By Nebson Mupunga
2011
This paper proposes a risk modelling framework for debt sustainability analysis in MEFMI member states. The proposed framework seeks to help member countries develop a risk model that explicitly recognizes, measure and control the relative costs and risks inherent in public debt taking into consideration the linkages with key macroeconomic policies consistent with maintaining debt sustainability. This will facilitate prudent risk management of sovereign debt, while minimizing the potential debt-related burden on tax payers and maximizing the resources available for other expenditures.

The framework complements and augments the traditional debt sustainability analysis framework by facilitating assessment of the costs and risks of desired debt composition. It facilitates the monitoring of key financial risks, and establishes strategies that ensure member countries are well placed to take advantage of new borrowing opportunities in a considered and risk conscious way. The framework also facilitates risk management by enabling the consideration of options for risk mitigation.

The framework was operationalised using Zimbabwe’s public debt data and the results highlighted the potential cost-risk trade-offs of alternative public debt strategies that the Zimbabwean Government envisaged to undertake. The results were heavily depended on the term structure of interest rates and the need for proper yield curve modelling was underscored to ensure the robustness of model results. The basic steps and issues in public debt risk modelling were highlighted and a recommendation was made for member countries to develop in house risk models using a cautious step by- step approach based on country circumstances rather than using sophisticated or off the shelf models.