FOREIGN TRADE UNIVERSITY

FACULTY OF BANKING AND FINANCE

INTERNATIONAL FINANCE MID-TERM

ESSAY
A STUDY ON LATIN AMERICAN DEBT
CRISIS IN THE 1980S AND LESSON
FOR VIETNAM IN PUBLIC DEBT
MANAGEMENT

Course: TCHE414(2-1920).1_LT
Mentor: Assoc. Prof. Dr. Mai Thu Hien
Author: Group 6
Name ID
Vũ Thị Thu Nga 1714450079
Lê Khánh Ngân 1714450022
Vũ Thị Minh Nghĩa 1714450023
Tạ Mai Linh 1714450038
Nguyễn Thạch Thảo 1613340083

Hanoi, 20th March 2020

 MEMBERS’ ROLE

No. Name ID Role Rating

Vũ Thị Thu Nga 1714450079
1 Write Introduction, 10/10
Conclusion, assign tasks
for members
Lê Khánh Ngân 1714450022
2 Write Chapter 4 10/10
Vũ Thị Minh 1714450023
3 Write Chapter 3 10/10
Nghĩa
Tạ Mai Linh 1714450038
4 Write Chapter 5 10/10
Nguyễn Thạch 1613340083
5 Write Chapter 3 8/10
Thảo

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 TABLE OF CONTENTS
ACKNOWLEDGEMENTS………………………………….………..……………….1
ABSTRACT…………….………………………………………………………………2
CHAPTER 1: INTRODUCTION.................................................................................. 2
1.1. Rationale ............................................................................................................... 2
1.2. Literature review .................................................................................................. 4
1.3. Objectives of research .......................................................................................... 6
1.4. Methodology ......................................................................................................... 6
1.5. Scope of the research ........................................................................................... 7
1.6. Research structure ............................................................................................... 7
CHAPTER 2: THEORETICAL BASIS ....................................................................... 7
2.1. General theory about Public debt ....................................................................... 7
2.1.1. Definition of Public debt ............................................................................... 7
2.1.2. Economic nature and impact of Public debt on the economy ................... 9
2.1.3. Classification ................................................................................................ 10
2.1.4. Factors affecting Public debt ...................................................................... 11
2.1.5. Debt forms and Public debt tools ............................................................... 12
2.2. Public debt Management ................................................................................... 14
2.2.1. Definition ...................................................................................................... 14
2.2.2. The importance of Public debt management ............................................ 14
2.3. Public debt crisis ................................................................................................ 15
2.3.1. Definition ...................................................................................................... 15
2.3.2. Causes of Public debt crisis ........................................................................ 16
2.3.3. Consequences of Public debt crisis ............................................................ 17
CHAPTER 3: LATIN AMERICAN PUBLIC DEBT CRISIS IN THE 1980S ....... 18
3.1. Causes of Latin American Public debt crisis ................................................... 18
3.1.1. Internal causes ............................................................................................. 18
3.1.2. External causes ............................................................................................ 21
3.2. Progressions of the Latin American Public debt crisis ................................... 23
3.3. Impacts of the Latin American Public debt crisis ........................................... 25
3.3.1. Impacts on the Latin American countries ................................................. 25
3.3.2. Impacts on the global economy .................................................................. 26
3.4. The reactions and solutions of Latin American countries to the crisis ......... 27
3.4.1. The reactions of Latin American countries to the crisis .......................... 27
3.4.2. The measures of Latin American countries to the crisis.......................... 28

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 3.5. Achieved result ................................................................................................... 33
3.5.1. Positive effects .............................................................................................. 33
3.5.2. Negative effects ............................................................................................ 35
CHAPTER 4: VIETNAM PUBLIC DEBT AND LESSON FROM LATIN
AMERICAN PUBLIC DEBT CRISIS TO VIETNAM............................................. 36
4.1. Current situation of Vietnam public debt ........................................................ 36
4.1.1. Scale of public debt ...................................................................................... 37
4.1.2. Structure of public debt .............................................................................. 39
4.1.3. The cause of the increase in Vietnam public debt .................................... 42
4.1.4. The impacts of public debt on Vietnam macroeconomy .......................... 45
4.2. Lessons from Latin America debt crisis for Vietnam ..................................... 48
4.3. Measures to apply lesson from the crisis in Vietnam’s context ..................... 50
4.4. Policy recommendation for Public debt management in Vietnam ................ 53
CHAPTER 5: CONCLUSION .................................................................................... 56
REFERENCES……...……………..……………………………….…………………60

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 LIST OF FIGURES
Figures 3-1: Latin American external debt and reserve. ......................................... 19
Figures 3-2: Latin American Total debt, Total debt service and Interest ............... 20
Figures 3-3: Mexico Crude oil prices from 1861 to 2011. ......................................... 21
Figures 3-4: Total Debt and Public Debt by Region .................................................. 24
Figures 3-5: Decomposition of economic growth (Source: OPEC) .......................... 26
Figures 4-1. Total public debt of Vietnam period 2010 - 2018 ................................. 37
Figures 4-2. Public debt in Asian developing countries ............................................ 38
Figures 4-3 Structures of total public debt ................................................................. 39
Figures 4-4 Structure of total public debt .................................................................. 40
Figures 4-5. Structure of Government debt ............................................................... 41
Figures 4-6. Structure of Government-guaranteed debt ........................................... 41
Figures 4-7. Fiscal balance of Vietnam (%) ............................................................... 43
Figures 4-8. Vietnam's foreign exchange reserves 2016-2019................................... 52
Figures 4-9. Vietnam total reserve 2010-2018 ............................................................ 52

LIST OF TABLES

Tables 4-1. Total public debt of Vietnam (billion VND) ........................................... 38

Tables 4-2. Public debt payment using budgetary expenditure (billion VND) ....... 45

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 ACKNOWLEDGEMENTS
Before going into the main content of the essay, group 5 would like to express our
sincere gratitude to the lecturer in charge of the subject, Assoc. Prof. Dr. Mai Thu
Hien, who has accompanied us in the idea development process and advise us to
write the outline of the essay. Your in-depth lectures are the source of inspiration
for us to implement this topic and also help us to build the foundation and develop
the direction of the essay.

However, due to the lacking in expertise knowledge because all members of the
group are not students major in Department of Finance and Banking, this essay
will surely have many flaws and shortcomings. Our group hopes to receive your
profound comments and guidance to help us further improve the quality of our
essay content in the future. Once again, we sincerely thank you. Lastly, we would
like to wish you plenty of good health and contentment to carry on your noble
mission of passing on knowledge to future generations Foreign Trade University
students.

Best regards,

Group 6.

1
 ABSTRACT
This paper will empirically investigates, summarizes and assesses the nature
of public debt, the causes and effects of the Latin American public debt crisis in
the 1980s, as well as the ways countries behaved during the time of the catastrophe.
Furthermore, we will provide a practical analyzation of the situation in Vietnam
today on the basis of comparison with international practices and lessons learned
from the Latin American debt crisis in order to clarify the present issues and
recommend some solutions to public debt management in Vietnam.

CHAPTER 1: INTRODUCTION

1.1. Rationale
Government debt has been regarded as a major source of capital to finance
the economic growth for the less developed or developing countries. Among all
influencing factors to an economy, there is the fact that debt emerges as an
indispensable part which could affect either positively or negatively to economic
stability. Therefore, to a country, good debt management would bring significant
benefit to national development, while poor management could, in long-term, lead
a country into serious problems, e.g. high taxation of the domestic consumers,
uncontrolled inflation and so on.

In the recent years, foreign debt problem, however, has become one of the
basic problems in the developing countries. The debt crisis which occurred in Latin
American countries in the early 1980s destabilized the economy of many
developing countries with low income. The Latin America’s debt crisis in the 80s
also known as “The decade of loss” had started since the 1970s. In that period,
countries in the Latin America such as Brazil, Argentina and Mexico had quite an
impressive development mainly from the large scale external debt, aiming at
developing domestic industries and improve the infrastructure. However, by 1980s,
Latin American countries had faced difficulties in huge debt payment. Since the
middle of 1975-1982, the public debts of Latin American countries to financial

2
institutions and World Bank increased at the annual public debt to GDP ratio of
more than 20% which raised the total debt from USD 75 billion in 1975 to more
than USD 315 billion in 1983. Interest and principal payment increase steadily
from USD 12 billion in 1975 to USD 66 billion in 1982. Besides, the global crisis
in 1979 and 1980 affected the developing countries in OECD. So, Latin American
countries were incapable of maintaining the high economic growth rate and the
foreign payable loan exceeded the earning. Actual income and living standard
sharply decreased, followed by the collapse of the dictatorships in the region such
as Brazil and Argentina. The Latin America crisis lasted for a period and was
gradually over in the early 1990s when countries officially declared the end of “the
decade of loss”, totally out of debt crisis and/ got started for the next period.

Vietnam, like many other developing countries, has a high demand for loan
in order to implement various socio-economic and infrastructural construction
projects. However, the consequences of the public debt crises that happened in
Latin American countries during 1980s are good lessons for the country to be
careful with its budgetary decisions. Specially, significant increase in accumulated
public debt in Vietnam after the global financial crisis in 2007-08 raises concerns
regarding sustainable growth in medium to long-term. In fact, Vietnam’s total
public debt increased from approximately 40% of GDP in 2007 to 56.3% of GDP
in the end of 2010, slightly decreased to 54.9% of GDP in 2011 due to high
inflation. Simultaneously, external debt of the nation increased from 32% to
approximately 42% of GDP 1 . The remaining challenges in public debt
management show that this is the time for a thorough and comprehensive
renovation in fiscal policy in order to gradually bring the budget back to its balance
and maintaining long-term stability for the economy. Lessons learned from what
happened during the past debt crisis, about the causes of the crisis as well as the
ways countries behave and resolve the matter can become valuable experiences for
Vietnam in the process of reviewing the state of its public debt, suggesting the
solutions to minimize and manage public debt effectively, thereby reducing the

1
The Government’s Report No. 305/BC-CP dated October 30th, 2012 on the situation of public debt.

3
risks which could lead to a debt crisis. For the above reason, our team chose to
study the topic “Public debt crisis in Latin America in the 1980s and lessons
learned for Vietnam” to contribute the issues.

1.2. Literature review

Following the debt crisis in the 1980s, there was intensive research on
determinants of a sovereign debt crisis. According to the study of Schclarek and
Ramon- Ballester (2005), the data of 20 Latin American and Caribbean nations in
five years during 1970 – 2002 were separated seven periods which includes every
five years.

Furthermore, due to the beginning of economic crisis over the world, most
empirical scholars researches the causal relationship between the indebtedness and
economic growth by applying a non-linear and concave connection pattern.
Classical economists, such as Smith (1776), Ricardo (1951), and Mill (1845)
considered that the public debt effect destructively a country’s economic. The
Ricardian Equivalence theory noted that the financing of public expenditure via
taxation and borrowing is equal. Governments can finance their expenditures
either through taxes or by issuing bonds. Since bonds are loans, they must
eventually be repaid—presumably by raising taxes in the future. Suppose that the
government finances some extra spending through deficits. According to the
hypothesis, taxpayers will anticipate that they will have to pay higher taxes in
future. As a result, they will increase their savings to pay the future tax increase;
they could reduce their current consumption to do so. The effect on aggregate
demand would be the same as if the government had chosen to tax now. Therefore,
there is neutral effect of public debt on economic growth.

On the contrary, in the Investment Saving-Liquidity Preference Money

Supply (IS-LM) model, Keynesian economists pointed out that an increase in
government debt, which induced by deficit financed fiscal policy, will improve the
level of income, the transaction demand for money and prices. Keynesian
economists often argue that private sector decisions sometimes lead to inefficient

4
macroeconomic outcomes which require active policy responses by the public
sector, in particular, monetary policy actions by the central bank and fiscal policy
actions by the government, in order to stabilize output over the business cycle.

Harmon (2012) studies the impact of public debt on three major economic
indicators (inflation, GDP growth and interest rates) in Kenya on the period 1996
to 2011. Adopting a descriptive research design and simple linear regression
models, the research finds out there is a weak positive relationship between the
public debt and inflation while links between public debt – GDP growth as well as
public debt – interest rates are negative.

Ahmad (2012) confirm that inflation is a critical problem in many countries,

especially in the less developed countries. Using the OLS regression estimation,
their paper empirically studies the effect of domestic debt on inflation in Pakistan
for the period 1972 to 2009. The research observes domestic debt and domestic
debt servicing enhance the price level in Pakistan. The estimated results show the
volume of domestic debt and domestic debt servicing have significantly positive
effects on price level. Authors argue the floating debt, i.e. treasury bills make up a
large proportion of total domestic debt, and the interest rate, i.e. the cost of
domestic borrowing or debt servicing are main reasons to enhance price level.

Until now there are few studies on impacts of public debt in literature
emphasized on countries in the ASEAN region. One example is Muhammad
(2017). Other authors focused on individual countries such as Muhammad (2008),
Pham (2011), Lee & Ng (2015). Lau and Baharumshah (2005) investigate the issue
of fiscal sustainability by adopting families of panel unit root tests for a panel of
10 Asian countries including India, Indonesia, Korea, Malaysia, Nepal, Pakistan,
Philippines, Singapore, Sri Lanka, and Thailand for the period 1970-2003. They
find favorable evidence of mean-reverting behaviour for the cluster of Asian-10
countries by adopting the commonly used panel unit root technique; while using
the series-specific unit root test, they found that four out of ten countries (Korea,
Malaysia, Singapore and Thailand) are stationary, suggesting little evidence of

5
fiscal sustainability in these Asian countries. Then, Adedeji and Thornton (2010)
exploit panel unit root and co-integration techniques and employed a dynamic
ordinary least squares (DOLS) model to distinguish between ‘strong’ and ‘weak’
sustainability for five Asian countries–India, Pakistan, Philippines, Sri Lanka,
Thailand–for the period 1974-2001. The results indicate that government revenue
and expenditure in a panel of these economies were non-stationary and co-
integrated series. However, the co-integration coefficient is significantly less than
unity, indicating ‘weak’ fiscal sustainability and the likelihood that policy
measures would be required to put public finances on a more sustainable basis.
Syed et al. (2014) explore the issue of sustainability of fiscal policy for ten Asian
countries. Bui et al. (2015) perform an analysis of Vietnam’s fiscal and public debt
sustainability. The findings demonstrate that no sustainability, as well as potential
risk, is reflected by Vietnam public debt and fiscal policy.

Although the researches related with the development of public debt

management in Vietnam confirmed that debt management is becoming a great
challenge to the government, they are still lack of optimal solutions. Therefore, a
research of evaluation of public debt management techniques in Vietnam,
highlights the strengths and weaknesses of them and recommendations for a more
effective and sustainable management system is of certain academic and practical
value.

1.3. Objectives of research

- Public debt crisis in Latin America in the 1980s

- Current situation of public debt and public debt management policy in Vietnam

1.4. Methodology
- Collect data and information published on the media

- Collect data from professional reports for the period of 2010 - 2017

- Qualitative research through data collection from World Bank, IMF and Ministry
of Finance from which to process and analyze in order to draw specific conclusions
about the current situation of public debt in Vietnam
6
1.5. Scope of the research
- Research on a national level in Latin America in the 1980s

- Research on a national level in Vietnam

- Research issues related to the current state of public debt in Vietnam

1.6. Research structure

The remainder of this paper is structured as follows: Section 2, we go through
the basic concepts and theory of public debt, public debt management and public
debt crisis. Section 3, we synthesize and take in to account the causes as well as
consequences of Latin American public debt crisis and the Governments’ policy
responses to the crises, to draw on lessons learnt for Vietnam. Section 4, firstly the
study shall focus on the analysis of the current situation and negative impacts of
fiscal deficit and increasing public debt on significant macro variables such as
economic growth, inflation, interest rate, exchange rate, trade deficit, etc. that
Vietnam is and may be encountering in the coming period. Secondly, the study
conducts an assessment of risks and sustainability of Vietnam’s public debt from
several angles regarding solvency, macro-economic instability, etc. to make a basis
for the identification of crisis potential and evaluation on the sustainability of
public debt in the future. And finally, the research provides some policy options
for the improvement of transparency, supervisory and management of public debt
towards sustainability in Vietnam’s future.

CHAPTER 2: THEORETICAL BASIS

2.1. General theory about Public debt

2.1.1. Definition of Public debt
Public debt is a concept that is mentioned quite diverse in debt management
activities of countries. Depending on the purpose, scope and practice of each
country's debt management practices, public debt has different interpretations and
definitions. Specifically:

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 * According to the International Monetary Fund (IMF):

“In the broad sense, public debt is a public sector debt obligation, which
includes all obligations of the government, local governments, central banks and
independent organizations (50% of operating capital belongs to the state or belongs
to the state budget decides and in the case of default, the state must pay debts on
behalf of). Public debt in the narrow sense is the debt of the central government,
local levels and the debt of an independent government-guaranteed organization.”

Through the IMF concept, the public debt sector is divided into two sectors:
the financial public sector and the non-financial public sector. However, in fact,
the debt figures of the two sectors guaranteed by the government are included in
public debt. This means that public debt under the IMF excludes central bank debt
and non-government-guaranteed debts of public sector deposit and non-deposit
institutions, leading to inaccurate total public debt.

* According to the World Bank (WB):

Public debt is understood as the debt obligation of 4 groups of subjects

including:

(1) Debt of the Central Government and central ministries, agencies

(2) Debts of local governments

(3) Debt of the Central Bank

(4) The debt of independent organizations that the Government owns more
than 50% of the capital of the country or belongs to the state budget decided and
in the case of default, the state must pay debt on its behalf.

Thus, we can see the concept of public debt of the World Bank is the concept
of public debt most fully.

8
 *According to the Law on public debt management issued by the Vietnamese
government in 2017:

"Public debt prescribed in this Law includes government debt, guaranteed

government debt and local government debt." In which the Law stipulates:

- Government debt is a debt arising from domestic and foreign loans which
is signed and issued on behalf of the State and on behalf of the Government.

- Government-guaranteed debt is a loan guaranteed by the State's policy-

making enterprises or policy banks.

- Local government debt is a debt incurred by the provincial People's

Committee.

We can see that Vietnam's Public Debt Management Law 2017 stipulates a
narrower scope of public debt than the definition of IMF and WB because our
scope does not include central bank debt and debt. of state-owned enterprises.
Therefore, when researching Vietnam's public debt report, there will be a
difference with the report of the international.

2.1.2. Economic nature and impact of Public debt on the economy

*Nature of public debt

In terms of the nature, public debt comes from the budget deficit or in other
words, the total government revenue is not enough to cover its total spending. To
solve this problem the government must cut spending or increase budget revenues.
Cutting spending is not an easy option in the short term so the government often
option to increase budget revenue.

The government raises its budget revenue in two ways. First, it chooses to
increase taxes - the largest and most direct source of government revenue.
However, the increase in taxes can lead to a reduction in consumption, a decrease
in labor dynamics leading to an economic recession. Second, the government will

9
borrow domestic and foreign loans through the central bank. Issuing shares or
bonds to investors, thereby increasing public debt, leading to budget deficit.

* Effect of public debt

From the economic nature of public debt, we consider the impact of public
debt on the economy in two directions: positive and negative.

On the positive side, firstly, public debt satisfies the domestic capital demand
to ensure social security. In the early stages of development, in order not to regress
private investment, foreign loans are an additional source of capital for socio-
economic development. Second, public debt helps the government solve the
problem of state budget overspending. While tax increases, tightening spending
need a long time to change, printing money leads to inflation, foreign loans help
the government to promptly offset state budget deficits. Thirdly, borrowing by
issuing bonds or government shares is also a tool through which the government
regulates monetary policy. Investment accelerates the integration process of a
country with international access to capital without reducing domestic investment
or spending.

On the negative side, public debt makes macro-economic crisis unstable.

Many foreign loans can reduce the national position in the international arena,
causing the domestic exchange rate to fluctuate. Domestic borrowing raises
interest rates, increases investment costs, reduces investment incentives leading to
economic recession. From the effects on it affect stability the macroeconomic
environment has led to high interest rates accompanied by inflation and exchange
rate fluctuations that increase the trade deficit. And when public debt is too large,
it will lead to a public debt crisis. The public debt crisis happened which led to the
monetary crisis and economic crisis not only affected a country but also led to the
regional economic union, heavier then spread throughout the world.

2.1.3. Classification
*Classified by loan sources:

10
 According to this method, public debt is divided into two types of domestic
and foreign loans, these divisions not only show geographical factors but also show
elements of cash flow movement. , when conducting statistics and calculating the
value of public debt in a number of countries, including Vietnam, people often do
not care about domestic debt but only foreign debt, which leads to errors when
making The results of statistical calculations on public debts of a country make it
difficult for managers to control and propose timely measures to solve arising
problems.

*Classified by debtors

According to Vietnam's Public Debt Management Law (2017), public debt

has been divided into three categories:

- Government debt: Including debt issued by the Government to issue debt

instruments, Debts to be signed by the Government to sign domestic or foreign
loan agreements; Central budget debt is borrowed from the State's financial reserve
fund, state budget and off-budget state financial fund.

- Debts guaranteed by the Government include: Debts of enterprises

guaranteed by the Government; the liabilities of the State policy bank are
guaranteed by the Government.

- Debts of local governments include: Debts due to the issuance of municipal

bonds; Debts of local budgets borrowed from the State policy bank, provincial
financial reserve fund, state budget and other loans in accordance with the law on
state budget; Debt due to on-lending of ODA and concessional loans.

2.1.4. Factors affecting Public debt

In order to ensure a stable economy, a government must ensure that the public
debt ratio is under control and in order to do this, debt managers and budget
managers need to do a good job of forecasting, planning, and contributing to
macroeconomic stability. To do that well, we need to understand the factors

11
affecting public debt from there, prevent and solve the instability problems caused
by these factors in time.

Firstly, public debt is closely related to the budget balance. From the nature
we analyzed above, we can see that the budget deficit clearly reflects the state of
the value of public debt of a country. That is, when the deficit gap is narrowed,
loans are reduced, making public debt also reduced.

Secondly, market interest rates have an impact on government debts, when

interest rates increase or decrease will determine the value of loans increased or
decreased. At the same time, the increase in interest rates will make the
government's loans more difficult, unable to guarantee the ability of the
government to repay debts on time.

Thirdly, the real growth rate of the economy affects public debt in two
directions. First, the economy is growing fast, the government easier to borrow
money, resulting in increased public debt. Second, rapid economic growth is often
accompanied by inflation, which leads to the maturity of payments to the
government for debt.

Fourthly, exchange rate is a factor that has a great impact on foreign

borrowing. Exchange rate fluctuations cause the cost of the loan: can increase or
decrease as the exchange rate increases or decreases.

2.1.5. Debt forms and Public debt tools

According to the characteristics of the loans, the form of debt is divided into
two main groups: direct loan and indirect loan from inside and outside the country.
Each type of loan has its advantages and disadvantages, suitable for specific
circumstances, depending on the credit rating and position of each country in the
market.

*Direct loan

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 Governments have an option to provide funding for significant deficits
through borrowing money directly from commercial banks, supranational
institutions (e.g., International Monetary Fund, Banks world, Asian Development
Bank, ...). These loans under the law on public debt management (2017) take the
following form:

 Official development assistance loan (ODA loan) is a foreign loan

with a preferential element amounting to at least 35% for a conditional loan related
to the purchase of goods and services under the provisions of foreign sponsor or at
least 25% for a loan without conditions.
 Foreign concessional loans are foreign loans with more favorable
conditions than commercial loans, but the concessional elements have not yet met
the standards of ODA loans.
 Commercial loans are loans based on market conditions.

Among the direct loans listed, ODA loans are the most important source of
capital for developing countries, typically Vietnam. This loan can be received in
the forms of bilateral aid, multilateral aid, grant aid or non-governmental aid.

* Indirect loan

The Government can carry out indirect loans through organizations and
individuals to offset the budget deficit by issuing short-term debt instruments such
as bills, bonds, and certificates ... Votes are the preferred form of government
including Vietnam. According to Vietnam's Law on Public Debt Management
(2017), bonds include:

 Government bonds are debt instruments issued by the Government

to raise capital for the state budget or restructure debt.

13
  Municipal bonds are debt instruments issued by provincial People's
Committees to raise funds for local budgets.
 Government-guaranteed bonds are debt instruments issued by State-
owned enterprises and policy banks and guaranteed by the Government.
 Treasury bills are debt instruments issued by the State Treasury, with
a term not exceeding 52 weeks.
 The national construction bond is a bond issued by the Government
to mobilize capital from the People to invest in building important national works
and other essential constructions for production, life and creation, material and
technical facilities for the country.

2.2. Public debt Management

2.2.1. Definition
*According to IMF:

“Public debt management is the process of establishing and executing a

strategy for managing the government’s debt in order to raise the required amount
of funding at the lowest possible cost over the medium to long run, consistent with
a prudent degree of risk. It should also meet any other public debt management
goals the government may have set, such as developing and maintaining an
efficient market for government securities.”

2.2.2. The importance of Public debt management

The first role is to make sure that debt can be serviced under a wide range of
circumstances, including economic and financial distresses, provided meeting
debt’s cost and risk objectives.

This task in a broader context for public policy means that, debt managers
should share the same concerns with fiscal policy authorities and monetary policy
authorities. For example: debt sustainability level, government financing
requirements, borrowing costs.

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 The second role is to make policy choices, which concerning: Preferred risk
tolerance, parts of the government’s balance sheet management, contingent
liabilities management, sound governance for debt management. The objectives
are: to reduce vulnerability to contagion and financial shocks.

Poorly structured debt portfolio often leads to crises. For example:

- Excessive focus on possible cost savings (from debt issuance) renders more
short-term or floating rate debt. When the country’s creditworthiness changes, the
debt has to be refinanced, which creates more exchange rate/monetary pressures.

- A debt portfolio that is robust to shocks places the government in a better

position to effectively manage financial crises.

Government debt portfolio is usually the largest financial portfolio with

complex and risky structure, thus has substantial risk to overall financial stability.
Hence, sound risk management practices are essential.

In situations where there are sound macroeconomic policy settings, risky debt
management practices increase the vulnerability of the economy to economic and
financial shocks. Although government debt management policies may not have
been the sole or even the main cause of such crises, the maturity structure, and
interest rate and currency composition of the government’s debt portfolio, together
with substantial obligations in respect of explicit and implicit contingent
liabilities— not least in relation to the financial sector—have contributed to the
severity of the crises.

2.3. Public debt crisis

2.3.1. Definition
The public debt crisis is a situation where the debt increases too much beyond
the control, regulation and repayment of the government. Unpaid debt as a result
of compound interest makes the debt more unsettled, the longer the budget deficit
leads to the serious economic recession.

15
2.3.2. Causes of Public debt crisis
* Double liabilities and poor management

The biggest cause of the public debt crisis is the debt that cannot be repaid.
These debts are continually added to each other and the interest will be added to
the interest. That debt is growing and there is no way to reduce interest or extend
it longer so that debtors can successfully repay the debt.

Additionally, the poor management of the government, local governments at

all levels were evident in the 1960-1970 period in Western countries when they
were unable to control loans and public expenditures. In addition, in some
countries, especially in poor, low-level, poorly managed countries, there is
corruption and corruption of a group of people for the group's sake, where many
loans come with export priority, ... making money flow out of the country much
more than money flowing in.

* Improper Loan

These are loans that the government does not have the support of the people
or the loans that the government must inherit from the predecessors. The fact is
that many less developed countries started their independence from the enormous
debts that could be caused by the war.

* Globalization, international integration

The influence of economic decisions, contracts, treaties and international

organizations has been helping rich countries to form the backbone of today's
globalization. While most countries are flooded with poverty and debt, some hold
huge wealth, but it is not a coincidence that rising standards of living with policies,
rich countries have paid terrible prices. Rich countries are also indebted, but they
have the means to avoid risk more than poor countries.

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2.3.3. Consequences of Public debt crisis
The consequences of the debt crisis will not only affect the target countries
of the borrowing countries, but will also affect the lending countries.

* For borrowers

The debt crisis framework is like an earthquake that shakes a nation in every
way. In the economy, the economy is in recession with high inflation, declining
GDP, stagnant production, increase of unemployment.

From the instable economy it leads to political instability, pushing

developing countries deep into dependence on capitalist countries. Gradually
leading to the political intervention of capitalist countries to government policies
eroding the economy. Finally, the lives of people is in extreme poverty.

* For lenders

The economies of capitalist countries during the debt crisis are also not bright
when their big debtors declare bankruptcy and cannot repay their debts, the
governments of those countries will suffer a heavy loss and that pulls the economic
growth down which is also the reason that the European Union EU is always trying
to help Greece - biggest debtor. In addition, when borrowers are indebted, they
will try to cut spending by reducing imports, which affect capital revenues and
cause unemployment.

Therefore, when the debtor encounters debt crisis means that the reduced
liquidity affects the circulation of frozen market goods. It is more serious when the
debtor's debt accounts for an important part of the debtor's economy, which easily
leads to the bankruptcy of the domino effect causing a series of capitalist
bankruptcy, the collapse of international organizations, leading to the global
economic crisis.

17
 CHAPTER 3: LATIN AMERICAN PUBLIC DEBT CRISIS
IN THE 1980S

3.1. Causes of Latin American Public debt crisis

With the large scale and the several consequences that it caused, the Latin
American crisis has always been in the scope of research by many economists and
politicians, there have been many causes given by the researchers to explain this
crisis. In this essay, we just list and summarize some of the main reasons that we
think they had the greatest impacts on the public debt crisis in Latin America.

3.1.1. Internal causes

*Inefficient economic structure and the foreign capital dependence

In the 1980s, Latin American nations were less-developed countries with

GDP was about 4014$/year. Their economic structures didn’t develop the same
among different fields and their income primarily came from exporting oil. After
two times the oil price skyrocketed, Latin America countries in general, especially
Mexico, gained huge revenue and were evaluated to have strong potential in
economic growth. However, in fact, due to the inefficient domestic economic
model and the inappropriate administration in macro policy, those countries not
only couldn’t reach the development expectations but also faced a significant
setback and ended up to the public debt crisis. Their inadequacies in economic
decisions derived from a big problem: the monopoly in process of moving up to
economic market and making it work ineffectively. In the 1980s, major economic
sectors in Latin American countries still were in the government protectionism, it
eliminated the self-developed motivation of those fields so they grew slowly and
usually made loans but didn’t consider how to use them effectively. In the same
period, financial market in general and stock in particular in the area didn’t really
advance so the firms ‘demand for loans at banks increased. Moreover, the
inappropriate government’s management made state banks remain the low interest
rate to protect the key sectors, which deviated completely to the law of supply and
demand, it was the reason why demand exceeded supply. In order to satisfy this

18
demand, the governments forced to stand out and borrow foreign capital. It was
not the only fault in economic policy administration of Latin American nations,
the misleading investment in industrialization was the biggest mistake, which
leaded to public debt crisis. Due to the weak economic model, governments
decided to invest in industrialization. In order to do it, they must import materials
and equipment from foreign countries. It was the reason why Latin American
nations were from oil trade surplus to trade gap, which made current account
deficit and those countries were forced to borrow foreign capital to cover
government purchasing. However, the industrialization development in the market
which was not free with too much intervention of government had no effect in
improving the economic area. Looking at the chart below, we can see clearly in
the late 1970s and early 1980s, after applying this industrialization model,
economic growth in Latin American countries not only decreased but also reached
to negative growth, the trade balance also decreased. Thus unreasonable
investment in industrialization failed to boost the economy but instead resulted in
huge foreign debt.

Figures 3-1: Latin American external debt and reserve.

19
 From the weak economic governance that led to high demand for foreign
debt, Latin American countries became too dependent on foreign investment.
Since World War II, the proportion of foreign investment in this region only
fluctuated at 19%, but during the period 1975-1980 the investment rate increased
to approximately 23% with the majority was short-term investments. And as soon
as the economy showed signs of going down, but in the early 1980s, foreign
investment capital also exited massively, making the rate of foreign investment
decline significantly to 17% in the 1990s. Latin American accustomed to rely on
borrowing; this was a shock for the Latin American economy, causing the risk of
default to begin to rise. (See the figure below)

Figures 3-2: Latin American Total debt, Total debt service and Interest
*The impact of export deficit

As we said above, due to the demand of borrowing capital to cover

government purchasing and for private areas, the public debt crisis in Latin
American boomed, however, it was not the only reason. In the 1970s and 1980s,
the income of Latin American countries mainly came from exporting oil. However,

20
after the first shock of oil price, imported countries had trade protection policy,
restricted import to increase domestic production and purchasing. Those actions
made huge effect to the quantity of the oil exported of Latin American, especially
Mexico.

Figures 3-3: Mexico Crude oil prices from 1861 to 2011.

The export of Latin American area not only was affected from international
trade policy, but also suffered from high inflation in the early 1980s. The reason
for the inflation was many countries’ currencies were based on the USD. When the
USD increased because of the deficit situation in the US, Latin American countries’
currencies were pushed up accordingly. This situation was most serious in Mexico,
the inflation ration in 1981 rose dramatically to 27%. The inflation had significant
impact in exported products so the income from exporting decreased leading the
current account deficit. The Latin American countries couldn’t depend on the
income from foreign currencies to repay foreign loans. Consequently, the
repayment of debt was more difficult and eventually a series of countries had to
declare insolvency, the public debt crisis spread.

3.1.2. External causes

*The wrong investment decision of the Europe and the USA

21
 The foreign capital poured into the Latin American made indirectly public
debt crisis in this area. After the first shock of oil price, the OPEC countries had
current account surplus. These countries brought the large amount of huge profit
come from exporting oil to the bank system in the Europe and the USA. The
investment destination of those banks was Latin American area. The reason for
this choice was that many Latin American countries were major oil exporters,
which gained high profits. When the international banks just looked at the oil
reserve of these nations and clearly, they had a lot of potential profit sources and
could rank well in credit safety. However, the fault was that banks didn’t consider
the foundation of economic structure and the development direction of these
countries revealed the weakness in the lately 1960s. The evidence was that they
had inappropriate micro policy and used loans ineffectively, didn’t have profit and
eventually it leaded to budget deficit and insolvency. In addition, the idea that a
country's government couldn’t be insolvent and the public debt was absolutely safe
was not right, especially for countries that were still in the transition like Latin
America. Because they didn’t considered carefully, they poured too much capital
into this area and then immediately withdrew capital when seeing some signals of
decline, which caused these young economies completely lose their ability to resist,
making public debt crisis become bigger.

*The increase several times of real value of the loan due to the appreciation
of the dollar.

Most public debts of Latin American countries were denominated in dollars

with floating interest rates based on LIBOR rates. However, by 1978, the US
budget deficit made the LIBOR rate rise from 9.5% to 16.6%. This pushed up the
USD price, increased the real value of credits in USD, and also increased interest
rates. It is the reason for the debt obligations of Latin American countries become
more and more burdensome, leading governments to declare insolvency.

22
3.2. Progressions of the Latin American Public debt crisis
During the 19070s, there were two huge oil price shocks which made current
account deficits in many Latin American nations. By contrast, these shocks made
current account surpluses among oil-exporting nations. At that time, large US
money-center banks were encouraged by government to be willing intermediaries
between two distinct groups, providing the exporting countries with a liquid, safe
place for their fund and then lending those funds to Latin American nations (FDIC
1997)2.

The sharp increase in oil prices caused many Latin American countries to
search out more loans to cover the high prices, and even some oil-producing
countries took on substantial debt for economic development, hoping that high
prices would persist and allow them to pay off their debt. Therefore, Latin
American received the lending funds from US commercial banks and other
creditors rose significantly during the 1970s. At the end of 1970, the total debt
from all foreign sources was $29 billion, but at the end of 1978, Latin American
saw a dramatically increase of this number to $159 billion and the figure for 1982
was reached $327 billion (FDI 1997). Still, by 1982, there were nine largest US
money-center banks contributed to Latin American and other less-developed
countries debt which made up 176% and 290% of their entire capital respectively
(Sachs 1988)3.

2 FDIC (1997), The LDC Debt Crisis, An Examination of the Banking Crises of the 1980s and Early 1990s, Federal
Deposit Insurance Corporation
3 Sachs, Jeffrey D. “International Policy Coordination: The Case of the Developing Country Debt Crisis.”

23
 Figures 3-4: Total Debt and Public Debt by Region
As interest rate rose in the US and Europe in 1979, debt payments also went
up, making it harder for borrowing nations and pay back their debts. The decline
in the exchange rate with the US dollar which meant that Latin American
government finally suffered from massive amount of their national currencies, as
well as losing their purchasing power. At the same time, nominal interest rate
increased globally, and in 1981 the world economy suffered from recession. The
Latin American countries realized their debt burdens unsustainable.

The crisis occurred in August 1982 when Mexico Minister Jesus Silva
Herzog declared that Mexico would no longer be able to service its debt, which
was totally $80 billion. In the wake of crisis, most commercial banks reduced
sharply or halted new lending to Latin America. As much of Latin America's loans
were short-term, a crisis ensued when their refinancing was refused. Billions of
dollars of loans that previously would have been refinanced were now due
immediately. Other countries quickly followed it: Argentina (1982, 1989), Bolivia
(1980, 1986, and 1989), Brazil (1983, 1986- 1987) and Ecuador (1982, 1983). This
created a chain reaction that triggered a debt crisis across the Latin American
region.

During the 1980s, a period is referred to as the “lost decade” of many Latin
American countries, which were unable to service their foreign debt. The public
debt crisis caused serious damage to the economy of both creditor and debtors. The
24
biggest creditors are European and American state banks and governments, when
the crisis occurred, the financial and banking systems of these countries suffered
from facing high credit risks. Meanwhile, the public debt crisis not only
undermined the economy of Latin America but also made them unable to borrow
in the future to overcome the crisis because the prestigious banks in the world
placed these countries on the list of high lending risks, and Latin American
countries also suffered great losses in international trade due to the creditors
applied some sanctions through economic protection policies, blockade and
confiscate their assets abroad

3.3. Impacts of the Latin American Public debt crisis

3.3.1. Impacts on the Latin American countries
In debt crisis, the peso is devaluated nearly 50% again the US dollar.
Consequently, elevated inflation rates reach 100% and the economy turns into a
recession. In 1982, the economy shrinks by 0.6%, followed by a shrink of 4.2% in
1983. Real GDP per capita falls with respectively 3% and 6% in 1982 and 1983.
During the following five years, it decreases by 11% in total. In the same period,
real wages fall by approximately 30% (Buffie 1989)4. Unemployment increases to
high levels, especially in rural areas. In 1982, contractions in investment and
consumption negatively contributed to economic growth.

After the devaluation of the peso in February 1982, net exports sharply
increase, the only positive contributor to growth. In the five years after the crisis,
Mexico’s terms of trade declined by 42.2%. But at the end of 1986, Mexico is still
saddled with a huge foreign debt amounting to 78% of GDP and inflation exceeds
100%. In the same year, world market oil prices collapsed, adversely impacting
the economy’s economic performance. Between 1983 and 1988, Mexico’s real
GDP grew at an average rate of just 0.1% per year. Therefore, the 80s are
considered to be the “lost decade”.

4 Buffie, E.F. (1989), Mexico 1985-86: From Stabilizing Development to the Debt Crisis.

25
 Figures 3-5: Decomposition of economic growth (Source: OPEC)

The debt crisis of 1982 was the most serious of Latin America's history.
Incomes and imports dropped; economic growth stagnated; unemployment rose to
high levels; and inflation reduced the buying power of the middle classes5. In fact,
in the ten years after 1980, real wages in urban areas actually dropped between 20
and 40 percent6. Additionally, investment that might have been used to address
social issues and poverty was instead being used to pay the debt.

After years of accumulating external debt, risen world interest rates, the
worldwide recession and sudden devaluations of the peso caused external debt
payments to rise sharply. Since November 1982, several forms of debt
restructuring were applied, including the Baker plan and Brady plan. Under the
Brady plan, US banks assumed the losses on Mexican debt. The IMF assisted with
three financial packages, which were accompanied by structural reforms.

3.3.2. Impacts on the global economy

The crisis of the 1980s counted with a more elaborate international
institutional financial architecture, but that did not turn out to be advantageous for
the region, as it forced Latin America to service its external debt beyond its

5 Ferraro, Vincent (1994). World Security: Challenges for a New Century

6 Felix, David (Fall 1990). "Latin America's Debt Crisis".

26
capacity and forced it into unduly contractionary macroeconomic policies. This
public debt crisis not only affected the Latin American country but also it had
impacts on global economy.

Western, particularly US and UK banks, faced bankruptcy if Latin American

debt payments stopped. Instead, the IMF – and later the World Bank – gave bailout
loans. This was exceptional; for the first time in its history, default was not used
by Latin American countries as a way to deal with a debt crisis. Jose Antonio
Ocampo, the former Colombian minister of finance, argued the response in the
1980s "was an excellent way to deal with the US banking crisis, and an awful way
to deal with the Latin American debt crisis"7. The current experience in Europe
suggests not that the lessons have not been learned, but that those in power are
once again acting to protect banks, regardless of the consequences.

Latin America is not the only region to have suffered from the boom-bust
caused by what economics professor Stephany Griffith-Jones has labeled
"unfettered global finance". Much of Africa was effectively in a debt-caused
depression through the 1980s, 1990s and into the 00s. The Asian financial crisis in
the late-1990s was followed by similar events in Russia, before the US and
European crises of today.

3.4. The reactions and solutions of Latin American countries to the crisis
3.4.1. The reactions of Latin American countries to the crisis
* Phase 1 (From before the crisis - 1985)

During this period, many macro changes were made as economists and
policymakers predicted that the crisis would happen in a short period of time, the
crisis would end as soon as the economy was shown signs of recovery. In order to
escape the crisis, there were some attempts to establish a union among the region's
creditors. Typically, the conference took place in Cartagena, Chile in 1984 (later
known as the Cartagena consensus). After this conference, the debts of both

7 International political economic (Spring 2013)

27
Bolivia and Ecuador were postponed, while large debtors such as Mexico, Brazil
or Venezuela still continued to negotiate directly with their banks, and Argentina
still expressed rigidity and not compromise. This can be seen that despite the
efforts, there was no certain consensus in the region, many countries wanted to
resolve their debts on their own. This conservatism made Latin America sink even
further into the crisis.

* Phase 2 (Starting from September 1985)

The debt crisis entered phase two with the initiation of the first Baker Plan in
Seoul in order to make adjustments in creating lending laws which were more
effective along with a credit package attached. At that time, the bailout was not
enough to completely resolve the crisis, and the next two years, replaced by the
second Baker Plan, which innovated in facilitating repurchasing activities or
exchanging debt and allowed the issuance of bonds with low interest rate.

*Phase 3 (starting in March 1989, almost seven years after the start of the
crisis)

Phase 3 began with the Brady Plan, which involved reducing the debt balance,
along with facilitating the Latin American region to borrow from international
private sources. This was the last stage of the crisis, and Latin American countries
also gradually recovered their economy. However, a decade of crisis recession
reduced the region's contribution to world GDP by 1.5%, along with a regional
GDP per capita of 8% lower than that of industrialized nations and 23% compared
to the average of whole world.

3.4.2. The measures of Latin American countries to the crisis

a) Short-term measures

* Bridge loans

One of the first preventive measures taken by the commercial banks was the
extension of bridge loans, which permitted countries to continue paying the interest
28
on their loans, even though they were not able to pay the principal8. Bridge loans
were, in effect, new loans granted by the banks to allow sovereigns to pay the
interest on their old loans. To ensure that no bank was paying a disproportionate
share of the new loans, each bank was only responsible for contributing a specified
percentage of its own outstanding loans to the debtor nation. By permitting this
form of transaction, the banks were protecting themselves. Because the borrowing
nations had not completely defaulted on their payments, the banks could still
declare the loans as assets on their balance sheets9. Without this provision banks
were required by regulatory and accounting rules to declare a loan
"nonperforming” 10 if interest payments were more than ninety days late, an
unfavorable prospect from the bank's financial perspective. It was especially vital
that banks kept borrower nations from defaulting on their loans because many of
the large banks had loaned out more money than they actually had to lend. In fact,
when the debt crisis began in 1982, the nine largest commercial banks had loaned
250% of their capital to sovereign debtors. It was therefore imperative to the
banks' own survival that the debtor nations continued to pay, at the very least, the
interest on their loans. Thus, immediately following the announcement of the debt
crisis, many large banks extended new loans in order to prevent complete default,
in hopes of cutting their own losses.

* Debt restructuring

In the face of falling economic growth rates and rising inflation, the “Baker
plan” was implemented in 1982, proposed by US Treasury secretary Baker (Van
Wijnbergen, 1991)11. In return for economic reforms, high-debt countries would
get new access to medium-term new loans, in addition to rolling over of
amortization of old loans. New loans had to come both from commercial creditors
and the official lending institutions. In June 1983, the “Paris Club”, representing
creditor governments, rescheduled Mexico’s sovereign debt owed to major

8 Goldman, supra note 8, at166

9 Goldman, supra note 8, at 167
10 Power, supra note 2, at 2710.
11 Van Wijnbergen (1991), Mexico and the Brady Plan, Economic Policy, World Bank.

29
creditor countries (World Bank, 2004). The Paris Club is an informal group of
financial officials from most western economies, which provides financial services
such as debt restructuring and debt relief. With access to capital markets restored,
it was hoped that the economic reforms would allow the debtors to grow out of
debt. However, capital outflows went up rather than down, inflation skyrocketed,
investment fell and over the period 1982-1988, no economic growth took place in
Mexico at all. Consequently, external debt rose to 78% of GDP in 1987, marking
the failure of the “Baker Plan”.

In September 1989, the “Brady plan” was agreed, legitimizing the concept of
debt relief. By now, it was believed that US banks could withstand projected losses
on Latin American debt (Tammen, 1990)12. The “Brady Plan” forced them to do
so. The basic idea was to make debt relief acceptable to commercial bank creditors
by offering a smaller but much safer payment stream in exchange for the original
claim that clearly could not be serviced in full (FDIC). The Mexican government
and the Bank Advisory Committee representing the commercial bank creditors
reached an agreement on a financing package covering the period 1989-92,
restructuring approximately USD 49.8bn of Mexico's external debt. As only long-
term debt with commercial banks was restructured, roughly half of the debt was
involved (Van Wijnbergen, 1991). Commercial banks involved had three options
(Odubekun, 2005)13:

1. Banks could exchange old loans for new bonds at a discount of 35%
of their face value, keeping interest rates at market levels (equivalent to
LIBOR + %)
2. Banks could exchange old debt for face-value new bonds (called par
bonds) bearing fixed interest rates of 6.25%

12 Tammen, M.S. (1990), The Precarious Nature of Sovereign Lending: Implications for the Brady Plan, Cato Jounal
13 Odubekun, F. (2005), Debt Restructuring and Rescheduling, US Treasury Department.

30
 3. Banks could provide additional loans over the next three years
equivalent to 25% of the banks’ initial medium- and long-term loans, which
implied no debt relief but the provision of new money

Most banks opted for the par bond (47%), implying interest rate reduction.
Other banks chose to reduce the principal (40%), a few offered new loans (13%).
Another agreement was reached with the Paris Club, representing creditor
governments, covering USD 2.6bn of principal and interest payments falling due
in the period 1989-1992 (Van Wijnbergen, 1991). The “Brady plan” substantially
improved Mexico’s ability to service its external debt by reducing interest and
principal payments (Dornbusch, 1994)14.

* Structural reforms

In December 1982, Mexico started far-reaching structural reforms, which

were a condition for receiving the IMF loan. The reforms included: fiscal austerity,
privatization of state-owned companies, reductions in trade barriers, industrial
deregulation, and foreign investment liberalization. Owing to rigidly enforced
fiscal discipline, the budget deficit halved from 17.6% in 1982 to 8.9% in 1983.
Fiscal austerity was accompanied by stringent monetary policy.

With an extensive trade reform, Mexico opened up the economy. The

percentage of domestic (non-oil) tradable production covered by import quotas
was lowered from 100% in 1984 to less than 20% in 1991. Also, maximum import
tariffs were cut. As a result, non-oil merchandise exports doubled their share of
total exports to two-thirds. In May 1989, foreign investment regulations were
considerably relaxed and made more transparent.

Also the tax system underwent a number of reforms, encouraging capital

inflows and raising sanctions for tax evasion. The government also initiated a
process of financial market liberalization. Ceilings on commercial banks’ deposit

14 Dornbush, R. and Werner, A. (1994), Mexico: Stabilization, Reform and No Growth.

31
interest rates were removed. Forced allocation of commercial credit towards
favored sectors had also been abolished and credits privatize the commercial
banks, which were nationalized in 1982. However, banking sector reforms were
delayed. Mexico still lacked inadequate banking sector supervision, although the
government guaranteed both deposits and liabilities.

b) Long-term measures

Firstly, Latin American countries have had reasonable public debt treatment.
Developing countries which have debt develop rational economic structures, have
focus on capital investment and have clear repayment plans. Especially, they must
avoid borrowing to invest in inefficient projects, abuse excessively short-term
borrowings. The flow of short-term investment flows into a country can quickly
be withdrawn massively as investors see the risk, which will cause great imbalance
to the economy, therefore being over-reliant on public debt is extremely dangerous.

Secondly, they improve foreign currency loans and inflexible exchange rate
policy. Most countries in crisis maintain a fixed exchange rate regime and anchor
the local currency to the US dollar. Maintaining a fixed exchange rate regime will
cause the domestic currency to be overvalued because strong currencies such as
the US dollar are flexibly floating. Consequently, the competitive power of
country’s international trade is reduced. Moreover, when the domestic currency is
devalued, the burden of foreign debt will increase that will cause difficulties in
payment of this country.

Thirdly, building an effective financial and banking system and reserving

foreign exchange reasonably for self-defense against crisis risks. We can see
clearly that, with the potential financial resources of the world, it is impossible to
avoid or eliminate financial crises completely. Each country must learn to protect
itself, find ways to eliminate risks for the economy. It means that this nation must
build a legally banking system which has abundant foreign exchange reserves, has

32
flexible exchange rate regime, encourages long-term investment flows and limits
short-term capital flows with high risks.

Finally, they establish international forums to handle economic crisis issues.

Today, due to the globalization of the world economy, crises occur globally, but
the adjustment measures are only national. Therefore, during a meeting in
Washington on October 3, 1998, Finance Ministers and Central Bank Governors
of G7 countries asked Hans Tietmayer, the President of Bundes Bank to present
advice regarding the measures to adjust international finance. Mr. Hans Tietmayer
came up with the idea of establishing an "International Financial Stability
Forum" 15 and was agreed. In its first meeting held in April 1999, the Forum
discussed two tasks: firstly, reducing the potential risks of financial institutions
such as hedging funds; secondly, introducing measures to reduce the abnormal
fluctuations of international capital flows. These are important measures to reduce
the causes of the crisis that in fact emerging economies in the late twentieth century
occurred.

3.5. Achieved result

3.5.1. Positive effects
According to Moore & Thomas (2010), developing countries seem to be
defined as those with relatively high debt16. The proceeds from government debt
can potentially have significantly positive influences on economic growth if the
funds are spent to improve the productive capacity of the country. By using the
meta-analysis approach to address the issue, the authors indicated that there exists
a significantly positive relation between debt and economic growth.

Egbetunde (2012) examined the causal nexus between public debt and
economic growth in Nigeria over the period of 1970 - 2010 using a Vector
Autoregressive (VAR). The estimated results showed there exists a bi-directional
causality relationship between public debt and economic growth. The author

15 Criminal Finance: The Political Economy of Money Laundering in a Comparative Legal Context
16 Moore, W., & Thomas, C. (2010). A meta-analysis of the relationship between debt and growth.

33
concluded the relationship between public debt and economic growth is positive
only if the government is honest with the loan obtained and uses it reasonably for
the purpose of economic development.

Al-Zeaud (2014) empirically assesses the impact of public debt on the

performance of the Jordanian economy between 1991 and 2010. Using OLS
estimation, the results show public debt and population growth play a critical
role in economic growth17. It indicates that public debt fosters economic growth
while population growth is detrimental to it. Thus, according to the author, in order
to attain sustained economic growth, Jordanian government should maintain the
positive influence of public debt and reduce the negative impact of population
growth.

As the result, on the 10th anniversary of the debt crisis, those who have
watched it unfold are increasingly reluctant to write this off as a lost decade. “This
has been a decade of preparation and learning that has given Latin America a new
foundation for economic growth” said Jaime Pellicer, debt expert at the Center for
Latin American Economic and Monetary Studies, an organization of central banks
based in Mexico City.

What governments have learned is how to govern without running the whole
economy: how to set priorities, how to delegate to private enterprise, how to make
more effective use of less money.

Latin American officials insist that the new foundation of growth through
exports with production dominated by private initiative is a stronger one and is
beginning to show results. Manufactured goods now account for more than half of
Mexico’s exports, against only about one-fifth in 1983.

And there are finally some signs that the workers in those export-oriented
industries are beginning to benefit, although they are far from recovering the

17 Al-Zeaud, H.A. (2014). Public debt and economic growth: An empirical assessment.

34
buying power that was slashed in half over the past decade. In Mexico, for example,
although the minimum wage still lags behind inflation, contracts for unionized
workers have begun to improve over the past three years. “The wages of 1981 were
paid with foreign debt and could not be sustained,” President Carlos Salinas de
Gortari told reporters last week. “Today’s wages are being paid with domestic
savings and they can be sustained.”

3.5.2. Negative effects

In order to empirically examine the highly disputed the nexus between
sovereign debt and economic growth for 20 developed countries over the periods
1954 – 2008 and 1905 – 2008, Lof & Malinen (2014)18 employs the panel vector
auto regressions (panel VAR). These authors find no evidence for an impact of
public debt on growth, even at higher levels of public debt. However, they find a
significantly negative reverse impact of economic growth on public debt.

Puente-Ajovin and Sanso-Navarro (2014) examines the possible causal link

between national debt (public debt, non-financial corporate debt, and household
debt) and economic growth for 16 OECD countries between 1980 and 2009.19 Via
the bootstrap Granger causality test, the estimated results show government debt
does not cause the growth of real GDP per capita. Furthermore, the economic
growth negatively influences government debt.

Using a dynamic panel GMM estimator, Zouhaier and Fatma (2014)

empirically studies the effect of debt on economic growth of 19 developing
countries over the period 1990-2011. The estimated results confirm a significant
negative impact of debt on economic growth in these countries.

The effect on developing countries was dramatic. In testimony before the

House Committee on Foreign Affairs last month, William R. Cline, a senior fellow

18
Lof, M., & Malinen, T. (2014). Does sovereign debt weaken economic growth?
19
Puente-Ajovin, M., & Sanso-Navarro, M. (2014). The causal relationship between debt and growth: evidence from
OECD Countries.

35
at the Institute for International Economics, a Washington-based research
organization, said that as a result of the world recession, the value of developing
country exports declined by an average of 1 percent in the 1981-1982 period;
during the same period, Eurodollar interest rates averaged 15 percent. By contrast,
between 1976 and 1980 developing country exports grew at an average annual rate
of 23 percent. Eurodollar interest rates averaged 9 percent.

As a result of this new environment, Latin American economies last year

expanded by just 1.6 percent, according to a recent survey conducted by the Inter-
American Development Bank. As Mr. Kuczynski put it in his article, ''The music
has stopped.''

As the result, the debt crisis of 1982 was the most serious of Latin America's
history. Incomes and imports dropped; economic growth stagnated;
unemployment rose to high levels; and inflation reduced the buying power of the
middle classes. In fact, in the ten years after 1980, real wages in urban areas
actually dropped between 20 and 40 percent. Additionally, investment that might
have been used to address social issues and poverty was instead being used to pay
the debt.

CHAPTER 4: VIETNAM PUBLIC DEBT AND LESSON

FROM LATIN AMERICAN PUBLIC DEBT CRISIS TO
VIETNAM

4.1. Current situation of Vietnam public debt

For a developing country like Vietnam, borrowing is one of the necessary
tools to finance capital, meet investment needs and encourage production
development during periods of low economic accumulation. . However, like any
other country in the world, if the debt is abused and the borrowed funds are
allocated inefficiently, the debt will become a burden for the future, making the
sustainability of the economy is threatened.

36
4.1.1. Scale of public debt
With the development of the economy, Vietnam's public debt rose up very
fast in 2010 – 2016, but tends to decrease in the recent years.

Figures 4-1. Total public debt of Vietnam period 2010 - 2018

According to Ministry of Finance’s report, in the period 2010-2012,
Vietnam’s public debt decreased from 56.3% to 50.8% of GDP. However, till 2016
it is up to 63.7% of GDP (about to reach the public debt ceiling as stipulated by
the National Assembly, 65% of GDP) and 61.3% of GDP in 2017.

37
 Year Public debt Year Public debt

2010 1,124,638 2014 2,141,610

2011 1,392,020 2015 2,746,840

2012 1,647,124 2016 2,863,869

2013 1,954,261 2017 3,130,000

Tables 4-1. Total public debt of Vietnam (billion VND)

The scale of public debt in 2017 was more than 3.130 million billion VND, nearly
3 times in 2010 (1.12 million billion), nearly 8 times in 2006 and 18 times more
than the year 2001. The average growth rate of public debt in the period 2011 -
2015 is 16.3% per year, an increase nearly 3 times the economic growth rate.
However, the marginal rate of public debt is decreasing: in 2014, public debt
increased by 3%, in 2015 only increased by 2.7%.

Figures 4-2. Public debt in Asian developing countries

38
 Because there are certain differences in the calculation of public debt
between Vietnam and the world and the level of public debt over GDP changes
from time to time (for example, due to the impact of exchange rates), the figures
may not be similar between the different reports. According to IMF data, the scale
of Vietnam's public debt in 2014 was over 60% of GDP and that is the highest rate
among developing countries in the region. It can be seen that most of these
countries maintain the public debt below 60% of GDP, particularly in Indonesia,
the public debt ratio is very low, approximately 25% of GDP. Vietnam's public
debt increased by 5%, from 56.3% in 2010 to 61.3% in 2017. Meanwhile,
Cambodia increased by only 1.6%, Indonesia increased by 4.4%, Malaysia by
2.3% and Thailand by 2.1%, Philippines by 11.9%. While ad-hoc measures and
privatization receipts are likely to keep debt below 65 percent in the near- to
medium-term in the absence of further consolidation efforts, or in the case of
adverse shocks, Vietnam’s debt could breach the debt limit within a few years.

4.1.2. Structure of public debt

In particular, government debt and Government guaranteed debt are the two
main components of public debt in Vietnam, respectively at 85.6% and 13.5% in
2018, local government debt tends to increase but not significantly, staying at
about 1% of Vietnam's total public debt. Government debt proportion in the total
public debt was relatively stable, fluctuating at 80% and tending to increase
slightly.

Figures 4-3 Structures of total public debt

39
 Along with the increase in public debt, the structure of Vietnam’s public debt
has also changed.

The proportion of domestic debt to total public debt increased from 44.4% in
2010 to 55.4% in 2018.

Figures 4-4 Structure of total public debt

In government debt, the proportion of foreign debt decreased, in the period

from 2010 to 2016, decreased from 59.8% to 48.1%. Because of the increasing
demand for capital, while the access to foreign capital is limited, the Government
has to rely mainly on domestic loans.

40
 Figures 4-5. Structure of Government debt

In contrast, the foreign debt in the Government-guaranteed loan balance

increased, replacing domestic debt.

120

100

80

60 Foreign debt
Domestic debt
40

20

0
2010 2011 2012 2013 2014 2015 2016

Figures 4-6. Structure of Government-guaranteed debt

Domestic debts are mostly in the form of Government bonds, mainly held by
commercial banks: The proportion of Government bonds held by commercial
banks is up to 55.4% at the end of 2016. There are two main risks: (1)a decline in

41
the sustainability of commercial banks, because any sudden drop in the value of
Government bonds can have immediate negative consequences. for a summary of
banks' assets and (2)increasing difficulties for private enterprises, especially small
and medium enterprises, in accessing affordable sources of credit from commercial
banks. In the period 2011 – 2013, most of Vietnam's government bonds have short
medium terms (shorter or equal 3 years) with an average interest rate of over 10%
for 5-year bonds, which increases pressure on payment, especially in period 2014-
2016. However, at the present, all of government bonds have maturities of more
than 5 years and the average maturity is 13.52 years with the average interest rate
of 6.07% per year.

In terms of access to international capital markets, up to now, Vietnam's

foreign borrowing activities have mainly been through ODA loans and
concessional loans from governments and international financial institutions.
However ODA loans have decreased since Vietnam became a middle-income
country in 2010. Mr.Trương Hùng Long, head of the Finance Ministry’s
Department of Debt Management and External Finance said: “In the past, we were
allowed to access loans that required repayment over 30 to 40 years. Now, the time
has been reduced to 20 to 25 years, even to a decade for some donors. The interest
rate on these loans has more than doubled from under one percent to over two
percent, and pressure on repaying ODA loans is growing because of the shortening
terms”.. Increasing in private commercial borrowing in the private sector has
mainly caused by the group of enterprises with FDI.

Access to international capital markets in the form of commercial loans is

quite limited and mainly through the Government's international bond issuance

4.1.3. The cause of the increase in Vietnam public debt

The high level of public debt in Vietnam was derived from larger fiscal
deficit, particularly due to a sharp rise of recurrent expenditure and inefficient
public investment projects undertaken by state owned enterprises in recent years.

42
 Figures 4-7. Fiscal balance of Vietnam (%)
Figure shows the fiscal balance in Vietnam over the period 2010-2019. The
fiscal deficit indicates that the government spending is higher than its revenue over
the period. Despite increasing revenue steadily, the gap between expenditure and
revenue of government was broad for the recent years, especially after 2011.
Vietnam is now attracting massive scale of FDI, so that larger fiscal spending is
used for infrastructure investment during the stage of rapid development. However,
the pace of expansion of the expenditure may not continue for a long period.
Meanwhile, public administration has accounted for a large proportion of public
expenditure and tends to move up in recent years.

The industrial structure of the VN economy has been changed in the past
decades. Agriculture is in trend of decline while industry and service has increased
significantly. This could be the result that FDI has transformed the economic
structure to have larger shares of manufacturing industries. Also, public investment
in infrastructure and other industrial bases has been increased. These factors have
increased public expenditures and private borrowings.

Domestic debt is mostly used to finance budget deficit of Vietnamese

government until 2012. In detail, more than 70% of total debt of government is
derived from domestic resources in 2000-08. However, due to global financial
crisis and widening in trade deficit which, in turn, contributed to a loss of

43
confidence in the currency, large private capital outflows (as domestic residents
switched their VND denominated assets into foreign currency denominated assets
or gold) led to severe loss in international reserves, and finally depreciations of the
exchange rate. As a result, Vietnam’s external debt increased by more than 7.5
times from 19,668 billion VND in 2008 to 1,647,124 billion VND in 2012. Even
though, foreign borrowing has already exceeded by 1.75 times compared to
domestic borrowing in 2013.

Furthermore, Vietnam’s total public debt increased from approximately 40%

of GDP in 2007 to approximately 56.3% of GDP in the end of 2010 due to the
global financial crisis in 2007-2008, then slightly decreased to 54.9% of GDP in
2011.

The debt service principal amount has increased by 3 times from 62.6 trillion
VND in 2010 to 187,9 trillion VND in 2014. The volume of rollover was 260.8
trillion VND in 2014 (Table 2) and was 288.7 trillion VND in 2015. The primary
reason is that majority of bonds have been issued in a very short maturity since
2009, from 1 to 3 years. The maturity dates of these bonds have been starting in
2011; therefore, total principal payment has increased rapidly. The appearance of
some kinds of short-term bills (3-6 month of maturity) also increased the amount
of principal payment. After that, long-term bonds were promoted to be issued more.
National Assembly issued Resolution No. 78/2014/QH13 to limit government
bonds under 5-year maturities from 2015. However, the demand for long-term
bonds is still very low.

44
 Year 2010 2011 2012 2013 2014 2015 2016

Principle 62,602 78,450 110,54 125,81 187,91 203,44 160,59

Debt
Interest 24,503 32,184 43,837 59,996 72,886 85,259 90,371
service
payment
288,70
Total 87,105 110,634 154,386 185,814 260,803 250,963
2

Interest payment/Budget
3,2% 4,2% 5,1% 5,2% 6,6% 6,8% 7,1%
expenditure

Tables 4-2. Public debt payment using budgetary expenditure (billion VND)
Besides, interest payment accounted for a large proportion of budget
expenditure. Compared to total expenditure, interest payment increased rapidly,
from 3.2% in 2010 to 6.8% in 2015. In terms of volume, interest payment increased
by 2 times in a 2010-2015 period. Expenditure for interest payment was often at a
high level. This is hiding the budget for development investment, as a direct result
of high public debt ratio. Moreover, education expenditure, pension and social
securities, and public administration also accounted for large amount, especially
pension expenditure has increased recently and will continue to rise because of
aging process in Vietnam.

4.1.4. The impacts of public debt on Vietnam macroeconomy

To clarify the impacts of budget deficit and public debt on macroeconomic
variables, including GDP growth, inflation, interest rate, trade balance and
exchange rates, we have carried out a qualitative analysis of possible budget deficit
transmission and various solutions to financing them.

*Inflation

Government expenditure which is not funded by tax revenues or other kinds

of revenue may be the culprit of excessive aggregate demand and inflation. This
situation is more likely to happen if government spending is funded by surplus

45
money supply that is pumped into the economy. If a small part of fiscal deficit is
financed in that way, inflation will by no means occur. However, when the funding
is enormous and continuous for several years, the economy will eventually get into
a situation where the high inflation rate is seen in a long time. In reality, Vietnam
has experienced the same impacts in the past years. Most of its fiscal deficit has
funded by government bonds and even money issued by Central Bank in the form
of advancing state budget20. However, a large number of government bonds and
government-guaranteed bonds are sold to big commercial banks. They are then left
in the state bank as a pledge in order for commercial banks to take out money
through open market operations or rediscounting. Finally, this causes an increase
in the money supply, resulting in inflation. According to statistics of the Hanoi
Stock Exchange (HNX), the total amount of government bonds and government-
guaranteed bonds in circulation is about 336 thousand billion dongs, equaling more
than 13% of the nominal GDP and nearly 12% of money supply M2 of the year
2011. Thus, besides the private sector’s high demand for credit, public expenditure
funded by government bonds has also indirectly led to sharp increasing money
supply recently.

*Interest

Under no control of administrative limitation, interest is determined by

demand and supply in the capital market, where household savings and business
investment converge. Total of government savings and private savings, also called
national savings, will reflect the supply while investment represents the demand
of loan market. Budget deficit results in a decline in government savings and
national savings, leading to a fall in capital supply and an increase in the interest
rate in the market. As a result, the increasing interest rate brings about a decline in
private savings. This situation is called crowding out effect. In other words,
excessive public spending is the culprit of state budget deficit. Government is put
under pressure to borrow capital by issuing bonds, resulting in a lower amount of

20
According to term 23, State budget Law 2002, an advance on the state budget aims to temporarily
dispose of the budget deficit according to the government’s decisions.

46
available capital in the market that the private sector is supposed to access with a
low cost. In recent years, the structure of loans in Vietnam has experienced a
change from external debts into domestic debts. By the end of 2011, external debts
accounted for 56% of total debts while domestic ones occupied 43% of total debts
and followed an upward trend. However, this trend hardly seems to be a positive
picture that Vietnam is less dependent on foreign countries. In fact, it shows a fall
in foreign concessional loans. Because of a high interest rate of foreign commercial
loans, we had to switch over to domestic loans. Nevertheless, that government
borrowed a large number of domestic loans crowded out private sector, leading to
the lower economic growth when 1 capital unit was not used effectively by the
public sector.

*Trade balance and exchange rates

Consumers in a country are able to spend more than the value of domestic
products and services by importing goods from other countries. Thus, if the
government expands expenditure without imposing policies on restricting private
spending, there will be an increasing demand for imports and trade deficit. A
decline in private investment caused by the budget deficit can be easily explained
by crowding-out effect while an increase in government spending on imports is the
reason for a drop in net exports. As a result of the increase in public spending and
budget deficit, the gross domestic consumption is higher than the domestic output.
In order to meet the demand for additional expenditure, both domestic production
and imports will go up, causing the trade deficit. Especially, the budget deficit
affects adversely trade deficit in countries dependent on imported raw materials
like Vietnam.

Budget deficit has other impacts on trade deficit. Importing goods and
services leads to abroad asset outflow. When imports surpass exports, we have to
pay an amount of foreign currency to foreigners. They, then, invest such foreign
currency in stocks, corporate bonds, government bonds or real estate. As a result,
when budget deficit happens, Vietnam becomes a net importer of goods and
services and a net exporter of properties. Foreigners are holding more and more

47
domestic assets. Budget deficit reduces the capital supply of private sector, causing
higher interest rate. When other factors are constant, higher interest rates could
attract external capital to flow to domestic market, leading to increases in the
supply of foreign currency and local currency prices. However, in Vietnam, this
impact is not enough to offset the pressure of the currency depreciation due to
serious trade deficit. Furthermore, the inflow of capital from abroad is limited by
high inflation and unpredictable exchange rates in Vietnam.

*Growth

In response to an increase in inflation and current account deficit due to long-

lasting deficit, Vietnamese government as well as others usually imposes
administrative interventions in controlling prices and exchange rates. However,
such methods result in the shortage of aggregate demand because they distort
domestic production factor markets leading to unreasonable resource allocation. It
is also because the lack of imported inputs, limiting the capacity of production and
exportation. Over time, long-lasting expansionary fiscal policy worsens current
account balance and accelerates inflation. Deterioration in belief in domestic
currency and economy will cause foreign capital outflows unless the government
accepts to suffer from drawbacks of tightening money supply and raising interest
rates in order to revive the belief in domestic currency. Vicious circle of budget
deficit – trade deficit – budget deficit may occur when policies on price control
and trade reduce revenues from taxes, especially those from imported goods. This
results in more difficulties in shrinking budget deficit, so the policy on increasing
taxes or imposed new ones is the final solution to such a situation. As a result, high
taxes and fees discourage production in the private sector, causing low or negative
growth

4.2. Lessons from Latin America debt crisis for Vietnam

The above mentioned chapter shows that fundamental reasons for the debt
crisis in Latin American countries in the 1980s were the combinations between the
populist policies – over spending and carelessly, ineffectively and corruptively
borrowing from foreign resources – which might be considered as a policy failure.

48
In the scenario, the countries became vulnerable to risk of capital withdrawal made
by investors. Once it had become the truth, it would have been too late to tackle
crisis.

From the above reasons, lessons can be drawn on for Vietnam. Firstly,
reckless and ineffective government borrowing with the probability of corruption
while maintaining budget deficit for big spending is the first notion. Although most
of Vietnam’s current debts are from ODA of other countries with favorable interest
and are mostly long term ones, the ability to continue to receive such favorable
cannot be prolonged as Vietnam has made itself a middle income country while
facing quite a few risks from government borrowing such as risk of long term risk,
risk of foreign exchange rate, etc.

Secondly, effectively control of external borrowing is necessary. First,

external borrowing increases vulnerability to external conditions. When debt is
contracted at a floating rate, higher foreign interest rates lead to increase in debt-
servicing costs. This raises budgetary outlays, which may translate into a larger
deficit. Likewise, a depreciation of the currency has the same effects. Second,
when the government borrows to cover a growing deficit, foreign borrowing leads
to an unsustainable level of debt, and substantial use of foreign exchange to service
the debt. In the long run, this may lead to debt crisis. Although total external debt
of Vietnam (% of GDP) is still under safe threshold, experiences from Latin
America countries show that there is no safe external debt threshold that applies to
all countries.

Thirdly, all the erupted crises relate to poor mechanism and structure of the
economy which particularly is demonstrated in: (i) existing problems in finance
and banking system, lack of effective supervision; (ii) lack of transparency in
private businesses, lack of separation of ownership and management; (iii)
untransparent relationship between the Government and major corporations, etc.
Therefore, the economic restructuring especially in finance and banking sector is
a critical and objective requirement to address similar crises.

49
 Fourthly, if the nation maintains the USD based – fixed exchange rate system,
the economy should well prepare for the worst situations, in the long run it can
often lead to balance of payments crisis.

4.3. Measures to apply lesson from the crisis in Vietnam’s context

Firstly, to avoid reckless and ineffective government borrowing, IMF’s
harsh structure adjustment policies such as contractionary policy (reducing the
budget to decrease budget deficit, adversely affecting public debt, maintaining the
low credit growth and decreasing spending and inflation) is needed. The fiscal
policy should be rigidly enforced according to a clear roadmap, by using revenues
exceeding the yearly estimate to pay debts, and striving for the budget deficit to be
maintained at 4% from now to 2020, maintained at 3% after 2020, etc.

To maintain the low credit growth, The State Bank of Vietnam (SBV)
recently set a credit growth target for 2019 of 14 per cent, focusing on priority
fields to ensure risk control and support economic growth. The SBV will also
continue to set credit growth quotas for each bank, depending on its health, to
regulate overall credit growth and support government targets.

In order to improve the effectiveness of the use of funds, especially with the
sharp decrease of ODA sources and more dependence on commercial loans at
higher interest rates in the short-term, it is essential to further modernize the State
Budget system. The first recommendation is to further strengthen State Budget
transparency, to promote more public participation in the budget process at all
levels of government and to improve accountability. For example, the State Budget
submitted to the National Assembly and Local People’ Councils should be
disclosed at the same time so that citizens can provide feedback. State Budget
information should be communicated clearly and concisely to facilitate citizens’
understanding of and participation in budget discussions. Secondly, there is a need
for more discipline in implementing approved spending plans. Actual spending has
in recent years significantly exceeded planned spending. Such big changes affect
the credibility and integrity of spending plans. To address this, we recommend that

50
major changes to budget appropriations be approved through a supplemental
budget. This should help to promote more efficient spending. The third
recommendation is to introduce medium-term budgeting. A medium-term budget
would provide projections of total revenue, spending and borrowing over the
coming three to five years. This would enable the government and the public to
estimate the cost and affordability of its development plans. The fourth
recommendation is to consolidate reporting on all activities of the public sector so
that the government, the National Assembly and citizens have a fuller picture of
fiscal policy. This could be done through consolidated government financial
statements with full information on revenue, expenditure, financial and non-
financial assets, and liabilities. Like in other countries, the State Budget is not the
only channel through which public services are delivered. In Vietnam there are for
example extra budgetary funds and state enterprises. It is important to monitor
risks to the State Budget emanating from these. As previous global crises have
shown the biggest risks to the State Budget often come from extra budgetary public
sector activities.

Secondly, in order to effectively control external borrowing. The

sustainability of public debt depends not only on the level of debt of a country but
also on the ability of the nation to continue borrowing, in which
creditworthiness(IIR) plays a very important role, to avoid the liquidity crisis. Over
the time, Vietnam's creditworthiness has gradually improved and is currently lower
than the investment level by about 2-3 units according to the rating of the world's
leading credit rating agencies. Although there are no published figures on IIR
ratings for Vietnam, credit ratings can be converted according to the rating of
independent credit rating agencies. Accordingly, Vietnam belongs to a group of
countries with limited access to international capital markets. Moreover, the State
Bank of Vietnam needs to increase foreign reserves to use in case Vietnam’s
government lose the ability to pay the debt. Besides, a sufficient foreign reserve is
needed to stabilize exchange rate.

51
 Vietnam's foreign exchange reserves have increased sharply recently after
the State Bank of Vietnam focused on buying foreign currencies from banks.

Figures 4-8. Vietnam's foreign exchange reserves 2016-2019

However, total reserves (% of total external debt) in Vietnam reported since 2010
have been low, despite of slight increase.

Figures 4-9. Vietnam total reserve 2010-2018

Moreover, suitable capital account should be opened along with health
improvement of the domestic finance – banking sector and simultaneously, a
mechanism to monitor macro and micro finance is essential to effectively control

52
the credit of private enterprises as well as private borrowing with government’s
underwriting. .

Thirdly, to avoid risks from USD based – fixed exchange rate system,
Vietnam should implement healthy and cautious macroeconomic policies to
maintain suitable exchange rate system.

In 2016, the State Bank of Vietnam decided to change exchange rate system
from fixed exchange rate system to floating exchange rate system, but under
control of SBV. Basically, Vietnam is still following fixed exchange rate system,
but more flexible than before. At the end of 2015, statistical data showed that, with
the corresponding exchange rate system, the value of VND was still under control;
however, the SBV has made every effort and steadily with the goal of a stable
exchange rate and flexibility in line with the movements of international financial
markets, especially fluctuations of CNY or interest rates of the Fed. It is clear fact
that, with the old exchange rate system, the value of VND was greatly affected by
the appreciation of the USD when the Fed raised interest rates and fluctuations of
CNY - a major trading partner of Vietnam (in 2015, Vietnam had a trade deficit of
about US $ 3.4 billion with China).

4.4. Policy recommendation for Public debt management in Vietnam

The main objective of the public debt management is to consider strategy and debt
structure-related risks, thereby making policy orientation adjustments to maintain
public debt sustainability in medium and long term. Thus, in this section, we are
trying to suggest some policies for further discussion so as to find out appropriate
methods of managing current public debt and budget deficit in Vietnam.

*Establishing the Public debt Monitoring Committee under the Finance and
Budget Committee of the National Assembly

The establishment of the Public debt Monitoring Committee allows close,

subjective and independent public debt monitoring and management. The Public
debt Monitoring Committee is empowered to access to all information about public
53
and external debt of other Ministries in public sector, including Ministry of
Finance, SBV, SOEs, etc. The information must include details of the scales,
maturities, interest rates, currencies, strategies, etc. of all domestic as well as
external debts. This will be the basis for public debt supervisors and managers can
monitor, analyze and supervise the total debt of the public sector and then give
appropriate policy advice to the National Assembly. The Public debt Monitoring
Committee has to carry out and support the Finance and Budget Committee to
quarterly propose the Overall report on public debt monitoring and management
to the National Assembly. This report must summarize the latest updated
information and cover discussions about policy and market developments. Also,
the Public debt Monitoring Committee has the authority to coordinate and
collaborate with stakeholders; and right to implement essential processes of
administration, auditing, accounting and reporting.

*Establishing a system of debt safety indicators

To strengthen the fiscal discipline, it is necessary to set up a system of

indicators regulating on debt limit in terms of quantity and flows of repayment.
These limits can be presented in both nominal value and in percentage of important
macroeconomic variables. The scope of limitation applied is divided by each type
of debt: total public debt, external public debt, domestic public debt, and total
external debt. Normally, the limit to the total debt is expressed as a percentage of
GDP and export, and limit to the debt service is expressed as a percentage of total
tax revenue and foreign reserves or limit of annual debt to capital expenditure ratio.
However, the important thing is that the National Assembly must provide
reasonable limits. If too low, they can hinder the Government in implementing
necessary reactions during the crisis because the adjustment or approval of new
regulations takes time. Conversely, if the limit is set at too high level, they are
pointless. Once issued, the fiscal disciplines of the government need closely
monitoring by the Public debt Monitoring Committee.

*Debt accounting according to international standards

54
 In order to exactly assess the practice and then propose appropriate strategies
of debt management, the accounting of budget and public debt must be performed
transparently following international standards. The off-balance sheet expenditure
accounts must be absolutely avoided. The budget deficit measures, except for
unsustainable revenues and revenues from sale of property, need further
calculations for accurateassessment of current fiscal situation. In addition, the
budget burdens arising in the future, such as pension payments or health insurance,
should also be included in the forecasts of the budget deficit to get a more accurate
picture of public debt outlook in the medium and long term.

Due to its potential risks to public debt, the SOEs’ debt should also be
sufficiently calculated, analyzed and reported in the current definition of the public
debt in Vietnam. The analysis and assessment of the SOEs’ debt should be
considered as an inseparable part of the report on Vietnam's public debt.

*Enhancing domestic debt market

Enhancing, both primary and secondary, domestic government bond market

is very important. In short-term, the Government may have to accept high domestic
borrowing cost for the development of the Government bond market. However,
time by time, once this market develops and has higher liquidity, the Government
can mobilize capital at a low cost. The development of the market will help the
Government to mobilize capital with long maturities, fixed interests and especially
in domestic currency. Therefore, the risks related to interest rates, exchange rates
and rollovers will be minimized. In addition, the growth of the secondary
Government bond market will also be followed by the development of the
corporate bond market, as the Government bonds is the standard for determining
the risk of other debt instruments.

*Tax system reform

Finally, tax system should be reformed to ensure criteria for sustainable,

efficient, fair and transparent revenue. The tax burden needs properly reducing

55
adjustment. However, this level of reasonability depends very much on the process
of public spending cut. Thetoo high tax burden will make the tax system less
effective because it encourages tax evasion and distort the resource allocation. Tax
and fee system should be reviewed to avoid overlapping. The taxes should be
adjusted to ensure social security for low-income people, to encourage savings and
limit consumption, especially imported luxury consumer goods.

CHAPTER 5: CONCLUSION

In the context of a society with limited resources, borrowing seems to be a

desirable method that allows governments to finance required expenditures.
Government borrowing is accepted as long as it is consistent with a sound fiscal
policy. The fundamental reasons for the debt crisis in Latin American countries in
the 1980s were the combinations between the populist policies – over spending
and carelessly, ineffectively and corruptively borrowing from foreign resources –
which might be considered as a policy failure. The lessons in public debt
management which can be drawn on for Vietnam is that it is time for Vietnam to
carry out a thorough and comprehensive fiscal reform in order to bring its budget
to the balanced status for assuring the debt sustainability and prolonged economic
stability. In order to achieve that, we need to have a proper management and
thorough control from the government as well as the strictly implementation to
economy context. Only when we can ensure the security in public debt
management, can our economy grow sustainably in the long-term, putting the first
bricks to build ideal conditions for the next generation. Therefore, we hope that
the topic of Public debt as well as public debt crisis handling will continue to be

56
of national interest there will be many innovative and new solutions to increasingly
improving the situation of public debt in Vietnam.

57
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