A country has GDP of 10bn pesos and its government has borrowed 1bn pesos of money domestically and $4bn in U.S. dollars. The exchange rate is $1 = 1 peso. Interest rates are 10% on peso denominated debt and 5% on dollar denominated debt.
(a) What is the debt/GDP ratio?
(b) How much are interest payments as a percentage of GDP?
(c) According to UIP what should happen to the exchange rate?
(d) If the exchange rate goes to $1 = 4 pesos, how do your answers to (a) and (b) change?