## ppea2024039

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### EXECUTIVE SUMMARY — CONTEXT and ADMINISTRATIVE DETAILS
- Purpose: Supplement provides additional guidance to IMF and World Bank staff on implementation of the Bank-Fund Debt Sustainability Framework for Low Income Countries (LIC-DSF) approved in 2017, complementing the 2018 Bank-Fund guidance note on the LIC-DSF (IMF and WB, 2018).
- Rationale:
  - Climate change risks and domestic public debt vulnerabilities have become more prominent since 2017.
  - Debt restructurings have increased in complexity, creating a need for further guidance on the use of the LIC-DSF in restructuring situations.
- Positioning: Prepared as a first step within the current IMF and World Bank Boards-approved framework while a deeper review of the LIC-DSF is progressing.
- Administrative details:
  - Date: July 18, 2024.
  - All aspects of the 2018 LIC-DSF Guidance Note remain in effect, except as modified in this supplement.

### A. CLIMATE-CHANGE — Findings and Guidance on Incorporation into DSAs
- Core premise:
  - Climate-change risks and climate investments and policies affect debt sustainability via impacts on baseline macroeconomic forecasts and expected volatility.
  - Climate change includes slow-moving long-term shifts and sudden extreme weather events; both can reduce productivity, government revenues, and increase spending needs for reconstruction, adaptation, and social protection.
  - Climate investments and policies can mitigate impacts on growth and volatility.
- When coverage is required or encouraged:
  - Required in DSAs accompanying requests for Fund Resilience and Sustainability Facility arrangement (RSF arrangement) or World Bank Development Policy Operation with Catastrophic Deferred Drawdown Options (DPOs with CAT DDOs).
  - Encouraged in all other cases, with a presumption for inclusion in DSAs accompanying or issued following publication of WB or IMF in-depth topical analyses, and for countries where climate change and climate adaptation or transition management policies are assessed as macrocritical in Fund’s Article IV and program reports, or considered essential in WB Development Policy Financing operations.
- Write-up requirements when climate is incorporated:
  - Indicate how slow-moving shifts and changes in frequency/intensity of extreme events affect the baseline, including whether positive effects from climate-related investment on resilience and growth are part of the baseline and whether baseline assumptions are aligned with authorities’ climate policies (including Nationally Determined Contributions) or adjusted for staff views (e.g., investment pledges).
  - Clearly refer to the source of assumptions and any adjustments.
  - Discuss whether and how extreme weather impacts on volatility around the baseline are reflected, and whether investments and climate-linked debt instruments are accounted for in climate-focused stress tests.
  - If incorporation changes the risk or sustainability assessment relative to the previous DSA, country teams should engage early with authorities on realism of assumptions and financing sources.
- Modeling and scenario guidance:
  - Stand-alone climate-change macro models and tools can inform macro assumptions in the baseline or alternative scenarios (examples include WB CCDR, IMF CPD, WB CC-MFMod).
  - Use of alternative scenarios is encouraged (not required). Alternative scenarios can:
    - Capture longer-term interplay between climate change and climate policies, including climate-related investment (public and private) and social spending where data are available.
    - Provide a benchmark for calibrating the government share of additional economy-wide climate spending consistent with an unchanged outlook relative to the baseline for debt risk and sustainability—i.e., the maximum amount financeable by a realistic mix of higher primary deficit, loans and grants without an unidentified financing gap.
  - If no stand-alone model is available, basing long-term growth projections on long-term historical trend can be a starting point for near-term analysis, with caveats where data limit quantification.
- Stress-test guidance:
  - The tailored natural disaster stress test remains mandatory for:
    - Small developing states prone to natural disaster (IMF, 2016).
    - LICs that meet criteria for frequency (around 2 disasters every 3 years) and economic losses (above 5 percent of GDP per year) from natural disasters (IMF and WB, 2018, Table 10).
  - The tailored natural disaster stress test is optional for other LICs.
  - Calibration of the tailored stress test should be updated when in-depth analysis is available (e.g., WB’s CC-MFMod or IMF CPD).
  - Customized stress tests on external and overall public debt can accommodate triggering shocks in period t+5 (as in IMF’s DIGNAD model) or outside the 10-year forecast horizon relevant for the risk rating, allowing incorporation of feedback from climate policies to growth.
  - Results from stand-alone climate-change macro models and tools can inform calibration of stress tests.
- Guidance on climate-linked debt instruments:
  - Climate-linked debt instruments can be captured quantitatively in the DSA baseline and/or in built-in, customized stress tests; or used as a qualitative mitigating factor in informing judgment, especially in borderline cases.
  - Instruments tend to decrease volatility and can affect baseline projections or stress-test calibrations depending on design and activation status.
  - Modeling should account for design features (e.g., trigger thresholds, reprofiling horizon, disbursement profile, concessionality).
- Empirical examples:
  - Vanuatu 2023 Article IV staff report: real GDP growth lowered by 0.5 percentage points, current account balance lowered by 1.3 percent of GDP, fiscal deficit increased by 0.35 percent of GDP relative to disaster-free projections on average over the projection period.
  - Niger DSA (3rd ECF Review): “pessimistic dry/hot climate scenario/partial adaptation” alternative scenario based on G5 Sahel CCDR projections with no impact on Moderate risk rating though debt burden indicators are considerably higher than baseline but do not breach sustainability thresholds.
  - Kenya’s tailored natural-disaster stress test: shock in second forecast year calibrated to historical 2008–11 drought; used to illustrate limited fiscal space and underscore need for institutional reforms and mobilizing concessional climate financing.
  - Benin’s customized natural disaster stress test: calibration using WB MANAGE “pessimistic dry/hot climate scenario”; mitigation effects from CAT-DDO financing and additional public investment modeled by DIGNAD; conclusions: (i) short-run analysis suggests no impact on the Moderate risk rating; (ii) extreme natural disaster shock can increase debt ratios in the long term despite CAT-DDO financing.
- Climate-linked instrument typology and guidance (selection):
  - Climate Resilient Debt Clauses (CRDCs): timebound standstill and reprofiling after pre-specified disasters; World Bank 2023 example defers principal and/or interest up to 2 years with modified amortization that maintains original average weighted maturity and does not extend final maturity date.
  - Country insurance (including WB CAT-DDO loans): provides additional financing when triggered; model in stress tests to capture mitigation effect and account for concessional/non-concessional mix and drawdown period length.
  - Sustainability-linked sovereign bonds: baseline debt service as if targets met; alternative scenario where targets are not met and additional debt service payments are triggered.
  - Debt-for-Nature swaps: qualitative mitigating factor; once signed, can be incorporated in baseline via stock-flow adjustment and change in debt service profile; must consider non-debt liabilities tied to conservation targets and guarantees with subsidy components.

### Tools and models referenced
- Burns, Jooste, and Schwerhoff (2021) — model accounting for different weather scenarios and differences in country vulnerabilities.
- DIGNAD toolkit — Excel interface to run a general equilibrium model evaluating debt sustainability risks and funding needs to rebuild public infrastructure following natural disasters.
- Additional model references: Marto, Papageoregiou, and Klyuev (2017); Aligishiev, Ruane, and Sultanov (2023).

### B. DOMESTIC PUBLIC DEBT VULNERABILITIES — Findings and Guidance
- Objective: Provide more granular guidance on accounting for domestic public debt vulnerabilities in risk and sustainability assessments of overall public debt.
- Approach:
  - Centered on a risk-based qualitative analysis of:
    - Dynamics of public debt stock and debt service.
    - Consistency of domestic public borrowing plans with maintaining macroeconomic and financial stability.
- Rationale: Existing LIC-DSF framework analyzes domestic public debt vulnerabilities through overall public debt dynamics, which can mask domestic vulnerabilities; overall risk rating has rarely been used to flag heightened risks from domestic developments.
- Practical elements — Risk-based qualitative analysis should consider:
  1) Recent developments and projections of solvency and liquidity domestic public debt indicators:
     - Examples: domestic public debt-to-GDP and domestic public debt service-to-revenue ratios as defined in the framework.
     - Compare projected dynamics to historical patterns and average projected values over the medium-term to medians across LIC-DSF countries with projected non-zero domestic public debt and domestic public debt service as of end-2023.
     - Medium-term generally understood to span the first five years of the forecast period.
     - Medians (estimated, rounded values) used as benchmarks: 17 percent for the average domestic public debt-to-GDP ratio and 22 percent for the average domestic public debt service-to-revenue ratio.
     - Interpretative guidance:
       - Risk signal benign if both average solvency and liquidity indicators are below medians and projected dynamics do not deviate significantly from historical patterns.
       - If either average solvency or liquidity indicator exceeds its median or projected dynamics deviate significantly, closer scrutiny of domestic public borrowing plan warranted.
       - If both indicators exceed medians or projected dynamics deviate significantly, more pronounced scrutiny and detailed analysis required.
  2) Consistency of the domestic public borrowing plan with macroeconomic and financial stability:
     - Assess projected take-up of new domestically issued public debt by creditor types (domestic banks; domestic non-bank financial institutions; resident non-financial sector; central bank where monetary financing present; and non-residents).
     - Evaluate realism of assumptions and associated risks considering creditors’ business models and rollover risks.
     - Useful starting point: compare projected net domestic financing with maximum/average level observed in recent past or an extrapolated projection consistent with historical trends.
     - Inform assessment with macrofinancial analysis of domestic financial sector health and prospects for stable external financing access, and IMF/WB capacity development advice on debt management.
     - If central bank is important creditor, cover consistency with broader macroframework assumptions (e.g., inflation).
     - Where share of FX-denominated or FX-indexed debt in domestic public debt is economically significant, cover debt risks from REER realignment.
     - Assess functioning of primary and secondary government bond markets to identify market pressure signs (surging secondary yields; falling bid-to-offer ratios; widening gap between offered coupon rates and effective auction interest rates; increased shares of variable-rate debt; abrupt shifts to shorter maturities; inability to rollover maturing debt).
- Presentation and data:
  - Depth of discussion should reflect potential severity of risks associated with domestic public debt.
  - A panel chart presenting dynamics of domestic public debt indicators and domestic financing assumptions should be added to standard DSA charts for all countries with projected non-zero domestic public debt.
  - Teams should leverage policy discussions and regular publications: medium-term debt management strategy; annual borrowing plan; debt management report; investor presentations; debt bulletin; issuance calendar; debt statistics.
  - Where analysis depth is constrained by data availability, teams should engage with authorities to collect missing data.
- Joint consideration and judgment:
  - Joint consideration of domestic public debt burden indicators and macroeconomic/financial stability risks informs final overall public debt risk and sustainability assessments.
  - Signals to inform judgment include: trajectory of domestic public debt dynamics; consistency of borrowing plan with stability; realism of projected take-up by main creditors; intensity of pressures in primary and secondary markets.
  - Signals weighed against mitigating factors (e.g., low rollover risk associated with specific holders).
- Country examples (selected):
  - Bangladesh 2023 Article IV: robust discussion of domestic holdings including National Saving Certificates, treasury instruments, Sukuks, and recent trends in government securities yields.
  - Ghana 2023 Article IV and 1st ECF Review DSA: changes over 2012-22 in debt and debt service composition; liquidity challenges and domestic public debt service-to-revenue ratios; comparisons to peers.
  - Kenya 2023 Article IV and 6th ECF/EFF Reviews and 1st RSF Review DSA: creditor composition, maturity profile, yields, financing strategy under liquidity constraints; sovereign-financial nexus risks.
  - Sierra Leone 8th ECF Review DSA: analysis of commercial banks’ capacity to take up projected debt issuance.
  - Burkina Faso, Mali, Ghana examples: detailed primary/secondary market functioning and incorporation of domestic vulnerabilities in overall risk assessment.
- Example indicators for panel-chart (2018-32 referenced):
  - Net domestic debt issuance 1/ (estimate based on calculated public gross financing need net of gross external financing, drawdown of assets, other adjustments and domestic debt amortization; excludes short-term debt issued and matured within the calendar year)
  - Domestic debt to GDP ratio
  - Domestic debt service to revenues incl. grants
  - Borrowing terms: Avg. real interest rate (Domestic MLT debt); Avg. real interest rate on new borrowing; Avg. maturity (incl. grace period); Avg. grace period; Domestic short-term debt (Short-term)
  - Borrowing assumptions (average over 10-year projection)
  - Shares in new domestic debt issuance
  - Median of average projected values over the first five years of the forecast period across countries using the LIC DSF with non-zero domestic debt, end-2023.

### C. USE OF THE LIC-DSF IN DEBT RESTRUCTURING SITUATIONS — Findings and Guidance
- Purpose: Provide guidance on using DSAs to support creditors’ and debtors’ decisions during debt restructurings.
- Objective and required outcomes:
  - Where public debt is unsustainable and authorities undertake debt restructuring in a Fund-supported program, restructuring must aim to restore debt sustainability over the medium term.
  - Debt sustainability is a key requirement for Fund lending and a prerequisite for achieving medium-term external viability and for providing adequate safeguards that the Fund will be repaid; “medium term” generally understood to cover a period of five years.
  - For countries where debt is “in distress” (restructuring negotiations ongoing or impending), restoring debt sustainability implies reducing the risk rating to at least a moderate risk of external debt distress over the same period, with additional considerations for the PV of overall public debt to GDP ratio.
  - Restoring sustainability from “in distress” should result in significant or sustained breaches of applicable thresholds no longer being observable; stronger performance relative to thresholds may be required to create “some space” or “substantial space” to absorb shocks.
- Time horizons and stricter cases:
  - Shorter time horizons and stronger requirements apply when Fund-supported programs involve PRGT exceptional access or high combined GRA-PRGT credit exposure:
    - Exceptional access/high combined credit exposure requires restoring public debt sustainability with high probability to a point where application of the LIC-DSF would yield a rating of low or moderate overall risk of public debt distress:
      - (i) within 36 months from Board approval of the financing request or within the period of a newly approved arrangement (whichever is longer); or
      - (ii) within the remaining period of an arrangement, in cases where the Board approves an augmentation or rephasing request.
  - A restructuring that restores debt sustainability in the medium term is also necessary for World Bank Development Policy Financing (DPF).
- Practical elements that restructuring targets should produce:
  1) Required Time Horizon:
    - i. For Fund-supported programs not involving PRGT exceptional access or high combined GRA-PRGT credit exposure: the required time horizon is the “medium term”, generally understood to cover a period of five years.
    - ii. For Fund-supported programs involving PRGT exceptional access or high combined GRA-PRGT credit exposure: the required time horizon is the one set forth above (36 months or as specified).
  2) External Debt Indicators:
    - All external debt indicators should fall durably below their respective thresholds by the required time horizon.
    - For typical non-exceptional-access cases, five years after program approval and beyond, the four external debt indicators should be below their respective thresholds under the baseline, and “significant or sustained breaches should no longer be observable.”
    - Application of judgment: short-lived or marginal breaches may be tolerated and discounted via judgment, but stricter application of judgment is warranted relative to non-restructuring situations.
  3) Overall Public Debt Indicators:
    - Evolution of overall public debt indicators should support assessment that debt sustainability will be restored within the required timeframe.
    - Restructuring strategy must ensure overall public debt is put on a sustainable path within the required time horizon, taking account of the relevant benchmark for the PV of overall public debt to GDP ratio and application of judgment.
    - In PRGT exceptional access/high combined GRA-PRGT credit exposure cases, the PV of overall public debt to GDP ratio should fall below its benchmark within the required time horizon, subject to judgment.
- Application of judgment and financing assurances:
  - For non-exceptional-access cases, judgment on the PV benchmark could allow for more than deeming away short-lived or marginal breaches, but any additional time must be adequately justified and consistent with Fund-supported program parameters and the Fund’s financing assurances policy.
  - Restructuring targets must be consistent with the Fund-supported program parameters and satisfy the Fund’s financing assurances policy, which requires Fund-supported programs to be “fully financed,” covering program and post-program periods.
  - Targets should ensure debt service projections for the program and post-program periods are consistent with the financing assurances policy.
- Sovereign discretion and creditor agreements:
  - DSA can be used to determine restructuring envelope needed to restore sustainability, but:
    - (i) decision to restructure is sovereign’s sole discretion; and
    - (ii) debtor and creditors must agree on restructuring perimeter and terms to achieve debt sustainability under the program macro-framework.
- Scenario analysis using the LIC-DSF:
  - Scenario analysis can help authorities assess relative merits of restructuring proposals, considering impact on debt indicators, prospects for creditor support, and economic costs of inaction or delayed/insufficient action.
  - When evaluating proposals involving domestic public debt restructuring, due consideration should be given to both potential benefits and costs.
  - Users should adapt the macro framework to capture feedback effects, including:
    - Financial stability: losses on domestic public debt holdings affect banks’ profitability and capital; analysis should draw on FSAPs to determine potential recapitalization needs and mitigation factors (banks holding capital in excess of prudential minimum; foreign-bank parent support; industry-funded recapitalization fund).
    - Monetary policy transmission: consider spillovers to inflation, central bank credibility and effectiveness, and private sector access to finance.
    - Fiscal policy effectiveness: restructuring could reduce fiscal revenues from debt holders and compromise access to domestic capital markets, disrupting budget implementation; include impact on household savings (e.g., domestic pension fund restructuring) for fiscal mitigation and political feasibility.
    - Growth: macrofinancial feedback effects are expected to reduce growth.
    - Legal uncertainty: complement economic analysis with legal analysis of domestic public debt features and feasibility of legal reforms.
  - Assess impact on debt sustainability using techniques in Section B to determine whether post-restructuring dynamics and borrowing plan support restoring sustainability within required timeframe.
- Presentation of analysis at different restructuring stages:
  - Pre-restructuring baseline: shows impact of all debt obligations as contracted or modified; residual BoP financing gap typically assumed financed through accumulation of arrears rolled over by a long-term PV-neutral bond (a notional security with an interest rate of 5 percent and grace period and maturity longer than the 20-year LIC DSF projection horizon).
  - Timing for incorporating debt treatments in baseline DSA:
    - Debt treatments can be incorporated in the baseline only once agreements are firm.
    - An “agreement-in-principle” (AIP) is not sufficiently firm.
    - Inclusion generally requires sufficient confidence, informed by an agreed MOU with an Official Creditor Committee (OCC) or bilateral agreements or settlement of a bond exchange.
    - Use judgment when including partial treatments; claims without finalized treatment should be included at pre-restructuring terms.
    - Where MOU or representative agreement reached with a permanent standing forum (Paris Club or Common Framework OCC with Paris Club participation), baseline could incorporate comparable treatment of all other official creditors or include treatments sequentially as bilateral agreements are concluded.
  - Alternative restructuring scenarios:
    - When public debt is unsustainable in baseline, present an alternative restructuring scenario to illustrate how sustainability would be restored forward-looking.
    - Illustrative scenarios show adjustment effort needed and capture any AIPs or authorities’ strategies for different creditors, aiding creditor decisions on financing assurances and restructuring implementation consistent with IMF program parameters.
    - Care needed not to prejudge specific treatment for residual creditors as agreements with significant creditors are reached.
    - Example: Zambia’s 2022 ECF program required PV of external debt to fall to 84 percent of exports over the medium-term to restore sustainability; illustrative scenario explained need for tighter PV of external debt to exports target and showed even with large reduction in PV of external debt, substantial GDP rebasing would be needed for PV of external debt to GDP to be consistent with general threshold.

### State-Contingent Debt Instruments (SCDIs) — Role and Assessment
- SCDIs bear contractual debt service obligations tied to a pre-defined state variable.
- While timely agreement on an unconditional debt treatment is first best, SCDIs can help bridge debtor-creditor differences and contain costs of prolonged negotiations when uncertainty is high.
- Assessment steps:
  1) Identify which creditors will receive the instrument; absent information, assume all do, consistent with comparability of treatment.
  2) Assess average impact of the SCDI on external debt burden indicators and risk of distress if triggered. Use scenario analysis when precise triggers would change payoffs; use stochastic or options-pricing methodologies or adapt MAC SR-DSF Debt Fanchart Module techniques for expected values where appropriate.
  3) Assess whether the SCDI leaves exposures uncapped or produces pay-offs in too many adverse states; use MAC SR-DSF Debt Fanchart Module techniques as appropriate.
- Practical considerations:
  - Inclusion of SCDIs may take more time to assess than unconditional treatments and can carry economic costs of delay.
  - SCDIs can have a positive role in future debt crisis prevention by adjusting debt service in adverse states.

### Macrofinancial implications of domestic debt restructurings — country examples (Box 4)
- Financial stability:
  - Ghana 2023: estimates of NPV reduction from domestic debt exchange and impact on banks’ capital adequacy ratios based on presumed regulatory adjustments.
  - Sri Lanka 2023: diagnostic exercise for major banks including comprehensive AQR; contingency for recapitalization costs for public banks included in DSA.
- Monetary policy transmission:
  - Sri Lanka 2024: estimated significant drop in central bank’s net worth due to 2023 domestic debt restructuring; emphasized need to rebuild central bank capital to preserve independent monetary policy.
- Fiscal policy effectiveness:
  - Ghana 2023: domestic debt exchange design aimed to keep T-bills out of restructuring so short-term market remained functional as critical instrument until long-term market restored.
- Assessing impact on debt sustainability:
  - Ghana 2023 DSA: baseline did not include yet-to-be-finalized restructuring but used techniques from Section B to illustrate how restructuring would affect overall risk and sustainability assessment.
  - Guidance: no presumption for inclusion/exclusion of domestic public debt in restructuring decisions; country-specific analysis needed. If large share of debt held by public sector entities and deep relief needed, or if bank holdings are large relative to capital buffers and restructuring losses trigger government support, domestic restructuring may be limited or negative in effect.
  - Where external financing gap is present, domestic public debt restructuring can contribute to closing it only to extent that foreign investors hold domestically issued public debt.
  - LIC-DSF can help authorities develop data-driven scenario analysis to inform inclusion/exclusion decisions and estimate capacity to repay external creditors under different scenarios.

*Source: Supplement to 2018 Guidance Note on the Bank-Fund LIC-DSF (excerpts).*

### EXECUTIVE SUMMARY

### EXECUTIVE SUMMARY

### CONTEXT
- Purpose: Supplement provides additional guidance to IMF and World Bank staff on implementation of the Bank-Fund Debt Sustainability Framework for Low Income Countries (LIC-DSF) approved in 2017, complementing the 2018 Bank-Fund guidance note on the LIC-DSF (IMF and WB, 2018).
- Rationale:
  - Climate change risks and domestic public debt vulnerabilities have become more prominent since 2017.
  - Debt restructurings have increased in complexity, creating a need for further guidance on the use of the LIC-DSF in restructuring situations.
- Positioning: Prepared as a first step within the current IMF and World Bank Boards-approved framework while a deeper review of the LIC-DSF is progressing. The full review will explore ways to adapt the framework to evolving debt vulnerabilities and analytical advances.
- Administrative details:
  - Date: July 18, 2024.
  - All aspects of the 2018 LIC-DSF Guidance Note remain in effect, except as modified in this supplement.

### A. CLIMATE-CHANGE — Findings and Guidance on Incorporation into DSAs
- Core premise:
  - Climate-change risks and climate investments and policies affect debt sustainability via impacts on baseline macroeconomic forecasts and expected volatility.
  - Climate change includes slow-moving long-term shifts and sudden extreme weather events; both can reduce productivity, government revenues, and increase spending needs for reconstruction, adaptation, and social protection.
  - Climate investments and policies can mitigate impacts on growth and volatility.
- When coverage is required or encouraged:
  - Required in DSAs accompanying requests for Fund Resilience and Sustainability Facility arrangement (RSF arrangement) or World Bank Development Policy Operation with Catastrophic Deferred Drawdown Options (DPOs with CAT DDOs).
  - Encouraged in all other cases, with a presumption for inclusion in DSAs accompanying or issued following publication of WB or IMF in-depth topical analyses, and for countries where climate change and climate adaptation or transition management policies are assessed as macrocritical in Fund’s Article IV and program reports, or considered essential in WB Development Policy Financing operations.
- Write-up requirements when climate is incorporated:
  - Indicate how slow-moving shifts and changes in frequency/intensity of extreme events affect the baseline, including whether positive effects from climate-related investment on resilience and growth are part of the baseline and whether baseline assumptions are aligned with authorities’ climate policies (including Nationally Determined Contributions) or adjusted for staff views (e.g., investment pledges).
  - Clearly refer to the source of assumptions and any adjustments.
  - Discuss whether and how extreme weather impacts on volatility around the baseline are reflected, and whether investments and climate-linked debt instruments are accounted for in climate-focused stress tests.
  - If incorporation changes the risk or sustainability assessment relative to the previous DSA, country teams should engage early with authorities on realism of assumptions and financing sources.
- Modeling and scenario guidance:
  - Stand-alone climate-change macro models and tools can inform macro assumptions in the baseline or alternative scenarios (examples include WB CCDR, IMF CPD, WB CC-MFMod).
  - Use of alternative scenarios is encouraged (not required). Alternative scenarios can:
    - Capture longer-term interplay between climate change and climate policies, including climate-related investment (public and private) and social spending where data are available.
    - Provide a benchmark for calibrating the government share of additional economy-wide climate spending consistent with an unchanged outlook relative to the baseline for debt risk and sustainability—i.e., the maximum amount financeable by a realistic mix of higher primary deficit, loans and grants without an unidentified financing gap.
  - If no stand-alone model is available, basing long-term growth projections on long-term historical trend can be a starting point for near-term analysis, with caveats where data limit quantification.
- Stress-test guidance:
  - The impact of extreme but plausible weather events on outcome distributions around the central projection can be analyzed via stress tests.
  - The tailored natural disaster stress test remains mandatory for:
    - Small developing states prone to natural disaster (IMF, 2016).
    - LICs that meet criteria for frequency (around 2 disasters every 3 years) and economic losses (above 5 percent of GDP per year) from natural disasters (IMF and WB, 2018, Table 10).
  - The tailored natural disaster stress test is optional for other LICs.
  - Calibration of the tailored stress test should be updated when in-depth analysis is available (e.g., WB’s CC-MFMod or IMF CPD).
  - Customized stress tests on external and overall public debt can accommodate triggering shocks in period t+5 (as in IMF’s DIGNAD model) or outside the 10-year forecast horizon relevant for the risk rating, allowing incorporation of feedback from climate policies to growth.
  - Results from stand-alone climate-change macro models and tools can inform calibration of stress tests.
- Guidance on climate-linked debt instruments:
  - Supplement provides guidance on accounting for climate-related innovative debt instruments in DSAs (high-level consideration; specific modalities discussed in the supplement).

### B. DOMESTIC PUBLIC DEBT VULNERABILITIES — Findings and Guidance
- Objective: Provide more granular guidance on accounting for domestic public debt vulnerabilities in risk and sustainability assessments of overall public debt.
- Approach:
  - Centered on a risk-based qualitative analysis of:
    - Dynamics of public debt stock and debt service.
    - Consistency of domestic public borrowing plans with maintaining macroeconomic and financial stability.
- Rationale: The existing LIC-DSF framework analyzes domestic public debt vulnerabilities through overall public debt dynamics, which can mask domestic vulnerabilities; in practice, the overall risk rating has rarely been used to flag heightened risks from domestic developments.
- Practical elements:
  - Use more granular indicators and narrative analysis to capture domestic financing pressures, rollover and refinancing risks, currency and maturity mismatches, and implications for macrofinancial stability.
  - Country teams should assess whether domestic borrowing plans are consistent with maintaining macroeconomic and financial stability, and flag risks where inconsistency exists.

### C. USE OF THE LIC-DSF IN DEBT RESTRUCTURING SITUATIONS — Findings and Guidance
- Purpose: Provide guidance on using DSAs to support creditors’ and debtors’ decisions during debt restructurings.
- Key elements:
  - Setting debt restructuring targets where restructuring is undertaken in context of a Fund-supported program.
  - Modalities of DSA scenario analysis to help authorities assess relative merits of different restructuring proposals, with special attention to cases involving domestic public debt or state-contingent debt instruments (SCDIs).
  - Presentation of DSA analysis at different stages of the restructuring process to inform negotiations and program design.
- Special considerations:
  - Pay particular attention to macrofinancial implications when domestic public debt or SCDIs are involved.
  - Use scenario analysis to compare restructuring proposals, including their effects on public debt dynamics, debt service, and macrofinancial stability.
  - Provide tailored presentation of analysis for different restructuring stages to support credible targets and informed creditor-debtor discussions.

### SUPPLEMENT STRUCTURE (selected)
- Contents include:
  - Glossary.
  - CONTEXT.
  - SUPPLEMENTARY GUIDANCE with sections:
    - A. Climate-Change.
    - B. Domestic Public Debt Vulnerabilities.
    - C. Use of the LIC-DSF in Debt Restructuring Situations.
  - Boxes and Figures illustrating examples and models (e.g., Box 1, Box 2, Figures on LIC exposure and vulnerability).

*Prepared by IMF and World Bank teams; approved July 18, 2024.*

### 7.      Depending on their economic relevance and data availability, the impact of climate-

### 7.      Depending on their economic relevance and data availability, the impact of climate-

### Climate-linked instruments in DSAs: general guidance
- Climate-linked debt instruments can be captured:
  - quantitatively in the DSA baseline and/or in built-in, customized stress tests; or
  - used as a qualitative mitigating factor in informing judgment, especially in borderline cases when a country’s baseline debt burden indicators are just above their thresholds.
- Instruments tend to decrease volatility and can affect baseline projections or stress-test calibrations depending on design and activation status.
- Modeling of instruments should account for their design features (e.g., trigger thresholds, reprofiling horizon, disbursement profile, concessionality).

### Tools and models referenced
- Burns, Jooste, and Schwerhoff (2021) — model accounting for different weather scenarios and differences in country vulnerabilities.
- DIGNAD toolkit — user-friendly Excel interface to run a general equilibrium model evaluating debt sustainability risks and funding needs to rebuild public infrastructure following natural disasters (link provided in source).
- Additional model references: Marto, Papageoregiou, and Klyuev (2017); Aligishiev, Ruane, and Sultanov (2023).

### Empirical examples of coverage of climate risks and policies in DSAs (Box 1)
- Use of stand-alone climate macro models in baseline:
  - Vanuatu 2023 Article IV staff report: real GDP growth lowered by 0.5 percentage points, current account balance lowered by 1.3 percent of GDP, fiscal deficit increased by 0.35 percent of GDP relative to disaster-free projections on average over the projection period.
  - Similar approach taken in Tonga’s 2023 Article IV staff report.
- Use in alternative scenarios:
  - Niger’s DSA (3rd ECF Review) includes a “pessimistic dry/hot climate scenario/partial adaptation” alternative scenario based on G5 Sahel CCDR projections; conclusion: no impact on Moderate risk rating though debt burden indicators are considerably higher than baseline but do not breach sustainability thresholds.
- Extrapolation of historical trends in baseline:
  - Kenya (5th EFF/ECF Reviews and RSF Request) and Niger (3rd ECF review) DSAs capture long-term shifts by extrapolating historical growth trends reflecting climate-related shocks and incorporating climate-related investments planned by authorities.
- Effects on distribution around central projections via stress tests:
  - Kenya’s tailored natural-disaster stress test: shock in second forecast year calibrated to historical 2008–11 drought; used to illustrate limited fiscal space and underscore need for institutional reforms, public investment efficiency, and mobilizing concessional climate financing or private sector solutions.
  - Benin’s customized natural disaster stress test (3rd EFF/ECF Reviews): shock calibrated using WB MANAGE model “pessimistic dry/hot climate scenario”; mitigation effects from CAT-DDO financing and additional public investment modeled by DIGNAD; conclusions: (i) short-run analysis suggests no impact on the Moderate risk rating; (ii) extreme natural disaster shock can increase debt ratios in the long term despite CAT-DDO financing.

### Overview of climate-linked debt instruments (Box 2)
- General guidance:
  - Include instruments in the baseline if signed, issued, triggered, or assessed consistent with the financing envelope when building that scenario.
  - Otherwise, assess under alternative scenarios or as part of customized natural disaster stress tests.
- Climate Resilient Debt Clauses (CRDCs):
  - Provide timebound standstill and debt service reprofiling to free up fiscal space after pre-specified natural disasters.
  - Can be captured in baseline qualitatively or quantitatively if activated, or in customized stress-test calibration for debts with CRDCs.
  - Modeling should consider events covered, trigger thresholds, reprofiling horizon, etc.
  - 2023 World Bank example: CRDCs in IBRD loans and IDA credits for tropical cyclones/hurricanes and earthquakes, with deferral of principal and/or interest up to 2 years and modified amortization that maintains original average weighted maturity and does not extend final maturity date.
- Country insurance (including WB CAT-DDO loans):
  - Provides additional financing when triggered; impacts debt burden indicators in stress scenarios.
  - Can be assessed in baseline if activated, or in customized stress test to capture mitigation effect.
  - Modeling should account for concessional/non-concessional mix and disbursement profile parameters (e.g., drawdown period length and potential extension).
  - Benin DSA example: customized stress test includes mitigation impact of a CAT-DDO triggered by an extreme but plausible natural disaster shock.
- Sustainability-linked sovereign bonds:
  - Change financial or structural bond aspects (e.g., coupon step-up/step-down) if issuer misses/achieves pre-defined environmental, social or sustainability targets.
  - In baseline, include bond’s debt service as if targets are met; consider alternative scenario where targets are not met and additional debt service payments are triggered.
  - Discuss downside risks to meeting targets.
- Debt-for-Nature swaps:
  - Qualitative mitigating factor from potential partial debt relief and/or change in debt service profile (e.g., reduced interest payments or buyback of privately held debt at below-market interest rates).
  - Once signed, can be incorporated in baseline as part of external financing plan via stock-flow adjustment and change in debt service profile.
  - Swaps redirect expenditure from debt service to climate-related/sustainability projects—should be reflected in fiscal projections.
  - Assessment should consider establishment of non-debt liabilities tied to conservation targets and potential use of guarantees that may have subsidy components and could change creditor seniority in distress.

### Domestic public debt vulnerabilities: framework and indicators
- Domestic public debt vulnerabilities are incorporated through assessment of overall (domestic and external) debt vulnerabilities.
- Mechanical risk signal for overall public debt derived from:
  - four external debt burden indicators compared with indicative thresholds; and
  - PV of overall public debt-to-GDP compared with its indicative benchmark.
- Need for granular analysis arises from imperfect substitutability between FX and domestic-currency public debt in LICs due to:
  - persistent negative national saving-investment balance and limited financial sector reach;
  - weaker domestic savings mobilization increasing macroeconomic and financial stability risks from domestic debt dynamics.
- Risk-based qualitative analysis should consider:
  1) Recent developments and projections of solvency and liquidity domestic public debt indicators:
     - Examples: domestic public debt-to-GDP and domestic public debt service-to-revenue ratios as currently defined in the framework.
     - Compare projected dynamics to historical patterns and average projected values over the medium-term to medians across LIC-DSF countries with projected non-zero domestic public debt and domestic public debt service as of end-2023.
     - Medium-term generally understood to span the first five years of the forecast period.
     - Medians (estimated, rounded values) used as benchmarks: 17 percent for the average domestic public debt-to-GDP ratio and 22 percent for the average domestic public debt service-to-revenue ratio.
     - Interpretative guidance:
       - Risk signal considered benign if both average solvency and liquidity indicators are below medians and projected dynamics do not deviate significantly from historical patterns.
       - If either average solvency or liquidity indicator exceeds its median or projected dynamics deviate significantly, closer scrutiny of domestic public borrowing plan warranted.
       - If both indicators exceed medians or projected dynamics deviate significantly, need for even more pronounced scrutiny and more detailed analysis.
  2) Consistency of the domestic public borrowing plan with macroeconomic and financial stability:
     - Assess main assumptions on projected take-up of new domestically issued public debt by creditors in domestic market (domestic banks; domestic non-bank financial institutions; resident non-financial sector; central bank where monetary financing present; and non-residents).
     - Evaluate realism of assumptions and associated risks considering creditors’ business models and rollover risks.
     - Useful starting point: compare projected net domestic financing with maximum/average level observed in recent past or an extrapolated projection consistent with historical trends.
     - Inform assessment with macrofinancial analysis of domestic financial sector health and prospects for stable external financing access, and IMF/WB capacity development advice on debt management.
     - If central bank is important creditor, cover consistency of assumed take-up with broader macroframework assumptions (e.g., inflation).
     - Where share of FX-denominated or FX-indexed debt in domestic public debt is economically significant, cover debt risks from REER realignment.
     - Assess functioning of primary and secondary domestic government bond markets to identify signs of market pressures, such as:
       - surging secondary market yields;
       - falling bid-to-offer ratios at different maturities;
       - widening gap between offered coupon rates and effective auction interest rates;
       - increased shares of variable interest rate debt;
       - abrupt shifts to the shorter end of the maturity spectrum;
       - inability to rollover maturing debt in the primary market.

*Source: Supplement to 2018 Guidance Note on the Bank-Fund LIC-DSF (excerpts).*

### 10.      The depth of the discussion should reflect the potential severity of risks associated

### 10.      The depth of the discussion should reflect the potential severity of risks associated with domestic public debt gleaned from the above analysis

### Depth of analysis, data sources, and presentation
- Depth of discussion should reflect the potential severity of risks associated with domestic public debt.
- A panel chart presenting the dynamics of domestic public debt indicators and domestic financing assumptions should be added to the standard set of DSA charts for all countries with projected non-zero domestic public debt.
- Teams should leverage policy discussions with authorities and regular publications, such as:
  - medium-term debt management strategy
  - annual borrowing plan
  - debt management report
  - investor presentations
  - debt bulletin
  - issuance calendar
  - debt statistics
- Where analysis depth is constrained by data availability, teams should actively engage with authorities to collect missing data to strengthen future DSAs.
- Box 3 provides country examples of coverage of different facets of domestic public debt vulnerabilities.

### Joint consideration for overall public debt risk and sustainability assessments
- Joint consideration of domestic public debt burden indicators and any macroeconomic and financial stability risks from the domestic public borrowing plan informs the final overall public debt risk and sustainability assessments.
- Signals to inform teams’ judgment on final rating of overall public debt distress include:
  - trajectory of domestic public debt dynamics
  - consistency of domestic public borrowing plan with maintaining macroeconomic and financial stability
  - realism of projected take-up of new debt by the government’s main creditors
  - intensity of pressures in the primary and secondary government bond markets
- These signals must be weighed against mitigating factors, e.g., low rollover risk associated with specific holders of domestic government debt.

### Country examples (Box 3)
- Recent Developments and Projections of Domestic Public Debt Indicators
  - Bangladesh’s 2023 Article IV Consultation (IMF, 2023b): robust discussion of domestic holdings of debt, differentiating National Saving Certificates, treasury instruments, and Sukuks, and recent trends on government securities yields.
  - Ghana’s 2023 Article IV and 1st ECF Review DSA (IMF, 2024b): covers changes over 2012-22 in debt and debt service composition (share of domestic public debt in overall debt; share held by different domestic creditors; share of domestic public debt service in overall debt service) and liquidity challenges (historical evolution of domestic public debt service and domestic public debt service-to-revenue ratios; comparisons to peers).
- Analysis of Consistency of Domestic Public Borrowing Plan with Maintaining Macroeconomic and Financial Stability / Analysis of Projected Take-Up of New Domestic Public Debt by Main Creditors
  - Kenya’s 2023 Article IV and 6th ECF/EFF Reviews and 1st RSF Review DSA (IMF, 2024c): discusses creditor composition, maturity profile and yields, authorities’ financing strategy under challenging liquidity conditions; elaborates on sovereign-financial nexus risks.
  - Ghana’s 2023 DSA (IMF, 2024b): examines sovereign-financial nexus via share of government securities in bank assets and bank capital position, and in balance sheets of other non-bank financial institutions.
  - Sierra Leone’s 8th ECF Review DSA (IMF, 2023g): critically analyzes commercial banks’ capacity to take up projected debt issuance.
- Functioning of Primary and Secondary Government Domestic Bond Markets
  - Burkina Faso’s 2023 ECF Request DSA (IMF, 2023c): thorough discussion of domestic financing at the WAEMU regional bond market (placements treated as domestic public debt for DSA purposes).
  - Ghana’s 2023 DSA (IMF, 2024b): deep dive into composition of local currency bond issuances in recent years.
  - Mali’s 2023 Article IV DSA (IMF, 2023e): financing pressures discussion includes figure on withheld and unfilled auctions of regional debt on the primary market.
- Incorporation of Domestic Public Debt Vulnerabilities in Overall Risk and Sustainability Assessments
  - Burkina Faso’s DSA (IMF, 2023c): discusses medium-term risks related to debt cash management and implications for debt sustainability; notes additional reliance on domestic public debt could change risk assessment given maturity and cost characteristics.
  - Ghana’s DSA (IMF, 2024b): examines impact of domestic public debt restructuring and vulnerabilities (incurrence of domestic arrears, issues with debt data transparency); examines debt management and medium-term challenges for restoring domestic market access and financial sector stability.
  - Sierra Leone’s DSA (IMF, 2023g): highlights impact of domestic public debt-related risks on overall debt risk rating; underlines importance of domestic public debt market development and enabling creditor institutions to manage risks as part of authorities’ Medium-Term Debt Strategy.

### Figure and indicators (example referenced)
- Panel-chart style indicators to be included for countries with non-zero domestic public debt (example spans 2018-32).
- Indicators referenced include:
  - Net domestic debt issuance 1/ (estimate based on calculated public gross financing need net of gross external financing, drawdown of assets, other adjustments and domestic debt amortization; excludes short-term debt issued and matured within the calendar year)
  - Domestic debt to GDP ratio
  - Domestic debt service to revenues incl. grants
  - Borrowing terms: Avg. real interest rate (Domestic MLT debt); Avg. real interest rate on new borrowing; Avg. maturity (incl. grace period); Avg. grace period; Domestic short-term debt (Short-term)
  - Borrowing assumptions (average over 10-year projection)
  - Shares in new domestic debt issuance
- Median of average projected values over the first five years of the forecast period across countries using the LIC DSF with non-zero domestic debt, end-2023 (figure context).

---

### C.   Use of the LIC-DSF in Debt Restructuring Situations

### Objective and required outcomes
- Where public debt is unsustainable and authorities undertake debt restructuring in a Fund-supported program, restructuring must aim to restore debt sustainability over the medium term.
- Debt sustainability is a key requirement for Fund lending and a prerequisite for achieving medium-term external viability and for providing adequate safeguards that the Fund will be repaid, with “medium term” generally understood to cover a period of five years.
- For countries where debt is “in distress” (restructuring negotiations ongoing or impending), restoring debt sustainability implies reducing the risk rating to at least a moderate risk of external debt distress over the same period, with additional considerations for the PV of overall public debt to GDP ratio.
- Restoring sustainability from “in distress” should result in significant or sustained breaches of applicable thresholds no longer being observable; stronger performance relative to thresholds may be required to create “some space” or “substantial space” to absorb shocks.

### Time horizons and stricter cases
- Shorter time horizons and stronger requirements apply when Fund-supported programs involve PRGT exceptional access or high combined GRA-PRGT credit exposure.
  - Exceptional access/high combined credit exposure requires restoring public debt sustainability with high probability to a point where application of the LIC-DSF would yield a rating of low or moderate overall risk of public debt distress:
    - (i) within 36 months from Board approval of the financing request or within the period of a newly approved arrangement (whichever is longer); or
    - (ii) within the remaining period of an arrangement, in cases where the Board approves an augmentation or rephasing request.
- A restructuring that restores debt sustainability in the medium term is also necessary for World Bank Development Policy Financing (DPF).

### Practical elements that restructuring targets should produce
1) Required Time Horizon:
  - i. For Fund-supported programs not involving PRGT exceptional access or high combined GRA-PRGT credit exposure: the required time horizon is the “medium term”, generally understood to cover a period of five years.
  - ii. For Fund-supported programs involving PRGT exceptional access or high combined GRA-PRGT credit exposure: the required time horizon is the one set forth above (36 months or as specified).
2) External Debt Indicators:
  - All external debt indicators should fall durably below their respective thresholds by the required time horizon.
  - The restructuring strategy should ensure that projections show the country at low or moderate risk of external debt distress by the required time horizon, possibly with “some space” or “substantial space” to absorb shocks.
  - For typical non-exceptional-access cases, five years after program approval and beyond, the four external debt indicators should be below their respective thresholds under the baseline, and “significant or sustained breaches should no longer be observable.”
  - Application of judgment: short-lived or marginal breaches may be tolerated and discounted via judgment, but stricter application of judgment is warranted relative to non-restructuring situations.
3) Overall Public Debt Indicators:
  - Evolution of overall public debt indicators should support assessment that debt sustainability will be restored within the required timeframe.
  - Restructuring strategy must ensure overall public debt is put on a sustainable path within the required time horizon, taking account of the relevant benchmark for the PV of overall public debt to GDP ratio and application of judgment.
  - In PRGT exceptional access/high combined GRA-PRGT credit exposure cases, the PV of overall public debt to GDP ratio should fall below its benchmark within the required time horizon, subject to judgment (stricter test).

### Application of judgment and financing assurances
- For Fund-supported programs not involving PRGT exceptional access or high combined exposure, application of judgment on the PV benchmark for overall public debt to GDP could go beyond deeming away short-lived or marginal breaches, but any additional time must be adequately justified and consistent with Fund-supported program parameters and the Fund’s financing assurances policy.
- Restructuring targets must be consistent with the Fund-supported program parameters and satisfy the Fund’s financing assurances policy, which requires Fund-supported programs to be “fully financed,” covering program and post-program periods.
- The restructuring targets should ensure debt service projections for the program and post-program periods are consistent with the financing assurances policy, constraining feasible paths to achieve a moderate risk of external debt distress at the required time horizon.

### Sovereign discretion and creditor agreements
- While the DSA can be used to determine the debt restructuring envelope needed to restore sustainability:
  - (i) the decision to restructure is within the sovereign’s sole discretion; and
  - (ii) debtor and creditors must agree on restructuring perimeter and terms to achieve debt sustainability under the program macro-framework.

### Scenario analysis using the LIC-DSF
- Scenario analysis can help authorities assess relative merits of restructuring proposals, considering:
  - impact on debt indicators
  - prospects for creditor support
  - economic costs of inaction or delayed/insufficient action (shallow restructuring)
- When evaluating proposals involving domestic public debt restructuring, due consideration should be given to both potential benefits and costs.
- Users should:
  1) Adapt the macro framework to capture feedback effects, including:
     - Financial stability: imposing losses on domestic public debt holdings typically affects banks’ profitability and capital; analysis should draw on financial sector assessments (e.g., recent FSAP) to determine if government recapitalization would be required. Potential fiscal costs can be mitigated where:
       - (i) banks hold capital in excess of the prudential minimum; or
       - (ii) foreign-bank parents can provide capital; and/or an industry-funded recapitalization fund is available.
     - Monetary policy transmission mechanism: consider spillover impact on inflation, effectiveness of central bank tools, and private sector access to finance; damage to banking sector balance sheets may constrain credit growth, slowing investment.
     - The fiscal deficit and effectiveness of fiscal policy: restructuring could reduce fiscal revenues from holders of debt; could compromise access to domestic capital markets for a protracted period—reducing available financing volume and increasing cost—thus disrupting budget implementation and fiscal effectiveness. Impact on household savings (e.g., restructuring of domestic pension funds) should be included to account for potential fiscal mitigation measures and political/social feasibility.
     - Growth: macrofinancial feedback effects are expected to reduce growth.
     - Legal uncertainty: complement economic analysis with legal analysis of domestic public debt features and feasibility of required legal reforms; legal uncertainty can delay process and exacerbate macroeconomic risks.
  2) Assess impact on debt sustainability, drawing on techniques in Section B, to determine whether post-restructuring dynamics of domestic public debt burden indicators and the domestic public borrowing plan support restoring debt sustainability within the required timeframe.

*Source: IMF-WB staff review and Supplement to 2018 Guidance Note on the Bank-Fund LIC-DSF (excerpts).*

### Box 4 provides country examples of analysis of macrofinancial implications of domestic debt

### Box 4. Country Examples of Analysis of Macrofinancial Implications of Domestic Debt Restructurings

### Financial Stability
- Ghana (IMF, 2023k): IMF staff report for Ghana’s 2023 ECF Request discusses implications for banks’ balance sheets of the domestic public debt exchange operation.
  - Included estimates of the NPV reduction likely to result from the domestic debt exchange, based on expert calculations of the discount rates banks would adopt in their accounting of the operation.
  - Staff discussed the impact on banks’ capital adequacy ratios based on the presumed regulatory adjustments.
- Sri Lanka (IMF, 2023l; IMF, 2023m): Authorities conducted a diagnostic exercise for major banks, including a comprehensive asset quality review (AQR), to assess the impact of the 2023 domestic public debt restructuring.
  - Contingency for recapitalization costs for public banks was included in the DSA (private banks were expected to meet their own capital needs).

### Monetary Policy Transmission Mechanism
- Sri Lanka (IMF, 2024d): Authorities and staff estimated a significant drop in the central bank’s net worth due to the 2023 domestic debt restructuring.
  - Operation details: holdings of T-bills were converted to T-bonds, and agreement to settle past due bills to the Asian Clearing Union (ACU).
  - Report highlighted the importance of rebuilding the central bank’s capital position to enhance its credibility in conducting independent monetary policy.

### Impact on Effectiveness of Fiscal Policy
- Ghana (IMF, 2023k): Debt management after the 2023 domestic debt exchange aimed to maintain minimal functioning of domestic debt markets and develop a roadmap for gradual resumption of activity.
  - T-bills were not included in the restructuring, so the short-term domestic debt market would remain functional and a critical instrument for both investors and the government until the functioning of the longer-term bond market would be restored.

### Assessing the Impact on Debt Sustainability
- Ghana (IMF, 2023k) DSA: Discussed impact of the public debt restructuring operation (including a domestic public debt exchange) on debt sustainability.
  - Baseline scenario did not include the yet-to-be-finalized public debt restructuring but drew on techniques outlined in Section B to highlight how it would impact overall risk and sustainability assessment.
- Guidance on inclusion/exclusion of domestic public debt in restructuring decisions:
  - No presumption of inclusion or exclusion; country situations differ.
  - Domestic public debt restructuring can be significant or indispensable in some cases, but in others it can bring very little or have a negative impact overall.
  - If a large share of debt is held by public sector entities and deep debt relief is needed to restore debt sustainability, or if domestic banks’ holdings of government bonds are large relative to their capital buffers and restructuring losses trigger the need for government support of the financial system, the contribution of a domestic public debt restructuring may be very limited, and possibly negative.
  - Where an external financing gap is present, domestic public debt restructuring can directly contribute to closing it only to the extent that foreign investors are holders of domestically issued public debt.
  - Using the LIC-DSF can help authorities develop data-driven, country-specific scenario analysis to inform inclusion/exclusion decisions and estimate capacity to repay external creditors under different scenarios.

### State-Contingent Debt Instruments (SCDIs)
- Role and risks of SCDIs:
  - SCDIs are instruments that bear contractual debt service obligations tied to a pre-defined state variable.
  - While timely agreement on an unconditional debt treatment is first best, SCDIs can help bridge debtor-creditor differences and contain costs of prolonged negotiations, especially when uncertainty around economic outlook is high.
  - Assessment of SCDIs’ consistency with preserving debt sustainability requires several steps:
    - First: Identify which creditors will receive the instrument; in absence of specific information, assume all do, in line with the creditor principle of comparability of treatment.
    - Second: Assess how the SCDI would on average impact external debt burden indicators and the risk of distress if triggered. Depending on SCDI complexity, use either a scenario analysis around the baseline DSA or a stochastic approach to determine relative probabilities of potential outcomes.
      - A scenario analysis is recommended when precise triggers (not included in the baseline) would result in a higher or lower payoff.
      - For a stochastic approach, consider options-pricing methodology or adapt techniques underpinning the Debt Fanchart Module of the Sovereign Risk and Debt Sustainability Framework for Market Access Countries (MAC SR-DSF) to place an expected value on the SCDI.
    - Third: Assess whether the SCDI leaves exposures uncapped or produces pay-offs in too many states of the world where the country’s repayment capacity is diminished. Use techniques underpinning MAC SRDSF Debt Fanchart Module as appropriate.
- Practical considerations:
  - Inclusion of SCDIs may take more time to assess than unconditional treatments and can carry economic costs of delay.
  - SCDIs can have a positive role in future debt crisis prevention by adjusting debt service in adverse states.

### Presentation of Analysis in DSAs at Different Stages in the Restructuring Process Under a Fund-Supported Program
- Pre-restructuring DSA baseline:
  - Shows impact of all debt obligations, as contracted or modified in earlier restructurings or debt management exercises, on debt burden indicators under the program macro-framework.
  - Estimated residual BoP financing gap typically assumed financed through accumulation of arrears on existing obligations, which in the DSA can be assumed rolled over by a long-term PV-neutral bond (a notional security with an interest rate of 5 percent and grace period and maturity longer than the 20-year LIC DSF projection horizon).
  - Presence of significant or sustained breaches of debt thresholds that cannot be deemed away generally triggers an “In Debt Distress, Unsustainable” rating: (1) Presence of external or domestic arrears that cannot be deemed away (IMF and WB, 2018, ¶90); (2) Impending debt restructuring negotiations other than voluntary market-based debt re-profiling operations (IMF and WB, 2018, ¶90); (3) High probability of future distress event (IMF and WB, 2018, ¶91); (4) Unidentified external financing gap (IMF and WB, 2018, ¶91).
  - Final assessment must incorporate broader judgment including degree of confidence in macroeconomic framework.
- Timing for incorporating debt treatments in baseline DSA:
  - Debt treatments can be incorporated in the baseline only once agreements are firm.
  - An “agreement-in-principle” (AIP) is not sufficiently firm to be included in the DSA baseline.
  - Inclusion in the baseline generally requires sufficient confidence that the agreement will be implemented as agreed, which can be informed by an agreed Memorandum of Understanding (MOU) with an Official Creditor Committee (OCC) or a bilateral agreement with an individual creditor, or settlement of a bond exchange.
  - Use judgment when including partial treatments (e.g., agreement with one creditor group while others remain outstanding).
  - Where an MOU or representative agreement has been reached with a permanent standing forum (Paris Club or Common Framework OCC with Paris Club participation), baseline DSA could incorporate a comparable treatment of all other official creditors or include treatments sequentially as bilateral agreements are concluded.
  - Claims without sufficiently finalized treatment by the time the DSA is prepared should be included at their pre-restructuring terms.
- Alternative restructuring scenarios:
  - When public debt is assessed unsustainable in the baseline DSA, present an alternative restructuring scenario in the staff report supporting the IMF-supported program request or DSA to illustrate how debt sustainability would be restored forward-looking.
  - Illustrative scenarios can show adjustment effort needed and capture any AIPs or authorities’ strategies for different creditors, aiding creditor decisions on financing assurances and restructuring implementation consistent with IMF program parameters.
  - Sharing of information should remain consistent with guidance note on information sharing in sovereign debt restructurings (WB, 2023a and IMF, 2023h).
  - Care is needed not to prejudge specific treatment for residual creditors as agreements with significant creditors are reached.
  - Example: Zambia’s 2022 ECF-supported program required the PV of external debt to fall to 84 percent of exports over the medium-term to restore debt sustainability; given no specific PV of external debt to GDP target was set because of GDP measurement concerns, the illustrative scenario helped explain why a tighter PV of external debt to exports target was needed and showed that even with a large reduction in PV of external debt, a substantive upward rebasing of GDP would be needed for resultant PV of external debt to GDP to be consistent with the general threshold for that indicator.

*Source: IMF-WB staff review of Fund country reports.*

### References

### ppea2024039 - References

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- International Monetary Fund, 2021a, “Issues in Restructuring of Sovereign Domestic Debt,“ IMF Policy Paper No. 2021/071, available at: www.imf.org/-/media/Files/Publications/PP/2021/English/PPEA2021071.ashx, (Washington).
- International Monetary Fund, 2021b, “Fund Concessional Financial Support For Low-Income Countries—Responding To The Pandemic,” IMF Policy Paper No. 2021/053, available at: www.imf.org/-/media/Files/Publications/PP/2021/English/PPEA2021053.ashx, (Washington).
- International Monetary Fund, 2021c, “Selected Decisions and Selected Documents of the IMF, Forty-Second Issue,” available at: www.imf.org/external/pubs/ft/sd/2022/42nd_Sel_Dec_EN_Web_FINAL.pdf http://www.imf.org/external/np/pp/eng/2016/110416.pdf, (Washington).
- International Monetary Fund, 2022a, “Guidance Note for Surveillance Under Article IV Consultations,” IMF Policy Paper No. 2022/029, available at: www.imf.org/en/Publications/Policy-Papers/Issues/2022/06/23/Guidance-Note-for-Surveillance-Under-Article-IV-Consultations-519916, (Washington).
- International Monetary Fund, 2022b, “Reviews of the Fund’s Sovereign Arrears Policies and Perimeter,” IMF Policy Paper No. 2022/023, available at: www.imf.org/-/media/Files/Publications/PP/2022/English/PPEA2022023.ashx, (Washington).
- International Monetary Fund, 2023a, “Resilience and Sustainability Facility—Operational Guidance Note,” IMF Policy Paper No. 2023/051, available at: www.imf.org/-/media/Files/Publications/PP/2023/English/PPEA2023051.ashx, (Washington).
- International Monetary Fund, 2023h, “Staff Guidance Note on Information Sharing in The Context of Sovereign Debt Restructurings,” Policy Paper No. 2023/027, available at: www.imf.org/-/media/Files/Publications/PP/2023/English/PPEA2023027.ashx, (Washington).
- International Monetary Fund, 2024e, “Policy Reform Proposals to Promote the Fund’s Capacity to Support Countries Undertaking Debt Restructuring,” Policy Paper 2024/017, available at: www.imf.org/-/media/Files/Publications/PP/2024/English/PPEA2024017.ashx, (Washington).

### IMF Country Reports and Case Documents (selected entries)
- International Monetary Fund, 2023b, “Bangladesh: 2023 Article IV Consultation, First Reviews Under the Extended Credit Facility Arrangement, Arrangement Under the Extended Fund Facility, and the Resilience and Sustainability Facility Arrangement, Requests for a Waiver of Nonobservance of a Performance Criterion, and Modifications of Performance Criteria-Press Release; Staff Report; and Statement by the Executive Director for Bangladesh,” Country Report No. 2023/409, available at: www.imf.org/en/Publications/CR/Issues/2023/12/13/Bangladesh-2023-Article-IV-Consultation-First-Reviews-Under-the-Extended-Credit-Facility-542460, (Washington).
- International Monetary Fund, 2023c, “Burkina Faso: Request for a Four-Year Arrangement Under the Extended Credit Facility-Press Release; Staff Report; and Statement by the Executive Director for Burkina Faso,” Country Report No. 2023/343, available at: www.imf.org/en/Publications/CR/Issues/2023/10/03/Burkina-Faso-Request-for-a-Four-Year-Arrangement-Under-the-Extended-Credit-Facility-539973, (Washington).
- International Monetary Fund, 2023d, “Kenya: Fifth Reviews under the Extended Fund Facility and Extended Credit Facility Arrangements and Request for a 20-month Arrangement under the Resilience and Sustainability Facility, Requests for Extension, Rephasing, and Augmentation of Access, Modification of a Performance Criterion, Waiver of Applicability for Performance Criteria and Waiver of Nonobservance for a Performance Criterion, and Monetary Policy Consultation Clause-Press Release; Staff Report; and Statement by the Executive Director for Kenya,” Country Report No. 2023/266, available at: https://www.imf.org/en/Publications/CR/Issues/2023/07/19/Kenya-Fifth-Reviews-Under-the-Extended-Fund-Facility-and-Extended-Credit-Facility-536772, (Washington).
- International Monetary Fund, 2023e, “Mali: 2023 Article IV Consultation-Press Release; Staff Report; Staff Supplement; and Statement by the Executive Director for Mali, Country Report No. 2023/209, available at: https://www.imf.org/en/Publications/CR/Issues/2023/06/14/Mali-2023-Article-IV-Consultation-Press-Release-Staff-Report-Staff-Supplement-and-Statement-534760,” (Washington).
- International Monetary Fund, 2023f, “Niger: Third Review Under the Extended Credit Facility Arrangement, Request for Extension, Rephasing, and Modification of Performance Criteria of the Extended Credit Facility Arrangement, and Request for an Arrangement Under the Resilience and Sustainability Facility-Press Release; Staff Report; and Statement by the Executive Director for Niger,” Country Report No. 2023/254, available at: https://www.imf.org/en/Publications/CR/Issues/2023/07/12/Niger-Third-Review-Under-the-Extended-Credit-Facility-Arrangement-Request-for-Extension-536300, (Washington).
- International Monetary Fund, 2023g, “Sierra Leone: Eighth Review Under the Extended Credit Facility Arrangement, Request for a Waiver of Nonobservance of Performance Criterion, and Financing Assurances Review,” Country Report No. 2023/377, available at: www.imf.org/en/Publications/CR/Issues/2023/11/28/Sierra-Leone-Eighth-Review-Under-the-Extended-Credit-Facility-Arrangement-Request-for-a-541789, (Washington).
- International Monetary Fund, 2023i, “Tonga: 2023 Article IV Consultation-Press Release; and Staff Report,” Country Report No. 2023/361, available at: www.imf.org/en/Publications/CR/Issues/2023/11/03/Tonga-2023-Article-IV-Consultation-Press-Release-and-Staff-Report-541117, (Washington).
- International Monetary Fund, 2023j, “Vanuatu: 2023 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Vanuatu,” Country Report No. 2023/115, available at: www.imf.org/en/Publications/CR/Issues/2023/03/20/Vanuatu-2023-Article-IV-Consultation-Press-Release-Staff-Report-and-Statement-by  -the-531181, (Washington).
- International Monetary Fund, 2023k, “Ghana: Request for an Arrangement Under the Extended Credit Facility- Press Release; Staff Report; and Statement by the Executive Director for Ghana,” Country Report No. 2023/168, available at: https://www.imf.org/en/Publications/CR/Issues/2023/05/17/Ghana-Request-for-an-Arrangement-Under-the-Extended-Credit- Facility-Press-Release-Staff-533541, (Washington).
- International Monetary Fund, 2023l, “Sri Lanka: Request for an Extended Arrangement Under the Extended Fund Facility-Press Release; Staff Report; and Statement by the Executive Director for Sri Lanka,” Country Report No. 2023/116, available at: www.imf.org/en/Publications/CR/Issues/2023/03/20/Sri-Lanka-Request-for-an-Extended-Arrangement-Under-the-Extended-Fund-Facility-Press-531191, (Washington).
- International Monetary Fund, 2023m, “Sri Lanka: First Review Under the Extended Arrangement Under the Extended Fund Facility, Requests for a Waiver of Nonobservance of Performance Criterion, Modification of Performance Criteria, Rephasing of Access, and Financing Assurances Review-Press Release; Staff Report; and Statement by the Executive Director for Sri Lanka,” Country Report No. 2023/408, available at: www.imf.org/en/Publications/CR/Issues/2023/12/12/Sri-Lanka-First-Review-Under-the-Extended-Arrangement-Under-the-Extended-Fund-Facility-542441, (Washington).
- International Monetary Fund, 2024a, “Benin: Third Review under the Extended Fund Facility and the Extended Credit Facility Arrangements and Request for an Arrangement under the Resilience and Sustainability Facility-Press Release; Staff Report; and Statement by the Executive Director,” Country Report No. 2024/003, available at: www.imf.org/en/Publications/CR/Issues/2024/01/04/Benin-Third-Review-under-the-Extended-Fund-Facility-and-the-Extended-Credit-Facility-543392, (Washington).
- International Monetary Fund, 2024b, “Ghana: 2023 Article IV Consultation, First Review Under the Extended Credit Facility Arrangement Under the Extended Credit Facility, Request for Modification of Performance Criteria, and Financing Assurances Review-Press Release; Staff Report; Staff Supplement; and Statement by the Executive Director for Ghana,” Country Report No. 2024/030, available at: www.imf.org/en/Publications/CR/Issues/2024/01/25/Ghana-2023-Article-IV-Consultation-First-Review-Under-the-Extended-Credit-Facility-544137, (Washington).
- International Monetary Fund, 2024c, “Kenya: 2023 Article IV Consultation-Sixth Reviews Under the Extended Fund Facility and Extended Credit Facility Arrangements, Requests for Augmentations of Access, Modification of Performance Criteria, Waiver of Nonobservance of Performance Criteria, Waiver of Applicability of Performance Criteria, and First Review Under the Resilience and Sustainability Facility Arrangement-Press Release; Staff Report; and Statement by the Executive Director for Kenya,” Country Report No. 2024/013, available at: www.imf.org/en/Publications/CR/Issues/2024/01/17/Kenya-2023-Article-IV-Consultation-Sixth-Reviews-Under-the-Extended-Fund-Facility-and-543889, (Washington).
- International Monetary Fund, 2024d, “Sri Lanka: 2024 Article IV Consultation and Second Review Under the Extended Fund Facility, Request for Modification of Performance Criterion, and Financing Assurances Review-Press Release; Staff Report; and Statement by the Executive Director for Sri Lanka,” Country Report No. 2024/161, available at: www.imf.org/en/Publications/CR/Issues/2024/06/13/Sri-Lanka-2024-Article-IV-Consultation-and-Second-Review-Under-the-Extended-Fund-Facility-550261, (Washington).

### World Bank Publications and Reports
- World Bank, 2021, “World Bank Group Climate Change Action Plan 2021–2025: Supporting Green, Resilient, and Inclusive Development”, available at: http://hdl.handle.net/10986/35799, (Washington: World Bank).
- World Bank, 2022, “G5 Sahel Region Country Climate and Development Report”, CCDR Series, available at: https://hdl.handle.net/10986/37620, (Washington: World Bank).
- World Bank, 2023a, “Bank Guidance: Staff Guidance Note on Information Sharing in the Context of Sovereign Debt Restructurings,” available at: http://documents.worldbank.org/curated/en/099071823185030773/BOSIB04c6182f30950b8a9077e64373f1e9, (Washington: World Bank).
- World Bank, 2023b, “Ending Poverty on a Livable Planet: Report to Governors on World Bank Evolution,” available at: documents.worldbank.org/curated/en/099092823122522428/BOSIB0c8b6a4f20d90b86e035c5e46c8414, (Washington: World Bank).
- World Bank, 2023c, “Benin Country Climate and Development Report,” CCDR Series, available at: https://openknowledge.worldbank.org/handle/10986/40688, (Washington: World Bank).

*References as listed in the source document ppea2024039 - References.*

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_Source: https://www.imf.org/-/media/files/publications/pp/2024/english/ppea2024039.pdf_