Luận văn thạc sĩ UEH early warning system for sovereign debt crisis in developing countries for

VIETNAM - NETHERLANDS PROGRAMME

FOR M.A. IN DEVELOPMENT ECONOMICS

EARLY WARNING SYSTEM FOR SOVEREIGN DEBT CRISIS

IN DEVELOPING COUNTRIES FOR PERIOD 1981-2010

Supervisor: Prof. Dr. Nguyen TrongHoai

Student: Vu ThiLan Phuong

Class: MDE 20

Ho Chi Minh City, October 2016

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ABSTRACT

This study constructed an Early warning system to explain and predict sovereign debt crisis

in 31 developing countries whose data is available through the period 1981-2010 at one

year precedence by employing three-stage strategy with multinomial logit regression. While

three-stage strategy allowed selecting the best predictors among wide range of explanatory

variables, multinomial logit regression solved “post-crisis” bias and thus, improved

prediction quality. The main findings are: (i) Solvency, measured by Public debt over GDP

ratio, is positively correlated with sovereign debt crisis; (ii) Liquidity measures are highly

associated with sovereign debt crisis. When short-term debt to total external debt ratio

grows up or reserves to total external debt ratio decrease, the likelihood of both entering

into debt crisis and remaining in debt crisis rises; (iii) The macroeconomic fundamentals

significantly affect sovereign debt crisis: while GDP per capita growth rate is negatively

associated with both entering into and remaining in crisis , inflation only affect positively

post-crisis period; (iv) The international liquidity, represented by the three-month the U.S.

Treasury bill rate, is highly associated with the first year of crisis and the following years of

crisis rather than the initial year of crisis and (v) both external trade link and political

institution measurements do not impact on sovereign debt crisis. As a result, the study

specified a multinomial logit Early warning model predicting sovereign debt crisis at one

year precedence with six determinants namely Public debt over GDP ratio, Short-term debt

to total external debt ratio, Reserves to total external debt ratio, GDP per capita growth rate,

Inflation rate and Three-month the U.S. Treasury bill rate. In addition, several policy

implications are recommended for the countries to avert sovereign debt crisis.

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ACKNOWLEDGEMENT

First and foremost, I would like to take this opportunity to express my sincere gratitude to

Prof. Dr. Nguyen Trong Hoai, my supervisor, for his strong support and useful advice from

the very first days of my research work. He was patient and sympathetic towards my delay.

His inspiration as well as prompt and intellectual guidance has encouraged me to finish the

thesis.

Finally, I would like to express my deepest grateful to my family, my colleagues and my

friends for their continuous encouragement and support during the time I were busy with

the study. Thanks to their understanding and help, my thesis was finally completed.

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TABLE OF CONTENTS

CHAPTER I: INTRODUCTION.........................................................................................................1

1.1 RESEARCH STATEMENT............................................................................................................................... 1

1.2 RESEARCH OBJECTIVES............................................................................................................................... 2

1.3 RESEARCH QUESTIONS................................................................................................................................. 2

1.4 RESEARCH STRUCTURE ............................................................................................................................... 2

CHAPTER II: LITERATURE REVIEW...........................................................................................4

2.1 SOVEREIGN DEBT CRISIS AND EARLY WARNING SYSTEM ................................................................. 4

2.1.1 Sovereign debt crisis ............................................................................................................................................ 4

2.1.2 Early warning system (EWS)............................................................................................................................... 6

2.2 THEORETICAL LITERATURE ON DEBT DEFAULT.................................................................................. 7

2.2.1 Model of debt overhang ....................................................................................................................................... 7

2.2.2 Model of debt repudiation .................................................................................................................................... 9

2.3 EMPIRICAL LITERATURE ON SOVEREIGN DEBT CRISIS ....................................................................11

2.3.1 Sovereign debt crisis and liquidity measures ..................................................................................................... 11

2.3.2 Sovereign debt crisis and solvency measures..................................................................................................... 12

2.3.3 Sovereign debt crisis and macroeconomics fundamentals ................................................................................. 13

2.3.4 Sovereign debt crisis and external trade link...................................................................................................... 13

2.3.5 Sovereign debt crisis and political institutions................................................................................................... 14

2.3.6 Sovereign debt crisis and global liquidity .......................................................................................................... 15

2.4 CHAPTER REMARKS.....................................................................................................................................16

CHAPTER III: RESEARCH METHODOLOGY ......................................................................... 18

3.1 MODEL SPECIFICATION ..............................................................................................................................18

3.2 VARIABLES AND MEASUREMENTS ...........................................................................................................20

3.2.1 Sovereign debt crisis .......................................................................................................................................... 20

3.2.2 Explanatory variables......................................................................................................................................... 22

3.2.2.1 Country characteristics............................................................................................................................... 22

3.2.2.2 Exogenous factor........................................................................................................................................ 25

3.2.3 Analytical framework for the study.................................................................................................................... 25

3.3 DATA SOURCES ..............................................................................................................................................27

3.4 ESTIMATION METHOD.................................................................................................................................27

CHAPTER IV: RESEARCH RESULTS.......................................................................................... 30

4.1. PRELIMINARY STATISTICS........................................................................................................................30

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4.2. REGRESSION RESULTS FOR EWS .............................................................................................................33

4.2.1 Individual regression .......................................................................................................................................... 33

4.2.2 Backward stepwise regression............................................................................................................................ 35

4.2.3 Multinomial logit regression and final specification .......................................................................................... 35

4.2.4 Result discussion................................................................................................................................................ 39

4.2. CHAPTER REMARKS....................................................................................................................................44

CHAPTER V: CONCLUSION........................................................................................................... 46

5.1 CONCLUSION..................................................................................................................................................46

5.2. POLICY IMPLICATIONS ..............................................................................................................................48

5.3 RESEARCH LIMITATION..............................................................................................................................49

5.4 FURTHER RESEARCH RECOMMENDATION............................................................................................50

REFERENCE ............................................................................................................................................ 51

APPENDICES............................................................................................................................................ 54

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LIST OF ABBREVIATIONS

CPIA Country Policy and Institutional Assessment

EWS Early Warning System

FDI Foreign Direct Investment

GDP Gross Domestic Product

IMF International Monetary Fund

M2 Broad Money Supply

NEER Nominal effective exchange rate

REER Real effective exchange rate

U.S. United States

WB World Bank

WDI World Bank Development Indicators

WEO World Economic Outlook Database

WGI Worldwide Governance Indicators

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