Debt sustainability index: Our updated scores showing the risk of debt distress

  • We update our debt sustainability index for 46 emerging & frontier markets to flag countries with high risk of distress
  • The most vulnerable countries are Sri Lanka, Jamaica, Tunisia, Ghana (new entrant), Mongolia, El Salvador, and Kenya
  • The least vulnerable are Nigeria, Uzbekistan, Vietnam, Kazakhstan, Peru, Cameroon (new entrant), and Cote d’Ivoire
Debt sustainability index: Our updated scores showing the risk of debt distress

Following the release of the IMF’s updated WEO projections this month, we have updated our debt sustainability index to assess debt risks across 46 emerging and frontier markets. The update impacts 19 of the 27 variables (7 of which are due to unchanged numerators but updated denominators).

We also include one methodological change to the way we measure public external debt, which we hope captures last year’s debt build-up in a more timely and accurate way – see “Methodological issues” below for a full explanation.

We have divided the scorecard into three distinct categories: 1) fiscal policy and debt dynamics; 2) debt stock and flow; and 3) debt composition. For each category, we display the raw data in separate tables below. We then devise a composite debt sustainability index.

Fiscal policy & debt dynamics scorecard
Debt stock & flow scorecard

Debt composition scorecard

We then score each variable in terms of standard deviations better (worse) than the sample median and take the simple average across variables to arrive at a composite debt sustainability index, as well as sub-indexes for fiscal policy & debt dynamics, debt stock & flow, and debt composition (we remove 10 countries due to insufficient data – see table notes). The resulting output is a quick and dirty way to quantify debt sustainability risk for each country on a relative basis.

Debt sustainability index

Results

After excluding countries with insufficient data, we find that the most vulnerable countries are Sri Lanka, Jamaica, Tunisia, Ghana, Mongolia, El Salvador, and Kenya. This is broadly unchanged from April, with the bottom seven constituents unchanged barring a swap of Pakistan (out) for Ghana (in). There is also some shuffling of the order, with Sri Lanka swapping with Jamaica to take the bottom spot and Mongolia swapping from 3rd to 5th most vulnerable with Tunisia.

On the other hand, the least vulnerable countries are Nigeria, Uzbekistan, Vietnam, Kazakhstan, Peru, Cameroon, and Cote d’Ivoire. The top seven constituents are also broadly unchanged from January barring a swap of Serbia (out) for Cameroon (in) and some minor reshuffling of rank (with Nigeria swapping with Uzbekistan to take the top spot). The chart below shows the biggest movers:

Biggest movers

Moreover, a simple scatter plot shows that there is a negative relationship between the overall debt sustainability score and the country risk premium (measured by the EMBI), as we should expect. A log-linear line of best fit is statistically significant at the 99% confidence level with an R2 = 22.3% (though this drops to 95% and 12.3%, respectively, if Sri Lanka is excluded as an outlier).

Debt sustainability index vs EMBI spread

We can use this model to make broad inferences about bond valuations, with large residuals pointing to under/overvaluation. On that basis, Sri Lanka, Ecuador, Ethiopia, Nigeria, Angola, and Cameroon, all stand out as notably undervalued (though it may be appropriate to remove Sri Lanka as an outlier). Meanwhile, Jamaica, Mongolia, Colombia, Indonesia, Vietnam, Serbia, and Morocco appear to be the most overvalued credits.

We also backtest our January model by regressing the residuals (ie estimated over/undervaluation) on the actual change in EMBI spread from 20 January to 23 April. We find that the residuals are positively correlated with actual performance over that period (ie the estimated over/undervaluation was reduced) and statistically significant at the 99% confidence level with an R2 = 30.8%.

Projected vs actual spread change

However, it becomes statistically insignificant if Sri Lanka and Ecuador are removed as outliers – and there is certainly an argument for removing Ecuador since the bulk of its improvement followed directly from the election earlier this month.

While the results should thus be taken with a grain of salt, it is notable that 5 of the 6 countries the model flagged as being most undervalued in January have been significant outperformers (Sri Lanka, Ecuador, Angola, El Salvador, and Tunisia), barring only Nigeria which performed roughly in line with the EMBI index.  

Methodological issues

While we appreciate our model is highly stylised, the simplified and transparent approach is part of its appeal and we find it mostly offers intuitive results (and where it does not, this can be a signal for further investigation). Of course, we urge our readers to take this data and its conclusions with a pinch of salt, and caution that it should be used in conjunction with traditional country risk analysis. While the scorecard flags countries at high risk of debt distress, a more comprehensive multivariate model would be necessary to draw statistically significant quantitative conclusions about spreads and default risk.

We also recognise some drawbacks of this approach. It fails to account for potential nonlinearities and threshold effects within variables, while equal weighting may ignore potential differences in importance. In addition, more timely and thorough data can be found for many countries using official sources, providing a more complete snapshot (but making cross-country comparison more difficult). Data availability and the vintage of the available data is another challenge, with most of the World Bank IDS indicators pertaining to external debt stock and composition only updated through 2019.

The longer the lag, and less contemporaneous the data is, the less useful it is as an early warning indicator. We have tried to compensate for this by deflating 2019 external debt values by the 2020 estimate for GDP and exports to account for the drastic changes seen across these indicators in 2020, and by proxying the 2020 public external debt stock by multiplying the proportion of public debt denominated in FX in 2019 by the 2020 public debt estimate (a methodological change from January). This yields an imperfect approximation but is the best we can do given existing data constraints.

Moreover, we omit other indicators which might be a significant cause or signal of distress, including institutional factors and qualitative differences in public financial management and debt management capacity. Nor have we included a variable to capture default experience or payment track record, which can be an important indicator of willingness to pay and predictor of default. However, we have chosen a more general approach to allow for cross-country comparison, and think our scorecard serves as a useful warning light for debt distress.

In the Appendix, each variable is detailed with sources and relevant metadata. We welcome feedback from our readers on methodology and coverage and remain available to answer any questions. 

Appendix: data explanations and sources

Budget balance / GDP: Proj. budget deficit (surplus) as % of GDP for 2021. Source: IMF April 2021 WEO. Frequency: Annual (2021)

Primary balance / GDP: Proj. primary deficit (surplus) as % of GDP for 2021. Source: IMF April 2021 WEO. Frequency: Annual (2021)

Debt-stabilizing primary balance / GDP: Debt stabilizing primary balance implied from IMF WEO for 2021-26 period. Source: IMF April 2021 WEO. Frequency: Annual (2021-26)

Actual – stabilizing primary balance: Difference between proj. 2021 primary balance and implied debt stabilizing balance. Source: IMF April 2021 WEO. Frequency: Annual (2021-26)

r – g differential: Difference between proj. 2021-26 real GDP growth and proj. 2021-26 real interest rate (effective interest rate minus inflation) implied from IMF WEO. Note: positive (negative) differential increases (decreases) debt, all else equal. Source: IMF April 2021 WEO. Frequency: Annual (2021-26)

Annual FX forecast (%): Proj. annual appreciation (depreciation) of currency over 2021-26 implied by IMF WEO (derived by dividing proj. GDP in local currency terms by proj. GDP in US$ terms). Source: IMF April 2021 WEO. Frequency: Annual (2021-26)

Public debt / GDP: Public debt / GDP ratio in 2020. Source: IMF April 2021 WEO. Frequency: Annual (2020)

Interest / GDP: Proj. interest payments (derived by subtracting budget balance from primary balance) as % of GDP in 2021. Source: IMF April 2021 WEO. Frequency: Annual (2021)

Interest / revenue: Proj. interest payments % of government revenue in 2021. Source: IMF April 2021 WEO. Frequency: Annual (2021)

Total external debt / GDP: External debt (public and private) in 2019 as % of GDP in 2020. Source: World Bank International Debt Statistics for external debt and IMF April 2021 WEO for GDP. Frequency: Annual (2019 and 2020)

Public external debt / GDP: Public debt / GDP in 2020 times ratio of public external debt to total public debt in 2019 (methodological change). Source: World Bank International Debt Statistics for external debt and IMF April 2021 WEO for public debt and GDP. Frequency: Annual (2019 and 2020)

Total external debt / exports: External debt (public and private) in 2019 as % of 12-month trailing exports of goods. Source: World Bank International Debt Statistics for external debt and IMF Direction of Trade Statistics (via Bloomberg) for goods exports. Frequency: Annual (2019) for debt and monthly (Dec 2020) for exports

Public external debt / exports: Public and publicly guaranteed (PPG) external debt in 2019 as % of 12-month trailing exports of goods. Source: World Bank International Debt Statistics for external debt and IMF Direction of Trade Statistics (via Bloomberg) for goods exports. Frequency: Annual (2019) for debt and monthly (Dec 2020) for exports

Total external debt service / exports: Proj. external debt service (public and private, principal and interest) in 2021 as % of 12-month trailing exports of goods. Source: World Bank International Debt Statistics for external debt and IMF Direction of Trade Statistics (via Bloomberg) for goods exports. Frequency: Annual (2021) for debt service and monthly (Dec 2020) for exports

Public external debt service / exports: Proj. public and publicly guaranteed (PPG) external debt service (principal and interest) in 2021 as % of 12-month trailing exports of goods. Source: World Bank International Debt Statistics for external debt and IMF Direction of Trade Statistics (via Bloomberg) for goods exports. Frequency: Annual (2021) for debt and monthly (Dec 2020) for exports

Public external debt service / revenue: Proj. public and publicly guaranteed (PPG) external debt service (principal and interest) in 2021 as % of proj. government revenue in 2021. Source: World Bank International Debt Statistics for external debt and IMF April 2021 WEO for revenue. Frequency: Annual (2021)

Effective interest rate (%): Proj. 2021 interest payments / 2020 public debt stock. Source: IMF April 2021 WEO. Frequency: Annual (2020 and 2021)

FX-denominated (%): Ratio of public external debt to total public debt in 2019 (methodological change). Source: World Bank International Debt Statistics for PPG external debt and IMF April 2021 WEO for public debt and GDP. Frequency: Annual (2019)

ST external (% of total): % of PPG external debt as of 2019 that is short-term. Source: World Bank International Debt Statistics. Frequency: Annual (2019)

Concessional (% of external): % of PPG external debt as of 2019 that is on concessional terms per World Bank definitions. Source: World Bank International Debt Statistics. Frequency: Annual (2019)

Bilateral (% of external): % of PPG external debt as of 2019 held by bilateral creditors. Source: World Bank International Debt Statistics. Frequency: Annual (2019)

Multilateral (% of external): % of PPG external debt as of 2019 held by multilateral creditors. Source: World Bank International Debt Statistics. Frequency: Annual (2019)

Bonds (% of external): % of PPG external debt as of 2019 corresponding to publicly traded eurobonds. Source: World Bank International Debt Statistics. Frequency: Annual (2019)

Other private sector (% of external): % of PPG external debt as of 2019 held by private creditors, excluding publicly traded eurobonds. Source: World Bank International Debt Statistics. Frequency: Annual (2019)

China (% of external): % of PPG external debt as of 2019 held by Chinese creditors (public or private). Source: World Bank International Debt Statistics. Frequency: Annual (2019)

Related reading

Taper tantrum scorecard, 20 February

Debt sustainability index, 20 January

External liquidity scorecard, 11 January


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