The bottom line is that it is nearly impossible to compartmentalize the risks from local currency domestic debt and dollar-denominated external debt. Even external creditors who do not care about development will be forced to pay attention to public debt and its dynamics out of self-interest.

Given this, for the LIC DSF to continue focusing on external debt distress, the IMF and World Bank must demonstrate that causality in LICs flows from external debt to public debt—that an unsustainable public debt trajectory is _caused_ by an unsustainable external debt trajectory—and then spell out the corrective policies. This is a tall order. Alternatively, one would need to make the case that instability in external debt dynamics is being driven by the private sector rather than the public sector, once again unlikely because of the small amounts of private external borrowing in LICs.

This points to giving nominal public debt and its dynamics primacy in the LIC DSF. It also points to the need for a consistent analysis across public debt and external debt. As we shall see in the next section, this is not the case. Further, the formulas in the external DSA template are riddled with conceptual problems, making the output hard to interpret.

# **7. A Technical Appraisal of the LIC DSF Template**

Two main tables are included in DSAs using the LIC DSF: one presenting the DSA for total external debt, public plus private; and a table presenting the DSA for total public debt. We start with the latter.

# _Public Sector DSA Template_

The DSA for public debt breaks down the annual change in the public debt-to-GDP ratio into components attributable to primary fiscal deficits, interest rates, growth rates and exchange rates, as well as factors such as privatization receipts (debt is reduced) and contingent liabilities (debt is increased). There is also a residual term: the difference between the actual increase in the debt-to-GDP ratio and that “predicted” by the above factors.

This is a useful framework, but it should be improved in four ways.

- First, _the public sector DSA should report debt on a currency, and not residency, basis_ . Public sector DSAs using the 2017 framework report debt on a residency basis (domestic lenders versus nonresident lenders) rather than by currency on the argument that this enables a better understanding of vulnerability to a crisis. This is a step backwards because it impedes a clear picture of debt dynamics, in particular the transmission of currency depreciation via foreign currency-denominated debt. Vulnerability to a BoP crisis is a valid concern, based on the idea that nonresidents holding local currency debt, such as T-bills, may be the first to head to the exits and cause a currency collapse. But this vulnerability should be assessed as a separate exercise in foreign exchange reserve adequacy given current account deficits and total shortterm external debt, which would include nonresident holdings of local currency T-bills. This step backwards in the 2017 revision needs to be reversed and the public sector DSA should report debt on a currency basis.<sup>10</sup>

- Second, _in addition to the decomposition of the annual change in the public debt-to-GDP ratio into the components listed above, an assessment of debt dynamics based on the primary deficit and (r-g) is necessary for timely warnings about impending unsustainability._ Further,

> 10 Recall Note 2 to Table 4 above on Ghana, where the foreign currency share of public debt had to be reverseengineered to decompose the real interest rate into its local and foreign currency components.

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