Public Information Notice No. 02/69

Public Information Notice: IMF Discusses Assessments of Sustainability

July 11, 2002

On June 14, 2002, the Executive Board of the International Monetary Fund (IMF) discussed the framework for assessing fiscal and external sustainability, based on a paper prepared by IMF staff.¹

Background

Assessments of the sustainability of a country's external and public debt are a key element in the IMF's work on member countries. Judgments about debt sustainability—whether the debt can be serviced without an unrealistically large correction to the balance of income and expenditure—underpin the IMF's decisions in program contexts, in particular by helping to determine when financing is appropriate, what would be an appropriate amount of financing to provide, and whether a debt restructuring may be needed. These judgments become critical—and in many cases, particularly finely balanced—in cases of emerging market countries that are highly integrated into global capital markets and may have large financing needs.

A number of aspects of the existing work of IMF staff are relevant to assessing sustainability. Medium-term projections of the balance of payments and of fiscal developments are a staple of IMF staff work on member countries, particularly in a program setting. The staff has also developed a set of tools for assessing external current account and real exchange rate sustainability. In addition, there are tools for assessing reserve adequacy and monitoring liquidity risks. Financial sector stability assessments, which have recently been added to the IMF's toolkit, may help identify the vulnerability of the financial system to various shocks, sometimes with important implications for contingent claims on the government. But, while all these elements are present in the staff's work, their application has not been sufficiently consistent and disciplined to ensure the overall assessment of sustainability is credible.

For this reason, the staff is developing a framework for assessing sustainability that builds on existing best practice. The aim is both to strengthen the elements that go into assessing sustainability and bring them into a common framework.

This framework centers on the staff's medium-term projections. These projections will continue to be undertaken by staff working on a particular country, incorporating their knowledge of country-specific conditions. The framework is intended to impart a greater element of discipline and transparency to these projections, by laying bare the underlying assumptions and their implications. It also incorporates a standard set of sensitivity tests, examining the effects of alternative assumptions about the time paths of variables affecting the ability to service debt and the costs of financing it. This approach does not seek to eliminate the need for judgment in assessing sustainability—notably, in judging the probability that an adverse scenario may materialize—but to ensure that such judgments are sufficiently well-informed.

This approach will progressively be applied to surveillance of countries with significant access to international financial markets, as well as requests for use of the IMF's general resources.

Executive Board Assessment

Executive Directors welcomed the opportunity to discuss the work on which the Fund staff has embarked to strengthen its approach to assessing debt sustainability. Judgments about sustainability, which assess a country's capacity to service its debt without an unrealistically large future correction in the balance of income and expenditure, underpin the Fund's decisions in program contexts, helping to determine when financing is appropriate, what might be a sensible level of access, and whether a debt restructuring may be needed. Debt sustainability analyses also play an important role in supporting the Fund's advice on appropriate policy adjustments, and are an integral part of the Fund's crisis prevention initiatives.

Directors welcomed the approach outlined in the paper as an important step forward in imparting greater discipline and transparency to the process of assessing sustainability. They noted, in particular, the effort that will be made to better discipline projections by laying bare the basis on which they are made and by systematically subjecting them to sensitivity tests. At the same time, Directors stressed that debt sustainability depends upon the confluence of several factors—including macroeconomic developments, political and social constraints on adjustment, and the availability and cost of private and official financing. In this light, a strengthened framework should not be designed to dispense with the element of judgment in assessing sustainability, but to ensure that such judgment is adequately informed.

Against this background, Directors generally considered that the framework proposed by staff will go a long way in improving the quality of staff projections and the credibility of the Fund's overall assessments of sustainability. Directors supported the building blocks of the framework, and they supported, in particular, an approach that brings together relevant information rather than attempting to generate a single indicator of sustainability. A number of Directors also stressed that staff reports should include more comprehensive data on the composition of public debt to underpin the Fund's sustainability assessments. These Directors highlighted the importance of continued progress on the provision of comprehensive data for surveillance.

Directors also made many specific suggestions for improving and refining the framework and guiding its application; the staff will take these into account in the period ahead. In particular, Directors noted the importance of strengthening the analysis of macroeconomic linkages underlying the assessments and better integrating information on the financial sector, including that from the FSAP process, into the sustainability framework. They also encouraged staff to develop a variety of indicators against which debt sustainability may be assessed, including market-based indicators as well as projected financing flows.

Directors noted that the staff intends to apply the framework, on a progressive basis, and carefully taking account of experience, principally for all requests for use of Fund resources in the General Resources Account and in the context of Fund surveillance of members with significant market access. The applicability of the framework is not limited to one specific group of countries, and consideration will be given to the appropriate scope of its application going forward.

Today's discussion also provided the opportunity for a preliminary exchange of views on the possible inclusion of the information presented in the debt sustainability framework in published staff reports. Clearly, there is a tension, in this regard, between the view that publication would enhance the credibility of the Fund's sustainability assessments and strengthen its accountability, and the concern that, given the sensitivity of the subject, publication could lead to misinterpretations by the public and adverse market impacts. As several Directors suggested, information that could give rise to such concerns will for the time being be presented separately, and we will return to the question of how best to address the issue of its publication after gaining some experience with the initial application of the framework.

Finally, Directors also noted the importance of integrating the approach to assessing sustainability into other related work in progress. In this context, they looked forward to further discussing the interaction of balance sheets of various sectors of the economy at the forthcoming seminar on the balance sheet approach to preventing and resolving financial crises. These two seminar discussions are to lay the foundation for subsequent discussions regarding access to Fund resources and sovereign debt restructuring.