Debt sustainability and fiscal risk analysis
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Debt Sustainability and Fiscal Risk Analysis. Using the LIC Templates PFAM Course April 24, 2007. Mark Roland Thomas, PRMED [email protected] Outline. Introduction The External Template The Fiscal Template Operational Factors Beyond the LIC DSF. Introduction.

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Debt sustainability and fiscal risk analysis

Debt Sustainability andFiscal Risk Analysis

Using the LIC Templates

PFAM Course

April 24, 2007

Mark Roland Thomas, PRMED

[email protected]


Outline

Outline

  • Introduction

  • The External Template

  • The Fiscal Template

  • Operational Factors

  • Beyond the LIC DSF


Introduction

Introduction

Debt sustainability concepts and the Bank


When is debt sustainable

When is Debt Sustainable?

  • Liquidity: can the country pay today?

    • The answer depends on what “can” is

  • Solvency: is the country likely to be able to pay at all points in future?

    • The answer depends on the current debt

    • It also depend on current economic policies

    • And it also depends on broader institutional strength

  • Any solvency problem must eventually manifest itself as a liquidity problem

    • Analyze vulnerability: identify relevant risk concepts

    • In LICs, it is important to account for loan terms

      • Present value, concessionality, grant element


The joint bank fund dsf

The Joint (Bank-Fund) DSF

  • An operational approach to debt sustainability in LICs

    • External

    • Fiscal

  • A DSA is a 20-year forecast of debt burden indicators under baseline assumptions and stress tests

    • Conducted jointly by IMF and WB teams but the tool can be used by authorities, others

  • DSA forecasts, combined with policy specific debt thresholds, lead to a risk rating

    • Used by IDA: 0/50/100 grant rule

    • Joint LIC-DSF analysis is a core element of WPAs


Dsa output

DSA Output


The dsf what it is and isn t

The DSF: what it is and isn’t

  • The DSF is part of our due diligence as a responsible creditor

  • It tells us whether current debt levels and policies pose a risk of debt distress

  • If they do, we move towards grants

  • The DSF is not a needs assessment

  • The DSF is not a binding framework on the borrower

  • The DSF is not imposed on other creditors


Timeline

Timeline

  • April 05: DSF adopted; first joint Bank-Fund DSAs

  • March 06: 1st Board Review

    • Confirmed design and asked for 2nd paper addressing:

      • Pace of new borrowing post debt relief

      • Domestic debt

      • Moderate risk category

  • November 06: 2nd Board Review

    • Reported to EPSB, November 29

  • April 07: Staff guidelines and web publication of DSAs

    • Improved framework for collaboration with IMF

  • June 07: Full rollout of DSA-based approach to IDA grant allocation

  • FY08: DSF mainstreamed in budgets and WPAs and sent stand-alone for information to the Board of IDA


The external template

The External Template


External dsa

External DSA

  • Focus on external public debt

    • Private debt is a consideration but not an integral part of the analysis

      • Low levels in LICs and data constraints

  • External DSA is built on relatively rich empirical underpinnings

    • Kraay and Nehru (WBER, 2007)

  • IDA bases decisions on the external picture

    • Moral hazard concerns


External debt definitions

External debt: definitions


Indicative external debt thresholds

Institutional strength and quality of policies

Poor

CPIA<3.25

Medium

3.25<CPIA<3.75

Strong

CPIA>3.75

Debt service-to-exports

15

20

25

Debt service-to-revenue

25

30

35

NPV of debt-to-GDP

30

40

50

NPV of debt-to-exports

100

150

200

NPV of debt-to-revenue

200

250

300

Indicative External Debt Thresholds


External template structure

External Template: Structure

Inputs

Input External

  • Historic values and projections of macroeconomic variables:

    • Current account balance

    • XGNF

    • FDI

    • GDP

    • Exchange rate

      Inp_Out_Debt

  • Debt service projections on the stock of debt at the base year

  • Levels and terms of projected new borrowing

Outputs

SR_Table_Baseline

  • Projected debt burden indicators: NPV/GDP, NPV/X, DS/X

  • Decomposition of debt dynamics into its driving forces

    SR_Table_Stress

  • Projected debt burden indicators under stress test

Risk of debt distress

Relevant indicative thresholds

Other considerations

  • Domestic debt

  • Remittances


Evolution of external debt

Evolution of External Debt


Standardized risk analysis

Endogenous variables

Nominal GDP

Identified Debt creating flows

Nominal Interest Rate

Debt Stock

Variables at historical levels

Real GDP growth

GDP Deflator

Non-Interest CA

Net FDI

Unchanged Variables

Exports

Imports

Exchange Rate

Standardized Risk Analysis

  • Stress tests and alternative scenarios

    • Alternatives: cost of finance and historical

    • Stress: GDP growth, export growth, inflation, net non-debt creating flows, combination, exchange rate

    • Trade-off: comparability and transparency with specificity and realism


Risk ratings

Risk Ratings

  • Low Risk

    • Policy dependent indicative thresholds not breached under baseline or stress tests

  • Moderate Risk

    • Thresholds breached only under stress tests

    • If only one threshold, briefly, there is room for debate

  • High Risk

    • Baseline breaches thresholds, although no existing payment difficulties

  • In Debt Distress

    • Either, debt service thresholds persistently or significantly breached…

    • Or, significant existing arrears

  • NB: the risk rating takes into account all scenarios, baseline and alternatives, plus country knowledge

  • IDA grants response should not affect risk rating


The fiscal template

The Fiscal Template


Fiscal analysis

Fiscal Analysis

  • Adds public domestic debt

  • Fiscal deficit becomes the key driver

    • Long-run government budget constraint

  • Nuances when considering domestic debt

    • Term structure: domestic is shorter term

    • Domestic market interest rates

    • Inflation and indexation

    • Concentration and financial repression?


Domestic debt ppg

Domestic Debt (PPG)

  • Obligations to domestic (resident) creditors

  • Usually refers to debt payable in domestic currency, although the actual payment may be indexed to inflation or a foreign currency

  • In LICs, domestic debt usually refers to debt of the central government

  • Domestic debt may also include wage and supplier arrears


Contingent liabilities

Contingent Liabilities


Fiscal template structure

Fiscal Template: Structure

Inputs

Input Fiscal

  • Historic values and projections of macroeconomic variables:

    • Public sector debt data

    • Fiscal variables

    • Privatization Receipts

    • Recognition of implicit contingent liabilities

    • Financing assumptions

Outputs

Table_Baseline

  • Projected debt burden indicators: NPV/GDP, NPV/X, DS/X

  • Decomposition of debt dynamics into its driving forces

    Table_Stress

  • Projected debt burden indicators under stress test

Revise risk of debt distress?


Evolution of public debt

Evolution of Public Debt


Illustration

Illustration

Domestic Debt Dynamics

Identified Factors

Primary balance

Endogenous debt dynamics

Change in real interest rate

Real GDP growth

Changes in prices and exchange rates


Operational factors

Operational Factors

Board Reviews and Staff Guidance


Direct responses to the board s requests in a dsf2 paper

Direct Responses to the Board’s Requests in a “DSF2” Paper

  • The Pace of New Borrowing

    • A 5 percent of GDP in-a-year caution flag

  • Domestic Debt

    • Public Sector DSA requirement

    • Possibility of “splitting the risk rating”

  • Risk Ratings

    • Use of a three-year moving average to set the indicative debt burden thresholds

    • No change in the moderate risk category


Economic projections in dsas

Economic Projections in DSAs

  • The battle against optimism

    • Active use of the historical scenario

    • Referral to past DSAs and their projections

    • “High-investment low-growth” check

      • Particularly under caution flag

    • Rigor in financing assumptions as well as growth and exports


The new landscape

The New Landscape

  • Nonconcessional borrowing by LICs is a reality

    • Including MRDI recipients

  • Realism about financial flows is needed in DSAs

    • Need not imply endorsement of borrowing plans

  • Active modeling can signal costs and risks

  • Other vulnerability indicators may be brought in where private credit is large

    • List of indicators is suggestive only

    • Economical approach recommended


Other institutions

Other Institutions

  • IMF

    • Despite some breakdowns, overall collaboration has been good

    • Joint work commences prior to briefing paper stage

    • Bank participation in IMF mission is encouraged

    • IMF: early agreement on timing and full file sharing

    • WB: early, full participation and prompt review and clearance

    • Guidelines provide more detailed step-by-step

  • Main RDBs

    • Suggested approach sent to RDBs at working level

      • Inputs based on preliminary tables and charts

      • Attendance at meetings at government invitation

      • Bank responsible for sharing final document


The role of prmed

The Role of PRMED

  • Support

    • Staff training (e.g., hub training events)

    • Online materials and guidance notes

    • Ad hoc advisory services

    • Regional priority DSAs

  • Review and clearance

    • Clearance is in conjunction with Regional PREM director

    • Country interpretation versus DSF-wide concerns

    • See the Guidance Note

    • Price setting for FRM

    • Submission to Board

  • R&D

    • Domestic debt

    • Risk ratings vis-à-vis outcomes

  • Creditor outreach including database maintenance

  • Borrower training


Staff guidelines

Staff Guidelines

  • Definitions and departures from previous practice

  • Design of macroeconomic scenarios

  • Treatment of domestic and private external debt

  • Description of responsibilities and timeline

  • Review process

  • HIPCs

  • Model outline


Beyond the dsf

Beyond the DSF

Fiscal Sustainability in MICs


Tailored middle income analysis

Tailored Middle-Income Analysis

  • MIC features:

    • Greater variety of debt instruments

      • But concessionality and grant element less germane (no need to use present value)

    • Emerging markets’ participation in international capital markets

      • Market risks in addition to exogenous shocks

      • Shorter time horizon

    • More, higher-quality data

      • Option for modeling covariance, monte-carlo simulation, value-at-risk analysis


Thank you

Thank You

Questions…


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