On new instruments, two proposals that have received wide attention are GDP-indexed bonds and a proposal for overcoming “original sin”, as discussed in section 2.3. Both proposals provoke the question of why such instruments have not been introduced spontaneously by the market: is it because of barriers to financial innovation, and therefore the need for the IFIs to play a catalytic role in generating a critical mass? Or is it that fundamental economic problems need to be addressed in policies, institutions and governance, which take time to address and will not be solved by such instruments? Whichever the answer, the development of such instruments is not imminent.

Another area of progress is debt sustainability analysis (DSA); but it may be difficult to develop practical approaches to key issues. These include ascertaining whether the real exchange rate is in equilibrium or not, and how to model and estimate the interactions among primary fiscal balances, real interest rates and growth. Inadequate data, especially on contingent liabilities, represents yet another impediment. A recent review of methods to incorporate uncertainty into DSA, including those being developed in the IMF, concludes that the IMF approach is likely to be the most valuable for practitioners.<sup>48</sup> In sum, the main breakthrough so far in the field of MAC debt is at the country level. The evident willingness of some countries to address unsustainable public debt situations by reestablishing creditworthiness through fiscal effort is worth encouraging. How exactly IFIs can encourage such efforts is a matter of some debate; what should not be debated is that stronger fiscal fundamentals are a necessary condition for success; for most countries, this implies lowering public debt levels.

# **7.  CONCLUDING REMARKS**

The macroeconomic crises of the 1980s and 1990s have spurred concerns about sovereign debt and capital account openness. Based on a framework drawn from the growth, capital flows and crisis literature, we find that sovereign debt is constraining growth in MACs at current levels of indebtedness. However, the chances of another 1980s-type crisis have receded since the turbulence of the late 1990s. On what is being done, the willingness of countries facing debt sustainability problems to persistently run large primary fiscal surpluses stands out. Based on the relatively low thresholds for debt sustainability identified in the literature and the even lower thresholds at which public debt seems to hurt growth, this response is justified.

For MACs, a major lesson of the crises of the 1980s and 1990s is that paying attention to the government’s intertemporal budget constraint (GIBC) is vital. Crises, no matter their origin in the public or private sector, tend to end up affecting the GIBC adversely. It is not enough to achieve single-digit inflation, as Russia did just six months before its 1998 meltdown; it is not enough to ensure that macroeconomic policy is conservative and that the public finances are in good order, as in Korea before 1997-98. The channels through which the GIBC gets affected are varied and not always straightforward. In addition to the standard variables—primary fiscal balances, real interest rates and growth rates—these include whether or not the enterprise and financial sectors are efficient and competitive with well-structured balance sheets; contingent liabilities, whether explicit (guaranteeing bonds issues by loss-making state enterprises) or implicit (bailing out banks even when there is no explicit deposit insurance); over-valued real exchange rates; and pension reform costs. Also included is the potential impact of exogenous shocks, when the government may be called upon to play the role of a shock absorber. Assessing

> 48 Burnside (2004), drawing upon IMF (2002, 2003b).

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