*FRAMEWORK & ANALYSIS TOOLS

FOR SOVEREIGN DEBT

 *INTRODUCTION
Significant work is underway in the statistics and accounting professions
to add considerations of sustainability to measurements of public sector
debt.
 Although the adoption of standards in this area is likely to take some
time, some applications are gradually becoming broadly accepted.
This presentation provides an insight to debt sustainability analysis,
portfolio analysis, and fiscal risk and vulnerability analysis.
These forms of analysis use debt statistics
 *Definition of debt sustainability
Debt is sustainable when a borrower is expected to be able to continue
servicing its debts without an unrealistically large correction to its income
and expenditure balance.
Debt sustainability, thus, reflects a country’s solvency, liquidity, and
adjustment capacity:
• A government is solvent if the present value (PV) of its current and
future primary expenditure (net of interest) is no greater than the PV3 of
its current and future stream of income receipts.
• A government is liquid if it is able to rollover its maturing debt
obligations in an orderly manner.
• Debt sustainability also captures the notion that there are social and
political limits to adjustments in spending and revenue that determine a
country’s willingness (as opposed to its economic ability) to pay.
* The World Bank and IMF jointly introduced a standardised debt
sustainability framework (DSF) for conducting public and external
debt sustainability analysis (DSA) in low-income countries (LICs) in
2005. Widely used by both borrowers and lenders, the DSF helps
guide the borrowing decisions of LICs, provides guidance for
creditors’ lending and grant allocation decisions, and improves
World Bank and IMF assessments and policy advice. Although the
terms “DSF” and “DSA” are sometimes used interchangeably, they
are in fact distinct: the DSF is the framework within which a DSA is
produced for a particular country.

*Rationale for DSA

 *Debt Sustainability Analysis
The primary aim of the DSF is to guide borrowing decisions of low-income
countries in a way that matches their need for funds with their current and
prospective ability to service debt, tailored to their specific circumstances.
 Given the central role of official creditors and donors in providing new
development resources to these countries, the framework simultaneously
provides guidance for their lending and grant-allocation decisions to ensure
that resources to LICs are provided on terms that are consistent with their
long-term debt sustainability and progress towards achieving the SDGs.
The forward-looking nature of the DSF allows it to serve as an "early
warning system" of the potential risks of debt distress so that preventive
action can be taken in time.
 The DSA framework consists of two complementary assessments of the sustainability
of (i) total public sector debt and (ii) total external (i.e., public and private) debt.
 It focuses on gross rather than net debt, to facilitate comparability of information
across countries—since data on asset positions are usually not available on a
consistent and/or timely basis.
 For both public sector debt and external debt, the assessment is made by comparing
the path of debt indicators in a baseline scenario and in a series of sensitivity tests.
 The baseline scenario is based on a set of macroeconomic projections that articulate
the government’s intended policies. The framework requires an explicit specification
of the main assumptions and parameters underlying the baseline scenario and the
stress tests. The paths of debt indicators in the baseline and the stress tests permit
an assessment of the vulnerability of the country to shocks.

* Debt sustainability analysis (DSA)

framework features
 The framework focuses on the present value of debt obligations
for comparability, as terms extended to LICs vary considerably
and still carry concessionality. A 5 percent discount rate is used
to calculate the present value of external debt.

 To assess debt sustainability, debt burden indicators are

compared to indicative thresholds over a projection period.
There are four ratings for the risk of external public debt
distress :

*Assessing debt to avoid risks

 low risk, generally when all the debt burden indicators are below the thresholds in both
baseline and stress tests;

 moderate risk, generally when debt burden indicators are below the thresholds in the
baseline scenario, but stress tests indicate that thresholds could be breached if there are
external shocks or abrupt changes in macroeconomic policies;

 high risk, generally when one or more thresholds are breached under the baseline
scenario, but the country does not currently face any repayment difficulties; or

 in debt distress, when the country is already experiencing difficulties in servicing its debt,
as evidenced, for example, by the existence of arrears, ongoing or impending debt
restructuring, or indications of a high probability of a future debt distress event (e.g. debt
and debt service indicators show large near-term breaches or significant or sustained
breach of thresholds).
 To flag countries with significant public domestic debt, the framework provides a signal
for the overall risk of public debt distress, which is based on joint information from the
four external debt burden indicators, plus the indicator for the present value of public
debt-to-GDP ratio.

 Countries with different policy and institutional strengths, macroeconomic performance,

and buffers to absorb shocks, have different abilities to handle debt. The DSF, therefore,
classifies countries into one of three debt-carrying capacity categories (strong, medium,
and weak), using a composite indicator, which draws on the country’s historical
performance and outlook for real growth, reserves coverage, remittance inflows, and the
state of the global environment in addition to the World Bank's Country Policy and
Institutional Assessment (CPIA) index. Different indicative thresholds for debt burdens are
used depending on the country’s debt-carrying capacity.

 Thresholds corresponding to strong performers are highest, indicating that countries with
good macroeconomic performance and policies, can generally handle greater debt
accumulation.
 Corresponding to these categories, the framework establishes three indicative
thresholds and a benchmark for each of five debt burden indicators (assessed in
terms of GDP, exports, and revenues). Thresholds corresponding to strong
policy performers are highest.
 A first set of criticisms focuses on the very concept of ‘debt sustainability’ the DSF uses. For
example, Eurodad (2001) proposes a poverty-centred debt sustainability instead. It is argued
that resources available to LIC governments should first of all be used for poverty-reducing
expenditures; the remaining resources (if any) can be spent on less essential expenditures,
including servicing external debt (see also Berlage et al., 2003). Under this alternative
approach, the levels of debt that can be considered ‘sustainable’ will be (much) below the
thresholds put forward by the DSF, at which debt servicing problems have historically
manifested themselves.
 The IMF’s own Berg et al. (2014) take issue with the DSF’s threshold approach, which implies
a loss of information, and the DSF’s ‘worst-case aggregator’ (WCA), whereby the risk of debt
distress is evaluated as high if a single debt burden indicator crosses its threshold in the
baseline scenario. They show that the WCA makes the DSF ‘too conservative’ (i.e., it
predicts debt crises too often) and less accurate than a number of alternative aggregating
methods.

*Critique of DSA
 Panizza (2015) critiques the use of the DSF as a ‘crystal ball’ to decide between grants
and loans (by the IDA and others), based on the well-documented unreliability of long-
term growth projections and other macroeconomic forecasts (see e.g., Blanchard and
Leigh, 2013). His own suggestion is to index concessional loans to the ex post realisation
of GDP, on which lenders and borrowers have more accurate information than on future
GDP.
 By using the CPIA as the only criterion to differentiate the debt thresholds, the DSF
ignores other relevant country characteristics, say the level of international reserves.
 Moreover, grouping very diverse countries in three categories according to their CPIA
scores may result in an underestimation (overestimation) of the borrowing capacity of
countries that perform well (poorly) in other areas.
 Not adequately capturing the potentially beneficial effects of debt-financed public
investment on growth, exports and/or revenues, and thus on debt sustainability.

*Critique of DSA continued…..

 The MTDS, designed by the World Bank and the IMF, provides a framework for
developing an effective public sector debt management strategy—that is, to
achieve a desired composition of the public sector debt portfolio that reflects a
cost-risk analysis and captures the government’s preferences with regard to the
cost-risk trade-off.
 It is a tool for evaluating and managing the risk involved in different debt
compositions; facilitating coordination with fiscal and monetary management;
and enhancing transparency.
 It operationalizes country authorities’ debt management objectives—for example,
ensuring the government’s financing needs and payment obligations are met at
the lowest possible cost consistent with a prudent degree of risk. The MTDS
framework underscores the need for sound public sector debt management data.

* Portfolio Analysis and Medium-Term

Debt Strategy (MTDS)
Developing effective medium-term debt management strategies requires a
number of important inter linkages to be recognized. Ideally, the medium-term
debt strategy should be embedded in an overall framework that includes:
 debt sustainability analysis
 considerations of the wider economic framework;
 a cost-risk analysis of the various financing strategies available
 an annual borrowing plan to operationalize the strategy in the immediate
budgetary period; and
 market development plans.
To determine the appropriate debt management strategy, the performance of
alternative strategies should be evaluated in terms of their impact on costs
and risks
 *Fiscal risk analysis
 An evaluation of fiscal risks is an input to helping governments define a strategy
for managing whatever debt (and other liabilities and assets) they have chosen
to hold and for deciding which should be part of a long-term portfolio and
which should be disposed of.
 While fiscal risks may be analysed individually, different risks may partially
offset each other or may occur under different circumstances.
 To get a sense of the overall risk to public sector solvency, it is important to
conduct an assessment covering the different risks at the same time. This
should be done by analysing alternative scenarios.
 Like DSAs, these should include the implications of changes in macroeconomic
variables, but they should also explore the implications of assumptions
regarding: the probability of occurrence of various contingent liabilities; and
prices and recovery rates of financial assets on the government’s balance sheet.
 * Compilation of accurate public sector
statistics is a crucial step in conducting
such an assessment:

 The institutional coverage of statistics used to assess fiscal risks should be as

broad as possible, so as to encompass all activities with potential implications
for the public finances (including quasi-fiscal activities). The statistics should,
therefore, also cover, to the extent possible, other public sector entities (for
example, extra budgetary funds, nonfinancial public corporations, the central
bank, and other public financial corporations) that may be excluded from the
central or general government definition but may generate significant fiscal
risks.
As alluded to earlier on in the presentation, debt sustainability
analysis tools are significant for purposes of:
* guiding the borrowing decisions of LICs,
* providing guidance for creditors’ lending and grant allocation
decisions;
* Improving institutional assessments such as the World Bank and
IMF;
* Informing policy.

*Recap of relevance of
analysis frameworks:
Having noted the importance of analysis tools in sovereign debt, it is critical to
contextualize the framework, in terms of assessing the applicability of such
instruments to our current situation.

Various questions may assist us to discuss the appropriateness of the frameworks and
tools e.g;

a). Do we have the institutional mechanisms relevant to conduct such analyses?

*Look at government structures;

*Research vehicles that can conduct the assessments a

*Applicability OF Analysis Tools

b). Financial resources required to conduct the assessments –

* Look at funding availability to conduct analyses;

* Options for financing the analyses – is the money there or would
we need to borrow more money in order to carry out
assessments?;

*Applicability OF Analysis
Tools
c). Institutional willingness to carry out debt analyses-

* do we want to carry out the analyses in the first place?

* who regulates the execution of such analyses by countries?
* In the event that we are mandated to carry them out, how effective is our
compliance?
It’s important to note that the major DSA was developed by the IMF and
World Bank, who also fund a vast number of development initiatives
globally. Therefore it’s in our best interests to comply, as such international
bodies influence financing, even by other bodies such as the Paris Club.

*Applicability OF Analysis Tools

d). Transparency of financials –

* are the local decision-makers willing to be prudent with regards

to financial reporting,
* Who regulates these local decision-makers?
* How empowered are international bodies such as the World
Bank and IMF to govern sovereign states in terms of financial
requirements?

*Applicability OF Analysis
Tools
e). Compatibility of policy mechanisms with international
instruments –

* what do we prioritize?

*Applicability OF Analysis
Tools
The applicability of frameworks and analyses for sovereign debt is difficult
in the African context. The tools carry the general weakness of treating
countries as homogenous entities. For example, debt sustainability
problems in Ghana and Mozambique are due to misuse of public resources
and weak fiscal institutions. Ethiopia, Kenya and Rwanda on the other
hand have sustainability challenges arising from big investments in
infrastructure. The DSF does not distinguish between the two.

This however does not undermine the relevance of the tools, as they work
complimentarily with the SDGs

*CONCLUSION