The Interplay Between Public and Private External Debt Stocks

• Author: Joanna Siwińska‐Gorzelak,Michał Brzozowski
• DOI: http://doi.org/10.1111/infi.12095
• Date: 01 December 2016
• Published date: 01 December 2016

The Interplay Between Public

and Private External

Debt Stocks

MichałBrzozowski and Joanna Siwi

nska-Gorzelak

Faculty of Economic Sciences, University of Warsaw, Warsaw, Poland.

Abstract

Using a sample of 48 emerging and developing countries in the 1970–2012

period, we investigated the interactions between the stock of sovereign

debt and the quantity of corporate external borrowing. We found that

public external debt hinders private-sector access to external loan and

bond markets. By contrast, the stock of private debt in international

financial markets exerts a positive influence on public external debt from

all sources except other private creditors. We also found the incidence of

bank crises, capital account openness and the rate of economic growth to

be among the macroeconomic variables that have a significant impact on

both public and private external debts.

I. Introduction

Benjamin Friedman, studying the experience of the United States between the 1920s

and 1980s, found that ‘a long-standing regularity characterizing the US debt markets

was that public- an d private-sector bor rowing exhibited suffic ient negative covaria-

tion over time, b oth cyclically and secularly’(Friedman 1987, p. 398). More recently,

the negative relationshi p between US government and private deb t has also been

International Finance 19:3, 2016: pp. 311–332

DOI: 10.1111/infi.12095

© 2016 John Wiley & Sons Ltd

studied and documented by Gorton et al. (2012). In the same vein, A

gca an d

Celasun (2012) have noted that developing countries with high sovereig n debt tend

to have relatively low levels of external private deb t.

There are firm reasons to hypothesize th at the stocks of public and private debts

can be related. However, as Friedman’s paper shows, this relat ionship is not rock

solid. The quest ion of whether the o bserved negative correl ation between public a nd

private debts is restric ted to the US experience in p articular t imes, or is eviden ce of

a more durable styliz ed fact, remains una nswered by the literature. T he sharp

increase in public debt of many develope d countries and the growing d ependence of

corporate sectors in emerg ing markets on foreign finance over the last ten yea rs

clearly indicate t hat understandin g the consequences of pu blic debt is now more

pressing than ever.

Although there is partial e vidence that public de bt crowds out the private sector

from domestic financial markets (Hauner 2009, Ismihan and Ozkan 2012), the two-

way relationship betwee n private and sovereign exter nal debts for a large sample of

countries has not received much attention in the literature s o far. In this paper, we

aim to fill that gap.

From a theoretical perspective, t here are reasons to hypothesi ze that the link

between private and sovereign e xternal debts is ne gative. As has been docu mented,

growing sovereign debt increases the risk of sovereign default, which pulls up the

costs of public- and private-sector borrowing (Cavallo and Valenzuela 2010, A

gca

and Celasun 2012, Klein and Stellner 2014). Therefore, it is feasib le that sovereign

debt could limit the access of t he corporate sector to foreign finan ce. However, the

relationship between public and private debts could run both ways, and the

influence of private external deb t on public debt has not yet been invest igated.

The goal of this paper is to test empirically the hypothesis of a two-way relationship

between public- and private-sector debts. Using a sample of48 emerging and developing

countries

1

in the 1970–2012 period, we concentrate on the relationship between the level

of private debt and the quantity of various types of public external borrowing. The

novelty of the paper resides in its focus on the interplay between the volumes of public

and private external debts, rather than on the interest rates levied on borrowers in

foreign financial markets.

The paper is structured as follows: the literature review in Section II is followed by a

description of theempirical methodology and a discussion of main resultsin Section III.

Section IV summarizes the empirical findings of the paper.

1

Aclassification into emerging an d developing economies is usua lly based on income per capita. For

instance, the United Nation Industri al Development Organization grouping defines countries w ith per

capita GDP of 10,00 0–20,000 international dollars as emer ging industrial econ omies, and countries

with income below the thresh old of 10,000 as developing. The list of sample countries is presented in

the Appendix.

312 MichałBrzozowski and Joanna Siwi

nska-Gorzelak

© 2016 John Wiley & Sons Ltd