## What Is Debt Sustainability?

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### When debt is sustainable
- A debt instrument is a financial claim that requires payment of interest, principal, or both by the debtor to the creditor at a future date.
- Countries incur debt to a wide range of creditors, including private bond holders, banks, other countries and their official lending institutions, and multilateral lenders such as the World Bank.
- A country’s public debt is considered sustainable if the government is able to meet all its current and future payment obligations without exceptional financial assistance or going into default.
- Analysts look at whether policies needed to stabilize debt are feasible and consistent with maintaining growth potential or development progress.
- When countries borrow from financial markets, risks associated with refinancing are important too.
- Definitions of public debt:
  - Narrow: budgetary central government.
  - Broader: general government (budgetary central government, state and local government, extrabudgetary units, and social security funds).
  - Broadest: public sector debt combining general government with public nonfinancial corporations and public financial corporations, including the central bank; includes publicly guaranteed debt and external public debt.
- To properly assess a country’s debt sustainability, it is important to cover all types of debt that pose a risk to a country’s public finances.
- Focusing only on a narrowly defined concept of public debt can lead to unexpected increases (example: loss-making state-owned enterprise debt that is publicly guaranteed ultimately falls on the central government).
- In advanced economies and emerging markets, debt sustainability analysis frequently—though by no means exclusively—focuses on the general government.
- In low-income countries nearly complete coverage of both public and publicly guaranteed debt is standard.
- Holders of public debt matter:
  - IMF and World Bank assessments cover both domestic and external public sector debt.
  - Sovereign credit rating agencies typically concentrate on market-based external public sector debt.

### Why some debt is good
- Public debt is one way to raise money for development; other ways include raising domestic revenue, improving the efficiency of spending, reducing corruption, and improving the business environment.
- These alternatives may take time to materialize and may not be enough.
- Countries should be prepared to keep debt sustainable and ensure it does not jeopardize growth and stability.
- Unsustainable debt can lead to debt distress—where a country is unable to fulfill its financial obligations and debt restructuring is required.
- Defaults can cause borrowing countries to lose market access and suffer higher borrowing costs, in addition to harming growth and investment.
- Three key considerations for countries deciding whether to take on new debt:
  - New borrowing should be consistent with fiscal spending and deficit plans. The new borrowing should be carefully set to keep public debt on a sustainable path.
  - Countries should take a comprehensive approach and compare the return from contracting debt with the cost of accumulating debt. Debt that finances productive social and infrastructure spending can lead to higher income that may ultimately offset the cost of debt service and help balance the risks to debt sustainability.
  - Countries should make efforts to improve debt reporting and debt statistics in the context of comprehensive medium-term debt management strategies. Debt statistics should include coverage of public and publicly guaranteed debt that is as broad as possible, including debt of state-owned enterprises. Sharing this data with lenders can encourage responsible lending.

### How much is too much?
- A country’s debt-carrying capacity depends on several factors: the quality of institutions and debt management capacity, policies, and macroeconomic fundamentals.
- A country’s capacity to carry debt can change over time and is influenced by the global economic environment.
- IMF frameworks for assessing debt sustainability in low-income countries and countries with access to capital markets take individual countries’ debt-carrying capacity into consideration and are calibrated in reference to previous episodes of debt distress for groups of countries with similar economic characteristics.
- Calibrations lead to debt sustainability analysis thresholds for key public debt indicators that signal higher risk if that indicator exceeds (or is expected to exceed) its threshold; thresholds can be either based on historical experience or convey information about the likelihood of future debt distress.
- These frameworks consider the degree of uncertainty in projections of the debt and debt service indicators through fan charts and stress tests.
- Because assessments are based on projections of debt, interest, and key macroeconomic variables, both frameworks rely on tools to help gauge the realism of these forecasts.
- The IMF’s approach to debt sustainability also leaves room for informed judgment.
- In the context of the pandemic, key points:
  - Question: whether debt-carrying capacities have improved sufficiently to handle elevated debt levels.
  - Since the global financial crisis, low interest rates have arguably increased countries’ capacity to borrow, but this does not necessarily translate into an ability to handle higher debt service.
  - Experience shows limits to countries’ debt-carrying capacity—and rising debt-service burdens need to be carefully managed.
- Growth’s role:
  - All else equal, higher growth improves debt dynamics.
  - Most historical cases of significant debt reductions without restructuring have involved a surge in growth.
  - In many of these cases growth was driven by factors outside the countries’ control, such as a global boom, the coming onstream of natural resources exports, or improved terms of trade.
  - Without such external impulses, stimulating growth domestically for a sustained period can be difficult and can require new debt (for instance, to fund public investment).
- With the current uncertain outlook for growth, debt service needs to be carefully managed, and strengthening debt management and debt data should be top priorities.

*DALIA HAKURA is a deputy division chief in the IMF’s Strategy, Policy, and Review Department.*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2020/september/what-is-debt-sustainability-basics.pdf_