Local debt expansion... vulnerability reduction? An assessment for six crises-prone countries

In recent years, for most emerging markets, public debt has decreased and its composition has evolved toward domestic currency. This progress is remarkable in terms of reduced financial vulnerability, which has been underpinned by favourable financing conditions and related deepening of local debt markets. In this paper, we assess the vulnerability reduction —conveyed in the ratio of total debt to GDP— achieved for six selected emerging economies, focusing on the importance of exchange rate evolution relative to the proactive policies that fiscal authorities have implemented to reduce the external exposure of debt. We first disentangle both components in the current structure of debt to show that proactive debt management has been the dominant factor in the reduction of the forex debt share. We then perform a stress test within a debt sustainability analysis framework. The results show that proactive debt management policies have —somehow paradoxically— entailed a short-term cost, preventing a more dramatic reduction in the debt to GDP ratio, but this is more than compensated by the benefits in terms of financial vulnerability reduction in the face of financial turbulences, reducing simultaneously the probability of such contingency.