Debt Sustainability: A Practitioner

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Debt Sustainability A Practitioners 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

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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
• Solvency
• Liquidity
• Vulnerability

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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.

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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)

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Obvious problematic cases can be identified
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PITFALLS IDENTIFIED

• 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.
• 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 scenarios.
• 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.

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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

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Assessing Debt sustainabilitya new thought
model

• Two step model (aim to develop more dynamic
  indicators)
• 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
• define flexible thresholds (barriers of default)
  above which debt is unsustainable. Setting
  benchmarks for domestic and private sector debt.

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Modern anatomy of a crisis
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Scenario analysis with key debt ratios remains
one of the most used analytical tools
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Scenario analysis Russia appears manageable,
even in face of oil price shock
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Debt sustainability the broader context (1)

• Debt sustainability should be stronger canvassed
  in the Monterrey Consensus and MDG.
• Enhance south/south trade
• Develop local capital market to reduce
  vulnerabilities of financing projects in foreign
  currency
• 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.

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Debt sustainability the broader context (2)

• Enhance relationship with creditors thru stronger
  IRPs and compliance to Principles
• Enhance risk management practice
• as Basel 2 could curtail the supply of resource
  flows (FDI/Trade)
• By enhancing financial soundness and governance
  (disclosure, facilitate market discipline)

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