Alphacast Debt Sustainability Analysis: Colombia

Contents:

- Introducing Debt Sustainability Analysis

- Example: Colombia

- Methodology

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Introducing Debt Sustainability Analysis

Alphacast has integrated into it's platform a Debt Sustainability Analysis (DSA) Tool. Basically, this tool can help you forecast the Debt/GDP ratio of a country, taking into account specific characteristics such as growth, inflation, interest rates on domestic and foreign debt, exchange rate depreciation and primary surplus. The tool also applies shocks to generate a fan-chart style chart so it can account for uncertainty into the forecasts (see Methodology for more information). It will take literally less than a minute to generate charts just like this one below. Click here for a detailed explanation on how to use our new tool. Read below some examples to illustrate how to use this tool to produce your own analysis.

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Example: Colombia

Over the past few years, Colombia has registered consecutive primary deficits and low growth rates. Recently, the government tried to reduce its primary deficit, so they could put public debt on a sustainable path again. Colombia's debt is primarily internal, although the country has sizable external liabilities as well, with about a third of total borrowing coming from international sources.

In our base scenario we assume that Colombian GDP will grow according to expectations, that is, at a constant 3% annual rate. For the GDP deflator growth, we keep it at 3.5% across the next decade. Regarding interest rates, we assume that the domestic debt rate will steadily decrease from 9% in 2023 to 8.1% in 2032, while the external rate shows a stable upward trend from 5.3% in the beginning of the period to 8.1% by the end. However, we suppose that the Treasury will be able to adjust fiscal policy and register fiscal balance.

With this set of assumptions, Colombia's Debt/GDP ratiowill show a small increase in the next decade. The base scenario (median of the distribution of results), the ratio's trajectory would be slightly ascendant, finishing at a rate moderately higher than the 2020 peak of 72% of GDP. However, as seen below, shocks to each component of the model may increase (or decrease) the Debt-to-GDP ratio in different directions - resulting in a higher or lower level based on the future behavior of the key variables involved.

The dynamics for each variable included in the DSA can be seen below. They include trajectories under shocks to the baseline scenario (quantile 50). The parameters of this simulation can be changed updated and running this pipeline.

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Methodology

Our Debt Sustainability Model uses the standard debt dynamic equation to generate forecasts for the Debt/GDP ratio throughout the next 10 years. Specifically, we use the following the equation:

In which:

$d_{t+1}$ is the ratio Debt/GDP for the t+1 period;

$\alpha$ is the share of foreign debt in relation to total debt;

$g_t$ is the real growth of GDP at the period t;

$\pi_t$ is the variation of the GDP deflator for the period t;

$\Delta\epsilon_t$ is the devaluation of the exchange rate between the local currency to the US dollar during the period t;

$i_{dt}$ is the implicit interest rate for the domestic debt, it is calculates as the ratio between the interest paid for the internal debt during the period t and the internal debt in the period t-1;

$i_{ft}$ is the implicit interest rate for the foreign debt, it is calculates as the ratio between the interest paid for the internal debt during the period t and the internal debt in the period t-1;

$pd_t$ is the primary deficit of the government during the period t.

We measure the public debt and the primary déficits according to the Non-financial Public Sector concept, but this might change according to the available statistic for each country.

We account for uncertainty by applying random shocks for each variable. These shocks are constructed by simulating a Multivariate Normal Distribution that uses as input the historical covariance matrix between those variables and their forecasts for the next 10 years. We simulate 2000 shocks for each each year and compute the quantiles of the Debt/GDP forecasts according to our DSA equation.

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