The views expressed in this presentation are the views of the author and do not necessarily reflect the

views or policies
of the Asian Development Bank Institute (ADBI), the Asian Development Bank (ADB), its Board of Directors, or the
governments they represent. ADBI does not guarantee the accuracy of the data included in this paper and accepts no
responsibility for any consequences of their use. Terminology used may not necessarily be consistent with ADB official
terms.

COMMENTS ON
MOHANTY—FRAMEWORK
FOR MANAGING PRIVATE
DEBT
Atish R. Ghosh
International Monetary Fund

ADBI Conference: Managing Private and Local Government Debt in Asia

November 30-December 1, 2017, Tokyo, Japan

* The views expressed in this presentation are those of the author and do not necessarily represent those of the IMF or
IMF policy
SUMMARY
 Large body of literature/analytical frameworks on public debt sustainability, much
less on private debt
 Recent build up of private sector debt in EMEs
 Rising corporate sector leverage (how does it compare to pre-1997 East Asia?)
 Rising household indebtedness, including due to rising housing prices (cause and effect?)
 Much of the debt is dollar-denominated (taper tantrum, lift-off)
 Reliance of banks on wholesale funding/non-core liabilities (how does it compare to pre-
GFC reliance on wholesale funding by Icelandic, Irish, etc. banks?)
 Limited role for financial intermediation and private debt in most macro models
 Models often “pierce the financial veil”; representative agent; aggregate corporate sector

 More analytical work post-GFC, including interaction of collateral/exchange rate/asset

prices (e.g., Korinek et al.)
 But even less on the policy framework for managing private debt—different set of
considerations (e.g., financial sector development/financial inclusion vs. financial sector
resilience); only one sovereign borrower, but many private borrowers with individual assets
and liabilities (cannot aggregate)
 Some rules-of-thumb on when debt is excessive
 Makes more sense for household debt than corporate debt (for corporations, should depend on what the
borrowing was used for—investment? Carry-trade? Equity buy-backs? Interest deductibility?)
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SUMMARY (CONT.)
 Potential triggers for policy action
 Frameworks for detecting credit booms
 Credit gaps (but, while most crises preceded by credit boom, most
credit booms do not end in crisis)
 Aggregate debt service ratio—surely want to differentiate
corporates from households; also differentiate by sector (e.g.,
financial sector vs. manufacturing vs. property, etc.)
 Other early warning indicators
 Deviation of asset (house) prices from model-implied trend (price-to-
income/ price-to-rent ratio). Can look at equity price-dividend ratio, but
otherwise more difficult for corporates
 Currency overvaluation (high value of collateral encourages more
lending), but hard to calculate capital account overvaluation ex ante
 Non-core liabilities of banking system; stress tests of banks’ and
corporates’ balance sheets 3
SUMMARY (CONT.)

 Greater regulation of private sector borrowing?

 Counter-cyclical buffers
 Other macroprudential measures
 Tax on banks’ non-core liabilities
 Corporate sector—mandatory hedging?
 Monetary policy? (respond to asset prices? credit growth?)

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FRAMEWORK FOR PRIVATE SECTOR DEBT
 Conceptually, much more difficult than for public sector debt
 How much is too much debt?
 Public sector: debt sustainability analysis (one borrower, or few borrowers if include
independent local government debt); trade-offs in terms of Keynesian stimulus spending;
provision of public goods, etc.
 Even for public sector, hard to determine how much debt is too much (debt sustainability
analysis); when will the sovereign run into debt-servicing problems (type I and type II
errors); what is the role of the public sector and provision of public goods etc.
 For private sector borrowers—millions of individual entities, each with their own liabilities
and assets, and debt-servicing capacity; at best, we can set very crude rules-of-thumb
(e.g., max LTV ratios for bank lending)
 Very little experience/empirical work on what are risky ratios at an aggregate level (credit
scores)
 Sometime perverse incentives (e.g., due to “lend and distribute” or CDS, creditors are not
interested in a value-preserving debt workout)—cannot necessarily rely on private sector
assessments
 One (wo)man’s debt is another (wo)man’s asset—so does too much debt imply too much
“financialization” of the economy?

 Need a conceptual framework

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FIRST PRINCIPLES APPROACH
 First principles approach:
 Commercial transactions—government should not care … unless there are
externalities
 What externalities might exist:
 May depend on form of liability—securitized debt (who is holding it)? Bank lending?
Direct borrowing from abroad? Pension funds (that will have to be bailed out)?
 If household and corporate liabilities are to banks, and banks serve an essential
function in the economy or if there is potential moral hazard because of deposit
insurance, then a potential externality
 May depend on whether domestic or foreign banks (care more about the former?)
 Also depends on currency—Korinek (and related) models on non-pecuniary
externalities related to foreign currency borrowing
 Excessive borrowing might result in asset price bubbles—followed by fire sales;
downturn of the whole economy
 Moral hazard—e.g., FX-denominated mortgages (with implicit assumption that
government will have to bail out householders or banks)

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EMPIRICAL APPROACH
 Empirical approach:
 Identify rules-of-thumb of crisis vulnerability
 Credit growth above trend
 House prices above normal rent/income ratios
 Leverage ratios above historical norms

 Pragmatic
 Easy to explain to policy makers
 Helps identify indicators—and therefore measures to be taken

 But…
 Type I and type II errors
 Gives no framework for analyzing trade-offs

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HOW WE MIGHT PROCEED
 Adopt an empirical approach, but grounded in first principles
 Identify potential risks, but hone in on those that imply externalities
 E.g., observe large increase in corporate debt (or carry trade)…why
does it matter if certain corporations go bankrupt? These are not
banks…though government may be forced to bailout because
unemployment effects/pension losses
 E.g., observe rapid credit growth…assume the worst will happen (abrupt
end, with widespread defaults/bad loans):
 Who would be affected? Which sectors? What are possible spillovers and
externalities? Why should policy makers care? (But remember: sub-prime
mortgages were a small proportion of all US mortgages)
 A large research agenda—theory combined with empirics
 Even more difficult: identify indicators/metrics to which policy makers
can respond, and measures they can implement
 Crises are very costly…but not infinitely costly: a system that never has
crises is very likely overly-regulated
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CONCLUSION
 Another excellent, thoughtful paper on an emerging
issue of critical importance in many EMEs, full of
useful data and analysis of trends
 Identifies many of the key questions that policy
makers need to confront
 A useful start to a long, difficult research agenda

 Suggestions:
 Try to ground in first principles—why should policy
makers care? What is risky? Why? What are the
externalities?
 Then translate into implementable rules-of-thumb and
indicators for policy makers to take preventive action
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