Low-income countries (LICs) have often struggled with large external debts. The IMF and the World Bank have developed a framework to help guide countries and donors in mobilizing the financing of LICs' development needs, while reducing the chances of an excessive build-up of debt in the future. The Debt Sustainability Framework (DSF) was introduced in April 2005 and is periodically reviewed. The current framework was approved by IMF and World Bank Executive Boards in September 2017 and has been implemented since July 2018.

Strategic approach to reach goals

The framework is designed to guide the borrowing decisions of LICs in a way that matches their financing needs with current and prospective repayment ability.

Under the DSF, debt sustainability analyses (DSAs) are required to be conducted regularly. These consist of: (i) an analysis of a country’s projected debt burden over the next 10 years and its vulnerability to economic and policy shocks—baseline and stress tests are calculated; and (ii) an assessment of the risk of external and overall debt distress , based on indicative debt burden thresholds and benchmark, respectively, that depend on the country’s macroeconomic framework and other country-specific information.

Assessing debt to avoid risks

The DSF analyzes both external and public sector debt. The framework focuses on the present value of debt obligations for comparability, as terms extended to LICs vary considerably and still carry concessionality. A 5 percent discount rate is used to calculate the present value of external debt.

To assess debt sustainability, debt burden indicators are compared to indicative thresholds over a projection period. There are four ratings for the risk of external public debt distress:

• low risk, generally when all the debt burden indicators are below the thresholds in both baseline and stress tests;
• moderate risk, generally when debt burden indicators are below the thresholds in the baseline scenario, but stress tests indicate that thresholds could be breached if there are external shocks or abrupt changes in macroeconomic policies;
• high risk, generally when one or more thresholds are breached under the baseline scenario, but the country does not currently face any repayment difficulties; or
• in debt distress, when the country is already experiencing difficulties in servicing its debt, as evidenced, for example, by the existence of arrears, ongoing or impending debt restructuring, or indications of a high probability of a future debt distress event (e.g., debt and debt service indicators show large near-term breaches or significant or sustained breach of thresholds).

To flag countries with significant public domestic debt, the framework provides a signal for the overall risk of public debt distress, which is based on the joint information from the four external debt burden indicators, plus the indicator for the present value of public debt-to-GDP ratio.

Countries with different policy and institutional strengths, macroeconomic performance, and buffers to absorb shocks, have different abilities to handle debt. The DSF, therefore, classifies countries into one of three debt-carrying capacity categories (strong, medium, and weak), using a composite indicator, which draws on the country’s historical performance and outlook for real growth, reserves coverage, remittance inflows, and the state of the global environment in addition to the World Bank's Country Policy and Institutional Assessment (CPIA) index. Different indicative thresholds for debt burdens are used depending on the country’s debt-carrying capacity.

Thresholds corresponding to strong performers are highest, indicating that countries with good macroeconomic performance and policies, can generally handle greater debt accumulation. […]