The external costs associated with Australia's foreign debts : analysis and measurement

Abstract

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 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.