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

Fiscal Crises: The Role of the Public Debt Investor Base and Domestic Financial Markets as Aggravating and Mitigating Factors Author name(s): R. Bhattacharya, K. Johnson, M. Nkusu, and M. WangWP/22/240 IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. 2022 DEC © 2022 International Monetary Fund WP/22/240 IMF Working Paper Finance Department Fiscal Crises: The Role of the Public Debt Investor Base and Domestic Financial Markets as Aggravating and Mitigating Factors Prepared by: R. Bhattacharya, K. Johnson, M. Nkusu, and M. Wang* Authorized for distribution by Carlo Sdralevich and Olaf Unteroberdoerster December 2022 IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. ABSTRACT: The paper evaluates the key drivers of fiscal crises in a sample of countries from all three income groups—advanced, emerging, and low-income countries, using fiscal crisis data recently developed by the IMF’s Fiscal Affairs Department. The empirical study focuses on three questions: (1) How does the composition of debtholders (domestic vs. foreign, resident vs. non-resident, or official vs. non-official) affect the probability of a fiscal crisis, after controlling for the level of public debt and other relevant variables?; (2) How does the development and size of the domestic financial sector affect the probability of a fiscal crisis?; and (3) How do changes in the debt level affect the probability of a fiscal crisis, for given compositions of the sovereign debt investor base and different levels of development and size of domestic financial markets? Our findings confirm the benefits of financial development, the danger of heavy reliance on a non-resident investor base, and also that emerging market economies have a lower debt carrying capacity compared to the full sample. RECOMMENDED CITATION: Bhattacharya, R,, K. J ohnson, M. Nkusu, and M. Wang. 2022. “Fiscal Crises: The Role of the Public Debt Investor Base and Domestic Financial Markets as Aggravating and Mitigating Factors.” IMF Working Paper 22/240. JEL Classification Numbers: E44, F20, F21, F30, F34, F36, E6 Keywords: Fiscal Crisis; Sovereign Debt Investor Base; Domestic Financial Market Author’s E-Mail Address: RBhattacharya@imf.org ; Mnkusu@imf.org ; MWang3@imf.org ; 525jacobjohnson@gmail.com; WORKING PAPERS Fiscal Crises: The Role of the Public Debt Investor Base and Domestic Financial Markets as Aggravating and Mitigating Factors Prepared by R. Bhattacharya, K. Johnson, M. Nkusu, and M. Wang1 1 The author(s) would like to thank Olaf Unteroberdoerster, David Moore, Carlo Sdralevich, Xuehui Han, German Villegas Bauer, Rui Mano, and participants at seminar presentations of the paper hosted by the Finance and Western Hemisphere Departments of the IMF for useful comments and suggestions. Rafael Flores provided excellent assistance in preparing the paper. The authors are responsible for any remaining errors and omissions. IMF WORKING PAPERS Fiscal Crisis: The Role of the Public Debt Investor Base and Domestic Financial Markets INTERNATIONAL MONETARY FUND 2 Contents I.INTRODUCTION ............................................................................................................................................ 4 II. LITERATURE REVIEW .................................................................................................................................... 5 III. DATA ............................................................................................................................................................... 6 IV. MODEL .......................................................................................................................................................... 10 V. RESULTS ....................................................................................................................................................... 11 Role of the Investor Base: Some Regression Results ................................................................................. 11 Marginal Effects of the Investor Base ........................................................................................................... 13 Marginal Effects of Domestic Financial Markets .......................................................................................... 16 Marginal Effects of Financial Development Index ........................................................................................ 19 Marginal Impact of Debt ...................................................