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Debt Sustainability: A
Practitioner’s view
Multi-stakeholder consultation on “Sovereign debt for sustained
development: Issues for countries that access financial markets”
by Khalid Sheikh
Senior Vice President
Emerging Markets Analysis & Multilateral Organisations
New York March 7-8, 2005
Definition Debt Sustainability (1):
Three key drivers
“ a situation in which a borrower is expected to be able to
continue servicing its debts without an unrealistic
largecorrection to the balance of income and expenditure ”
(IMF, 2002 Assessing Sustainability)
 Key drivers
1. Solvency
2. Liquidity
3. Vulnerability
Emerging Markets Analysis & Multilateral Organisations
Definition of debt sustainability (2)
1.
Solvency: the present discounted value of future primary fiscal surpluses must be at
least equal to the value of the existing stock of public debt
2.
Not practical nor demanding, because this would permit a government to run large
primary deficits for a period of time, if it could commit itself to running primary
surpluses of a sufficient size thereafter.
3.
In reality, running large primary surpluses for a long period of time would be costly and
politically very difficult.
4.
Sustainability needs to be viewed in relation to a fiscal adjustment path that is both
economically and politically feasible, and it should imply that the budget constraint is
satisfied without an unrealistically large future correction in the primary balance.
Emerging Markets Analysis & Multilateral Organisations
Definition raises practical questions?
 How do we define payment capacity ?
 Which types of debt (public/private, local/foreign) should
be included in the measurement?
 How do we measure or model vulnerability risk? (e.i.
myopic market behaviour)
 What is perceived as an “ unrealistic large correction” ?
 Should debt sustainability be seen as unrelated to social
and political goals of the debtor country (e.i. MDG)
Emerging Markets Analysis & Multilateral Organisations
Obvious problematic cases can be
identified
Emerging Markets Analysis & Multilateral Organisations
PITFALLS IDENTIFIED
1. Taxes are denominated in local currency, while bulk of debt is often
still in foreign currency. The ability to generate exports and foreignexchange revenues needs to be analyzed separately.
2. Focus on government debt misses potential debt problems in the
private sector, that can become liabilities of the public sector. We
incorporate “skeletons” in our scenario’s.
3. But in case of a shock, a country can get into a “vicious cycle” with
adverse movements in growth, tax revenue, credit flows, spreads all
interacting, which is difficult to capture in the scenarios.
Emerging Markets Analysis & Multilateral Organisations
Lessons learned
 Debt sustainability should be assessed by looking at many
indicators simultaneously and comparing them against
empirically set benchmark values, which are adjusted for
country specific factors.
 More and more frequent Scenario-analysis and Portfolio
stress testing.
 Low hanging fruit can be poisonous as bad decisions are
taken in good times.
 Do rely on your own sentiments and information
Emerging Markets Analysis & Multilateral Organisations
Assessing Debt sustainability:
a new thought model
 Two step model (aim to develop more
dynamic indicators):
1. Three (macro) sector (corporate, bank and government)
model: develop a set of equations that attempt to define
the correlation and trigger mechanisms to measure debt
dynamics
2. define flexible thresholds (barriers of default) above which
debt is unsustainable. Setting benchmarks for domestic
and private sector debt.
Emerging Markets Analysis & Multilateral Organisations
Modern anatomy of a crisis
1. Severe currency
volatility
Attempts to
stabilize, risk
premia
Attempts to flee
Exchange rate
risk
4. Massive capital
outflow
Loss of confidence
2. Sharp rise in
interest rates
Interest rate risk
3. Overextension of
risk exposure
3d. Corporations &
Households
3a. Financial
institutions
Risk transfers due to financial
inter-linkages (claims and
obligations) between sectors
3c. Rest of the world
3b. Government
sector
Emerging Markets Analysis & Multilateral Organisations
Scenario analysis with key debt ratios remains
one of the most used analytical tools
80
70
60
50
40
30
20
10
Brazil, debt/GDP projections
1994 1996 1998 2000 2002 2004 2006 2008
Baseline projections
Ex ternal grow th shock in y ear t and temporary
slippage in policies.
Internal shock in y ear t by slippage in fiscal
policy for an ex tended period
Emerging Markets Analysis & Multilateral Organisations
Scenario analysis Russia: “appears
manageable, even in face of oil price shock”
90
Russia, debt/GDP projections
80
70
60
50
40
30
20
10
1995
1997
1999
2001
2003
2005
2007
1. B asline pro jectio ns public debt-to -GDP ratio
2. Real interest rate at 1997-04 averages plus two standard deviatio ns in 2005 and 2006
3. Real GDP gro wth at 1997-04 averages minus two standard deviatio ns in 2005 and 2006
4. P rimary (no n-interest) surplus at 1997-04 averages minus two standard deviatio ns in 2005
and 2006
5. Co mbinatio n (2-4) using a single standard deviatio n sho ck
6. One-time 30 percent real depreciatio n in 2005
7. Fall in o il prices to USD 15 in 2005 and 2006 andd to USD 20 afterwards
Emerging Markets Analysis & Multilateral Organisations
Debt sustainability: the broader
context (1)
 Debt sustainability should be stronger canvassed
in the Monterrey Consensus and MDG.
1. Enhance south/south trade
2. Develop local capital market to reduce vulnerabilities of financing
projects in foreign currency
3. All stakeholders in important infrastructure projects (public and
private) should work closely together in a joint monitoring panel to
ensure adequate management of all major social, economic and
political risks in large infrastructure projects.
Emerging Markets Analysis & Multilateral Organisations
Debt sustainability: the broader
context (2)
 Enhance relationship with creditors thru stronger
IRP’s and compliance to Principles
 Enhance risk management practice:
1. as Basel 2 could curtail the supply of resource flows
(FDI/Trade)
2. By enhancing financial soundness and governance
(disclosure, facilitate market discipline)
Emerging Markets Analysis & Multilateral Organisations
Key Challenges
View on
Top of the
Pyramid
Private
Business
Sector
Civil Society
&
NGO
Community
Private
Financial
Sector
Public
Sector
Co-operation
&
strategic alliances
among
4 sectors
are
crucial for
Achieving
Debt Sustainability!!
Emerging Markets Analysis & Multilateral Organisations