Debt Sustainability Index: Updated scores showing the risk of debt distress

Following the release of the IMF's updated WEO projections this month and recent update of the World Bank IDS database to include 2020 debt data, we have updated our sovereign debt sustainability index to assess debt risks across 46 emerging and frontier markets. The update impacts all 27 variables.

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 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, with Egypt receiving a score for the first time after addressing data gaps and Ethiopia dropping out due to a lack of updated WEO data). The resulting output is a quick and dirty way to quantify debt sustainability risk for each country on a relative basis:

Note: To request access to all the data from our Sovereign Debt Sustainability Index, please click here.

Results

After excluding countries with insufficient data (see table notes above), we find that the most vulnerable countries are Sri Lanka, Ghana, Mongolia, Tunisia, Egypt, Kenya and Pakistan. This is broadly unchanged from April, with Egypt receiving a score for the first time after addressing some data gaps and Pakistan re-entering the bottom seven, while improving scores saw Jamaica and El Salvador drop out of the bottom seven. There is also some shuffling of the order, with Ghana, Mongolia and Kenya scoring worse and Tunisia scoring better.

On the other hand, the least vulnerable countries are Vietnam, Nigeria, Kazakhstan, Uzbekistan, Cameroon, Ecuador, and Peru. The top seven constituents are also broadly unchanged from April barring a swap of Cote d’Ivoire (out) for Ecuador (in) and some minor reshuffling of rank – with Vietnam leapfrogging Nigeria and Uzbekistan to take the top spot). The chart below shows the 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 = 34.7% (though this drops to 95% and 19.6%, respectively, if Sri Lanka, Tunisia, and El Salvador are excluded as outliers).

We can use this model to make broad inferences about bond valuations, with large residuals potentially pointing to under/overvaluation. On that basis Sri Lanka, Tunisia, El Salvador, Ecuador, Nigeria, Belarus, Ukraine and Turkey all stand out as notably undervalued (though it is probably most appropriate to remove Sri Lanka, Tunisia and El Salvador as outliers). Meanwhile, Mongolia, Jamaica, Colombia, Indonesia, Serbia, Peru, Vietnam, and Morocco appear to be the most overvalued credits.

We back test our April model by regressing the residuals (ie estimated over/undervaluation) on the actual change in EMBI spread from 28 April to 23 October. Unlike the January update, when we found residuals to be positively correlated with actual performance and statistically significant, we find the relationship this time to be weak and statistically insignificant, suggesting any valuation conclusions derived from the model should be taken with a grain of salt.

Taking an alternative approach, we regress the April debt sustainability score by the change in spread for each country-specific EMBI index. We find that the debt sustainability score in April explained 20% of the change in spreads over the subsequent 6-month period at a 95% confidence interval, with each standard deviation difference in score translating to a 170bps difference in performance. Once again, this relationship breaks down once outliers are removed, though, suggesting the index is most useful at flagging cases of potentially extreme risk.

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 a 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 from 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 2020.

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 October 2021 WEO. Frequency: Annual (2021)

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

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

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

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 October 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 October 2021 WEO. Frequency: Annual (2021-26)

Public debt / GDP: Proj. public debt / GDP ratio in 2021. Source: IMF October 2021 WEO. Frequency: Annual (2021)

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

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

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

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

Total external debt / exports: External debt (public and private) in 2020 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 (2020) for debt and monthly (Jun 2021) for exports

Public external debt / exports: Public and publicly guaranteed (PPG) external debt in 2020 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 (2020) for debt and monthly (Jun 2021) 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 (2020) for debt and monthly (Jun 2021) 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 (2020) for debt and monthly (Jun 2021) 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 October 2021 WEO for GDP. Frequency: Annual (2021)

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

FX-denominated (%): Ratio of public external debt to total public debt in 2020. Source: World Bank International Debt Statistics for external debt and IMF October 2021 WEO for GDP. Frequency: Annual (2020)

ST external (% of total): % of PPG external debt as of 2020 that is short-term. Source: World Bank International Debt Statistics. Frequency: Annual (2020)

Concessional (% of external): % of PPG external debt as of 2020 that is on concessional terms per World Bank definitions. Source: World Bank International Debt Statistics. Frequency: Annual (2020)

Bilateral (% of external): % of PPG external debt as of 2020 held by bilateral creditors. Source: World Bank International Debt Statistics. Frequency: Annual (2020)

Multilateral (% of external): % of PPG external debt as of 2020 held by multilateral creditors. Source: World Bank International Debt Statistics. Frequency: Annual (2020)

Bonds (% of external): % of PPG external debt as of 2020 corresponding to publicly traded eurobonds. Source: World Bank International Debt Statistics. Frequency: Annual (2020)

Other private sector (% of external): % of PPG external debt as of 2020 held by private creditors, excluding publicly traded eurobonds. Source: World Bank International Debt Statistics. Frequency: Annual (2020)

China (% of external): % of PPG external debt as of 2020 held by Chinese creditors (public or private). Source: World Bank International Debt Statistics. Frequency: Annual (2020)

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