Station 4 demonstrates how to determine each country’s debt-carrying capacity and derives the respective thresholds for debt indicators.
Countries with different policy and institutional strengths, macroeconomic performance, and buffers to absorb shocks, have different abilities to handle debt. Such abilities are also influenced by the global environment through demand for LICs’ exports and remittance inflows into LICs.
A country’s debt-carrying capacity is established to determine the debt and debt service thresholds that will apply when assessing the extent of risks. Countries are classified based on a composite indicator using country-specific information.
The weak, medium, and strong debt-carrying capacity categories determine the country’s thresholds for the external DSA and the benchmark for the public DSA.
Composite Indicator (CI) for Classifying Countries
The previously used LIC DSF World Bank Country Policy Institutional Assessment (CPIA) has been replaced by the Composite Indicator (CI), which includes CPIA plus other macroeconomic variables.
- The CI uses 10 years of data (5 years of history and 5 years of projections) to smooth out economic cycles and encourage forward-looking policy discussions.
- Mixing historical data and projections allows the framework to capture ongoing changes in the outlook for each country’s fundamentals.
- CI classification of any given LIC is weak, medium, or strong.
The calculation of the latest and past CI scores are found in the “CI Summary” sheet of the latest published template.
CI is calculated as the weighted sum of the non-debt predictors of debt distress, where the weights are given by the average estimated coefficients across several statistical models.
Exercise: Input your 10 year average values in the table below. Click 'Enter' on your keyboard to see the result.
The CI is calculated as follows:
where g and gw are growth and world growth respectively, and where all variables are in percent, except the CPIA score.
The coefficients are:
Reserves are measured in percent of imports.
The reserves2 term is calculated as follows: (the ratio of reserves scaled by imports)2 *100. For example, if reserves are 26.244%, reserves2 is calculated as (26.244/100)2*100
Reserves are measured in GDP.
CI Debt-Carrying Capacity
Assessing a Country’s Debt-Carrying Capacity
The composite indicator falls below the 25th percentile of this distribution
The composite indicator falls at or between the 25th and 75th percentiles
The composite indicator falls beyond the 75th percentile (see illustrative cut-off values)
Frequency: The CI is calculated twice a year based on the April and October World Economic Outlook Reports (WEOs), and the CPIA released by the World Bank in July, then predetermined/frozen between these two points.
Potential changes to a country’s CI classification:
Changing the current CI classification requires two consecutive signals to avoid volatility in classification while recognizing ongoing policy changes.
THRESHOLDS AND BENCHMARKS
Thresholds for PPG External Debt
- Countries that remain at weak or medium capacity should pay special attention to the debt service threshold and minimize liquidity risks from their future debt service.
Benchmark for Total Public Debt
Takeaways for Station 4
- A country’s debt-carrying capacity is determined by 5 years of historical data and 5 years of country-specific and global projections.
- The Composite Indicator (CI) is a weighted average of the country’s CPIA score computed by the World Bank, the country’s growth, reserves, remittances, and world growth.
- The weights are based on the statistically estimated coefficients for each variable; are the same for every LIC; and will remain unchanged until the next LIC DSF comprehensive review.
- Based on the country’s debt carrying capacity (weak, medium, or strong), the LIC DSF has four thresholds for the PPG external debt and one benchmark for the total public debt.
- These thresholds apply to the ratios of stocks, such as external PPG debt-to-GDP and external PPG debt-to-exports, which are depicted in present value terms to reflect a very long projection horizon of 20 years. They also apply to ratios of flows, such as external PPG debt service-to-revenue and external PPG debt service-to-exports.
- The benchmark refers to the present value of the total public debt-to-GDP, which includes PPG external as well as public domestic debt.