1. Central to operationalizing the debt-sustainability framework is determining at what point debt becomes unsustainable, i.e., at what point debt indicators reach “danger levels”. The HIPC Initiative, in order to determine debt relief for HIPC countries, uses a present value (PV) of debt-to-exports ratio of 150 percent as a sustainability threshold. However, this ratio is considered to be conservative—implying that the “danger level” is higher—and makes no allowance for country-specific differences. Since the HIPC Initiative encompasses a diverse group of creditors to agree on the required amount of debt relief, the choice of a single debt-sustainability threshold as opposed to country-specific thresholds has the advantage of simplifying the implementation of the Initiative. The primary purpose of the low-income debt-sustainability framework, however, is not the facilitation of debt relief but informing new borrowing and lending decisions. Given that countries are likely to differ in their ability to sustain a given debt level, debt-sustainability thresholds that serve as the basis for lending or borrowing decisions would need to take those country-specific differences into account. It needs to be emphasized, though, that this is not an exact science and assessing prudent debt levels will necessarily involve a large degree of judgment.
2. The World Bank (Kraay and Nehru, 2004) empirically examined the determinants of “debt distress”, which was defined as periods in which countries resorted to exceptional financing in any of three forms: (i) significant arrears on external debt, (ii) Paris Club rescheduling, and (iii) non-concessional balance-of-payments support from the IMF. Using probit regressions, the analysis found that three factors explained a substantial fraction of the cross-country and time-series variation in the incidence of debt distress: the debt burden, the quality of policies and institutions, and shocks. They showed that these results were robust to a variety of alternative specifications, and that the core specifications had substantial out-of-sample predictive power.
3. Drawing partly on work by Gottschalk and Loko (2003), Fund staff have replicated the analysis in Kraay and Nehru with three modifications: (i) the dataset was limited to low-income countries; (ii) debt distress was defined purely by the occurrence of significant arrears to official creditors; and (iii) a different dataset was used for NPV of debt calculations.59 This appendix presents the results of this analysis, which broadly corroborate the World Bank’s findings. The appendix also surveys some of the existing empirical literature on debt-sustainability thresholds and factors influencing them.
Illustration of Proposed Debt-Sustainability Framework
1. This Appendix illustrates the proposed framework for debt-sustainability analyses in low-income countries. The output generated by the two templates for the assessment of external and public debt sustainability is presented on the basis of two hypothetical country cases. In general, both parts of the analysis would be conducted for each low-income country—consistent with the approach adopted in the Fund for emerging markets and industrialized countries—unless domestic debt of the public sector (external debt of the private sector) is negligible. In this case, a single analysis of external (public) debt would generally be sufficient. Moreover, for those low-income countries that have access to private international capital markets and hold relatively small amounts of concessional debt, the Fund’s “emerging-market template” may be a more suitable analytical tool for debt-sustainability assessments.