In addition, the text of the DSA should include historical time series on the key variables driving debt dynamics, including the ratio of the primary deficit to GDP, pd, the composite real interest rate, rc, and its L and FX components, growth rates, and a discussion of contingent liabilities. Further, the simulations going forward to assess debt sustainability risks should be based on the stochastic properties of these variables. Also, if residuals have been historically high, some explanation needs to be provided; at present, there is none.

Suppose the ratio of debt to GDP, d, is above 60%, pd>0 and rc>g based on recent history. Then based on EM crisis experience, it is likely that d is on an unsustainable trajectory with high probability. This would call for lowering pd, reducing external borrowing if the FX component of rc is high and volatile, and focusing on better spending composition and domestic resource mobilization. Further, if local real interest rates are high, then there is serious risk of crowding out private investment. Such “corrective policy” issues are typically included in IMF reports; but placing them in the context described above would enhance the urgency and provide early warning.

We contrast a DSA for Japan with one for Sri Lanka and then make recommendations on improving the DSA template to fit the EM debt context better. This is followed with suggestions on improving the nearterm risk assessment and medium-term projection modules.

Section II discusses the new MAC SRDSF DSA template. Section III provides a reality check by contrasting the DSAs for Japan, an AE whose government borrows only in its local, currency, and Sri Lanka, an EM whose government borrows both in its local and foreign currencies. The differences prove significant. Section IV outlines how the DSA template could be usefully modified for gauging the underlying drivers of debt sustainability in EMs. It also discusses risk assessment in the MAC SRDSF and makes suggestions on how this could be better aligned with our preferred template. Section V summarizes the main recommendations.

# **II. Sovereign Risk and Debt Sustainability Framework (SRDSF)—IMF’s 2023 MAC DSA Template**

<mark>The application of the new MAC SRDSF DSA template began in 2023—for example, the public sector DSA for India issued in December 2022 (IMF 2022) uses the old template. But the DSAs for Japan and Sri Lanka issued in 2023 are based on the new template. Hence, we refer to the new MAC SRDSF template as the “2023 MAC DSA” template.</mark>

# _Derivation of difference equation for public debt-to-GDP ratio_

<mark>Box 3, pp 29-31, in IMF (2022) derives the difference equation for the public debt-to-GDP ratio underlying the 2023 DSA template. We rederive this equation in a simpler manner with the goal of acquainting the reader with the underlying formulas. In section III, we discuss desirable modifications in the template for EMs based on a comparison of Japan, an AE, and Sri Lanka, an EM.</mark> Let D be nominal public debt at the end of the year and Y for GDP during that year, both in local currency, with d representing the debt ratio, D/Y. The change in d from year-to-year, , can be broken down into the following different components, all as percentages of GDP: tt tt−1 dd −dd

1. Primary fiscal deficit (non-interest expenditure minus total revenue)

2. Contribution from real interest rate 3. Contribution from real GDP growth rate 4. Contribution from exchange rate changes 4. Contribution from exchange rate changes 5. Other factors such as privatization revenue (decrease in debt) or contingent liabilities (increase) 6. A residual term equal to minus the sum of 1 to 5 above, which add up to the “identified debt creating flows”. IMF (2022) calls the residual the “stock-flow adjustment” or SFA, tt tt−1 to capture “all other effects”. dd −dd 5. Other factors such as privatization revenue (decrease in debt) or contingent liabilities (increase)

- to capture “all other effects”.

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