Interactions between public debt management and debt dynamics and Sustainability: theory and application to Colombia

Abstract. In this paper we present an analysis of optimal public debt management and its interaction with debt sustainability and apply it to Colombia. Optimal public debt management, already a difficult and complex issues for emerging market economies, becomes even more challenging when a country has a large and growing and possibly unsustainable debt path that requires a major primary fiscal adjustment to restore debt sustainability. We survey the analytical literature on optimal public debt management and debt sustainability and financeability and emphasize the aspects that are more relevant for emerging markets with limited policy credibility. We then apply the analysis to the case of Colombia. This part first discusses the sustainability of the debt dynamics of the country and provides a primary gap analysis under various scenarios about the fiscal adjustment of the country. Then it provides an overview of the public debt structure and its management in the last decade, considers value at risk scenarios and stress tests for the current structure of the public debt (domestic and external). Finally, it analyses the issue of optimal debt management by: a) considering a VaR and Debt-at-Risk approach; b) describing and discussing the reference model used by the policy authorities; and c) analyzing the challenges faced in the management of the public debt of Colombia in the next few year in a context in which domestic and international market access may be partially or severely limited. Over the next few years the authorities will face a very delicate task of managing the country debt under conditions of limited domestic market access, limited policy credibility, some economic and political/security uncertainty and unfavorable international financial and real market conditions. A sound management of the public debt by type, maturity and currency composition will be essential for the achievement of financial and debt stability.