## 1. Issues Related to Coverage of Public Debt ## Source details **Canonical URL:** [1. Issues Related to Coverage of Public Debt](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2013/_050913.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2013/_050913.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2013/_050913.pdf.json) --- ### Introduction and conceptual framework - Public debt is regarded as sustainable when the primary balance needed to at least stabilize debt under both the baseline and realistic shock scenarios is economically and politically feasible, such that the level of debt is consistent with an acceptably low rollover risk and with preserving potential growth at a satisfactory level. - If no realistic adjustment in the primary balance—i.e., one that is both economically and politically feasible—can bring debt to below such a level, public debt is considered unsustainable. - Higher debt increases the likelihood of unsustainability because, other things equal: - (i) a higher debt requires a higher primary surplus to sustain it; - (ii) higher debt is usually associated with lower growth and higher interest rates, thus requiring an even higher primary balance. ### Practical considerations for assessing debt sustainability in MACs - Assessments require probabilistic judgments about the trajectory of debt and availability of financing on favorable terms. - Important practical questions: - Are debt burden indicators projected, at a minimum, to stabilize at levels consistent with an acceptably low rollover risk and with preserving growth at a satisfactory level, taking into account cyclical considerations, not only in the baseline scenario but also under plausible stressed scenarios? - Are the level and trajectory of the debt burden indicators underpinned by realistic projections for primary balance adjustment? - Are the assumptions for other key macroeconomic variables (e.g., growth and interest rates) realistic? - Is the debt profile well balanced in terms of maturity, currency composition, and investor base so as to facilitate continued market access? ### Areas for improvement identified in the 2011 review - Shortcomings highlighted for MAC DSAs included: - Realism of baseline assumptions. - Risks associated with the debt profile (financing structure). - Analysis of macro-fiscal risks. - Vulnerabilities related to the level of public debt. - Coverage of fiscal and public debt aggregates. - Contingent liabilities and the use of fan charts were emphasized as important complementary tools. ### Risk-based approach (Section II) - Guidance: depth and extent of analysis commensurate with concerns regarding sustainability while maintaining standardization. - Operational requirements: - An excel-based template developed and required for all MAC teams; all MAC teams required to conduct a basic DSA comparing the baseline with alternative scenarios. - Triggers for “higher scrutiny” cases (require deeper analysis and modules beyond the basic DSA): - Current or projected debt-to-GDP ratio above 60 percent if AE or 50 percent if EM. - Current or projected gross financing needs-to-GDP ratio above 15 percent if AE or 10 percent if EM. - Countries that have or are seeking exceptional access to Fund resources (including those that received exceptional access and are undergoing post-program monitoring). - Requirements for “higher scrutiny” cases: - Use a set of tools to identify and assess specific risks to debt sustainability. - Produce a standardized summary of risks in a heat map and prepare a write-up discussing risks, including country-specific considerations. - Flexibility permitted, but departures from standard guidance should be flagged and agreed with review departments. ### Guidance on the application of flexibility - Flexibility should be used judiciously and transparently: - Country teams may treat some countries with indicators below benchmarks as “higher scrutiny” if vulnerabilities exist. - Country teams may treat some countries with indicators above benchmarks as “lower scrutiny” if mitigating factors (e.g., sufficiently large highly-liquid assets) exist. - Country-specific considerations that may warrant “higher scrutiny” despite lower aggregate indicators include: - Large projected fiscal adjustment. - Volatile growth. - Large spreads. - High external financing requirements. - A large share of debt held by non-residents. - A large share of foreign-currency denominated debt. - A rapid increase in short-term debt. ### Potential indicators for additional analysis in lower scrutiny countries (Table 1) - Indicators and benchmarks (AEs / EMs): - 3-year cumulative primary balance adjustment (percent of GDP): 2 / 2 - Coefficient of variation of growth: 1 / 1 - Bond yield spreads or EMBI global spreads (basis points): 2/ 600 / 600 - External financing requirements (percent of GDP): 3/ 25 / 15 - Public debt held by non-residents (share of total): 45 / 45 - Public debt in foreign-currency (share of total): n.a. / 60 - Annual change in the share of short-term public debt at original maturity: 1.5 / 1.0 - Notes: - Source: Fund staff estimates. - 1/ Benchmarks are rounded. See Annex II. - 2/ Bond yield spreads for AEs, defined as the spread over U.S. or German bonds of similar maturity, and EMBI spreads for EMs. - 3/ Defined as current account balance plus amortization of total short-term external debt at remaining maturity. ### Data coverage and other design issues (Section III) - Three important issues for coverage of public debt: - Coverage of the “public” sector. - Long-term spending pressures. - Gross versus net debt. - DSAs should be based on gross debt; complementary analysis based on net debt can be presented to show the impact of risk-mitigating factors when relevant. - Coverage of public debt in the DSA should be as broad as possible but consistent with the coverage of fiscal accounts monitored for surveillance and program purposes and should consider availability and frequency of fiscal data. - Government intervention in the financial sector should be carefully reflected in fiscal accounts and public debt either directly or through stress tests. - Complementary net debt analysis is particularly relevant where countries were reclassified from “higher scrutiny” to “lower scrutiny” based on the level of their highly-liquid assets. ### Box 1 — Issues Related to Coverage of Public Debt - Public sector coverage: - DSA public sector coverage expected to match macroeconomic framework for surveillance and program monitoring. - Fund guidance based on Government Finance Statistics Manual 2001 and the Manual on Fiscal Transparency. - Many countries report fiscal aggregates only at general government, budgetary central government, or central government level due to data availability and treatment difficulties for some public entities, including state-run financial entities. - Staff encouraged to add, at least, high-risk public enterprises under fiscal targets. - Net vs. gross debt: - DSA should be based on gross debt; net debt can be applied as complementary measure when relevant. - Considerations for net-debt measures: - (i) whether the country has large financial assets that could realistically be used to repay or service debt; - (ii) whether reliable data on government assets are available. - DSAs presented on a net basis are expected to clearly disclose the definition of net debt used. - Use of a standard statistical definition of net debt in line with the Public Sector Debt Statistics Guide is recommended. - Alternative measures (e.g., net financial liabilities or debt-net-of highly liquid assets) may be used where the standard concept is incomplete or data constraints bind. - Long-run spending pressures: - When relevant information is available, DSAs should reflect vulnerabilities associated with pension and/or health systems. - Assessing the impact of long-term spending pressures often requires time-consuming modeling techniques. - Key consideration: how soon and how likely these pressures could materialize, depending on system characteristics, percent of the population covered, and elderly dependency ratio. - One reporting option: estimate fiscal cost of projected spending increases associated with pension and/or health care systems in the absence of reform; reflect as a memo item (in present value terms). - The macroeconomic framework could be extended beyond the 5-year projection horizon to illustrate long-term impacts. ### Box 2 — Reporting of Financial Sector Intervention in Fiscal Accounts and DSAs - Treatment of government interventions in fiscal accounts: - If government intervention creates a claim on a financial institution of equivalent value (intervention at market price), record as a financing transaction below the line with no effect on the fiscal balance. - If the government receives less than full value (intervention above market price implying a subsidy), record the shortfall above the line as government expense under capital transfer. - Impact on public debt: - Effect on gross debt depends on whether intervention is financed by borrowing or use of liquid assets. - Effect on net debt depends on whether there is a capital transfer; without a capital transfer net debt generally does not increase unless the government acquires direct equity (not netted out of gross debt). - With a capital transfer, net debt generally increases. - Accounting standards and DSAs: - GFSM 2001: gains/losses from changes in fair value of acquired assets not recognized above the line but directly impact government net worth. - Private sector accounting standards may recognize realized and unrealized gains/losses above the line depending on asset classification. - DSAs should capture expected realization of contingent liabilities timely; at minimum assess expected losses from changes in value of acquired assets through stress tests. - Explicit guarantees and contingent liabilities: - Guarantees reported once called or if a provision is made; GFSM 2001 asks for disclosure of contingencies as memorandum items. - DSA should routinely capture impact of explicit guarantees via stress-testing; analyze losses considered highly probable in stress tests if no provision is made at extension; when called, record as capital transfer and/or financial transaction below the line depending on claim value received. - Quasi-fiscal operations and public entities outside general government: - Prudent to reflect quasi-fiscal operations undertaken by public entities outside general government in DSA and fiscal accounts. - Wider aggregates than general government should be considered to capture risks to public debt. - Quasi-fiscal activities by central bank or government-owned asset management companies should be reflected; implicit carrying costs and settlement of central bank losses should be reported over time as memo items and consolidated into public debt in the DSA. - DSA horizon and baseline construction: - Standard projection horizon: 5-year projection horizon. - For Fund-supported programs, repayments to the Fund start between 3¼ and 4½ years after program start. - Departures from 5-year horizon when relevant (e.g., long-term spending pressures); complementary longer-timeframe analysis may be proposed with SPR agreement and rationale presented. - Baseline scenario must be consistent with the macroeconomic framework and realistic assumptions for: - (i) real GDP growth; - (ii) inflation measured by the GDP deflator; - (iii) government revenues and grants; - (iv) non-interest government expenditures; - (v) current stock of gross debt, including projection of interest and amortization payments, average maturity, breakdown between foreign and local currency-denominated debts; - (vi) interest rate and gross financing terms and conditions (currency, grace, maturity); - (vii) exchange rate; - (viii) other debt-creating (or reducing) flows, including bank recapitalization costs and privatization proceeds. - Baseline should be constructed around programmed macroeconomic adjustment for UFR (or near UFR) cases and most likely scenario for surveillance countries. - Impact of debt level on growth and interest rates should be factored in; contractionary impact of fiscal adjustment on growth should be taken into account. - Projections of GDP deflator and exchange rates should consider impact of programmed adjustment on relative prices in line with WEO guidelines. - Debt structure, financing assumptions, and granularity: - Emphasizes importance of structure of debt for market access and debt sustainability (rollover risk, currency composition). - Template allows a wide range of financing instruments varying by interest rate, payment terms, grace period, maturity, currency, and residency of holder. - Staff encouraged to discuss financing assumptions with authorities, informed by the country’s medium-term debt management strategy (MTDS). - Granularity determined by staff based on risks and data availability; higher granularity improves risk assessment accuracy. - Simplifying assumptions possible where information unavailable and risks low. - Residual financing needs automatically filled with a domestic-currency bond; staff should minimize residual financing needs. For pre-funding, staff should hard-code “0” for the year in which financing is obtained and adjust for pre-funded year(s). - Standard alternative scenarios in the basic DSA: - Historical scenario: real GDP growth, the primary balance, and real interest rates set at their historical average; other variables same as baseline. - Constant primary balance scenario: primary balance assumed unchanged compared to the first year of the projection (in percent of GDP); other variables same as baseline. - Baseline ratios much lower than standardized alternatives may signal unrealistic baseline assumptions and warrant discussion. - DSAs should include customized alternative scenarios prepared by staff (e.g., active policy vs no-change-in-policy, risks from weak/highly indebted public entities, guarantees on PPPs). - Reporting guidelines and DSA outputs: - Basic DSA output should include: - (i) selected economic indicators under the baseline scenario, including evolution of debt burden indicators; - (ii) latest relevant market indicators, such as risk rating, EMBI and CDS spreads; - (iii) debt dynamics under the baseline, presenting contributions of different factors to the evolution of the debt-to-GDP ratio; - (iv) the debt-stabilizing primary balance; - (v) the maturity structure (short-term vs medium- and long-term debt) and currency composition (domestic vs foreign currency-denominated debt); - (vi) comparison of evolution of debt burden indicators under baseline, historical, constant primary balance, and where relevant, contingent liabilities and customized scenarios. - Commentary focus (for lower scrutiny cases a DSA write-up is not required but staff document commentary should focus on risks to debt sustainability): - Whether debt burden indicators, including level and trajectory of debt-to-GDP ratio, remain at or below levels consistent with an acceptably low rollover risk and preserving growth during forecasting period under baseline and plausible stressed scenarios. - Realism of required primary balance path compared with historical primary balances and cross-country distributions, accounting for institutional settings. - Assessment of realism of projected interest-growth differential and its implications. - Close examination of evolution and size of residuals in the debt dynamics; large residuals should be explained. - Discussion of risks associated with particular financing types (foreign currency-denominated, short-term, domestically-issued) and potential bunching of maturities. - Flagging of apparent inconsistencies between sovereign risk ratings, sovereign spreads, and DSA findings. ### A comprehensive identification of specific risks to debt sustainability is at the core of — A. Realism of the Baseline Scenario - Debt dynamics critically determined by assumptions for key macro variables: real GDP growth, primary balance, inflation (GDP deflator). - DSA template tools: - Track record tool: examines forecast errors for growth, primary balance, and inflation versus peers; uses Spring WEO vintages t-1 (projections) and t+2 (actuals); calculates median forecast error and percentile rank against other MACs. - Fiscal adjustment realism tool: closer scrutiny required if either: - planned cyclically-adjusted primary fiscal adjustment over any three years during the projection horizon is larger than 3 percent of GDP; or - average of the cyclically-adjusted primary balance for any consecutive 3-year period during the projection horizon is greater than 3.5 percent of GDP. - Boom-bust detection tool (applied to countries that may be in a boom): - Country in a boom if output gap positive for three consecutive years, or three-year cumulative change in credit-to-GDP exceeds 15 percent for EMs and 30 percent for AEs. - Tool plots baseline growth rate against past boom-bust cases to inform customized scenarios. ### B. Vulnerability of the Debt Financing Profile - Debt structure characteristics increasing vulnerability: maturity, currency composition, creditor base. - High share of short-term debt at original maturity increases rollover and interest-rate risks. - High share of foreign-currency-denominated debt increases exchange-rate vulnerability and pressure on FX reserves. - Undiversified creditor base or concentration in non-residents increases rollover risk. - Early warning benchmarks (signal approach) used; benchmarks reduced for caution: - Benchmarks reduced by roughly 75 percent for EMs and 50 percent for AEs. - Table of debt profile benchmarks (rounded values): - Bond yield spreads or EMBI global spreads (basis points): AEs 800; EMs 800. - External financing requirements (percent of GDP): AEs 35; EMs 20. - Public debt held by non-residents (share of total): AEs 60; EMs 60. - Public debt in foreign currency (share of total): AEs n.a.; EMs 80. - Annual change in the share of short-term public debt at original maturity: AEs 2.0; EMs 1.5. - If profile risks identified, staff should scrutinize financing assumptions and consider alternative scenarios with higher interest rates, shorter maturities or grace periods, or a more depreciated exchange rate. - Staff encouraged to tailor and explain discretion when country-specific circumstances warrant deviations. ### C. Sensitivity of Debt Burden Indicators to Macro-Fiscal Shocks (Summary of Macro-Fiscal Stress Tests — Table 3) - Module assesses implications for debt sustainability from shocks to primary balance, growth, interest rate, and exchange rate; allows interactions among variables. - Stress-test specifications (size, duration, and default interactions preserved): 1. Primary balance - Minimum shock equivalent to 50 percent of planned cumulative adjustment or baseline minus half of the 10-year historical standard deviation, whichever is larger. - Additional borrowing leads to increase in interest rate of 25 basis points per 1 percent of GDP worsening of the deficit. 2. Real GDP growth - Real GDP growth reduced by 1 standard deviation for 2 consecutive years. - Primary balance deteriorates (revenue-to-GDP ratio same as baseline, but ratio of non-interest expenditures to GDP increases as level of spending kept same as baseline). - Deterioration in primary balance leads to higher interest rate (see above). - Decline in growth leads to lower inflation (0.25 percentage point per 1 percentage point decrease in GDP growth). 3. Interest rate - Nominal interest rate increases by the difference between the maximum real interest rate over history (last 10 years) and the average real interest rate level over projection, or by 200bp, whichever is larger. - Size of shock adjustable if risks are high (gross financing needs are higher). 4. Exchange rate - Estimate of real exchange rate overvaluation, or maximum historical movement of exchange rate over 10 years, whichever is highest. - Pass-through to inflation with default elasticity of 0.25 for EMs and 0.03 for AEs. - Design principles: - Sizes and durations in Table 3 are minima; interactions adjustable for country specifics. - Use country-specific revenue and expenditure elasticities where available. - Consider non-linearity in revenue-to-GDP relationships and persistence in interest-rate increases when debt remains elevated. - Adjustments to shock sizes should be transparently presented and explained. - Combined shock scenario: - Aggregates individual shocks while avoiding double counting; nets out overlapping effects (e.g., primary balance deterioration from growth shock); incorporates largest effect of individual shocks on relevant variables. - Customized alternative DSA scenarios: - Template allows flexible design for real GDP growth, inflation, revenue-to-GDP ratio, non-interest expenditures-to-GDP ratio, interest rate, and exchange rate. - Customized scenarios can capture spillovers, no-policy-change scenarios, sovereign-financial sector feedback loops, sudden stops, commodity price/volume shocks. - Staff may consider behavior of the non-commodity primary balance in assessing debt sustainability. ### D. Contingent Liabilities - Framework includes tools for assessing risks from realization of contingent liabilities (CLs); CL risks considered alongside realism, financing profile vulnerability, and macro-fiscal sensitivity. ### Contingent liabilities (CLs): overview and key message - CLs can arise from explicit or implicit guarantees to banks, sub-national governments, public or private enterprises, and from ongoing government intervention in the financial system. - Implicit CLs account for the bulk of the so-called “hidden deficits”—increases in public debt not explained by headline fiscal balances. - Corresponding stress tests should be included in DSAs, when appropriate. ### Quantitative triggers for banking-crisis contingent liabilities (Table 4 benchmarks) - Two quantitative triggers: - (i) cumulative change in private sector credit-to-GDP ratio over 3 years; - (ii) loan-to-deposit ratio. - Table 4 benchmarks: - EMs: Private sector credit-to-GDP (3-year cumulative level change) Above 15 percent - AEs: Private sector credit-to-GDP (3-year cumulative level change) Above 30 percent - EMs and AEs: Loan-to-deposit ratio Above 1.5 - When indicator values are higher, likelihood of a banking crisis (with fiscal costs) is higher. - If a trigger is breached, a standard financial CL shock based on banking system size will be automatically generated. ### Standard contingent liability shock calibration - Empirical calibration reference: Laeven and Valencia (2012) estimate gross fiscal outlays for financial system bailouts averaged about 10 percent of financial system assets. - Shock calibrated to gross rather than net fiscal outlays. - Standard CL shock also includes: - a one standard-deviation shock to growth and resulting deterioration of the primary balance, - increase in interest rates, - decrease in inflation (see growth shock in Table 3). - Calibration tailored to country-specific circumstances depending on ownership of at-risk banks, magnitude of likely government intervention, bail-in mechanisms, and past resolution strategies. - Write-up should discuss calibration when it diverges from the standard. ### House prices and additional indicators (AEs) - For AEs, average annual increase in nominal housing prices over preceding 5-year period in excess of 7.5 percent is a useful indicator of banking crises. ### Use of FSSA and Risk Assessment Matrix (RAM) - Findings of FSSA should inform identification of financial sector risks. - RAM integrates FSSA outputs and provides qualitative assessment and rating (high, medium, low) of likelihood that risks will be exposed over a three-year horizon. - CL shock should be undertaken for higher and lower scrutiny cases whenever: - (i) quantitative triggers are breached; or - (ii) financial sector vulnerabilities identified in the FSSA or by country team in absence of recent FSSA. ### Other sources of contingent liabilities and guidance - Staff encouraged to identify and calibrate stress tests for other CL sources: natural disasters, PPP failures, bailouts of SOEs, subnational government defaults. - Guidance: “Fiscal Risks—Sources, Disclosure, and Management”. - Country history should inform vulnerability to natural disasters (look at last 10 years); use http://www.emdat.be for data reference in source text. - Government hedging instruments should be considered as mitigating factors. - Non-financial sector CL shocks should be analyzed as customized scenarios. ### Confidentiality, moral hazard, and market sensitivity - Staff should be mindful of confidentiality policies, moral hazard, and market sensitivity when discussing CLs. - Fund’s Transparency Policy provides safeguards including the possibility for members to request deletions of highly market-sensitive material. ### Fan charts: probabilistic uncertainty around the baseline - Fan charts required for higher scrutiny countries (Box 4). - Staff should present: - a symmetric fan chart (upside and downside risks equally likely), - an asymmetric fan chart (staff’s best assessment of likelihood of shocks). - Fan chart tool (FAD, incorporated in MAC DSA template) relies on historical annual data for: - (i) real GDP growth; - (ii) effective real interest rate on government debt; - (iii) variation in the real exchange rate; - (iv) primary balance in percent of GDP. - Methodology: - Country-specific historical data generate sample means and variance-covariance matrix defining joint normal distribution. - Draws generate shocks added to baseline and fed into debt evolution identity to calculate projected debt path distributions. - Joint normality yields symmetrical fan charts; staff should consider modifying joint normality to reflect plausible asymmetries. - Tool does not account for intertemporal correlations between variables or potential autocorrelation. - Fan charts can be complemented by vector autoregression–based fan charts; if used, staff must state assumptions (sample period, variables, lag length, inclusion/exclusion of fiscal policy reaction, central scenario definition). ### Reporting risks for "higher scrutiny" cases - Reporting comprises: - (i) a write-up discussing identified risks to debt sustainability; - (ii) a heat map and two fan charts summarizing such risks. - Write-up guidelines: cover country-specific factors that mitigate/amplify risks, realism of baseline, debt profile risks, macro-fiscal risks, contingent liabilities, and structural breaks/assumptions. - When debt judged unsustainable or sustainability in question, staff may discuss: - estimates of maximum sustainable primary balances, - estimates of maximum sustainable debt ranges. - Annex VI presents quantitative methods for estimating maximum sustainable debt ranges. ### Heat map thresholds and debt-profile risk classification (EMs) - Early-warning classification: country deemed at high risk for an indicator when recent data are above 75 percent of benchmark for that indicator. - Low risk thresholds: recent data below 25 percent of benchmark for EMs; for AEs low risk threshold is below 50 percent of benchmark. - Selected EM debt-profile indicator thresholds (Risk Assessment for EMs: Debt Profile): - EMBI global spreads (basis points): Low risk Below 200; Moderate risk Between 200 and 600; High risk Above 600 - External financing requirements (percent of GDP): Low risk Below 5; Moderate risk Between 5 and 15; High risk Above 15 - Public debt in foreign currency (share of total): Low risk Below 20; Moderate risk Between 20 and 60; High risk Above 60 - Change short-term public debt (in percent of total debt): Low risk Below 0.5; Moderate risk Between 0.5 and 1.0; High risk Above 1.0 - Public debt held by non-residents (share of total): Low risk Below 15; Moderate risk Between 15 and 45; High risk Above 45 ### Benchmarks and risk classification (debt burden benchmarks — Table 7) - Debt burden benchmarks: - Emerging Markets: Debt-to-GDP ratio 70; GFN-to-GDP ratio 15 - Advanced Economies: Debt-to-GDP ratio 85; GFN-to-GDP ratio 20 - For “higher scrutiny” group, debt level indicator benchmark derived from signal approach increased by about 20 percent (to 70 for EMs and 85 for AEs). - Risk-color logic for debt-to-GDP (applies analogously to GFN-to-GDP): - High (red): Baseline above benchmark — Yes; Stress test above benchmark — Yes - Moderate (yellow): Baseline above benchmark — No; Stress test above benchmark — Yes - Low (green): Baseline above benchmark — No; Stress test above benchmark — No ### Debt profile indicators and thresholds (selected) - Bond spreads (basis points): - Low risk: Below 400 - Moderate risk: Between 400 and 600 - High risk: Above 600 - External financing requirements (percent of GDP): - Low risk: Below 17 - Moderate risk: Between 17 and 25 - High risk: Above 25 - Change in short-term public debt (in percent of total debt): - Low risk: Below 1.0 - Moderate risk: Between 1.0 and 1.5 - High risk: Above 1.5 - Public debt held by non-residents (share of total): - Low risk: Below 30 - Moderate risk: Between 30 and 45 - High risk: Above 45 - Additional lower and upper risk-assessment benchmarks (note to heat map): - EMBI spreads: 200 and 600 basis points - External financing requirement: 5 and 15 percent of GDP - Change in share of short-term debt: 0.5 and 1.0 percent - Public debt held by non-residents: 15 and 45 percent - Share of foreign-currency denominated debt: 20 and 60 percent ### Heat map and visualization of risks - Heat map summarizes risks from DSA modules: - First and second rows: impact from macro-fiscal shocks (primary balance, real GDP growth, real interest rate, exchange rate) and contingent liabilities on debt-to-GDP and GFN-to-GDP. - Third row: likelihood of debt-profile risks (bond spread, reserves to short-term debt ratio, external financing requirements, share of short-term debt, share of foreign currency debt). - Heat map does not produce overall debt rating; it summarizes tool results and complements DSA write-up and fan charts. - Interpretation guidance: - Cells green if country value less than lower risk-assessment benchmark, red if above upper benchmark, yellow if between lower and upper benchmarks, white if data unavailable or stress test not relevant. - For debt burden benchmarks: green if not exceeded under shock or baseline; yellow if exceeded under shock but not baseline; red if exceeded under baseline; white if stress test not relevant. - For “higher scrutiny” countries two fan charts required: - One symmetric distribution of risks. - One asymmetric distribution not centered on baseline to reflect team’s best assessment. - Template allows asymmetric shock distributions (e.g., truncate upside when baseline incorporates significant fiscal adjustment). ### Procedural and timing requirements - DSA frequency: - Prepare at least once a year for program countries (at each review for exceptional access cases) and at the time of Article IV consultation for non-program countries. - DSAs should be undertaken for all requests for UFR in the GRA; thereafter annual for program countries unless developments warrant more frequent analysis. - For exceptional access countries, updated DSA should be included in every review. - Early engagement between area departments and SPR: - For Article IV consultations, engagement expected to start 3–6 months before mission. - For program countries, consultation should start as early as possible to converge on assumptions and interpretation. - Staff should discuss DSA results with authorities, especially for exceptional access and high debt countries; write-up should highlight authorities’ differing views. ### Annex I — Debt dynamics (analytical decomposition) - Framework based on identity for evolution of public debt distinguishing foreign-currency and domestic-currency debt stocks and flows. - Key components and notation: - D^f_t: stock of foreign currency-denominated debt at end of period t - D^d_t: stock of local currency-denominated debt at end of period t - e_{t+1}: nominal exchange rate (LC/USD) at end of period t+1 - i^f_{t+1}: effective nominal interest rate on foreign currency-denominated debt in period t+1 - i^d_{t+1}: effective nominal interest rate on local currency-denominated debt in period t+1 - T_{t+1}: total public sector revenues in local currency in period t+1 - G_{t+1}: total grants to public sector in local currency in period t+1 - S_{t+1}: public expenditures excluding interest payments in local currency in period t+1 - O_{t+1}: other identified debt-creating flows in period t+1 (examples: privatization receipts; recognition of contingent liabilities; debt relief; bank recapitalization) - RES_{t+1}: residual ensuring identity holds; users should ensure consistency between stock and flow definitions to minimize RES. - Decomposition isolates contributions to change in debt-to-GDP ratio from effective interest rate, real GDP growth, exchange rate, primary balance and other factors; alternative expressions isolate effective real interest rate, real GDP growth, and real exchange rate contributions. ### Annex II. Debt Burden and Debt Profile Risk Benchmarks - Definition of debt distress events: - EMs: 1) Default (arrears on principal or interest to commercial or official creditors); 2) Restructuring and rescheduling (alters original debtor-creditor contract terms); 3) IMF financing (addressing liquidity issues associated with sovereign debt distress). - AEs: 1) Default (sovereign not current on debt obligations, S&P definition); 2) Restructuring and rescheduling; 3) IMF financing in excess of 100 percent of quota; 4) Inflation greater than 35 percent per annum; 5) Sovereign spreads greater than 1000 basis points or 2 standard deviations from country average. - Debt burden indicators (both EMs and AEs): - General government debt (percent of GDP) - Gross public financing requirements (percent of GDP) - Debt profile risk indicators for EMs: - 1) EMBIG spreads - 2) Gross external financing requirements (percent of GDP) - 3) Share of foreign currency-denominated public debt in total public debt - 4) Change in share of short-term public debt at original maturity in total public debt - 5) Share of debt held by non-residents in total public debt - Debt profile risk indicators for AEs: - 1) Bond yield spreads (spread over U.S. or German bonds at similar maturity) - 2) Gross external financing requirements (percent of GDP) - 3) Change in share of short-term public debt at original maturity in total public debt - 4) Share of debt held by non-residents in total public debt - Signal-approach benchmarks: - Derived using Kaminsky et al (1998) signal approach by minimizing missed crises and false alarms; calculated as sample-specific medians for AEs and EMs, excluding countries with no debt distress and excluding outliers. - Noise-to-signal ratio below 100 suggests indicator is efficient predictor. - To differentiate “higher scrutiny” group, debt level indicator benchmark increased by about 20 percent (to 70 for EMs and 85 for AEs). - Signal-approach benchmarks for EMs (indicative): - Gross government debt (percent of GDP): 60; Noise-to-signal ratio: 51; Direction to be safe: < - Gross public sector financing requirements (percent of GDP) 2/: 15; Noise-to-signal ratio: 92; Direction to be safe: < - 2/ Defined as current account balance plus amortization of short-term external private and public debt at remaining maturity. - EMBI global spreads (basis points): 800; Noise-to-signal ratio: 28; Direction to be safe: < - External financing requirements (percent of GDP): 20; Noise-to-signal ratio: 40; Direction to be safe: < - Public debt in foreign currency (share of total): 80; Noise-to-signal ratio: 64; Direction to be safe: < - Annual change in share of short-term public debt at original maturity: 1.5; Noise-to-signal ratio: 83; Direction to be safe: < - Signal-approach benchmarks for AEs (indicative): - Gross government debt (percent of GDP): 70; Noise-to-signal ratio: 44; Direction to be safe: < - Gross public sector financing requirements (percent of GDP) 2/: 20; Noise-to-signal ratio: 60; Direction to be safe: < - Bond spreads (basis points) 3/: 800; Noise-to-signal ratio: 27; Direction to be safe: < - 3/ Defined as the bond spread over U.S. or German bonds at similar maturity. - External financing requirements (percent of GDP): 35; Noise-to-signal ratio: 18; Direction to be safe: < - Annual change in share of short-term public debt at original maturity: 2; Noise-to-signal ratio: 58; Direction to be safe: < - Debt held by non-residents (share of total) 4/: 60; Noise-to-signal ratio: 57; Direction to be safe: < - 4/ Although not estimated for EMs due to data limitations, it is also applied to EMs in the framework. - Risk assessment benchmarks for debt profile indicators (early warning scaling): - Early warning benchmarks scaled down from signal-approach benchmarks to provide earlier cautionary signals. - Risk Assessment Benchmarks for EMs (indicative): - EMBI global spreads (basis points): Indicative benchmark: 800; Early warning upper benchmarks (75 percent): 600; Early warning lower benchmarks (25 percent): 200 - External financing requirements (percent of GDP): Indicative benchmark: 20; Early warning upper benchmarks (75 percent): 15; Early warning lower benchmarks (25 percent): 5 - Public debt in foreign currency (share of total): Indicative benchmark: 80; Early warning upper benchmarks (75 percent): 60; Early warning lower benchmarks (25 percent): 20 - Annual change in share of short-term public debt at original maturity: Indicative benchmark: 1.5; Early warning upper benchmarks (75 percent): 1.0; Early warning lower benchmarks (25 percent): 0.5 - Share of public debt held by non-residents: Indicative benchmark: 60; Early warning upper benchmarks (75 percent): 45; Early warning lower benchmarks (25 percent): 15 - Risk Assessment Benchmarks for AEs (indicative): - Bond spreads (basis points): Indicative benchmark: 800; Early warning upper benchmarks (75 percent): 600; Early warning lower benchmarks (50 percent): 400 - External financing requirements (percent of GDP): Indicative benchmark: 35; Early warning upper benchmarks (75 percent): 25; Early warning lower benchmarks (50 percent): 17.5 - Annual change in share of short-term public debt at original maturity: Indicative benchmark: 2.0; Early warning upper benchmarks (75 percent): 1.5; Early warning lower benchmarks (50 percent): 1.0 - Share of public debt held by non-residents: Indicative benchmark: 60; Early warning upper benchmarks (75 percent): 45; Early warning lower benchmarks (50 percent): 30 ### High debt levels are associated with — impacts and conceptual factors - Impacts of high public debt: - High debt associated with lower subsequent growth, potentially perpetuating recessions and worsening debt outlook. - High debt requires large primary surpluses to stabilize or reduce debt; sustaining such surpluses for several years can be difficult. - High debt increases vulnerability to growth shocks and reduces scope for countercyclical fiscal policy. - For a given maturity structure, high debt generally means high rollover requirements, increasing sovereign vulnerability to market risk and magnifying impact of interest-rate shocks on debt-to-GDP. - Conceptual factors for country-specific sustainable debt levels: - (i) ability to generate primary surpluses to service debt; - (ii) growth prospects; - (iii) cost of borrowing reflecting interest cost of existing debt and market perceptions of ability to service future borrowings; - (iv) history of meeting debt obligations; - (v) vulnerability to shocks; - (vi) nature of investor base; and other factors. - Empirical evidence: - Wide variation in sustainable debt levels: Argentina defaulted around 60 percent of GDP; Japan sustained over 150 percent of GDP. - No single common level across countries at which debt is perceived unsustainable. - Public debt varies widely across countries for a given level of sovereign spreads. - Analytical work has moved toward country specificity in estimating maximum sustainable public debt ranges. - Quantitative methodologies for estimating country-specific maximum sustainable public debt ranges — three approaches: - A. Early Warning (Signal) Approach: - Uses past experience to identify debt level best predicting subsequent debt crisis by minimizing noise-to-signal ratio. - Allows country-specific thresholds by optimizing percentile rank of debt-to-GDP distribution. - B. Exceptional Fiscal Performance Approach: - Based on debt dynamics linking debt-to-GDP (d) to real interest rate (r), GDP growth (g), and primary balance (p). - Determines steady-state debt for constant r, g, p; uses maximum sustainable primary balance and appropriate r–g to derive maximum sustainable debt. - Uses country’s best historical fiscal performance as proxy for future fiscal performance; history matters caveat noted. - C. The Uncertainty Approach: - Builds on WEO (2003); derivative of exceptional fiscal performance approach. - Uses historical fiscal performance, shocks to revenues, credibility of expenditure adjustment to set primary balance path; uses historical growth track record and maximum interest rate for r–g paths. *Source: "1. Issues Related to Coverage of Public Debt," PUBLIC DEBT SUSTAINABILITY ANALYSIS IN MARKET-ACCESS COUNTRIES (excerpt).* ### 1. Issues Related to Coverage of Public Debt _____________________________________________________ 9 ### 1. Issues Related to Coverage of Public Debt ### Introduction and conceptual framework - Public debt is regarded as sustainable when the primary balance needed to at least stabilize debt under both the baseline and realistic shock scenarios is economically and politically feasible, such that the level of debt is consistent with an acceptably low rollover risk and with preserving potential growth at a satisfactory level. - If no realistic adjustment in the primary balance—i.e., one that is both economically and politically feasible—can bring debt to below such a level, public debt is considered unsustainable. - Higher debt increases the likelihood of unsustainability because, other things equal: (i) a higher debt requires a higher primary surplus to sustain it; (ii) higher debt is usually associated with lower growth and higher interest rates, thus requiring an even higher primary balance. ### Practical considerations for assessing debt sustainability in MACs - Assessments require probabilistic judgments about the trajectory of debt and availability of financing on favorable terms. - Important practical questions to address: - Are debt burden indicators projected, at a minimum, to stabilize at levels consistent with an acceptably low rollover risk and with preserving growth at a satisfactory level, taking into account cyclical considerations, not only in the baseline scenario but also under plausible stressed scenarios? - Are the level and trajectory of the debt burden indicators underpinned by realistic projections for primary balance adjustment? - Are the assumptions for other key macroeconomic variables (e.g., growth and interest rates) realistic? - Is the debt profile well balanced in terms of maturity, currency composition, and investor base so as to facilitate continued market access? ### Areas for improvement identified in the 2011 review - Shortcomings highlighted for MAC DSAs included: - Realism of baseline assumptions. - Risks associated with the debt profile (financing structure). - Analysis of macro-fiscal risks. - Vulnerabilities related to the level of public debt. - Coverage of fiscal and public debt aggregates. - Contingent liabilities and the use of fan charts were emphasized as important complementary tools. ### Risk-based approach (Section II) - The guidance proposes a risk-based approach: the depth and extent of analysis are commensurate with concerns regarding sustainability while maintaining a reasonable level of standardization. - An excel-based template has been developed and should be used by all MAC teams; all MAC teams are required to conduct a basic DSA comparing the baseline with alternative scenarios. - Triggers for requiring deeper analysis (i.e., classification as “higher scrutiny” cases) include: - Current or projected debt-to-GDP ratio above 60 percent if classified as an advanced economy (AE) or 50 percent if classified as an emerging market economy (EM). - Current or projected gross financing needs-to-GDP ratio above 15 percent if classified as AE or 10 percent if classified as EM. - Countries that have or are seeking exceptional access to Fund resources (this includes countries that received exceptional access and are undergoing post-program monitoring). - For “higher scrutiny” cases, teams are required to: - Use a set of tools to identify and assess specific risks to debt sustainability (modules beyond the basic DSA). - Produce a standardized summary of risks in a heat map and prepare a write-up to discuss risks, including any country-specific considerations. - Flexibility is permitted in applying triggers and metrics, but departures from standard guidance should be flagged clearly and agreed with review departments during the review process. ### Guidance on the application of flexibility - Flexibility should be used judiciously and transparently; country teams can: - Treat some countries with indicators below benchmarks as “higher scrutiny” if vulnerabilities exist. - Treat some countries with indicators above benchmarks as “lower scrutiny” if mitigating factors (e.g., sufficiently large highly-liquid assets) exist. - Country-specific considerations that may warrant “higher scrutiny” despite lower aggregate indicators include: - Large projected fiscal adjustment. - Volatile growth. - Large spreads. - High external financing requirements. - A large share of debt held by non-residents. - A large share of foreign-currency denominated debt. - A rapid increase in short-term debt. ### Potential indicators for additional analysis in lower scrutiny countries (Table 1, preserved exactly) - Indicators and benchmarks (AEs / EMs): - 3-year cumulative primary balance adjustment (percent of GDP): 2 / 2 - Coefficient of variation of growth: 1 / 1 - Bond yield spreads or EMBI global spreads (basis points): 2/ 600 / 600 - External financing requirements (percent of GDP): 3/ 25 / 15 - Public debt held by non-residents (share of total): 45 / 45 - Public debt in foreign-currency (share of total): n.a. / 60 - Annual change in the share of short-term public debt at original maturity: 1.5 / 1.0 - Notes attached to Table 1 (preserved): - Source: Fund staff estimates. - 1/ Benchmarks are rounded. See Annex II. - 2/ Bond yield spreads for AEs, defined as the spread over U.S. or German bonds of similar maturity, and EMBI spreads for EMs. - 3/ Defined as current account balance plus amortization of total short-term external debt at remaining maturity. ### Data coverage and other design issues (Section III) - Three important issues for coverage of public debt: - Coverage of the “public” sector. - Long-term spending pressures. - Gross versus net debt. - DSAs should be based on gross debt; complementary analysis based on net debt can be presented to show the impact of risk-mitigating factors when relevant. - Coverage of public debt in the DSA should be as broad as possible but consistent with the coverage of fiscal accounts monitored for surveillance and program purposes and should consider availability and frequency of fiscal data. - Government intervention in the financial sector should be carefully reflected in fiscal accounts and public debt either directly or through stress tests. - Complementary net debt analysis is particularly relevant where countries were reclassified from “higher scrutiny” to “lower scrutiny” based on the level of their highly-liquid assets. ### Box 1 — Issues Related to Coverage of Public Debt (exact points preserved) - Public sector coverage: - The coverage of the public sector in the DSA is expected to be the same as in the macroeconomic framework for surveillance and program monitoring purposes. - Fund guidance on coverage is based on Government Finance Statistics Manual 2001 and the Manual on Fiscal Transparency. - Many countries report fiscal aggregates only at the general government level or at the budgetary central government or central government level due to data availability and difficulties with appropriate treatment of some public entities, including state-run financial entities. - Staff is encouraged to add, at least, high-risk public enterprises under fiscal targets. - Net vs. gross debt: - The DSA should be based on gross debt, but net debt can be applied as a complementary measure to reflect factors that could mitigate risks associated with high levels of gross debt. - Considerations for net-debt measures include: (i) whether the country has large financial assets that could realistically be used to repay or service debt; and (ii) whether reliable data on government assets are available. - DSAs presented on a net basis are expected to clearly disclose the definition of net debt used. - The use of a standard statistical definition of net debt in line with the Public Sector Debt Statistics Guide is recommended. - Alternative measures (e.g., net financial liabilities or debt-net-of highly liquid assets) may be used where the standard concept is incomplete or data constraints bind. - Long-run spending pressures: - When relevant information is available, DSAs should reflect vulnerabilities associated with pension and/or health systems. - Assessing the impact of long-term spending pressures is not straightforward and often requires time-consuming modeling techniques. - A key consideration is how soon and how likely these pressures could materialize, depending on country-specific conditions such as system characteristics, percent of the population covered, and elderly dependency ratio. - One reporting option is to estimate the fiscal cost of projected spending increases associated with the pension and/or health care system, in the absence of reform; the fiscal cost can then be reflected in the DSA tables as a memo item (in present value terms). - The macroeconomic framework could also be extended beyond the 5-year projection horizon to illustrate the impact of such expenditures on fiscal and debt sustainability over the long term. - Box footnotes preserved: - 1/ For recent estimates of net debt, please see the Fiscal Monitor (April 2012). - 2/ See “The Challenge of Public Pension Reform in Advanced and Emerging Economies” for recent estimates of these costs for some AEs and EMs. *Source: "1. Issues Related to Coverage of Public Debt," PUBLIC DEBT SUSTAINABILITY ANALYSIS IN MARKET-ACCESS COUNTRIES (excerpt).* ### Box 2. Reporting of Financial Sector Intervention in Fiscal Accounts and DSAs ### Box 2. Reporting of Financial Sector Intervention in Fiscal Accounts and DSAs ### Treatment of government interventions in fiscal accounts - General principle: - If government intervention creates a claim on a financial institution of equivalent value (intervention is based on market price), the operation is recorded as a financing transaction below the line with no effect on the fiscal balance. - Such an operation does not change the government’s net worth. - If the government receives less than the full value of the asset it exchanges (intervention is above market price implying a subsidy), the shortfall in value needs to be recorded above the line as government expense under capital transfer. ### Impact on public debt - Effect on gross debt: - Depends on whether the intervention is financed by borrowing or use of liquid assets. - Effect on net debt: - Depends in principle on whether there is a capital transfer. - In cases without a capital transfer, net debt generally does not increase unless the government acquires direct equity (which is not included in the assets that are netted out of gross debt). - In cases with a capital transfer, net debt generally increases. ### Accounting standards, fair value gains/losses, and DSAs - Recognition differences: - Under the Government Finance Statistics Manual 2001 (GFSM 2001), gains and losses arising from changes in the fair value of acquired assets, whether realized or unrealized, are not recognized above the line but directly impact the net worth of the government. - Under internationally accepted private sector accounting standards adopted by some governments: - Realized and unrealized gains and losses of assets classified as held for trading are included above the line in the period in which they arise. - Unrealized gains and losses of assets classified as available for sale do not have an immediate impact on the fiscal balance until such assets are sold. - DSA implications: - Despite differing accounting standards, DSAs should capture in a timely manner any expected realization of contingent liabilities. - At a minimum, DSAs should assess the impact of expected losses arising from changes in the value of acquired assets through stress tests. ### Explicit guarantees and contingent liabilities - Reporting in fiscal accounts: - Explicit guarantees are reported once the guarantee is called or if a provision is made. - GFSM 2001 asks explicitly for the disclosure of the value of contingencies in memorandum items in the fiscal accounts. - DSA treatment: - The impact of explicit guarantees on debt should be routinely captured by stress-testing in the DSA. - If at the time the guarantee is extended a provision is not made, the DSA should analyze risks from losses that are considered highly probable in the context of stress tests. - When the guarantee is called, depending on the value of the claim received by the government on the defaulting bank, the operation is recorded as a capital transfer and/or financial transaction below the line. ### Quasi-fiscal operations and public entities outside general government - Recommendation: - When intervention takes place by public entities outside the general government, it is prudent to reflect such quasi-fiscal operations in the DSA and fiscal accounts. - To the extent possible, wider aggregates than general government should be considered for the DSA and fiscal accounts to capture risks to public debt. - Specific entities and memo reporting: - Quasi-fiscal activities undertaken by the central bank (e.g., liquidity support) or government-owned asset management companies should be routinely reflected in the fiscal accounts and public debt. - Implicit carrying costs of quasi-fiscal activities by central banks (including the settlement of central bank losses resulting from past interventions) or other public entities undertaking interventions should be reported over time as memo items in the fiscal accounts and consolidated into public debt in the DSA. ### DSA horizon and baseline construction - Standard projection horizon: - Assessments of debt sustainability should generally be based on a 5-year projection horizon. - For Fund-supported programs, repayments to the Fund start between 3¼ and 4½ years after the start of a program. - When to consider departures from the 5-year horizon: - Consider longer horizons where a 5-year horizon may not capture relevant risks (for example, long-term spending pressures from an aging population or ballooning debt service). - For prolonged fiscal adjustment where debt burden indicators remain high during the 5-year period, teams could, by agreement with SPR, propose complementary analysis based on a longer timeframe; the rationale should be presented in the policy note and staff report. - Baseline scenario requirements: - The baseline scenario should be consistent with the macroeconomic framework presented in the accompanying staff document and based on reliable data and realistic, consistent assumptions for: - (i) real GDP growth; - (ii) inflation measured by the GDP deflator; - (iii) government revenues and grants; - (iv) non-interest government expenditures; - (v) the current stock of gross debt, including the projection of interest and amortization payments, the average maturity, and a breakdown between foreign currency and local currency-denominated debts; - (vi) the interest rate and other gross financing terms and conditions (such as currency denomination and grace and maturity period of new borrowing); - (vii) the exchange rate; and - (viii) other debt-creating (or reducing) flows, including bank recapitalization costs and privatization proceeds. - The baseline should be constructed around the programmed macroeconomic adjustment for UFR (or near UFR) cases and the most likely scenario for surveillance countries. - The impact of the debt level on growth and interest rates should be factored in; the potential contractionary impact of the fiscal adjustment on growth would need to be taken into account. - Projections of the GDP deflator and exchange rates should take into account the impact of the programmed adjustment on relative prices in line with WEO guidelines on projections. ### Debt structure, financing assumptions, and granularity - Importance of debt structure: - The framework emphasizes the importance of the structure of debt to assess prospects for market access and debt sustainability, including rollover risk and currency composition. - Financing assumptions: - The template allows for a wide range of possible financing instruments varying by interest rate, payment terms, grace period, maturity, currency denomination, and residency of holder. - Staff are encouraged to discuss appropriate assumptions for new financing with authorities, informed by the country’s medium-term debt management strategy (MTDS). - Data and granularity: - The appropriate extent of granularity of new financing will be determined by staff based on risks and availability of information. - Higher granularity allows a more accurate assessment of risks, including to the debt profile and investor base. - Simplifying assumptions could be made where information is unavailable and risks with the debt profile are low. - If there are residual financing needs, these are automatically filled in the template with a domestic-currency bond; staff should minimize residual financing needs. For pre-funding, staff should adjust the residual financing line by hard-coding “0” for the year in which financing is obtained, and for the year(s) that is (are) pre-funded. ### Standard alternative scenarios in the basic DSA - The basic DSA includes two standardized alternative scenarios: - Historical scenario: real GDP growth, the primary balance, and real interest rates are set at their historical average. Other variables are the same as in the baseline. - Constant primary balance scenario: the primary balance is assumed to remain unchanged compared to the first (current) year of the projection (in percent of GDP). Other variables are the same as in the baseline. - Role of alternative scenarios: - Baseline debt ratios that are much lower than those in standardized alternative scenarios may signal unrealistic baseline assumptions and warrant discussion. - DSAs should include any customized alternative scenarios prepared by staff (for example, active policy vs no-change-in-policy scenarios, risks from weak or highly indebted public entities, guarantees on PPPs). ### Reporting guidelines and DSA outputs - Basic DSA output should include: - (i) selected economic indicators under the baseline scenario, including the evolution of debt burden indicators; - (ii) latest relevant market indicators, such as risk rating, EMBI and CDS spreads; - (iii) the debt dynamics under the baseline scenario, presenting contributions of different factors to the evolution of the debt-to-GDP ratio; - (iv) the debt-stabilizing primary balance; - (v) the maturity structure (short-term vs medium- and long-term debt) as well as the currency composition of public debt (domestic vs foreign currency-denominated debt); and - (vi) a comparison of the evolution of debt burden indicators under the baseline, historical, constant primary balance, and, where relevant, contingent liabilities and customized scenarios. - Commentary focus: - For lower scrutiny cases a DSA write-up is not required, but staff document commentary should focus on risks to debt sustainability. - Key assessment issues include: - Whether debt burden indicators, including the level and trajectory of the debt-to-GDP ratio, remain at or below levels consistent with an acceptably low rollover risk and preserving growth during the forecasting period under baseline and plausible stressed scenarios. - The realism of the required primary balance path, compared with historical primary balances and cross-country distributions, accounting for institutional settings. - The assessment of the realism of the projected interest-growth differential and its implications. - Close examination of the evolution and size of residuals in the debt dynamics; large residuals should be explained. - Discussion of risks associated with particular types of financing (foreign currency-denominated, short-term, domestically-issued) and potential bunching of maturities. - Flagging of apparent inconsistencies between sovereign risk ratings, sovereign spreads, and DSA findings. *Source: IMF staff (Box 2 excerpt).* ### 22. A comprehensive identification of specific risks to debt sustainability is at the core of ### A comprehensive identification of specific risks to debt sustainability is at the core of ### A. Realism of the Baseline Scenario - Debt dynamics are critically determined by assumptions for key macro variables, including real GDP growth, primary balance, and inflation (GDP deflator). - Tools provided in the DSA template: - Examine the track record in projecting macroeconomic variables relative to the track record for all other countries. - Assess the realism of projected fiscal adjustments relative to cross-country historical experience. - Assess growth projections in countries that may have entered a boom-bust cycle. - Forecast track record tool: - Produces yearly history of forecast errors (actual minus projected) for growth, primary balance, and inflation. - Projections taken from the Spring WEO vintage at year t-1; actuals from the Spring WEO vintage at year t+2. - Calculates: (a) the median forecast error for the country from available historical projections; and (b) the percentile rank of this median forecast error in the distribution of median forecast errors from other MACs. - A low percentile reflects a median forecast error that is relatively large compared to other countries and may indicate persistent optimism in past projections. - Staff can choose comparator group: all MACs, program MACs, or surveillance MACs. - Fiscal adjustment realism tool: - Requires closer scrutiny if either: - the planned cyclically-adjusted primary fiscal adjustment over any three years during the projection horizon is larger than 3 percent of GDP; or - the average of the cyclically-adjusted primary balance for any consecutive 3-year period during the projection horizon is greater than 3.5 percent of GDP. - Boom-bust detection tool (applied only to countries that may be in a boom): - Country defined to be in a boom if: - output gap positive for three consecutive years, or - three-year cumulative change in the credit-to-GDP ratio exceeds 15 percent for EMs and 30 percent for AEs. - Tool plots baseline growth rate against growth experience of past boom-bust cases to inform customized scenarios. ### B. Vulnerability of the Debt Financing Profile - Debt structure characteristics that increase vulnerability: maturity, currency composition, and creditor base. - High share of short-term debt at original maturity increases rollover and interest rate risks. - High share of foreign currency-denominated debt increases exchange rate vulnerability and pressure on foreign exchange reserves. - A creditor base that is undiversified or concentrated in non-residents increases rollover risk. - Early warning benchmarks (signal approach) used to gauge debt profile risks; benchmarks reduced for caution: - Benchmarks reduced by roughly 75 percent for EMs and 50 percent for AEs. - Table of debt profile benchmarks (rounded values): - Bond yield spreads or EMBI global spreads (basis points): AEs 800; EMs 800. - External financing requirements (percent of GDP): AEs 35; EMs 20. - Public debt held by non-residents (share of total): AEs 60; EMs 60. - Public debt in foreign currency (share of total): AEs n.a.; EMs 80. - Annual change in the share of short-term public debt at original maturity: AEs 2.0; EMs 1.5. - If risks from the debt profile are identified, staff should scrutinize financing assumptions and consider alternative scenarios with: - higher interest rates, - shorter maturities or grace periods, - a more depreciated exchange rate. - Staff encouraged to tailor and explain discretion in assessments when country-specific circumstances warrant deviations from standardized calibrations. ### C. Sensitivity of Debt Burden Indicators to Macro-Fiscal Shocks - Module assesses implications for debt sustainability from shocks to: primary balance, growth, interest rate, and exchange rate. - Stress tests allow for interaction among variables (e.g., lower primary balance associated with higher borrowing costs). - Table 3 — Summary of Macro-Fiscal Stress Tests (size, duration, and default interactions preserved): 1. Primary balance - Minimum shock equivalent to 50 percent of planned cumulative adjustment or baseline minus half of the 10-year historical standard deviation, whichever is larger. - Additional borrowing leads to increase in interest rate of 25 basis points per 1 percent of GDP worsening of the deficit. 2. Real GDP growth - Real GDP growth is reduced by 1 standard deviation for 2 consecutive years. - Primary balance deteriorates (the revenue-to-GDP ratio remains the same as in the baseline, but the ratio of non-interest expenditures to GDP increases as the level of spending is kept the same as in the baseline). - Deterioration in primary balance leads to higher interest rate (see above). - Decline in growth leads to lower inflation (0.25 percentage point per 1 percentage point decrease in GDP growth). 3. Interest rate - Nominal interest rate increases by the difference between the maximum real interest rate over history (last 10 years) and the average real interest rate level over projection, or by 200bp, whichever is larger. - Size of shock can be adjusted if risks are high (gross financing needs are higher). 4. Exchange rate - Estimate of real exchange rate overvaluation, or maximum historical movement of exchange rate over 10 years, whichever is highest. - Pass-through to inflation with default elasticity of 0.25 for EMs and 0.03 for AEs. - Examples of interactions and empirical references are provided (Aisen and Hauner (2008); Chadha et al. (1992); Roberts (1995); Kaminsky and Schmuckler (2002); Ca’Zorzi et al. (2007)). - Stress test design principles: - Size and duration in Table 3 are minima; interaction degrees adjustable for country specifics. - Use country-specific estimates of revenue and expenditure elasticities where available. - Consider non-linearity in revenue-to-GDP relationships and persistence in interest rate increases when debt remains elevated. - Adjustments to shock sizes should be transparently presented and explained in reviews and staff reports. - Combined shock scenario: - Aggregates individual shocks while avoiding double counting; nets out overlapping effects (e.g., primary balance deterioration from growth shock). - Combined shock incorporates the largest effect of individual shocks on all relevant variables. - Customized alternative DSA scenarios: - Template allows flexible design for real GDP growth, inflation, revenue-to-GDP ratio, non-interest government expenditures-to-GDP ratio, interest rate, and exchange rate. - Customized scenarios can capture spillovers from crises in other countries, no-policy-change scenarios, feedback loops between sovereign and financial sector, sudden stops of capital flows, and commodity price/volume shocks for major commodity producers. - Staff may also consider the behavior of the non-commodity primary balance in assessing debt sustainability. ### D. Contingent Liabilities - The framework includes assessment tools for potential risks from the realization of contingent liabilities. - Contingent liability risks are considered alongside realism, financing profile vulnerability, and macro-fiscal sensitivity to provide a comprehensive risk-based DSA. *Source: IMF staff.* ### 34. Contingent liabilities (CLs) can have a significant impact on fiscal sustainability, and ### 34. Contingent liabilities (CLs) can have a significant impact on fiscal sustainability, and ### Overview and key message - Contingent liabilities (CLs) can arise from explicit or implicit guarantees to banks, sub-national governments, and public or private enterprises, and from ongoing government intervention in the financial system. - Implicit CLs account for the bulk of the so-called “hidden deficits”—increases in public debt not explained by headline fiscal balances. - Corresponding stress tests should be included in DSAs, when appropriate. ### Quantitative triggers for banking-crisis contingent liabilities - Two quantitative triggers are defined to help identify risks to debt sustainability posed by potential banking crises: - (i) cumulative change in private sector credit-to-GDP ratio over 3 years; - (ii) loan-to-deposit ratio. - Table 4 benchmarks: - EMs: Private sector credit-to-GDP (3-year cumulative level change) Above 15 percent - AEs: Private sector credit-to-GDP (3-year cumulative level change) Above 30 percent - EMs and AEs: Loan-to-deposit ratio Above 1.5 - When these indicator values are higher, the likelihood of a banking crisis (with attendant fiscal costs) is higher. - If a quantitative trigger is breached, a standard financial CL shock based on the size of the banking system will be automatically generated. ### Standard contingent liability shock calibration - Empirical calibration reference: - Laeven and Valencia (2012) estimate gross fiscal outlays for financial system bailouts averaged about 10 percent of financial system assets. - The shock is calibrated to gross rather than net fiscal outlays. - The standard CL shock also includes: - a one standard-deviation shock to growth and resulting deterioration of the primary balance, - increase in interest rates, - decrease in inflation (see growth shock in Table 3 in the source). - Calibration should be tailored to country-specific circumstances, depending on: - (i) whether potential banks at risk are domestically- or foreign-owned; - (ii) the likely magnitude of government’s intervention; - (iii) the specific bail-in mechanism; - (iv) resolution strategies adopted in the past (e.g., unlimited deposit guarantees, open-ended liquidity support, repeated recapitalizations, regulatory forbearance). - The write-up should discuss calibration when it diverges from the standard calibration. ### House prices and additional indicators (AEs) - For AEs, evolution of house prices can inform identification of debt sustainability risks. - Analytical work: an average annual increase in nominal housing prices over the preceding 5-year period in excess of 7.5 percent has been found to be a useful indicator of banking crises in AEs. ### Use of FSSA and the Risk Assessment Matrix (RAM) - Findings of the Financial System Stability Assessment (FSSA) should inform identification of financial sector risks. - The Risk Assessment Matrix (RAM) integrates analytical outputs from FSSA and provides a qualitative assessment and a rating (high, medium, or low) of the likelihood that risks will be exposed by shocks over a three-year horizon. - A contingent liability shock should be undertaken for both higher and lower scrutiny cases whenever: - (i) the quantitative triggers are breached; or - (ii) financial sector vulnerabilities are identified in the FSSA, or by the country team in the absence of a recent FSSA. ### Other sources of contingent liabilities and guidance - Staff is encouraged to identify vulnerabilities and calibrate stress tests associated with other possible sources of CLs, including: - natural disasters, - failures of Public-Private Partnerships (PPPs), - bailouts of state-owned enterprises (SOEs), - subnational government defaults. - Guidance: - “Fiscal Risks—Sources, Disclosure, and Management” provides guidance on identification of fiscal risks beyond the central government. - A country’s history should inform vulnerability to natural disasters. Staff encouraged to look at the last 10 years of history to guide assessment of likelihood and magnitude of costs. - Information on a country’s history of natural disasters can be found at: http://www.emdat.be. - The government’s use of hedging instruments should be considered as a mitigating factor. - Non-financial sector CL shocks should be analyzed in the DSA as customized scenarios. ### Confidentiality, moral hazard, and market sensitivity - When discussing CLs, especially those associated with the financial system, staff should be mindful of confidentiality policies, moral hazard, and market sensitivity. - The Fund’s Transparency Policy provides safeguards including the possibility for members to request deletions of highly market-sensitive material. ### Fan charts: probabilistic uncertainty around the baseline - Fan charts provide a probabilistic view of uncertainty around the baseline and are required for higher scrutiny countries (Box 4). - Staff should present: - a symmetric fan chart (upside and downside risks equally likely), - an asymmetric fan chart (staff’s best assessment of likelihood of shocks). - Fan chart tool (FAD, incorporated in MAC DSA template) relies on historical annual data for: - (i) real GDP growth; - (ii) the effective real interest rate on government debt; - (iii) the variation in the real exchange rate; - (iv) the primary balance in percent of GDP. - Methodology notes: - Country-specific historical data generate sample means and the variance-covariance matrix defining a joint normal distribution. - Draws from the joint distribution generate shocks added to the baseline and fed into the debt evolution identity to calculate projected debt path distributions. - By construction, joint normality yields symmetrical fan charts; staff should consider modifying joint normality to reflect plausible asymmetries (e.g., downside bias to primary balance or real exchange rate). - The tool does not take into account intertemporal correlations between variables or potential autocorrelation of individual variables. - Fan charts can be complemented by alternative fan charts based on vector autoregression; if used, staff must state assumptions including: - (i) sample period; - (ii) variables included and lag length; - (iii) inclusion/exclusion of a fiscal policy reaction function; - (iv) definition of the central scenario. ### Reporting risks for "higher scrutiny" cases - Reporting comprises two elements: - (i) a write-up discussing identified risks to debt sustainability; - (ii) a heat map and two fan charts summarizing such risks. - Guidelines for the write-up should cover country-specific factors that mitigate or amplify risks, realism of baseline, debt profile risks, macro-fiscal risks and contingent liabilities, and discussion of structural breaks and assumptions. - In cases where debt is judged unsustainable or sustainability is in question, staff may discuss: - estimates of maximum sustainable primary balances, - estimates of maximum sustainable debt ranges. - Annex VI presents quantitative methods for estimating maximum sustainable debt ranges. ### Heat map thresholds and debt-profile risk classification (EMs) - Early-warning classification rule: a country is deemed at high risk with respect to a particular indicator when recent data are above 75 percent of the benchmark for that indicator. - Low risk thresholds: recent data below 25 percent of the benchmark for EMs; for AEs the low risk threshold is below 50 percent of the benchmark. - Selected EM debt-profile indicator thresholds (Risk Assessment for EMs: Debt Profile): - EMBI global spreads (basis points): Low risk Below 200; Moderate risk Between 200 and 600; High risk Above 600 - External financing requirements (percent of GDP): Low risk Below 5; Moderate risk Between 5 and 15; High risk Above 15 - Public debt in foreign currency (share of total): Low risk Below 20; Moderate risk Between 20 and 60; High risk Above 60 - Change short-term public debt (in percent of total debt): Low risk Below 0.5; Moderate risk Between 0.5 and 1.0; High risk Above 1.0 - Public debt held by non-residents (share of total): Low risk Below 15; Moderate risk Between 15 and 45; High risk Above 45 *Source: PUBLIC DEBT SUSTAINABILITY ANALYSIS IN MARKET-ACCESS COUNTRIES, International Monetary Fund* ### 49. Macro-fiscal and CLs risks are measured in relation to certain benchmarks for the ### _050913 - 49. Macro-fiscal and CLs risks are measured in relation to certain benchmarks for the ### Benchmarks and risk classification - Benchmarks are established for the debt-to-GDP ratio and the GFN-to-GDP ratio to capture solvency and liquidity risks respectively. - Benchmarks differ for Emerging Markets (EMs) and Advanced Economies (AEs); benchmarks for AEs are higher than those for EMs. - Table 7: Debt Burden Benchmarks - Emerging Markets: Debt-to-GDP ratio 70; GFN-to-GDP ratio 15 - Advanced Economies: Debt-to-GDP ratio 85; GFN-to-GDP ratio 20 - For countries in the “higher scrutiny” group, the debt level indicator benchmark derived from the signal approach is increased by about 20 percent (to 70 for EMs and 85 for AEs). - Risk-color logic for debt-to-GDP (applies analogously to GFN-to-GDP): - High (red): Baseline above benchmark — Yes; Stress test above benchmark — Yes - Moderate (yellow): Baseline above benchmark — No; Stress test above benchmark — Yes - Low (green): Baseline above benchmark — No; Stress test above benchmark — No ### Debt profile indicators and thresholds - Debt profile indicators are assessed against low/moderate/high risk thresholds (Table 6). - Bond spreads (basis points) - Low risk: Below 400 - Moderate risk: Between 400 and 600 - High risk: Above 600 - External financing requirements (percent of GDP) - Low risk: Below 17 - Moderate risk: Between 17 and 25 - High risk: Above 25 - Change in short-term public debt (in percent of total debt) - Low risk: Below 1.0 - Moderate risk: Between 1.0 and 1.5 - High risk: Above 1.5 - Public debt held by non-residents (share of total) - Low risk: Below 30 - Moderate risk: Between 30 and 45 - High risk: Above 45 - Additional lower and upper risk-assessment benchmarks (note to heat map) - EMBI spreads: 200 and 600 basis points - External financing requirement: 5 and 15 percent of GDP - Change in share of short-term debt: 0.5 and 1.0 percent - Public debt held by non-residents: 15 and 45 percent - Share of foreign-currency denominated debt: 20 and 60 percent ### Heat map and visualization of risks - The heat map summarizes risks to debt sustainability from the DSA modules: - First and second rows: impact from macro-fiscal shocks (primary balance, real GDP growth, real interest rate, exchange rate) and contingent liabilities on debt-to-GDP and GFN-to-GDP. - Third row: likelihood of debt-profile risks (bond spread, reserves to short-term debt ratio, external financing requirements, share of short-term debt, share of foreign currency debt). - The heat map does not produce an overall debt rating; it summarizes tool results and is intended to complement the DSA write-up and fan charts. - Interpretation guidance: - Cells highlighted green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if between lower and upper benchmarks, white if data is unavailable or stress test not relevant. - For debt burden benchmarks: green if not exceeded under shock or baseline; yellow if exceeded under shock but not baseline; red if exceeded under baseline; white if stress test not relevant. - For countries under “higher scrutiny”: - Two fan charts required: - One symmetric distribution of risks. - One asymmetric distribution not centered on the baseline to reflect the team’s best assessment of the likely balance of risks. - The template allows asymmetric shock distributions (e.g., truncate upside when baseline incorporates a significant fiscal adjustment). ### Procedural and timing requirements - A DSA should be prepared at least once a year for program countries (at each review for exceptional access cases) and at the time of the Article IV consultation for non-program countries. - DSAs should be undertaken for all requests for UFR in the GRA. Thereafter, DSAs should be done on an annual basis for program countries, unless developments warrant more frequent analysis. - For exceptional access countries, an updated DSA should be included in every review. - Early engagement between area departments and SPR is required to identify risks and design scenarios: - For Article IV consultations, engagement is expected to start 3–6 months before the mission. - For program countries, consultation should start as early as possible to facilitate convergence on assumptions and interpretation. - Staff should discuss DSA results with authorities, especially for exceptional access and high debt countries; the write-up should highlight authorities’ views when they differ from staff views. ### Annex I — Debt dynamics (analytical decomposition) - The MAC DSA framework is based on an identity for the evolution of public debt distinguishing foreign-currency and domestic-currency debt stocks and flows. - Key components and notation (as presented): - stock of foreign currency-denominated debt at the end of period t: D^f_t - stock of local currency-denominated debt at the end of period t: D^d_t - nominal exchange rate (LC/USD) at the end of period t+1: e_{t+1} - effective nominal interest rate on foreign currency-denominated debt in period t+1: i^f_{t+1} - effective nominal interest rate on local currency-denominated debt in period t+1: i^d_{t+1} - total public sector revenues in local currency in period t+1: T_{t+1} - total grants to the public sector in local currency in period t+1: G_{t+1} - public expenditures excluding interest payments in local currency in period t+1: S_{t+1} - other identified debt-creating flows in period t+1: O_{t+1} (examples: privatization receipts; recognition of contingent liabilities; debt relief; bank recapitalization) - RES_{t+1} is a residual ensuring the identity holds; users should ensure consistency between stock and flow definitions to minimize RES. - The decomposition isolates contributions to the change in the debt-to-GDP ratio from: - the effective interest rate - real GDP growth - the exchange rate - the primary balance and other factors - the effective real interest rate, real GDP growth, and the real exchange rate (alternative expressions) - Definitions and algebraic expressions in the annex show the stepwise division of the identity by nominal GDP, definitions of ρ_{t+1} = (1+g_{t+1})*(1+π_{t+1}), and subsequent isolation of each contribution to the debt dynamic. *Source: IMF staff estimates as presented in the supplied content.* ### Annex II. Debt Burden and Debt Profile Risk Benchmarks ### Annex II. Debt Burden and Debt Profile Risk Benchmarks ### Definition of debt distress events - For EMs, debt distress events are defined as: - 1) Default: arrears on principal or interest payments to commercial or official creditors; - 2) Restructuring and rescheduling: any operation which alters the original terms of the debtor-creditor contract; or - 3) IMF financing: addressing liquidity issues associated with sovereign debt distress. - For AEs, debt distress events are defined as: - 1) Default: a sovereign not current on its debt obligations (Standard and Poor’s definition); - 2) Restructuring and rescheduling: any operation which alters the original terms of the debtor-creditor contract; - 3) IMF financing: in excess of 100 percent of quota; - 4) Inflation: greater than 35 percent per annum; or - 5) Sovereign spreads: greater than 1000 basis points or 2 standard deviations from the country average. ### Debt burden and debt profile risk indicators - Debt burden indicators (used for both EMs and AEs): - - General government debt (percent of GDP) - - Gross public financing requirements (percent of GDP) - Debt profile risk indicators for EMs: - 1) EMBIG spreads; - 2) Gross external financing requirements (percent of GDP); - 3) Share of foreign currency-denominated public debt in total public debt; - 4) Change in share of short-term public debt at original maturity in total public debt; - 5) Share of debt held by non-residents in total public debt. - Debt profile risk indicators for AEs: - 1) Bond yield spreads (spread over U.S. or German bonds at similar maturity); - 2) Gross external financing requirements (percent of GDP); - 3) Change in share of short-term public debt at original maturity in total public debt; - 4) Share of debt held by non-residents in total public debt. ### Signal-approach benchmarks: methodology and adjustments - Benchmarks derived using the signal approach (Kaminsky et al (1998)) by minimizing the sum of missed crises and false alarms. - Benchmarks calculated as sample-specific medians for AEs and EMs, excluding countries with no debt distress event and excluding outliers per the stated deviation rules. - A noise-to-signal ratio below 100 suggests the indicator is an efficient predictor of debt distress. - To differentiate countries within the higher scrutiny group for heat maps, the debt level indicator benchmark derived from the signal approach is increased by about 20 percent (to 70 for EMs and 85 for AEs). ### Signal-approach benchmarks for EMs (indicative) - Debt burden indicators: - Gross government debt (percent of GDP): 60; Noise-to-signal ratio: 51; Direction to be safe: < - Gross public sector financing requirements (percent of GDP) 2/: 15; Noise-to-signal ratio: 92; Direction to be safe: < - 2/ Defined as current account balance plus amortization of short-term external private and public debt at remaining maturity. - Debt profile indicators: - EMBI global spreads (basis points): 800; Noise-to-signal ratio: 28; Direction to be safe: < - External financing requirements (percent of GDP): 20; Noise-to-signal ratio: 40; Direction to be safe: < - Public debt in foreign currency (share of total): 80; Noise-to-signal ratio: 64; Direction to be safe: < - Annual change in the share of short-term public debt at original maturity: 1.5; Noise-to-signal ratio: 83; Direction to be safe: < ### Signal-approach benchmarks for AEs (indicative) - Debt burden indicators: - Gross government debt (percent of GDP): 70; Noise-to-signal ratio: 44; Direction to be safe: < - Gross public sector financing requirements (percent of GDP) 2/: 20; Noise-to-signal ratio: 60; Direction to be safe: < - 2/ Defined as current account balance plus amortization of short-term external private and public debt at remaining maturity. - Debt profile indicators: - Bond spreads (basis points) 3/: 800; Noise-to-signal ratio: 27; Direction to be safe: < - 3/ Defined as the bond spread over U.S. or German bonds at similar maturity. - External financing requirements (percent of GDP): 35; Noise-to-signal ratio: 18; Direction to be safe: < - Annual change in the share of short-term public debt at original maturity: 2; Noise-to-signal ratio: 58; Direction to be safe: < - Debt held by non-residents (share of total) 4/: 60; Noise-to-signal ratio: 57; Direction to be safe: < - 4/ Although not estimated for EMs due to data limitations, it is also applied to EMs in the framework. ### Risk assessment benchmarks for debt profile indicators (early warning scaling) - Early warning benchmarks are scaled down from signal-approach benchmarks to provide earlier cautionary signals and are derived by minimizing the sum of type I and type II errors versus VEE and VEA results. - Separate early warning benchmarks for EMs and AEs were calculated. - Risk Assessment Benchmarks for EMs (indicative): - EMBI global spreads (basis points): Indicative benchmark: 800; Early warning upper benchmarks (75 percent): 600; Early warning lower benchmarks (25 percent): 200 - External financing requirements (percent of GDP): Indicative benchmark: 20; Early warning upper benchmarks (75 percent): 15; Early warning lower benchmarks (25 percent): 5 - Public debt in foreign currency (share of total): Indicative benchmark: 80; Early warning upper benchmarks (75 percent): 60; Early warning lower benchmarks (25 percent): 20 - Annual change in the share of short-term public debt at original maturity: Indicative benchmark: 1.5; Early warning upper benchmarks (75 percent): 1.0; Early warning lower benchmarks (25 percent): 0.5 - Share of public debt held by non-residents: Indicative benchmark: 60; Early warning upper benchmarks (75 percent): 45; Early warning lower benchmarks (25 percent): 15 - Risk Assessment Benchmarks for AEs (indicative): - Bond spreads (basis points): Indicative benchmark: 800; Early warning upper benchmarks (75 percent): 600; Early warning lower benchmarks (50 percent): 400 - External financing requirements (percent of GDP): Indicative benchmark: 35; Early warning upper benchmarks (75 percent): 25; Early warning lower benchmarks (50 percent): 17.5 - Annual change in the share of short-term public debt at original maturity: Indicative benchmark: 2.0; Early warning upper benchmarks (75 percent): 1.5; Early warning lower benchmarks (50 percent): 1.0 - Share of public debt held by non-residents: Indicative benchmark: 60; Early warning upper benchmarks (75 percent): 45; Early warning lower benchmarks (50 percent): 30 *Source: Annex II. Debt Burden and Debt Profile Risk Benchmarks* ### 1. High debt levels are associated with ### 1. High debt levels are associated with ### Impacts of high public debt - High debt levels are associated with lower subsequent growth. This can perpetuate recessions and worsen the debt outlook. - High debt requires large primary surpluses just to stabilize the level of debt, let alone decrease it. Sustaining high primary surpluses for several years can be difficult. - High debt increases the vulnerability to growth shocks and reduces the scope for countercyclical fiscal policy. - For a given maturity structure, high debt generally means high rollover requirements, which increases the sovereign’s vulnerability to market risk and magnifies the impact of an interest rate shock on the debt-to-GDP ratio. ### Why the sustainable level of debt should vary by country — conceptual factors - The maximum sustainable level of debt for a country depends on country-specific factors, including: - (i) ability to generate primary surpluses, and therefore service its debt; - (ii) growth prospects; - (iii) cost of borrowing that reflects both the interest cost of debt already contracted and market perceptions of a country’s ability to service future borrowings; - (iv) history of meeting its debt obligations (whether it had debt distress/ lost market access); - (v) vulnerability to shocks; - (vi) nature of investor base; and other factors. ### Why the sustainable level of debt should vary by country — empirical evidence - Experience shows wide variation: - Argentina defaulted when its debt was around 60 percent of GDP while Japan has continued to sustain a debt-to-GDP ratio of over 150 percent of GDP. - There is no one common level across countries at which debt has been perceived to become unsustainable. - Public debt varies widely across countries for a given level of sovereign spreads. That two countries with very different levels of public debt have similar spreads reflects the important role country-specific factors play in market participants’ perception of sovereign risk. - As a result, recent analytical work has moved toward introducing more country specificity in estimating maximum sustainable public debt ranges (Ostry et. al., 2011). - The 2005 reform to the debt sustainability framework for low-income countries allowed debt thresholds to vary across countries in accordance with a country’s macro fundamentals and debt management capacity. ### Quantitative methodologies for estimating country-specific maximum sustainable public debt ranges - Overview: Three main approaches are presented — A. Early Warning (Signal) Approach; B. Exceptional Fiscal Performance Approach; C. The Uncertainty Approach. - A. Early Warning (Signal) Approach - Key principle: Based on past experience, what is the level of debt that best predicts a subsequent debt crisis? This is the same approach as used in the VEE and VEA. - Method: - Countries that experienced debt distress in the past are selected. - The optimal debt threshold is derived by minimizing the noise-to-signal ratio. - For any given threshold X, a signal is considered to have been sent if actual debt in that year is greater than X. - Whether a signal was sent is compared to whether the country experienced a debt crisis in the subsequent year. For each country-year there are four possible outcomes (labeled A-D). - Errors in prediction are represented by cells B (false alarms) and C (missed crises). The exercise varies the threshold X to find the value that minimizes the sum of (i) missed crises as a share of total number of crises and (ii) false alarms as a share of total number of non-crises. - Country-specific thresholds: - Instead of a common debt-to-GDP threshold across all countries, the methodology allows for country-specific factors by minimizing the loss function over the percentile rank of the distribution of the debt-to-GDP in each country. - Once the optimal common percentile is identified, the country-specific threshold is obtained from the country’s distribution of the debt-to-GDP ratio. - B. Exceptional Fiscal Performance Approach - Basis: Starts from the debt dynamics relationship linking the debt-to-GDP ratio (d) to the real interest rate (r), GDP growth rate (g) and primary balance (p). - Steady-state: The debt dynamics can be rearranged to obtain the steady-state level of debt for constant values of r, g, and p. - Key idea: The higher the primary balance a country can sustain, the lower the interest rates it faces, and the higher the growth rate it can maintain, the higher the steady-state level of debt that can be maintained. - Operational step: Determine the maximum sustainable level of primary balance and an appropriate level for r – g; these together yield the maximum level of debt that can be sustained. If debt exceeds this level, it will rise indefinitely as the primary balance required to stabilize it is beyond the maximum that can be sustained. - Use of history: Using a country’s best historical fiscal performance as a proxy for future fiscal performance helps inform the assessment of maximum fiscal effort. Reinhart et al. (2003) is cited: “history matters: a country’s record at meeting its debt obligations and managing its macroeconomy in the past is relevant to forecasting its ability to sustain moderate to high levels of indebtedness for many years into the future.” - Caveats: Relatively low primary surpluses in the past may reflect periods with no urgent need for fiscal adjustment and do not imply a country cannot achieve higher surpluses when faced with high or unsustainable debt. For r – g, historical experience can be informative, but the assessment is essentially forward-looking and comparator countries’ experience could be used where appropriate. - C. The Uncertainty Approach - Builds on WEO (2003) and is a derivative of the exceptional fiscal performance approach, relying on the same underlying concepts and equations. - Under this approach: - A country’s historical fiscal performance, taking into account shocks to revenues and credibility of expenditure adjustment, sets the basis for the path of primary fiscal balance. - The historical track record for growth and the maximum level of interest rate is taken as a basis for the paths of the interest rate-growth differential. *Public Debt Sustainability Analysis in Market-Access Countries — Section: 1. High debt levels are associated with* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2013/_050913.pdf_