Question

When performing debt sustainability analysis, what are the key components that should inform the analysis is declaring whether public debt is unsustainable?

Answer 1

Debt Sustainibility Analysis is a tool that measures how the country's current level of debt and borrowing affects its present and future ability to meet its debt-service obligation. It is a tool to better detect, prevent, and resolve potential crises. It became operational in 2002.

Two main Components of Debt sustainibility Analysis that helps in declaring whether public debt is unsustainable-

1) Rollover Risk

Rollover in simple terms means to carry forward or to adjust in next coming period. Debts are generally rolled over. This poses an additional risk that a DSA must take into account: the risk that borrowing costs change. In situations where the debtor loses all access to credit markets, it becomes impossible to refinance debts. This risk is referred to as liquidity risk.

2) Multiple Equilibria

The process of forming expectations that underlies the market’s assessments of debt sustainability may lead to multiple equilibria. The thought that debts are sustainable with high probability translates into a low interest rate that, in turn, makes full debt payment a more likely outcome. On the other hand, fears of unsustainable debt lead to higher borrowing costs that validate the perceptions of unsustainability.

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