Development of an Advance Warning Indicator of External Debt Servicing Vulnerability

The main objective of this paper is to develop a leading indicator of external debt servicing vulnerability that would serve as an advance signal of payments interruption. The traditional and widely used ratios of debt servicing capacity, such as the ratio of the balance on current account to debt service payments, and the ratio of external debt to exports among others, primarily measure a country's current capacity to handle its international obligations. However, they fail to test vulnerability of debtor countries to oncoming debt servicing problems, or to signal in advance an imminent situation of payments interruption. The proposed index combines a number of variables which have preceded payments interruption by a number of countries in recent years. These situations have been preceded with a varying time lead by all or most of the following developments: 1. A significant erosion in the international liquidity position. 2. A sharply faster growth rate of external debt than the rate of growth in export earnings. 3. An acceleration in the inflation rate experienced by the country. 4. A shortfall in exports or a deterioration in export performance. 5. Adverse internal political developments. The compiled index is a weighted average of sub-indices or ratios which measure recent changes in the variables listed above. The index was applied to 20 developing countries (LDCs) accounting for about 80 percent of total external debt. Depending on their score, these countries were grouped in five categories ranging from those signalling significant improvement in their debt servicing capacity to those signalling an imminent payments interruption.