Applegate, Craig John
Description
An important macroeconomic issue in Australia is whether
Australia's foreign debt, particularly that of the private sector,
imposes an external cost on other residents of the country. The
traditional source of an external cost associated with foreign debt
is ruled out in the Australian case as it is found not to have any
monopsony power in the world capital market. However, an
external cost can also come from interaction between private and
public debt.
This interaction could occur in...[Show more] the event of default, in
which the government intervenes with the debt repayment of the
private sector. The possibility of default, although examined in the
literature, has not been explicitly incorporated in the Australian
foreign debt debate. In light of this, a model is developed in which
it is sometimes optimal for the government to intervene in
repayments of private sector foreign debt. The external cost
imposed by the private sector foreign debt takes the form of the
imposition of an ex-ante expected default penalty on other
borrowers within an economy.
In the 1980's, the governments of those countries which
have had problems in repaying their debts and which have also
had large private sector foreign debts, have tended to interfere in
the repayment of those private foreign debts. The scale of
Australia's foreign debt as a proportion of G.N.P. is found to be
roughly comparable to that of Latin America. Between January 1990 and March 1993 , the
Commonwealth of Australia is found to have paid an average of
0.55 percent on its seven-year borrowings in the Eurodollar
market above the rate paid by the I.M.F'/World Bank. This is
interpreted as the default risk premium on Australia's debt. It
appears to be possible that it may be in the interest of the
Australian government to interfere in the foreign debt repayments
of both the public and private sector in the future. The analysis in
chapter seven indicates that it is possible for foreign debt to result
in an external cost in these circumstances.
A time-series analysis for the Australian government
eurodollar debt is carried out for the period 1986 to 1993, when
the Commonwealth's credit-rating was downgraded. The economic
variables identified in the literature, however, were found to be
statistically insignificant in this case. The chosen factors for default
risk premia are those that are considered to be relevant to the two
major theories used in the empirical analysis. These are the
efficient risk-sharing and default-based penalty theories of
sovereign debt. These include exogenous shocks and variables
relating to both the benefit and penalty for default.
Although theory and recent history suggest that such an
external cost exists, in the case of Australia for the period covered,
the determinants of this external cost are difficult to establish.
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