Government Debt Sustainability in Iran: Evidence from a Threshold Regression Model

The financial crisis during 2007-2008 and the cost of fiscal policy reform, increasingly revealed the importance of "government debt sustainability" in economic literature. Accordingly, this paper examines "government debt sustainability" based on a nonlinear fiscal reaction function. For this purpose, a fiscal reaction function has been estimated using a Smooth Transition Regression (STR) model in Iran for the period 1971-2014. The findings support a threshold behavior of two regimes in the fiscal reaction functions. In addition, the results indicate that in the first regime (when the ratio of government foreign debt to GDP is less than 3.90%), the government reaction to central bank and domestic banks and non-bank financial institutions debts are not sustainable. However, in the second regime (when the ratio of government foreign debt to GDP is greater than 3.90%), the government reaction to all three types debt (central bank, domestic banks and non-bank financial institutions and foreign debts) are sustainable. Therefore, due to the impact of public debt on economic growth through various channels, it is necessary that "debt sustainability" be considered as a main variable in the objective function of fiscal policies in Iran.