Debt Sustainability Analysis

Debt Sustainability Analysis or DSA refers to the analysis of a nation's capacity that helps determine whether it can service its ensuing debt and fiscal policy objectives without making excessively large adjustments, which might compromise stability. It helps gauge a developing nation's financing requirements and capacity to make repayments.

Also referred to as the debt sustainability model, the IMF or International Monetary Fund and the World Bank utilize it to measure the borrowing and lending decisions surrounding developing and low-income nations. Thus, this tool can better spot, resolve and prevent potential crises. There are two types of DSA models - market-access debt and low-income country debt sustainability models.

• The debt sustainability analysis is a structured examination of a nation's debt-carrying capacity based on a framework instituted by the IMF and the World Bank.
• There are various benefits of debt sustainability analysis. For example, it helps loan providers understand the risk profiles of the various countries borrowing money from them to finance important development projects or programs. Moreover, it allows investors to better estimate the losses or gains they might record.
• Market access and low-income country are two types of debt sustainability models.
• Enabling lenders to tailor financing terms is a key objective of IMF debt sustainability analysis.

The debt sustainability analysis refers to a structured assessment of a developing economy based on the DSA framework. It guides low-income nations’ borrowing decisions in a manner that matches their fund requirement with their prospective and current capacity to service the debt, customized to specific circumstances.

The IMF and World Bank instituted this model. Both these international institutions promote sustainable growth in developing nations. The three main goals of pillars of this analysis are as follows:

• Ensuring the nations borrowing money are on the right path to sustainable development
• Helping low-income nations to balance their financing requirements with their repayment capacity.
• Enabling loan providers to gauge and anticipate future risks and customize the terms of financing

Different low-income countries' debt sustainability reports are published at fixed intervals. Such reports highlight a couple of risk factors – overall and external debt distress risks. These components have a base scenario computed based on a sequence of macroeconomic projections and factors that consider the intended policies of the government. There are clearly defined parameters and scenarios. Moreover, the model involves applying sensitivity tests to the base scenario, offering a confidence interval of the probabilistic situations that may materialize with changing factors, which include macroeconomic developments, policy variables, and financing costs.

One must ensure not to interpret DSA rigidly or mechanically. Instead, individuals or organizations must assess the results against relevant nation-specific scenarios, which include specific features of a certain country's borrowings, policy space, and policy track record.

Let us look at the two types of debt sustainability models.

• Low-Income Country DSA: This model helps in debt sustainability analysis for low-income countries, which are economies facing significant difficulty or challenges in fulfilling their development objectives. These are the main nations for this type of analysis since the risk and reward profile is very uncertain for investors. Projecting borrower payments in a low-income nation is difficult owing to the political and economic uncertainty faced by the country.
• Market-Access DSA: Market Access DSA applies to emerging or developing market economies. Such economies have the ability to access global capital markets.

One of the most crucial aspects that help analyze debt sustainability is the total money borrowed by a nation. Indeed, borrowing funds can allow nations to finance crucial projects and development programs. However, if the amount borrowed is too high, it can overwhelm a nation's finances, leading to default.

High amounts of debt in low-income nations and emerging or developing economies have raised concerns in recent years with regard to their ability to sustain such debt levels. The rising public debt will likely increase the tension between fulfilling crucial development objectives and containing debt vulnerabilities.

A nation's public debt is sustainable when the government can fulfill all the future and current payment obligations without defaulting or exceptional financial assistance. That said, publicly guaranteed debt is also considered to determine debt sustainability in low-income nations.

Besides public and public guaranteed debt, a nation's ability to sustain debt depends on multiple factors, such as development, quality of debt management and institutions, policies, macroeconomic fundamentals, etc. That said, a nation's debt-carrying capacity changes due to the dynamic economic environment.

The IMF utilizes a framework to evaluate the ability to sustain debt in low-income nations and countries that can access capital markets. Such a framework considers individual nations' debt-carrying capacity. It utilizes a composite indicator that takes into account a nation's historical performance, remittance inflows, real growth outlook, and other factors. Moreover, it involves using multiple indicative thresholds for debt burden, depending on a nation's capacity to carry debt.

The thresholds that correspond to strong performers are maximum, which indicates that nations with decent macroeconomic policies and performance can typically manage greater debt accumulation. Based on such benchmarks and thresholds, IMF debt sustainability analyses include risk evaluation of overall and external debt distress based on different categories.

Let us look at a few debt sustainability assessment examples to understand the concept better.

Example #1

In May 2023, the International Monetary Fund staff updated their debt sustainability and macroeconomic views on Zambia. Julie Kozack, an IMF spokesperson, said that the impact and details regarding the updates would be available in the staff report, which the financial agency will publish after its board takes into account the request for the first review's completion. The African country was one of the major causalities of the pandemic-induced economic collapse. The nation has been a defaulter since 2020. It availed of IMF funding in August 2022.

Example #2

According to the IMF, Ghana is targeting an external debt service relief worth $10.5 billion from 2023 to 2026. This announcement indicates how significantly the forthcoming debt overhaul might impact investors. Currently, Ghana's debt is unsustainable. However, the West African country is trying to restore the risk of debt distress to a ''moderate'' status by 2028.

One can go through the following points to understand the importance of debt sustainability analysis for low-income countries and developing or emerging economies.

• It enables lenders to get a clear idea regarding the risk profiles of the different nations borrowing funds from them.
• Knowing about the risks of the countries borrowing funds helps investors better assess the returns they can expect or the losses they might suffer.
• Another key benefit of debt sustainability analysis is that it allows the borrowers to balance their requirement for financing with their capacity to repay the funds on time and fulfill the financial obligation.

This has been a guide to what is Debt Sustainability Analysis. Here, we explain its importance, examples, how to do it, and types. You can learn more about it from the following articles –

• Finance vs Economics
• Government Intervention
• External Debt