Public Debt Sustainability Analysis in Advanced and Emerging Market Economies:

The IMF’s New Framework

April 2014 International Monetary Fund

at

Eurasian Economic Commission

Until recently, focus of debt sustainability analysis was on debt trajectories….

New MAC DSA introduced in 2013

Key features of new DSA framework

MAC DSA examples

Key features of the new MAC DSA

• More analysis for countries with potentially greater vulnerabilities

Risk - based approach

• Realism of underlying assumptions

• Risks to debt level, gross financing needs, and debt profile, macro-fiscal nexus, and bank-sovereign nexus

Multifaceted analysis

• Standardized charts and tables, fan charts, heat map, write-up

Clear and transparent presentation of results

Risk assessment based on benchmarks derived from early warning model

Toolkit is flexible and can be tailored to country-specific circumstances

Risk indicators

• Risk indicators include:

– Ratio of debt to GDP

– Ratio of gross financing needs to GDP

– Bond spreads

– Gross external financing requirements

– Share of public debt in foreign currency

– Share of debt held by non-residents

– Change in short-term public debt

Public debt

burden

Debt profile

Country’s debt burden

Market perception

Rollover risks

Signal approach

Other risk considerations

• Inclusion of guarantees and quasi-fiscal operations

– DSAs are done on a gross debt basis

– Government guarantees are sometimes included

– State-owned enterprises that impact the fiscal balance are sometimes included

• Relation between domestic debt capital market and public debt sustainability

– Banks’ holdings of sovereign debt can help lower sovereign borrowing costs

– But it may have implications for public debt accumulation and fiscal adjustments

Risk-based approach

Public debt to GDP > 50/60% for EMs/AEs

Public gross financing needs (GFN) to GDP > 10/15% for EMs/AEs

Exceptional access to Fund resources

Lower scrutiny

Higher scrutiny

Judgment

Risk-based outputs

8

Basic DSA

DSA write-up

Basic DSA

Realism of baseline assumptions

Heat map, fan charts, debt profile indicators

where relevant Customized and

contingent liabilities analysis

Lower scrutiny Higher scrutiny

Basic DSA (1)

-20

-15

-10

-5

0

5

10

15

cumulative

-20

-15

-10

-5

0

5

10

15

20

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Debt-Creating Flows Above

Primary deficit Real GDP growth Real interest rate Other debt-creating flows Residual Change in gross public sector debt

projection

(in percent of GDP)

As of March 26, 2013

2011 2012 2013 2014 2015 2016 2017 2018 Sovereign Spreads

Nominal gross public debt 26.2 36.8 37.4 37.9 37.8 36.4 34.8 33.5 32.2 EMBI (bp) 450

Public gross financing needs 5.0 6.7 8.1 5.6 6.4 6.5 6.5 6.9 7.3 CDS (bp) 475

Nominal net public debt 26.2 36.8 37.4 37.9 37.8 36.4 33.5 32.2

Real GDP growth (in percent) 4.0 5.2 0.2 0.0 2.8 3.5 3.5 3.5 3.5 Ratings Foreign Local

Inflation (GDP deflator, in percent) 16.2 14.4 8.0 5.0 7.2 7.6 7.8 7.8 7.8 Moody's Aa3 Aa3

Nominal GDP growth (in percent) 20.9 20.3 8.2 5.0 10.2 11.4 11.6 11.6 11.6 S&Ps AA AA-

Effective interest rate (in percent) 3/ 4.4 5.8 5.0 1.7 1.9 2.2 2.4 2.6 2.8 Fitch AA A

Debt, Economic and Market Indicators 1/

Projections

2002-2010

Actual

Basic DSA (2)

Alternative Scenarios

Composition of Public Debt

Baseline Historical Constant Primary Balance

52

54

56

58

60

62

64

66

2011 2012 2013 2014 2015 2016 2017 2018

Gross Nominal Public Debt

(in percent of GDP)

projection

0

2

4

6

8

10

12

2011 2012 2013 2014 2015 2016 2017 2018

Public Gross Financing Needs

(in percent of GDP)

projection

0

10

20

30

40

50

60

70

2002 2004 2006 2008 2010 2012 2014 2016 2018

By Maturity

Medium and long-term

Short-term

projection

(in percent of GDP)

0

10

20

30

40

50

60

70

2002 2004 2006 2008 2010 2012 2014 2016 2018

By Currency

Local currency-denominated

Foreign currency-denominated

projection

(in percent of GDP)

Realism of baseline assumptions

Cross-country tools to help identify potential optimism

Forecast track record

Projected fiscal adjustment Boom-bust

Realism of baseline assumptions

-10

-8

-6

-4

-2

0

2

4

6

2004 2005 2006 2007 2008 2009 2010 2011 2012

Year

Real GDP Growth

Interquartile range (25-75)

Median

Italy forecast error

-1.46

7% Has a percentile rank of:

Italy median forecast error, 2004-2012:

Distribution of forecast

errors: 1/

(in percent, actual-projection)

Source: Italy 2013: Article VI Consultation Staff Report, September 2013

Forecast track record

pess

imis

tic

op

tim

isti

c

Realism of baseline assumptions

1/ For Italy the bulk of the adjustment already occurred in 2012 and the pace of consolidation slows to 1 percent of GDP in 2013. Source: Italy 2013: Article VI Consultation Staff Report, September 2013

0

2

4

6

8

10

12

14

Less

-4

-3

-2

-1

0

1

2

3

4

5

6

7

8

Distribution 4/

Italy

3-Year Adjustment in Cyclically-Adjusted

Primary Balance (CAPB) 1/ (Percent of GDP)

Mo

re

Projected fiscal adjustment

Real GDP

Growth Shock

Primary

Balance Shock

Change in the

Share of Short-

Term Debt

Exchange Rate

Shock

Contingent

Liability shock

Debt level

Foreign

Currency

Debt

Real Interest

Rate Shock

Exchange Rate

Shock

Contingent

Liability Shock

Primary

Balance Shock

Real Interest

Rate Shock

Market

Perception

Gross financing needs

Public Debt

Held by Non-

ResidentsDebt profile

External

Financing

Requirements

Real GDP

Growth Shock

Heat map

Risks to debt level and GFN

• Capture interactions between key macro variables

• Designed to balance standardization and tailoring country-specific circumstances

Macro-fiscal stress tests

15

pass-through to higher inflation

pass-through to higher interest rate

Primary balance shock

primary balance deteriorates,

interest rate increases,

inflation declines

Real GDP growth shock

Real interest rate shock

Real exchange rate shock

• Triggered automatically for countries with banking

sector vulnerabilities

• May also be relevant to assess risks related to

natural disasters, PPPs, SOEs

Contingent liabilities shocks

•Shock of 10 percent of banking system assets

•Primary balance deteriorates, interest rate increases, inflation decreases

Financial sector CL shock

Triggers AEs EMs

Private sector credit-to-

GDP (3-year cumulative

level change)

30% 15%

Loan-to-deposit ratio 1.5 1.5

Real Exchange Rate Shock

Combined Macro-Fiscal Shock

Additional Stress Tests

Baseline Contingent Liability Shock

Reform Fatigue Deep recession and confidence shock

Italy Public DSA - Stress Tests

Macro-Fiscal Stress Tests

Baseline Primary Balance Shock

Real GDP Growth Shock

Real Interest Rate Shock

110

115

120

125

130

135

140

145

150

2013 2014 2015 2016 2017 2018

Gross Nominal Public Debt(in percent of GDP)

240

250

260

270

280

290

300

310

2013 2014 2015 2016 2017 2018

Gross Nominal Public Debt

(in percent of Revenue)

15

17

19

21

23

25

27

29

31

2013 2014 2015 2016 2017 2018

Public Gross Financing Needs

(in percent of GDP)

110

120

130

140

150

160

170

2013 2014 2015 2016 2017 2018

Gross Nominal Public Debt(in percent of GDP)

240

250

260

270

280

290

300

310

320

330

340

2013 2014 2015 2016 2017 2018

Gross Nominal Public Debt

(in percent of Revenue)

15

20

25

30

35

40

2013 2014 2015 2016 2017 2018

Public Gross Financing Needs

(in percent of GDP)

Real GDP

Growth Shock

Primary

Balance Shock

Change in the

Share of Short-

Term Debt

Exchange Rate

Shock

Contingent

Liability shock

Debt level

Foreign

Currency

Debt

Real Interest

Rate Shock

Exchange Rate

Shock

Contingent

Liability Shock

Primary

Balance Shock

Real Interest

Rate Shock

Market

Perception

Gross financing needs

Public Debt

Held by Non-

ResidentsDebt profile

External

Financing

Requirements

Real GDP

Growth Shock

Heat map

Risks to debt profile

Debt Profile Vulnerabilities Upper early warning Lower early warning

20

60

87%

1 2

200

600

356

bp

1 2

5

15

17%

1 2

0.5

1

- 4.5%

1 2

EMBI External Financing

Requirement

Annual Change in Short - Term Public

Debt

Public Debt in Foreign Currency

(in basis points) 4/ (in percent of GDP) (in percent of total) (in percent of total)

15

45 24%

1 2

Public Debt Held by Non - Residents

(in percent of total)

Fan charts

Evolution of Predictive Densities of Gross Nominal Public Debt

(in percent of GDP)

100

105

110

115

120

125

130

135

140

145

2011 2012 2013 2014 2015 2016 2017 2018

10th-25th 25th-75th 75th-90thPercentiles:Baseline

Symmetric Distribution

100

105

110

115

120

125

130

135

140

145

2011 2012 2013 2014 2015 2016 2017 2018

Restricted (Asymmetric) Distribution

no restriction on the growth rate shock

no restriction on the interest rate shock

0 is the max positive pb shock (percent GDP)

no restriction on the exchange rate shock

Restrictions on upside shocks:

Source: Italy 2013: Article VI Consultation Staff Report, September 2013

DSA write-up

• Reflects staff’s overall assessment of debt sustainability risks

• Highlights vulnerabilities and country-specific circumstances that mitigate or amplify risks

• Includes background and key assumptions, including the realism of the baseline

Example - Mexico

Gross debt levels in Mexico, at 45 percent of GDP projected by end-2013, remain moderate. The broad institutional coverage of Mexico’s public debt…provides reassurance that gross liabilities of the public sector are well captured… Given Mexico’s debt structure, the pass-through of either interest rates or exchange rate shocks to the budget is relatively small over the projection period… While public debt profile indicators are below early warning benchmarks, there is a large share of debt held by non-residents—about 48 percent of total debt.

Example - Romania

The main risks arise from underperformance of GDP growth and a banking sector contingent liability, which could push the public debt ratio to nearly 50 percent of GDP…however, …banks are well capitalized with limited exposure to short-term external debt. External vulnerabilities persist due to relatively high external debt and rollover needs…

Example - Italy

Italy

Source: IMF staff.

4/ An average over the last 3 months, 21-Mar-13 through 19-Jun-13.

Real GDP

Growth Shock

2/ The cell is highlighted in green if gross financing needs benchmark of 20% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock

but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.

Italy Public DSA Risk Assessment

1/ The cell is highlighted in green if debt burden benchmark of 85% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not

baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.

Real Interest

Rate Shock

External

Financing

Requirements

Real GDP

Growth Shock

Heat Map

Upper early warning

Evolution of Predictive Densities of Gross Nominal Public Debt

(in percent of GDP)

Debt profile 3/

Lower early warning

400 and 600 basis points for bond spreads; 17 and 25 percent of GDP for external financing requirement; 1 and 1.5 percent for change in the share of short-term debt; 30

and 45 percent for the public debt held by non-residents.

Foreign

Currency

Debt

Public Debt

Held by Non-

Residents

(Indicators vis-à-vis risk assessment benchmarks)

Market

Perception

Gross financing needs 2/ Primary

Balance Shock

Real Interest

Rate Shock

Exchange Rate

Shock

Contingent

Liability Shock

Primary

Balance Shock

Debt Profile Vulnerabilities

3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark,

yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white.

Lower and upper risk-assessment benchmarks are:

Change in the

Share of Short-

Term Debt

Exchange Rate

Shock

Contingent

Liability shock

Debt level 1/

1 2

Not applicable

for Italy

400

600

273

bp

1 2

17

25

51%

1 2

1.0

1.5

0.8%

1 2

Bond Spread over

German Bonds

External Financing

Requirement

Annual Change in

Short-Term Public

Debt

Public Debt in

Foreign Currency

(in basis points) 4/ (in percent of GDP) (in percent of total) (in percent of total)

100

105

110

115

120

125

130

135

140

145

2011 2012 2013 2014 2015 2016 2017 2018

10th-25th 25th-75th 75th-90thPercentiles:Baseline

Symmetric Distribution

100

105

110

115

120

125

130

135

140

145

2011 2012 2013 2014 2015 2016 2017 2018

Restricted (Asymmetric) Distribution

no restriction on the growth rate shock

no restriction on the interest rate shock

0 is the max positive pb shock (percent GDP)

no restriction on the exchange rate shock

Restrictions on upside shocks:

30

45

30%

1 2

Public Debt Held

by Non-Residents

(in percent of total)

At close to 130 percent of GDP, Italy’s public debt ratio is the second highest in the euro area and financing needs are large… Given the debt structure (average maturity around 7 years), the direct interest pass-through to the budget is relatively slow… The country’s high total external financing requirements point to continued vulnerability to changes in market perceptions.

Appendix

Indicators AEs EMs

3-year cumulative primary balance adjustment (percent of GDP) 2 2

Coefficient of variation of growth 1 1

Bond yield spreads or EMBI global spreads (basis points) 600 600

External financing requirements (percent of GDP) 25 15

Public debt held by non-residents (share of total) 45 45

Public debt in foreign-currency (share of total) n.a. 60

Annual change in the share of short-term public debt at

original maturity 1.5 1.0

Lower scrutiny

Higher scrutiny

Indicators for additional analysis

Macro-fiscal shocks in detail

26

Risk Size and Duration of Shocks Default Interaction

Primary

balance

Minimum shock of 50 percent of planned

cumulative adjustment or baseline minus

half of the 10-year historical standard

deviation, whichever is larger.

Additional borrowing leads to increase in interest rate of 25 basis

points per 1 percent of GDP worsening of the deficit.

Real GDP

growth

Real GDP growth is reduced by 1

standard deviation for 2 consecutive

years.

Primary balance deteriorates (the revenue-to-GDP ratio remains the

same as in the baseline, but the ratio of non-interest expenditures to

GDP increases as the level of spending is kept the same as in the

baseline). Deterioration in primary balance leads to higher interest

rate (see above).

Decline in growth leads to lower inflation (25 percentage points per 1

percent of GDP growth).

Interest

rate

Nominal interest rate increases by the

difference between the maximum real

interest rate over history (last 10 years)

and the average real interest rate level

over projection, or by 200bp, whichever

is larger.

Size of shock can be adjusted if risks are high (gross financing needs

are higher).

Exchange

rate

Estimate of real exchange rate

overvaluation, or maximum historical

movement of exchange rate over 10

years, whichever is highest.

Pass-through to inflation with default elasticity of 0.25 for EMs and

0.03 for AEs.