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The Burden of the Debt Definition of Debt Burden: Debt burden is the cost of servicing debt.

For consumers it is the cost of interest payments on debt. The debt burden will be higher for credit cards and loans with high interest. The debt burden on mortgages will be relatively lower compared to value of loan. For countries the debt burden is the cost of servicing the public debt. Most of this debt burden is a really transfer from one generation to another. However, National debt can be a real debt burden because:

If the debt is held externally. E.g. 25% of US debt is held abroad making US liable for external interest transfers.

When debt is held externally, it may also cause a depreciation in the exchange rate and hence a worsening of the terms of trade. (imports more expensive) High public debt may also cause higher taxes which distort work incentives e.t.c

Debt Burden Ratios This is the ratio of debt burden to income. For example, if you pay 2,000 in debt interest and have an income of 40,000. Your debt burden ratio is 5% If you a country has a debt burden of 100bn and pays debt interest of 60bn. Its debt burden is 60%. Sometimes the debt burden is measured as GDP / Total debt As deficits continue, the national debt goes up. For instance, the U.S. national debt at the end of 1999 exceeded $5 trillion, enough to get anyone worried. In per capita terms, that means that the national debt already amounts to about $20,000 per person. Do they actually have to pay off this debt? It is the notion that every person in the country owes a large debt that makes the existence of the debt seems so serious. By and large, we owe the national debt to ourselves. Each individual shares in the obligation to repay the public debt, but many individuals own the national debt in the form of treasury bonds held directly or indirectly through financial intermediaries. As a first step, one could think of the liability that the debt represents as cancelling out the asset that the debt

represents to the individuals who holds claims on the government. In this case, the debt would not be a net burden on society. However, this argument is limited by the fact that a large portion of the debt is owned by foreigners. The portion of the debt owned by foreigners does represent a future tax burden to be borne by the taxpayers. A more important sense in which the debt may be a burden is through the potential longrun effects of te deficit and debt on the capital stock. Debt financing increases the interest rate and reduces investment. Hence, the capital stock will be lower with the debt financing than otherwise, and output will be lower as a result of debt financing of a deficit. This is a real burden. Thus, if the debt is burden, it is a burden for reasons very different from those suggested by the statement that every person in the United States has a debt of $20,000 as a share of the national debt. The major source of burden arises from the possible effects of the national debt on the countrys net national worth: An increase in the national debt can reduce the capital stock and/or increase the nations external debt. The Debt Overhang Hypothesis The "debt overhang" is defined as the difference between the face value of debt outstanding and its market value -- the expected present value of future resource transfers (debt service minus new debt) from the borrower to the lender. It is a state wherein a debt burden that is so large that an entity cannot take on additional debt to finance future projects, even those that are profitable enough to enable it to reduce its indebtedness over time. It is also used to determine whether the debt is affecting the debtor countries economic growth via reduction in investment. Debt overhang theory is based on the premise that if debt will exceed the countrys repayment ability with some probability in the future, expected debt service is likely to be an increasing function of the countrys output level. Thus some of the returns from investing in the domestic economy are effectively taxed away by existing foreign creditors and investment by domestic and new foreign investor is discouraged.

Debt servicing, including interest payments and repayments, may also be a real linkage from an indebted country. It takes large benefit from the domestic economy to transfer to the foreign economy. Therefore, the country foregoes some spectacular multiplier accelerator

effects. According to Metwally and Tamaschke (1994) as cited by Karagol, this decreases the domestic countrys ability to grow its economy and raises its dependence on foreign debt. It is argued that a debt overhang creates adverse incentive effects on the economic growth in the long run.

The "debt overhang" proposition belongs to the group of moral hazard interpretations of the current debt crisis. Their advocates argue that a "debt overhang" provides a disincentive for adjustment. Both concepts have been put into a specific context. "Adjustment" (which can be thought of as economic reform) refers to the debtor's decision to invest or to consume in a twoperiod model. The economy "inherits" a given stock of debt in the first period which must be serviced in the second period. The decision in period one is to consume or to invest, the latter yielding a return in period two, which serves to pay back the debt and to consume. This decision is presumed to be biased towards consumption in the presence of a "debt overhang". The "debt overhang" may act like a tax on the debtor's consumption in period two. This is because for over-indebted countries, debt service does not depend on scheduled interest and amortization anymore, but is linked to their economic performance via arrears and involuntary lending. If a debtor is only servicing part of his debt, reduced consumption in period one is not offset by higher consumption in the future, because the creditor would reap all or most of the benefits of that adjustment effort. Consequently, it does not pay to invest. The country will instead consume its resources in period one, and will then (have to) default upon its debt. Hence the conclusion, that debt relief would increase the incentive of a debtor country to make an adjustment effort (to invest), because it would leave a larger share of the benefits from investment to the debtor. Debt relief would be in the interest of both debtor and creditor, since now at least part of the debt is repaid.

Other channels through which the need to service a large amount of external obligations can affect economic performance include the crowding out effect. Due to high real interest rates, terms of trade of over borrowed country worsens and shut-off from foreign credit markets. It is expected that investments would have declined because of the decrease in available resources for financing investment and macroeconomic conditions. Moreover, because of the expected higher taxes and deteriorated domestic policies that will affect real returns on investment since the debtor country has to pay their debt obligations, this has led to a decreasing growth rates on investment. In addition, foreign borrowing affects future growth through the effect on interest payment obligations. This causes a higher stock of outstanding debt. This means that external

borrowing increases future debt service obligations because the foreign exchange constraint tightened in the future (Kamin et al., 1989).

In summary, in the debt overhang hypothesis, external debt causes a negative effect on investment. The debtor country cannot benefit fully from an increase in production. A part of the production goes to creditor countries to pay the debt service and this point is a consideration for investment and production decisions.

Debt Burden in the Philippine Setting A major problem facing nations today, particularly the developing ones such as the Philippines, is the size of their external debt. According to the World Bank, total external debt may be defined as debt owed to non-residents repayable in terms of foreign currency, goods or services. When debt gets so large, countries have trouble even paying interest on the loans. As a result, some developing nations talk about defaulting, or not repaying borrowed money, and when countries approach default, borrowers and lenders often try to revise the repayment schedule. Some lenders have found creative ways to resolve the debt crisis. For instance, the Philippines was unable to repay a major loan to the Bank of America, which in turn accepted an offer of 40% stock ownership in the Bank of the Philippines instead of the repayment (Clayton, 1995).

The Philippines had turned to International Monetary Fund (IMF) previously in 1962 and 1970 when it had run into balance of payments difficulties. It did so again in late 1982. An agreement was reached in February 1983 for an emergency loan, followed by other loans from World Bank and transnational commercial banks. Negotiations began again almost immediately after the moratorium declaration between Philippine monetary officials and the IMF. The situation became complicated when it came to light that the Philippines had understated its debt by some US$ 7 billion to US$ 8 billion, overstated its foreign exchange reserves by approximately US$ 1 billion, and contravened its February 1983 agreement with the IMF by allowing a rapid increase in the money supply. A new standby arrangement was finally reached with the IMF in December 1984, more than a year after the declaration of the moratorium (Library of Congress Country Studies).

The Philippines spends a third of its national budget every year for debt servicing. Outstanding external debt as of December 2005 was $54,186 million and about $53,304 million as of March 2006 (Bangko Sentral ng Pilipinas).

Economic theory suggests that reasonable levels of borrowing by a developing country are likely to enhance its economic growth. Countries at early stages of development have small stocks of capital and are likely to have investment opportunities with rates of return higher than those in advanced economies. As long as they use the borrowed funds for productive investments and do not suffer from macroeconomic instability, policies that distort economic incentives, or sizable adverse shocks, growth should increase and allow for timely debt repayments. These predictions hold even in theories based on the more realistic assumption that countries may not be able to borrow freely because of the risk of debt repudiation. Thus, some considerations suggest that at reasonable levels of debt, further borrowing would be expected to have a positive effect on growth. Others stress that large accumulated debt stocks may be a hindrance to growth. Both these elements together imply that debt is likely to have nonlinear effects on growth (Pattillo, et al., 2002).

Risks of External Debt to Philippine Economy High external debts are believed to have harmful effects to the economy. By having a big external debt, the country might focus too much and allot a big part of its budget to the payment of the debt and forget the other aspects of the country that it has to work on. Also, the reputation of a country is also at stake when external debt is looked at and may discourage investments to enter into the country. High external debt also tends to precipitate crises - if, at some point, investors lose faith in the Philippines' ability to service its external debt or its ability to roll the debt over, they would be expected to pull capital out of the country. That would lead to a decline in the Peso, making the debt burden (which is largely denominated in dollars) more onerous. This could further undermine the confidence of investors in the Philippines, leading to further capital flight and further Peso declines, creating a self-fulfilling prophecy of eventual default.

Articles and Arguments on Debt burden in RP (Source: ABS-CBN News 2009, 2010, 2012)

High budget deficit= High Debt burden. The table above shows how huge the deficit our country has incurred on the year 2009. What happened? These are the facts:

Govt Debt Burden Rises to P4.2T


2009- The debt burden of the government continued to get heavy as the global crisis forced the Arroyo administration to spend more on pump-priming activities to stimulate the local economy. The Bureau of the Treasury yesterday reported that the outstanding debt of the national government rose to P4.227 trillion as of end-June from P3.963 trillion a year ago. It was also up month-on-month from P4.219 trillion as of end-May. If divided among the countrys estimated population of 90 million, each would have a share of P46,966 of the total debt of the government. Of the outstanding debt, P2.38 trillion were loans denominated in local currency and borrowed from domestic sources. The remaining P1.85 trillion were denominated in foreign currencies. The government has adopted the policy of borrowing more from local creditors to avoid too much exposure to foreign-exchange volatility. A depreciation of the local currency increases the peso value of debts denominated in dollars.

Peso-denominated loans are usually borrowed through the sale of treasury bills and bonds in the local capital market. Foreign loans are sourced mainly from multilateral lending institutions like the Asian Development Bank and the World Bank, as well as from foreign governments and the sale of sovereign bonds offshore. The Treasury also reported that the national government had a contingent debt of P580.5 billion as of end-June. Contingent debts are loans secured by government agencies and state-owned companies that carry a sovereign guarantee. In case of defaults by the borrowers, the national government will have to pay these loans.

2010 Burden: Philippine Deficits and Debts


2010- Each Filipino now owes P47,039 to local and foreign creditors, based on the national government's total debt stock as of September. A month before that, each of the 92.2 million Filipinos owed P45,889. The culprit: the widening budget deficit that prompts the government to borrow some more. Additional debts, which address current funding needs but could be paid in the future, translate to more debt burden for future generations. The fact that the Philippines has been spending more than it earns is not earthshaking. Even the richest of countries have budget gaps. But prudence dictates that this deficit, which is a fiscal policy issue, has to be manageable. Already, there are concerns about how the Philippines is faring as far as fiscal discipline is concerned. The Philippines blew past its P250-billion fiscal gap target for 2009, recording a deficit of P272.5 billion with one more month to go before the year ends.

The Countrys Current Debt Situation


According to UP Professor Benjamin Diokno, like his mother, PNOY, will take over from an administration that leaves behind a big national debt.

This means servicing would probably take up most of the nations scant resources. Right now, when Mrs. Arroyo took power in 2001, our public debt is just the national governments. Public debt was P2.2 trillion, Diokno pointed out. Now, Diokno says, We have public debt of P4.5 trillion and still dont know real picture. Diokno said this implies that Aquino will have to spend more money for debt servicing right now. Interest rates are low not because of GMA but because its a worldwide situation. When things normalize, I think this government will be faced with a serious debt service problem. With debt at P4.5 trillion, every 1 percentage point increase in interest rates would translate to P45 billion pesos [in additional debt servicing]. Right now, for example, average interest rate is 4%, Diokno added. He also said, If things normalize, it goes to 5%, thats translates into P4 billion. If it goes up to 6 thats a lot of money you can use for social services.

2012- Country's External Debt Burden Eases


2012- The countrys external debt service burden (DSB) as monitored by the central bank declined by 1.32 percent year-on-year to $6.113 billion in the first 10 months of 2011, mainly because of the strength of the peso versus all major currencies at the time of assessment. Based on Bangko Sentral ng Pilipinas (BSP) preliminary data, the principal DSB was lower at $3.895 billion compared to last years $4 billion while interest payments amounted to $2.218 billion, up by two percent compared to the same period in 2010. DSB, which refers to payments of both principal and interests but excludes foreign debt refinancing or conversion of debt into equity, is expected to reach more than $8 billion for the full year 2011, according to BSP estimates which assumed an exchange rate of P42-P45: $1. Based on projections from the central banks international department, the DSB is seen to peak at $10.5 billion by 2015, largely due to maturing National Government bonds amounting to almost $1 billion and other major private sector borrowings worth $4.2 billion. The private sector, based on BSP projections, has an expected DSB of $4 billion for 2011 while the public sector which includes NG guaranteed foreign debt, has almost $6 billion.

The projected DSB is arrived at using the yearly borrowing program of the government and corporates, as well as BSP estimates for exports of goods and receipts from services and income. BSP said that for 2012 and after, they expect DSB to grow by 6.4 percent. As of September 2011, the countrys external debt totaled $62.4 billion, up 4.4 percent year-onyear. The BSP, in a study, said the countrys outstanding external debt is still within the central banks Early Warning System (EWS) threshold of 25.045 percent and the international benchmarks 20-25 percent limit. The EWS is what the BSP use for assessing debt sustainability. The latest outstanding debt show the Philippines sufficient foreign exchange earnings are enough to service maturing principal and interest payments for 2011.

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