Making the Low-Income Country Debt Sustainability Framework Fit for Purpose

The World Bank and the International Monetary Fund use the Low-Income Country Debt Sustainability Framework to assess the sustainability of sovereign debt in about 75 low- and middle-income developing countries. It is overdue for a review, and this paper recommends that it be replaced for three reasons. First, it was designed when official concessional external debt was virtually synonymous with public debt. Over the past decade, however, the marginal cost of borrowing for Low-Income Country Debt Sustainability Framework countries has been defined increasingly by domestic and external debt markets. This has rendered the framework largely obsolete. Second, the framework focuses mainly on external debt, but development outcomes in the framework countries are more closely related to overall public debt. The mission of the World Bank—and, increasingly, the International Monetary Fund—is to improve growth, stability and living standards. So public debt ought to be the principal focus of the revised Low-Income Country Debt Sustainability Framework. Third, causality in the framework countries flows from fiscal deficits to current account deficits rather than the other way around, and the public component constitutes the lion’s share of total external debt. To focus on external debt distress in these circumstances is tantamount to tackling the symptom—accumulated current-account deficits—instead of the fundamental cause: fiscal deficits, or the gap between government investment and saving. The experiences of Ethiopia, Ghana and Zambia illustrate the arguments. The paper recommends a framework based on nominal public debt and its dynamics, supplemented with a thorough analysis of international liquidity. Discarding the Low-Income Country Debt Sustainability Framework could well be disruptive in the short run. However, the alternative would be worse: retaining an obsolete framework that has failed to anticipate public debt crises and is poorly aligned with the Sustainable Development Goals.