IMF entrance – Washington DC.

Investors may be wise to take with a grain of salt the International Monetary Fund’s latest projections about the sustainability of emerging market (EM) debt levels, says the global investment manager Eaton Vance.

The source of this advice is impeccable: the IMF, notes the Eaton Vance Global Income team.

A new IMF study^[1] of its own “debt sustainability analyses” found that the studies have been overly confident about fiscal and/or growth forecasts, exchange-rate growth and projected “residuals” like other external financing. Interest rates were consistently projected to be too high.

The study found that:

• Debt projection errors were skewed toward optimism for most groups of countries. Evidence of systematic bias toward optimism was observed even after controls were applied for major economic shocks.
• The magnitude of errors tended to increase as forecast horizons extend (1-5 years after).
• The degree of optimism observed has increased over successive vintages for most groups of countries.

The study looked at projected debt-to-GDP levels for both external and total public debt, and compared them with actual outcomes over a five-year forecasting horizon. The analysis focused on 75 countries designated as “low-income countries” by the IMF according to GNP per capita between 2005 and 2015.

Optimism was most pronounced for:

• The wealthiest half of countries examined, even though all were low-income, by definition.
• Countries designated “frontier” by the IMF – those with market access or potential for market access.
• Those assessed to have “moderate risk for debt distress.”
• Countries with IMF programs.

“ Our own experience suggests that the IMF study is still underestimating the problem: Debt burdens of many EM countries may be even less sustainable than is indicated. That’s why we believe that a focus on individual country fundamentals through proprietary research is the key to successful investing in EM debt.”

[1] IMF Working Paper: Debt Sustainability Analyses for Low-Income Countries: An Assessment of Projection Performance, by Henry Mooney and Constance de Soyres, September 2017

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