Financial crises,debt overhang,and firm growth in transition economies

ABSTRACT

We examine the effects of the global financial crisis of 2008 and the European debt crisis of 2011 on the relationship between capital structure, investments, and performance for Eastern European companies. While the existing literature documents how firms’ investments are sensitive to the availability of internal funds and to debt holdings, we further investigate whether this investment sensitivity also translates in different levels of performance, and document that capital structure indeed has both a direct and an indirect effect, mediated by the capital expenditure channel. We show that firms with higher financial flexibility experience higher investments and returns on capital. Over-levered firms instead suffer from a debt overhang condition, forcing them to curb investments, and consequently experiencing lower performance. Overall, we provide evidence on the importance of capital structure and financial flexibility on investments and performance, showing the real consequences of the debt overhang condition on firm value creation. Firms should therefore aim at maintaining adequate financial flexibility in order to be able to pursue future profitable investment opportunities, and avoid the under-investment problem arising from a debt overhang situation.     

Corruption and public debt: a cross-country analysis

Using data from a large panel of countries over the period 1995–2015, this article empirically investigates the effect of corruption on public debt. Overall, the estimates reveal that corruption increases public debt. The effect, however, appears to be heterogeneous across income-related sample splits: it is stronger for advanced economies, but weaker and less statistically robust for less-developed countries, where external factors such as foreign aid may also affect public debt. The analysis suggests the inadequacy of conventional wisdom assuming that more detrimental fiscal effects of corruption arise in low-income countries.     

Endogenous longevity,public debt and endogenous growth

This study explores the mechanism that causes an inverted U-shaped relationship between the public debt to GDP ratio and the economic growth rate which is observed in empirical studies. We show that this relationship is caused even when the government does not introduce the golden rule of public finance, and government health care expenditure has important role in generating this relationship.     

The effect of monetary and fiscal credibility on public debt: empirical evidence from the Brazilian economy

This study relates to the literature regarding credibility effect on public debt for developing economies under inflation targeting. The novelty is the investigation of effects of both monetary and fiscal credibility on public debt and its management. The main idea is that high credibility might improve public debt management. With this purpose, this paper addresses empirical evidence based on the Brazilian experience. The findings denote that credibility is an important instrument to improve the public debt management under inflation targeting.     

Macroeconomic effects of terms of trade fluctuations in commodity exporting advanced economies

The paper examines the impact of world commodity prices on national output and trade balances in Australia, Canada, New Zealand, and Norway, OECD economies that, unlike other advanced economies, are heavily dependent on commodity exports. Contrary to Dutch disease theory based on real exchange rate adjustment, it highlights the relative price effects of terms of trade (ToT) changes on gross domestic product and net exports with reference to the experience of this unique set of OECD countries. The econometric analysis verifies key predictions of this alternative perspective that ToT fluctuations should (i) have no significant short-run impact on GDP and that (ii) due to relative price effects a strong positive relationship between the ToT and net exports is unlikely.     

Ricardian equivalence and the public and private saving nexus in India

This study tests the Ricardian equivalence theorem (RET) and examines the responsiveness of private saving to public saving in India. Most estimators do not provide support for the empirical validity of RET and long-run cointegration between public and private saving. The increases in household saving (HHS) seem to have been engendered by the provision of saving incentives, institution of saving schemes, self-driven motivation to save, and the precautionary accumulations induced by uncovered uncertainties in incomes, rather than by Ricardian behaviour of households. The self-imposed aversion to debt and debt bequest, borrowing and liquidity constraints, and the intertemporal smoothing of consumption have been the added catalysts that contributed to the increases in HHS. The households with binding borrowing constraints, inadequate or no insurance and uncovered uncertainties in incomes seem to have been saving more to pay for higher inflation-tax. The fiscal consolidation and generation of public saving are essential to reduce the tax burden (both explicit through fiscal taxes and implicit through inflation-tax), minimize the likelihoods of economic and financial crises, and maintain the internal and external value of domestic currency.     

Inflation targeting in Brazil

The purpose of this paper is to examine the Inflation Targeting (IT) framework as it is applied in the case of Brazil since its adoption in June 1999. For this purpose we first summarize the macroeconometric model utilized by the Central Bank of Brazil (BCB) in its pursuit of the IT framework. While the focus of this paper is on Brazil, we also examine the experience of other countries with IT (in particular, the BRIC countries: Brazil, Russia, India, and China), both for comparative purposes and for evidence of the extent of success of this ‘new’ economic policy pursued by other IT countries. In addition, we compare the experience of Brazil with IT and with that of non‐IT countries. In the context of non‐IT countries, we ask the question of whether it makes a difference in the fight against inflation whether a country has adopted IT or not. Finally, we examine some features of the Brazilian experience with IT regime.     

The 90% public debt threshold: the rise and fall of a stylized fact

We put the original Reinhart–Rogoff data-set, made public by Herndon et al. (2013), to a formal econometric test to identify public debt thresholds endogenously. We show that the nonlinear relation between debt and growth is not robust. Taken with a pinch of salt, our results suggest, however, that a negative association between central government debt and growth may set in at debt levels as low as 20% of GDP. Further (and greater) thresholds may exist, but their magnitude is uncertain. For general government debt, the threshold is considerably higher at about 50%. Country-specific estimates reveal a large amount of cross-country heterogeneity. For some countries including the United States, a nonlinear negative link can be detected at about 30% of GDP. For others, no nonlinearities can be established. Our results are a formal econometric confirmation that the 90% public debt threshold is not in the Reinhart–Rogoff data. But our results also seem to suggest that public debt be associated with poor economic performance at fairly moderate public debt levels. The absence of threshold effects or low estimated thresholds may not preclude the emergence of further threshold effects, especially as public debt levels are rising to unprecedentedly high levels.     

Geopolitical risks and recessions in a panel of advanced economies: evidence from over a century of data

This paper uses a panel of 17 advanced countries over the annual period of 1899–2013, to analyze for the first time, the role played by geopolitical risks in predicting recessions. After controlling for other standard predictors based on a logit model, we find that while aggregate geopolitical risks do not have any predictive ability, geopolitical acts enhance the probability of future recessions, with geopolitical threats reducing the same.     

De-industrialisation and the balance of payments in advanced economies

This paper defines de-industrialisation as a secular declinein the share of manufacturing in national employment. De-industrialisation,in this sense, has been a widespread feature of economic growthin advanced economies in recent decades. The paper considersbriefly what explains this development and quantifies some ofthe factors responsible. It then examines the experience ofBritain and America, which are two countries that have combinedrapid de-industrialisation with a strong overall economic performance.The paper considers both the domestic situation of manufacturingindustry in these countries and its foreign trade performance.It concludes by examining in detail the British balance of payments,and documenting how improvements in the non-manufacturing spherehave helped offset a worsening performance in manufacturingtrade.     

Human capital formation and public debt: growth and welfare effects of three different deficit policies

We analyze an endogenous growth model public educational spending. We show that the balanced budget policy and the policy with a slight deficit yield higher growth than a debt policy where public debt grows at the same rate as GDP, unless the government is a creditor. As concerns welfare, it can be demonstrated that a strong deficit policy yields lower welfare than a balanced budget and a slight deficit policy, unless initial debt ratios are low and the intertemporal elasticity of substitution is high. Finally, there may exist an inverted U-shaped relation between welfare and deficit-financed educational spending.     

The role of debt profile vulnerabilities in sovereign distress

Sovereign debt distress has raised difficult issues in terms of debt sustainability in the past, but it has been associated not only with medium-term debt dynamics, but also with various dimensions of the debt profile that have typically built vulnerabilities over time. Vulnerabilities associated with the public debt structure and liquidity may play an important role in derailing a stable debt trajectory and thus contribute to debt distress. Financial developments may also contribute to the building in sovereign debt vulnerabilities, as deterioration in financial stability indicators can affect the balance sheet of the national treasury. Based on the experience during 37 debt distress events in countries with market access between 1993 and 2010, this article identifies early warning indicators of sovereign debt distress and defines thresholds – for the whole sample and for different regions – at which these latter have been associated with distress in the past. This approach allows us to assess indicators on an individual basis, and to develop a composite indicator of debt vulnerabilities as well.     

Currency devaluations,aggregate demand,and debt dynamics in economies with foreign currency liabilities

The article uses a post Kaleckian model to analyze how currency devaluations affect aggregate demand and capital accumulation in an economy with foreign currency liabilities in the short-run. In benchmark post Kaleckian open economy models, currency devaluations have two effects. First, they change international price competitiveness and thus affect net exports. Second, devaluations change income distribution and thereby affect consumption and investment demand. The overall effect on aggregate demand and investment is ambiguous and depends on parameter values. Existing models, however, disregard balance sheet effects that arise from foreign currency-denominated external debt. The article develops a novel post Kaleckian open economy model that introduces foreign currency-denominated external debt and balance sheet effects to examine the demand-effects of devaluations. Furthermore, the article models the dynamics of external and domestic corporate debt. It discusses how an economy may end up in a vicious cycle of foreign-currency indebtedness and derives the conditions under which indebtedness becomes stable or unstable. It shows that the existence of foreign currency-denominated debt means that contractionary devaluations are more likely, and that foreign interest rate hikes, and high illiquidity and risk premia compromise debt sustainability. Devaluations only stabilize debt ratios if they succeed in boosting domestic capital accumulation.     

Professional scepticism in two economies with cultural differences and the public interest: evidence from China and the United States

Auditors’ professional scepticism is a topical concern for the audit profession and public interest. This study examines professional scepticism among fraud auditors in the forensic accounting profession in China (CN) and the United States (US). Data are collected from 373 and 401 CN and US auditors, respectively, in two economies with cultural differences. The multinomial logistic regression results indicate that both CN and US fraud auditors have higher levels of professional scepticism than general auditors do. There are no significant differences in traits between CN and US fraud auditors. High-ranking fraud auditors have higher levels of professional scepticism than junior-ranking fraud auditors for both CN and US auditors. The results of our sensitivity analysis validate the main results and indicate the findings’ robustness. Results support the normative pillar of the institutional theory (Scott 1995) that asserts actors (fraud auditors) of institutions would share common norms and beliefs in a social system because they are rooted in professional affiliations (accounting bodies) (DiMaggio and Powell 1983). Our findings contribute to the literature in the arena of the interests of the public and the economy.     

Restructuring financial systems in transition and developing economies: an approach based on the French financial system

The aim of this paper is to contribute to the debate on the redesigning of financial systems in Central and Eastern European and developing countries by focusing attention on specific financial institutions appropriate to easing the transition and fostering the creation of markets. The paper argues that the immediate emulation of the better-known institutions of the most developed, market-based financial systems, i.e. the US and the UK, should not be taken for granted. It underlines, instead, the importance of drawing inspiration from the experiences of a variety of institutions and financial systems. Particularly relevant are those systems that have experienced forms of transition and a mix, over time, of market and state intervention.
The approach of this paper is one of institutional financial economics (Neave, 1991 and Williamson, 1986), in which structural details of financial institutions and contracts, in our case French financial institutions, are analysed. We argue that the principles on which some French financial institutions are based and aspects of their functioning are of value to reformers. We discuss the lessons that can be learnt from the Crédit National, the Commissariat Général du Plan, the CODEVI and the SOFARIS.     

Relative price shifts,economies of scale and poverty during economic transition1

Economic transition is associated with significant shifts in relative prices between private and public goods. If, as a result, public goods claim a larger share of total expenditures, economies of scale in consumption increase. We show how relative price changes might alter the welfare of different‐sized households in the short run and over time. We illustrate, for a selection of transition economies, that conventional poverty profiles are quite sensitive to assumptions made about economies of scale in consumption. In particular, the common view that large households with many children are poor relative to small households (such as those comprising the elderly) is shown to be highly non‐robust.     

Determinants of nonresident government debt ownership

We examine the determinants of nonresident government debt ownership, accounting for domestic and external factors and financial variables during the period 2000Q2–2014Q4, focussing on a small euro area open economy: Portugal. Our results show that better fiscal positions, higher systematic stress in Europe and higher shares of monetary and financial institutions (MFI) cross-border holdings of public debt, increase the share of nonresident held debt, and rising sovereign yields decrease that ratio.     

Reelection,growth and public debt

In this work we examine how economic growth affects public debt when interacted with reelection prospects. Reelection considerations shorten political time horizons and give rise to political myopia that exacerbates debt accumulation. That laxer institutional reelection restrictions (e.g., no term limits) mitigate this effect due to electoral accountability is well known. Incorporating growth, we find that this mitigation can be reversed because less myopic, and more accountable, incumbents put more emphasis on smoothing the effects of growth across generations. We test these predictions using an annual-based panel of U.S. states over the period 1963–2010. Our identification strategy rests on constitutionally-entrenched differences in gubernatorial term limits that provide plausibly exogenous variation in reelection prospects, and aggregate national TFP shocks that are exogenous to individual states. Our estimates indicate that when reelection is possible a one standard deviation positive income shock induces, within the same year, a relative increase of approximately $40 in real per capita public debt.     

An empirical characterization of the effects of public debt on economic growth

Based on a data set of 115 economies, this article empirically investigates the relation between public debt and economic growth. Using the World Bank’s classification for income groups, we initially find that those countries that present the lowest public debt are characterized by the highest economic growth, while the smallest growth rates are associated with the highest public debt. Nevertheless, this conclusion is tempered when we analyse the countries by income level: low-income countries have a different behaviour with respect to lower-middle, upper-middle and high-income countries. When using the IMF’s country classification, the results do not suggest a clear pattern in the public debt–economic growth nexus across different countries, but indicate a heterogeneous relationship between such key macroeconomic variables.     

Inflation targeting in an import dependent indebted economy

This paper develops a one-sector Kaleckian model of an import dependent indebted small open economy; where the mark-up rate is sensitive to both changes in the interest rate and the exchange rate and foreigners provide part of the long-term finance. The short-run consequences of an inflation targeting policy in the form of high interest rates and strong domestic currency are explored. Among the possible short-run scenarios, the one most relevant for developing countries involves a decline in the profit rate, the capacity utilization rate and the rate of accumulation as well as the employment rate and the real wage. Leverage ratio of the firms and the extent of external indebtedness play an important role in bringing about this result. Long-run analysis reveals that this scenario is associated with instability in the long run and that, also in the long run, the extent of foreign indebtedness and the responsiveness of capital inflows to the return on existing portfolios are important in determining the direction of the effects of inflation targeting on the equilibrium debt–capital ratio.