WPS4170 The "How to" of Fiscal Sustainability A Technical Manual for Using the Fiscal Sustainability Tool1 Luca Bandiera, Nina Budina, Michel Klijn and Sweder van Wijnbergen2 Abstract Fiscal sustainability analysis is an important component of macroeconomic analysis for many developing countries. To further enhance understanding of fiscal policy and the constraints faced by policy makers, we develop a toolkit for fiscal sustainability analysis (FSA) in middle-income countries, which builds on previous work in this area and on new developments in dealing with uncertainty. The FSA toolkit includes an excel-based FSA tool and a technical manual accompanying it. The FSA tool is standardized and simple, but at the same time flexible enough to allow for user-defined country specifics. This manual provides step-by-step technical instructions for running the FSA tool, and includes mathematical appendices and a glossary. World Bank Policy Research Working Paper 4170, March 2007 The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent. Policy Research Working Papers are available online at http://econ.worldbank.org. 1A companion background paper, published as WPS 4169 surveys various FS approaches that have been incorporated in the FS tool and presents an application of this tool for Turkey. 2First and second author: World Bank, Washington DC, USA, third author: HEAS BV, Netherlands, fourth author: University of Amsterdam, Netherlands. Table of Contents 1. Structure of the Fiscal Sustainability Tool.................................................................................... 4 2. The Instruction Sheet.................................................................................................................... 5 2.1 Configuring the FS tool: the Options Menu ......................................................................6 2.2 Importing new data: Import Data menu.............................................................................7 2.3. The Stochastic Simulations menu......................................................................................9 3. The Input Sheet........................................................................................................................... 13 4. The Seigniorage Sheet and Steady State Fiscal Consistency Approach (as in Anand and van Wijnbergen) ........................................................................................................................................ 19 5. The Base Case Scenario Sheet.................................................................................................... 22 5.1. Dynamic Forward-Looking Debt Simulation..................................................................22 5.2. Dynamic Consistency Measure........................................................................................23 5.3. Additional Outputs...........................................................................................................23 5.4. Oil Rich Country Base Case Scenario Sheet ...................................................................26 6. The Alternative Scenario Sheets................................................................................................. 29 7. The Bounds Test Sheets.............................................................................................................. 40 8. Summary of Output..................................................................................................................... 48 References........................................................................................................................................... 51 Glossary .............................................................................................................................................. 53 Appendix A.1: Derivation of Public Debt Decomposition Dynamics................................................ 66 A.1.1 Set of Variables............................................................................................................... 66 A.1.2 Public Debt Decomposition Equation............................................................................. 67 A.1.3 Public Debt Decomposition in Oil Rich Countries......................................................... 68 A.1.4 Inflation and seigniorage formulas ................................................................................. 70 Appendix A.2 Multivariate Stochastic Simulations............................................................................ 71 Tables Table 1. Component of the change in public net debt to GDP ratio....................................................23 Table 2. Output of the sheet "Table_SR" ............................................................................................25 Table 3. Component of the change in public net debt to GDP ratio for ORC.....................................27 Table 4. Output of the Sheet "Table_SR_Oil".....................................................................................28 Table 5. "A1_historical" sheet.............................................................................................................30 Table 6. Output Table of the Alternative Scenario..............................................................................35 Table 7. Output Table of the No Policy Change Scenario...................................................................37 Table 8. Output Table of the Low Oil Price Scenario .........................................................................39 Table 9. Real Interest Rate Bound Test. ..............................................................................................42 Table 10. Real GDP Bound Test..........................................................................................................43 Table 11. Primary Balance Bound Test...............................................................................................44 Table 12. Combined Bound Test .........................................................................................................45 Table 13. Nominal Exchange Rate Depreciation.................................................................................46 Table 14. Contingent Liabilities Shock ...............................................................................................47 2 Figures Figure 1. A Stylized Presentation of the FS Tool for MICs ..................................................................4 Figure 2. Input Sheet: Baseline............................................................................................................14 Figure 3. Input Sheet: Oil Revenues and Prices ..................................................................................16 Figure 4. Seigniorage Sheet.................................................................................................................20 Figure 5. Required Deficit Reduction..................................................................................................21 Figure 6. Inflation Maximizing Seigniorage........................................................................................21 Figure 7. Macroeconomic and Debt Data Input for the Alternative Scenario.....................................31 Figure 8. Assumptions for the Alternative Scenario............................................................................32 Figure 9: Oil Revenues and Prices.......................................................................................................32 Figure 10. External Debt Management for the Alternative Scenario ..................................................33 Figure 11. Input Sheet for No Policy-Change Scenario ......................................................................36 Figure 12. Input Sheet for Market Forecast Scenario..........................................................................38 Figure 13. Representation of Alternative Scenarios and Bound Tests ................................................48 Figure 14. Debt Ratios and Gross Financing Needs............................................................................49 Figure 15. Stochastic Simulations of Net Public Debt and Required Deficit Reduction ....................50 3 1. Structure of the Fiscal Sustainability Tool This manual gives a technical description and instruction for running the Fiscal Sustainability Analysis (FSA) template. First, it presents all the model blocks. Second, it lists all the data requirements to implement the model. Third, it gives detailed instructions on how to run the model and how to perform stochastic simulations and various stress tests. Finally, this note also gives some guidance on how to read output tables and graphs. Figure 1. A Stylized Presentation of the FSA Template for MICs Instruction Sheet 2. Country settings 1. Country characteristics: 3. Features of the analysis a. Country selections a. Oil-rich/Non Oil a. Fiscal reaction function b. Period of analysis b. Net/gross domestic b. Stochastic simulations c. Data imports debt Input sheet 1. Data Inputs for baseline net debt decomposition 2. Additional assumptions for alternative scenarios Steady state consistency Dynamic simulations 1. Seigniorage revenue and base 1. Baseline debt decomposition money projections 2. Alternative scenarios 2. Required deficit reduction 3. Bounds tests 4. Stochastic simulations Stochastic simulations Scenario analysis 1) Debt ratios 1) Debt ratios 2) Required deficit 2) Required deficit reduction reduction 3) Gross financing needs Output Output Output 1) Seigniorage chart Fan charts of: 1. Table baseline, Alternative 2) Required deficit 1) Public debt Scenarios and Bounds Tests reduction chart 2) Required deficit 2. Table Gross fin. needs reduction 3. Summary graphs 4 The template has 6 sections: i) the instruction sheet to select the country and various options to perform the analysis, ii) the input sheet, iii) the seigniorage sheet containing the base money and seigniorage projections, iv) a baseline scenario sheet for the calculation of the baseline debt decomposition, v) build-in sheets for three types of alternative scenarios and five standardized bound tests and a sheet to perform stochastic simulations, and vi) four output sheets containing summary tables and graphs of all scenarios and fan charts for stochastic simulations (Figure1). As the model enforces consistency between different parts, the user should never change formulas. Doing so may introduce inconsistencies. In what follows we discuss the model block by block. 2. The Instruction Sheet The instruction sheet contains three buttons that will help the user with configuring the workbook, importing data, selecting different features of the analysis and making fan charts. In addition to the buttons there is also a "sheet control panel" which allows the user to manage the hidden/visible sheets and enable functions for oil rich countries. The settings configured and the data imported by the buttons are stored in the "input_fiscal" sheet and are used to configure automatically all working and output sheets. Not all data might have been imported successfully by using these buttons; for example Life Databases (LDB) variables might have missing values. Therefore, after completing the menus in the instructions sheet, the "input_fiscal" sheet needs to be carefully checked for missing values. Once "input_fiscal" is filled in correctly, the baseline and stress test results are automatically calibrated and summarized in the output tables in sheets "Table_SR" (debt ratios) and "Table_GF" (gross financing need). The panel chart in sheet "Figure" is automatically populated. If stochastic simulations are run, fan charts are also created. 5 2.1 Configuring the FS tool: the Options Menu To configure the workbook, parameters and other input values need to be set through the "options" menu. All settings will be stored in the "input_fiscal" sheet and affect the entire workbook. The values are transferred through formula linkages. As the model enforces consistency between different parts, the user should never change formulas or add/delete columns/rows. Step by step walkthrough Step 1: Getting started 1 To start the options menu click on the button that is located in the instruction sheet. Step 2: Configuring the options a. Select a country from the combo box pull- 2 down list which contains all Middle Income Countries. b. Choose the definition of domestic debt by selecting one of the two radio buttons. Gross debt excludes the Central Bank from the definition of the public sector, and does not account for its holdings of public debt. If the option "net debt" is chosen, the Central Bank is included in the definition of the public sector and the debt stock nets out the Central Bank's net holdings of Government debt. The tool of analysis requires that interest payments be consistent with the definition of gross (net) domestic debt to calculate the correct nominal and real domestic interest rate (see section 3. The Input Sheet, point 7 for a more detailed description). c. The historical and projections periods are automatically set throughout the template by specifying the first year of projections. The tool of analysis requires 10 years of historical data and 5 years of projections. d. The fiscal reaction function characterizes the fiscal behaviour of the government. The tool for FSA allows for an endogenous fiscal policy response of the primary balance to past public debt developments. If the fiscal reaction function option is switched on it will affect the stochastic simulations and all the alternative scenarios and bound tests. The policy reaction function is defined as pdt = pdt - (bt - bt ) i i -1 -1 With pdi as the fiscal deficit in percent of GDP in the i-th scenario, which differs from the primary deficit pd for a fraction of the additional debt to GDP ratio bi in the i-th scenario in period t-1 with respect to the debt to GDP ratio b in the baseline scenario in period t-1. The magnitude of the 6 plausible fiscal adjustment is country specific and depends not only on the outstanding public debt or the cyclical fluctuations of the output with respect to its potential trend, but also on the quality of policies and institutions. The user should determine separately the size of the adjustment and use the FSA tool to obtain consistent results over the projection period. A normal value for the adjustment coefficient would be between 0 and the real interest rate, such that the primary deficit would be reduced to pay at least some of the additional real interest burden. Such a value guarantees solvency. The default value for is 0. 2.2 Importing new data: Import Data menu Step by step walkthrough Step 1: Getting started 1 To start the input selection menu click on the "import data" button that's located in the instructions sheet. Step 2: Configuring the year range 2 The default value for the first year of projections is the year earlier configured in the settings menu. If needed, change the first year of the projection period to adjust the year range. This causes all years in the entire workbook to update. Press next. 3 Step 3: Input selection The tools can be populated in three alternative ways: 1. To use data from a LDB excel file turn on "use LDB excel" radio button and press browse to select a valid LDB file. Please refer to the LDB excel file section below. 2. To connect to the LDB web service turn on "Connect to Live Data Base" radio button and press okay. Please refer to Live database web service below. 3. To populate the input sheet manually from a user defined file, turn on the "manual input" radio button and press okay. This will close the window and activate the "Input_fiscal" sheet, where all cells marked in yellow need to be filled. 7 2.2.1 Populating the template from an LDB Excel file 1 Step 1: Locating a valid LDB file. After pressing browse a dialog box will popup to help you locate your LDB excel file. Select the desired file and press ok. 2 Step 2: Confirming the choice If the file is a valid LDB file a dialog box will display a content summary. Check the summary and confirm if this is the right file by pressing "yes" or "no". If yes is selected, the"input selection" dialog box 1 will show the path of the selected file, press OK to import data from the selected file. If no, select the correct file. 2.2.2. Populating the template from the LDB web service 1 Step1: Confirming the country setting The country configured in the options menu is already selected from the pull-down combo box as default value. Change the setting if needed and press the "Go!" button to retrieve country fiscal data from LDB web service. Note that the computer must be connected to the World Bank intranet to access the LDB web service. 2.2.3. The LDBd worksheet After collecting data from LDB web service or LDB file the program switches to the "LDBd" sheet and populates it. This is not the "Input_fiscal" sheet where imported data eventually are inserted, but a temporary sheet to check the data that have been imported from the selected source. Depending on data availability in the selected source, time codes or time code values per year may be missing. The Import Data program will display the missing time codes in a dialog box. 8 Rows correspondents to the missing time codes are set in red to indicate missing values. If the time code is available, the value for each year will be imported from the selected source even if this is not the correct value. Therefore all data needs to be carefully checked before copying it to the "Input_fiscal" sheet. Once data are checked, to import them into the "Input_fiscal" sheet press the button. To change the first year of projection or import data from a different data source press the button to start over. 2.3. The Stochastic Simulations menu This menu is used to configure stochastic simulations of the public debt to GDP ratios over the 5-year projection period and to represent the outcome with a fan chart. The simulator generates random realizations for the four variables determining the effects of interest rates and growth on the debt ratios: the real exchange rate (% change), the real domestic interest rate (%), the real foreign interest rate (%) and the real growth rate (% change). Each of these variables is assumed to be normally distributed with mean and variance defined by the user. The number of simulations is set at 500 but accurate results require at least 5000 simulations. The start year value is set as the first year of projections in the "Input_fiscal" sheet3. All parameters, input values and data generated in this menu will be stored in the following sheets: "StochSim, RDRim, Simout, SIM PSD Sheets". If they are needed in another sheet, the values are transferred through formula linkages. As the model enforces consistency between different parts, the user should never change formulas or add columns/rows. 2.3.1 Step by step walkthrough Step 1: Open the Stochastic Simulations menu. To start the stochastic simulations menu click on "Run Stoch Sim" button in the instructions sheet. A dialog box will pop up. 1 Step 2: Define the output variables. Select which output variable you want to see reported by 2 turning on the respective radio button: 1) RDR (for "Required Deficit Reduction"); or 2) PSD (for "Public Sector Debt"). 3In the next release, the user will be able of selecting the length of the simulation period. 9 The first option, RDR, lists for each year the deficit reduction required to maintain the public debt to GDP ratio at the value it had in the beginning of that year. The second option, PSD, lists the ratio of public sector debt to GDP in each year. Either one or both options can be chosen in sequence. Step 3: Define the distribution parameters of the random variables. The user can assume the random variables as independently distributed or specify a joint probability function. 3 3.1) Independent variables. Distributions of all four random variables need to be configured by entering values for the average mu and the standard deviation sigma that will be used in the simulation period. The default value for each mu is the average over the 5-year projection period of the baseline located in the "Table" sheet. The default value for the sigma is the 10-year historical standard deviation also located in the "Table" sheet. The StochSim macro (i) generates random numbers with a uniform distribution over the range [0,1], (ii) applies an inverse normal cumulative distribution to transform these random numbers in normally distributed realizations with mean 0 and variance 1. (iii) Then the variables are multiplied by their respective values for sigma, and mu is added, transforming them in normal variates with mean mu(i) and sd sigma(i) for all four values of i. 3.2. Variables with a joint distribution. The user also has the option to supply a full covariance matrix with off- diagonal elements representing covariances between the variables. The matrix is activated by clicking on "Use matrix" at the bottom of the "Randomize" panel. The program then applies a Cholesky decomposition to the covariance matrix and uses the resulting Cholesky matrix to generate 4 random variables with the same covariance matrix as the one supplied by the user, introducing dependence between the four variables (see annex A.2 for details). By default the covariances are zero so that the variables are independent. Step 4: Setting the length of the simulation period. 4 Currently not active, the simulation 4 period is 6 years, starting from the first year of projections as defined in the 5 "Input_fiscal" sheet. 5 Step 5: Setting the number of random simulations. The simulation takes about one minute per 1000 runs depending on the speed of the computer. The number of simulations is set at 500 but accurate results require at least 5000 simulations. 10 Step 6. Starting the simulations. Now to start the stochastic simulation press "Next". 6 2.3.2. The Fan Chart After the StochSim macro has generated the distribution(s) of the selected output variable(s), the fan chart will show the distribution of the output variables graphically. Step by step walkthrough Step 1: Defining the percentile. The top and bottom lines of the fan chart represent 2.5 percentiles; i.e. the area between the top and bottom lines contains the middle 95% of the values generated in each period by the stochastic simulations. 1 Other percentiles can be chosen by the user by entering them consecutively in ascending order in the top-left box and pushing the enter button . Note that the percentiles must be in ascending order (e.g. 5, 10, 25) and must be larger than 2.5 and smaller than 50. The graph will show both the upper percentiles and the corresponding lower percentiles (hence the requirement to enter numbers lower than 50). The percentiles are not cumulative; so 10 represents the top 10th percentile, 25 the top 25th percentile, etc. Step 2: Producing the fan chart. When all chart areas are defined, press the "Make fan chart" button that will automatically switch to the "Graph DSP 2 SIM" sheet where the fan charts and chart tables are reported. Step 3: Interpreting the fan charts. Multiple fan charts can be produced to use all the options of the FSA tool. The fan charts and chart tables are added after the last used column in sheet "Graph DSP SIM" as shown. The fan charts report the baseline projections of public debt or required deficit reduction in percent of GDP with a white line. The results of the stochastic simulations are shown according to the percentiles selected in , in the shaded areas. 1 11 4 3 Step 4: Content of the chart tables. The chart tables report the number of simulations (top left in row 1), the average values Mu and the standard deviation Sigma (rows 1 to 4) used to parameterise the distribution of the 4 stochastic variables, the bottom 2.5 percentile, and the values of the selected percentiles as difference from the bottom percentile (from row 6). The last line of data reports the baseline projections. If the fiscal reaction function option is selected, the chart tables report also the alternative scenarios and bound tests affected by the selection of the fiscal reaction function. The content of the chart table is reported in the table below. Number of ê-Mu g-Mu simulations ê-Sigma g-Sigma r*-Mu r-Mu r*-Sigma r-Sigma Last First year Second Third Fourth Fifth historical of year projection Lowest Lowest Lowest Lowest Lowest Lowest num num num num num num Block nth Block Block Block Block Block percentile bottom bottom bottom bottom bottom Block central Block Block Block Block Block percentile centre centre centre centre centre Block 100-nth Block Top Block Top Block Top Block Top Block Top percentile Baseline Baseline Baseline Baseline Baseline baseline 12 3. The Input Sheet The input sheet includes all the debt, macroeconomic data and assumptions needed to use the template (Figure 2). Parameters and imported or copied data are stored only in the input sheet. If they are needed in another sheet, the values are transferred through formula linkages. Refer to Section 2. The Instruction Sheet for information on how to set parameters and import data. Once "input_fiscal" is filled in correctly, the baseline and stress test results are automatically calibrated and summarized in the output tables in sheets "Table_SR" (debt ratios) and "Table_GF" (gross financing need). If stochastic simulations are enabled the default values of the average and standard deviation of the random variables are defined. If the fiscal reaction function is enabled, the stochastic simulations and all stress tests are consistent with the automatic fiscal rule. In general, the implementation of this model requires 10 years of historical data as well as 5 years of projections for key macroeconomic indicators that are used in the FS template. However, in environments with sparse data, a shorter period of actual data could be accommodated (e.g. 5 years). Regarding macroeconomic projections, this model can be used in conjunction with a macro projection framework, or alternatively, could be populated using the live data base of the Bank. The implementation of this model requires projections for all variables listed in below, except for the public debt stock, which is derived from public debt dynamics used in the FSA template. However, since we recognize that for many market access countries foreign borrowing maybe rationed by the markets, we allow the user to enter country-specific assumptions for allowable foreign borrowing, derived from any macroprojection framework. Since the change in public debt is derived from the public debt dynamics equation and the external foreign currency debt path is predetermined, the time path for domestic public debt is derived as a residual. For all variables the following information is to be provided: 1) Unit of measurement: national currency, U.S. dollar, index number in column A 2) Scale: billions, millions, percent in column B 3) Database: source of data (LDB, GDF, other sources) in column C 4) Series Code, in case data are from a database in column D 5) Descriptor: eg. "External debt stock", in column E 6) Notes in column F. Data requirements which need to be filled in the input sheet are divided in 6 main blocks (Figure 2): 1) Debt stock and debt service data 2) Fiscal data 3) GDP, prices and exchange rates 4) Monetary data 5) Other factors 6) Assumptions for baseline projections For oil reach countries (ORCs), the FSA tool includes an additional block for oil revenues and prices. 13 Figure 2. Input Sheet: Baseline 1) Debt stock and debt service data Cell range G4:X12, Fig. 1. Debt data include: · Gross total public debt, defined as the sum of gross external and gross domestic debt for the past 10 (5) years and if available projections for the external public debt. Debt stocks are usually reported at the end of each calendar year. · Gross or net domestic public debt, defined as gross domestic debt held by the public and the banking system, net of the central bank's holdings of treasury debt. · Debt service data refer to interest payments and amortization of foreign and domestic public debt for the past 10 (5) years. · Holding of government securities by the central bank. · Short-term public sector debt. 14 2) Fiscal data Cell range G15:X19, Fig. 1 Fiscal data refer to the appropriate coverage of the public sector: total revenues and grants, total expenditure, interest expenditure and the overall balance. Interest payments on domestic debt have to be consistent with the adopted definition of domestic debt. See point 7 below for a discussion of how the FSA tool accommodates both a gross or net definition of interest payments on domestic debt. Data from this block are used to report a liquidity indicator, gross financing needs, which measures how much cash the government has to have in hand to cover all the claims coming due in the current year (data for the past 10 (5) years are calculated in cells G79:X79; the input sheet). The gross financing need in the current year is measured as the sum of the amortization of foreign and domestic public debt coming due during the current year, the interest expenditure, and the primary deficit also for the current year. To calculate this indicator for the projection period, we use the available projections for external public debt and amortization of external debt from LDB or from the existing macroprojection framework. For domestic debt we allow the user to manually insert data for the projected average maturity of domestic debt. The default assumption in this version of the template is that the average maturity of domestic public debt will remain the same as in the base year (cells S54:X54 from the input sheet). 3) GDP, prices and exchange rates Cell range G22:X29, Fig. 1 This section includes data on gross domestic product in current and constant prices; average and end-of-period exchange rates with respect to the U.S. dollar; and domestic and foreign (US) consumer price index (CPI), average for the period. The average exchange rate is used to convert in U.S. dollar the gross financing need of the government and to simulated domestic debt payments in the alternative scenario. End of period exchange rate is used to estimate the contribution to debt dynamics of real exchange rate devaluation and of the real interest rate on foreign debt. By default, the template reports current WEO projections for the U.S. CPI. For ORC only, the template requires the input of non-oil GDP in current and constant market prices. 4) Monetary data Cell range G32:X34, Fig. 1. Monetary data include base money (defined as Reserve Money and Currency in circulation) and net foreign assets (NFA) of the Central Bank, end-of-period. The template assumes net debt decomposition, as public debt is net of the Central Bank credit to the government and the Central Bank's holdings of government paper and of NFAs. By default, NFAs are assumed to earn and interest rate equal to the LIBOR rate on the U.S. dollar: LIBOR rates can be retrieved from the Intarnational Financial Statistics or other financial databases. 5) Other factors Cell range G37:X39, Fig. 1. Other factors refer to any other variable which have a direct impact on debt dynamics, other than the primary fiscal balance, the contribution of interest rate/growth differential and the exchange rate. 15 These factors can be considered as non-debt creating forms of financing of the government such as privatization receipts or the creation of new government liabilities as in the case of the recognition of implicit or contingent liabilities and the cost of bank recapitalization, which have not been included in the primary surplus definition. Privatization receipts are inserted with the negative sign, as reducing net debt. Depending on the appropriate dimension of the public sector other factors could be increases in quasi-fiscal liabilities, such as deficits of extra-budgetary funds of line ministries or SOEs used to subsidize key economic sectors, or subsidies issued through the CB. 6) Oil revenues and prices (for oil rich countries) Cell range G42:X48, Fig. 3 For ORCs the debt decomposition assumes a fiscal rule, according to which the non-oil primary deficit is financed by oil revenues evaluated at a budget reference price and the change in the net public debt ratio also accounts for the accumulation of assets in a ring-fenced oil fund. The debt decomposition in ORCs requires additional data input. A section called "Oil revenues and prices" becomes available in the input sheet if ORCs function is enabled in the "Instruction" sheet (see section 2, the Instruction sheet). This section includes 2 subsections: a) Net oil revenues include the oil revenue, net of oil related expenditure and transfers evaluated at the reference price used in the government budget; and the net accumulation of oil assets in the oil stabilization fund, equal to total net oil revenues at market price net of the reference price oil revenues. b) Oil prices used in the analysis are: oil market prices (consistent with WEO or DECPG projected oil prices); baseline reference prices, used to evaluate oil revenue in the fiscal budget; and alternative price level to assess the robustness of the oil revenue rule at possible drop in oil market prices. Figure 3. Input Sheet: Oil Revenues and Prices With respect to the standard debt decomposition, the following changes are assumed in the "Input_fiscal" sheet: 1) Fiscal data: revenues refer to the non-oil revenues; total expenditure to the non-oil total expenditure. 2) GDP, prices and exchange rates: current and constant price non-oil GDP is required. 3) Monetary data: NFA are net of oil assets, reported in the oil-stabilization fund. 16 7) Assumptions for baseline projections Cell range E50:X54, Fig. 1. This section specifies the assumptions for the real interest rate and maturity structure of domestic debt. The template requires projections for stock, interest payments and amortization on external debt and calculates the implicit nominal and real interest rate and maturity structure of external debt. Similar projections for domestic debt might not be directly available. Therefore, the template allows the user to insert alternative assumptions to calculate the real interest on domestic debt: 1) Insert projections for domestic debt stock and interest payments (cells S39:X40). In this case, the implicit nominal interest rate is derived as interest payments in period t divided by domestic debt stock in the period t-1; The real interest rate is derived deflating the nominal interest rate by the domestic inflation rate; 2) Insert projections for the real domestic interest rate (cells S41:X41). In this case the real interest rate is exogenously determined by the user and the nominal interest rate is derived by the template. To correctly calculate the implicit nominal and real interest rate, the user has to define whether data on domestic debt and domestic interest expenditure are reported on a gross or a net basis (cell E38 in the Input sheet). If the data are reported on a gross basis, then the template assumes that the interest rate paid on monetary debt (held by the Central Bank) is equal to that paid on non-monetary domestic debt (held by the public). If data on domestic debt and interest payments are reported on a net basis, then the template uses the net public domestic debt during the previous period to calculate the implicit average interest rates on public domestic debt. The assumptions allow the user to specify the projected maturity structure of domestic debt, by inserting the average number of years needed to amortize the current stock of debt (cells S54:X54). By default, the template assumes that the maturity structure is constant and equal to the maturity calculated for the last year of actual data. 17 Box 1. Baseline Input Data Requirements A. Baseline Input Data Requirements Dt=Bt+etB*t-etNFA*t, public sector net debt, end of the period (eop), in local currency units (LCU) Bt : domestic net/gross debt in LCU (excludes net credit to the government of the Central bank), eop B*t : foreign debt in LCU (includes domestic debt issued in FX and any domestic debt linked to FX), eop NFA*t: stock of net foreign assets in dollar terms, in LCU, eop PRP*t: amortization on external MLT debt, in LCU PRPt: amortization on domestic MLT debt, in LCU Int*t: interest payment on public foreign debt, in LCU CBHt: Holding of government securities by the Central Bank, in LCU, eop. STDt: Short term debt, in LCU eop. Et: nominal exchange rate LCU/$, eop Et, : nominal exchange rate LCU/$, average (av) av Mt: monetary base at the eop, period t Pt,AV: average CPI level for period t Yt: real GDP in period in LCU t Tt: tax revenue, in LCU Gt: total primary expenditure, in LCU INTt: Total public interest expenditure, in LCU OBt: Overall balance of the public sector, in LCU it is the dollar nominal interest rate earned over reserves over the period t l it is the nominal interest rate on domestic debt paid over the period t (average) d it is the dollar nominal interest rate paid on foreign debt and reserves over the period (average) f B. Variables Calculated by the Template t,AV=(Pt,AV-Pt-1,AV)/Pt-1,AV is average consumer price inflation from year t-1 to year t t,AV=(P*t,AV-P*t-1,AV)/P*t-1,AV, where P*t is the average U.S consumer price index. gt: (Yt-Yt-1)/Yt-1, real GDP growth rate in the year t. st=(Et-Et-1)/Et-1, rate of change of the nominal exchange rate, LCU/1US$, eop êt=(1+st)*(1+*t,AV)/(1+t,AV)-1 is the rate of change in bilateral real exchange rate, (LCU per 1 USD), where + denotes real depreciation, while ­ denotes real appreciation. PBt=( Tt - Gt)- primary balance as a share of GDP Maturity=(B*t+Bt)/(PRP*t+PRPt) Real interest rate on public debt:t (1+ it )(1+ e)t )/(1+ t ) -1 + (1-t ) (1+ it )/(1+t ) -1 {[ f * ] } {[ d ] } Share of external public debt in total public debt, t=B*t-1/(B*t-1+Bt-1) Gross Financing Needs = -Pdt+PRP*t+PRPt+STDt t=(Mt-Mt-1)/(PtYt) is defined as seigniorage revenue as ratio to GDP. OFt are other exogenous factors of public debt accumulation that may increase or decrease the outstanding stock of net public debt such as privatization receipt or recognition of contingent liabilities ­ percent of GDP. pd- primary balance as a share of GDP Tt: total government revenues in LCU Gt: total non-interest expenditure in LCU 18 4. The Seigniorage Sheet and Steady State Fiscal Consistency Approach (as in Anand and van Wijnbergen) 4.1. Seigniorage The sheet "Seigniorage" calculates seigniorage for each year of the projection period and in the long run, assuming that real growth and inflation remain constant at their values as in last year of projection period. To account for link between seigniorage revenue and inflation, we benchmark seigniorage revenue using a Cagan money demand function, where nominal base money stock, M at the end of each period t-1 is a function of nominal income and expected average inflation during the period t: M eopt-1 = AYt e- et Pt Where Mt eop -1 is Base Money at the end of period t-1, Pt,AV is the average CPI in year t, t,AV=(Pt,AV- Pt-1,AV)/Pt,AV, Yt is the real GDP in year t, is the semi-elasticity of money demand with respect to inflation and A is a constant term. In sheet "Seigniorage" (Fig. 3), data to calculate base money are reported in cells A9:I15. All data are linked to the input sheets. The sheet "Seigniorage" also calculates the inflation maximizing seigniorage revenue for each year of the projection period, using the Cagan money demand formula and assuming a semi-elasticity of inflation of 0.3 (see cells B20:H20; Seigniorage sheet, Fig. 4): SRt = Mt - Mt-1 Pt+1Yt+1e- t +1- PtYte- t Pt Yt = Pt Yt For the purpose of the derivation of the long ­run sustainability condition at the end of the projection period, steady state seigniorage revenue is calculated, assuming that money demand grows at a constant rate, given that both inflation and real growth rate are at their constant long-run values: (cell I5:I23; Seigniorage sheet): = Ae- (g + + g) 19 Figure 4. Seigniorage Sheet. 4.2.Steady state fiscal policy consistency To assess the consistency of fiscal policy in steady state for alternative scenarios, the "Seigniorage" sheet calculates the required deficit reduction (RDR) in percent of GDP needed to maintain a stable debt to GDP ratio in steady state for alternative inflation rates (Fig. 5). In steady state, positive values of the RDR indicates that fiscal policy is not consistent with a stable debt ratio and either inflation need to rise to increase seigniorage revenue or primary deficit need to be reduced. The RDR is defined as the difference between the primary deficit, net of seigniorage, required to stabilize the debt to GDP ratio in steady state pdss and the primary deficit pd at the end of the projection period. pdss is assumed to vary as a function of steady state seigniorage ss calculated for inflation rates increasing from 0 to 1000 percent. rdrss = pdss ( ss ) - pdt , +5 Steady state fiscal consistency is tested for the baseline scenario, the country specific alternative scenario the historical scenario. In the baseline, lower RDR than in the historical, imply that macroeconomic fundamentals are expected to improve with respect to historical averages and/or fiscal policy to be more restrictive. In this case, the failure to reduce primary deficits with respect to the past fiscal policy outcomes would result in higher inflation. The alternative country specific scenario would signal risks to fiscal sustainability that might imply larger RDR than assumed in the 20 baseline. If fiscal adjustment needed to maintain stable debt ratios is considered unachievable, the tool would signal that higher inflation is likely in the event of shocks. The fiscal policy consistency estimates also the maximum seigniorage revenue that could be obtained by monetizing the fiscal deficit and therefore defines the minimum RDR, given inflation maximizing seigniorage (Fig.6), for the three alternative scenarios. Figure 5. Required Deficit Reduction Figure 6. Inflation Maximizing (In percent of GDP) Seigniorage 15.0 10.0% Baseline Steady state 9.0% onit 10.0 alternative Country Specific Alternative Scenario Historical Scenario 8.0% duceRticifeD 5.0 P)DGfo P 7.0% 0.0 6.0% Steady state historical -5.0 5.0% ed (% 4.0% uir -10.0 Steady state GDfotnecreP 3.0% eqR baseline -15.0 2.0% 1.0% -20.0 0.0% 0% 200% 400% 600% 800% 1000% 0% Inflation rate 100% 300% 500% 700% 900% Inflation rates 21 5. The Base Case Scenario Sheet The sheet "Table" lists the main macroeconomic assumptions used in the fiscal sustainability analysis. The sheet also shows the dynamic forward-looking debt simulation (derived from debt updating equation shown in Annex A1)4. The sheet also summarizes the results of alternative scenarios and bound tests. Sheet "Table_SR" reports the same results of the baseline analysis in a printable format. 5.1. Dynamic Forward-Looking Debt Simulation The change in Net public debt (the sum of net external and net domestic public debt) is decomposed in the different factors as reported in Table 1, with the sign of the contribution to the change in net public debt in percent of GDP. The FSA tool presents the factors of the debt decomposition as in Table 2: the primary balance (line 4, a negative term indicate a primary surplus), seigniorage revenue (line 7, a negative item) and automatic debt dynamics factors (line 8). The automatic debt dynamics is further decomposed into a contribution of the real interest rate net of real growth rate (line 9) and the capital gain or loss on external public debt due to changes in the real exchange rate (line 15, a positive item indicates a real depreciation) 5. The contribution of the real interest rate distinguishes between the contribution of real interest rate on domestic and foreign public debt, net of interest rate earned on NFA (see Table 3 for the mathematical derivation of the different terms of the debt decomposition). The template also includes other debt-creating or debt- reducing flows (line 15, a positive item): privatization receipts (line 16, a negative item); recognition of contingent liabilities (line 17, a positive item); and other factors (in line 18, such as the cost of recapitalizing the banking sector, a positive item). The public debt ratio is then projected as the sum of the debt ratio in the previous period and the total sum of the contributions of various factors as described above. Since many market access countries are credit constrained, the template allows for a pre-determined path of external public debt, deriving domestic public debt path as a residual. This base case public debt decomposition also indicates the relative importance of various contributing factors to the evolution of the debt ratio. Finally, it also serves as a basis for stress tests, by simulating a number of shocks by assuming some deviation of variables used in this public debt decomposition from their historical averages. The results of these tests are summarized as well, together with the baseline assumptions and projections in sheet "Table" and "Table_SR" (see Table 4)6. 4Footnotes also report the formulas in the spreadsheet. 5Note that full separation between the different channels in the debt equation is not possible. As a result, the term defined as real exchange rate depreciation also includes the exchange rate revaluation effect on interest payments on foreign currency denominated debt. 6Stochastic simulation exercises conducted for a sample of emerging market countries indicate that debt crises are typically preceded by shocks to economic variables equal to two standard deviations during two years. 22 Table 1. Component of the change in public net debt to GDP ratio Formula Sign Line in Component "Table" 1) Primary balance: (gt -tt) + 4 2) Seigniorage: t - 7 11 4) Domestic real interest rate cost: (idt -t)bt -1 (1+t)(1+ gt) + + (i f t-*t)b*t-1 12-13 (1+ *t )(1+ gt ) 5) Foreign real interest rate cost + - (ilt - *t ) nfa*t-1 (1+ *t )(1+ gt ) gt 3) Real GDP growth: (1+ gt) dt 14 -1 - ^ 6) Capital loss due to real exchange et (1+ i f t )b*t-1 - (1+ ilt )nfa*t-1) [ ] 15 rate depreciation + (1+ *t)(1+ gt) 5.2. Dynamic Consistency Measure The FS tool also calculates two additional sustainability indicators: the primary balance at which debt-output ratio is stabilized in each projection year and at the end of the projection period (cells:Y39; Table sheet): In addition, the FS tool also calculates the corresponding required deficit reduction, defined as the difference between projected and debt - stabilizing primary balance during each projection year and in the long run (at the end of the projection period) (cell: Y40; Table sheet). Note that a positive number indicates inconsistency between inflation targets and stable debt ratios - if public debt is to be kept constant, larger fiscal adjustment is necessary to avoid higher inflation that would otherwise close the gap by bringing in more seigniorage revenue. 5.3. Additional Outputs The template also reports the gross financing needs of the public sector (defined as the public sector deficit, plus all maturing debt). This variable is derived, for all the scenarios as well as for the sensitivity tests, in percent of GDP and in billions of dollars (sheet "Table_GF").7 7In the stress and bound tests the calculations of the gross financing needs assume the same maturity structure as in the baseline scenario. 23 The third section of the output table provides information regarding the macroeconomic assumptions underlying the baseline scenario and how they compare to historical outcomes. In this section the historical averages and standard deviations are calculated over the past 10 (5) years, to calibrate stress tests and bound tests. Eventually, the fourth section of the output table reports the result of the stress tests and bound tests. 24 Table 2. Output of the sheet "Table_SR" Table --.: Public Sector Debt Sustainability Framework, 2001-2011 (In percent of GDP, unless otherwise indicated) Actual Projections 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Debt-stabilizing I. Baseline Projections primary balance 11/ Public sector debt 1/ 89.5 77.8 69.8 63.2 61.2 54.2 49.0 44.5 39.6 34.4 29.0 -0.8 o/w foreign-currency denominated (net) 2/ 37.3 32.0 21.9 17.5 17.1 16.1 15.1 14.0 13.5 12.8 12.1 o/w domestic debt (net) 3/ 52.2 45.8 47.9 45.8 44.1 38.0 34.0 30.4 26.1 21.7 16.9 Change in public sector debt 32.0 -11.7 -8.0 -6.6 -2.0 -7.1 -5.1 -4.6 -4.9 -5.1 -5.4 Identified debt-creating flows (4+7+8+16) 30.0 -16.9 -14.6 -8.1 -2.1 -7.1 -5.1 -4.6 -4.9 -5.1 -5.4 Primary deficit -7.8 -6.3 -6.8 -7.0 -6.5 -6.5 -6.5 -6.5 -6.5 -6.5 -6.5 Revenue and grants 75.9 70.8 70.0 67.1 67.2 66.0 65.3 65.3 65.3 65.3 65.3 Primary (noninterest) expenditure 68.1 64.5 63.2 60.1 60.7 59.4 58.8 58.8 58.8 58.8 58.8 Seignorage -3.6 -0.9 -0.9 -1.5 -0.6 -0.7 -0.6 -0.6 -0.6 -0.6 -0.6 Automatic debt dynamics: 23.6 -9.7 -7.0 0.4 5.5 0.6 2.4 2.6 2.3 2.0 1.7 Contribution from interest rate/growth differential 13.6 -2.2 2.6 2.6 4.5 0.7 2.5 2.6 2.4 2.1 1.8 Of which contribution from real interest rate 9.0 4.4 6.8 8.3 7.4 3.7 5.1 5.0 4.5 4.0 3.5 Contribution from domestic real interest rate 4/ 7.3 2.2 5.8 7.3 6.2 2.1 3.5 3.5 3.1 2.7 2.2 Contribution from real interest rate on foreign debt 5/ 2.3 2.1 1.2 1.3 1.6 1.7 1.7 1.6 1.5 1.4 1.3 Contribution from real interest rate on net foreign assets 6/ -0.5 0.1 -0.2 -0.2 -0.4 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 Of which contribution from real GDP growth 4.7 -6.6 -4.3 -5.7 -2.9 -2.9 -2.6 -2.3 -2.1 -1.9 -1.6 Contribution from real exchange rate depreciation 7/ 10.0 -7.5 -9.6 -2.2 0.9 -0.2 -0.1 -0.1 -0.1 -0.1 -0.1 Other identified debt-creating flows 17.8 0.0 0.0 0.0 -0.4 -0.4 -0.4 0.0 0.0 0.0 0.0 Privatization receipts (negative) 17.8 0.0 0.0 0.0 -0.4 -0.4 -0.4 0.0 0.0 0.0 0.0 Recognition of implicit or contingent liabilities 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Other (specify, e.g. bank recapitalization) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Residual, including asset changes (2-3) 2.0 5.2 6.6 1.5 0.1 0.0 0.0 0.0 0.0 0.0 0.0 Public sector debt-to-revenue ratio 1/ 117.9 109.9 99.7 94.2 91.1 82.1 75.1 68.1 60.6 52.7 44.4 Primary deficit that stabilizes the debt-to-GDP ratio -39.8 5.4 1.2 -0.4 -4.5 0.6 -1.4 -1.9 -1.6 -1.4 -1.1 Required deficit reduction 32.0 -11.7 -8.0 -6.6 -2.0 -7.1 -5.1 -4.6 -4.9 -5.1 -5.4 Gross financing need 9/ 96.1 66.4 46.1 36.3 36.9 34.3 31.2 28.3 24.9 21.5 17.9 in billions of U.S. dollars 140.0 122.5 111.0 109.8 128.9 10-Year 10-Year 125.1 122.3 119.4 114.0 106.2 96.0 Historical Standard Projected Key Macroeconomic and Fiscal Assumptions Average Deviation Average Real GDP growth (in percent) -7.5 7.9 5.8 8.9 4.8 4.0 5.6 5.0 5.0 5.0 5.0 5.0 5.0 5.0 Average nominal interest rate on public debt (in percent) 10/ 58.5 33.0 27.5 22.3 19.6 40.0 13.9 11.0 13.2 13.1 13.1 12.9 12.8 12.7 Average nominal interest rate on public domestic debt (in percent) 11/ 80.3 51.1 42.0 28.0 22.0 11.3 14.6 14.6 14.6 14.6 14.6 Average nominal interest rate on forex debt (in percent) 11/ 11.3 7.9 5.7 8.0 10.3 8.4 2.0 10.4 10.9 10.9 10.9 10.9 10.9 10.8 Average nominal interest rate on NFA (in percent) 12/ 11.3 7.9 5.7 8.0 10.3 5.0 5.0 5.0 5.0 5.0 5.0 Average real interest rate (including exchange rate revaluation on foreign currency denominated debt) 31.8 -2.2 -3.2 9.4 13.8 8.2 11.2 5.5 8.9 9.5 9.3 9.2 9.0 8.6 Average real interest rate on public domestic debt (nominal rate minus change in CPI, in percent) 26.9 6.6 16.8 18.2 15.2 19.3 20.9 5.3 10.2 11.2 11.1 11.1 11.1 10.0 Average real interest rate on forex debt (nominal rate minus change in CPI, in percent) 8.5 6.3 3.5 5.4 7.6 6.0 1.8 8.0 8.4 8.4 8.4 8.4 8.4 8.4 Change in the real exchange rate (Local currency per US dollar) 13/ 44.3 -20.3 -30.6 -10.3 5.1 -1.0 -0.5 -0.4 -0.8 -0.8 -1.0 Nominal appreciation (increase in US dollar value of local currency, in percent) -53.6 -11.8 17.7 4.3 -8.5 -24.0 24.1 -2.4 -1.4 -0.5 -0.2 -0.2 0.0 ... Inflation rate (in percent) 53.4 44.5 25.2 9.9 6.8 51.2 29.7 6.0 4.5 3.5 3.5 3.5 3.5 4.1 US Inflation rate (in percent) 2.8 1.6 2.3 2.7 2.7 2.4 2.5 2.5 2.5 2.5 2.5 Growth of real primary spending (deflated by GDP deflator, in percent) 1.5 2.0 1.4 3.6 5.9 16.9 35.9 2.8 3.8 5.0 5.0 5.0 5.0 4.4 Base Money (percent of GDP) 10.1 7.7 7.0 7.8 7.8 8.1 1.2 7.7 7.7 7.7 7.7 7.7 7.7 Debt-stabilizing II. Stress Tests for Public Debt Ratio primary A. Alternative Scenarios balance 17/ A1. Key variables are at their historical averages in 2005-09 14/ 60.2 59.3 58.6 57.8 56.6 55.1 -0.8 A2. No policy change (constant primary balance) in 2005-09 54.2 47.8 42.5 36.8 30.9 24.6 -0.1 A3. Country-specific shock in 2005, with reduction in GDP growth (relative to baseline) of one standard deviation 15/ 96.1 105.5 107.8 113.5 121.3 130.5 -13.2 A4. Selected variables are consistent with market forecast in 2005-09 54.2 49.0 44.3 39.3 34.1 28.5 -0.7 B. Bound Tests B1. Real interest rate is at historical average plus two standard deviations in 2005 and 2006 76.3 96.9 94.4 91.6 88.6 85.4 -3.0 B2. Real GDP growth is at historical average minus two standard deviations in 2005 and 2006 71.0 93.7 107.7 122.2 137.3 152.8 -5.8 B3. Primary balance is at historical average minus two standard deviations in 2005 and 2006 60.1 61.1 57.1 52.8 48.2 43.4 -1.4 B4. Combination of 2-4 using one standard deviation shocks 76.9 97.2 96.3 95.1 93.8 92.2 -4.6 B5. One time 30 percent real depreciation in 2005 16/ 63.5 58.7 54.6 50.2 45.5 40.6 -1.3 B6. 10 percent of GDP increase in other debt-creating flows in 2005 64.2 59.4 55.4 51.0 46.4 41.5 -1.3 25 5.4. Oil Rich Country Base Case Scenario Sheet If the ORC function is enabled in the "Instructions" sheet, all output and calculation sheets show the suffix "_oil", with the exception of the sheets "Table", "Seigniorage" and of the sheets used to perform the stochastic simulations and produce the fan charts: "StochSim", "Graph DSP SIM", "outputsim" and "rdrsim". The structure of the results of the debt sustainability analysis reported in the sheets "Table" and "Table_SR_Oil" remains equal to the standard analysis as presented in this section. However, the debt decomposition assumes a fiscal rule for the non-oil primary deficit, financed through the oil revenues evaluated at a reference budget price and the change in net debt depends also on the accumulation of net oil assets in an oil-stabilization fund, according to the debt decomposition formula presented in Appendix A28 and summarized in Table 3. The change in Net public debt, is decomposed in (Table 4) the non-oil primary deficit (line 4, a negative term indicate a primary surplus), oil revenues at reference price (line 7, a negative item), seigniorage revenue (line 8, a negative item) and automatic debt dynamics factors (line 9). The automatic debt dynamics is further decomposed into a contribution of the real interest rate net of real growth rate (line 10) and the capital gain or loss on external public debt due to changes in the real exchange rate (line 15, a positive item indicates a real depreciation) 9. The contribution of the real interest rate distinguishes between the contribution of real interest rate on domestic and foreign public debt . The change in net public debt also depends on the accumulation of net oil assets (line 16), which includes the net inflow in the oil stabilization fund of oil revenues net of oil revenues evaluated at the reference price and interest earned on the stock of oil assets10. The template also includes other debt-creating or debt-reducing flows (line 19). The second section of the output sheet reports the non-oil primary deficit that stabilizes the public debt to GDP ratio and the required deficit reduction (RDR) with respect to the baseline non-oil primary deficit to stabilize the debt ratio. In addition the table reports also: 1) the main assumptions underlying the fiscal rule: market and reference oil price and the non- oil primary deficit as a percentage of non-oil GDP; 2) the stock of assets in the oil stabilization fund and the net annual changes; 3) the gross public debt (net of central bank holding of government securities); and 4) the gross financing needs. The third section reports the underlying general macroeconomic variables and the fourth section the result of the alternative scenarios and bound tests. 8Footnotes also report the formulas in the spreadsheet. 9Note that full separation between the different channels in the debt equation is not possible. As a result, the term defined as real exchange rate depreciation also includes the exchange rate revaluation effect on interest payments on foreign currency denominated debt and on the interest earned on NFA and the oil stabilization fund. 10The interest element includes also the interest earned on other NFA. 26 Table 3. Component of the change in public net debt to GDP ratio for ORC Formula Sign Line in Component "Table" 1) Non-oil primary balance: (gt -tt) + 4 2) Oil revenues at reference price oilrt - 7 3) Seigniorage: t - 8 12 4) Domestic real interest rate cost: (idt -t)bt -1 (1+t)(1+ gt) + (i f -*t)b*t-1 13 5) Foreign real interest rate cost t (1+ *t )(1+ gt ) + gt 6) Real GDP growth: (1+ gt) dt 14 -1 - ^ 7) Capital loss due to real exchange et (1+ i )b*t-1 - (1+ ilt )(nfa*t-1 + oat-1) [ f * ] 15 t rate depreciation + (1+ )(1+ gt ) * t 8) Net changes in the assets of the oil (ilt - *t )(nfa*t-1 + oa*t-1) 16 * stabilization fund (1+ *t ) (1+ gt ) +oat - 27 Table 4. Output of the Sheet "Table_SR_Oil" 28 6. The Alternative Scenario Sheets The sheet "Table" also summarizes the four alternative scenarios and the six bound tests. The template contains the following alternative scenarios: Historical Average Scenario: This scenario presents an alternative evolution of the debt ratio under the assumption that all key variables (real growth rate, real interest rates, inflation, real exchange rate, primary balance to GDP ratio, seigniorage revenue to GDP ratio are constant and equal to their historical averages over the projection period. The template calculates averages over a ten-year period, and uses that information to project debt dynamics five years ahead.11 This scenario is a rough test of the "realism" of baseline projections; the baseline projections may be argued to be overly optimistic when it differs remarkably from predicted debt evolution if historical patterns were followed. Of course, this scenario may be somewhat misleading if significant changes in economic policies have taken place in recent history--using the early years of transition, for instance, would bias the "historical" value of certain parameters and thus might result in too high a debt ratio. More generally, circumstances reflecting credible changes in policies (and thus lower baseline debt ratio projections) may look anomalous in comparison. In any case, using this scenario--and justifying any large anomalies--could usefully discipline baseline projections. The "A1_historical" sheet (Table 5) reports the result of this scenario. Key real macroeconomic variables are assumed to be at their historical average, as calculated in the bottom section of the sheet (cells B71:L76, Fig. 4). The table reports in red the variables modified with respect to the baseline scenario: primary balance, primary expenditure, seigniorage revenue, the real and nominal interest rates on domestic, foreign debt and NFA of the Central Bank and growth of real primary spending. 11If country teams wish to change the parameters used in this scenario, changes should be made in the "Table" sheet, and justification provided. 29 Table 5. "A1_historical" sheet Alternative Scenario 1: Key Variables at Historical Average (In percent of GDP, unless otherwise indicated) Actual Projections 2005 2006 2007 2008 2009 2010 2011 Debt-stabilizing I. Baseline Medium-Term Projections primary deficit Public sector debt 1/ 61.2 60 59 59 58 57 55 o/w foreign-currency denominated (net) 17.1 17.9 18.2 18.5 19.6 21.0 23.0 o/w foreign-currency denominated (gross) 22.7 23.3 23.3 23.4 24.3 25.4 27.1 o/w domestic debt (net) 3/ 44.1 42.3 41.0 40.1 38.1 35.6 32.2 Change in public sector debt -2.0 -1.0 -1.0 -0.6 -0.8 -1.1 -1.5 0.0 Identified debt-creating flows (4+7+12) 9.4 -1.0 -1.0 -0.6 -0.8 -1.1 -1.5 0.0 Primary deficit 4.6 -6.0 -6.0 -6.0 -6.0 -6.0 -6.0 -4.1 Revenue and grants 67.2 66.0 65.3 65.3 65.3 65.3 65.3 Primary (noninterest) expenditure 71.8 59.9 59.3 59.3 59.3 59.3 59.3 Seigniorage -0.6 -0.7 -0.6 -0.6 -0.6 -0.6 -0.6 -0.6 Automatic debt dynamics 2/ 5.5 6.2 6.1 6.0 5.8 5.6 5.2 4.7 Contribution from interest rate/growth differential 4.5 6.3 6.2 6.1 6.0 5.7 5.4 4.9 Of which contribution from real interest rate 7.4 8.7 8.5 8.4 8.2 8.0 7.6 7.1 Contribution from domestic real interest rate 4/ 6.2 7.7 7.5 7.4 7.2 6.8 6.4 5.8 Contribution from real interest rate on foreign debt 5/ 1.6 1.3 1.3 1.3 1.3 1.4 1.4 1.5 Contribution from real interest rate on net foreign assets 6/ -0.4 -0.3 -0.3 -0.3 -0.3 -0.3 -0.2 -0.2 Of which contribution from real GDP growth -2.9 -2.4 -2.3 -2.3 -2.3 -2.2 -2.2 -2.1 Contribution from real exchange rate depreciation 7/ 0.9 -0.2 -0.1 -0.1 -0.1 -0.2 -0.2 -0.2 Other identified debt-creating flows 0.0 -0.4 -0.4 0.0 0.0 0.0 0.0 0.0 Privatization receipts (negative) 0.0 -0.4 -0.4 0.0 0.0 0.0 0.0 0.0 Recognition of implicit or contingent liabilities 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Other (specify, e.g. bank recapitalization) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Residual, including asset changes (2-3) -11.4 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Public debt in percent of revenues 1/ 91.1 91.3 90.7 89.8 88.5 86.8 84.5 Primary deficit that stabilizes the debt-to-GDP ratio 6.6 -5.0 -5.1 -5.4 -5.2 -4.9 -4.5 -4.1 Required deficit reduction -2.0 -1.0 -1.0 -0.6 -0.8 -1.1 -1.5 -2.0 Gross financing 5/ 36.9 27.6 26.0 24.8 23.6 22.2 20.3 in billions of U.S. dollars 128.9 99.6 100.0 101.8 104.0 104.7 103.0 For debt Key macroeconomic and fiscal assumptions stabilization Average nominal interest rate on public debt (percent) 6/ 15.9 14.2 12.7 11.7 11.7 11.7 11.7 11.7 Average nominal interest rate on public domestic debt (in percent) 11/ 22.0 25.3 23.8 22.8 22.8 22.8 22.8 22.8 Average interest rate on foreign-currrency denominated debt 10.3 8.4 8.5 8.5 8.5 8.5 8.5 8.5 Average nominal interest rate on NFA (in percent) 12/ 8.4 8.5 8.5 8.5 8.5 8.5 8.5 Average real interest rate (nominal rate minus change in domestic CPI, percent) 9.1 8.2 8.2 8.2 8.2 8.2 8.2 8.2 Average real interest rate on domestic debt (nominal rate minus change in domestic CPI, p 15.2 19.3 19.3 19.3 19.3 19.3 19.3 Average real interest rate on foreign debt debt (nominal rate minus change in U.S. CPI, pe 7.6 6.0 6.0 6.0 6.0 6.0 6.0 Change in the real exchange rate (Local currency per US dollar) 13/ 5.1 -1.0 -0.5 -0.4 -0.8 -0.8 -1.0 -1.0 Nominal depreciation of local currency (LC per dollar) 9.3 2.5 1.4 0.5 0.2 0.2 0.0 0.0 Exchange rate (US dollar per LC) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Nominal appreciation of local currency (increase in US dollar value of local currency) -8.5 -2.4 -1.4 -0.5 -0.2 -0.2 0.0 Inflation rate (GDP deflator, in percent) 6.8 6.0 4.5 3.5 3.5 3.5 3.5 3.5 US Inflation rate (in percent) 2.7 2.4 2.5 2.5 2.5 2.5 2.5 2.5 Growth of real primary spending (deflated by GDP deflator, in percent) 5.9 -13.2 2.9 4.0 4.0 4.0 4.0 Base Money (percent of GDP) 7.8 7.8 7.8 7.9 8.0 8.0 8.1 30 Country-Specific Alternative Scenario: This scenario is user-defined and models the impact of country-specific shocks that the country is considered most vulnerable to in the medium term. Shocks could consist of fiscal slippages; a slowdown in the growth rate, higher borrowing costs, terms of trade shocks, sudden stops in the availability of external financing, or realization of contingent liabilities. Country teams are at liberty to design this scenario based on the particulars of the country. The template allows for two possibilities: the user could either link this scenario to a complete alternative macroeconomic projection framework, or alternatively, the user could specify a path for the key variables (real interest, growth, exchange rates, inflation, primary balance and seigniorage revenue to GDP ratios) and make an assumption about the debt management strategy. Key parameters have to be derived from financial programming and inserted in the input sheet, in the input block that lists the assumptions for the country-specific alternative scenario (cell range F126:X144, Input Sheet). The input block for this alternative scenario has 3 main sections: 1) Macroeconomic and debt data: in this section the user has to import data form an alternative macroeconomic scenario (Fig. 7). For data not inserted, the template uses data inserted in the baseline section of the input sheet, unless other assumptions are inserted as explained in point 2) below. Figure 7. Macroeconomic and Debt Data Input for the Alternative Scenario 2) Assumptions: alternatively to the previous section, the user can insert only the main assumptions referring to: a. Domestic real interest rate (in percent) b. Foreign real interest rate (in percent) c. Real GDP growth (in percent) d. Real exchange rate depreciation (in percent) e. Primary deficit (in percent of GDP) f. Contingent liabilities (In percent of GDP) g. Inflation (in percent) 31 Those assumptions have to be inserted in the input sheet cells S147:X153 (Fig. 8). For cells left blank, the template uses assumptions as in the baseline, if no data are inserted in the Macroeconomic and Debt Data section. Figure 8. Assumptions for the Alternative Scenario. 3) Oil revenues and prices (visible for ORC only): in this section, the user can insert fiscal rules based on alternative market and reference oil prices (input sheet S156:X161, Fig. 9) . In ORC, public debt dynamics are particularly sensitive to assumptions about projected and budget reference oil prices, which determine the net oil revenues and acceptable level of non-oil deficits. The cost of oil price forecasting errors are asymmetric, with the cost of over predicting being far greater than the cost of under predicting. The country specific alternative scenario for ORC maintains the consistency of the non-oil primary balance with the oil revenue at reference price. In this scenario, non-oil expenditures are assumed to increase one to one with reference price oil revenues and be equal to total oil and non-oil revenues. The choice of a reference price which results to be above the market price for the projection period would imply a decumulation of oil assets and eventually the resort to domestic financing of the non-oil primary deficit, if oil assets are depleted.. For ORC, the fiscal sustainability analysis considers the effect of the accumulation of net oil assets on net public debt, according to the debt decomposition presented in Table 3. Figure 9: Oil Revenues and Prices Descriptor 2006 2007 2008 2009 2010 2011 Oil revenues and prices Net oil revenues 2,021.5 2,295.8 6,031.3 8,833.0 11,394.2 13,972.7 Reference price-oil revenue 5,216.1 5,570.5 13,195.8 18,605.1 23,489.4 28,161.8 Oil stabilization fund -3,194.6 -3,274.7 -7,164.5 -9,772.1 -12,095.2 -14,189.1 Oil prices Country specific alternative scenario 25.0 25.5 26.0 26.5 27.1 27.6 Baseline 60.0 60.0 60.0 60.0 60.0 60.0 32 4) External debt management assumptions: in this section, the user decides the evolution of external debt, assuming that the maturity structure will remain unchanged with respect to the baseline. The user can choose among the following options: a. Same as the baseline b. Constant in dollar terms: borrowing is supposed to cover only principal repayments from first year of projection c. Constant in percent of GDP: debt maintained constant is percent of GDP as in first year of projection d. Sudden stop in the first year of projections: New disbursements are assumed to be nil in the first year of projections and to resume in the following years according to baseline, in dollar terms. e. Declining path: gross external debt adjusts according to the user inputed target chosen in cell X169, in percent of GDP. The user can choose between: an automatically calculated constant adjustment path (default) or; insert a user defined path. The user specifies the debt management option by inserting the corresponding number in cell R163 in the Input Sheet (Fig. 10). The default option is "Same as baseline". The chosen option constrains gross external debt to a given path (see cells S164:X169), with domestic debt determined as a residual. Figure 10. External Debt Management for the Alternative Scenario Text case for alternative scenario. In the text case used in the template, the alternative scenario evaluates the effects of the faltering of the country's fiscal program in the first year of projections, with implications on interest rates, exchange rates, growth and the availability of foreign financing. The following assumptions are inserted in the Assumptions section (Fig. 8): · Primary fiscal balance is reduced by 1% of GDP in 2005 and stays at 3% thereafter; · GDP growth slows at -3% in 2005 and picks up at 3% thereafter; · Domestic interest rate picks at 20% and declines at 15% in real terms; · Contingent liabilities of 15% of GDP increase the domestic debt burden; · Interest rate on foreign debt increases at 10 percent in real terms in 2005-2008; · The real exchange rate depreciates by 30% in 2006. · Inflation rates increases by one standard deviation in 2006, with respect to baseline, and gradually decreases at 5% 33 · In addition, the country is assumed not able to borrow internationally in 2006. This scenario corresponds to option 4 of the external debt management section (Fig. 10). The output of the alternative scenario is reported in sheet "A3_alternative" in the template (Table 6). The decomposition table reports the debt dynamics consistent with the alternative macroeconomic assumptions specified in the input sheet. 34 Table 6. Output Table of the Alternative Scenario Alternative Scenario 3: Country-Specific Scenario (In percent of GDP, unless otherwise indicated) Actual Projections 2005 2006 2007 2008 2009 2010 2011 Debt-stabilizing I. Baseline Medium-Term Projections primary deficit Public sector debt 1/ 36.1 61.2 96 105 108 113 121 130 o/w foreign-currency denominated (net) 23.8 17.1 24.5 18.1 14.8 13.6 13.0 12.5 o/w foreign-currency denominated (gross) 30.8 22.7 24.5 18.1 14.8 13.6 13.0 12.5 o/w domestic debt (net) 3/ 12.3 44.1 71.6 87.3 93.0 99.9 108.3 117.9 Change in public sector debt -2.0 34.9 9.4 2.4 5.6 7.8 9.1 0.0 Identified debt-creating flows (4+7+12) -3.8 34.9 9.4 2.4 5.6 7.8 9.1 0.0 Primary deficit -6.5 -3.0 -3.0 -3.0 -3.0 -3.0 -3.0 -13.2 Revenue and grants 23.9 67.2 55.8 45.2 39.8 38.1 38.3 39.1 Primary (noninterest) expenditure 21.0 60.7 52.8 42.2 36.8 35.1 35.3 36.1 Seignorage -0.6 -2.8 -1.8 -1.1 -0.7 -0.5 -0.5 -0.5 Automatic debt dynamics 2/ 3.4 25.7 14.1 6.5 9.3 11.3 12.6 13.7 Contribution from interest rate/growth differential 2.4 19.5 10.2 9.2 10.4 11.6 12.7 13.8 Of which contribution from real interest rate 5.3 15.6 13.0 12.3 13.5 14.9 16.3 17.6 Contribution from domestic real interest rate 4/ 4.1 13.4 10.7 10.6 12.3 13.9 15.2 16.6 Contribution from real interest rate on foreign debt 5/ 1.6 2.4 2.3 1.7 1.2 1.1 1.0 1.0 Contribution from real interest rate on net foreign assets 6/ -0.4 -0.2 0.0 0.0 0.0 0.0 0.0 0.0 Of which contribution from real GDP growth -2.9 3.9 -2.8 -3.1 -3.1 -3.3 -3.5 -3.8 Contribution from real exchange rate depreciation 7/ 0.9 6.1 3.9 -2.7 -1.0 -0.3 -0.1 -0.1 Denominator = 1+g++g 1.1 1.0 1.1 1.1 1.1 1.1 1.1 1.1 Other identified debt-creating flows 0.0 15.0 0.0 0.0 0.0 0.0 0.0 0.0 Privatization receipts (negative) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Recognition of implicit or contingent liabilities 0.0 15.0 0.0 0.0 0.0 0.0 0.0 0.0 Other (specify, e.g. bank recapitalization) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Residual, including asset changes (2-3) 1.8 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Public debt in percent of revenues 1/ 151.2 91.1 172.3 233.1 271.1 297.5 316.5 333.8 Primary deficit that stabilizes the debt-to-GDP ratio -4.5 -37.9 -12.4 -5.4 -8.6 -10.8 -12.1 -13.2 Required deficit reduction -2.0 34.9 9.4 2.4 5.6 7.8 9.1 10.2 Gross financing 5/ 36.9 43.1 50.9 53.1 55.2 57.6 59.3 in billions of U.S. dollars 128.9 186.1 288.5 368.3 431.9 485.1 531.9 For debt Key macroeconomic and fiscal assumptions stabilization Real GDP growth (in percent) 4.8 -6.0 3.0 3.0 3.0 3.0 3.0 3.0 Average nominal interest rate on public debt (percent) 6/ 15.9 11.0 13.2 13.1 13.1 12.9 12.8 Average nominal interest rate on public domestic debt (in percent) 11/ 16.8 80.0 50.0 35.0 25.0 20.0 18.5 18.5 Average interest rate on foreign-currrency denominated debt 10.3 12.4 12.5 12.5 10.9 10.9 10.9 10.9 Average nominal interest rate on NFA (in percent) 12/ 5.0 5.0 5.0 5.0 5.0 5.0 5.0 Average real interest rate (nominal rate minus change in CPI, percent) 9.1 33.8 18.1 9.2 11.8 13.1 13.6 Average real domestic interest rate (nominal rate minus change in CPI, percent) 9.4 40.0 20.0 15.0 15.0 15.0 15.0 Change in the real exchange rate (Local currency per US dollar) 13/ 30.0 15.0 -14.2 -6.6 -2.2 -1.0 -1.0 Nominal depreciation of local currency (LC per dollar) 9.3 77.8 1.4 0.5 0.2 0.2 0.0 Exchange rate (US dollar per LC) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Nominal appreciation of local currency (increase in US dollar value of local currency) -8.5 -43.7 -1.4 -0.5 -0.2 -0.2 0.0 Inflation rate (in percent) 6.8 40.0 30.0 20.0 10.0 5.0 3.5 3.5 US Inflation rate (in percent) 2.7 2.4 2.5 2.5 2.5 2.5 2.5 2.5 Growth of real primary spending (deflated by GDP deflator, in percent) 5.9 -18.3 -17.6 -10.3 -1.5 3.5 5.2 Base Money (percent of GDP) 7.79 8.7 8.3 7.8 7.6 7.5 7.5 35 No Policy Change Scenarios: This scenario assumes that current policies (as of the base year, defined as the last year for which actual data exist) regarding revenue and expenditure are maintained for the projection period. As negotiations with authorities entail indications to raise revenue and cut expenditure, it would be instructive to compare the baseline projections thus obtained against a no-change scenario. This alternative scenario assumes that the primary balance to GDP ratio remains unchanged with respect to the last year of actual data. Fiscal revenue and primary expenditure remain constant in percent of GDP and interest expenditure in national currency assumes the same nominal interest rate on domestic and foreign debt as in the baseline. All other macroeconomic data are assumed unchanged with respect to baseline. The assumptions regarding this scenario are incorporated in the input block for this scenario in the input sheet (cell range E95:X105, Input Sheet, Fig. 11). The output of this scenario is reported in sheet "A2_npc" (Table 7). Figure 11. Input Sheet for No Policy-Change Scenario 36 Table 7. Output Table of the No Policy Change Scenario Alternative Scenario 2: No Policy Change (Constant Primary Balance) (In percent of GDP, unless otherwise indicated) Actual Projections 2005 2006 2007 2008 2009 2010 2011 Debt-stabilizing I. Baseline Medium-Term Projections primary deficit Public sector debt 1/ 61.2 53.7 47.8 42.5 36.8 30.9 24.6 o/w foreign-currency denominated (net) 17.1 16.0 14.7 13.4 12.5 11.5 10.3 o/w foreign-currency denominated (gross) 22.7 21.3 19.8 18.3 17.2 15.9 14.4 o/w domestic debt (net) 3/ 44.1 37.7 33.1 29.1 24.3 19.4 14.4 Change in public sector debt -2.0 -7.6 -5.8 -5.3 -5.6 -5.9 -6.3 0.0 Identified debt-creating flows (4+7+12) -4.2 -7.6 -5.8 -5.3 -5.6 -5.9 -6.3 0.0 Primary deficit -6.5 -6.5 -6.5 -6.5 -6.5 -6.5 -6.5 -0.1 Revenue and grants 67.2 67.2 67.2 67.2 67.2 67.2 67.2 Primary (noninterest) expenditure 60.7 60.7 60.7 60.7 60.7 60.7 60.7 Seignorage -0.6 -0.7 -0.6 -0.6 -0.6 -0.6 -0.6 -0.6 Automatic debt dynamics 2/ 3.4 0.0 1.7 1.8 1.5 1.2 0.8 0.7 Contribution from interest rate/growth differential 2.4 0.2 1.8 1.8 1.6 1.3 1.0 0.8 Of which contribution from real interest rate 5.3 3.1 4.3 4.1 3.6 3.0 2.4 2.0 Contribution from domestic real interest rate 4/ 4.1 1.6 2.8 2.7 2.3 1.8 1.3 0.9 Contribution from real interest rate on foreign debt 5/ 1.6 1.7 1.7 1.6 1.4 1.3 1.2 1.1 Contribution from real interest rate on net foreign assets 6/ -0.4 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 Of which contribution from real GDP growth -2.9 -2.9 -2.6 -2.3 -2.0 -1.8 -1.5 -1.2 Contribution from real exchange rate depreciation 7/ 0.9 -0.2 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 Other identified debt-creating flows -0.4 -0.4 -0.4 0.0 0.0 0.0 0.0 0.0 Privatization receipts (negative) -0.4 -0.4 -0.4 0.0 0.0 0.0 0.0 0.0 Recognition of implicit or contingent liabilities 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Other (specify, e.g. bank recapitalization) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Residual, including asset changes (2-3) 2.2 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Public debt in percent of revenues 1/ 91.1 79.8 71.1 63.2 54.8 46.0 36.7 Primary deficit that stabilizes the debt-to-GDP ratio -4.5 1.1 -0.6 -1.2 -0.8 -0.6 -0.2 -0.1 Required deficit reduction -2.0 -7.6 -5.8 -5.3 -5.6 -5.9 -6.3 -6.4 Gross financing 5/ 36.9 22.5 20.1 17.0 13.5 9.9 6.2 in billions of U.S. dollars 128.9 82.0 79.0 71.7 61.6 48.8 33.1 For debt Key macroeconomic and fiscal assumptions stabilization Real GDP growth (in percent) 4.8 5.0 5.0 5.0 5.0 5.0 5.0 5.0 Average nominal interest rate on public debt (percent) 6/ 15.9 11.0 13.2 13.1 13.1 12.9 12.8 Average nominal interest rate on public domestic debt (in percent) 11/ 16.8 9.9 12.5 12.3 12.0 11.5 10.7 10.7 Average interest rate on foreign-currrency denominated debt 10.3 10.4 10.9 10.9 10.9 10.9 10.9 10.9 Average nominal interest rate on NFA (in percent) 12/ 10.3 5.0 5.0 5.0 5.0 5.0 5.0 5.0 Average real interest rate (including real exchange rate appreciation) 10.3 4.6 7.7 8.3 7.9 7.6 7.0 Change in the real exchange rate (Local currency per US dollar) 13/ 5.1 -1.0 -0.5 -0.4 -0.8 -0.8 -1.0 -1.0 Nominal depreciation of local currency (LC per dollar) 9.3 2.5 1.4 0.5 0.2 0.2 0.0 Exchange rate (US dollar per LC) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Nominal appreciation of local currency (increase in US dollar value of local currency) -8.5 -2.4 -1.4 -0.5 -0.2 -0.2 0.0 Inflation rate (in percent) 6.8 6.0 4.5 3.5 3.5 3.5 3.5 3.5 US Inflation rate (in percent) 2.7 2.4 2.5 2.5 2.5 2.5 2.5 2.5 Growth of real primary spending (deflated by GDP deflator, in percent) 5.9 5.0 5.0 5.0 5.0 5.0 5.0 Base Money (percent of GDP) 7.79 7.71 7.66 7.66 7.66 7.66 7.66 37 Market Forecast Scenario: For countries where market forecasts of key macroeconomic variables are available, the economists should include them in the template as well. This could serve as a useful check on optimism regarding policies that might be inherent in baseline projections. The implementation of this alternative scenario requires the user input for selected variables consistent with market forecast in the input block for the assumptions/projections to be utilized in this scenario (cell range E205:X216, Input Sheet). Note that if nothing is imputed in this block, the market forecast scenario picks up the base case scenario assumptions/projections by default (Fig. 12). Figure 12. Input Sheet for Market Forecast Scenario Lower oil prices (ORC only): This scenario deals explicitly with the impact of oil price uncertainty on net public debt dynamics, evaluating the robustness of the oil price fiscal rule with respects to market oil prices lower than in the baseline. This scenario is not a fully alternative one, but it assumes that macroeconomic fundamentals gross external debt and the oil reference price remain unchanged with respect to baseline projections. The relevant input in the "Input_fiscal" sheet is in S48:X48 (Fig. 3). The output of the scenario is reported in sheet "Table_Lowest_oil" (Table 8). 38 Table 8. Output Table of the Low Oil Price Scenario Table --.: Public Sector Debt Sustainability Framework, 2001-2011 (In percent of GDP, unless otherwise indicated) Projections 2006 2007 2008 2009 2010 2011 Debt-stabilizing I. Baseline Projections primary balance 17/ Public sector debt 1/ -1.0 1.2 2.1 3.5 4.8 7.2 -16.2 o/w foreign-currency denominated (net) -20.0 -17.2 -14.7 -11.2 -7.7 -4.4 o/w domestic debt (net) 3/ 19.0 18.4 16.7 14.6 12.5 11.6 Change in public sector debt 1.2 2.2 0.9 1.4 1.3 2.4 Identified debt-creating flows (4+7+8+16) 1.2 2.2 0.9 1.4 1.3 2.4 Non-oil primary deficit 17.9 18.4 17.1 17.5 17.7 18.5 Revenue and grants 7.9 8.4 9.0 9.6 9.8 10.0 Primary (noninterest) expenditure 25.8 26.9 26.1 27.1 27.5 28.5 Oil revenue at reference price 4/ -19.9 -19.3 -18.8 -19.2 -19.3 -18.8 Seignorage -0.7 -0.6 -0.5 -0.5 -0.4 -0.4 Automatic debt dynamics: 0.5 1.1 0.8 0.7 0.5 0.4 Contribution from interest rate/growth differential 0.1 1.0 1.0 0.9 0.8 0.6 Of which contribution from real interest rate 0.0 1.0 1.0 1.0 1.0 0.8 Contribution from domestic real interest rate 5/ 0.3 0.9 1.0 1.0 1.0 0.8 Contribution from real interest rate on foreign debt 6/ -0.3 0.1 0.0 0.0 0.0 0.0 Of which contribution from real GDP growth 0.1 0.0 -0.1 -0.1 -0.2 -0.2 Contribution from real exchange rate depreciation 7/ 0.4 0.0 -0.1 -0.3 -0.3 -0.2 Contribution from net changes in the assets of the oil stabilization fund 3.4 2.6 2.2 3.0 2.9 2.6 Net inflow in the oil stabilization fund 4.1 3.1 2.7 3.4 3.3 2.9 Contribution from real interest rate on oil assets 8/ -0.7 -0.6 -0.5 -0.4 -0.4 -0.3 Other identified debt-creating flows 0.0 0.0 0.0 0.0 0.0 0.0 Privatization receipts (negative) 0.0 0.0 0.0 0.0 0.0 0.0 Recognition of implicit or contingent liabilities 0.0 0.0 0.0 0.0 0.0 0.0 Other (specify, e.g. bank recapitalization) 0.0 0.0 0.0 0.0 0.0 0.0 Residual, including asset changes (2-3) 0.0 0.0 0.0 0.0 0.0 0.0 Public sector debt-to-revenue ratio 1/ -12.6 14.1 22.7 36.2 49.0 72.2 Primary deficit that stabilizes the debt-to-GDP ratio 16.7 16.3 16.2 16.1 16.3 16.2 Required deficit reduction -9.2 -10.6 -9.9 -11.0 -11.2 -12.4 Low-Scenario oil prices US$/bbl 25.0 25.5 26.0 26.5 27.1 27.6 Oil Reference Prices for Fiscal Rule US$/bbl 33.0 30.0 30.0 30.6 31.2 31.8 Oil stabilization fund net inflow, % of GDP -4.1 -3.1 -2.7 -3.4 -3.3 -2.9 Oil stabilization fund net assets 24.4 21.3 18.6 15.2 11.9 9.0 Non-Oil Primary Deficit, % of Non-Oil GDP 38.1 38.5 35.0 35.0 35.5 36.5 Gross Public Debt (In billions of US dollars) 18.4 17.9 17.5 17.3 17.3 17.5 (In percent of GDP) 16.8 15.4 14.3 13.7 13.1 13.0 Gross financing need 9/ 31.5 43.4 51.2 59.9 67.1 76.5 in billions of U.S. dollars 34.5 50.3 62.3 75.3 88.5 103.5 Projected Key Macroeconomic and Fiscal Assumptions Average Real Oil GDP growth (in percent) 5.1 5.1 5.4 4.0 4.0 4.0 Real Non-Oil GDP growth (in percent) 7.0 5.3 5.4 5.5 5.5 5.5 Real GDP growth (in percent) 6.1 5.2 5.4 4.8 4.8 4.8 5.2 Average nominal interest rate on public debt (in percent) 9/ 6.3 9.6 10.5 10.2 9.7 9.7 9.3 Average nominal interest rate on public domestic debt (in percent) 10/ 16.8 11.9 11.4 10.8 10.1 10.1 11.9 Average nominal interest rate on forex debt (in percent) 10/ 1.0 4.1 3.7 3.2 2.6 2.2 2.8 Average nominal interest rate on NFA (in percent) 11/ 5.0 5.0 5.0 5.0 5.0 5.0 Average real interest rate (including exchange rate revaluation on foreign currency denominat -2.5 4.0 5.2 6.0 6.7 6.7 4.3 Average real interest rate on public domestic debt (nominal rate minus change in CPI, in perce 5.3 5.4 6.0 6.6 7.1 7.1 6.3 Average real interest rate on forex debt (nominal rate minus change in CPI, in percent) -1.4 1.6 1.2 0.7 0.2 -0.3 0.3 Average real interest rate on NFA (nominal rate minus change in CPI, in percent) 2.6 2.5 2.5 2.5 2.5 2.5 2.5 Change in the real exchange rate (Local currency per US dollar) 13/ -4.9 -0.2 0.7 2.0 3.2 3.2 0.6 Nominal appreciation (increase in US dollar value of local currency, in percent) -3.4 -3.5 -3.5 -3.5 -3.5 -3.5 -3.5 Inflation rate (in percent) 11.5 6.5 5.5 4.2 3.0 3.0 5.6 US Inflation rate (in percent) 2.4 2.5 2.5 2.5 2.5 2.5 2.5 Growth of real primary spending (deflated by CPI, in percent) 2.9 7.3 0.2 6.7 7.3 6.9 5.2 Primary deficit 17.9 18.4 17.1 17.5 17.7 18.5 17.9 Base Money (percent of GDP) 5.66 5.63 5.55 5.55 5.55 5.55 39 7. The Bounds Test Sheets Bounds tests are used to assess the behavior of the public debt ratio under different assumptions on key parameters. Shocks equal to 2 standard deviations with respect to the 10-year historical averages during the first two years of the projection period are applied separately to the real interest and growth rates, and the primary balance, respectively. The template also examines debt trajectories in the case of a 30 percent real depreciation of the local currency and a contingent liabilities shock of 10 percent of GDP. The latter is presented as a rough measurement of an increase in debt- creating flows, given the difficulties in discussing contingent liabilities risk.12 In addition, a combined shock of 1 standard deviation with respect to historical averages of these variables for the first two years of the projection period is also reported. The magnitude of shocks to individual variables is consistent with shocks that have typically been observed in the run-up to a crisis. In the same way, the combined shock is consistent with the historical evidence that such shocks do not happen in isolation, but occur simultaneously.13 In all bounds tests, variables revert to the baseline projection after two years.14 It is important to emphasize that these tests do not represent full-fledged scenarios, as there is no interaction among variables. More specifically, the stress tests are built by replacing in the baseline projections the value of one variable (for instance, the interest rate), leaving all other variables unchanged, with only a few exceptions: (i) interest payments on debt are endogenous, i.e., they increase in scenarios where interest rates are higher; (ii) public sector revenues are endogenous with respect to GDP: shocks in the latter also affect revenue; and, of course, (iii) the debt stocks are endogenous. But the remaining parameters are left mostly unchanged: for example, in the stress tests featuring a shock to GDP, the real exchange rate remains unchanged. Each bounds test is calculated in a different sheet, which presents the debt decomposition table and the gross financing needs modified according to the simulated shock. Variables modified in the bounds tests are highlighted in red as in the case of the alternative scenarios. 1) Shock to the Real Interest Rate This shock is represented in sheet "B1_Irate". The real interest rates on domestic and foreign debt are supposed to be equal to their historical average plus 2 standard deviations for the first and second year of projections, respectively. The real interest rates return as in the baseline in the following years (cells O49:P55, Table 9). 12This issue was discussed in detail in SM/03/206. Section V presents various approaches to evaluating risks arising from contingent liabilities, distinguishing between those explicit and implicit in nature. Appendix III contains cross- country econometric evidence on the cost of banking crises. 13See "Sustainability Assessments-Review of Application and Methodological Refinement", IMF, 2003. 14 These shocks are based on the IMF (2003) and serve as a 95 confidence interval around the baseline. In particular, stochastic simulations show that the most extreme bound test provides an upper bound of the debt ratios that is likely to be exceeded only with a probability of less than 1 percent. The second most extreme bound test provides an upper bound likely to be exceeded with a probability between 1 to 5 percent. 40 2) Shock to real GDP Growth This shock is represented in sheet "B2_GDP". The growth rate is assumed to be equal to the historical average minus 2 standard deviations for the first and second year of projections. The growth rate returns as in the baseline in the following years (cells O48:P48, Table 10). 3) Shock to the Primary Balance This shock is represented in sheet "B3_PB". The primary deficit (in percent of GDP) is assumed to be equal to the historical average plus 2 standard deviations for the first and second year of projections. The primary deficit returns as in the baseline in the following years (cells O18:P18, Table 11). In addition, primary expenditure adjusts to be consistent with the new primary balance, while revenue remains unchanged with respect to the baseline (cells O20:P20, Table 11). 4) Combined Shocks to the real interest rate, growth and the primary balance. This shock is represented in sheet "B4_Combined". All three variables are assumed to be equal to their historical averages plus 1 standard deviation for the real interest rate and the primary deficit and minus 1 standard deviation for the growth rate. Shocks are assumed to last the first two years of the projection period. All variables return to their baseline value after the second year (Table. 12). 5) Nominal depreciation This shock is represented in sheet "B5_depreciation". The nominal exchange rate15 is assumed to depreciate by 30 percent in the first year of projection. The rate of change of the exchange rate afterwards is equal to what was assumed in the base case. Thus the level of the nominal exchange rate is permanently modified with respect to the baseline (cell O58, Table 13). 6) Contingent Liability Shock This shock is represented in sheet "B6_CL". The Contingent liabilities shock assumes that other factors increase by 10 percent in the first year of the projection period and return to zero afterwards. The main reason behind this one-off increase is the realization of contingent liabilities. (cell O35, Table 14). 15This scenario assumes inflation as in the baseline. Therefore, the nominal depreciation corresponds to a real depreciation. 41 Table 9. Real Interest Rate Bounds Test. Bound Test 1: Real Interest Rate Shock (In percent of GDP, unless otherwise indicated) Projections 2006 2007 2008 2009 2010 2011 Debt-stabilizing I. Baseline Medium-Term Projections primary deficit Public sector debt 1/ 76.3 96.9 94.4 91.6 88.6 85.4 o/w foreign-currency denominated (net) 22.7 29.8 29.8 31.1 32.9 35.6 o/w foreign-currency denominated (gross) 28.1 34.9 34.7 35.8 37.3 39.7 o/w domestic debt (net) 3/ 53.5 67.1 64.6 60.5 55.8 49.8 Change in public sector debt 15.0 20.6 -2.5 -2.8 -3.0 -3.2 0.0 Identified debt-creating flows (4+7+12) 15.0 20.6 -2.5 -2.8 -3.0 -3.2 0.0 Primary deficit -6.5 -6.5 -6.5 -6.5 -6.5 -6.5 -3.0 Revenue and grants 66.0 65.3 65.3 65.3 65.3 65.3 Primary (noninterest) expenditure 59.4 58.8 58.8 58.8 58.8 58.8 Seigniorage -0.6 -0.5 -0.5 -0.5 -0.5 -0.5 -0.5 Automatic debt dynamics 2/ 22.5 28.0 4.5 4.2 4.0 3.7 3.5 Contribution from interest rate/growth differential 22.8 28.2 4.6 4.5 4.3 4.1 3.8 Of which contribution from real interest rate 25.7 31.8 9.2 8.9 8.6 8.3 7.9 Contribution from domestic real interest rate 4/ 24.2 29.8 6.9 6.6 6.2 5.7 5.1 Contribution from real interest rate on foreign debt 5/ 2.0 2.5 2.7 2.7 2.8 2.9 3.1 Contribution from real interest rate on net foreign assets 6/ -0.5 -0.5 -0.4 -0.4 -0.4 -0.3 -0.3 Of which contribution from real GDP growth -2.9 -3.6 -4.6 -4.5 -4.4 -4.2 -4.1 Contribution from real exchange rate depreciation 7/ -0.3 -0.2 -0.1 -0.2 -0.3 -0.3 -0.4 Other identified debt-creating flows -0.4 -0.4 0.0 0.0 0.0 0.0 0.0 Privatization receipts (negative) -0.4 -0.4 0.0 0.0 0.0 0.0 0.0 Recognition of implicit or contingent liabilities 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Other (specify, e.g. bank recapitalization) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Residual, including asset changes (2-3) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Public debt in percent of revenues 1/ 115.6 148.3 144.5 140.3 135.7 130.8 Primary deficit that stabilizes the debt-to-GDP ratio -21.5 -27.1 -4.0 -3.7 -3.5 -3.2 -3.0 Required deficit reduction 15.0 20.6 -2.5 -2.8 -3.0 -3.2 -3.5 Gross financing 5/ 46.1 58.6 44.4 41.6 38.6 34.9 in billions of U.S. dollars 168.3 230.1 187.5 190.0 190.7 187.4 For debt Key macroeconomic and fiscal assumptions stabilization Real GDP growth (in percent) 5.0 5.0 5.0 5.0 5.0 5.0 5.0 Average nominal interest rate on public debt (percent) 6/ 36.5 35.0 13.0 12.8 12.7 12.5 12.5 Average nominal interest rate on public domestic debt (in percent) 11/ 67.0 65.5 14.6 14.6 14.6 14.6 14.6 Average interest rate on foreign-currrency denominated debt 12.0 12.1 10.9 10.9 10.9 10.9 10.9 Average nominal interest rate on NFA (in percent) 12/ 12.0 12.1 10.9 10.9 10.9 10.9 10.9 Average real interest rate (nominal rate minus change in GDP deflator, percent) 30.5 30.5 9.5 9.3 9.2 9.0 9.0 Average real interest rate on domestic debt (nominal rate minus change in domestic CPI, perc 61.0 61.0 11.2 11.1 11.1 11.1 Average real interest rate on foreign debt debt (nominal rate minus change in U.S. CPI, percen 9.6 9.6 8.4 8.4 8.4 8.4 Change in the real exchange rate (Local currency per US dollar) 13/ -1.0 -0.5 -0.4 -0.8 -0.8 -1.0 -1.0 Nominal depreciation of local currency (LC per dollar) 2.5 1.4 0.5 0.2 0.2 0.0 0.0 Exchange rate (US dollar per LC) 0.0 0.0 0.0 0.0 0.0 0.0 Nominal appreciation of local currency (increase in US dollar value of local currency) -2.4 -1.4 -0.5 -0.2 -0.2 0.0 Inflation rate (in percent) 6.0 4.5 3.5 3.5 3.5 3.5 3.5 US Inflation rate (in percent) 2.4 2.5 2.5 2.5 2.5 2.5 2.5 Growth of real primary spending (deflated by GDP deflator, in percent) 2.8 3.8 5.0 5.0 5.0 5.0 Base Money (percent of GDP) 7.7 7.7 7.7 7.7 7.7 7.7 42 Table 10. Real GDP Bounds Test Bound Test 2: Real Output Shock (In percent of GDP, unless otherwise indicated) Actual Projections 2005 2006 2007 2008 2009 2010 2011 Debt-stabilizing I. Baseline Medium-Term Projections primary deficit Public sector debt 1/ 61.2 71.0 93.7 107.7 122.2 137.3 152.8 o/w foreign-currency denominated (net) 17.1 21.2 28.8 34.0 41.5 50.9 63.6 o/w foreign-currency denominated (gross) 22.7 26.5 33.9 38.9 46.2 55.3 67.8 o/w domestic debt (net) 3/ 44.1 49.9 64.9 73.7 80.7 86.4 89.1 Change in public sector debt -2.0 9.8 22.7 14.1 14.5 15.1 15.5 0.0 Identified debt-creating flows (4+7+12) -1.7 9.8 22.7 14.1 14.5 15.1 15.5 0.0 Primary deficit -6.5 1.3 10.0 10.0 10.0 10.0 10.0 -5.8 Revenue and grants 67.2 66.0 65.3 65.3 65.3 65.3 65.3 Primary (noninterest) expenditure 60.7 67.3 75.3 75.3 75.3 75.3 75.3 Seigniorage -0.6 0.2 0.3 -0.6 -0.6 -0.6 -0.6 -0.6 Automatic debt dynamics 2/ 5.5 8.7 12.9 4.6 5.1 5.6 6.0 6.4 Contribution from interest rate/growth differential 4.5 8.9 13.0 4.8 5.4 6.0 6.5 7.1 Of which contribution from real interest rate 7.4 4.1 7.4 9.2 10.5 11.8 13.1 14.3 Contribution from domestic real interest rate 4/ 6.2 2.4 5.2 6.7 7.5 8.3 8.8 9.1 Contribution from real interest rate on foreign debt 5/ 1.6 1.9 2.4 2.7 3.0 3.6 4.3 5.3 Contribution from real interest rate on net foreign assets 6/ -0.4 -0.2 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 Of which contribution from real GDP growth -2.9 4.8 5.5 -4.5 -5.1 -5.8 -6.5 -7.3 Contribution from real exchange rate depreciation 7/ 0.9 -0.2 -0.1 -0.1 -0.3 -0.3 -0.5 -0.6 Other identified debt-creating flows 0.0 -0.5 -0.5 0.0 0.0 0.0 0.0 0.0 Privatization receipts (negative) 0.0 -0.5 -0.5 0.0 0.0 0.0 0.0 0.0 Recognition of implicit or contingent liabilities 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Other (specify, e.g. bank recapitalization) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Residual, including asset changes (2-3) -0.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Public debt in percent of revenues 1/ 91.1 107.7 143.5 165.0 187.2 210.3 233.9 Primary deficit that stabilizes the debt-to-GDP ratio -4.5 -8.5 -12.6 -4.0 -4.5 -5.0 -5.4 -5.8 Required deficit reduction -2.0 9.8 22.7 14.1 14.5 15.1 15.5 15.9 Gross financing 5/ 36.9 38.5 59.2 66.2 72.3 77.8 82.1 in billions of U.S. dollars 128.9 124.1 181.2 218.3 257.8 300.1 343.9 For debt Key macroeconomic and fiscal assumptions stabilization Real GDP growth (in percent) 4.8 -7.2 -7.2 5.0 5.0 5.0 5.0 5.0 Average nominal interest rate on public debt (percent) 6/ 15.9 11.0 13.2 13.1 13.1 12.9 12.8 Average nominal interest rate on public domestic debt (in percent) 11/ 22.0 11.3 14.6 14.6 14.6 14.6 14.6 14.6 Average interest rate on foreign-currrency denominated debt 10.3 10.4 10.9 10.9 10.9 10.9 10.9 10.9 Average nominal interest rate on NFA (in percent) 12/ 5.0 5.0 5.0 5.0 5.0 5.0 5.0 Average real interest rate (nominal rate minus change in GDP deflator, percent) 9.1 5.0 8.7 9.7 9.6 9.4 9.3 Change in the real exchange rate (Local currency per US dollar) 13/ 5.1 -1.0 -0.5 -0.4 -0.8 -0.8 -1.0 -1.0 Nominal depreciation of local currency (LC per dollar) 9.3 2.5 1.4 0.5 0.2 0.2 0.0 Exchange rate (US dollar per LC) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Nominal appreciation of local currency (increase in US dollar value of local currency) -8.5 -2.4 -1.4 -0.5 -0.2 -0.2 0.0 Inflation rate (in percent) 6.8 6.0 4.5 3.5 3.5 3.5 3.5 3.5 US Inflation rate (in percent) 2.7 2.4 2.5 2.5 2.5 2.5 2.5 2.5 Growth of real primary spending (deflated by GDP deflator, in percent) 5.9 2.8 3.8 5.0 5.0 5.0 5.0 Base Money (percent of GDP) 7.8 7.7 7.7 7.7 7.7 7.7 7.7 43 Table 11. Primary Balance Bounds Test Bound Test 3: Primary Balance Shock (In percent of GDP, unless otherwise indicated) Actual Projections 2005 2006 2007 2008 2009 2010 2011 Debt-stabilizing I. Baseline Medium-Term Projections primary deficit Public sector debt 1/ 61.2 60.1 61.1 57.1 52.8 48.2 43.4 o/w foreign-currency denominated (net) 17.1 17.9 18.8 18.0 17.9 17.9 18.1 o/w foreign-currency denominated (gross) 22.7 23.2 23.9 22.9 22.6 22.3 22.2 o/w domestic debt (net) 3/ 44.1 42.2 42.3 39.1 34.8 30.3 25.3 Change in public sector debt -2.0 -1.2 1.0 -4.0 -4.3 -4.6 -4.9 0.0 Identified debt-creating flows (4+7+12) -1.7 -1.2 1.0 -4.0 -4.3 -4.6 -4.9 0.0 Primary deficit -6.5 -0.6 -0.6 -6.5 -6.5 -6.5 -6.5 -1.4 Revenue and grants 67.2 66.0 65.3 65.3 65.3 65.3 65.3 Primary (noninterest) expenditure 60.7 65.4 64.7 58.8 58.8 58.8 58.8 Seigniorage -0.6 -0.7 -0.6 -0.6 -0.6 -0.6 -0.6 -0.6 Automatic debt dynamics 2/ 5.5 0.6 2.7 3.1 2.8 2.6 2.3 2.0 Contribution from interest rate/growth differential 4.5 0.7 2.7 3.2 3.0 2.7 2.5 2.2 Of which contribution from real interest rate 7.4 3.7 5.6 6.1 5.7 5.2 4.8 4.2 Contribution from domestic real interest rate 4/ 6.2 2.1 3.9 4.4 4.0 3.6 3.1 2.6 Contribution from real interest rate on foreign debt 5/ 1.6 1.7 1.8 1.9 1.8 1.8 1.7 1.7 Contribution from real interest rate on net foreign assets 6/ -0.4 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 Of which contribution from real GDP growth -2.9 -2.9 -2.9 -2.9 -2.7 -2.5 -2.3 -2.1 Contribution from real exchange rate depreciation 7/ 0.9 -0.2 -0.1 -0.1 -0.1 -0.1 -0.2 -0.2 Other identified debt-creating flows 0.0 -0.4 -0.4 0.0 0.0 0.0 0.0 0.0 Privatization receipts (negative) 0.0 -0.4 -0.4 0.0 0.0 0.0 0.0 0.0 Recognition of implicit or contingent liabilities 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Other (specify, e.g. bank recapitalization) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Residual, including asset changes (2-3) -0.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Public debt in percent of revenues 1/ 91.1 91.1 93.6 87.4 80.8 73.8 66.4 Primary deficit that stabilizes the debt-to-GDP ratio -4.5 0.6 -1.6 -2.5 -2.2 -2.0 -1.7 -1.4 Required deficit reduction -2.0 -1.2 1.0 -4.0 -4.3 -4.6 -4.9 -5.1 Gross financing 5/ 36.9 31.1 32.4 24.6 21.6 18.5 15.0 in billions of U.S. dollars 128.9 113.5 127.1 104.0 98.9 91.2 80.6 For debt Key macroeconomic and fiscal assumptions stabilization Real GDP growth (in percent) 4.8 5.0 5.0 5.0 5.0 5.0 5.0 5.0 Average nominal interest rate on public debt (percent) 6/ 15.9 11.0 13.2 13.1 13.1 12.9 12.8 Average nominal interest rate on public domestic debt (in percent) 11/ 22.0 11.3 14.6 14.6 14.6 14.6 14.6 14.6 Average interest rate on foreign-currrency denominated debt 10.3 10.4 10.9 10.9 10.9 10.9 10.9 10.9 Average nominal interest rate on NFA (in percent) 12/ 5.0 5.0 5.0 5.0 5.0 5.0 5.0 Average real interest rate (nominal rate minus change in GDP deflator, percent) 9.1 5.0 8.7 9.7 9.6 9.4 9.3 Change in the real exchange rate (Local currency per US dollar) 13/ 5.1 -1.0 -0.5 -0.4 -0.8 -0.8 -1.0 -1.0 Nominal depreciation of local currency (LC per dollar) 9.3 2.5 1.4 0.5 0.2 0.2 0.0 Exchange rate (US dollar per LC) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Nominal appreciation of local currency (increase in US dollar value of local currency) -8.5 -2.4 -1.4 -0.5 -0.2 -0.2 0.0 Inflation rate (in percent) 6.8 6.0 4.5 3.5 3.5 3.5 3.5 3.5 US Inflation rate (in percent) 2.7 2.4 2.5 2.5 2.5 2.5 2.5 2.5 Growth of real primary spending (deflated by GDP deflator, in percent) 5.9 13.0 3.9 -4.6 5.0 5.0 5.0 Base Money (percent of GDP) 7.8 7.7 7.7 7.7 7.7 7.7 7.7 44 Table 12. Combined Bounds Test Bound Test 4: Combined One Standard Deviation Shock (In percent of GDP, unless otherwise indicated) Actual Projections 2005 2006 2007 2008 2009 2010 2011 Debt-stabilizing I. Baseline Medium-Term Projections primary deficit Public sector debt 1/ 61.2 76.9 97.2 96.3 95.1 93.8 92.2 o/w foreign-currency denominated (net) 17.1 22.9 29.9 30.4 32.3 34.8 38.4 o/w foreign-currency denominated (gross) 22.7 28.2 35.0 35.3 36.9 39.2 42.6 o/w domestic debt (net) 3/ 44.1 54.0 67.4 65.9 62.8 59.0 53.8 Change in public sector debt -2.0 15.6 20.4 -1.0 -1.2 -1.3 -1.6 0.0 Identified debt-creating flows (4+7+12) -1.7 15.6 20.4 -1.0 -1.2 -1.3 -1.6 0.0 Primary deficit -6.5 -3.3 -3.3 -6.5 -6.5 -6.5 -6.5 -4.6 Revenue and grants 67.2 66.0 65.3 65.3 65.3 65.3 65.3 Primary (noninterest) expenditure 60.7 62.6 62.0 58.8 58.8 58.8 58.8 Seigniorage -0.6 0.2 0.2 0.6 0.6 0.6 0.6 0.6 Automatic debt dynamics 2/ 5.5 19.1 24.0 4.9 4.7 4.6 4.3 4.0 Contribution from interest rate/growth differential 4.5 19.3 24.1 5.1 5.0 4.8 4.7 4.4 Of which contribution from real interest rate 7.4 18.3 22.9 9.6 9.4 9.2 9.0 8.7 Contribution from domestic real interest rate 4/ 6.2 17.0 21.1 6.9 6.7 6.4 6.0 5.5 Contribution from real interest rate on foreign debt 5/ 1.6 1.8 2.2 2.7 2.8 2.9 3.1 3.3 Contribution from real interest rate on net foreign assets 6/ -0.4 -0.4 -0.4 -0.1 -0.1 -0.1 -0.1 -0.1 Of which contribution from real GDP growth -2.9 1.0 1.3 -4.5 -4.4 -4.4 -4.3 -4.4 Contribution from real exchange rate depreciation 7/ 0.9 -0.2 -0.1 -0.1 -0.2 -0.3 -0.3 -0.4 Other identified debt-creating flows 0.0 -0.4 -0.5 0.0 0.0 0.0 0.0 0.0 Privatization receipts (negative) 0.0 -0.4 -0.5 0.0 0.0 0.0 0.0 0.0 Recognition of implicit or contingent liabilities 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Other (specify, e.g. bank recapitalization) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Residual, including asset changes (2-3) -0.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Public debt in percent of revenues 1/ 91.1 116.5 148.9 147.4 145.6 143.6 141.2 Primary deficit that stabilizes the debt-to-GDP ratio -4.5 -18.9 -23.7 -5.5 -5.3 -5.2 -5.0 -4.6 Required deficit reduction -2.0 15.6 20.4 -1.0 -1.2 -1.3 -1.6 -1.9 Gross financing 5/ 36.9 44.4 55.5 45.2 43.2 41.0 38.0 in billions of U.S. dollars 128.9 151.7 191.3 167.7 173.3 177.7 178.9 For debt Key macroeconomic and fiscal assumptions stabilization Real GDP growth (in percent) 4.8 -1.6 -1.6 5.0 5.0 5.0 5.0 5.0 Average nominal interest rate on public debt (percent) 6/ 15.9 25.3 23.8 13.0 12.8 12.7 12.5 12.5 Average nominal interest rate on public domestic debt (in percent) 11/ 22.0 46.2 44.6 14.6 14.6 14.6 14.6 14.6 Average interest rate on foreign-currrency denominated debt 10.3 10.2 10.3 10.9 10.9 10.9 10.9 10.9 Average nominal interest rate on NFA (in percent) 12/ 10.2 10.3 5.0 5.0 5.0 5.0 5.0 Average real interest rate (nominal rate minus change in GDP deflator, percent) 9.1 19.3 19.3 9.5 9.3 9.2 9.0 9.0 Average real interest rate on domestic debt (nominal rate minus change in domestic CPI, p 15.2 40.2 40.2 11.2 11.1 11.1 11.1 Average real interest rate on foreign debt debt (nominal rate minus change in U.S. CPI, percent) 7.8 7.8 8.4 8.4 8.4 8.4 Change in the real exchange rate (Local currency per US dollar) 13/ 5.1 -1.0 -0.5 -0.4 -0.8 -0.8 -1.0 -1.0 Nominal depreciation of local currency (LC per dollar) 9.3 2.5 1.4 0.5 0.2 0.2 0.0 0.0 Exchange rate (US dollar per LC) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Nominal appreciation of local currency (increase in US dollar value of local currency) -8.5 -2.4 -1.4 -0.5 -0.2 -0.2 0.0 Inflation rate (in percent) 6.8 6.0 4.5 3.5 3.5 3.5 3.5 3.5 US Inflation rate (in percent) 2.7 2.4 2.5 2.5 2.5 2.5 2.5 2.5 Growth of real primary spending (deflated by GDP deflator, in percent) 5.9 1.5 -2.7 -0.4 5.0 5.0 5.0 Base Money (percent of GDP) 7.8 7.7 7.7 7.7 7.7 7.7 7.7 45 Table 13. Nominal Exchange Rate Depreciation Bound Test 5: Real Exchange Rate Shock (In percent of GDP, unless otherwise indicated) Actual Projections 2005 2006 2007 2008 2009 2010 2011 Debt-stabilizing I. Baseline Medium-Term Projections primary deficit Public sector debt 1/ 61.2 63.5 58.7 54.6 50.2 45.5 40.6 o/w foreign-currency denominated (net) 17.1 24.6 23.0 21.4 20.5 19.5 18.4 o/w foreign-currency denominated (gross) 22.7 32.7 30.8 28.8 27.6 26.2 24.8 o/w domestic debt (net) 3/ 44.1 38.9 35.8 33.2 29.7 26.1 22.2 Change in public sector debt -2.0 2.2 -4.7 -4.1 -4.4 -4.7 -4.9 0.0 Identified debt-creating flows (4+7+12) -1.7 2.2 -4.7 -4.1 -4.4 -4.7 -4.9 0.0 Primary deficit -6.5 -6.5 -6.5 -6.5 -6.5 -6.5 -6.5 -1.3 Revenue and grants 67.2 66.0 65.3 65.3 65.3 65.3 65.3 Primary (noninterest) expenditure 60.7 59.4 58.8 58.8 58.8 58.8 58.8 Seigniorage -0.6 -0.7 -0.6 -0.6 -0.6 -0.6 -0.6 -0.6 Automatic debt dynamics 2/ 5.5 9.8 2.8 3.0 2.7 2.5 2.2 1.9 Contribution from interest rate/growth differential 4.5 0.7 3.0 3.1 2.9 2.6 2.4 2.1 Of which contribution from real interest rate 7.4 3.7 6.0 5.9 5.5 5.0 4.6 4.1 Contribution from domestic real interest rate 4/ 6.2 2.1 3.6 3.7 3.4 3.0 2.7 2.3 Contribution from real interest rate on foreign debt 5/ 1.6 1.7 2.6 2.4 2.3 2.2 2.0 1.9 Contribution from real interest rate on net foreign assets 6/ -0.4 -0.1 -0.2 -0.2 -0.2 -0.2 -0.2 -0.1 Of which contribution from real GDP growth -2.9 -2.9 -3.0 -2.8 -2.6 -2.4 -2.2 -1.9 Contribution from real exchange rate depreciation 7/ 0.9 9.1 -0.1 -0.1 -0.2 -0.2 -0.2 -0.2 Other identified debt-creating flows 0.0 -0.4 -0.4 0.0 0.0 0.0 0.0 0.0 Privatization receipts (negative) 0.0 -0.4 -0.4 0.0 0.0 0.0 0.0 0.0 Recognition of implicit or contingent liabilities 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Other (specify, e.g. bank recapitalization) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Residual, including asset changes (2-3) -0.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Public debt in percent of revenues 1/ 91.1 96.2 90.0 83.6 76.9 69.7 62.2 Primary deficit that stabilizes the debt-to-GDP ratio -4.5 -8.7 -1.8 -2.4 -2.1 -1.9 -1.6 -1.3 Required deficit reduction -2.0 2.2 -4.7 -4.1 -4.4 -4.7 -4.9 -5.2 Gross financing 5/ 36.9 26.6 25.9 23.3 20.3 17.1 13.7 in billions of U.S. dollars 128.9 97.1 102.1 99.4 93.9 85.9 74.7 For debt Key macroeconomic and fiscal assumptions stabilization Real GDP growth (in percent) 4.8 5.0 5.0 5.0 5.0 5.0 5.0 5.0 Average nominal interest rate on public debt (percent) 6/ 15.9 11.0 13.2 13.1 13.1 12.9 12.8 Average nominal interest rate on public domestic debt (in percent) 11/ 22.0 11.3 14.6 14.6 14.6 14.6 14.6 14.6 Average interest rate on foreign-currrency denominated debt 10.3 10.4 10.9 10.9 10.9 10.9 10.9 10.9 Average nominal interest rate on NFA (in percent) 12/ 5.0 5.0 5.0 5.0 5.0 5.0 5.0 Average real interest rate (nominal rate minus change in GDP deflator, percent) 9.1 5.0 8.7 9.7 9.6 9.4 9.3 Change in the real exchange rate (Local currency per US dollar) 13/ 5.1 50.9 -0.5 -0.4 -0.8 -0.8 -1.0 -1.0 Nominal depreciation of local currency (LC per dollar) 9.3 56.2 1.4 0.5 0.2 0.2 0.0 Exchange rate (US dollar per LC) 0.0 0.000 0.000 0.000 0.000 0.000 0.000 Nominal appreciation of local currency (increase in US dollar value of local currency) -8.5 -36.0 -1.4 -0.5 -0.2 -0.2 0.0 Inflation rate (in percent) 6.8 6.0 4.5 3.5 3.5 3.5 3.5 3.5 US Inflation rate (in percent) 2.7 2.4 2.5 2.5 2.5 2.5 2.5 2.5 Growth of real primary spending (deflated by GDP deflator, in percent) 5.9 2.8 3.8 5.0 5.0 5.0 5.0 Base Money (percent of GDP) 7.8 7.7 7.7 7.7 7.7 7.7 7.7 46 Table 14. Contingent Liabilities Shock Bound Test 6: Contingent Liability Shock (In percent of GDP, unless otherwise indicated) Actual Projections 2005 2006 2007 2008 2009 2010 2011 Debt-stabilizing I. Baseline Medium-Term Projections primary deficit Public sector debt 1/ 61.2 64.2 59.4 55.4 51.0 46.4 41.5 o/w foreign-currency denominated (net) 17.1 19.1 18.3 17.5 17.3 17.2 17.3 o/w foreign-currency denominated (gross) 22.7 24.5 23.4 22.4 22.0 21.6 21.4 o/w domestic debt (net) 3/ 44.1 45.0 41.2 37.9 33.7 29.2 24.2 Change in public sector debt -2.0 2.9 -4.7 -4.1 -4.4 -4.6 -4.9 0.0 Identified debt-creating flows (4+7+12) -1.7 2.9 -4.7 -4.1 -4.4 -4.6 -4.9 0.0 Primary deficit -6.5 -6.5 -6.5 -6.5 -6.5 -6.5 -6.5 -1.3 Revenue and grants 67.2 66.0 65.3 65.3 65.3 65.3 65.3 Primary (noninterest) expenditure 60.7 59.4 58.8 58.8 58.8 58.8 58.8 Seigniorage -0.6 -0.7 -0.6 -0.6 -0.6 -0.6 -0.6 -0.6 Automatic debt dynamics 2/ 5.5 0.6 2.8 3.0 2.7 2.5 2.2 1.9 Contribution from interest rate/growth differential 4.5 0.7 2.9 3.1 2.9 2.6 2.4 2.1 Of which contribution from real interest rate 7.4 3.7 6.0 6.0 5.5 5.1 4.6 4.1 Contribution from domestic real interest rate 4/ 6.2 2.1 4.2 4.2 3.9 3.4 3.0 2.5 Contribution from real interest rate on foreign debt 5/ 1.6 1.7 1.9 1.8 1.8 1.7 1.7 1.7 Contribution from real interest rate on net foreign assets 6/ -0.4 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 Of which contribution from real GDP growth -2.9 -2.9 -3.1 -2.8 -2.6 -2.4 -2.2 -2.0 Contribution from real exchange rate depreciation 7/ 0.9 -0.2 -0.1 -0.1 -0.1 -0.1 -0.2 -0.2 Other identified debt-creating flows 0.0 9.6 -0.4 0.0 0.0 0.0 0.0 0.0 Privatization receipts (negative) 0.0 -0.4 -0.4 0.0 0.0 0.0 0.0 0.0 Recognition of implicit or contingent liabilities 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Other (specify, e.g. bank recapitalization) 0.0 10.0 0.0 0.0 0.0 0.0 0.0 0.0 Residual, including asset changes (2-3) -0.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Public debt in percent of revenues 1/ 91.1 97.3 91.0 84.8 78.1 71.0 63.5 Primary deficit that stabilizes the debt-to-GDP ratio -4.5 -9.4 -1.8 -2.4 -2.1 -1.9 -1.6 -1.3 Required deficit reduction -2.0 2.9 -4.7 -4.1 -4.4 -4.6 -4.9 -5.2 Gross financing 5/ 36.9 26.9 26.2 23.7 20.7 17.6 14.1 in billions of U.S. dollars 128.9 98.3 103.0 100.2 94.7 86.8 75.8 For debt Key macroeconomic and fiscal assumptions stabilization Real GDP growth (in percent) 4.8 5.0 5.0 5.0 5.0 5.0 5.0 5.0 Average nominal interest rate on public debt (percent) 6/ 15.9 11.0 13.2 13.1 13.1 12.9 12.8 Average nominal interest rate on public domestic debt (in percent) 11/ 22.0 11.3 14.6 14.6 14.6 14.6 14.6 14.6 Average interest rate on foreign-currrency denominated debt 10.3 10.4 10.9 10.9 10.9 10.9 10.9 10.9 Average nominal interest rate on NFA (in percent) 12/ 5.0 5.0 5.0 5.0 5.0 5.0 5.0 Average real interest rate (nominal rate minus change in GDP deflator, percent) 9.1 5.0 8.7 9.7 9.6 9.4 9.3 Change in the real exchange rate (Local currency per US dollar) 13/ 5.1 -1.0 -0.5 -0.4 -0.8 -0.8 -1.0 -1.0 Nominal depreciation of local currency (LC per dollar) 9.3 2.5 1.4 0.5 0.2 0.2 0.0 Exchange rate (US dollar per LC) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Nominal appreciation of local currency (increase in US dollar value of local currency) -8.5 -2.4 -1.4 -0.5 -0.2 -0.2 0.0 Inflation rate (in percent) 6.8 6.0 4.5 3.5 3.5 3.5 3.5 3.5 US Inflation rate (in percent) 2.7 2.4 2.5 2.5 2.5 2.5 2.5 2.5 Growth of real primary spending (deflated by GDP deflator, in percent) 5.9 2.8 3.8 5.0 5.0 5.0 5.0 Base Money (percent of GDP) 7.8 7.7 7.7 7.7 7.7 7.7 7.7 47 8. Summary of Output The FS template also provides a summary of output for public debt dynamics, and gross financing needs under the baseline, the alternative scenarios and bounds tests. These results are summarized in the sheet "Table_SR" (see Table 2). The results of each alternative scenario and bounds tests are reported in the bottom section of sheet "Table_SR" in cells B70:AA82 (Figure 13). Together with debt dynamics, the output table reports the debt stabilizing primary balance for each alternative scenario and bounds test. . The gross financing needs for different scenarios and bounds tests are presented in the sheet "Table_GF". Analogous output tables are also reported for ORCs. Figure 13. Representation of Alternative Scenarios and Bounds Tests The sheet "Figure" provides a graphical summary of the results (see Fig. 14). Both charts report debt trends and gross financing needs for the projection period according to the baseline, to the two most extreme stress tests (including bounds tests, the historical scenario and the no policy-change scenario) and to the alternative scenario. 48 Figure 14. Debt Ratios and Gross Financing Needs 180 Debt-to-GDP Ratio (in percent) 160 Baseline Alternative scenario (country-specific shock) 140 Second most extreme stress test Most extreme stress test 120 100 80 60 40 20 2005 2006 2007 2008 2009 2010 2011 450 Gross External Financing Need (in billions of U.S. dollars) 400 Baseline Alternative scenario (country-specific shock) 350 Second most extreme stress test Most extreme stress test 300 250 200 150 100 50 0 2005 2006 2007 2008 2009 2010 2011 Source: Staff calculations. 49 The results of the stochastic simulations are presented in sheet "Graph DSP SIM" through fan charts (Figure 15) that report the realizations of the debt-to-GDP ratio and the Required Deficit Reduction in percent of GDP between the bottom and to top 2.5 percentiles. The charts report the results of the stochastic simulations according to the chosen percentiles and the baseline debt to GDP ratio or required deficit reduction. If the fiscal reaction function is enabled, the charts report also for which scenarios the fiscal reaction function has been activated. Figure 15. Stochastic Simulations of Net Public Debt and Required Deficit Reduction 50 References Anand, R., R. Rocha and S. van Wijnbergen, (1988), "Inflation, External Debt and Financial Sector Reform: A Quantitative Approach to Consistent Fiscal Policy with an Application to Turkey", NBER Working Paper No.2731. Anand, Ritu & van Wijnbergen, Sweder, 1989. "Inflation and the Financing of Government Expenditure: An Introductory Analysis with an Application to Turkey," World Bank Economic Review, Oxford University Press, vol. 3(1), pages 17-38. Baunsgaard, T. (2003), "Fiscal Policy in Nigeria: Any Role for Rules?", IMF Working Paper 03/155, International Monetary Fund, Washington D.C. Blanchard, Olivier, 2004 "Fiscal Dominance and Inflation Targeting: Lessons from Brazil", NBER Working Paper 10389 Budina, N. and N. Fiess, (2005), "Public debt and Its Determinants in Market Access Countries: results from 15 Case Studies.", mimeo World Bank. Budina, N. and S. van Wijnbergen, (2007), "Quantitative Approaches to Fiscal Sustainability Analysis: A New World Bank Tool applied to Turkey", World Bank WP#4169. Buiter, Willem, H. (1990), Principles of Budgetary and Financial Policy, Harvester Wheatsheaf, Hertfordshire, UK. Buiter, Willem, H.(2003). "Fiscal Sustainability", 2004, mimeo EBRD. Burnside, Craig (2005), Fiscal Sustainability in Theory and Practice: A Handbook, The World Bank, Washington DC. Burnside, Craig (2004), Assessing New Approaches to Fiscal Sustainability Analysis, World Bank, mimeo. Brixi, Hana Polackova and Allen Schick (editors) (2002), "Government at Risk: Contingent Liabilities and Fiscal risk." World Bank and Oxford University Press. Davis, J. M., R. Ossowski, and A. Fedelino (2003), "Fiscal Policy Formulation and Implementation in Oil-Producing Countries", Washington, D.C.: International Monetary Fund Dervis, Kemal and Nancy Birdsall (2005), "A Stability and Growth Facility", discussion paper prepared for the conference on IMF Reform, Institute for International Economics, IIE mimeo, Washington DC. 51 Devlin, Julia and Michael Lewin (2004), "Managing Oil Booms and Busts in Developing Countries". In Joshua Aizenman and Brian Pinto, editors, Managing Economic Volatility and Crises: A Practitioner's Guide. Cambridge University Press, 2005, forthcoming. Frankel, Jeffrey, and Shang-Jin Wei (2004), "Managing Macroeconomic Crises: Policy Lessons", in Joshua Aizenman and Brian Pinto, editors, Managing Economic Volatility and Crises: A practitioner's Guide. Cambridge University Press, forthcoming. Gill, Indermit and Brian Pinto (2005), "Public Debt in Developing Countries: Has the Market- Based Model Worked?", Policy Research Working Paper 3674, World Bank. Heller, Peter S. (2005), "Understanding Fiscal Space." PDP/05/4. IMF. IMF (2002), Assessing Sustainability, Washington DC. IMF (2003), Sustainability Assessments ­ Review of Aplication and Methodological Refinements. IMF(2003), "Public Debt in Emerging Markets: Is It Too High?, Chapter III, World Economic Outlook, IMF. IMF (2005), "Government Guarantees and Fiscal Risk." March. IMF and IDA(2005), Operational Framework for Debt Sustainability Assessments in Low- Income Countries ­ Further Considerations, March 28, 2005, Washington DC. Ntamatungiro, Joseph (2004), "Fiscal Sustainability in Heavily Indebted Countries Dependent on Nonrenewable Resources: The Case of Gabon", IMF Working Paper 04/30. Pinto, Guvich, and Ulatov (2004), "Lessons from the Russian Crisis of 1998 and Recovery", in Managing Volatility and Crises: A Practitioner's Guide, edds. Aizenman and Pinto. Sargent and Wallace (1981), "Some Unpleasant Monetarist Arithmetic", The Federal Reserve of Bank of Minneapolis Quarterly Review, pp. 1-17. World Bank, Azerbaijan Public Expenditure Review, 2002 World Bank, Kazakhstan Country Economic Memorandum, 2005 and background papers on oil wealth management. World Bank(2005), How To Do a debt Sustainability Analysis for Low-Income Countries, May 20, 2005, Washington DC. 52 Glossary Amortization Amortization is the process of reducing a debt through regular installment payments, as opposed to paying off the debt all at once. Payments usually include repayment of principal and interest. Arrears Arrears are overdue payments of principal and/or interest. Balance of Payment (BoP) Balance of Payment (BoP) is a statistical statement that systematically summarizes, for a specific time period, the economic transactions of an economy with the rest of the world. Transactions, for the most part between residents and nonresidents, consist of those involving goods, services, and income; those involving financial claims on, and liability to, the rest of the world; and those (such as gift) classified as transfers, which involve offsetting entries to balance ­ in an accounting case ­ one-sided transactions. Base Money Base money is also called monetary base, or high-powered money. Composed of currency and coins outside the banking system plus Central Bank liabilities to the deposit money banks (reserves held by the latter at the Central Bank). The control over the amount of high-powered money in the economy is the main route through which the monetary authorities control the money supply. Bounds Test Bounds tests are a way to assess the behavior of the public debt ratio after shocks to key variables. Under bounds tests, variables are assumed far away from their values in the baseline scenario. A common approach is to assume an increase/decrease of twice the standard deviation of the relevant variable. Cagan Money Demand Function In a Cagan money demand function, nominal base money stock, M at the end of each period t-1 is a loglinear function of nominal income and expected average inflation during the period t: M eopt-1= AYt e- et Pt Where Mt eop -1 is Base Money at the end of period t-1, Pt is the average price level in year t, Yt is real GDP in year t, is the semi-elasticity of money demand with respect to inflation and A is a constant term. This functional form was used by Cagan in his analysis of the German hyperinflation. 53 Capital Account of the Balance of Payments The Capital account of a country is an account of the balance of payments which records capital transfers and the acquisition and disposal of non-produced, non-financial assets between individuals, businesses, and government agencies in that country and those in other countries. These transactions are separated from transactions recorded on current account because capital account transactions are not directly related to the process of production and consumption. Choleski Factorization The Cholesky decomposition is named after André-Louis Cholesky, who found that a symmetric positive-definite matrix can be decomposed into a lower triangular matrix and the transpose of the lower triangular matrix. The lower triangular matrix is called the Cholesky factorization of the original, positive-definite matrix. Contingent/hidden Liability Contingent liabilities are characterized by the fact that one or more conditions must be fulfilled before a financial transaction takes place. They may arise from obligations from government guarantees of minimum pension or deposit insurance, the pension reform (or the absence of it), non-sovereign borrowing and liabilities of regional and local governments, government insurance schemes as well as bank failures and other financial sector bailouts. They are usually not explicitly shown on government accounts. Concessional Rescheduling Concessional Rescheduling is a rescheduling of debt that leads to a reduction in the net present value of future debt service payments. Consolidated Accounts of the Public Sector Consolidated Accounts of the Public Sector in this paper include the accounts of the general and local (state, province, municipalities...) government and the Central Bank. Contemporaneous and Serial Correlation Contemporaneous correlation is the correlation between two contemporaneous (the same time period) variables such as Xt and Yt. Serial correlation is the correlation between the observations of one variable in different time periods, such as Xt and Xt-1. Also refer to Correlation. Correlation Correlation is a statistical measure of how much the movements of two random variables are related. The degree of correlation is measured by correlation coefficient ranging between -1 and +1. A result of -1 means a perfect negative correlation, +1 means a perfect positive correlation, and 0 means no correlation at all. A positive correlation between two variables means that they tend to move up and down together. A zero correlation means that the change in value of one variable has no impact or bearing on the change in value of the other variable. Current Account Current Account is an account in the balance of payments which records the transactions with the rest of the world in three broad categories: goods and services (which is subdivided into 54 goods and services), income (including interest, profits and wages) and current transfer (grants received and given). Indexed Debt Indexed Debt is debt whose principal value is linked to external variables such as the price level or a country's exchange rate with respect to a particular currency (usually the US dollar). Debt Relief Debt relief is an arrangement intended to reduce the burden of debt on a country, usually including forgiveness of part or all of what is owed to creditors who may include private banks and other entities, government, or international financial institutions. Debt Service Debt service is the sum of interest payments and repayments of principal made on a periodic base on a debt instrument. Deficit Monetization Financing government deficits by issuing base money. Domestic Debt Domestic debt generally refers to the debt owed to creditors resident in the same country as the debtor, and denominated in local currency, but it is possible for debtors to issue local currency debts that can be purchased by non-residents and held abroad. It is also possible for governments to issue domestic debt in a foreign currency (e.g. US dollar -denominated bonds). Domestic Public Debt Public debt refers to debt owed by the public sector, including central, region and local government and public enterprises, of which government holds more than 50% of ownership. Also refer to Domestic Debt. Elasticity of money demand with respect to nominal interest rates In Economics, elasticity means the incremental percentage change in one variable divided by the percentage change of another variable triggering the change in the first variable. Emerging Markets markets in newly industrialized or developing countries with capital markets at early stages of institutional development. Endogeneity In econometrics, endogeneity refers to the fact that a variable included in a model is determined within the model. If it is not, the variable is exogenous. Expenditure An amount of money that is spent on goods and services. Expenditure is part of payments by government that do not arise because of an obligation incurred earlier. A loan repayment is not expenditure, but interest is. 55 Export Credit Agency Export credit agency provides generally non-concessional export credits (loans). In addition to concessional financing, most governments of developed countries either extend non-concessional export credit loans directly to the borrower or provide guarantees of export credit finance obtained by exporters from banks and financial institutions. External Debt External debt is the part of a country's debt owed to creditors outside the country, which will require payment of principal and/or interest at some point in the future. This includes debt owed to private commercial banks, governments, or international financial institutions. External Public Debt Refer to External Debt and Public Debt. Extrabudgetary At each level of government, there are three groups of operations: budgetary, extrabudgetary and social security. Budgetary operations are covered in the budget. Extrabudgetary operations, which are carried out outside of the budget, raise resources through compulsory levies and provide nonmarket goods and services. Social security schemes are a special category of extrabudgetary operations. Fan Chart Fan Charts are used to depict confidence bands corresponding to different degrees of uncertainty around the median projections, for example of debt-to-GDP ratios. Fiscal Dominance Fiscal dominance refers to the situation where higher real interest rates on public debt lead to increased fears of default and therefore higher risk premia and again higher real interest rates. In such circumstances using active interest rate rules to combat inflation destabilizes the economy (Blanchard (2005), Schabert and van Wijnbergen (2006). Fiscal Reaction Function The fiscal reaction function models primary balance as function of its underlying variables. The idea is that fiscal outcome is not independent and government and policy makers deliberately adjust policies in response to different economic and fiscal conditions. Fiscal Rule In the widest sense, fiscal rule refers to budgetary institution, or a set of rules and regulations according to which budgets are drafted, approved and implemented. In a more narrow sense, the term refers to legislated restrictions on fiscal policy that set specific limits on aggregate fiscal indicators such as the fiscal balance, primary balance (non-interest surplus), debt and expenditure or taxation. Fiscal Sustainability Fiscal sustainability refers to government fiscal policies. A set of fiscal policies is unsustainable if the present and prospective fiscal stance results in a persistent and rapid increase in the public 56 debt-to-GDP ratio. Fiscal sustainability is closely linked to the concepts of solvency and liquidity. Floating Exchange Rate Floating exchange rate is also called flexible exchange rate or market-determined exchange rate. It is the exchange rate that is determined by the unregulated forces of supply and demand. General Government General government comprises central government, state/regional government and local government. General Government Account General Government Account is the record of fiscal revenue, expenditure and balance of general government. Government Budget Constraint Government Budget Constraint implies that any excess of government expenditure and net interest payment on debts over current revenue (taxes) has to be financed by public borrowing, sale of assets or money creation. It can be shown in an equation: Government financial deficit Financing sources Primary expenditure Debt sales to the public + Net interest payments on debt = + Sales of PS assets - Taxes + Money creation Gross Financing Need The gross financing need measures how much cash the government has to have in hand to cover all the claims coming due in the current year. It is calculated as the sum of the amortization of foreign and domestic public debt coming due during the current year, the interest expenditure, and the primary deficit also for the current year. HP-filter The Hodrick-Prescott filter (HP-filter) is a mathematical tool used in macroeconomics, specifically in the analysis of business cycles. It is used to obtain a smoothed non-linear representation of a time series, one that is more sensitive to long-term than to short-term fluctuations. The adjustment of the sensitivity of the trend to short-term fluctuations is achieved by modifying a multiplier . The reasoning for the formula is as follows: Let yt for t =1,2,...,T denote the logarithms of a time series variable. Given an adequately chosen, positive value of , there is a "trend component", denoted by , that minimizes 57 Inflation Targeting Inflation targeting has been adopted by several countries with floating exchange rate systems, as a way to anchor inflation expectations. Its most distinguishing feature is the announcement of a quantitative target for inflation. It evolved most directly from the practices of Germany's Bundesbank and the Swiss National Bank in late 1970s and 1980s. For example, the Bundesbank, though it conducted short-term policy with reference to targets for money supply growth, derived those targets each year by calculating the rate of money growth estimated to be consistent with the bank's long-run desired rate of inflation, normally 2 percent per year. Hence, the Bundesbank indirectly targeted inflation, using money growth as a quantitative indicator to aid in the calibration of its policy. Notably, the evidence suggests that, when conflicts arose between its money growth targets and inflation targets, the Bundesbank generally chose to give greater weight to its inflation targets Inflation Tax Inflation tax is the amount of nominal money balances individuals have to accumulate just to keep the real value of money balances constant, and is calculated as the product of inflation rate (tax rate) and real base money (tax base). Inflation tax transfers purchasing power from household to government. Intertemporal Constraint of Government The intertemporal, or solvency constraint of a government requires the present value of future primary fiscal surpluses and seigniorage to be at least as large as present value of initial debt. It can be summarized in a formula: Net Public Debt to output ratio =PV of terminal net liabilities +PV of primary surpluses to output ratio + PV of seigniorage to output ratio Laffer Curve Laffer Curve describes the concave relationship between the tax rate and tax revenue. The basic idea is that tax revenue increases with the tax rate when the tax rate is lowbut decreases when the tax rate is high. In case of seigniorage revenue, the relevant "tax" rate is the rate of inflation. Seigniorage revenue increases with inflation at low inflation rates and decreases at high inflation rates (beyond the rate at which seigniorage is maximized). With Cagan money demand functions, the maximum is reached at 1/ (cf the Cagan money demand function entry in this glossary). Liquidity Extent to which assets are liquid, i.e. are in cash or can readily be converted into cash. 58 Long-run sustainability condition Long-run sustainability condition on deficits is the condition under which they can be maintained indefinitely without ever declining or increasing debt-to-GDP ratios as a result. It can be used as a simple tool of fiscal sustainability assessment (Anand and van Wijnbergen (1989)). The primary surplus (percentage of GDP) needs to equal the growth adjusted real interest rate times the debt-to-GDP ratio, minus seigniorage (also as a percentage of GDP). Market Access Country The developing countries which have access to international capital market are called market access countries. Maturity Maturity is the length of time to the date the loan principal is due; if measured from the date the loan was extended, it refers to the original maturity; if measured from the current date, we refer to it as the residual or effective maturity. Monte Carlo Simulation Monte Carlo Simulation is a method of simulation whereby random values from a known distribution are generated repeatedly for the purposes of experimentation. Net Foreign Asset of the Monetary Authorities (Central Bank) Net foreign assets refer to items on the balance sheet of the monetary authorities, which include the domestic currency value of (i) the net official international reserves (on the asset side, including gold, foreign exchange, the country's reserve position in the IMF, and holdings of SDRs; minus, on the liability side, including short-term liabilities to foreign monetary authorities ­ that is, deposits of foreign central banks, swap facilities, overdrafts, and some medium- and long-term foreign debt, such as a country's use of IMF credits); and (ii) any other foreign assets minus liabilities of the monetary authorities not included in the definition of official reserves. Net Public Debt Net Public Debt is the sum of net external and domestic debt. Net external debt is total external debt minus net foreign assets. Net domestic debt is total domestic debt excluding government debt holding by the central bank. In formula, Dt=Bt+etB*t-etNFA*t, where Dt : net public debt Bt : domestic, non-monetary debt in LCU (excludes government debt held by the Central bank) B*t : foreign debt in dollar terms (includes domestic debt issued in FX and any domestic debt linked to FX). NFA*t: stock of net foreign assets in dollar terms et: end-of period exchange rate LCU/$ Normally Distributed Random Variable A continuous random variable X, taking all real values in the range [- ,]is said to follow a Normal distribution with parameters µ and if it has probability density function 59 We write This probability density function (p.d.f.) is a symmetrical, bell-shaped curve, centered at its expected value µ. The variance is . 2 Oil Price Fiscal Rule (OPFR) The fiscal rule that Nigeria recently implemented. Under this fiscal rule oil revenues are calculated at a pre-agreed price per barrel, called the reference price; revenues above this price are then saved by the government for use when oil prices might be lower than the reference price. Oil revenues computed at the reference price then serve as a benchmark for the non-oil fiscal deficit. This rule approximates the permanent income hypothesis for mature oil producers with a relatively constant oil extraction profile going far into the future. Also see Fiscal Rule. Paris Club The Paris Club is an informal group of official creditors comprising 19 permanent members which are governments have large claims on various other countries around the world. Its role is to find coordinated and sustainable solutions to the payment difficulties experienced by debtor nations. Paris Club creditors agree to rescheduling debts due to them. Rescheduling is a means of providing a country with debt relief through a postponement and, in the case of concessional rescheduling, a reduction in debt service obligations. The first meeting with a debtor country was in 1956 when Argentina agreed to meet its public creditors in Paris. Pegged Exchange Rate A type of exchange rate regime wherein a currency's value is matched to the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold. As the reference value rises and falls, so does the currency pegged to it. The exchange ratio may change in a predetermined manner over time ("crawling peg") or be fixed in time ("fixed exchange rate") Ponzi Game or Ponzi Finance In a Ponzi Game interest and amortization on old loans is fully funded from new borrowing. A ponzi game or Ponzi Finance Scheme violates the solvency condition. Primary Deficit (Surplus) The primary deficit (surplus) equals government total revenue minus total expenditure other than net interest. By excluding net interest, the primary deficit (surplus) provides a direct measure of the claim of the government on resources. The solvency condition requires the discounted value of all current and future primary surpluses to be at least equal to initial net public debt. Primary Fiscal Balance Primary fiscal balance equals to overall fiscal balance minus interest payment, where overall fiscal balance equals to total revenue less total expenditure. Also see Primary Deficit (Surplus). 60 Primary Expenditure Primary expenditure equals to total expenditure minus interest payment. Privatization Receipts Privatization receipts are the proceeds of the sales of equity in public sector. It may be recorded as negative net lending in fiscal accounts. Probability Density For a continuous random variable, a probability density function is the function whose integral over any set is the probability of the variable being in that set. So, the density function of a normal distribution is the well-known bell-shaped curve which implies that there is a high probability of being close to the mean and low probability of being a long way from it. Public Debt Public debt refers to public and publicly guaranteed debt (PPG) and is the sum of PPG external and PPG domestic debt. Public Debt Dynamics Public debt dynamics refers to the evolution of the debt to GDP ratio over time. It is a critically important basic tool for fiscal sustainability assessment. It can be summarized in the following formula: Public Net Debt to GDP ratio = Net Interest Payments to GDP ratio to GDP ratio + Primary deficit to GDP ratio ­ Seigniorage to GDP ratio Public Debt Ratio Public debt ratio refers to public debt to GDP ratio in the fiscal sustainability analysis. Public Sector Public sector refers to general government, including the nonfinancial public enterprises such as publicly owned railways and public enterprises. To properly link debt dynamics and money supply developments, the Central Bank should also be considered part of the public sector, whether it is independent or not. Publicly and Publicly Guaranteed Debt Publicly and Publicly Guaranteed Debt comprises the external debt of the public sector, defined as central, regional and local government and public enterprises. Public enterprises subsume all enterprises, of which the government owns 50 percent or more. PPG external debt also includes public sector-guaranteed private sector debt. More then 80 percent of total external debt in all low-income countries together is PPG external debt. 61 Quasi-fiscal activities Quasi-fiscal activities are the activities that don't show up explicitly in the budget, but affect net debt, such as non-payment of social security contributions by loss-making state enterprises or subsidies extended through the central bank. Required Deficit Reduction In steady state consistency framework, the required deficit reduction represents the difference between funding requirements and available funding sources at target values needed to stabilize debt-output ratio at the end of the projection period, which is derived from consistent fiscal and monetary policies. Revenue Revenue consists of receipts of government that do not give rise to obligation of repayment. Receipts from loans to the government are not revenues. Risk Premium Risk Premium is the excess return over a risk-free rate which investors require as compensation for the risk associated with holding a risky asset (like equity). Seigniorage (Revenue) Seigniorage is the net revenue derived from the issue of currency, or more accurately, base money: S = Nominal base money / Price level (P) Seigniorage has two components: pure seigniorage and inflation tax, presented as S = pure seigniorage + inflation tax = Real base money + (P/P) * real base moneyt-1 Pure seigniorage is the change in real money base, resulting from real output growth or a favorable shift in demand for money. Inflation tax equals to the products of inflation rate and real base money. Solvency A Government is solvent if the discounted value of all current and future (anticipated) primary surpluses is at least equal to the current net debt. Solvency Constraint of Government See definition of Intertemporal Constraint of Government. Sovereign Default Sovereign Default means default on sovereign debt, which is the debt issued or guaranteed by governments. 62 Standard Deviation Standard Deviation is a statistical measure of variability of a random variable. It is defined as the square root of the variance, which is in turn defined as the squared deviation from the mean divided by number of observations (for population) or one less than number of population (for sample). Stationary Stationarity is a term in econometric time series analysis. Usually it refers to weakly stationary, which means a stochastic process has a finite and constant mean, variance and covariance for all t and t-s. Steady State Consistency Approach Steady state consistency approach, developed in Anand and van Wijnbergen (1989), links inflation, fiscal deficits and public debt management and uses a consistency measure, the required deficit reduction, or rdr, to check the consistency of a range of inflation targets with stable debt-output ratios. The rdr is the deficit reduction necessary to restore consistency between a given inflation (money growth) target with stable debt-output ratios and other policy parameters and structural characteristics of the economy; alternatively, consistency be imposed which then yields the inflation rate consistent with structural stability, other policy variables and the financial structure of the economy for given (primary) deficits. Stress Test Stress tests are used to simulate public debt ratio behavior under different, usually adverse scenarios (higher world interest rates, lower growth, etcetera). Sudden Reversal of Capital Flow Sudden Stop of Capital Flow In response to questionable government policy or even arbitrary sentiment changes, the sudden drying up of new investments, refusal to roll over old debt, or even active withdrawal of money from a country, which may lead to acute liquidity problems in the country. VAR system A VAR system is a set of equations describings the dynamics of a number of variables as evolving from their joint past history and feedback to each other. A VAR model applies when each variable in the system does not only depend on its own lags but also depends on other variables and their lags. Variance covariance matrix In statistics and probability theory, the variance covariance matrix is a matrix of covariances between elements of a vector. It is the generalization to higher dimensions, of the concept of the variance of a scalar-valued random variable. If X is a column vector with n scalar random variable components, and k is the expected value of the kth element of X, i.e., k = E(Xk), then the variance covariance matrix is defined as: 63 The (i,i) diagonal element is the variance of Xi , (i,j) element is the covariance between Xi and Xj. Velocity Velocity measures how often money changes hand in a given time period. It is equal to the ratio of nominal GDP to the stock of money. It is inversely related to money demand. 64 Acronyms BoP Balance of Payment CBT Central Bank of Turkey CPI consumer price index DECPG Development Data Group DV dummy variable EBF extra budgetary fund EU European Union FDI foreign direct investment FS fiscal sustainability FSA fiscal sustainability analysis FX foreign exchange GDP gross domestic product GDF Global Development Finanace GMM generalized method of moments GNP gross national product HP Hodrick-Prescott IMF International Monetary Fund LCU local currency LDB Live Data Base LIC low income country LIBOR London Interbank Offered Rate MIC middle income country NPV net present value OLS ordinary least square OPEC Organization of Petroleum Exporting Countries OPFR Oil Price Fiscal Rule PS public sector PV present value RER real exchange rate REER real effective exchange rate SOE state owned enterprise TL Turkish lira VAR vector autoregression WB World Bank WEO World Economic Outlook 65 Appendix A.1: Derivation of Public Debt Decomposition Dynamics The following section provides a detailed description of the methodology used for decomposing public debt dynamics. Section A.1.1 lists the variables and their definitions used in the debt decomposition. Section A.1.2 derives the debt decomposition equation. Section A.1.3 derives the inflation and seigniorage formulas used in the template. A.1.1 Set of Variables 1) Dt=Bt+etB*t-etNFA*t, , public sector net debt 2) Bt : domestic debt in LCU 3) B*t : foreign debt in dollar terms 4) NFA*t: net foreign assets in dollar terms 5) et: end-of period exchange rate LCU/$ 6) Mbopt: monetary base at the beginning of period in time t (or monetary base eop at t-1) 7) it : domestic interest rate paid over the period (t-1,t] d 8) it : foreign interest rate paid on foreign debt and reserves on the period (t-1,t] f 9) it : LIBOR rate paid on net foreign assets of the central bank on the period (t-1,t] l 10) Pt,AV: average CPI level for period t 11) t,AV=(Pt,AV-Pt-1,AV)/Pt,AV is average consumer price inflation in the year t 12) t=(P*t-P*t-1)/P*t, where P*t is the average U.S consumer price index. 13) Yt: real GDP in period in LCU t 14) gt: (Yt-Yt-1)/Yt, real GDP growth rate in the year t. 15) st=(et-et-1)/et-1, 16) êt=(1+st)*(1+*t)/(1+t)-1 is the rate of change in the bilateral real exchange rate (LCU per 1 USD) etP*t/Pt,, where + denotes real depreciation, while ­ denotes real appreciation. 17) Small letters, dt,bt,b*t,nfa*t denote ratios of Dt, Bt, Bt* , NFAt* to GDP. 18) t=(Mbopt+1-Mbopt)/PtYt is defined as seigniorage revenue. 19) OFt : other exogenous factors of public debt accumulation that may increase or decrease the outstanding stock of net public debt such as privatization receipt or recognition of contingent liabilities. 66 A.1.2 Public Debt Decomposition Equation Dt = Bt + et Bt - et NFAt = (Gt -Tt ) - (M * * bop t+1- M bop t) + (1) + (1+idt)Bt-1 + (1+i )et B*t-1 -(1+ilt)et NFA*t-1 +OFt f t Let divide eq. (1) by PtYt, : f dt = bt + bt - nfat = (gt -tt ) - t + * * (1+ id t )bt-1 (1+ i )(1+ st )b*t-1 t (1+ ilt )(1+ st )nfa*t-1 (2) (1+ gt )(1+t ) + (1+ gt )(1+t ) - (1+ gt )(1+ t ) +oft Let multiply and divide the last two terms of the right-hand side by (1+*t) and group the real exchange rate components in (1+ êt): ^ ^ dt = bt + bt - nfat = (gt -tt ) - t + * * (1+ id t )bt-1 + (1+ i )(1+ et )b*t-1 f t - (1+ ilt )(1+ et )nfa*t-1 (3) (1+ gt )(1+ t ) (1+ gt )(1+ ) * t (1+ gt )(1+ ) * +oft t Let subtract dt from eq. (3): dt = dt -dt -1= bt +bt -nfat = (gt -tt)-t + * * (1+ idt )bt -1 (1+ gt )(1+t ) -bt + -1 (4) ^ + (1+ i )(1+ et )b*t f t -1 ( ^ * 1+ ilt )(1+ et )nfa*t -1 * (1+ gt )(1+ ) * * -nfat -1+oft t -bt - -1 (1+ gt )(1+ ) t Let decompose the real growth components gt /(1+ gt ) from eq. (4) dt = dt -dt-1 = bt +bt -nfat = (gt -tt)-t + * * (id t - t )bt -1 - gt (1+ t )(1+ gt ) (1+ gt )bt + -1 ^ ^ + (if t(1+et)- )b*t * t -1 + et b*t -1 - gt * (1+ )(1+ gt ) * bt -1 t (1+ )(1+ gt ) * t (1+ gt ) (ilt ^ ^ - (1+et)- )nfa*t * t -1 + et nfa*t-1 - gt * (1+ )(1+ gt ) * nfat-1 +oft t (1+ )(1+ gt ) * t (1+ gt ) Or dt = bt +bt -nfat = (gt -tt )-t - * * gt (idt -t )bt-1 + (1+ gt ) dt-1 + (1+t )(1+ gt ) (5) ^ ^ ^ + (if t(1+et )- )b*t-1 * t - (ilt (1+ et ) - )nfa*t-1 * t + et (b*t-1 - nfa*t-1) (1+ )(1+ gt ) * t (1+ )(1+ gt ) * t (1+ )(1+ gt ) * +oft t Table 1 highlights the different components of equation (5) with the sign of the contribution to the change in net public debt: 67 Table A1. Component of the change in public net debt Component Formula Sign 1) Primary balance: (gt -tt) + 2) Seigniorage: t - gt 3) Real GDP growth: (1+ gt) dt-1 - 4) Domestic real interest rate cost: (idt -t)bt -1 (1+t)(1+ gt) + ^ + (if t(1+ et) -*t)b*t-1 (1+ *t ) (1+ gt ) 5) Foreign real interest rate cost + ^ - (ilt (1+ et ) - *t ) nfa*t-1 (1+ *t )(1+ gt ) ^ 6) Capital loss due to real exchange et(b*t-1 - nfa*t-1) rate appreciation + (1+ *t)(1+ gt) A.1.3 Public Debt Decomposition in Oil Rich Countries In oil rich countries (ORC), a substantial share of fiscal revenues is derived from exhaustible natural resources (oil and gas, referred to simply as "oil"). With respect to the previous debt decomposition, the primary fiscal deficit is replaced with the non-oil primary deficit and net oil revenues are treated as a financing flow. Equation (3) above is modified to apply a fiscal rule governing the use of oil assets: net oil revenues, determined at a budget price, finances the non- oil primary deficit and additional net oil assets accumulate in an oil fund distinguished from net foreign assets. Total stock of oil assets OIL is denominated in dollar terms and it is decomposed into OIL* = OilRt + OA*t + (1+ il )OIL*t-1 (6) With OilR defined as oil revenues evaluated at the reference price assumed in the government budget net of oil related expenditure and transfers; OA* defined as the difference between the increase of oil assets at market price net of OilR; and the interest earned on the stock of oil assets in the previous period, assumed to be equal to the interest earned on NFA. Net debt in percent of GDP d is now defined as domestic and external public debt net of central bank holding of government securities, of NFA and of oil assets, defining lower case variables as upper case variables in percent of GDP: 68 ^ dt = bt + bt - nfat - oil = (gt -tt ) - oilrt - t + * * (1+idt )bt-1 +(1+ i )(1+ et )b*t-1 f t + (1+ gt )(1+ t ) (1+ gt )(1+ )* t (3') ^ ^ - (1+ ilt )(1+ et )nfa*t-1 * (1+ ilt )(1+ et )oil*t-1 +of (1+ gt )(1+ ) * -oat - t (1+ gt )(1+ ) * t t Analogously as the previous debt decomposition, let subtract dt-1 and let decompose the real growth components gt /(1+ gt ) and the real exchange rate component from eq. (3'): dt = bt +bt -nfat -oilt = (gt -tt )-oilrt -t - * * * (1+ gt ) dt-1 gt + (id t -t )bt-1 + (1+ t )(1+ gt ) ^ [ f * + (i f t- )b*t-1 * t - (ilt - )nfa*t-1 * t + et (1+ i )b*t-1 -(1+ ilt )(nfa*t-1 + oat-1) t ]+ (5') (1+ )(1+ gt ) * t (1+ )(1+ gt ) * t (1+ )(1+ gt ) * t * - (ilt - )oa*t-1 t (1+ )(1+ gt ) * -oat +oft * t According to eq. (5'), change in net public debt in percent of GDP is determined by non-oil primary deficit, oil revenues at budget price, seigniorage revenue, the real interest rate growth differential, capital gains (losses) from real exchange rate appreciation (depreciation), net accumulation of oil assets, interest earned on the stock of oil assets and other factors net. Table 2 highlight the different component of equation (5') with the sign of the contribution to the change in net public debt: Table A2. Component of the change in net public debt to GDP ratio for ORC Formula Sign Line in Component "Table" 1) Non-oil primary balance: (gt -tt) + 4 2) Oil revenues at reference price oilrt - 7 3) Seigniorage: t - 8 12 4) Domestic real interest rate cost: (idt -t)bt -1 (1+t)(1+ gt) + (if -*t)b*t-1 13 5) Foreign real interest rate cost t (1+ *t )(1+ gt ) + gt 6) Real GDP growth: (1+ gt) dt 14 -1 - ^ 7) Capital loss due to real exchange et (1+ i )b*t-1 - (1+ ilt )(nfa*t-1 + oat-1) [ f * ] 15 t rate depreciation + (1+ )(1+ gt ) * t 8) Net changes in the assets of the oil (ilt - *t )(nfa*t-1 + oa*t-1) 16 * stabilization fund (1+ *t ) (1+ gt ) +oat - 69 A.1.4 Inflation and seigniorage formulas To account for the Laffer curve property of seigniorage revenue with respect to nominal money growth and inflation, we benchmark seigniorage revenue using a Cagan money demand function, where nominal base money stock at the beginning of each period is a function of nominal income Pt Yt and expected average inflation t during the period t. Mt bop = APt Yt e- t Where Mt bop is base money at the beginning of period t, or end of period t-1; Pt is the CPI index average for the year t, t=(Pt-Pt-1)/Pt is the average inflation rate in period t, Yt is the real GDP in year t , is the semi-elasticity of demand for money with respect to inflation, A is a constant term. Seigniorage in period t is defined as the change in the real stock of base money over the period t, measured in percent of real GDP: t = Mt+1 - Mt bop bop = A Pt+1Yt+1e-t +1- PtYte-t = Pt Yt Pt Yt = e- [(1+ gt+1)(1+t+1)]-e- t +1 t For example, to calculate seigniorage revenue as a percent of GDP for 2004, we would need to take the difference between the stock of base money beginning 2005 and beginning 2004 and divide that by the product of the average price level in 2004 and the real GDP for 2004. Since the stock of base money is usually reported at the end of the year, we substitute the beginning 2005 year stock of base money with end of the previous year stock of base money (2004). Thus seigniorage revenue could be re-written as the difference between stock of base money at the end 2004 and the stock of base money at the end-2003, divided by the product of 2004 average price level and the real GDP. Essentially, seigniorage revenue as a share of GDP depends on the elasticity of demand for money with respect to inflation, GDP growth and average inflation. In the steady state, under the assumption of constant inflation and growth, the seigniorage revenue could be rewritten as follows: = e- [(1+ g)(1+)-1] 70 Appendix A.2 Multivariate Stochastic Simulations The interaction of the underlying variables can be represented by a vector autoregressive model (VAR) defined as follows. Let V be a vector, composed of the real interest rate on foreign and domestic debt, real GDP growth rate, and the change in the real exchange rate, e-hat. Vt = (rt ,rt , gt,e^t) f d The vector evolves in an autoregressive pattern. K Vt = 0 + kVt-k + t k=1 where ~ (0,) represents a vector of serially uncorrelated normal errors with Ets = 0, for t s . The contemporaneous and serial correlations among the forcing variables are incorporated via the coefficients and . Econometric regression on historical data will yield estimates of the coefficients, ^'s and an estimate of the variance-covariance matrix ^ . Once the VAR system is estimated, the VAR model can then be used to generate a vector of shocks yt normally distributed with covariance matrix ^ . This is done in a 2-step process. First generate four time series of random numbers, xt i.i.d.as a standard normal distribution with mean o and variance 1, and using Monte Carlo simulations. Next, series of shocks to the underlying variables (rt ,rt , gt,e^t) with the appropriate covariance matrix ^ are created by f d defining yt = Lxt , where L is the Choleski factorization of ^ , specifically L'L = ^ . If a fiscal policy reaction is chosen as an option, the primary fiscal balance pdt is computed by incorporating the fiscal response to last period's debt-to-GDP ratio. The resulting debt-to-GDP ratios are updated from year to year by feeding the simulated (rt ,rt , gt,e^t) and f d pdt into the debt updating equation and repeating these steps until the terminal year of projection. Nina Budina C:\USER_PRM\2006\FSA_Tool\FSCourse\Final_docs\WP_Papers\FSA_TechnicalManual_final.doc 03/13/2007 6:33:00 PM 71