The Debt Sustainability Framework for Low-Income Countries

Introduction

Last Updated: July 13, 2018

Low-income countries (LICs) face significant challenges in meeting their development objectives, including the Sustainable Development Goals (SDGs), while at the same time ensuring that their external debt remains sustainable.

In April 2005, the Executive Boards of the International Monetary Fund (IMF) and the International Development Association (IDA) approved the introduction of the Debt Sustainability Framework (DSF), a tool developed jointly by IMF and World Bank staff to conduct public and external debt sustainability analysis in low-income countries. The latest review of the framework was approved by the Executive Boards in September 2017, and introduced reforms to ensure that the DSF remains appropriate for the rapidly changing financing landscape facing LICs and to further improve the insights provided into debt vulnerabilities.

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.

Reflecting the 2017 comprehensive review, DSAs conducted under the DSF consist of:

• a composite indicator to assess country’s debt-carrying capacity drawing on a set of country-specific and global factors (including institutional strength measured by the World Bank calculated on the CPIA score);

• realism tools to facilitate closer scrutiny of the baseline projections;

• a standardized forward-looking analysis of the debt and debt service dynamics under a baseline scenario and in the face of plausible shocks, where the scale and interactions of shocks are calibrated to country experience;

• newly-introduced tailored stress tests to better evaluate country-specific risks stemming from contingent liabilities (consistent with the coverage of public sector debt), natural disasters, volatile commodity prices, and market-financing shocks; and

• modules that provide a richer characterization of debt vulnerabilities (from domestic debt and market financing) and better discrimination across countries within the moderate risk category.

The DSF uses one template for both external debt and for public sector debt. Given that concessionality is an important element in financing LICs, the debt concept used in the template focuses on the present value (PV) of debt. The template generates output tables and charts that display the realism of the baseline projections, debt and debt-service dynamics under the baseline scenario, and that summarize the results of standardized alternative scenarios and stress tests. The template is flexible enough that it can be adapted to country-specific circumstances where warranted.

The assessment of external debt-burden indicators in relation to thresholds reflects the key empirical finding that a low-income country with better policies, institutions, assets, and macroeconomic prospects can sustain a higher level of external debt. The DSF, therefore, classifies countries into one of three debt-carrying capacity categories (strong, medium, and weak). 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.

 

Debt Burden Thresholds and Benchmarks Under the DSF   PV of external debt in percent of External debt service in percent of PV of total public debt in percent of GDP Exports Exports Revenue GDP Weak 30 140 10 14 35 Medium 40 180 15 18 55 Strong 55 240 21 23 70

On the basis of these thresholds and benchmark, DSAs include an assessment of the risk of external and overall debt distress based on four categories: low risk (when there are no breaches of thresholds); moderate risk (when thresholds are breached in risk scenarios); high risk (when thresholds are breached in the baseline scenario); and in debt distress (when a distress event, like arrears or a restructuring, has occurred or is considered imminent).