has its first impact on the public finances because natural resources tend to be state-owned. Therefore, a simultaneous widening of the fiscal and current account deficits would result. These shocks are common and need proper countercyclical fiscal policy to address (saving during booms and dissaving during busts). Moreover, the natural resource curse continues to be a serious problem, with wellconnected political elites benefiting the most from natural resource exports. Corruption, poor fiscal policy and lack of diversification may be more important than the ToT shock. Similarly, the effects of Fed tightening can be mitigated by governments that manage public resources well and have credible monetary policy.

Another set of exogenous shocks pertains to the COVID pandemic and climate change. How to address these is a more complicated matter, as these are non-economic shocks impacting LICs as innocent bystanders, for which suitable compensation via donor grants may need to be made.

# _Development and Debt Distress_

The World Bank’s primary goals are development and poverty reduction. The IMF’s primary goal is the avoidance of balance of payments (BoP) crises, although its LIC DSF website emphasizes the importance of meeting the SDGs while keeping external debt sustainable. It is fair to say that both institutions care deeply about development.

For organizations that care about development, is it sufficient to pay attention only to external debt distress? The answer is “No”, because the prime responsibility for achieving the SDGs is that of the government, making sustainable public finances and high-quality public spending essential. Unsustainable public finances have well-known and broad ramifications: macroeconomic collapse, a rise in country risk, higher uncertainty and an impaired climate for private investment. Public debt sustainability is the bedrock for economic growth and development.

Now suppose that you are an external creditor who cares only about being paid back. You would then care only about external debt distress. Can you assess external debt sustainability without paying attention to fiscal deficits and public debt sustainability and the related political economy? The answer is no, because these factors are prime determinants of country risk ratings, and the government and public sector are the main issuers of external debt. Besides, as outlined above, the logic flows from public debt dynamics (“cause”) to external debt dynamics (“symptom”).

To pursue this point further, could there be an instance of government domestic debt distress that has no impact on external debt? This is extremely unlikely because external creditors are likely to be holding some share of local currency government debt, such as T-bills, in addition to dollar-denominated external debt. But suppose they held only dollar-denominated debt and that the government, facing debt problems, decides to inflate away its local currency debt to preserve external borrowing access. Consider what might happen. First, the currency is likely to collapse and unless local revenues rise substantially, servicing dollar-denominated external debt will become difficult. Second, local currency debt is often short-term and, as the government seeks to roll it over, it will face much higher real interest rates. Third, domestic banks and pension funds which typically hold government local currency debt could go bust, forcing costly bailouts.

All this would feed into higher country risk and signal a fundamental fiscal problem that could lead to a collapse in the prices of externally issued, dollar-denominated debt in the secondary market, raising borrowing spreads and making rollovers difficult.

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