The countries of Latin America and the Caribbean must prioritize debt reduction to prudent levels to boost economic growth, favor productive investment and reduce the risk of a debt crisis, according to a new flagship report from the Inter-American Development Bank (IDB). ).
The study reveals that the region’s total debt rose to US$5.8 trillion, or 117% of GDP, from less than US$3 trillion in 2008. Meanwhile, public debt grew from 58% in 2019 to 72% in 2020 due to COVID-related tax packages, lower revenues and the recession, according to the publication "Dealing with debt, less risk for more growth in Latin America and the Caribbean"part of the IDB’s Development in the Americas series.
High levels of debt can hinder development, because they drive investors to demand higher returns, crowding out private investment and forcing governments to divert scarce resources to pay interest, instead of investing in infrastructure and public services. High debt levels also reduce the ability of countries to respond to future economic shocks to support households and businesses, and increase the risk of a crisis. The pandemic, the Russian invasion of Ukraine, high inflation, rising interest rates and low global growth, combined with high debt, increase the region’s vulnerability.
Given this scenario, governments should reduce their percentage of public debt, from an average of 70% to a range of 46%-55% of GDP, a level that the study considers prudent, always taking into account that the range will vary in each country. depending on its specific characteristics. Countries dependent on volatile commodity income should further reduce their debt levels.
"Well-managed and sustainable debt can help unlock the abundant growth potential of Latin America and the Caribbean"said Eric Parrado, chief economist at the Inter-American Development Bank. "Our new flagship report presents a pro-growth agenda, in which debt becomes an engine rather than a drag on growth. Offers governments of countries in the region comprehensive policy recommendations to strengthen macrofiscal institutions, reduce public debt, and ensure a business-friendly financing environment".
Strengthening fiscal institutions
The study discusses various policies that can help governments bring debt to prudent levels and promote debt sustainability. Stronger fiscal institutions can encourage governments to stop overspending in good times, create a buffer against bad times, and help countries provide credible fiscal guidance to reduce public debt levels. Fiscal rules help governments set numerical targets for budget and macroeconomic aggregates in a transparent way, so that they can be held accountable for those results. The study shows that the countries of Latin America and the Caribbean met only 57% of the objectives specified in the rules due to poorly designed rules.
Effective tax rules include strong legal foundations, credible enforcement mechanisms, flexibility to deal with shocks, and well-defined escape clauses among their ingredients. Independent fiscal councils are also key to the effectiveness of fiscal rules and the promotion of responsible policies, because they oversee and monitor the implementation of those rules.
Fiscal consolidation
The study highlights that the best way to reduce debt is through higher growth combined with efficient public spending and public revenue that is adequate and collected in a way that does not sacrifice growth.
In general, countries, especially those with high levels of spending and taxes as a percentage of GDP, should focus on improving the efficiency of both revenue collection and spending. The quality of public investment can be improved at all stages of the project cycle, transfer payments should be targeted to those who really need them, and tax monitoring should be improved. In countries where revenues and spending are a smaller percentage of national income, broadening the tax base and increasing public sector revenues would allow for greater public investment with a positive impact on growth.
Other opportunities include reforms to reduce labor informality, such as reducing tax incentives for companies to hire informal labor and shifting the financing of labor tax benefits to more general taxation.
Debt Management Strategies
The report also concludes that countries need to pay close attention to debt management strategies. Efficient institutions, such as well-functioning debt management offices and innovative debt instruments, are vital to managing the composition of debt. Pre-pandemic progress in improving that composition has stalled and countries must actively manage repayment schedules. More than half of the countries in the region face a debt service of more than 2.5% of GDP, and a quarter of them more than 5%, an amount similar to spending on education.
Countries should take full advantage of multilateral development banks and other official lenders that provide competitive long-term financing. In addition to offering loans at lower rates and longer terms than private markets, development banks offer technical expertise and other tools to help countries manage risk.
The report recommends creating a regional forum to improve the coordination of debt restructuring processes. This would complement current international efforts that have focused largely on low-income countries.
private debt
Private debt also increased before and during the pandemic. In general, the region’s domestic banking sectors have grown, and a quarter of countries have domestic credit of at least 100% of GDP. However, for another quarter of them credit is less than 50% of GDP. Access remains low, especially for households, small and medium-sized enterprises (SMEs), and women-led businesses.
Estimates point to a US$1.8 trillion gap between the demand and supply of funds available to SMEs in the region. Despite the availability of many programs to keep credit open for businesses during the pandemic, access remained an important factor in helping them survive the health crisis.
The general level of household indebtedness in the region continues to be relatively low compared to international standards, averaging 22% of GDP, well below other emerging economies (35%) and developed countries (77%). %). The report provides comprehensive new data on credit to households, and recommends that governments continue their efforts to improve access to credit, both for families and for SMEs.
The report also recommends that governments tailor interventions to precisely target promising companies that need support, but offer them a broader set of instruments, including equity or quasi-equity, so as not to increase their debt burden.