# **Box 1. Assumptions Underlying Debt Sustainability Projections**

The **initial level of the state government debt** is 27.8% of GSDP, its level at the end of 2003/04.

The **primary deficit** of the state government would deteriorate from 0.3% of GSDP in 2004/05 to 0.5% of GSDP in 2005/06, after which it will gradually improve to 0.1% of GSDP in 2006/07, turning into a surplus of 0.5% of GSDP in 2007/08 and widening this surplus to 0.8% of GSDP in 2008/09. It is assumed that the surplus will stay at 0.5% of GSDP thereafter.

The **real interest rate** of 5.5% comes from the macroeconomic projections of the World Bank’s Indian Development Policy Review (World Bank 2004c) report. After 2007/08 the real interest rate declines to 5% and stays at this rate thereafter.

The **inflation rate** is assumed to remain at 5% on the basis of the macroeconomic projections of the World Bank’s Indian Development Policy Review (World Bank 2004c) report.

The **real economic growth rate of the state** is assumed to be 8.5%, 6.5%, 6.0% for years 2004/05 through 2006/07 and staying at 6% for six more years, then gradually declining to 4.5% in 2021/22 and staying at this rate thereafter.

_Note:_ Nominal interest rate is calculated as: r_n= (1+r_r)(1+pi)-1, where pi is inflation, r_r is real interest rate.

**Table 3. Baseline Simulation with Fiscal Reform as Proposed in the MTFP**

|**Assumptions* **|2003|2004|2005|2006|2007|2008|2009|2010|2011|2012|2013|2014|
|---|---|---|---|---|---|---|---|---|---|---|---|---|
|Real interest rate (_r_)||5.5|5.5|5.5|5.5|5.0|5.0|5.0|5.0|5.0|5.0|5.0|
|Real growth rate (_g_)||8.5|6.5|6.0|6.0|6.0|6.0|6.0|6.0|6.0|5.8|5.7|
|Primary surplus (_x_)||-0.3|-0.5|-0.1|0.5|0.8|0.5|0.5|0.5|0.5|0.5|0.5|
|**Debt dynamics****|||||||||||||
|Debt(% ofGSDP) (_b_|)27.8|27.3|27.5|27.5|26.9|25.8|25.1|24.4|23.7|23.0|22.3|21.7|
||2015|2016|2017|2018|2019|2020|2021|2022|2023|2024|2025|2026|
|Real interest rate (_r_)|5.0|5.0|5.0|5.0|5.0|5.0|5.0|5.0|5.0|5.0|5.0|5.0|
|Real growth rate (_g_)|5.5|5.3|5.2|5.0|4.8|4.7|4.5|4.5|4.5|4.5|4.5|4.5|
|Primary surplus (_x_)|0.5|0.5|0.5|0.5|0.5|0.5|0.5|0.5|0.5|0.5|0.5|0.5|
|**Debt dynamics****|||||||||||||
|Debt(% of GSDP) (_b_|)21.1|20.5|20.0|19.5|19.0|18.6|18.2|17.8|17.4|17.0|16.6|16.2|

*Assumptions on interest and inflation rates are based on the World Bank projections in the India Development Policy Review (World Bank 2004c).  The assumptions on growth and the primary balance are based on the government of Tamil Nadu MTFP and, after 2009, authors’ estimates.

** Source: Authors’ simulation based on equation (4). Note: The years shown in the table denote fiscal years, e.g., 2003 stands for fiscal year 2003/04.

# **_4.2 Sensitivity analysis_**

One of the main shortcomings of the simple analytical models for assessing fiscal sustainability in general is that they seldom take into account the effects of uncertainty. Most of the fiscal sustainability studies use modeling frameworks without uncertainty (Burnside 2004). This can introduce bias in the policy recommendations. For instance, one might conclude that a policy is sustainable or not, but little is said about the probability with which a government might become insolvent or the risks to fiscal sustainability.

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