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G20 Meetings > 1999 Documents

Prudent Debt Management
(Backgrounder)

Finance Ministers and Central Bank Governors Meeting
Berlin, Germany, December 15 & 16, 1999

Why is Prudent Debt Management Important?

The size and composition of a country’s external debt plays a key role in determining its vulnerability to international financial crises. Excessive external debt can make a country susceptible to a sudden loss of financial market confidence. But even where a country’s overall level of debt is acceptable, the country may nonetheless be vulnerable to financial turbulence if the maturity structure of the debt, or "bunching" of debt repayments, leads to a concentration of payment obligations in a relatively short period.

This has led to a renewed interest by the international community in looking for ways of helping countries improve their debt management. The aim is to ensure that they are properly insulated from adverse external shocks that could otherwise trigger a financial crisis.

What is Being Done?

In reducing the vulnerability of countries to financial crises, one of the most important steps governments can take in the management of their own sovereign debt is to avoid an excessive buildup of short-term debt relative to their foreign exchange reserves.

This can be done through:

• innovative approaches to external borrowing. This includes the use of "structured notes," bond contracts that tie debt repayments to variables that affect a country’s ability to pay, such as the prices of key commodity exports; and
• contingent lines of credit with private external lenders. These provide a degree of "insurance" to a country by giving it an alternative source of borrowing if its access to conventional sources of financing is disrupted.

Unsound debt management in the private sector can also leave a country vulnerable to financial turbulence.

Steps to address excessive risk-taking by the private sector include:

• eliminating implicit or explicit government guarantees for external borrowing by private firms, which contribute to excessive foreign borrowing. One example of an implicit guarantee is a fixed exchange rate regime, which can create the illusion that there is no risk that a future fall in the exchange rate will increase the cost of repaying foreign-currency loans; and

• strengthening financial sector regulation and supervision. By establishing an efficient domestic capital market, governments can also provide domestic borrowers with a range of innovative and attractive domestic financing alternatives to external borrowing.

A Role for the G20

At their meeting in Berlin, ministers and governors of the G20 will consider how countries can use prudent external debt management to reduce their vulnerability to financial crises.

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Source: Department of Finance, Canada