New reforms to DSF to provide a simpler and more comprehensive way to assess risks to debt sustainability

The Debt Sustainability Framework (DSF) is the main tool for multilateral institutions and other creditors to assess risks to debt sustainability in Lower Income Countries (LICs). The framework classifies countries based on their assessed debt-carrying capacity, estimates threshold levels for selected debt burden indicators, evaluates baseline projections and stress test scenarios relative to these thresholds, and then combines indicative rules and staff judgment to assign risk ratings of debt distress.

However, since 2005, when the DSF was introduced, the economic environment in which many LICs operate changed significantly, resulting in potentially important gaps in the DSF. To cope with the evolving financing landscape, the DSF was reviewed on three occasions, most recently in 2012. While the 2012 review saw the introduction of several new features including incorporation of more country-specific information, there was room for further progress especially in improving the assessment of macro-linkages in stress tests and exploring the links between investment and growth. The 2017 review delivers a new framework that improves these features, and that significantly reduces the rate of false alarms – incorrectly predicting the occurrence of debt signals – and moderately decreases the rate of missed crises.

The features will ensure the DSF to strengthen the assessment of countries’ debt-carrying capacity by drawing on an expanded set of country-specific and global factors, instead of relying exclusively on the Country Policy and Institutional Assessment (CPIA). They will also introduce tools that will facilitate closer scrutiny of baseline macroeconomic projections and recalibrate standardized stress tests to better reflect the actual scale of shocks while adding tailored scenarios to better evaluate risks stemming from natural disasters, volatile export prices, market-financing shocks, and contingent liability exposures.

“The DSF will also provide a richer characterization of debt vulnerabilities including an enhanced assessment of domestic debt vulnerabilities, and new tools for assessing vulnerabilities to shifts in market financing conditions and enhance the guidance for a more even-handed application of judgment” said Paloma Anos Casero, Director of the Macroeconomics and Fiscal Management Global Practice.

The proposed reforms to the DSF would enable it to provide the basis for a richer and more informed policy discussion between Bank and Fund staffs and country authorities. Country-specific features (e.g., international reserve coverage) play an expanded role as inputs to the DSF and as drivers of the tailored scenario stress tests; the DSF’s outputs would include a much richer set of information on debt developments and debt vulnerabilities, better informing the discussion of policy options and trade-offs.

The implementation of the new framework will start in the second half of 2018, with the completion of the associated Staff Guidance Note and template.  A series of outreach and trainings for Bank and Fund staff and country authorities is planned across regions to roll-out the new framework on July 1, 2018.