Debt Sustainability Analysis as if Development Really Mattered

To achieve the United Nations 2030 Sustainable Development Goals (SDGs) and avoid the catastrophic consequences of climate inaction, emerging market and developing countries (excluding China) need to mobilize a massive volume of investments, with estimates ranging between $3-4 trillion annually by 2030. However, not only is developing countries’ fiscal space constrained by the features of global economy, but these countries are also constantly needing to respond to external shocks like the COVID-19 pandemic, climate change, geopolitical instability and interest rate hikes in major high-income countries. To further complicate the situation, debt levels in EMDEs (excluding China) are at record heights.

Considering these asymmetries and the investment needed to address development and climate crises, do developing countries have sufficient capacity to mobilize the recommended levels of external financing for climate and social priorities without jeopardizing debt sustainability?

Debt sustainability analyses (DSAs) are a crucial tool to assess vulnerability to sovereign debt distress, and in case of debt restructuring, the amount of debt relief needed. However, the DSAs performed by the International Monetary Fund (IMF) have fallen short in several aspects, including the exclusion of climate and development financing commitments.

In a new journal article in Development, Marina Zucker-Marques, Kevin P. Gallagher and Ulrich Volz devise and perform a reformed global external DSA that identifies the level of external debt developing countries can withstand while mobilizing the necessary finance for development and responding to external shocks. They find that, once external debt for climate and development needs are considered, 46 out of 62 economically vulnerable developing countries would face solvency limits and another 16 would face significant liquidity constraints.

Key findings

• The enhanced DSA reveals that in 2022, a group of 16 countries exceeded solvency thresholds, including 10 low-income countries (LICs), six lower-middle income countries (LMICs) and three upper-middle income countries (UMICs).
• Under the baseline scenario – which assumes declining interest rates, revised upwards IMF-projected growth rates and the gradual accounting for SDG and climate-related external financing needs – an additional 23 countries will surpass solvency indicators.
• By 2028, 41 of the 62 countries in our study are projected to surpass solvency indicators, of which 18 are LICs, 18 LMICs and three UMICs.
• The present value-to-gross domestic product (GDP) indicator was breached more frequently than the present value-to-exports indicator (37 countries). However, both indicators were breached simultaneously in 17 countries. Only seven countries breached the present value-to-exports indicator without breaching the GDP-based indicator.
• Under a more severe stress scenario, a total of 46 of the 62 countries analyzed could potentially breach the prescribed thresholds for public and publicly guaranteed (PPG) external debt solvency.

Policy recommendations

• Countries facing solvency problems will need meaningful debt relief to clean their balance sheets and be able to invest in green and inclusive recoveries.
• Beyond reforming DSAs and improving debt relief mechanisms, mobilization of both concessional and affordable financing will be essential. Concessional financing, including grants and low-interest loans, should be scaled up to provide immediate support to developing countries.

The urgent need for reformed DSAs, substantial debt relief and enhanced global cooperation is evident. Without these critical measures, EMDEs face the risk of defaulting on both their debt obligations and their development goals.

This journal article is based on an April 2024 report titled, ‘Defaulting on Development and Climate: Debt Sustainability and the Race for the 2030 Agenda and Paris Agreement.’