# _External sector DSA Template_

Annex 3 provides a tour of the external DSA template. It points out several conceptual flaws in the formulas used to decompose the annual change in the external debt-to-GDP ratio into components attributable to the noninterest current account deficit, interest rates, growth rates and exchange rates. These flaws impede a clear understanding of debt dynamics. But even if these flaws are corrected, the added value of the external DSA to policy insight is close to zero because with limited private external borrowing, external debt in most LIC DSF countries is largely a subset of public debt.

Even if the LIC DSF is retained in its present form, three improvements should be made:

1. Make the external and public sector DSAs consistent by using nominal local currency GDP as the denominator in both cases and converting foreign currency-denominated debt into local currency using end-of-year exchange rates (see Annex 3).

2. Re-derive the difference equation for the ratio of external debt to GDP using the same framework as for public debt. This would make it easier to interpret the different components of “endogenous debt dynamics” while ensuring consistency with the components of “automatic debt dynamics” in the public sector DSA (see Annex 3).

3. In both DSA tables, external and public, include the currency composition of debt in addition to information now given on the PPG component of total external debt and the external component of public debt based on residency. This will make debt dynamics—in particular, the impact of exchange rate changes which are usually sizable in LICs—easier to assess.

The better alternative would be to radically overhaul the LIC DSF by focusing on the risks posed by the level and dynamics of nominal public debt using the standard framework of the primary deficit and (r-g), and moving away from the benchmarks for PPG external debt. The external DSA does not add additional insights from a policy perspective given the stylized fact: in LIC DSF countries the public sector is the main borrower externally with fiscal deficits driving current account deficits and therefore, external debt dynamics. The external DSA should be dropped and be replaced by a thorough analysis of international liquidity as outlined above.

# _Is Zambia an Exception?_

We now discuss briefly the case of Zambia. The September 2017 DSA using the old LIC DSF (IMF 2017a) rated external debt distress high, warned about public debt vulnerabilities and highlighted the need for urgent fiscal consolidation. A key factor was a massive increase in external debt of 63 percentage points of GDP in 2015 over 2014, _two-thirds of which was attributed to newly discovered private external borrowing_ .

The July 2019 DSA using the 2017 revision of the LIC DSF (IMF 2019) rated external and overall debt at high risk of debt distress and said explicitly that public debt was on an unsustainable path. It included non-guaranteed state-owned enterprise liabilities in the debt perimeter.

Can we therefore conclude that all is well with the 2017 LIC DSF? The answer is no, because by July 2019, unsustainability of public debt was painfully obvious. For 2019, d was projected at 94%, r (calculated by the formula in Annex 1) was 8.9% and g was 2%, with a primary surplus of 1.1%—well below the debt stabilizing primary surplus of more than 6% of GDP.

The World Bank-IMF team doing the DSA deserve credit for discovering the large amount of private external debt in 2017 and widening the debt perimeter in 2019. But the team would have done better 23