Hiding public debt
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Hiding public debt

What are the causes of hidden debt?

Authors: Kim , H. J.; Esfahani, H. S.
Publisher: Economic Research Forum, Egypt

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This paper examines the determinants of hidden public debt that is, government financial commitments and contingent liabilities that do not receive official recognition and explicit budgetary allocations but are later assumed by the government as additional debt outside the normal budget. The paper proposes a measure of hidden debt and develops a model that examines its regularities.

The paper notes that government budgets are highly complex and difficult to track. Politicians are often reluctant to make government accounts transparent, either because it is difficult for them to do so or because they prefer to shield part of their activities from public scrutiny. The paper finds that:

  • forces that raise the demand for public expenditure – such as fractionalization and divisions in the government - motivate politicians to resort to disguised expenditure and debt as a means of alleviating constraints on explicit borrowing
  • hidden debt rises when the tightness of constraints on explicit borrowing increases
  • factors that reduce the cost of arranging off- budget debts, such as extensive government intervention in the economy, increase the incentive to hide debt

The paper concludes that the hidden public debt phenomenon is driven by the efforts of politicians to evade fiscal constraints imposed on the government by public pressure, institutional requirements and financial markets. The paper also notes that the politicians’ ability to incur disguised expenditures and liabilities depends on the form and extent of government interventions in markets. The paper suggests that:

  • reaching fiscal discipline requires institutional arrangements that curb the politicians’ use of hidden debt mechanisms
  • aspects of government intervention in markets should be studied further

The paper also discusses the performance of IMF standby programs and notes that the monitoring function (of fiscal operations) of standby programs is strong and the costs that it imposes on off-budget spending ensure that the stock of hidden debt tends to decline towards the end of the program. The paper states that standby programs are successful in bringing about fiscal discipline as long as they last, but not on a more permanent basis.

Finally, the author concludes that the proposed measure of hidden debt used in the paper could be useful for research on fiscal policy. The paper recommends that more information should be collected on the specifics of budget procedures that influence the costs and benefits of hidden debt, as this would provide important policy lessons for improving budget discipline.

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