- Using a sample of 53 high, middle and low income countries over 1970-2001, Reinhart, Rogoff and Savastano (2003) find country-specific external debt (public plus private) thresholds in the range of 1520 percent of GDP for countries that have a history of default and high inflation.

- Pattillo, Poirson and Ricci (2004) [PPR] find that external debt (public plus private) may start exerting a negative effect on growth at levels as low as 18 percent of GDP or 65 percent of exports, based on a sample of 61 developing countries from Africa, Asia, Latin America and the Middle East over the 1969-98 period, with the sample tilted towards MACs.

The results of the three studies cited above need to be qualified. The computation of sustainable debt levels by the methodology in IMF (2003) would suggest that countries such as Brazil, which have raised primary surpluses substantially, now have higher sustainable debt levels, especially as interest rates have fallen. But the opposite is true: the increases in primary surpluses have been driven by the recognition that current debt levels are not sustainable. Likewise, “bad” histories and debt intolerance can be overcome over a decade or two, as the examples in IMF (2004) indicate. And the results in PPR could be driven by weaknesses in policies, institutions and governance, which could explain both high indebtedness and low growth; the influence of such factors is difficult to measure.

# **6.  WHAT IS BEING DONE ABOUT MAC PUBLIC DEBT?**

Given the evidence presented above, MACs should in general aim to permanently lower public debt-to-GDP levels in order to reduce vulnerability and create a better platform for growth. This applies to countries such as Brazil, Jamaica and Turkey, which are already committed to reducing public indebtedness by running primary surpluses of unprecedented magnitude. Even countries such as India, which are not under any imminent threat of a crisis, are concerned about the impact of public debt and spending composition on long-run growth. Even success stories like Chile, Korea and Russia are attempting to lower public indebtedness. The discussion below focuses on the two extremes: where there is a clear public debt overhang and public indebtedness is hurting growth (e.g., Brazil, Jamaica, and Turkey); and where public debt is not a constraint to growth but is being paid down nevertheless (e.g., Chile, Korea, and Thailand).

# **6.1  Highly Indebted Countries**

In this group, the priority is to lower public indebtedness. To a large extent, the question of “How?” is being answered by the countries themselves: “By running large primary fiscal surpluses, and thereby signaling the country’s determination not to either inflate away its debt or default in an attempt to improve creditworthiness and lower spreads.”<sup>45</sup> Countries choosing this course have displayed remarkable political stamina and commitment. Two concerns have arisen during this process. The first is that political commitment might falter. The second is that the quality of the fiscal adjustment leaves a lot to be desired, as public investment programs have been cut to the bone, creating infrastructure gaps that could hurt growth and thereby compromise the process of attaining debt sustainability, as discussed in the section on the conceptual framework.

While both concerns are well-founded, we focus on the second one. Discussions of the possibly self-defeating form of fiscal adjustment tend to pay insufficient attention to the role of the market, politics and the quality of public investments. If the market is unforgiving as 45 But, as noted above, we cannot rule out that this attitude is endogenous to the historically low interest rates since 9/11/2001.

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