Managing foreign debt and liquidity risks in emerging economies: An overview

Recent crises have revealed major shortcomings in the management of foreign debt and liquidity in emerging market economies. The first section looks at lessons from recent crises on the dangers of excessive foreign debt, particularly if it is short-term. The second section considers official policies to manage foreign debt. It begins by evaluating the idea of “national liquidity”, ie comparing the total liquid assets over the whole economy with the total foreign debt, in terms of both conceptual validity and practicality. Drawing on this discussion, the question of how much government debt should be issued domestically and how much externally is then posed. The role of simple guidelines for government debt management and their relationship with reserve management is also discussed. The third section focuses on the issue of how the “optimal” size of foreign exchange reserves – if this is a useful concept – varies across countries and over time. The so-called “Guidotti rule” is discussed, along with some possible modifications. The final section examines possible policies towards the private sector’s external debt. Such policies include prudential rules for banks and other financial institutions, capital controls, possible disclosure requirements or regulations for companies, and restrictions on households. Options for developing domestic bond markets as an alternative to foreign borrowing are also examined.