Sovereign Debt FAQ

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The framework was renamed “Sovereign Risk and Debt Sustainability Framework for Market Access Countries” (MAC SRDSF) to better describe the full purpose and use of the framework, reflecting that the IMF debt sustainability analysis framework has always provided information on sovereign risk and now provides a specific risk classification.
Staff has introduced several innovations; the three most relevant reforms are: (i) the time-horizon-based analysis of risks, (ii) accounting for a broader set of country-specific characteristics and their interaction, and (ii) moving towards a stochastic analysis of sovereign risks.
Expected contributions to IMF core functions:
- Support surveillance and lending by providing state-of-the-art toolkit for analysis of sovereign stress.
- Improve policy advice by distinguishing near-term versus medium-term risks to calibrate crisis prevention versus crisis resolution actions.

Time-horizon-based analysis:
- Some models predict sovereign stress better at particular horizons.
- Helps devise appropriate policy responses and calibrate the pace of fiscal consolidation.
Accounting for country-specific characteristics:
- Proxies of debt carrying capacity introduced in the near-term risk tool (examples: index of institutional quality and history of stress).
- Investor-base information used to assess vulnerability to rollover risk in the GFN tool.
- Trigger stress tests introduced for specific types of countries.
Move towards stochastic analysis:
- Introduces a probability model for near-term sovereign risks.
- Replaces macro-fiscal stress-tests with enhanced debt fancharts that capture uncertainty surrounding the baseline.
- Recognizes sovereign risks and debt sustainability as probabilistic concepts accounting for a country’s full range of uncertainty.

Debt and GFN levels remain relevant in the MAC SRDSF:
- Debt level is accounted for in both the near-term tool and the medium term risk index derived from the fanchart.
- GFN level enters the medium term risk index through the GFN module.
The framework no longer assumes the same debt and GFN thresholds are relevant for all advanced and emerging economies.
Debt levels enter models alongside other country characteristics: debt structure, quality of institutions, international reserves, cyclical indicators, and global financial conditions.
The fanchart evolution reflects interest rates, growth rates, primary fiscal deficit path, and financing assumptions.

Sustainability assessments rely on three inputs:
- The SRDSF’s GFN module.
- The SRDSF’s fanchart module.
- A multivariate econometric model analogous to the logit model used in the near-term module but estimated on a dataset focused on “unsustainable events” (such as debt restructuring and hyperinflations).
Output summarized in a composite index where greater index values indicate higher risk.
Index divided into three risk zones based on the probability that debt is not sustainable:
- Lowest risk zone: probability of unsustainable debt strictly below 20 percent — interpreted as indicating that debt is sustainable with high probability.
- Middle risk zone: probability between 20 and 50 percent — interpreted as indicating that debt is sustainable but not with high probability.
- Highest risk zone: probability above 50 percent — interpreted as indicating that debt is unsustainable.
These mechanical signals are inputs to judgement-based sustainability assessments; relevant information not reflected in models can alter final assessments.

Judgment remains important to derive final horizon-based risk assessments and overall risk assessment because models simplify reality and cannot capture all relevant elements.
The new framework increases transparency in use of judgment:
- Clear guidance will be provided to IMF staff on using judgment to reflect country-specific information not captured by models.
- Application of judgment must be justified in the DSA write-up when it leads to risk assessments different from model-derived signals.

The IMF is not becoming a rating agency:
- IMF models focus on sovereign “stress” (broader than defaults/restructurings), whereas rating agencies focus on defaults/restructurings.
- The IMF does not attempt finely graded risk ratings; mechanical signals involve three risk levels: high, moderate, and low.
- Mechanical signals aim to prompt authorities to act when risks are classified as high.
The IMF’s move toward mechanical risk signals aligns with prior LIC DSF reforms in 2017 and is consistent with other surveillance institutions (example cited: European Commission).

Board decision on disclosure sought a middle ground: limited public disclosure for twelve months while providing full disclosure to the Board.
Rationale: give authorities time to familiarize themselves with new tools and DSA reporting modalities; public disclosure to be reconsidered after twelve months based on experience.
During the 12-month period, the following information will be dropped from published staff reports:
- The three-zone sustainability assessment in non-exceptional access program cases.
- The near-term risk signal and assessment in surveillance and precautionary program cases.
The near-term risk signal and assessment will not be disclosed to the public during the first 12-months after the switch to the new methodology to allow authorities to familiarize themselves with it.

Rollout of the new framework is expected for Q4 2021 or Q1 2022.
The current framework will continue to be used between Board approval and the rollout of the new framework.
Staff is preparing an outreach/training strategy to ensure the new framework and its output are well understood by country officials and the public.

The Guidance Note will include critical information on:
- Correct interpretation of the models.
- Handling special country cases.
- Evaluating conflicting signals.
- Identifying key situations where staff judgment would be essential.
The Guidance Note will also specify operational issues, including:
- Defining types of financial assets to incorporate in the mechanical framework.
- Identifying criteria for including or excluding certain central bank liabilities in the public debt concept and when to use a consolidated public sector concept (that includes the central bank).
- Further specifying parameters of the tailored stress test and long-term modules.