One sometimes hears the argument that countries cannot default on domestic debt. Reinhart and Rogoff (2010) show that high domestic debt explains why countries have defaulted on external debt at relatively low debt thresholds and that this has been associated with the temptation to inflate away debt. They therefore argue that the ratio of domestic public debt to the monetary base is a useful indicator of the risk of runaway inflation, while a good indicator of debt default risk is the ratio of public debt to revenue. South Africa’s ratios of public debt to government revenue and domestic debt to the monetary base have almost tripled since 2007. Like many other countries, South Africa’s current level of debt to revenue is much higher than the levels presented by Reinhart and Rogoff for countries that experienced debt defaults before the global financial crisis of 2008/9. It is worth emphasizing that the ratio in South Africa has gone up despite the revenue to GDP ratio being near its highest level in four decades, suggesting South African might be nearing the limit of what further tax increases could raise (see here and here).
The ratio of domestic debt to the monetary base, is still however, much lower than has been the case in the run-up to high-inflation episodes considered by Reinhart and Rogoff. The incentive for a government to gain from trying to inflate away their debt depends on several factors, including the maturity structure, currency composition and extent of inflation-linked bonds in the portfolio of their debt. If, for example, a country has mostly very long duration domestic debt, there may be a stronger incentive to try to inflate away its debt, creating great risk of hyperinflation.
