External Debt Sustainability: Guidelines for Low- and Middle-income Countries

Abstract

The high debt burden continues to hamper the growth prospects of many developing countries and is increasing their vulnerability. Bilateral official aid has declined sharply and financing by multilateral organizations is low. Developing countries have experienced net negative resource transfers, reducing their ability to invest. Finally, growth in these countries has lagged worldwide growth, particularly in Latin America and Africa. Poorer countries depend heavily on support of official institutions. Aid to poorer countries has diminished and in many cases their debt burden appears to be unsustainable. Countries with access to market borrowing on the other hand, have been affected by high volatility in international capital markets, while having fewer policy options than in the past to absorb shocks. Debt sustainability assessments normally focus on the behaviour of the external debt to GDP ratio, which depends on the behavior of debt, interest rates, the behaviour of GDP, and the movements in the real exchange rate. In crisis situations, countries can have recourse to debt restructuring or reduction, but such action cannot be a regular means of dealing with external financing problems, as it affects access to new financing. The process is defective and new solutions are required. There is good evidence on indicators and predictors of external debt crises. There are key macroeconomic indicators which, in general have a good capacity to predict debt problems, but they work with variable lags, and are not reliable in all cases. Thus, a good tracking system needs to be based on several of these indicators. The impact of sovereign credit ratings on access of developing countries to capital markets and on the terms of borrowing is significant. Worsening ratings can have adverse consequences on debt sustainability. To avoid this problem, credit agencies should expand their use of indicators, and take a broader view of developments than at present, including with regard to programmes that countries are undertaking with the support of the international financial institutions.

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