Joint World Bank-IMF Debt Sustainability Framework for Low-Income Countries

August 15, 2018

Low-income countries (LICs) have often struggled with large external debts. The IMF and the World Bank have developed a framework to help guide countries and donors in mobilizing the financing of LICs' development needs, while reducing the chances of an excessive build-up of debt in the future. The Debt Sustainability Framework (DSF) was introduced in April 2005 and is periodically reviewed. The current framework was approved by IMF and World Bank Executive Boards in September 2017 and has been implemented since July 2018.

Strategic approach to reach goals

The framework is designed to guide the borrowing decisions of LICs in a way that matches their financing needs with current and prospective repayment ability.

Under the DSF, debt sustainability analyses (DSAs) are required to be conducted regularly. These consist of: (i) an analysis of a country’s projected debt burden over the next 10 years and its vulnerability to economic and policy shocks—baseline and stress tests are calculated; and (ii) an assessment of the risk of external and overall debt distress , based on indicative debt burden thresholds and benchmark, respectively, that depend on the country’s macroeconomic framework and other country-specific information.

Assessing debt to avoid risks

The DSF analyzes both external and public sector debt. The framework focuses on the present value of debt obligations for comparability, as terms extended to LICs vary considerably and still carry concessionality. A 5 percent discount rate is used to calculate the present value of external debt.

To assess debt sustainability, debt burden indicators are compared to indicative thresholds over a projection period. There are four ratings for the risk of external public debt distress :

  • low risk, generally when all the debt burden indicators are below the thresholds in both baseline and stress tests; 

  • moderate risk, generally when debt burden indicators are below the thresholds in the baseline scenario, but stress tests indicate that thresholds could be breached if there are external shocks or abrupt changes in macroeconomic policies;

  • high risk, generally when one or more thresholds are breached under the baseline scenario, but the country does not currently face any repayment difficulties; or

  • in debt distress, when the country is already experiencing difficulties in servicing its debt, as evidenced, for example, by the existence of arrears, ongoing or impending debt restructuring, or indications of a high probability of a future debt distress event (e.g., debt and debt service indicators show large near-term breaches or significant or sustained breach of thresholds).

    To flag countries with significant public domestic debt, the framework provides a signal for the overall risk of public debt distress, which is based on the joint information from the four external debt burden indicators, plus the indicator for the present value of public debt-to-GDP ratio.

    Countries with different policy and institutional strengths, macroeconomic performance, and buffers to absorb shocks, have different abilities to handle debt. The DSF, therefore, classifies countries into one of three debt-carrying capacity categories (strong, medium, and weak), using a composite indicator, which draws on the country’s historical performance and outlook for real growth, reserves coverage, remittance inflows, and the state of the global environment in addition to the World Bank's Country Policy and Institutional Assessment (CPIA) index. Different indicative thresholds for debt burdens are used depending on the country’s debt-carrying capacity.

    Thresholds corresponding to strong performers are highest, indicating that countries with good macroeconomic performance and policies, can generally handle greater debt accumulation.

    Debt Burden Thresholds and Benchmarks Under the DSF


PV of external debt in percent of

External Debt service in percent of

PV of total public debt in percent of 

GDP

Exports

Export

Revenue

 GDP

Weak

30

140

10

14

 35

Medium

40

180

15

18

 55

Strong

50

240

21

23

 70

Integrating debt issues into policy advice

The DSF has enabled the IMF and the World Bank to integrate debt issues more effectively in their analysis and policy advice. It has also allowed comparability across countries.

The DSF is important for the IMF’s assessment of macroeconomic stability, the long-term sustainability of fiscal policy, and overall debt sustainability. Furthermore, debt sustainability assessments are taken into account to determine access to IMF financing, as well as for the design of debt limits in Fund-supported programs , while the World Bank uses it to determine the share of grants and loans in its assistance to each LIC and to design non-concessional borrowing limits.

The effectiveness of the DSF in preventing excessive debt accumulation hinges on its broad use by borrowers and creditors. LICs are encouraged to use the DSF or a similar framework as a first step toward developing medium-term debt strategies. Creditors are encouraged to incorporate debt sustainability assessments into their lending decisions. In this way, the framework should help LICs raise the finance they need to meet the Sustainable Development Goals (SDGs), including through grants when the ability to service debt is limited.

Key reforms that took effect in July 2018 include: (i) moving away from relying exclusively on the CPIA to classify countries’ debt-carrying capacity, and instead using a composite measure based on a set of economic variables; (ii) introducing realism tools to scrutinize baseline projections; (iii) recalibrating standardized stress tests while adding tailored scenario stress tests on contingent liabilities, natural disasters, commodity prices shock, and market-financing shock; and (iv) providing a richer characterization of debt vulnerabilities (including those from domestic debt and market financing) and better discrimination across countries within the moderate risk category.