## pp122617guidance-note-on-lic-dsf ## Source details **Canonical URL:** [pp122617guidance-note-on-lic-dsf](https://www.imf.org/-/media/files/publications/pp/2017/pp122617guidance-note-on-lic-dsf.pdf) ## Other formats - [Markdown version](/-/media/files/publications/pp/2017/pp122617guidance-note-on-lic-dsf.pdf.md) - [Structured JSON version](/-/media/files/publications/pp/2017/pp122617guidance-note-on-lic-dsf.pdf.json) --- ### Shock analysis of rating downgrades from moderate to high risk - Purpose: - Component of the LIC-DSF stress-testing framework assessing risks to debt sustainability under baseline and shock scenarios. - Informs how a move from moderate to high risk is mapped under standardized and tailored stress tests. - Empirical distribution (staff calculations from DSAs since LIC-DSF inception): - For debt stock indicators (PV of debt to GDP and PV of debt to export): - Median shock: around 20 percent. - Upper quartile shocks: larger than 40 percent. - For debt service indicators (debt service to revenue and debt service to export): - Median shock: around 12 percent. - Upper quartile shocks: larger than 35 percent. - Moderate-risk granularity (characterization of “space” to absorb shocks): - “Limited space to absorb shocks”: at least one baseline indicator close enough that the median observed shock would result in a downgrade to high risk. - “Substantial space to absorb shocks”: all baseline indicators well below thresholds such that only shocks in the upper quartile would downgrade to high risk. - All other moderate-risk countries: “some space to absorb shocks”. ### Stress-testing architecture and 2017 reforms - Main changes from the 2017 DSF reforms: - Reduced complexity from five indicators and 24 thresholds to four indicators and 12 thresholds. - Re-calibrated and re-designed standardized stress tests: 7 common re-calibrated and re-designed stress tests across external and public DSA, with improved macro-linkages. - Expanded tailored stress tests and improved guidance on domestic debt vulnerabilities and market-financing pressures. - Use: - Standardized and tailored stress tests evaluate baseline and adverse scenarios; shock analysis of downgrades from moderate to high risk is embedded in these stress tests. ### Inputs, coverage, and realism checks - Required inputs: - Comprehensive stock of public and publicly guaranteed debt and decision on public sector concept. - Macroeconomic projections covering 20 years (historical previous 10 years and projected 20 years). - Financing projections for external and public debt covering projection period. - Debt coverage: - Public sector sub-sectors include general government, non-financial public enterprises, financial public enterprises (including central bank), and other long-term obligations and contingent liabilities. - Principal focus for ratings: external public and publicly guaranteed (PPG) debt. - DSF conducted on gross debt (face value), with public financial corporations excluded but options to consider them as contingent risks. - Disclosure and consistency: - DSA write-up must disclose fully committed and undisbursed amounts of all recently-contracted loans (over the last 5 years) or still-active projects and explain exclusions. - Where DSA coverage differs from fiscal accounts, adjustments must be made and disclosed. - Narrower public debt coverage automatically triggers an additional contingent liabilities stress test. ### Macroeconomic projections and coordination - Projection requirements: - 20-year projection period; input historical (previous 10 years) and projected (next 20 years) values for most variables. - Baseline: most likely scenario given present information; ideally balanced relative to risks and consistent across fiscal, monetary, financial, and external sectors. - Horizon breakdown: - Medium-term (up to 5 years): IMF leads; baseline based on policies already in place or agreed program scenario. - Longer-term (beyond 5 years): informed by typical patterns for developing countries, spending needs for development goals, and country-specific factors. - Coordination: - IMF generally leads medium-term macro projections (3–5 years); World Bank leads longer-term growth and investment-growth relationship assessments. - Dispute resolution mechanism described in Appendix I for large deviations. ### Financing assumptions and grant projection rules - Near term and up to 5 years: - Follow authorities’ borrowing plan and/or donors’ financing plans for grants, concessional, and non-concessional borrowing. - Longer term: - Expected shift from grants to concessional loans, and from concessional to less concessional/commercial terms as countries grow. - Domestic debt expected to shift from central bank and short-term sources to market-based securities. - Projecting grants and MDB assumptions: - Include firmly committed grants; highly likely grants may be included only if their inclusion does not change the risk of debt distress rating. - For World Bank (IDA) and other MDBs: regular credit terms assumed for all years where grant finance is not already committed. - Definitions: - External gross financing needs = current account deficit + amortization of external debt − non-debt creating FDI inflows. - Public gross financing needs = fiscal balance + amortization of public external and domestic debt. - Footnote preserved: - "A debt is usually considered concessional when it includes a grant element of at least 35 percent. The grant element of a debt is the difference between the present value (PV) of debt and its nominal value, expressed as a percentage of the nominal value of the debt (please see IMF and World Bank (2013) for detailed discussions on PV and grant element)." ### Realism tools: purpose and key parameters - Four realism tools (published): - (A) drivers of debt dynamics, - (B) realism of planned fiscal adjustment, - (C) fiscal adjustment-growth relationship (multiplier tool), - (D) public investment-growth relationship. - Realism tool (C) parameters: - Default persistence parameter: "0.6." - Typical fiscal multiplier in a LIC: "about 0.4." - Realism tool (D) growth-accounting framework parameters and formulas: - Growth change: Y_t − Y_{t−1} over Y_{t−1} = β (G_t − G_{t−1})/G_{t−1} + ε_t, where β = 0.15 is the output elasticity. - Government capital accumulation: G_{t+1} = (1−δ) G_t + ɸ i_{G_t}, where ɸ = 1 and δ = 0.05. - Note: "The parameter values applied are derived from the empirical literature." ### Realism-tool signals and recommended responses - Drivers of debt dynamics (Tool A) signals: - (i) significant differences between past debt-creating flows and projected flows; - (ii) high unexpected changes in public debt over the past 5 years. - Realism of planned fiscal adjustment (Tool B): - Flags potential optimism if projected primary fiscal adjustment lies in the upper quartile of historical distribution (LICs with Fund-supported programs since 1990). - Users must justify pace, permanence of measures, strengthened fiscal frameworks, and social/political feasibility if flagged. - Consistency checks and comparative sources: - Compare projections with MDBs, U.N. Regional Commissions, OECD, Institute for International Finance, and commercial banks to place LIC-DSF projections within an informed comparator band. ### Standardized stress tests and default shock calibrations - Standardized stress tests (applied to years 2 and 3 unless noted): - B1. Real GDP growth: - Set to historical average minus one standard deviation, or baseline minus one standard deviation, whichever is lower. - Interaction: inflation elasticity to real growth = 0.6; primary balance deteriorates as revenue-to-GDP unchanged while non-interest spending level kept same. - B2. Primary balance: - Primary balance-to-GDP set to historical average minus one standard deviation, or baseline minus one standard deviation. - Interaction: domestic borrowing cost increases by 25 basis points per 1 percent of GDP deterioration in primary balance for LICs with domestic market financing. - For market-access countries, external commercial borrowing cost increases by 100 basis points per 1 percent of GDP worsening of the primary balance, or 400 basis points, whichever is lower. - B3. Exports: - Nominal export growth (USD) set to historical average minus one standard deviation, or baseline minus one standard deviation. - Interaction: real GDP growth elasticity to exports = 0.8. - B4. Other flows: - Current transfers-to-GDP and FDI-to-GDP set to historical average minus one standard deviation, or baseline minus one standard deviation. - B5. Depreciation: - One-time 30 percent nominal depreciation in the second year, or size needed to close REER overvaluation gap, whichever is larger. - Interactions: real net exports elasticity to real depreciation = 0.15 (starting year after shock); pass-through to inflation elasticity = 0.3 in year of shock. - B6. Combination: - Apply B1–B5 at half magnitude; apply interactions from each. - Historical scenario (A1): - Real GDP growth, primary balance-to-GDP, GDP deflator, non-interest current account, and net FDI flows set to their 10-year historical averages. - Notes: - Historical averages refer to last 10 years. - Default shocks and elasticities can be customized only with explanation; customization is generally discouraged to preserve comparability. ### Tailored stress tests and fully customized scenarios - Contingent liability stress test: - One-off increase in debt-to-GDP ratio in second year. - Components: - (i) minimum starting value of 5 percent of GDP (average cost to government of a financial crisis in a LIC since 1980). - (ii) tailored value for exposures not included in public debt definition. - Default/tailoring examples: - Financial market default/minimum: 5 percent of GDP. - SOE default: default shock default = 2 percent of GDP (median SOE external liability from 2016 Fund staff survey); can be reduced to 0% if already captured. - PPP default trigger: when PPP stock > 3 percent of GDP; default shock = 35 percent of PPP capital stock. - Other tailored shocks: - Natural disaster shock: - One-off 10 percentage points of GDP to debt-GDP ratio in second year for specified vulnerable countries. - Interactions: Real GDP growth −1.5 percentage points; exports −3.5 percentage points in year of shock. - Commodity price shock: - Applies when commodities ≥ 50 percent of exports (previous three-year period). - Exports shocked by price gap closing over 6 years; interactions include GDP growth −0.5 percentage points and fiscal revenues-to-GDP −0.75 percentage points per 10-percentage point price contraction for three years. - Market financing shock (market-access LICs): - 400 bps increase in cost of new external commercial borrowing sustained for 3 years (from year 2). - Shorter maturities for new commercial borrowing (to 5-year maturity, or 2/3 of assumed maturities, whichever shorter). - One-off FX depreciation equivalent to 15 percent in second year. - Fully customized scenarios: - Allow idiosyncratic risks (civil war, epidemic, project delays, contagion, policy slippage). - Can motivate moves to higher risk ratings if extreme. - Illustrative exercises (not affecting rating unless specified): debt restructuring paths, impact of possible grants, SDG-related financing scenarios. ### Risk signals, market financing pressures, and thresholds - External risk rating rules: - Low risk: none of PPG external debt indicators breach thresholds under baseline or most extreme stress test. - Moderate risk: none breach under baseline, but at least one breaches under stress tests. - High risk: any PPG external debt indicator breaches its threshold under the baseline. - "Most extreme stress test" = test yielding highest level of debt on or before tenth year. - Overall risk of public debt distress (joint five indicators: four external + PV of total public debt-to-GDP): - Low overall risk: PPG external low and total public debt-to-GDP below benchmark under baseline and most extreme shock. - Moderate overall risk: PPG external moderate; or PPG external low and public debt benchmark breached under stress tests. - High overall risk: any of four external indicators or total public debt indicator breach respective thresholds under baseline. - Market Financing Pressures Tool (for LICs with market access): - Benchmarks: - Public GFN: 14 percent of GDP - EMBI spread: 570 bps - Interpretation: - Breach of both: high market financing pressures. - Breach of one: moderate market financing pressures. - No breaches: low market financing risks. - EMBI data limited to LICs with longer international market access histories; for others, GFN breach serves as early warning. - Thresholds for PPG external debt (preserved table extract conventions): - CI classification cutoffs: - CI < 2.69 => Weak - 2.69 ≤ CI ≤ 3.05 => Medium - CI > 3.05 => Strong - PV of PPG external debt in percent of GDP (example preserved format in source): - Weak: 30 / 14 / 0 / 10 / 14 (table extract formatting preserved as presented in source) - Medium: 40 / 18 / 0 / 15 / 18 - Strong: 55 / 24 / 0 / 21 / 23 - Benchmarks for PV of total public debt vary with debt carrying capacity; rationale: domestic debt increasingly important and domestic vs external distinctions can blur. ### Judgment, short-lived and marginal breaches, and assets - Short-lived breaches: - Single short-lived breaches (1-year) should be discounted, but may be reintroduced via judgment in limited circumstances (e.g., bullet maturities on Eurobonds). - Short-lived breaches in the very near future should generally be brought back unless mitigating factors exist. - Marginal breaches: - Consider timing, breadth, dynamics, and confidence in macro forecast when discounting via judgment. - Justifications for overriding mechanical signals must be supported by evidence. - Optional probability approach may provide additional insight in borderline cases (Appendix VII). - Liquid financial assets: - Gross debt remains the DSA basis; assets can be accounted for via judgment when they are liquid, unencumbered, and readily available. - Illiquid assets generally should not mitigate breaches. - When assets are important to conclusions, their scale and characteristics must be reported in write-up; net debt can be a memorandum item. ### Debt-carrying capacity and Composite Indicator (CI) - CI formula: - CI = β1 * CPIA + β2 * g + β3 * Remittances + β4 * Import coverage of reserves + β5 * (Import coverage of reserves)^2 + β6 * g_W - Coefficients: - β1 = 0.385 - β2 = 2.719 - β3 = 2.022 - β4 = 4.052 - β5 = −3.990 - β6 = 13.520 - CI calculation conventions: - Based on 10-year averages composed of 5 years historical and 5 years projection. - CPIA held constant (latest value) over 5-year projection period. - CI revisions require two consecutive signals (April and October WEO updates) to upgrade/downgrade classification. ### Probability approach for borderline cases (Appendix VII) - Purpose: - Focuses on evolution of probability of debt distress over time via country-specific probit equations using one of four debt burden indicators (d_j) and non-debt explanatory variables (CPIA, country growth, reserves, squared reserves, remittances, world growth). - Data requirement: - Averages over a 16-year period: 5 years historical, current year, plus following 10-year projected data. - Decision rule: - Compare probabilities with probability cut-offs that minimize a loss function with Type I error weight 0.67. - Probability cutoffs (presented): - GDP: 0.155 - Exports: 0.160 - Revenue: 0.150 - Exports (alternate entry): 0.138 - Use cases: - Optionally used in borderline low/moderate or borderline moderate/high cases to inform judgment. - Template indicates applicability and automatically generates probability approach outcomes; DSA write-up should include both traditional and probability outputs when used. ### Treatment of State-Owned Enterprises (Appendix III) - Exclusion criteria for SOE debt from DSAs: - Enterprise can borrow externally without public guarantee; and operations pose limited fiscal risk. - Binding criteria in LICs when information limited: - High fiscal risk if enterprise carries out uncompensated quasi-fiscal activities or has negative operating balances. - Indicators for exclusion justification (Box AIII.1) include: - Managerial independence; relations with government; periodic audits; published comprehensive annual reports; financial sustainability; absence of contingent liabilities and currency mismatches. - IMF-supported program simplification: - Technical memorandum specifies any exclusion of enterprises for external debt limits and same exclusions expected in DSA. ### DSA write-up, process, and dispute resolution - DSA write-up must include: - Clear public debt definition, macro and financing assumptions, design and outputs of stress tests, realism-tool signals, staff judgment, and authorities’ views (including disagreements). - Production frequency: - Full LIC DSA generally at least once every calendar year; new DSA required with significant changes or IMF financing requests or non-concessional borrowing under World Bank processes. - Streamlined update allowed if more than one DSA in a year and circumstances unchanged; not applicable for new programs. - Review and clearance stages: - Joint IMF–World Bank preparation, departmental reviews, Policy Consultation Meeting, management clearance, mission refinements, circulation to Executive Boards, and publication subject to authorities’ consent. - Dispute resolution: - Attempt resolution at working level; escalate through mission chiefs and MTI director with specified five-working-day windows; unresolved issues escalated to managements who have five working days to resolve or agree to present differing staff views to Executive Boards. *Source: Excerpt from GUIDANCE NOTE ON THE BANK-FUND LIC DSF (sections and tables as provided).* ### 1. Shock Analysis of Rating Downgrades from Moderate to High Risk ______________________________ 45 ### Shock Analysis of Rating Downgrades from Moderate to High Risk ### Role within the LIC-DSF - The shock analysis of rating downgrades from moderate to high risk is a component of the LIC-DSF stress-testing framework, which assesses risks to debt sustainability under baseline projections and shock scenarios. - The 2017 reforms to the LIC-DSF strengthened stress testing, improving macro-linkages and simplifying indicators to better capture debt distress risks. ### Stress-testing architecture and relevant changes (from the 2017 reforms) - The 2017 DSF reforms: - Reduced complexity of debt indicators from five indicators and 24 thresholds to four indicators and 12 thresholds. - Re-calibrated and re-designed standardized stress tests, producing 7 common re-calibrated and re-designed stress tests across the external and public DSA, with improved macro-linkages. - Expanded tailored stress tests and improved guidance on domestic debt vulnerabilities and market-financing pressures. - Standardized stress tests and tailored stress tests are used to evaluate baseline and adverse scenarios; the shock analysis of rating downgrades informs how a move from moderate to high risk is mapped under these scenarios. ### Inputs and realism tools that feed the shock analysis - Key inputs to DSAs that influence shock outcomes include: - Macroeconomic variables and financing assumptions (see Sections III and IV for details on macroeconomic variables, and financing variables). - Realism tools that assess the quality of inputs and may lead analysts to adjust projections, including tools for: - Realism of planned fiscal adjustment. - Investment-growth nexus (realism of baseline growth projection with public investment). - Assessment of domestic debt vulnerabilities and market-financing pressures. - The framework emphasizes realism of financing projections when assessing shifts in risk classification (e.g., the projected share of concessional debt in total external debt). ### Procedures, coordination, and frequency implications for shock analysis - All LIC DSAs are prepared jointly by IMF and World Bank staff; shock analyses (including downgrades from moderate to high risk) are part of the full DSA package. - A full LIC DSA should generally be produced at least once every calendar year; a new DSA is required when there are significant changes in economic circumstances or borrowing assumptions (including conflict and natural disasters), or when there is a request for IMF financing or non-concessional borrowing under World Bank processes. - The DSA write-up must: - Provide a clear and concise description of the definition of public debt used; - Discuss key macroeconomic and financing assumptions, identifying key risks and vulnerabilities; - Describe the design and outputs of DSF stress tests; - Analyze signals from the framework and other judgmental factors to assign a risk rating; - Include the authorities’ views and any disagreement with staff’s main findings. ### How the shock analysis of downgrades is embedded in risk assessment - The framework: - Classifies countries by debt-carrying capacity to determine applicable thresholds. - Evaluates baseline projections and stress-test outcomes relative to those thresholds. - Combines indicative rules and staff judgment to assign risk ratings of external and overall public debt distress (low, moderate, high). - The shock analysis of rating downgrades from moderate to high risk is assessed through standardized and tailored stress tests, supplemented by realism tools and judgement on factors such as domestic vulnerabilities and market-financing pressures. *GUIDANCE NOTE ON THE BANK-FUND LIC DSF* ### 16. The DSA write-up may be streamlined in limited circumstances. If more than one DSA is ### GUIDANCE NOTE ON THE BANK-FUND LIC DSF — Excerpts (Sections III: Inputs; Debt Definition; Macroeconomic Projections; Financing Assumptions) ### Streamlined DSA write-up - If more than one DSA is required in a calendar year and circumstances have not changed significantly then staff can jointly prepare a streamlined update. - The streamlined update can focus on the main changes in assumptions and summarize their impact on debt indicators. - The streamlined approach does not apply in the event of a new program. - The DSA write-up should disclose the fully committed and undisbursed amounts of all recently-contracted loans (over the last 5 years) or still-active projects and provide a clear explanation for any exclusions. ### Where to go to learn more about the DSF - Information: The Joint World Bank–IMF Debt Sustainability Framework for Low-Income Countries and Debt Sustainability Framework for Low-Income Countries (DSF) pages on IMF and World Bank external websites contain links to further reading materials and presentations. - Training: - IMF and World Bank staff conduct periodic DSF workshops, both in Washington D.C. and around the world. - Workshops in Washington are offered primarily to IMF and World Bank staff members. - Workshops abroad are organized for country authorities. - The Massive Open Online Course on Debt Sustainability Analysis will be updated on the EdX platform. - For more information, contact the IMF Institute for Capacity Development and the World Bank’s Global Practice for Macroeconomic, Trade and Investment. ### Inputs — overview - The DSF toolkit requires: - Comprehensive information on the current stock of public and publicly guaranteed debt and a decision about the concept of the public sector to be used. - Macroeconomic projections covering 20 years. - Financing projections for external and public debt covering the projection period. - The Section discusses each of these issues in turn. ### Debt definition: coverage of the public sector - Public sector debt, in its broadest definition, comprises debt from several different sub-sectors, including: - General government (central, state, local governments, social security funds, extra-budgetary funds). - Non-financial public enterprises. - Financial public enterprises (including the central bank). - Other sources: long-term obligations of general government (e.g., unfunded liabilities of social security funds when not explicitly recognized as part of general government debt) and known and anticipated recognition of contingent liabilities (e.g., restructurings of financial institutions, PPPs with triggered guarantees). - The DSF should be based on near-complete coverage of public sector debt to ensure comparability across countries. - The debt definition covers both external and domestic debt: - (i) of the public sector: central, state and local governments, social security funds and extra-budgetary funds, the central bank, and public enterprises (the latter subsuming all enterprises that the government controls). - (ii) private sector debt guaranteed by the public sector. - Public financial corporations are excluded, but the DSF toolkit offers options to consider them as contingent risks. - The principal focus of the DSF, for ratings purposes, is on external public and publicly guaranteed (PPG) debt. ### Central bank and state enterprise considerations - Central bank debt: - Any external debt contracted on behalf of the government would constitute public debt (for instance, borrowing from the IMF). - Central bank debt issuance or foreign exchange swaps for monetary policy or reserves management are excluded from external public debt. - When a central bank is not consolidated as part of the debt concept, debt securities issued by the government and held by the central bank or any other advances to the government should also be included in public debt (i.e., no netting out). - State-owned enterprise (SOE) debt: - Include all available information on the debt of non-financial public enterprises. - Exclusion of a public enterprise from the DSA should only be considered if the enterprise poses limited fiscal risk: able to borrow without a guarantee from the government; does not carry out uncompensated quasi-fiscal activities; and has an established track record of positive operating balances (see Appendix III for detail). - Staff should provide a justification for omitting any fiscally-important public enterprise. - If data constraints limit coverage of SOE debt, the DSA needs to flag this as an omission and identify steps to enhance coverage in the next DSA. ### Consistency with fiscal accounts and disclosure - Where DSA public sector coverage differs from fiscal accounts, adjustments must be made to ensure consistency (e.g., external debt service-to-revenue ratio numerator and denominator must be consistent). - For SOEs included in public debt coverage, ensure the denominator captures any net income that they are already paying (subject to checks about the ability to continue to do so). - Any differences in coverage and adjustments made to ensure consistency must be disclosed. - The concept of public sector debt used is reported in detail in a DSF table; omissions or partial captures of sub-sectors must be explicitly flagged. - A narrower coverage of public debt in the LIC DSF will automatically trigger an additional contingent liabilities stress test to assess risks from omitted sectors; this test can affect the risk rating (Section VI.B). ### Debt definition: coverage of debt (gross debt) - The DSF is conducted on the basis of gross debt. - Gross debt captures the face value of debt and should include appropriate consolidations. - Gross debt is the appropriate concept for debt sustainability as it measures the burden of financing of debt service obligations for which the government is responsible. - The availability of liquid financial assets mitigates, but may not eliminate, risks to debt sustainability (e.g., due to currency or maturity mismatches); Section VIII.D discusses how to account for such assets in the final risk rating. ### Debt recognition and valuation - A government liability should be considered debt when future payments of interest and/or principal are required from the debtor to the creditor. Examples include debt securities, loans, and other accounts payable (including verified arrears to suppliers). - Verified and recognized obligations that are not debt arising from a financial claim (e.g., ICSID arbitration awards; amounts owed to suppliers) should also be included, on a best understanding of their due date. - Use of market value would create circularity; debt within the public sector concept should be shown on a consolidated basis to avoid double-counting. - Public debt should be included based on actual and expected disbursements: - Current public debt stocks should reflect debt outstanding and disbursed rather than commitments. - Projections should include a best estimate of disbursements from contracted and expected loans developed in consultation with the authorities (based on the authorities’ medium-term investment spending and associated financing plan). - The DSA write-up should disclose fully committed and undisbursed amounts of all recently-contracted loans (over the last 5 years) or still-active projects and explain exclusions. ### External debt definition - In principle, external debt should be defined based on the residency of the creditor; external debt should include local-currency denominated domestic debt owed to non-residents. - In practice, because of record-keeping difficulties and limited non-resident participation in domestic debt markets in LICs, foreign-currency denominated domestic debt can often be used as a proxy for external debt. ### Limited exclusions from the DSA - Cases where debt should be excluded (and such exclusions reported in the DSA write-up or as memo items): - Disputed claims: treat the entire amount in dispute as a contingent liability (not included in the stock, but modeled for contingent liability stress test). If only part is disputed, include the undisputed part and treat the disputed part as contingent. - Claims eligible for agreed debt relief (e.g., post-HIPC countries) should be excluded. ### Macroeconomic projections - The DSF analysis must be informed by a macroeconomic framework: interrelated projections of key macroeconomic variables covering sectors of the economy (the “baseline scenario”). - The DSA template requires some, but not all, macroeconomic variables of a typical macro-framework (see Table 2). - Projection requirements: - Specify the macroeconomic framework for a 20-year projection period. - For most variables, input both historical (previous 10 years) and projected (next 20 years beyond the current year) values. - The baseline should represent the most likely scenario given present information and ideally be balanced relative to risks. - Projections should be consistent across fiscal, monetary, financial, and external sectors. - Projection horizon breakdown: - Medium-term projections (up to 5 years): - For Bank and Fund staff, medium-term scenarios must be fully consistent with surveillance and program-related staff reports to which the DSA is appended. - In surveillance engagement, the baseline should be based on policies already in place and those announced that are, in the best judgment of the IMF team (in consultation with the Bank), likely to be implemented. - In program contexts, the baseline should be the adjustment program scenario agreed with authorities and incorporated into program targets. - The output and the real effective exchange rate (REER) gap should generally be assumed to close over the medium term. - Longer-term projections (beyond 5 years): - Should be informed by typical patterns for developing countries, including spending needed for development goals, stage of development, trends in the equilibrium real exchange rate, and country-specific factors (exposure to natural disasters or conflicts). ### Coordination and dispute resolution - IMF and World Bank staff should coordinate closely in producing DSAs, based on respective areas of expertise: - IMF generally leads on medium-term macroeconomic projections (3–5 years). - World Bank leads on longer-term growth prospects and, when required, on assessing the investment-growth relationship. - Bank and Fund country teams should agree on broad parameters and projections (including growth and new borrowing) prior to producing the DSA draft. - In case of large deviations between IMF and World Bank projections, teams are to revert to the dispute resolution mechanism described in Appendix I. ### Financing assumptions - The DSF template requires information on existing debt and planned new borrowing consistent with public and external gross financing requirements identified in the macroeconomic framework. - Users need to specify financing instruments with assumptions on: - External financing source: - Multilateral, encompassing: IMF/WB/Regional Development Banks (IADB, AfDB, ADB, EBRD); other plurilateral institutions should be broken out in a separate line. - Official bilateral, broken out into: Paris Club members and Non-Paris Club members. - Commercial. - Domestic financing sources, broken out into: central bank advances; short-term (under 1 year); medium and long term (MLT) (1–3 years); MLT (4–7 years); and long term (beyond 7 years). - The assumed debt instrument amount from each source and, if available, the residency of the debt holder. - The average terms of each debt instrument: interest rates, grace periods, and maturities of new public borrowing. - Definitions: - External gross financing needs = current account deficit + amortization of external debt − non-debt creating FDI inflows. - Public gross financing needs = fiscal balance + amortization of public external and domestic debt. ### Table 2 — Macroeconomic variables required for the LIC DSA (as presented) - Balance of Payments variables (currency: U.S. dollars): Current account balance; Exports of goods and services; o/w fuel and non-fuel commodities; Imports of goods and services; Current transfers, net total; Current transfers, official; Gross workers’ remittances (“personal transfers” in BPM6); Net foreign direct investment (excluding debt instruments); Exceptional financing; Gross reserves. - Public sector variables (currency: National currency): Public sector revenue (including grants); Public sector grants; Privatization receipts; Public sector expenditure; Public sector assets (liquid and readily available); Recognition of implicit or contingent liabilities; Other debt creating or reducing flows; Debt relief. - Debt variables: Stock of PPG external debt (medium and long term) (U.S. dollars); Stock of PPG external debt (short term) (U.S. dollars); Stock of private external debt (U.S. dollars); Stock of public domestic debt (National currency); Interest due on PPG external existing debt (U.S. dollars); Interest due on private external existing debt (U.S. dollars); Interest due on public domestic existing debt (National currency); Amortization due on PPG external debt (U.S. dollars); Amortization due on private external debt (U.S. dollars); Amortization due on public domestic existing debt (National currency); Stock of outstanding PPG arrears (U.S. dollars). - Other variables: GDP, current prices (National currency); GDP, constant prices (National currency); U.S. GDP deflator (None); Exchange rate versus U.S. dollar, end of period (National currency); Exchange rate versus U.S. dollar, average (National currency); Total investment (National currency); o/w government investment (National currency). *Source: Excerpt from GUIDANCE NOTE ON THE BANK-FUND LIC DSF (sections and tables as provided).* ### 36. Financing assumptions should take into account shifts in borrowing terms and ### pp122617guidance-note-on-lic-dsf - 36. Financing assumptions should take into account shifts in borrowing terms and ### Financing assumptions: near term and longer term - Over the near term and up to 5 years, assumptions should generally follow: - (i) the authorities’ borrowing plan, laid out in a published medium-term debt management strategy document (as agreed in a Bank budget support operation or Fund program where available); and/or - (ii) donors’ financing plans for grants, concessional, and non-concessional borrowing. - Over the longer term: - As countries grow, available external financing would be likely to shift from grants to concessional loans (for the poorest and most vulnerable countries), and from concessional loans towards less concessional loans and more loans on commercial and market terms (for others). - Domestic debt would be expected to shift from central bank and short-term sources to borrowing via a broader range of market-based securities (bonds) issued competitively (Appendix IV). ### Projecting grant financing and MDB assumptions - Care must be taken in projecting grant financing: - Several MDBs and other donors link their decisions to provide grants to the risk rating in the DSA. Assuming in the baseline that new grants are provided can improve the risk rating, and leave the donors unable to provide the grants. - The DSA should include firmly committed grants, and can include highly likely grants provided that their inclusion does not change the risk of debt distress rating (and thus is consistent with the grants being available). - Consultation with donors is needed. - For the World Bank (IDA) and other MDBs: - Regular credit terms on all lending should be assumed for all years in the projection period for which grant finance has not already been committed. - These lenders link the terms of their assistance and allocation of grants to the DSF risk rating, and thus a clean assessment without possible grants is needed. Grants from these donors committed on the basis of the DSA can then be captured at the next DSA cycle. - Footnote definition preserved: - "A debt is usually considered concessional when it includes a grant element of at least 35 percent. The grant element of a debt is the difference between the present value (PV) of debt and its nominal value, expressed as a percentage of the nominal value of the debt (please see IMF and World Bank (2013) for detailed discussions on PV and grant element)." ### Treatment of debt relief, data gaps, and disclosure - Debt relief under the HIPC and MDRI Initiatives: - Treatment depends on a country’s status in the process. - It should be reflected in the baseline for those countries that have reached the HIPC completion point, or in a customized scenario for pre-HIPC completion point countries (see Appendix V). - When precise information on loan amounts and terms is not available: - This needs to be disclosed in the DSA write up, and potential risks from data gaps should be discussed. - Every effort should be made to collect the information, drawing from multiple possible sources, including the creditor. - The DSA write-up should identify gaps, note possible risks, and discuss possible remedial measures to improve data collection. ### DSF realism tools: purpose and list - The realism assessment of the baseline scenario is critical for credible debt sustainability analysis. - The DSF includes four realism tools, each published: - (A) drivers of debt dynamics, - (B) realism of planned fiscal adjustment, - (C) fiscal adjustment-growth relationship, - (D) public investment-growth relationship. - Realism tools are designed to encourage examination of baseline assumptions and are not prescriptive. - If tools flag differences from cross-country or a country’s historical experience, justifications should be clearly discussed in the DSA write-up; otherwise, re-examination or revision of macro projections may be warranted. ### Realism tool (A): Drivers of debt dynamics - The tool presents a decomposition of past and projected drivers of external and public debt dynamics and automatically produces charts showing evolution of external and public debt to GDP ratios for three DSA vintages — the current DSA, the previous year DSA, and the DSA from 5 years past. - Accompanying summary charts show: - (i) the breakdown of drivers of debt dynamics; and - (ii) the composition of past forecast errors. - The tool provides two signals that may point toward areas requiring deeper consideration: - (i) significant differences between past debt creating flows and projected debt creating flows; and - (ii) high unexpected changes in public debt over the past 5 years. - Examples of cautions when interpreting contributions: - A high contribution of unexpected primary deficits to past debt accumulation would caution against counting on a lower contribution in future unless there are known reasons (e.g., changes in the fiscal framework, or one-off shocks in the past). - A low contribution of the GDP growth differential to limiting past debt accumulation would caution against counting on a substantial contribution in future unless there are known reasons (e.g., structural growth-enhancing changes). - A high contribution of real exchange rate depreciation to past debt accumulation would caution against a too optimistic assessment that future contributions will be negligible, unless justified by an assessment that the equilibrium real effective exchange rate gap has already closed. - A high contribution of unexpected other debt creating flows/the residual to past debt accumulation would caution against assuming a small future contribution unless total exposure to contingent liabilities has fallen (for instance, due to recapitalization of the financial sector). - Factors that have contributed to unexpected changes deserve special scrutiny for future assumptions. ### Realism tool (B): Realism of planned fiscal adjustment - The second tool assesses credibility of projected fiscal adjustment based on cross-country experience with sustained fiscal adjustments. - Comparison group: LICs that have requested Fund-supported programs (data cover Fund-supported programs for LICs (excluding emergency financing) approved since1990). - The tool presents the distribution of observed primary fiscal adjustment over a three-year horizon, against which a country’s projected primary fiscal adjustment is compared. - The tool flags potential optimism when the projected adjustment lies in the upper quartile of the distribution of past adjustments of the primary fiscal deficit. - Where the fiscal adjustment has started in the past, the entire adjustment (preceding and projected) should be taken into account for flagging optimism. - If the tool flags a potential problem, the user must justify that the assumed adjustment is credible, discussing: - pace of adjustment, - whether permanent tax and expenditure policy measures have been implemented, - whether fiscal frameworks have been strengthened, - social and political feasibility in the context of development priorities, poverty reduction plans, human rights, or social protection. - Users are encouraged to nest the assessment within broader signals from the multiplier tool and debt-drivers tools. ### Realism tool (C): Consistency between fiscal adjustment and growth - The third tool provides benchmarks for assessing consistency of fiscal adjustment and growth assumptions. - The tool compares the baseline growth projection against growth paths that assume only a fiscal impact from the last observed growth rate, with the fiscal impact calculated under a range of plausible fiscal multipliers, using a default persistence parameter of 0.6. - Default persistence parameter preserved: "0.6." - The tool flags potential optimism/pessimism when the projected growth path significantly deviates from the path derived using a typical multiplier in a LIC (about 0.4). - "A typical multiplier in a LIC country is expected to be low, around 0.4." - Where flagged, possible explanations include: - different multiplier values due to composition of fiscal adjustment, source of financing, macroeconomic policy mix, or different economic conditions; - other real shocks or structural changes affecting the economy (e.g., terms of trade shocks, or new natural resource production and exports coming on line). - If adequate explanations are not evident, consider revising baseline macroeconomic projections. ### Realism tool (D): Consistency between public investment and growth - The final tool assesses consistency between growth and public investment assumptions. - It uses a simple growth accounting framework to flag potential optimism/pessimism in the assumed relationship between public investment and growth, decomposing projected growth rates into: - (i) changes in the government capital stock (due to public investment), and - (ii) all other sources. - Users should ensure comparable public sector coverage across historical and projected data; if investment across a broader concept of the public sector (e.g., including state enterprises) is to be captured, the tool must be populated accordingly. - The DSF presents two charts: - current and previous projections for public and private investment; - simulated contribution of government capital and other factors to real GDP growth: (i) historical contribution of public investment to growth; (ii) previous projection for the contribution of public investment to growth; and (iii) current projection for the contribution of public investment to growth. - The growth/investment tool sends a signal of potential optimism/pessimism when: - There is a difference between the newly projected relationship between public investment and growth and the past projected relationship (based on the previous DSA). - There is a difference between the newly projected relationship between public investment and growth and the calculated historical relationship. - Parameters and formulas preserved from the growth accounting framework: - The change in growth follows: Y_t − Y_{t−1} over Y_{t−1} = β (G_t − G_{t−1})/G_{t−1} + ε_t, where β = 0.15 is the output elasticity. - The accumulation of government capital follows G_{t+1} = (1−δ) G_t + ɸ i_{G_t}, where ɸ = 1 is the public investment efficiency parameter, and δ = 0.05 is depreciation. - Note: "The parameter values applied are derived from the empirical literature." *Guidance Note on the Bank‑Fund LIC DSF (excerpts pp. 19–26).* ### 52. Where potential optimism/pessimism is flagged, the user should consider whether ### pp122617guidance-note-on-lic-dsf - 52. Where potential optimism/pessimism is flagged, the user should consider whether ### Realism checks for baseline projections (paras 52–54) - Users should evaluate whether flagged potential optimism/pessimism has a reasonable explanation (e.g., different investment efficiency estimates, differing impact of changes in capital stock on output based on country-specific factors). - Users might assess that parameters differ from DSF assumptions (examples given): - Stronger efficiency and higher impact due to strengthening of institutions. - Better prioritization of projects could lead to stronger effects from public investment. - Users should consider changes in macroeconomic context as explanations (example given): - Elimination of an output gap between DSA vintages could suggest a higher likelihood of crowding out (where public investment is offset one-to-one by declines in private investment). - Where no reasonable explanation exists, users should consider adjusting projections as part of the iterative DSA construction process. - Comparative checks: - To increase comfort in short-to-medium term elements, review projections for key macro variables prepared by other International Organizations (e.g., MDBs, U.N Regional Commissions, OECD) and alternative sources (e.g., Institute for International Finance, investment and commercial banks). - Such comparisons place LIC-DSF projections within a band of informed comparators to highlight over-optimism/pessimism. ### Illustration of realism-tool use (para 53) - Example summarized: - Public investment was previously scaled up; current projection assumes a high investment rate is being sustained. - The realism tool shows a higher contribution to growth from public investment in the current DSA. - Nonetheless, overall growth rate is lower than historical outturn; users need to consider whether this is explained by anticipated contraction in other sources of growth. ### Debt carrying capacity: overview (Section V, paras 55–56) - Debt carrying capacity determines debt and debt service thresholds for risk assessment. - The DSF classifies countries using a composite indicator (CI) that combines: - World Bank’s CPIA score, - real GDP growth, - remittances, - international reserves, - world growth. - For currency union members: - Union-wide reserve coverage is generally appropriate. - If a member has effectively lost access to the reserve pool (or will for an extended period), classification should use imputed reserves for the individual member, with a zero floor (imputed reserves can be calculated as reserve money minus net domestic assets where needed). ### Composite Indicator (CI): formula, coefficients, and calculation (paras 57–59) - CI formula (variables in percent except CPIA): CI = β1 * CPIA + β2 * g + β3 * Remittances + β4 * Import coverage of reserves + β5 * (Import coverage of reserves)^2 + β6 * g_W - Coefficients: - β1 = 0.385 - β2 = 2.719 - β3 = 2.022 - β4 = 4.052 - β5 = −3.990 - β6 = 13.520 - Notes on interpretation: - Likelihood of debt distress is positively correlated with indebtedness and negatively correlated with CPIA, country growth, reserves, remittances; favorable world growth reduces probability of debt distress. - The negative coefficient on the second (non-linear) reserve coverage variable implies diminishing returns of reserve accumulation above certain coverage. - CI calculation conventions: - Based on 10-year averages composed of 5 years of historical data and 5 years of projection. - CPIA (no projections) uses the latest value held constant over the 5-year projection period. - The DSF template automatically calculates the CI and shows changes at each update. ### CI cutoffs and example components (paras 60–62) - CI-based classification: - CI < 2.69 => Weak - 2.69 ≤ CI ≤ 3.05 => Medium - CI > 3.05 => Strong - Illustration (template output example): - Components, Coefficients, 10-year average values, CI score components, Contribution of components (example numbers preserved as presented): - CPIA: coefficient 0.385; 10-year average 3.09; CI component 1.194; contribution 42%; 1.17 41% - Real growth rate: coefficient 2.719; 10-year average 4.81%; CI component 0.135%; contribution 0.135% - Remittances: coefficient 2.022; 10-year average 6.71%; CI component 0.145%; contribution 0.145% - Import coverage of reserves: coefficient 4.052; 10-year average 31.76%; CI component 1.2946%; contribution 1.4752% - Import coverage of reserves^2: coefficient -3.990; 10-year average 10.09%; CI component -0.40; contribution -14%; -0.53 -19% - World economic growth: coefficient 13.520; 10-year average 3.53%; CI component 0.4817%; contribution 0.4716% - CI Score: 2.82 (Current period) and 2.85 (Previous Period) — example summary totals as presented. - Data sources and timing: - CI calculation should draw on IMF’s WEO releases (October and April) and World Bank’s annually published CPIA. - CI can be calculated once WEO submissions are finalized and does not change until a new WEO submission is finalized. - Remittances data should be consistent with macroeconomic forecast underlying the WEO framework. - The CI should only be revised if two consecutive signals indicate the need for an upgrade or downgrade (e.g., medium → strong requires both April and October updates in sequence to indicate strong). ### Thresholds for PPG external debt and benchmarks for total public debt (paras 63–64) - Purpose: - Indicative thresholds linked to country classification are used to analyze risk of external debt distress. Thresholds are statistically determined bounds above which risk is considered elevated. - External risk rating is assigned by comparing projected evolution of four PPG external debt burden indicators under baseline and stress scenarios to their thresholds; thresholds depend on debt carrying capacity. - Preserved table extract (as presented in source): - GDPExportsExportsRevenue - Weak301401014 - Medium401801518 - Strong552402123 - PV of PPG external debt in percent of - PPG external debt service in percent of - Debt carrying capacity (CI classification) - Weak35 - Medium55 - Strong70 - Debt carrying capacity (CI classification) - PV of total public debt - GDP - Benchmarks for total public debt: - Total public debt = PPG external debt + public domestic debt. - Benchmarks vary with debt carrying capacity (Table 7 referenced). - Rationale for including total public debt: - Domestic debt is an increasingly important financing source in many LICs (short-term nature creates rollover and interest-rate-reset risks). - Non-resident participation in local and regional debt markets blurs domestic vs external debt distinction. ### Stress tests: types and standardized scenarios (paras 65–67, Table 8) - Stress test categories: - Standardized stress tests: apply to all countries. - Tailored stress tests: apply to specific sets of countries with common risks. - Fully customized scenarios: optional, capture idiosyncratic risks. - Role: - The most extreme stress test informs mechanical risk signal and can shift the signal from “low” to “moderate” if a DSA threshold is breached. - DSA template automatically applies stress tests to external and public DSAs and produces a historical scenario realism check. - Standardized stress tests (six, applied to second and third years of projection unless otherwise noted): - B1. Real GDP growth: - Real GDP growth set to its historical average minus one standard deviation, or the baseline projection minus one standard deviation, whichever is lower for the second and third years of the projection period. - Interactions: - Inflation to decrease with an elasticity to real growth of 0.6. - Primary balance deteriorates as revenue-to-GDP remains same but non-interest expenditures-to-GDP increases (level of spending kept same). - B2. Primary balance: - Primary balance-to-GDP ratio set to its historical average minus one standard deviation, or the baseline projection minus one standard deviation, whichever is lower in the second and third years. - Interactions: - Domestic borrowing cost to increase by 25 basis points per 1 percent of GDP worsening of the primary balance for LICs with domestic market financing. - For market-access countries, external commercial borrowing cost to increase by 100 basis points per 1 percent of GDP worsening of the primary balance, or 400 basis points, whichever is lower. - B3. Exports: - Nominal export growth (in USD) set to its historical average minus one standard deviation, or the baseline projection minus one standard deviation, whichever is lower in the second and third years. - Interaction: - Real GDP growth rate lowered with an elasticity to exports of 0.8. - B4. Other flows: - Current transfers-to-GDP and FDI-to-GDP ratios set to their historical average minus one standard deviation, or baseline projection minus one standard deviation, whichever is lower in the second and third years. - B5. Depreciation: - One-time 30 percent nominal depreciation of the domestic currency in the second year of the projection period, or the size needed to close estimated real exchange rate overvaluation gap, whichever is larger. - Interactions: - Real net exports as a percent of GDP increases with an elasticity to real depreciation of 0.15, starting in the year following the shock. - Pass-through to inflation with an elasticity of 0.3 in the year of the shock. - B6. Combination: - Apply all individual shocks (B1 through B5) at half of the magnitude; apply interactions from each individual shock scenario. - Historical scenario (permanent shocks): - A1. Historical: - Real GDP growth, primary balance-to-GDP ratio, GDP deflator, non-interest current account, and net FDI flows set to their historical averages. - Notes and calibration: - Historical averages refer to last 10 years. - Default shocks and elasticities can be customized if warranted, but customization is generally discouraged to preserve cross-country comparability; exceptional circumstances require explanation in the write up. - The DSA also produces a historical scenario as a realism check: replacing baseline macro variables permanently with their 10-year historical averages; large deviations between baseline and historical scenarios should be explained (possible reasons: structural breaks, permanent improvements like new natural resources, or depletions that slow growth). *Source: GUIDANCE NOTE ON THE BANK-FUND LIC DSF (excerpts as provided).* ### 68. A contingent liability stress test—which involves a one-off increase in the debt-to-GDP ### pp122617guidance-note-on-lic-dsf - 68. A contingent liability stress test—which involves a one-off increase in the debt-to-GDP ### Contingent liability stress test: scope and design - Applies to all countries. - Shock timing: one-off increase in the debt-to-GDP ratio in the second year of the projection. - Shock components: - (i) minimum starting value of 5 percent of GDP (representing the average cost to the government of a financial crisis in a LIC since 1980). - (ii) a tailored value reflecting additional potential shocks for portions of the public sector not included in the definition of public debt used in the DSA; these are scaled to the size of potential exposures in these sectors. - Liabilities already included in the baseline projection should not be included in the stress test (e.g. a realized government guarantee). - When tailored elements are used, the DSA write-up must clearly explain the chosen parameters; the precise design is reported in the output of the DSA (Table 9). ### Tailored sectoral shocks (default settings and tailoring guidance) - Financial market - Default/minimum shock: 5 percent of GDP. - Users can tailor upward depending on country-specific vulnerabilities (e.g., asset quality reviews, bank recapitalization estimates). - Other elements of the general government - Default shock: 0 percent of GDP. - Tailoring considerations: whether other parts of general government have generated contingent liabilities in the past or have existing liabilities that could migrate to the government. - SOE debt - Default shock: 2 percent of GDP (median SOE external liability identified by a Fund staff survey conducted in 2016). - User checks required: - Verify size of state enterprise guarantees already captured in the debt definition for the baseline. - Ensure default does not exceed amount of SOE debt outstanding outside the baseline. - Examine past liabilities taken over by the government from SOEs and flow financial projections for SOEs to identify possible large debt problems. - Note: default shock of 2% of GDP will be triggered for countries whose government-guaranteed debt is not fully captured under the country's public debt definition; if already included and risks from non-guaranteed SOE debt are negligible, a country team may reduce this to 0%. - Public Private Partnerships (PPP) - Default trigger: when PPP stock is larger than 3 percent of GDP. - Default shock: calculated as 35 percent of the country’s PPP capital stock (proxying for the present value of direct and potential future fiscal costs from PPP distress and/or cancellations). - Capital stock drawn from the World Bank Database on PPPs. - Tailoring: users can consider whether up-to-date information on PPPs is available and whether exposure, given the stock, may be more or less than 35 percent assumed. ### Other tailored stress tests: triggers, scenarios, and interactions - Purpose: apply to countries exposed to specific risks (natural disasters, volatile commodity prices, market financing pressures). Countries exposed are automatically detected by the DSF template based on user inputs or predetermined triggers. - Natural disaster shock - Applies to: small states vulnerable to natural disasters (IMF 2016) and LICs meeting frequency and economic loss criteria based on EM-DAT during 1950–2015 (frequency: 2 disasters every 3 years; economic loss: above 5 percent of GDP per year). - Scenario: one-off shock of 10 percentage points of GDP to debt-GDP ratio in the second year of the projection period. - Interactions: Real GDP growth and exports are lowered by 1.5 and 3.5 percentage points, respectively, in the year of the shock. - Users should adjust default parameters if natural disaster effects are already embedded in the baseline; removing from year 2 any average effects of natural disasters already assumed. - Commodity price shock - Applies to: LICs where commodities constitute at least 50 percent of total exports (goods and services) over the previous three-year period. - Scenario: commodity exports are shocked by a commodity price gap in the second year of projection, which closes over 6 years; the price gap for fuel and non-fuel exports is multiplied by their respective commodity exports. - Interactions: - Real GDP growth reduced by 0.5 percentage points. - Fiscal revenues-to-GDP reduced by 0.75 percentage points in each of the three years starting from the second year of projection for each 10-percentage point contraction of commodity prices. - These gaps converge to the baseline in 6 years. - GDP deflator is reduced by the impact of the commodity price gap in the first year, converging to baseline in 6 years. - Users may apply net export adjustments where countries also import the commodity and should re-run tailored scenarios if large commodity imports could mitigate effects. - Market financing shock - Applies to: LICs with market access, defined as either (i) outstanding Eurobonds; or (ii) meeting the market access criterion for PRGT graduation but not graduated due to serious short-term vulnerabilities. - Scenario design: - A 400 bps increase (sustained for 3 years from the second year of projection) in the cost of new external commercial borrowing. - Shortening of maturities of new commercial external borrowing (to 5-year maturity, or 2/3 of the assumed maturities, whichever is shorter, with grace periods adjusted proportionally). - One-off FX depreciation equivalent to 15 percent in the second year. - Purpose: assess rollover risks from deteriorating global risk sentiment, temporary nominal depreciation, and shortened maturities; supplements market financing risks in the baseline under the market financing module. - Customization constraints and reporting - Users must customize scenarios based on country historical experience and authority inputs. - Customizations must not incorporate potential grant financing that would dampen shock impact (to avoid circularity). - Default parameters are calibrated from event studies and cross-country averages; customizable parameters are clearly indicated and must be explained in the DSA write-up when adjusted. ### Fully customized scenarios and illustrative analyses - The DSF template allows fully customized PPG external and public debt paths for idiosyncratic or data-limited analyses. - Customized scenarios affect risk signals similarly to other stress tests; extreme customized scenarios can motivate moves to higher risk ratings. - Examples motivating customized scenarios: - Idiosyncratic risks (civil war, epidemic/major public health crisis). - Large delays in investment projects adversely affecting growth and fiscal revenues. - Contagion-related macroeconomic risks. - Policy slippage resulting in very different debt paths. - Illustrative exercises (do not affect risk rating unless specified): - Debt restructuring scenarios illustrating different debt paths. - Illustrating the impact possible grants could have (noting constraints on projecting grants in baseline). - Scenarios associated with meeting the Sustainable Development Goals (SDGs), requiring supplementary cost and macro impact information and assessment of financing strategies and risks. ### Risk signals: model-based and market-financing benchmarks - Signal for the External Risk Rating (based on comparison of projected PPG external debt indicators with indicative thresholds for first 10 years under baseline and stress tests): - Low risk: none of the PPG external debt burden indicators breach thresholds under baseline or most extreme stress test. - Moderate risk: none breach under baseline, but at least one breaches under stress tests. - High risk: any PPG external debt burden indicator breaches its threshold under the baseline. - Note: "most extreme stress test" defined as the test yielding the highest level of debt on or before the tenth year of projection. - Signal for the Overall Risk of Public Debt Distress (based on joint information from five debt burden indicators: four external indicators + PV of total public debt-to-GDP compared with its indicative benchmark): - Low overall risk: PPG external debt has a low risk signal and total public debt-to-GDP remains below its benchmark under baseline and most extreme shock. - Moderate overall risk: PPG external debt has a moderate risk signal; or PPG external debt is low and the public debt stock indicator breaches thresholds/benchmark under stress tests. - High overall risk: any of the four external debt indicators or the total public debt burden indicator breach their corresponding thresholds/benchmark under the baseline. - Signal from the Market Financing Pressures Tool (for LICs with market access) - Benchmarks compared: projected baseline public gross financing needs (GFN) over next three years and current market sentiment (latest EMBI spread). - Benchmarks specified: - Public GFN: 14 percent of GDP - EMBI spread: 570 bps - Interpretation: - Breach of both benchmarks: signals high market financing pressures (increased liquidity needs amid worsening market sentiment) and higher rollover risks. - Breach of one indicator: signals moderate market financing pressures. - No breaches: market financing related risks are low. - Note: EMBI spreads data only available for LICs with longer histories of international market access; for LICs without EMBI spreads data, a breach in the GFN threshold can be treated as an early warning for potential market financing pressures. - Role of judgment - In addition to model signals, judgment is used to assess gravity of threshold breaches and country-specific factors not fully captured by the model. - Judgment also helps interpret short-lived and marginal breaches (discussion continues beyond supplied excerpt). *Source: GUIDANCE NOTE ON THE BANK-FUND LIC DSF (excerpt).* ### 79. Single short-lived breaches (1-year) should be discounted from the analysis, but may ### pp122617guidance-note-on-lic-dsf - 79. Single short-lived breaches (1-year) should be discounted from the analysis, but may ### Short-lived breaches and judgment - Single short-lived breaches (1-year) should be discounted from the analysis, but may be brought back via judgment under some limited circumstances. - Typical cause: bullet maturities on Eurobonds. - Timing matters: - Breaches in the first early years of the projections are more worrisome than those in the distant future. - Breaches at a longer horizon allow for debt management operations to smooth the debt service profile and/or for building buffers to meet payment obligations. - Recommendation: short-lived breaches occurring in the very near future should be brought back for purposes of determining the risk rating, unless mitigating factors exist. - Examples of mitigating factors: - The buffers provided by liquid financial assets (Section VIII.D). - A track record of market access at comparable volumes. ### Marginal breaches of thresholds - Marginal breaches should be viewed as a risk signal, but may be discounted via judgment where appropriate. - For temporary breaches of a small magnitude that last more than one year, the user should consider whether there are sufficient mitigating factors, including: - (i) the timing of the breach (the distant future being less worrisome); - (ii) the breadth of the breach (whether it extends beyond a single indicator); - (iii) the dynamics of the breach (with sharp prior increases in indicators signaling more concern); - (iv) the strength of confidence in the macroeconomic forecast. - Justifications for overriding the mechanical risk signal should be supported by sufficient evidence and a compelling argument that mitigating factors continue to be relevant. - Optional tool: the probability approach can be used to gain additional insight when there are small and temporary breaches, and under some circumstances can enable calculation using more precise country-specific information (Appendix VII). ### Domestic debt and market-financing vulnerabilities - When a high-risk signal comes from the public debt distress analysis: - Consider whether this should affect the final external risk rating. - If external debt is not measured on a residency basis, attempt to gather information on non-resident holdings of local currency government debt. - If non-residents are an important share of the stock and/or projected flow, revisit concerns about external risks because servicing and repaying this debt requires net resource transfers abroad. - Public debt distress and high overall debt service can squeeze priority primary spending; assess whether payment of external debt service and priority primary spending (safety net, wages, pensions, etc.) can no longer jointly be achieved, given minimum domestic debt service needs. - When there is a high-risk signal from the market-financing pressures tool, examine: - (i) where the liquidity need is deriving from; - (ii) the composition of the creditor base (who is holding debt that needs to be rolled over); - (iii) which creditors are expected to provide finance at the margin. - Example concern: high gross financing needs representing large net new borrowing (e.g., due to a high fiscal deficit) which the market may not be able to absorb. ### External private debt - Always assess whether a high level of non-guaranteed private external debt could increase government exposure to contingent liabilities and whether this warrants a change in external or overall risk ratings. - Channels of concern: - Excessive external borrowing by the non-financial private sector can indirectly raise public sector debt via pressures leading to currency depreciation. - Excessive external borrowing by the banking sector and/or a substantial currency mismatch in its balance sheet could lead to systemic problems and a need for direct government intervention and recapitalization, directly affecting public debt issuance. - Pay particular attention when private external debt has grown or is projected to grow rapidly. - Consider whether the private sector has liquid and readily available assets which could mitigate risks. - Implications can be derived by placing more weight on an appropriately-designed contingent liability stress test, or customized scenario. - Where data on private external debt is weak and indirect sources are required, this should be disclosed. ### Availability of liquid financial assets - If the government has significant financial assets that could be liquidated to service debt, the use of gross debt may overstate a country’s risks of debt distress. - It is not possible to present the DSA on a net debt instead of a gross debt basis since this implicitly imposes the very strong assumption that government assets and liabilities can perfectly offset each other; however, assets can be accounted for via judgment. - When government assets are already set aside or readily available and are sufficient to cover threshold breaches, they can be deemed to provide an offset. The user should closely assess and fully disclose in the DSA write-up the characteristics of the government assets considered for judgment. - Asset characteristics to assess: - Sufficient liquidity (i.e., not encumbered, can be liquidated quickly at prices reflecting fair value). Foreign exchange deposits and amounts in sinking funds generally would qualify (subject to their use not leading to a deterioration in reserve adequacy).45 - For assets denominated in local currency, consider: (i) the minimum needed level of deposits (given the usual check float); (ii) the ability to withdraw deposits from domestic financial institutions without creating systemic stress; (iii) whether they can be exchanged without impacting the exchange rate (i.e. whether the central bank has excess reserves). - Illiquid assets (e.g., equity shares in state-owned companies and untapped natural resources) generally should not be considered as a mitigating factor. - Assets held at sovereign wealth funds (or stabilization funds) and through other extra-budgetary funds can be considered, but exclude where they cannot be legally withdrawn to repay or service debt. - Reporting: where assets are important to DSA conclusions, their scale should be reported in the DSA write-up; a memorandum item can be added to the tables. Users can also report a net debt concept as a memorandum item in DSF tables, based on the assets considered. - Note: projections of assets must be consistent with projected above-the-line and below-the-line fiscal projections (a build-up of assets is only possible with an above-the-line fiscal surplus, or a below-the-line surplus). ### Long-term considerations (years 11–20) - In exceptional circumstances threshold breaches in years 11–20 may provide a rationale to change the risk rating. - Default rule: breaches projected to occur in projection years 11–20 do not normally give rise to a rating downgrade. - Exception: consider a change in rating when: - (i) such breaches are expected to be large, persistent and thus resulting in significant differences relative to historical averages; and - (ii) occur with a high probability despite occurring in the distant future. - Possible drivers: trends not easily amenable to policy interventions, such as climate change, population aging, known changes in donor financing frameworks, or expected exhaustion of natural resources. - Requirement: the user should clearly explain a rating change informed by such a breach, including why the breach can be expected to be large and persistent, and occur with high probability. ### Other considerations for judgment - Country-specific circumstances may warrant application of judgment to DSF results; when used, aim to reflect judgment in a customized alternative scenario. - Key circumstances include: - Conflict, fragility and violence (FCV): capture specific challenges via country-specific alternative scenarios for affected countries. - Reserve pooling arrangements: currency union members or members of regional financial arrangements (e.g., swap arrangements) may gain greater balance of payments protection from reserves pooling; consider adequacy of union-wide reserve coverage and access to the pool. Swap arrangements are not mitigating if largely/fully tapped. - Availability of insurance-type arrangements and state-contingent debt instruments: correctly model these in stress scenarios; their mitigating properties may support a more benign view of risks where there are marginal baseline breaches. - Level of confidence in the macro baseline: greater uncertainty increases probability of indicator breaches; use realism tools for guidance and illustrate country-specific macroeconomic risks in customized risk scenarios where appropriate. - Other events with reasonably high likelihood: consider impacts on external or public debt sustainability and draw on tools such as the Risk Assessment Matrix from the Article IV consultation to prepare customized alternative scenarios. ### Final risk ratings: process and definitions - DSF users are expected to combine model signals with judgment to arrive at: - A final rating of the risk of external debt distress: low, moderate, high. - A final rating of the overall risk of debt distress: low, moderate, high. - The DSF write-up should explain how conclusions were reached, including deviations from mechanical risk signals. - A country should be rated as “in debt distress” when a distress event has already occurred (with qualifications): - External rating: ongoing or impending debt restructuring negotiations, or outstanding external arrears on debt. - Overall rating: external debt distress and/or ongoing or impending domestic debt restructuring negotiations, or outstanding arrears on domestic debt instruments. - Qualifications where arrears may not trigger “debt distress”: - De minimis cases (where arrears are less than 1 percent of GDP). - Arrears arising from technical problems with payments or payment barriers, disputed claims, diplomatic disagreements, difficulties in establishing appropriate counterparts, or weak debt management (technical arrears). - Arrears to official bilateral creditors deemed away because of the existence of a debt relief agreement. - Arrears to private creditors where restructuring with the majority of creditors has been completed and the government is judged to be engaged in “good faith” negotiations with remaining holdouts. - Large outstanding arrears to external or domestic suppliers of goods and services could motivate a “debt distress” classification in very limited circumstances if non-payment reflects government insolvency and/or liquidity problems (i.e., arrears are forced borrowing by the government). - A country may also be assessed to be in debt distress when the DSA indicates a high probability of a future debt distress event arising from: - (i) large near-term breaches in debt service indicators (implying a high-risk signal where resources for payment cannot be identified); and/or - (ii) significant or sustained breaches of debt thresholds that, in staff’s judgment, render the debt position unsustainable. - Note: an assessment of “high risk” or “in debt distress” does not automatically mean debt is unsustainable in a forward-looking sense (the debt event could be liquidity-related). - The LIC DSF user should provide a full discussion in the DSA write-up of main risks to the ratings assessment (e.g., data coverage, macroeconomic uncertainty, policy implementation risks, global factors) and mitigating factors that could shift the risk assessment. ### Adding granularity to risk ratings: moderate risk characterization - Requirement: users must characterize the extent of debt vulnerabilities in countries rated at moderate risk of external debt distress. - Definition of “space” to absorb shocks: - The distance between baseline debt burden indicators and their thresholds measures the “space” a country has to absorb shocks without being downgraded to high risk. - Shocks considered are derived by looking at composite debt shocks across LICs that have resulted in a downgrade from moderate to high risk. - Characterizations for moderate-risk countries: - “Limited space to absorb shocks” where at least one baseline debt burden indicator is close enough to its respective threshold that occurrence of the median observed shock would result in a downgrade to high risk. - “Substantial space to absorb shocks” where all baseline debt burden indicators are well below their respective thresholds, such that only shocks in the upper quartile of the observed distribution of shocks would downgrade the country to high risk of debt distress. - All other moderate-risk countries are characterized as having “some space to absorb shocks”. *Source: GUIDANCE NOTE ON THE BANK-FUND LIC DSF (excerpts provided).* ### 96. For countries where judgment has been applied in determining the risk rating as ### pp122617guidance-note-on-lic-dsf - 96. For countries where judgment has been applied in determining the risk rating as ### Shock analysis of rating downgrades from moderate to high risk - Staff calculated the distribution of observed shocks that led to a rating downgrade to high risk of debt distress using DSAs produced since the LIC DSF inception. - Shocks are calculated as the observed change in debt burden indicators (peak in debt after and before the shock leading to a downgrade) in percentage of the respective threshold. - For debt stock indicators (PV of debt to GDP and PV of debt to export): - The median shock is around 20 percent. - Shocks in the upper quartile are those larger than 40 percent. - For debt service indicators (debt service to revenue and debt service to export): - The median shock is around 12 percent. - Shocks in the upper quartile are those larger than 35 percent. - Note on classification: In general, countries judged moderate would be automatically classified as having ‘limited space’ (any “shock” would leave them with a high-risk signal). However, countries with deemed away single short-lived breaches (1-year) would be classified excluding the short-lived breach. ### Assessing sustainability - A “significant or sustained breach” may warrant an “in distress” rating; assessment requires judgment. - Strong signals of unsustainability: - One or more debt burden indicators are continually rising and above thresholds as the forecast horizon advances. - Considerations for other significant or sustained threshold breaches: - (i) Duration: sustained would generally be understood to meet or exceed four to five-years. - (ii) Magnitude: how large the breaches are. - (iii) Timing: the first 5 years of the projection are more important. - (iv) Speed of reversal: how quickly near-term breaches begin to be reversed (rising breaches in the near-term before a turn-around are cause for greater concern). - (v) Coverage: whether they cover both debt and debt service indicators (extended breaches of solvency indicators matched by liquidity indicators contained beneath thresholds should be considered a mitigating factor). - Confidence in the macroeconomic framework: - Where confidence intervals are wide, the probability that breaches will be even larger and more protracted than projected generally rises. - Explanations for flags produced by realism tools need to be compelling; if not, users should recalibrate the macroeconomic framework towards a more central, and more easily justifiable, tendency. - Users are encouraged to develop their own explicit fan chart to further delve into the issue, where data availability allows (a standard VAR model could form the basis). - Broader judgment: - Sustainability implies a high likelihood that a country will be able to meet all its current and future financial obligations. - In practice, sustainability would imply that the debt level and debt service profile are such that the policies needed for debt stabilization under both the baseline and realistic shock scenarios are politically feasible and socially acceptable, and consistent with preserving growth at a satisfactory level while making adequate progress towards the authorities’ development goals. - Other factors not captured in the model—feasibility issues, debt structure and holders, and impact on development goals—also need to be accounted for. - Constructing a sustainable scenario from an “in distress” starting point: - Significant or sustained breaches should no longer be observable. - The macroeconomic framework should have strong credibility. - Judgment should bring robust and supportive arguments about the impact of other factors. - A higher probability that debt is sustainable would generally be associated with even stronger performance relative to thresholds (for instance, indicators converging beneath high risk thresholds, and below the sub-thresholds in the moderate category). ### Fiscal space - Definition: - Fiscal space refers to the room a government has to undertake discretionary policy relative to existing plans without undermining debt sustainability or market access. - Assessment involves consideration of context, financing, fiscal indicators, and fiscal impacts (IMF (2016a)). - Application to low income countries: - For the least developed countries dependent at the margin on donor aid, a qualitative assessment based on careful consultation with donors is necessary. - For countries financing at the margin from markets (and/or other non-concessional lenders), a deeper consideration of context, financing, fiscal indicators, and fiscal impacts can be undertaken. - LIC DSF role: - The LIC DSF does not require a fiscal space assessment, but provides tools to inform such an assessment by allowing insights into: - Context: Realism tools help understand the context for fiscal expansion, facilitate discussion about policy mix, fiscal multipliers, and investment efficiency. - Availability of financing: The DSF’s market financing module can flag risks of market financing pressures; this should be complemented with analysis of market responses to additional financing volumes. - State of public debt burden indicators: External and overall risk ratings give insight into risks to sustainability; high risk indicators in low-income countries do not necessarily rule out fiscal expansions if financed largely by grants or concessional borrowing. - Fiscal expansion scenarios: The DSF primary balance stress test can evaluate fiscal experiments (expansion or slower consolidation) and verify whether fiscal expansion could lead to a downgrade in external and/or overall debt risk ratings. - Limitations and further guidance: - DSF users seeking a full fiscal space assessment need to consult and consider a wider range of tools and indicators. - The DSF does not support a full fiscal space assessment; many other indicators of context and financing pressures, and models of investment impacts, should be deployed. - The guidance does not cover aggregation and weighting of considerations; DSF users should consult IMF (2016a) for more guidance. ### Review process and dispute resolution between IMF and the World Bank - Review process stages (summary): - Preparation of the draft DSA: - IMF country teams and World Bank country economists jointly prepare a draft DSA (write-up and template). - Preliminary meeting to discuss macroeconomic assumptions and coverage. - Draft DSA included in the IMF policy note. - World Bank country economist informs MTI Global Macro and Debt Analytics Unit about schedule and may request upstream comments. - Departmental review of the draft DSA: - IMF country team sends the draft DSA and policy note to SPR and other departments, and World Bank country economist as needed. - World Bank country economist sends draft DSA to MTI Global Macro and Debt Analytics Unit for formal review. - Objective: raise and resolve major issues related to content, coverage, and broad assumptions. - Policy consultation meeting (PCM): - Contentious issues should be discussed at a PCM with World Bank staff participation where possible. - Management clearance of the draft DSA: - IMF Management clears the policy note and draft DSA. - World Bank Practice Manager of the Global Macro and Debt Analytics Unit concurs and the MTI Director clears the draft DSA. - Mission: - IMF country teams and World Bank country economists refine the DSA with input from country authorities. - Staff should share draft tables and figures with authorities and explain tentative conclusions. - If one team did not participate in the mission, another meeting must be held to discuss new information and changes. - Departmental review of the DSA: - IMF country team sends the DSA and staff report to SPR and other departments. - World Bank country team sends the DSA to MTI Global Macro and Debt Analytics Unit for review and formal clearance. - Management clearance of the DSA: - IMF Management clears the staff report and the DSA. - World Bank Practice Manager concurs and the MTI Director with regional responsibility clears the DSA. - Circulation and publication: - IMF: staff report and DSA sent to SEC for circulation to the Executive Board; following the Board meeting, the DSA is published as a supplement to the staff report, assuming authorities’ consent. - World Bank: MTI ensures circulation of the DSA to IDA’s Executive Board within two months of submission to the IMF’s Board; the DSA is published as a standalone document, assuming authorities’ consent. - Dispute resolution: - Attempt to resolve disagreements at the working level first. - Working level: country economists discuss basis for disagreements and determine materiality. If material, the Fund mission chief and the Bank’s MTI Director should attempt agreement. - If unresolved, mission chief and MTI director, after consultation with SPR and Global Macro and Debt Analytics Unit, seek resolution within five working days; if unsuccessful, elevate to area department director at the Fund and vice president at the Bank to seek resolution within five working days. - If still unresolved, matter is brought to managements of both institutions. - The managements can, within five working days, resolve the dispute or decide that the DSA document will present the different views of the staffs to the Executive Boards; in the latter case each institution will present its views in its own words. ### Appendix II — The DSA write-up (outline and required elements) - Title and top-line classification: - Country X - Joint Bank-Fund Debt Sustainability Analysis - Risk of external debt distress: [low/medium/high/in debt distress] - Overall risk of debt distress [low/medium/high/in debt distress] - Granularity in the risk rating [Sustainability/moderate risk tool/tool not applicable] - Application of judgment [yes/no; key judgments applied] - Chapeau paragraph: - Specify external risk rating, signal from the model, how judgment was applied, assessment of overall risk, reasons for any difference from external risk rating. - Provide commentary on deeper granularity (e.g., “moderate, with significant space”). - Note vulnerability of the risk rating to policy slippages or other factors. - Footnote linked to the chapeau should report the country’s Composite Indicator score and classification of debt-carrying capacity (weak, medium, or strong). - Public debt coverage: - By default use PPG external and public debt; explain if full public debt coverage is not attainable. - Cover requirements for tailored stress test for contingent liabilities based on debt coverage. - Discuss known weaknesses or gaps in the data being used. - Table: the coverage of the public sector debt and design of contingent liability stress test. - Background on debt: - Evolution of PPG external debt and total public debt in recent years, including comparisons with previous DSA (developments related to debt relief, where relevant). - Composition and structure of public external and domestic debt (creditors, terms/concessionality). - Evolution of private external debt in recent years, where relevant. - Background on macro forecasts: - Main features in macroeconomic projections and major changes compared to the previous DSA. - Box to describe main assumptions in the macroeconomic framework: real sector (real economic growth with main drivers, inflation), fiscal variables (medium- and long-term fiscal measures, primary balance, borrowing costs), external sector (current account variables, external financing sources such as FDI, public external borrowing, private external borrowing, exceptional financing) and dynamics of foreign reserves. - Assumed financing mix between domestic and external financing, including prospects of concessional financing / grants and non-concessional / market financing with projected grant elements in the medium- and long-term. - Discussion of realism tool outputs, explaining why any flags should not be of concern. Charts: Realism tool charts. - Country classification and scenario stress tests: - Description of the composite indicator and applicable thresholds; note any changes and why they occurred. Table: Composite indicator and threshold tables. - Note prominent economic features qualifying the country for tailored stress tests and the market financing risk module; explain how scenario stress tests have been set up including justification for any changes in default settings. - External DSA required elements: - Signal from the model: - Projected evolution of PPG external debt burden indicators compared to thresholds in the baseline scenario; discussion of breaches, if any. - Projected evolution under stress tests including tailored stress tests compared to thresholds; discussion of breaches, if any. - Results of customized scenarios, where relevant. - Overall risk of public debt distress: - Signal from the model: - Projected evolution of total public debt under the baseline, including with respect to the benchmark on public debt to GDP. - Projected evolution under stress tests, including with respect to the benchmark on public debt to GDP. - Results of customized scenarios, where relevant. - Market module (where relevant): - Risks identified by the market-financing pressures tool. Table: Market Financing Pressures. - Deeper discussion of liquidity risks and creditor exposures where the tool provides a red flag. - Other factors to account for (application of judgment): - Existence of arrears/restructuring (with few exceptions this would lead to an “in debt distress” rating). - Discussion of one-off/marginal breaches (where relevant). - Are market risks important enough to override the risk rating? - Discussion of assets (where relevant). - Long-term considerations (where relevant). - Private external debt (should always be covered). - Other considerations (where relevant). - Risk rating and vulnerabilities: - Summary of assigned external and overall risk ratings (taking into account judgment). - Granularity in the risk rating (moderate-risk tool). Table: Qualification of the Moderate Risk Rating Category chart. - Discussions on key risks to debt sustainability and recommendations. - Authorities’ views: - DSA assumptions and results should be discussed with authorities; authorities’ views, including any disagreement, should be reflected in the concluding section of DSA write-ups. - Tables and charts to include: - Tables: Debt Sustainability Framework, Baseline Scenario (external and public); Sensitivity Analysis for Key Indicators of Debt (external and public); Risk signals summary table. - Charts: Debt accumulation and debt ratio charts (external and public). *Guidance Note on the Bank-Fund LIC DSF — extracted content as provided* ### Appendix III. Treatment of State-Owned Enterprises ### Appendix III. Treatment of State-Owned Enterprises ### Criteria for excluding public enterprise debt from DSAs - A public enterprise’s external debt can be excluded from the external DSA and its total debt from the public DSA if: - the enterprise can borrow externally without a public guarantee; and - its operations pose limited fiscal risk. - Exclusions must be explicitly described in the DSA write-up and justified using collected information on each enterprise: - managerial independence; - relations with the government; - periodicity of audits; - publication of comprehensive annual reports and protection of shareholders’ rights; - financial indices and sustainability; and - other risk factors (see Box AIII.1). - In LICs where comprehensive information may be limited, two criteria are binding in determining fiscal risk: - an enterprise would normally be judged to pose a high fiscal risk if it carries out uncompensated quasi-fiscal activities; or - an enterprise would normally be judged to pose a high fiscal risk if it has negative operating balances. - An enterprise could be deemed to have a low fiscal risk even if the above criteria paint a mixed picture or if not all information is available. Such judgments may rely on: - the enterprise’s financial strength; or - the enterprise’s track record. ### Treatment in IMF-supported programs - When there is an IMF-supported program, the decision to remove a public enterprise from the DSA is simplified: - the technical memorandum of understanding would specify any exclusion of enterprises for the purpose of the external debt limits; and - the same exclusions would be expected to apply in the DSA. ### Box AIII.1 — Indicators for exclusion of SOEs (detailed criteria) - Managerial independence, including pricing and employment policies: - cost-covering price setting for non-tradables; - average prices within 10 percent of the international benchmark for producers of tradables; - a tariff setting regime compatible with the long-term sustainability of the SOE in regulated sectors, comparable to private firms in the sector; - employment policies should be independent of civil service laws and should not be subject to intervention by the government in wage setting or hiring, except when clearly justified to address specific risks. - Relations with the government: - absence of direct or indirect subsidies, on-lending by the government and/or explicit or implicit loan guarantees that go beyond those given to private enterprises; - absence of quasi-fiscal activities such as uncompensated functions or absorbed costs not directly related to the SOE’s business objective and/or substituted for government spending (e.g., subsidies to the public given directly by the SOE compensated with government transfers); - the SOE should be subjected to the same regulatory and tax regimes as private firms in the industry; - absence of a high frequency of profit transfers from the SOE to the central budget. - Periodic audits: - periodic audits carried out and published by a reputable private accounting firm applying international standards; - a major international firm should ideally audit large public enterprises. - Publication of comprehensive annual reports and protection of shareholders’ rights: - published annual reports should include: i) audited balance sheets; ii) profit and loss statements; iii) off-balance sheet liabilities; iv) levels and changes in the enterprise’s overall activity; v) employment and investment; and vi) comparisons against other firms in the industry and international benchmarks; - governance structure should allow for appropriate protection of minority shareholder rights. - Financial conditions and sustainability: - market access, including industry-wide comparable costs of debt and borrowing rates comparable to private firms without a government loan guarantee; - less-than-full leveraging entailing a debt-to-asset ratio comparable to the industry average; - profitability, defined as operating balance to assets ratio, or defined as a positive ratio and higher than the average cost of debt in cases where there is no relevant comparator; - records and evaluations of past investments demonstrating an average rate of return at least equivalent to that required by cost-benefit analyses to approve new projects. - Absence of other risk factors, including but not limited to vulnerabilities stemming from: - contingent liabilities relative to its operating balance; - currency mismatches between the SOE’s main sources of revenue and its debt; - the importance of the public enterprise, as defined by size (e.g., debt service, employment, customer base, sales) and/or function (e.g., the provision of essential inputs or services). *Source: Appendix III. Treatment of State-Owned Enterprises, pp122617guidance-note-on-lic-dsf - Appendix III. Treatment of State-Owned Enterprises* ### Section VI). ### Section VI) ### Exchange rate pass-through and inflation modeling - The default exchange rate pass-through to domestic inflation is assumed to be 0.3 under the nominal depreciation stress test in the DSF (and therefore domestic inflation does not fully offset the impacts of nominal depreciation). - Inflation, as measured by a GDP deflator, is modeled to be reduced during the growth shock, which further deteriorate a nominal GDP growth rate. ### Fiscal effects of GDP and growth shocks - A proportional decline in public sector revenue is assumed under a real GDP shock because the revenue-to-GDP ratio is assumed to be unchanged in stress tests. - The real GDP shock is assumed not to have an impact on the level of government spending. - Consequence: lower tax revenue combined with unchanged spending results in a wider non-interest (primary) fiscal deficit, increased financing needs, and additional borrowing. ### Persistence and transmission of shocks on debt burden indicators - A shock to real GDP growth impacts both indebtedness and capacity to pay, since it reduces the measure of capacity to repay (nominal GDP, and public sector revenue) while increasing indebtedness. - Although a shock to GDP growth rate is modeled to last for only 2 years, the shock has a permanent impact on the levels of real and nominal GDP, because a return to the baseline real GDP growth rates after 2 years would not restore the original GDP levels projected in the baseline. - A shock to exports similarly deteriorates debt burden indicators through both numerator and denominator effects, with permanent impacts on export levels. ### Appendix VII — The Probability Approach in Borderline Cases - Purpose: focuses on the evolution of the probability of debt distress over time rather than on the evolution of debt burden indicators. - Calculation: the country-specific probability of debt distress is directly calculated from estimated probit equations using country-specific debt indicators and other key economic variables, along with global economic growth. - The probit specification uses one of the four debt burden indicators (d_j): PV of debt to GDP, PV of debt to exports, debt service to revenues, and debt service to exports. - Non-debt explanatory variables (X_k) included: CPIA, country growth, reserves, squared reserves, remittances, and world growth. - Data requirement: To generate country-specific probabilities of debt distress, the DSF requires averages of the relevant variables (country growth, reserves, remittances, and world growth) over a 16-year period consisting of 5 years of historical data, and the current year plus the following 10-year projected data. - Decision rule: the probabilities of debt distress are compared with probability cut-offs to derive a risk signal. - The probability cut-offs are those that minimize the loss function that penalizes Type I (“missed calls”) and Type II errors (“false alarms”) with the weight on Type I error set at 0.67. - Probability cutoffs (as presented in the source): - GDPExportsRevenueExports Probability cutoff0.155 0.1600.1500.138 - (Source text shows these entries in Table AVII.1 as presented above.) ### Use cases and operational guidance for borderline cases - Definition of borderline cases: - Marginal breaches are defined as temporary breaches of a small magnitude that last more than one year. - Borderline cases include situations where one of the debt indicator trajectories (under the baseline or most extreme stress test) has marginal breaches of a threshold, or where it hovers below a threshold but with small margins. - Practical borderline scenarios: - Borderline low/moderate: - (i) debt burden indicators are below thresholds in the baseline scenario, but - (ii) a threshold is nearly breached under a standardized stress test, or there is a small breach of a threshold under a standardized stress test. - Borderline moderate/high: - (i) stress tests result in one or more breaches, and - (ii) a threshold is nearly breached in the baseline scenario, or there is a small breach of a threshold in the baseline scenario. - When to use the probability approach: - Optionally used when a country’s risk rating is on the border between two categories with the relevant debt indicators close to the thresholds. - The probability approach can be used to both upgrade and downgrade a mechanical rating under the traditional approach. - The probability approach is a complementary tool to inform judgement in borderline cases; the final determination should also take into account other relevant factors discussed in Section VIII. - Users should be mindful that the probability approach sometimes points to implausible outlying probabilities using country-specific economic variables, which might be outliers in the LICs’ distribution. ### Output and documentation - The template indicates if the probability approach is applicable for a country and automatically generates the outcome of the probability approach along with charts and tables. - A DSA write-up should include charts and tables for both the traditional and probability approach when the latter informs judgement. *Source: GUIDANCE NOTE ON THE BANK-FUND LIC DSF — Section VI and Appendix VII* --- _Source: https://www.imf.org/-/media/files/publications/pp/2017/pp122617guidance-note-on-lic-dsf.pdf_