A Risk-Based Debt Sustainability Framework: Incorporating Balance Sheets and Uncertainty

Abstract

This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.This paper proposes a new framework for the analysis of public sector debt sustainability. The framework uses concepts and methods from modern practice of contingent claims to develop a quantitative risk-based model of sovereign credit risk. The motivation in developing this framework is to provide a clear and workable complement to traditional debt sustainability analysis which-although it has many useful applications-suffers from the inability to measure risk exposures, default probabilities and credit spreads. Importantly, this new framework can be adapted for policy analysis, including debt and reserve management.

Public Debt Sustainability in Developing Asia: An Update

“…In order to do so, DSA would have to be augmented with information about the balance sheet structure of the sovereign, including the central bank, and about contingent liabilities to other sectors in the economy. It would have to allow for sovereign assets to evolve with uncertainty against sovereign liabilities and also allow for linkages between sectors of the economy and the spillover of risk and feedback effects, such as between the finance and the public sector (Gray et al 2008). This will be the focus of future analysis.…”

Risk Framework Analysis in the Management of Sovereign Debt: The Argentine Case

“…Basing ourselves on Gray and Malone (2008) [9] framework we have two "partner" balance sheets: the Government's and the Monetary Authority's. Government assets include a claim on a portion of the foreign currency reserves held by the Monetary Authority and other public sector assets such as the present value of the primary fiscal surplus.…”

“…In consequence, through this measure we can estimate the volatility of any kind of instrument. In general terms we can define the P V 01 for any sequence of cash flows given a set of zero coupon interest rates for each maturity of this cash flow as 5 :…”

“…One of the most important is that this ratio is highly aggregated and cannot properly account for changes in sovereign risk appetite or currency composition of the debt and its maturity structure. Following Gray D. et al (2008) IMF [5] we can mention the most significant shortcomings of traditional DSA: Firstly, the level of the GDP ratio does not necessarily imply sustainable/unsustainable debt dynamics. A country may increase expenditure on investment activities and structural reforms to enhance future growth prospects or have to run large deficits to smooth consumption.…”

“…Sovereign balance sheet and CCA were first introduced by Gapen et al (2004 and 2005) [6], Gray (2002) [7], Gray, Merton andBodie (2002 and2006) [8], and Gray and Malone (2008) [9]. See this authors for a full description of the CCA approach.…”