The Global Dimension to Fiscal Sustainability

adjustments in most emerging market economies. Contagion, financial globalization’s
“evil twin”, further ensured that the pain was not only felt by countries at the
epicentre of the crises, but throughout global capital markets.

The inability and/or reluctance of emerging market countries to issue debt in
domestic currency fostered a close link between global capital markets and domestic
debt and this is identified in the literature on Original Sin and Debt Intolerance.² A
large share of public debt in emerging markets is denominated in foreign currency and
of short-maturity. The vulnerability of fiscal sustainability in emerging markets to
adverse external shocks has been widely studied (see inter alia Reinhart, Rogoff and
Savastano, 2003, Kaminsky, Reinhart and Végh, 2004, Calvo, Izquierdo and Talvi,
2003).

Emerging market sovereign bond spreads increased sharply across the board
following the 1998 Russian Crisis, when global liquidity temporarily vanished.
During 2002 and 2007 there has been a surge in global liquidity: capital flows
recovered and emerging market sovereign bond spreads reached record lows. The
easing of financing constraints of emerging market economies lead to a general
improvement of fiscal sustainability in emerging markets, see Hauner and Kumar
(2005).³

As global market conditions impact fiscal sustainability in emerging markets,
it appears that a significant part of debt dynamics in emerging markets are beyond the
direct control of domestic policy makers. A sudden stop increases the cost of capital
for emerging market borrowers, while a surge in global liquidity makes capital cheap.

² For the literature on Original Sin see Eichengreen and Hausmann (1999) and for Debt Intolerance see
Reinhart, Rogoff and Savastano (2003).

³ Hauner and Kumar (2005) argue that in recent years financial globalization and benign global market
conditions have helped emerging markets in their external financing and budgetary positions. They
argue that benefits from the benign environment have been substantial, but point out that the potential
reversal of the favourable external conditions underlines the need for further fiscal reforms.

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