# **4.2  What Are Countries Doing to Lower Vulnerability?**

Vulnerable countries such as Brazil, Turkey and Jamaica are running primary fiscal surpluses of unprecedented magnitude—and these have persisted for lengths of time that would have been considered politically impossible only a few years ago. This “revealed policy preference” may be the outcome of a realization that debt levels are too high and are hurting development; and that repeated defaults and restructurings are too costly in a long-term development sense. But we cannot rule out the influence of the extended period of historically low international interest rates following 9/11/2001 in deciding to pursue such a course. A last factor is that the relative roles of the government and private sector have been changing in a way that might be consistent with lower public debt-to-GDP ratios.

At the same time, affected countries have raised their reserves relative to short-term external debt, thereby lowering vulnerability to shifting market sentiment. These two responses—running large primary surpluses to dampen the upward trajectory of debt, and bolstering international liquidity—reduce exposure to the mix of unsustainable debt dynamics and vanishing international liquidity that were at the heart of the crises these countries suffered during the 1990s. In addition, the widespread adoption of flexible exchange rates and more conservative macroeconomic policies are a marked departure from the fixed exchange rates and expansionary macroeconomic policies of the 1980s.

One more point is noteworthy: a shift towards domestic currency debt in many of the major countries experiencing a crisis during the 1990s, including India and Brazil. Whether or not this lowers vulnerability depends upon whether it is accompanied by actions that strengthen the government’s solvency, for example, through the generation of higher primary fiscal surpluses achieved through expenditure and revenue reform as opposed to the political expedient of cutting public infrastructure investment;<sup>33</sup> and whether or not capital account convertibility exists. Box 6 discussed this issue in the Brazilian context.

# **4.3  What Does the Market Say?**

No matter the flaws of the market—and allegations of these are numerous, including myopia, greed, herding behavior and excessive risk-taking driven by moral hazard—it remains the ultimate arbiter of MAC debt destiny. Markets today are different today from the 1980s. The large money center banks have been largely replaced by emerging market bond markets. Sovereign external debt is held in diversified portfolios; moreover, even the nature of the investor base for MAC debt has changed in a way that could lead to greater stability.<sup>34</sup> There is greater awareness of individual country fundamentals, with more information readily available.

The incentives are also different on two counts: during the 1980s, at the political level, the fears of a systemic international financial crisis—because of the concentration of the debt in a few large money center banks—played a decisive role in galvanizing high-level support in the creditor countries for a resolution.<sup>35</sup> In spite of the high-level coordination facilitated by country debts being concentrated in a few large banks under the umbrella of the Baker and Brady Plans,

> 33 But recall the caveat that public infrastructure investment is often a money-losing proposition for political reasons.

> 34 Global Development Finance (2005).

> 35 The exposure of U.S. money center banks to countries restructuring debt was 215 percent of banks’ capital and 260 percent of their equity at end-1982; that of UK and Canadian banks was 275 percent and 195 percent of their respective equity;  Chuhan and Sturzenegger (2004).

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