External Debt, Growth and Sustainability
In a previous essay (Frenkel, 2001) we analysed the situation of the Latin American countries in the context of financial globalization in the late 1990s. This paper sets out a more formal analytical approach to this subject. In particular, we examine the dynamics of external debt from a balance-of-payments perspective, using the concept of sustainability.
External debt may be described as sustainable when there are no foreseeable major difficulties in meeting contracts in a timely and proper manner. Obviously, this does not actually guarantee that those contracts will be met. Sustainability is a judgement with respect to uncertain future events, based on present information and probable conjectures. The conditions of sustainability examined in this paper are reasonable a priori.
The country’s interest rate, which is determined by the international rate and the country risk premium, plays an important role in our analysis. The model we set forth reflects certain features of the “emerging market” economies, that is to say developing economies that were involved in three aspects of the financial globalization process: the opening of the local financial market and its integration with the international market, the absorption of net capital flows and the resulting accumulation of a significant stock of external obligations. Let us suppose that the countries we are examining have issued a certain amount of sovereign debt denominated in foreign currency (dollars) which has been placed on the international financial market and the local market. Information about the prices of bonds is freely available and any local or foreign agent can acquire sovereign bonds at market prices.
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