Debt Sustainability Framework

The Debt Sustainability Framework (DSF) is a structure defined to help Low-income Countries (LIC) determine their borrowing limits. The primary purpose of the DSF is to estimate the current and future repayment capacities of these nations and ensure they can borrow funds in proportion to such repayment abilities.

The debt sustainability framework test projects a nation's borrowing capacity for the next ten years, given its economic conditions and monetary policy. It helps international institutions understand a low-income country’s repayment capacity. In addition, it also assesses the financial risks associated with debt in these nations. Another facet of this framework is that it supports the IMF’s Sustainable Development Goals (SDGs), which outlines the importance of sustainable economic development.

• Debt Sustainability Framework (DSF) is a system that determines the borrowing capacity of low-income countries.
• The World Bank and International Monetary Fund (IMF) provide funds to these nations, i.e., Low-income Countries (LICs).
• There are three debt threshold limits, depending on need and performance. They are Strong, Medium, and Weak. In the first case, the funding is 100%, followed by 50% and zero.
• However, in the medium debt limit, the balance (50%) is given as credits. Similarly, for a weak threshold, the entire amount is issued as credits.

The Debt Sustainability Framework is a comprehensive system that identifies low-income countries' debt issues and monetary distress. Based on a country’s needs, the World Bank chalks out a DSF proposal for allocating funds to these nations. Other financial institutions like the International Monetary Fund (IMF) also contribute. This proposal helps them assess financing needs and determine debt limits.

The DSF was instituted in April 2005. However, it is reviewed and updated at regular intervals. The latest revision to the framework was in 2018. The public debt sustainability framework aims to resolve all debt-related issues of low-income countries and facilitate growth. 

The IMF debt sustainability framework is linked to the debt sustainability models - The Low-income Country Debt Sustainability Model and Market-access Debt Sustainability Model. The first model applies to countries where economic development is challenging, while the second model (the market-access model) is relevant to countries that can finance their development endeavors by borrowing from capital markets around the world.

Although every country might want to apply for DSF, only a few meet the criteria. A low-income country must have a long-term debt situation (eligibility shortfall) that does not allow it to borrow funds at regular market terms. If this is not the case, these nations must be eligible for part of the grants provided by the International Development Association (IDA). With these measures, it becomes possible for low-income countries to eventually achieve a debt-sustained state where per capita income surpasses the debt ceiling.

Certain ratios are used to ascertain eligibility under the public debt sustainability framework test. It considers the public-guaranteed external debt, gross domestic product (GDP), exports, and debt service. DSF also uses the Country Policy and Institutional Assessments (CPIA) to determine a specific LIC's position. However, this allocation will be under IDA 14, a system to disburse funds to LICs. It is further merged with the Performance Based Allocation (PBA) System. Here, PBA considers the per capita income and poverty levels.

The World Bank considers a few factors before allocating funds. Of these, "need" and "performance" are of great importance. Based on the debt performance, three limits, levels, or metrics are created. They also play a vital role in the lending and borrowing procedure. So, let us study the thresholds of debt sustainability framework in low-income countries to understand the concept in greater detail.

#1 - Strong

If a low-income country’s economic indicators (past performance, real growth projections, international reserves, remittance receipts, etc.) are stable and positive, they have strong debt thresholds. In such cases, international institutions extend almost 80% of the funding applied for by the nation. However, the chances of these countries receiving a full grant of funds from the World Bank are high.

#2 - Medium

In this case, a low-income country usually has an average ratio value. Thus, a medium risk level recommends that the World Bank offer 50% of the allocated funds to a low-income country. Moreover, the balance of 50% is given as credits.

#3 - Weak

A weak debt threshold limit is seen when a country's economic growth is abysmal. In such cases, the World Bank usually extends the entire balance as credits.

It must be noted that the debt sustainability framework poses certain challenges. Sometimes, debt indicators might be above threshold values. Hence, these indicators or ratios may not be enough to determine the debt threshold. Vulnerabilities, stock, and cash flow problems in a country must also be considered to widen the review scope.

Let us look at some examples to understand the IMF debt sustainability framework better.

Example #1

Countries A, B, and C want to borrow a certain amount of debt for the economic development of their nation. Per the IDA criteria, they can receive funds from the World Bank. However, the latter considers various metrics before moving forward with a country’s application.

According to the rules, the major ratios or indicators involved in the framework are the present value of external debt, external debt service, and the present value of the total public debt. Based on this calculation, A belonged to the medium threshold. B had the lowest debt limit. However, C received the highest funding because of a strong debt threshold.

Example #2

According to reports and data published in February 2023, G20 members discussed several key measures, including the debt sustainability framework, to support economic development in various countries. While no individual country was a focal point, the upcoming DSF aims to address many relevant issues countries regularly face, including climate change.

The importance of the debt sustainability framework for low-income nations cannot be exaggerated. Here are a few key points to consider.

• DSF helps low-income countries become eligible for fund allocation under IDA 14. 
• It enables these nations to eradicate debt-related problems and achieve their Sustainable Development Goals (SDGs).
• This method uses precise metrics to identify and highlight the sustainable level of borrowing that low-income nations can tolerate.
• It distinguishes between various parameters like debt distress, insolvency, and liquidity.
• Investors (domestic and international) can easily identify debt issues and make investment decisions using published DSF data.

This article has been a guide to Debt Sustainability Framework & its Meaning. We explain its debt burden thresholds, examples, & importance. You may also find some useful articles here -

• Debt Sustainability Analysis
• Multilateral Development Bank
• Economic Capital