# **I. Introduction**

In the wake of the financial crisis of 2008‐09, a number of governments, in both advanced and developing countries, undertook massive fiscal and monetary interventions in order to stave off a system‐wide financial and economic collapse. While necessary, the magnitude of the public liabilities incurred as a result of this unprecedented government action, and the consequences of exiting from the projected high debt scenario, have become in themselves a major source of concern about a future crisis.<sup>2</sup> History has indeed shown that public borrowing accelerates markedly and systematically ahead of a sovereign debt crisis.<sup>3</sup> The International Monetary Fund (IMF) projects that government debt to GDP ratios will rise to 85% in G20 countries by 2014 as a result of the crisis, from 62 percent in 2007.<sup>4</sup> While indeed important, G20 countries, with stronger institutions and policies, are better equipped to deal with pressures of this kind. Among more vulnerable developing, and especially low‐income countries (LICs), the ability to manage their public debt burdens effectively through a crisis of this magnitude is far from assured.

Empirical evidence supports the view that strong public debt management (DeM) institutions and policies have played a critical role in mitigating the effects of the financial crisis in middle income countries (MICs).<sup>5</sup> To some extent, the same could be said for LICs, but for different reasons. In the case of MICs, there has been positive policy action that led to risk reductions in their debt portfolios in the years leading up to the crisis. In the case of LICs, it has been the historical creditor relations dominated by the official sector on the external front, and in many cases (but not always), a captive investor base on the domestic front that has helped to insulate debt portfolios from becoming a source of financial vulnerability. However, the current environment will be particularly challenging for debt managers in LICs as financing options, from official as well as private sources, that were available to them before the crisis may no longer be available or may now have very different cost and risk characteristics. As a result, the challenges of the last two years will require a re‐evaluation of existing debt management strategies, focusing on the assessment and mitigation of potential risk.

While the acute phase of the crisis is over, many pitfalls still remain—foremost among them the potential for a new sovereign debt crisis (see Figure 1). In the LIC context, the pre‐crisis picture was one of optimism. Debt relief through the Highly Indebted Poor Country (HIPC) Initiative and the Multilateral Debt Relief Initiative (MDRI) gave countries new fiscal space and renewed potential for economic growth, which in turn induced new creditors with hardened terms to engage with LICs in both international and domestic markets. However, as conditions in the international capital markets deteriorated, many such plans have been on hold as a new reality has set in. In addition to the longer term trend of declining access to donor funding as LICs move up the development ladder, this flow may be drying up faster than previously anticipated given the severity of the financial crisis on sovereign balance sheets in donor countries. Such a shift in donor flows can fast‐forward the need for LICs to borrow on commercial terms, which could rapidly increase the exposure of their debt portfolios to financial risks if not managed prudently. These developments reinforce the importance of establishing strong institutions and policies.

> 2 See Braga (2010)

> 3 Reinhart and Rogoff (2010)

> 4 IMF Fiscal Affairs Department (2009); in fact the rise in debt levels comes uniquely from the advanced countries in the G20, whose general government debt levels are predicted to rise from 78.2 percent in 2007 to 118.4 percent in 2014.

> 5 See Anderson, Silva and Velandia (forthcoming, 2010)

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