<mark>rate is overvalued is important both from the current account balance and balance sheet currency mismatch perspective, but this will be reflected in projections of the nominal exchange rate.</mark> <mark>Lastly, liquidity is assessed in terms of gross financing requirements (GFN), or the sum of the fiscal deficit and maturing principal. For EMs, including international liquidity would be helpful because a shortage of foreign exchange reserves combined with a negative shock could accentuate rollover problems. The socalled May 2013 “taper tantrum” is a case in point. Mere mention that the US Fed was poised to begin reducing asset purchases under its quantitative easing program led to a selloff in US government bonds with contagion spreading to EMs. Five large EMs were judged particularly vulnerable by the markets at that time, based on high ratios of the sum of the current account deficit plus short-term external debt (original maturity less than a year plus maturing principal of long-term debt) to foreign exchange reserves.</mark><sup>9</sup> <mark>Another important aspect of liquidity pertains to the average maturity of debt, which is likely to be much shorter in EMs, giving less time to adjust to a shock.</mark> Blanchard, Felman and Subramanian (BFS 2021) point out that EMs must raise primary surpluses faster than AEs in response to a rise in borrowing costs because their debt has shorter maturity. Hence, a rise in marginal borrowing cost feeds into the average interest rate, on which debt dynamics depend, faster. More generally, BFS make a strong case that EMs have less fiscal policy space than AEs for various reasons, including weaker fiscal and monetary policy institutions, smaller governments relative to GDP—calling for a proportionally larger budget adjustment for a given reduction in the primary deficit as a percentage of GDP—and greater risk from contingent liabilities.

# **V. Summary of Recommendations**

EM governments typically borrow both in local and foreign currencies, are more vulnerable to sovereign debt crises and have less fiscal and monetary policy space than their AE counterparts. It would therefore make sense to have a separate DSF and DSA template for EMs. It would also be worthwhile to explore a common template for EMs and LICs given the shift to market borrowings in LICs with market sentiment now playing a big role in their debt sustainability, as set out in Gill and Pinto (2023).

The main modification we recommend in the 2023 DSA template from the EM perspective is to include the calculation of a composite real interest rate broken down into its local and foreign currency components to enable a better understanding of debt dynamics based on primary deficits and (r-g), and guide borrowing costs.

In addition, the DSA should include historical time series on primary deficits, the composite real interest rate and its local and foreign currency components, growth rates, and a discussion of contingent liabilities. If residuals have been historically high, some explanation should be provided. Lastly, the simulations going forward should be based on the stochastic properties of these variables and the comparator countries for cross-checks should be restricted to EMs.

> 9 These EMs were <mark>Brazil, India, Indonesia, Türkiye, and South Africa.</mark>

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