This paper examines economic developments in Trinidad and Tobago during 1990–94. Economic activity in 1992–93 was severely affected by a fall in output in the oil/gas sector, a sharp drop in the average oil export price, and persisting weakness in the nonpetroleum sector. As a result, real GDP declined further by a cumulative 3½ percent in the two-year period, and unemployment rose to more than 20 percent. Real domestic expenditure fell by 3½ percent a year, with declines in both consumption and investment.

Abstract

This paper examines economic developments in Trinidad and Tobago during 1990–94. Economic activity in 1992–93 was severely affected by a fall in output in the oil/gas sector, a sharp drop in the average oil export price, and persisting weakness in the nonpetroleum sector. As a result, real GDP declined further by a cumulative 3½ percent in the two-year period, and unemployment rose to more than 20 percent. Real domestic expenditure fell by 3½ percent a year, with declines in both consumption and investment.

IX. An Assessment of the Sustainability of Public Sector Debt 1/

Total public sector debt in Trinidad and Tobago, which was kept at around 25 percent of GDP through the mid-1970s, grew rapidly through the late 1980s to reach more than 90 percent of GDP by 1989. The build-up in both domestic and foreign debt initially reflected large borrowings by public enterprises to finance investment in the oil/gas sector, the petrochemical industry, and a steel plant. Subsequent borrowings following the collapse of petroleum prices in 1981-86 were to finance the government deficit as attempts were made to maintain spending at the past high levels. The resulting increase in the debt burden was aggravated by the drop in real GDP in 1982-93. However, the debt burden has been reduced steadily since 1989 to an estimated 71 percent of GDP by the end of 1994. Nonetheless, the end-1994 level remains high and total debt service obligations totalled over 13 percent of GDP; external debt service represented 30 percent of exports of goods and nonfactor services. Approximately two-thirds of the debt is external, which was about equally divided between fixed and floating interest rates. As Trinidad and Tobago is a middle-income country, the external debt is almost entirely nonconcessional. The Central Government portion amounts to about three-fourths of the outstanding public debt.

This section examines the medium-term fiscal sustainability of the Central Government’s debt from three analytical perspectives developed in the literature: a simplified balance sheet approach, a fiscal sustainability analysis, and an annuity or debt capacity approach. Each method brings to light a complementary view of the nature of the problem of fiscal and external viability.

1. A balance sheet approach 2/

The balance sheet approach focusses on the consolidated accounts of the public sector, which includes both current stocks of public assets and liabilities and the present value of future revenues and expenditures. 3/ The key feature differentiating this framework from conventional fiscal accounts is its forward-looking nature, which provides insights on the fact that any increase in debt--by definition of the balance sheet--must be matched by an increase in public revenue or current assets or a decrease in expenditures. These adjustments to an increase in debt involve not only current operations but also the present value of future flows. This framework complements the use of medium-term scenarios by highlighting the equivalence between the stock and flow dimensions of fiscal policy, thereby providing insights into problems of policy sustainability and evaluation of the medium-term profile.

The framework is based on a basic identity that public assets must equal liabilities, where public sector net worth is the balancing item. To focus the analysis on key policy variables, a public sector balance sheet is confined to one asset--the present value of expected revenues (R)--and three liabilities--the present value of expected non-interest expenditures and subsidies (G), and the stocks of domestic (D) and external (D*) debts. When net worth (K) is positive, the Government is solvent and is able to meet its obligations--i.e., the present value of expected revenues is equal to or greater than the present value of future expenditures and total public debt.

(1)R=G+D+eD*+K

or

(2)P=D+eD*+K;

where P is the present value of future primary balances and e denotes the exchange rate. The present value of future primary surpluses is estimated on the basis of the surpluses assumed in the medium-term projections with a constant value of annual surpluses thereafter. The latter is consistent with an assumption of declining primary surpluses in terms of GDP. The nominal value of external debt would also normally need to be adjusted to comparable present value terms, to discount the concessional component of official development assistance (ODA) loans; in the present case the concessional component is marginal and has been ignored. In all cases an international risk-free interest rate is used as a discount factor. 1/

Using end-1994 estimates, Trinidad and Tobago’s non-financial public sector has a significantly positive net worth as the present value of the future stream of expected primary surpluses exceeds the total stock of debt by about 85 percent (about 60 percent of GDP) (Table 18). 2/ This estimate is based on the medium-term policy projections for the consolidated nonfinancial public sector finances in 1995-99 that are included in the staff report for the 1994 Article IV consultation (SM/94/313; 12/30/94); the primary balance is held constant from the year 2000 onwards. The analysis assumes a discount rate of 8 percent. 1/

Table 18.

Trinidad and Tobago: Indicators of Non-Financial Public Sector Debt Sustainability

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Percentage changes from this indicator will not necessarily be identical with the projected actual change in the debt to GDP ratio, owing to other forms of domestic financing besides debt, namely privatization proceeds, which are significant in the 1993-97 period.

While the estimated result appears to provide a high degree of comfort, it is quite sensitive to the discount rate used. Net worth would drop to about 60 percent (about 43 percent of GDP) with a discount rate of 9 percent and would be eliminated at a discount rate of 13.5 percent. Thus, from a simplified net-worth point-of-view, the medium-term fiscal position appears relatively sound.

2. A fiscal sustainability approach

While there is no generally accepted view regarding the appropriate level of public sector debt for an economy, the key concern from a fiscal sustainability perspective is the impact of fiscal balances projected under a specific macroeconomic scenario on the public debt to GDP ratio. Under such an approach, a fiscal plan is sustainable if it results in a declining or stable public debt to GDP ratio. 2/

The fiscal sustainability approach is based on the definition of the change in public sector debt as a proportion of GDP (dD) defined as the primary balance as a proportion of GDP (P) plus the net effect on the debt stock (D) of the difference between the interest rate and the growth rate:

(3)dD=(rg)DP

where, r is the rate of interest and g denotes the rate of growth of GDP. 3/ While equation (3) does not indicate whether the initial level of debt is the desirable one, it indicates the primary balance necessary to ensure the sustainability of the fiscal plan, given the rate of growth, the average actual rate of interest on government debt and the initial debt-GDP ratio. In the steady state, defined as the fiscal stance that keeps constant the debt to GDP ratio, the primary surplus must equal the initial debt times the difference between the average interest rate on government debt and the nominal rate of growth (equation 4a).

(4a)P=(rg)D

The intertemporal budget constraint requires that the present value of primary surpluses, discounted at the rate of (r - g), be equal to or less than the initial debt/GDP ratio (4b).

(4b)D=P/(rg)

This requirement only comes into play when the interest rate exceeds the growth rate.

For the purposes of our exercise, it is assumed that the interest rate on domestic debt is maintained at 14.5 percent (the estimated 1994 average) through 1997 and then declines to 13 percent by 1999. The interest rate on foreign debt, which averaged about 7.5 percent in 1994, is projected to rise to about 10 percent in 1995 owing to an increase in international US dollar rates and the effects of the Eurobond borrowings; it is assumed to remain at 10 percent through the year 1999.

The results show a continuous decline in the expected evolution of the debt ratio over the period. While the weighted interest rate on the debt is almost double the nominal growth rate of GDP (of about 6 percent) throughout the 1995-99 period, the rising primary surpluses (averaging 8.4 percent of GDP) dominate. However, in 1995, the projected decline in debt is small (2 percentage points of GDP) and the significant declines from 1996 are predicated on a sharp rise in the primary surplus to more than double its 1994 level. In this respect, it should be noted that in the 1993-97 period the actual debt to GDP ratios have fallen or are expected to fall by more than the analysis would project, as a. result of the authorities’ divestiture program, the proceeds of which are not included in the primary surpluses. The analysis is also sensitive to the interest rate assumption: if external rates were to rise to 11 percent from 1995 onward, the projected decline in debt would drop by about 0.5 percentage points of GDP a year in 1995-96 and by 0.2 percentage points of GDP a year in 1997-99.

3. A debt capacity approach

The viability of an external debt profile can be assessed relative to the country’s theoretical maximum debt carrying capacity at any point in time. Under this approach, the maximum debt stock is the capitalized value of the primary surplus (the primary surplus divided by the rate of interest), or that amount which can be serviced indefinitely at a given interest rate. The indefinite stream of interest payments on the debt stock is essentially an annuity at the assumed interest rate. For the sake of simplicity and to concentrate on the external debt carrying capacity, the analysis under this approach will be limited to the Central Government and assume that the domestic debt stock is sustainable. Thus, the domestic primary surplus (excluding only foreign interest from the overall balance) is the indicator of the resources available to service the external debt.

Under this approach, and assuming the actual average interest rate prevailing on the existing stock, the external debt carrying capacity of the Central Government was at its limit in 1993 and was actually surpassed in 1994 at 32.1 percent of GDP (US$1.5 billion) versus a theoretical maximum of 27.2 percent of GDP (US$1.3 billion). 1/ For the medium-term outlook the analysis has been done using three alternative assumptions about the external interest rate. The first scenario assumes a rate of 8.0 percent, which would approximately prevail if Trinidad and Tobago were to follow its stated policy intention of favoring external borrowing from multilateral agencies (largely the IDB and the World Bank). The second assumes a roughly unchanged borrowing mix from that prevailing in 1994, which is assumed to cost about 10 percent. Finally, a rate of 12 percent is used to approximate the charge associated with borrowing on commercial terms, as was the case with the Eurobond issue in late 1994, which retained a coupon rate of 11.85 percent. For all years except 1995, and under all three alternative assumptions, the projected carrying capacity of the Central Government exceeds the projected debt to GDP ratio, and by increasing margins, so that by 1999, the projected debt level (15.8 percent of GDP) is only one-third of the capacity under the highest interest rate assumption (43.1 percent of GDP). However, for 1995 the expected debt level exceeds the projected debt carrying capacity for all but the lowest interest rate assumption, again highlighting the role of the privatization proceeds.

4. Conclusions

The generally satisfactory assessment of Trinidad and Tobago’s medium-term fiscal sustainability is reassuring although it is not without risk. The analysis of the nonfinancial Public sector’s net worth at end-1994, which includes as assets only projected revenues based on assumed GDP growth rates and fiscal measures, produces a significantly positive result under the authorities’ medium-term fiscal profile. A sharp rise in the international discount rate to about 13.5 percent from the 8 percent assumed would be required before the result would be reversed. However, the result is predicated on a significant fiscal effort yielding a major improvement in the primary balance over the medium-term. The analysis suggests that the medium-term fiscal profile is an appropriate one.

The projections of the debt/GDP ratio of the sustainability approach also yield generally satisfactory results, with the ratio projected to decline continuously throughout the medium-term. This approach highlights the sensitivity of the results to the interest rate assumption and the growth rate of GDP, which under the authorities’ medium-term program is expected to be lifted sustainably to higher real levels. However, for the initial years the margins of improvement are relatively small, with the major improvement occurring in the outlying years. As noted above, this approach underestimates the projected decline in the debt/GDP ratio on account of divestment program. The divestment program is projected to be largely completed in 1997 and contributes about 2 percentage points of GDP a year in resources to the Central Government in 1993-95.

The annuity type analysis of the debt capacity approach provides an interesting glimpse into the ability of the Central Government to carry external debt. This analysis highlights the importance of the type of financing and underscores the appropriateness of the authorities’ policy to maximize the use of multilateral financing options and de-emphasize Eurobond financing. The over-capacity debt burden in 1994-95, made possible by the divestment proceeds, again highlights the need to adhere to the medium-term fiscal profile of sharply increasing the primary surplus.

References

  • Blanchard, Olivier, “Suggestions for a New Set of Fiscal Indicators,” Department of Economics and Statistics Working Paper No. 79, (Paris: OECD, April 1990).

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  • Buiter, Willem H., “Measurement of the Public Sector Deficit and Its Implications for Policy Evaluation and Design,” Staff Papers, International Monetary Fund, Vol. 30 (June 1983), pp. 306-49.

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  • Guidotti Pablo E. and Manmohan S. Kumar, “Domestic Public Debt of Externally Indebted Countries,” Occasional Paper No. 80, IMF, Washington D.C., June 1991.

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  • Wijnbergen, Sweder van, “External Debt, Inflation, and the Public Sector: Toward Fiscal Policy for Sustainable Growth,” The World Bank Economic Review, Vol. 3, No. 3:297-320 (1990).

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  • “Sustainability of Fiscal Policy in the Major Industrial Countries,” Supplementary Note 2, World Economic Outlook, IMF, Washington D.C., October 1990.

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1/

The analysis concerns the nonfinancial public sector only.

2/

The approach used in this analysis is based on the formulation developed in Guidotti Pablo E. and Manmohan S. Kumar, “Domestic Public Debt of Externally Indebted Countries,” Occasional Paper No.80, International Monetary Fund, Washington D.C., June 1991. This approach was developed by Buiter, Willem H., “Measurement of the Public Sector Deficit and Its Implications for Policy Evaluation and Design,” Staff Papers, International Monetary Fund, Vol.30 (June 1983), pp. 306-49.

3/

Privatization proceeds have not been included in fiscal revenues, contrasting with the GFS methodology, as they are transitory in nature.

1/

No country risk premium is included as the purpose of the exercise is to analyze the level of such risk.

2/

The analysis could be extended to the financial public sector (largely the Central Bank). Following our simplified balance sheet analysis in this case, the NIR of the Central Bank, estimated at about 4.5 percent of GDP at end-1994, would be deducted from foreign debt. On the domestic side, data on the primary balance of Central Bank operations would be included in the total, while required banker’s reserves of 20 percent of deposits (about 8 percent of GDP) would be added to domestic debt of the public sector and discounted advances to the private sector would be deducted.

1/

Equal to the yield in late November 1994 on ten-year U.S. treasury note. This instrument was the base used for the latest Eurobond borrowing by Trinidad and Tobago in late 1994.

2/

This approach draws on a forward-looking indicator of fiscal policy sustainability developed by Olivier Blanchard, “Suggestions for a New Set of Fiscal Indicators,” Department of Economics and Statistics Working Paper No. 79, (Paris: OECD, April 1990). A similar approach applied to external debt was presented by Sweder van Wijnbergen, “External Debt, Inflation, and the Public Sector: Toward Fiscal Policy for Sustainable Growth,” The World Bank Economic Review, Vol. 3, No.3:297-320 (1990). See also calculations for the industrial countries in “Sustainability of Fiscal Policy in the Major Industrial Countries,” Supplementary Note 2, World Economic Outlook, International Monetary Fund, Washington D.C., October 1990.

3/

The analysis is valid in both nominal and real terms; we will use nominal values.

1/

This is made possible inter alia by the sale of public assets under the Government’s ambitious divestiture program, which has provided about 2.1 percent of GDP in resource inflows in both 1993 and 1994.