Sustainable debt and deficits in emerging markets

Rising fiscal deficits in the context of high debt ratios can trigger a sudden stop or reversal of capital inflows in an emerging market. These features were found together in early currency crises. Countries in these episodes had low private savings rates and low population densities. But higher private savings can compensate for government dissaving and reduce pressure on balance of payments. Second, in high population density emerging markets in a catch-up phase, sustainable debts and deficits may be higher. Analysis of the evolution of government debt shows how debt ratios fall with growth rates. An optimizing model of a small open emerging market economy (SOEME) with dualistic labour markets and two types of consumers, shows debt ratios would tend to be higher in high growth phases in such emerging markets, and the conditions under which fiscal and monetary coordination can occur. The paper concludes with some application to and assessment of Indian debt and deficit ratios