.5 1.1 2.2 -3.5
Source: Staff calculations.
Figure 8. Peru: Debt Determinants
15 10 5 0 10
1995 1997 1999 2001 2003 2005
Percent of GDP
Interest payments Primary deficit ( a surplus)
Growth effect Inflation effect
Revaluation effect Privatization
Residual (other factors) Change in public sector debt
Source:Staff calculations based on data from MEF and BCRP.
To analyze whether the current primary surplus forecast is enough to ensure fiscal sustainability of the public sector debt, and to arrive at policy recommendations, this section: (i) estimates the primary fiscal balances necessary to achieve desired debt-to-GDP targets by the year 2010; (ii) conducts a sensitivity analysis to account for a slowdown in economy activity and increasing interest rates; and (iii) includes foreign currency exposure risk.
Table 4 shows the required primary balances to achieve different debt-to-GDP ratio targets, assuming a 2005 starting point of public debt of 37.8 percent of GDP, a nominal interest rate on total public debt of 5.5 percent, inflation of 2.5 percent, and a real GDP growth rate of 5 percent, and thereafter assuming constant annual growth and real interest rate. If growth in coming years is a low 2 percent of GDP annually, and the real interest rate is 5 percent, a primary surplus of 2.6 percent is required to achieve a target public debt ratio of 30 percent of GDP by 2010. Under the same growth and real interest rates, a primary surplus of 3.5 percent of GDP is needed to bring public debt down to 25 percent of GDP by 2010, or a primary sur-plus of 4.5 percent to achieve public debt levels of 20 percent of GDP by 2010.
Under a higher growth scenario of 5 percent of GDP per year, annual primary surpluses of 1.3 percent of GDP are needed to achieve the public debt target of 30 percent of GDP by 2010; a 2.3 percent of GDP primary surplus is needed to reach public debt of 25 percent of GDP by 2010; or 3.3 percent of GDP primary surplus is needed to reach a public debt of 20 percent of GDP by 2010.
In Table 5, the same exercise is performed with interest rates gradually increasing to 8 percent by 2008 and remaining at that level in 2010. Assuming annual primary surpluses of 1.4 percent of GDP and growth at 5 percent of GDP (the government’s latest projections for the next five years), the debt-to-GDP ratio could go below 30 percent of GDP by 2010. However, Table 5 also shows an alternative scenario, where Peru posts a low primary surplus average of 0.5 percent of GDP (the primary surplus average from 2001–05), and the economy grows at 2 percent. Under this less opti-mistic scenario and with increasing interest rates, the debt-to-GDP ratio would actu-ally increase to about 41 percent by 2010.11
Table 4. Required Primary Balance to Achieve a Debt-to-GDP Ratio Target by 2010
Real interest rate (%)
Target Growth (%) 3 4 5 6 7 8
30% 2 1.9 2.2 2.6 2.9 3.3 3.6
25% 2 2.7 3.0 3.4 3.7 4.0 4.3
20% 2 3.7 4.0 4.3 4.6 4.9 5.2
30% 5 0.6 1.0 1.3 1.6 2.0 2.3
25% 5 1.7 2.0 2.3 2.6 2.9 3.2
20% 5 2.7 3.0 3.3 3.6 3.9 4.2
Source: Staff calculations based on Burnside (2005).
The government is increasingly relying on financial markets (both internal and external) as a source of funding. The domestic debt of the central government is expected to continue to rise through an expansion in issuance of sovereign local cur-rency bonds. The objective is to help limit curcur-rency risk and to rely more on domes-tic financing, which can promote further development of the domesdomes-tic capital market through lengthening of the yield curve and financial deepening.12
External debt as a percent of total public debt is declining, but currency risk still is a major concern. This section accounts for foreign exchange risk and tries to benchmark the risk of government debt. Figure 9 shows the results of taking into account exchange rate risk by including stochastic shocks to the nominal exchange rate, using the same assumptions as in the baseline scenario in Table 6, above (5 per-cent GDP growth, 2.5 perper-cent inflation, 3.7 perper-cent monetary base, and 1.4 perper-cent of GDP primary surplus). The fiscal sustainability paths13were derived after 1,000 simulated debt paths that depend on random draws of the neuvo sol/dollar exchange rate. Assuming a constant 76 percent share of external dollar-denominated debt, in 44 percent of the simulations, the debt-to-GDP ratio is above 30 percent by 2010, and only in about 5 percent of the draws does the debt-to-GDP ratio go below 25 percent.
Under a less optimistic scenario, with 2 percent annual real GDP growth and 0.5 percent primary surplus, the debt-to-GDP ratio paths change dramatically (Figure 10). In only 5 percent of the simulations does the debt-to-GDP ratio go below 30 percent, while in 50 percent of the outcomes, debt increases above 40 percent of GDP, indicating that the debt-to-GDP ratio could, in fact, increase under a com-bined scenario of low growth, low primary surpluses, and a shock to the exchange rate. Table 6 depicts the probabilities associated with the two scenarios, and shows that under a high-growth scenario, even with shocks to the exchange rate, the debt-to-GDP ratio has a more than 50 percent chance of falling under 30 percent by the year 2010. However, under a low-growth scenario of 2 percent and lower primary surplus of 0.5 percent of GDP, the debt-to-GDP ratio is more likely to increase, given the same shocks to the exchange rate.
In conclusion, the official forecasts for the next five years of an average of primary surplus of about 1.4 percent of GDP14and growth of 5 percent of GDP put Peru’s Table 5. Debt Dynamics Under Increasing Interest Rates Scenario
2005 2006 2007 2008 2009 2010
Interest rate assumption 6 7 8 8 8
Debt (end-of-period,
% of GDP)
Baseline 37.8 35.6 33.7 32.2 30.6 29.0
Alternative 37.8 37.7 37.9 38.5 39.1 39.7
Source: Staff calculations based on Burnside (2005).
Figure 9. Dynamic Fiscal Sustainability: Baseline Scenario
Figure 10. Dynamic Fiscal Sustainability: Alternative Scenario
0 5 10 15 20 25 30 35 40 45
2005 2006 2007 2008 2009 2010
Debt (% of GDP)
Average 5th percentile 95th percentile
Source:Staff calculations based on Burnside (2005).
Source:Staff calculations based on Burnside (2005).
0 5 10 15 20 25 30 35 40 45 50
2005 2006 2007 2008 2009 2010
Debt (% of GDP) Average 5th percentile 95th percentile
Table 6. Debt Dynamics
2006 2007 2008 2009 2010
Prob. that debt is above 38%
(baseline scenario) 24 15 10 6 7
Prob. that debt is below 30%
(baseline scenario) 0 14 28 42 56
Prob. that debt is above 38%
(alternative scenario) 45 50 54 58 61
Prob. that debt is below 30%
(alternative scenario) 0 0 2 3 4
Source: Staff calculations based on Burnside (2005).
debt-to-GDP ratio on a downward trend, and Peru could very well reach levels of less than 30 percent of GDP by 2010. Given the good external conditions, growth in the rest of the decade could be as strong as it has been in the last two years. How-ever, if global conditions change, and the scenario turns less positive, leading to a slowdown in economic activity and lower primary surpluses, Peru’s debt path would change, and could lead to an increase in debt-to-GDP to over 40 percent.
Debt Sustainability Recommendations
Fiscal surpluses and growth are the most important factors in Peru’s debt dynamics and are key to debt sustainability. The country’s fiscal stance is a crucial policy lever that the Government can utilize to manage its debt dynamics. The Gov-ernment needs to reach the expenditure and revenue quantitative and qualitative tar-gets (Loayza and Polastri 2006). The continued generation of primary surpluses is essential to bring down the debt level, especially in the event of a slowdown in GDP growth, rising interest rates, and a devalued exchange rate. This is all the more impor-tant given that safe thresholds of debt-to-GDP ratio are lower for emerging market countries.
The government should further minimize the debt risks by continuing to mod-ernize debt management, as discussed in the next sections.