Fiscal Crises: The Role of the Public Debt Investor Base and Domestic Financial Markets as Aggravating and Mitigating Factors

FiscalCrises:TheRoleofthePublicDebtInvestorBaseandDomesticFinancialMarketsasAggravatingandMitigatingFactors Authorname(s):R.Bhattacharya,K.Johnson,M.Nkusu,and M.Wang WP/22/240 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate. TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. 2022 DEC ©2022InternationalMonetaryFundWP/22/240 IMFWorkingPaper FinanceDepartment FiscalCrises:TheRoleofthePublicDebtInvestorBaseandDomesticFinancialMarketsasAggravatingandMitigatingFactors Preparedby:R.Bhattacharya,K.Johnson,M.Nkusu,andM.Wang* AuthorizedfordistributionbyCarloSdralevichandOlafUnteroberdoerster December2022 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate.TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. ABSTRACT:Thepaperevaluatesthekeydriversoffiscalcrisesinasampleofcountriesfromallthreeincomegroups—advanced,emerging,andlow-incomecountries,usingfiscalcrisisdatarecentlydevelopedbytheIMF’sFiscalAffairsDepartment.Theempiricalstudyfocusesonthreequestions:(1)Howdoesthecompositionofdebtholders(domesticvs.foreign,residentvs.non-resident,orofficialvs.non-official)affecttheprobabilityofafiscalcrisis,aftercontrollingforthelevelofpublicdebtandotherrelevantvariables?;(2)Howdoesthedevelopmentandsizeofthedomesticfinancialsectoraffecttheprobabilityofafiscalcrisis?;and(3)Howdochangesinthedebtlevelaffecttheprobabilityofafiscalcrisis,forgivencompositionsofthesovereigndebtinvestorbaseanddifferentlevelsofdevelopmentandsizeofdomesticfinancialmarkets?Ourfindingsconfirmthebenefitsoffinancialdevelopment,thedangerofheavyrelianceonanon-residentinvestorbase,andalsothatemergingmarketeconomieshavealowerdebtcarryingcapacitycomparedtothefullsample. RECOMMENDEDCITATION:Bhattacharya,R,,K.Johnson,M.Nkusu,andM.Wang.2022.“FiscalCrises:TheRoleofthePublicDebtInvestorBaseandDomesticFinancialMarketsasAggravatingandMitigatingFactors.”IMFWorkingPaper22/240. JELClassificationNumbers: E44,F20,F21,F30,F34,F36,E6 Keywords: FiscalCrisis;SovereignDebtInvestorBase;DomesticFinancialMarket Author’sE-MailAddress: RBhattacharya@imf.org;Mnkusu@imf.org;MWang3@imf.org;525jacobjohnson@gmail.com; WORKINGPAPERS FiscalCrises:TheRoleofthePublicDebtInvestorBaseandDomesticFinancialMarketsasAggravatingandMitigatingFactors PreparedbyR.Bhattacharya,K.Johnson,M.Nkusu,andM.Wang1 1Theauthor(s)wouldliketothankOlafUnteroberdoerster,DavidMoore,CarloSdralevich,XuehuiHan,GermanVillegasBauer,RuiMano,andparticipantsatseminarpresentationsofthepaperhostedbytheFinanceandWesternHemisphereDepartmentsoftheIMFforusefulcommentsandsuggestions.RafaelFloresprovidedexcellentassistanceinpreparingthepaper.Theauthorsareresponsibleforanyremainingerrorsandomissions. Contents I.INTRODUCTION4 II.LITERATUREREVIEW5 III.DATA6 IV.MODEL10 V.RESULTS11 RoleoftheInvestorBase:SomeRegressionResults11 MarginalEffectsoftheInvestorBase13 MarginalEffectsofDomesticFinancialMarkets16 MarginalEffectsofFinancialDevelopmentIndex19 MarginalImpactofDebt22 Robustnesschecks23 VI.CONCLUSION24 AnnexI.Variables’Description,SummaryStatistics,andCorrelations25 AnnexII:FullRegressionResults28 AnnexIII:AdditionalResultsforFIandFM31 AnnexIVRobustnesschecks32 References38 FIGURES 1:NumberofCountriesinCrisis7 2:SelectVariablesbyCountryType,2000–20189 3:AUROCModelPerformance,InvestorBase12 4:AverageMarginalEffectsofNonofficialDebtatDifferentGovernmentDebtLevels13 5:AverageMarginalEffectsofNonresidentDebtatDifferentGovernmentDebtLevels14 6:DecompositionofNonofficialDebt14 7:DecompositionofNonresidentDebt15 8:AverageMarginalEffectsofNonofficialDebtatDifferentGovernmentDebtLevels,Comparison15 9:AverageMarginalEffectsofNonresidentDebtatDifferentGovernmentDebtLevels,Comparison16 10:AverageMarginalEffectsofBankSectorandNonbankSectoratDifferentGovernmentDebtLevels16 11:AverageMarginalEffectsofCapitalMarketSizeatDifferentGovernmentDebtLevels17 12:AverageMarginalEffectsofNonbankFinancialSectorSizeatDifferentGovernmentDebtLevels17 13:AverageMarginalEffectsofCapitalMarketSizeatDifferentGovernmentDebtLevels,Comparison18 17:AUROCModelPerformance,FinancialDevelopment18 15:AverageMarginalEffectsofFDatDifferentGovernmentDebtLevels20 16:DecompositionofFMandFI20 17:AUROCModelPerformance,FinancialDevelopment21 18:AverageMarginalEffectsofGovernmentDebtatDifferentCapitalMarketSizes22 19:AverageMarginalEffectsofGovernmentDebtatDifferentCapitalMarketSizesbyCountryType23 20:AverageMarginalEffectsofGovernmentDebtatDifferentLevelsofFinancialDevelopmentby23 TABLES 1:RegressionResultsfortheInvestorBase12 2:RegressionResultsfortheDomesticFinancialMarket19 3:RegressionResultsforFinancialDevelopmentIndex21 I.INTRODUCTION TheCOVID-19pandemichasstretchedthefinancialresourcesavailabletothefiscalauthoritiesinmanycountries,raisingthespecterofdebtdistressforsomedevelopingcountries—emerginga