Answer to Question #253224 in Macroeconomics for Ade

Question

A small open economy has a nominal annual GDP of 17 billion pesos, and has been growing at a rate of 2% a year. It has 14 billion pesos of outstanding claims held against it by the rest of the world, which it services at an effective peso nominal interest rate of roughly 2% per annum. It holds claims worth the equivalent of 7 billion pesos on the rest of the world on which it receives an effective peso nominal interest yield of about 4% a year. Presently, its (nominal) current account balance (already excluding net interest payments) is in deficit to the tune of about -850 million pesos a year.

1. Suppose a level of debt-to-GDP is considered sustainable if it is not rising over time. Is the present level of the economy’s current account balance one that is consistent with debt sustainability? Present your analysis and any relevant calculations.

Answer 1

Given, 

A small country with the following information:

GDP of 17 Billion Pesos with a growth rate of 2% a year

14 Billion Pesos of outstanding claims against it by the rest of the world with a nominal interest rate of 2% per annum

7 Billion Pesos of claims on the rest of the world on which it receives interest yield of 4% a year

Current Account balance is in Deficit of about -850Million pesos a year

Now, according to the question, a level of Debt-to-GDP is said to be sustainable if it does not rise over time. 

An economy's debt is considered as sustainable if the government of that economy is able to meet all its present and future payment obligations without any external financial assistance, i.e. using the GDP to pay for all the debt. 

We know that the country's GDP a year is 17 Billion Pesos

The Current Balance of the country (excluding the net interest payments) is -850 Million Pesos.

However, it is given that the country faces 14 Billion Pesos of outstanding claims against it by the rest of the world with an interest of 2% per annum. 

Thus, 

Total GDP=17 Billion Pesos

Outstanding claims= 14Billion Pesos + 2%interest rate per annum, i.e.

280 million

Total Outstanding would be= 14 Billion and 280 million pesos

Now, adding the current account balance, 

we get:

Fifteen Billion and one thirty million pesos

Therefore, since the Total GDP of the economy is 17 Billion, the debt-to-GDP ratio would be sustainable as the GDP is enough to pay off all the outstanding debts without any external help needed.