A Balance-Sheet Approach to Fiscal Sustainability*

CID Faculty Working Paper No. 150

Eduardo Levy-Yeyati and Federico Sturzenegger**
October 2007


Recent empirical research on emerging markets debt, currency crises and fiscal sustainability has placed a significant focus on the role of currency mismatches with the emphasis placed on the currency composition of explicit government liabilities. The key insight of this paper is that these liabilities, while relevant, usually represent a small share of actual government liabilities: indeed, as an indicator of fiscal solvency, they are relatively uninformative – and possibly misleading – if not matched with the remaining liabilities (promises of wage and pension payments among others) and the asset side of the government’s balance sheet: financial and real government assets as well as the present value of future tax collection. These non-debt liabilities and assets may be affected by changes in the real exchange rate in a way that dwarfs the effect on the explicit liabilities which are typically the focus of attention. With this in mind, this paper proposes a balance-sheet approach that, as illustrated by the practical applications included here, may radically alter the results from traditional sustainability evaluations – and, more generally, the perception of a country’s fiscal vulnerability.

Keywords: assets, balance-sheet approach, currency, debt, emerging markets, fiscal sustainability, liabilities

JEL subject codes: P43, H20, H60, H61

*This paper was also published in the HKS Faculty Research Working Papers Series as Working Paper #RWP07-044. Faculty Research Working Papers have not undergone formal review and approval. Such papers are included in the series to elicit feedback and to encourage debate on important public policy challenges. Copyright belongs to the author(s). Papers may be downloaded for personal use only.

**Eduardo Levy-Yeyati is affiliated with the Business School – Universidad Torcuato Di Tella and the World Bank; Federico Sturzenegger is affiliated with the John F. Kennedy School of Government – Harvard University and the Business School – Universidad Torcuato Di Tella.