Debt Sustainability: A Practitioner’s view

Emerging Markets Analysis & Multilateral Organisations 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 ” “ 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 Definition Debt Sustainability (1): Three key drivers

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  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) Definition raises practical questions?

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 foreign- exchange 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  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 Lessons learned

Emerging Markets Analysis & Multilateral Organisations  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. Assessing Debt sustainability: a new thought model

Emerging Markets Analysis & Multilateral Organisations Modern anatomy of a crisis

Emerging Markets Analysis & Multilateral Organisations Scenario analysis with key debt ratios remains one of the most used analytical tools

Emerging Markets Analysis & Multilateral Organisations Scenario analysis Russia: “appears manageable, even in face of oil price shock”

Emerging Markets Analysis & Multilateral Organisations  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. Debt sustainability: the broader context (1)

Emerging Markets Analysis & Multilateral Organisations  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) Debt sustainability: the broader context (2)

Emerging Markets Analysis & Multilateral Organisations View on Top of the Pyramid Civil Society & NGO Community Private Financial Sector Public Sector Private Business Sector Key Challenges Co-operation & strategic alliances among 4 sectors are crucial for Achieving Debt Sustainability!!