Friday, 30 November 2012

The IMF’s rosy public debt projections*

I have analyzed and replicated the IMF’s Debt Sustainability Framework for Portugal provided in the adjustment program review reports (a table in the IMF Country Reports for Portugal). This IMF review report table contains the IMF projections for the levels of Portugal’s public debt from 2012 through 2030. The IMF review reports are the data sources for all graphs below.

In my opinion, the IMF’s debt projections should be interpreted as the “objectives” for the evolution of the levels of public debt, should the adjustment program perform as planned.

As is well known, the key condition to assure debt sustainability is that the economic (nominal/real) growth rate is higher than the (nominal/real) interest rate on the stock of debt.

The key points of my short analysis are:

  •         Even if the everything goes according to the troika and government plan, public debt dynamics seems barely sustainable, falling below 100% of GDP only around 2025
  •         Each review has resulted in the worsening of the public debt trajectory (please see figure below).

  •     This is to some extent explained by increases in the initial stock of debt – for example, resulting from Eurostat-mandated changes in the universe of public sector enterprises included in the consolidated accounts of the public sector. But one additional important explanation is that the adjustment program has had a worse than expected impact on economic growth resulting in lower growth projections with each review (please see figure below)

  •     Maybe I missed something, but I could not replicate the debt levels for 2014 and 2015. The difference in 2014 and 2015 debt levels explains 94% of the deviation between my 2030 estimates (debt at 88% of GDP) and the IMF's 5th review projection (84.8% of GDP)
  •     The IMF has, in each successive review revised interest rates lower (see figure below). (Addendum) Francesco Franco pointed out that at least some of the reductions in interest rates follow from the reduction in EU loan rates to Portugal - the 215 basis point EFSF margin was reduced to 0 - (Bloomberg’s David Powell recently noted what he called the "mysterious" reduction in interest rates from the 4th to the 5th review report, and this had me look at the evolution of interest rates in all IMF review reports). 

  •       Moreover, the debt trajectory is not really robust (see figure below). In fact, if nominal growth rates from 2012 turn out to be lower by one percentage point and the average interest rate from 2015 on to be higher by one percentage point than assumed by the IMF, the debt levels would rise by 2030, not fall.

The “Fazit”: Portugal’s sovereign debt is on a clearly unsustainable trajectory.  The IMF public debt projections fail to consider the impact on public debt trajectory of the external adjustment that is necessary to assure a sustainable external debt trajectory. The IMF external debt projections contained in the review reports are in my view, not realistic and not feasible at all. But that is a subject for another discussion.

*revised version.


  1. ricardo,

    in july 2012, there was a silent restructuring of the loan with the EU: check the rates and maturities granted to Portugal in July. Maturity went from 7.5 years to 15-20 years and rates from 5.5 to 3.5. this was defined as an unexpected decrease in interest payments.


  2. Ricardo, thanks for the analysis. Actually this is not surprising. Just would like to note on top of what you said that IMF assumes Portugal reaching 3% nominal growth by 2015 and higher by 2017...
    What I do not understand is why with so many experienced economists, Portugal is still taking this 'medecine' as granted from doctors who are experimenting as they go along. We know well that much of the advice is founded in very little robust empirical evidence and that unfortunately this fact is inconsistent with the displays of confidence from the IMF and the rest of the team and the use of statements such as 'as in many other countries it has been shown...'. When the memorandum was signed I commented in this blog that there was too little in terms of supporting growth in the measures chosen. This is clearly a problem and the continuation of a 'short term credit' perspective on structural adjustment will simply not pay off. It will result in a much deeper recession, flight of qualified people abroad (also undermining future growth) and such social tensions that an alternative and credible reform agenda will be much harder to implement. From an international perspective, Europe is desperate to find a champion of reform with an adjustment that works. This should give us some bargaining power but apparently the Portuguese Government seems totally unable to negotiate.

  3. Ricardo,

    It might be of interest to add this to your toolkit.

    Although it does not assume any economic model whatsoever (it is based entirely on the stock of public debt account identity db/dt = (g-t) + (r-y)b) one can add its own assumptions by adjusting their projected growth rates (say, for instance, that you assume the fiscal multiplier to be < 0 — simply increase the expected growth rate following a decrease in public consumption).