Public debt hurts citizens, says IMF

Mark Aguiar, director, international economics section for the International Monetary Fund (IMF) has said that sovereign borrowing negatively impacts citizens, increases volatility and lowers investment.

In a recent report published on the IMF’s website, he stated that, unlike the popular belief that public debt will fund investment and support national budget deficits, countries that borrow from global sovereign debt markets experience slower growth rates than countries that don’t.

The report surveyed the debt trend of 52 developing and emerging market economies over the last 20 years, to ascertain the impact of sovereign debt on these economies, and found that countries with high debt stock tend to have slow growth rates.

“The neoclassical paradigm predicts that countries that borrow (all else equal), should have faster growth and less volatile spending. The exact opposite is what we see in the data. Countries with external public savings with their foreign reserves exceeding external debt, experienced faster growth, while those that borrowed stagnated,” the report stated.

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The report further stated the data showed that public borrowing crowds out private investment and retards economic growth in these economies.

“Political incumbents prefer spending to occur while they are in office, which without a sound set of political institutions, leads to excess borrowing. Given a large stock of debt, governments are tempted or forced to tax private activity, including private investment and capital income. This crowds out private investment and retards growth,” it stated.

Countries that borrow more also showed higher volatility in government expenditure and private consumption than countries that don’t.

“In particular, there is a positive relationship between changes in debt and volatility of spending, indicating that more borrowing is associated with more volatile public spending. Again, this is contrary to the “smoothing” motive for borrowing predicted by the standard model,” it said.

Finally, the extra volatility induced by excessive borrowing and the consequences of default are not in the best interests of average citizens, and the citizenry would be better off if the government was denied access to debt markets.

“This raises another question: would making debt markets more efficient improve welfare? If citizens and their governments agree on how to evaluate the costs and benefits of borrowing, then the answer is a clear yes,” the report said.