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"Monetary Review - 1st Quarter 2000"

 

Interest and Dividend on Denmark's External Debt

Frank Øland Hansen and Lill Thanning Hansen, Statistics Department

INTRODUCTION

The average net interest on Denmark's external debt was 8.7 per cent in 1998. This figure may appear high in view of the decline in interest rates in recent years. The explanation is that Denmark's external liabilities accrue interest at a higher rate than Denmark's external assets. The interest on total assets in 1998 is thus calculated to be 3.9 per cent, while the interest on liabilities is calculated to be 4.8 per cent. The following describes how the gross interest level should be used to calculate and interpret the real interest burden on the external debt.

During the 1990s the level of interest on Denmark's external assets and liabilities declined and the spread between the interest levels for assets and liabilities narrowed. Three reasons for this trend are identified: the falling level of interest rates in Denmark and abroad, the narrowing of the interest-rate differential to the euro and a change in the composition of Denmark's external assets and liabilities.

GROSS STATISTICS

Since the beginning of the 1960s Denmark has built up external debt, which peaked at kr. 332 billion at the end of 1991. The debt accumulation is related to sustained deficits on the current account of the balance of payments from the mid-1960s to the end of the 1980s, and to value adjustments. Today, the interest payments on this debt are the primary reason that Denmark does not have a substantial surplus on the current account of the balance of payments, even though the balance of goods and services shows a surplus. The interest burden on the external debt is thus of great significance to the Danish economy.

The greater internationalisation in recent years is apparent from the fact that both Denmark's external assets and liabilities have increased rapidly, cf. Chart 1. The average external debt of kr. 292 billion in 1998 can thus be related to liabilities of kr. 1,447 billion and assets of kr. 1,155 billion. Denmark's net interest expenditure therefore conceals substantial gross interest payments to and from abroad.

Chart 1 DENMARK'S EXTERNAL ASSETS AND LISBILITIES

If the level of interest on the external debt is calculated as the net interest expenditure divided by the net debt the interest is more than 10 per cent in the period 1992-96, falling to 8.7 per cent in 1998, cf. Chart 2. However, this calculation is problematic since the liabilities accrue interest at a 1 per cent higher rate than the assets. The effect of this difference in interest rates on the large gross holdings is that the net interest level is far greater than the gross interest level. If the interest on liabilities is greater than the interest on assets there may even be net interest expenditure even if the external debt is zero. This was the case when Norway became a net creditor in 1997, but still had net interest expenditure of 7 billion Norwegian kroner ^[3] . In this case the net interest is negative, which is of course meaningless.

Chart 2 GROS AND NET INTEREST

A reduction of Denmark's external debt to zero thus cannot in itself be expected to reduce the net interest expenditure to zero. At the interest rates applying in 1998, even without an external debt Denmark would still have interest expenditure in the range of kr. 10 billion, which is solely due to the differing levels of interest on assets and liabilities. ^[2] The relation between the interest levels on assets and liabilities is thus of great significance to the scale of Denmark's net interest expenditure. The following sections consider the reasons for the differing interest levels on assets and liabilities.

INTEREST RATES AND INTEREST-RATE DIFFERENTIAL

Both Danish and international interest rates fell during the 1990s, cf. Chart 3. The interest-rate differential to Germany simultaneously narrowed.

Chart 3 DANISH AND GERMAN INTEREST-RATE LEVELS

Note : The interest-rate levels are annual averages.

The drop in interest rates has reduced the interest on both Denmark's external assets and external liabilities. In 1992 the interest rate on assets was thus 4.6 per cent, and on liabilities 6.7 per cent, while in 1998 the interest rate had fallen to 3.9 per cent for assets and 4.8 per cent for liabilities. In isolated terms the decrease in international interest rates and the consequential decline in Danish interest rates have reduced Denmark's net interest expenditure.

In some years the level of interest on total assets and liabilities appears to be low in relation to the level of interest rates. The low interest level is related to such factors as the exclusion of non-distributed profits in the compilation of interest and dividend, while trade credits, which rarely accrue interest, are included in the compilation of assets and liabilities.

The differing interest levels on assets and liabilities is related to among other things a combination of the currency composition of the assets and liabilities and Denmark's interest-rate differential to the euro. Since a far greater proportion of liabilities than assets are denominated in Danish kroner an equivalently larger proportion of Denmark's liabilities than assets accrue interest at the higher Danish rate.

During the period under review the difference between the level of interest on assets and liabilities narrowed from 2.1 per cent to 0.9 per cent. In isolated terms the narrowing reduced Denmark's net interest expenditure. The increasing volumes of assets and liabilities influence the trend in the opposite direction. Since the liabilities accrue interest at a higher rate than the assets, this increases Denmark's net interest expenditure.

COMPOSITION OF THE DEBT

The decline in interest rates and the narrowing of the interest-rate differential are two reasons for the development in the level of interest on Denmark's external assets and liabilities during the 1990s. A third reason is the change in the composition of assets and liabilities in terms of currency, maturity and instrument.

Since 1993 the proportion of equity securities among both assets and liabilities has increased, cf. Table 1. The increasing proportions of equity securities are a consequence of share purchases and high capital gains in recent years. This development implies a decrease in the registered interest on Denmark's assets and liabilities. This is because the registered return on shares is relatively low since the major part of the profits of business enterprises is normally not distributed and thus not registered. If capital gains are included in the return calculations show that the average real return on Danish shares was 6.2 per cent in the period 1922-1996. ^[3]

Table 1 DENMARK'S EXTERNAL ASSETS AND LIABILITIES¹

Kr. billion	1992	1993	1994	1995	1996	1997	1998
Assets
Foreign-exchange reserve (net)	45	60	65	59	75	108	116
Banks	284	336	346	309	343	409	470
Other shares	113	127	141	157	192	253	331
Other bonds	42	34	34	34	40	46	54
Other assets	154	161	156	147	153	174	185
Total	637	717	741	706	802	989	1155
Liabilities
The central government's foreign debt	98	134	147	118	104	103	94
Banks	256	207	184	185	214	292	370
Shares	82	89	109	134	155	202	257
Other bonds2	222	301	303	285	356	415	462
Other liabilities	301	287	272	246	234	248	265
Total	959	1018	1015	968	1063	1259	1447
Net liabilities	322	301	274	262	261	270	292

Source :	Danmarks Nationalbank, Denmark's External Debt 1998, Special Reports 3 December 1999.
1	Average of holdings at beginning and end of year.
2	Comprises Danish bonds issued in Denmark and abroad by private business enterprises and local government.

Even though the proportion of equity securities among both assets and liabilities has increased, for all years equity securities constitute a far larger proportion of the assets than of the liabilities. This factor contributes to the lower registered interest on Denmark's external assets than on its external liabilities.

Around one third of the liabilities are debt securities, while residents' holdings of foreign debt securities are relatively modest. Since the registered return on bonds on average is higher than on other outstandings the large difference in the portfolio volumes contributes to explaining the differing levels of interest on assets and liabilities. The calculated return on foreign debt securities is very high, which is probably related to problems in distributing interest and dividend by instrument and sector in 1997 and 1998, cf. Box 1.

Box 1 CALCULATION OF INTEREST AND DIVIDEND PAYMENTS

1	Cf. Lasse Tryde, Danmarks Nationalbank's New Reporting System for Payments Statistics, Danmarks Nationalbank, Monetary Review, 2nd Quarter 1999.

The banks' external assets and liabilities constitute a large proportion of Denmark's total external assets and liabilities. For this reason the development in the level of interest on the banks' external outstandings is of great significance to the development in the overall interest level.

With the exception of 1996 interest on the banks' assets and liabilities has declined since 1993, cf. Table 2. There is no tendency for the banks to change the composition of their instruments. On the other hand, the proportion of the banks' external assets and liabilities denominated in Danish kroner of their total external assets and liabilities has decreased since 1995. Since krone-denominated claims on average accrue interest at a higher rate than claims denominated in the cur.rencies of the EMU member states, the change in the banks' currency composition is a contributing factor to the declining interest rate in the last few years.

Table 2 INTEREST ON DENMARKS'S EXTERNAL ASSETS AND LIABILITIES

Per cent	1992	1993	1994	1995	1996	1997	1998
Assets
Foreign exchange reserve (net)	6.5	4.2	4.3	5.9	5.5	4.5	4.4
Banks	4.4	7.1	5.2	4.2	6.3 I	3.2	3.3
Other shares	4.2	1.6	1.8	2.1	3.2 I	2.0	1.8
Other bonds	11.0	6.7	9.6	9.8	8.7 I	10.4	9.5
Other assets	3.1	2.1	4.4	5.3	6.0 I	7.7	7.0
Total	4.6	4.7	4.5	4.4	5.5	4.1	3.9
Liabilities
The central government's foreign debt	7.6	6.0	6.2	6.5	6.3	4.5	5.4
Banks	4.1	7.3	6.9	5.2	8.8 I	4.4	3.8
Shares	4.5	4.5	4.2	3.7	5.9 I	3.6	3.6
Other bonds	12.5	9.6	9.2	6.9	6.3 I	6.6	5.3
Other liabilities	4.9	3.9	5.1	6.6	6.7 I	6.1	6.4
Total	6.7	6.6	6.7	6.0	6.8	5.3	4.8
Net	10.8	11.0	12.8	10.5	10.8	9.6	8.7

Source: The Payments Statistics and Denmark's External Debt.

In 1997 and 1998 the interest rates on the banks' external assets were very low and at the same time other assets accrued interest at a higher rate than before. This may be related to compilation problems, cf. Box 1. Other assets include loans, deposits, intercompany loans, trade credits and financial leasing. Since a large proportion of the banks' assets is loans and deposits it is probable that some interest payments concerning other assets ought instead to be registered under the banks' interest payments.

Factors such as liquidity and security play a vital role in the banks' placement policies and therefore the banks seldom achieve the highest interest levels. The large proportion of Denmark's total external assets held by the banks thus contributes to the lower level of interest on Denmark's external assets than on its liabilities.

The placement policy for the foreign-exchange reserve attaches great importance to high liquidity and the high credit standing of the counterparties. The foreign-exchange reserve therefore also contributes to the lower interest on Denmark's external assets.

METHOD

This compilation was made on the basis of the payment principle, i.e. only interest and dividend actually paid are included in the statistics. The accruals principle could alternatively be applied. According to the accruals principle interest is registered at the time the obligation to pay arises. This means that interest accruing during a financial period is registered for that period, regardless of whether it is actually paid during the period or not. The payment principle typically entails lower interest on Denmark's external assets and liabilities than the accruals principle. This is because non-distributed profits on equity securities and capital losses on issue of debt securities are not included. ^[4] On the other hand, until the end of 1998 Danish bonds issued abroad are compiled at nominal value, which is normally lower than market value. This implies that the return on Danish bonds is overvalued, cf. Box 2.

Box 2 COMPILATION OF DENMARK'S EXTERNAL DEBT

Another source of uncertainty about the calculated interest concerns payments of less than kr. 2 million, which are not distributed by instrument in the payments statistics before 1998. These payments are distributed in proportion to the distribution of payments exceeding kr. 2 million in each year, cf. Box 1. New information indicates that a larger proportion of income of less than kr. 2 million is dividend rather than interest. The return on foreign shares is therefore probably underestimated as a consequence of the assumption of proportionality.

CONCLUSION

Several factors are of significance to the development in Denmark's net interest expenditure and thereby of an important item of the balance of payments. If the external debt is reduced, the net interest expenditure declines. If the interest-rate differential to the euro narrows further in the coming years, the net interest expenditure will be reduced equivalently. If Denmark's assets and liabilities increase in parallel as a consequence of the greater internationalisation this will on the other hand increase the net interest expenditure as long as the liabilities accrue interest at a higher rate than the assets.

It is thus not possible to predict the development in Denmark's net interest expenditure solely by considering the development in the external debt. The magnitude of the interest-rate differential, the composition of the debt and the degree of internationalisation all contribute to determining this development.

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Footnotes

[1] J.P. Holter og T. Åmås, Yields on Norway's External Assets and Liabilities in 1997 (in Norwegian), Penger og Kreditt – 3/98.

[2] Assume that the liabilities are reduced by kr. 392 billion, while the volume of assets is unchanged. The value of Denmark's external assets and liabilities is thus equal, i.e. kr. 1,155 billion, and the external debt is eliminated. But if the liabilities still accrue interest at a rate 0.9 per cent higher than the assets, Denmark still has net interest expenditure of 0.9 per cent of kr. 1,155 billion, equivalent to approximately kr. 10 billion.

[3] T. Engsted and C. Tanggaard, Risk Premium on Danish Equity Securities (in Danish), Nationaløkonomisk Tidsskrift – 2/99.

[4] The capital loss on deep discounted central-government bonds issued abroad is included in this compilation, however.

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Version 1.0 March 2000 Nationalbanken.
Published by Danmarks Nationalbank March 2000, http://www.nationalbanken.dk