Debt and Democracy

• Author: Rabah Arezki and Markus Brückner
• Position: an Economist in the IMF Institute, and is a Ph.D. candidate at Pompeu Fabra University.

COMMODITY-exporting countries often experience large commodity price shocks that pose serious challenges to their macroeconomic stability. For example, the sudden influx of foreign earnings from a surge in commodity prices can increase a country’s real exchange rate (the nominal exchange rate, adjusted for inflation) and make its noncommodity exports less competitive. The effect of such unanticipated price changes on the competitiveness of commodity exporters has been studied widely by economists.

There are other significant, if less studied, repercussions on commodity-exporting countries from such price shocks, which boost both foreign reserves and government revenue. The way the government uses revenue earned from a commodity price surge has a direct effect on a country’s macroeconomic performance and can be beneficial or harmful.

When prices boom, the sudden increase in revenue makes it easier for commodity-exporting countries to repay their external debt. But booms end. A wise use of the revenue earned during good times would be to pay down external borrowing to prepare for leaner times. But a country that does not make judicious use of the windfall––or even uses the boom to accumulate more debt––may find itself in more difficulty. That is because debt would become a bigger portion of its diminished post-boom financial resources and would be harder to pay. The situation is compounded if, as is often the case, the debt is denominated in a foreign currency, such as U.S. dollars. If a windfall received during a commodity price boom is not used to reduce external debt, an external debt default (loosely defined here to include debt restructuring, even if there is no formal default) may follow. Some researchers argue that the 1970s commodity price booms spawned excessive external debt in a number of commodity-exporting countries—for example, Venezuela and Nigeria—which led to the debt crises of the 1980s (Deaton, 1996; Krueger, 1987; Sachs, 1989a).

The prevailing view in international finance literature is that high levels of external debt undermine economic performance by effectively acting as a tax on future investment projects and constraining the financing of these projects (Krugman, 1988; Sachs, 1989b). Given large swings in commodity prices in recent years and the 2009 debt crisis in Dubai, policymakers must gain an understanding of the link between the external debt of commodity-exporting countries and movements in international...