Back to Basics: What is Debt Sustainability?
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- Authors: DALIA HAKURA
- Published: September 1, 2020
Overview
- Title: What Is Debt Sustainability?
- Author: DALIA HAKURA
- Date: September 2020
- Read time indicator on page: Less than a minute(0 words) Read
- DALIA HAKURA is a deputy division chief in the IMF’s Strategy, Policy, and Review Department.
- Summary premise: Many factors go into assessing how much debt an economy can safely carry; elevated public debt in low-income countries and emerging market economies and the added spending needs from COVID-19 raise concerns about debt sustainability.
When debt is sustainable
- Definition: A country’s public debt is considered sustainable if the government is able to meet all its current and future payment obligations without exceptional financial assistance or going into default.
- Analytical focus:
- Analysts assess whether policies needed to stabilize debt are feasible and consistent with maintaining growth potential or development progress.
- When countries borrow from financial markets, risks associated with refinancing are important.
- Debt instrument and creditor coverage:
- A debt instrument is a financial claim that requires payment of interest, principal, or both by the debtor to the creditor at a future date.
- Countries incur debt to private bond holders, banks, other countries and their official lending institutions, and multilateral lenders such as the World Bank.
- Definitions of public debt (from narrow to broad):
- Narrow: budgetary central government.
- Broader: general government (budgetary central government, state and local government, extrabudgetary units, and social security funds).
- Broadest: public sector debt combining general government with public nonfinancial corporations and public financial corporations, including the central bank; also covers publicly guaranteed debt and external public debt (debt held by nonresidents).
- Importance of comprehensive coverage:
- To properly assess a country’s debt sustainability, it is important to cover all types of debt that pose a risk to a country’s public finances.
- Example risk: loss-making state-owned enterprise debt that is publicly guaranteed can shift the burden to the central government and weaken debt sustainability.
- Typical coverage by country group:
- Advanced economies and emerging markets: debt sustainability analysis frequently focuses on the general government.
- Low-income countries: nearly complete coverage of both public and publicly guaranteed debt is standard.
- Holders of public debt matter:
- IMF and World Bank assessments cover both domestic and external public sector debt.
- Sovereign credit rating agencies frequently concentrate on market-based external public sector debt.
Why some debt is good
- Role of borrowing:
- Public debt can finance important development programs and projects.
- Alternative financing and constraints:
- Alternatives include raising domestic revenue, improving efficiency of spending, reducing corruption, and improving the business environment, but these may take time and may not be sufficient.
- Risks of unsustainable debt:
- Unsustainable debt can lead to debt distress requiring debt restructuring; defaults can cause loss of market access, higher borrowing costs, and harm to growth and investment.
- Three key considerations before new borrowing:
- New borrowing should be consistent with fiscal spending and deficit plans.
- The new borrowing should be carefully set to keep public debt on a sustainable path.
- Compare the return from contracting debt with the cost of accumulating debt; debt that finances productive social and infrastructure spending can lead to higher income that may offset debt service costs and help balance risks to debt sustainability.
- Debt reporting and management:
- Countries should improve debt reporting and debt statistics as part of comprehensive medium-term debt management strategies.
- Debt statistics should include coverage of public and publicly guaranteed debt that is as broad as possible, including debt of state-owned enterprises.
- Sharing this data with lenders can encourage responsible lending.
How much is too much?
- Determinants of debt-carrying capacity:
- Quality of institutions and debt management capacity, policies, and macroeconomic fundamentals.
- Debt-carrying capacity can change over time and is influenced by the global economic environment.
- IMF frameworks:
- The IMF’s frameworks for low-income countries and countries with access to capital markets take into consideration individual countries’ debt-carrying capacity.
- Assessments are calibrated in reference to previous episodes of debt distress for groups of countries with similar economic characteristics.
- Calibrations lead to debt sustainability analysis thresholds for key public debt indicators that signal higher risk if that indicator exceeds (or is expected to exceed) its threshold; thresholds can be based on historical experience or convey information about the likelihood of future debt distress.
- Uncertainty and analytical tools:
- Frameworks consider the degree of uncertainty in projections of debt and debt service indicators through fan charts and stress tests.
- Because assessments are based on projections of debt, interest, and key macroeconomic variables, frameworks rely on tools to help gauge the realism of forecasts.
- The IMF’s approach to debt sustainability leaves room for informed judgment.
- Pandemic-era considerations:
- Question raised: whether debt-carrying capacities have improved sufficiently to handle elevated debt levels.
- Observation: since the global financial crisis, low interest rates have arguably increased countries’ capacity to borrow, but this does not necessarily translate into an ability to handle higher debt service.
- Historical lesson: there are limits to countries’ debt-carrying capacity; rising debt-service burdens need careful management.
- Role of growth:
- All else equal, higher growth improves debt dynamics.
- Most historical cases of significant debt reductions without restructuring involved a surge in growth, often driven by external impulses (global boom, natural resources exports coming onstream, improved terms of trade).
- Stimulating sustained domestic growth can be difficult and can require new debt (for example, to fund public investment).
- With an uncertain outlook for growth, debt service needs careful management; strengthening debt management and debt data should be top priorities.
Source: “What Is Debt Sustainability?” by DALIA HAKURA, September 2020, IMF F&D
Content in this bundle
- ¿Qué es la sostenibilidad de la deuda? ● Finanzas y Desarrollo ● Septiembre de 2020
- L’ABC de l’économie : Qu’est-ce que la viabilité de la dette ?
- Back to Basics: What is Debt Sustainability? – IMF F&D
- Policy Paper