Financial integration is an important support for the construction of the "Belt and Road" in mainland China. On the basis of learning from the practices of international organizations such as the World Bank and the IMF, and taking into account the actual situation of the economies along the Belt and Road, the Ministry of Finance released two sets of complementary debt sustainability analysis frameworks for low-income economies and market-financed economies in 2019 and 2023, respectively. This report reviews the assessment processes and data processing methods of the two frameworks, and compares the similarities and differences between them and the approaches of the respective international organization frameworks. In the future, when evaluating the debt sustainability and debt risk of Belt and Road economies, we can refer to the static debt indicator threshold given by the Ministry of Finance for risk classification for low-income economies, and evaluate the risk trend in combination with stress tests. For market-financed economies, different approaches can be used to assess short-, medium- and long-term debt sustainability and debt risk, taking into account the impact of changes in market conditions, such as changes in US interest rates and the VIX index.
In terms of trade, investment and financing, trade between economies along the Belt and Road and the mainland will recover to a record high in the second quarter of 2024, with Central Asia leading the way.
Financial integration is an important support for the construction of the "Belt and Road" in mainland China. By the end of June 2024, the financial authorities of 29 economies around the world had approved the Guiding Principles for Financing the Belt and Road. On the basis of learning from the practices of international organizations such as the World Bank and the IMF, and taking into account the actual situation of the economies along the Belt and Road, the Ministry of Finance released two sets of complementary debt sustainability analysis frameworks for low-income economies and market-financed economies in 2019 and 2023 respectively, forming a debt evaluation system that basically covers the Belt and Road. The system is a non-mandatory policy tool that encourages China and the Belt and Road economies to use debt sustainability analysis and assessment as an important reference for financing decisions.
On April 25, 2019, during the second Belt and Road Forum for International Cooperation, the Ministry of Finance released the Belt and Road Debt Sustainability Analysis Framework (hereinafter referred to as the "Framework for Low-Income Economies"), which is applicable to low-income economies along the Belt and Road, that is, those that are eligible for concessional loans from the Poverty Reduction and Growth Trust (PRGT) and the International Development Association (IDA), or those that are eligible for IDA non-reimbursable assistance
In terms of preparation, the applicable framework for low-income economies clarifies the scope of debt as debt that the broad public sector is required to pay principal and/or interest to creditors in the future, including bonds, loans and other payables. The broad public sector includes governments, state-owned financial and non-financial enterprises, and central banks. Due to the instability of low-income economies, it is necessary to forecast their macroeconomic trends over the next 20 years and adjust them according to factors such as debt change drivers, public investment, and fiscal adjustments. The longer forecast period given to low-income economies is due to the fact that low-income economies have more concessional loans and non-reimbursable aid in their debt structure, and their combined debt maturities are longer than those of high- and middle-income economies.
The macroeconomic indicators applicable to the framework in low-income economies are mainly divided into five categories, including balance of payments, public sector, debt, other macro, and financing, with 37 indicators. Compared to the LIC-DSF published by the World Bank, the "Government Investment" indicator has been added to the input data indicators. The government plays an important role in guiding investment, adjusting the investment structure, and implementing industrial policies through investment. The reason for emphasizing the government's role as an investor in the macroeconomic direction is that low-income economies typically have a larger share of public debt and are subject to higher exchange risk when repaying external debt.
In terms of data analysis, weak, medium and strong economies are classified according to factors such as policy and institutional evaluation scores, economic growth rate, remittance level, international reserves, global economic growth rate, etc., and stress tests in various scenarios are carried out accordingly.
Compared to the LIC-DSF published by the World Bank, this framework adds reverse stress testing. The stress test is to calculate the amount of loss after setting the stress scenario; A reverse stress test is a stress scenario in which a risk factor is reversed after a maximum amount of loss is set. Reverse stress testing is commonly used in the safety measurement of financial institutions, and as a supplement to the usual stress testing scenarios, more attention is paid to the magnitude of changes in risk factors, which can better grasp the weakness of the economy's debt position.
In terms of rating conclusions, different thresholds for public external debt and public debt indicators are assigned to different economic groups, and the corresponding risk level discrimination rules are set to obtain four rating conclusions: low risk, medium risk, high risk and external debt/debt distress.
The framework also provides exemptions for distress determinations: arrears less than 1% of GDP; Due to payment technology, payment barriers (sanctioned), disputes, diplomatic differences, difficulty in finding payment counterparties, etc.; Officially signed bilateral debt relief; The debt restructuring of the default to private creditors has been completed with the majority of creditors, and the government has determined that it has "good faith" to negotiate with the remaining creditors. If the situation is met, it can be appropriately judged to be a high risk rather than a difficult situation.
The shortcoming of this framework is the lack of a standardized determination of debt sustainability, which only provides guidance that an economy's risk level is not necessarily linked to its debt sustainability, i.e., when an economy is likely to meet its current and future service obligations.
On October 18, 2023, during the 3rd Belt and Road Forum for International Cooperation, the Ministry of Finance issued the Belt and Road Debt Sustainability Analysis Framework (for Market Finance Countries) (hereinafter referred to as the "Market Finance Economies Framework"), which is applicable to the Belt and Road market financing economies, that is, economies that can continue to raise funds in the international capital market at reasonable interest rates through borrowing or issuing securities.
In terms of preparations, the definition of debt scope in the framework for market-financed economies is basically the same as that for low-income economies, but the macroeconomic forecast time is shortened to 10 years, and the forecast check-factor expands the magnitude of fiscal adjustment, real economic growth, real effective exchange rate, output gap, and new financing duration.
The macroeconomic indicators of the framework for market-financed economies cover four categories: public sector, debt, macroeconomics, and others. Compared with the framework for low-income economies, the framework for market-financed economies adds financial market indicators such as total assets of the banking system, the VIX index, and the yield on 10-year U.S. Treasury bonds. The impact of financial market volatility on debt quality and default risk is even more relevant when measuring debt risk in high- and middle-income economies. At the same time, in contrast to the SRDSF framework published by the IMF, this framework specifically lists the "public investment" indicator under non-interest expenditure in the public sector.
In terms of data analysis, the analytical framework applied to market-financed economies looks at sovereign debt risk from a development perspective, taking into account the relationship between debt size and medium- and long-term economic growth.
In the recent analysis, it differs from the SRDSF published by the IMF in that this framework divides market-financed economies into high-income and middle-income economies, and assigns different analytical indicators to them. In the analysis, the decision tree model is proposed as the main model and logistic regression as the auxiliary model.
In the mid-term analysis, the framework follows the method and calculation parameters of the SRDSF framework, and finally uses the average of solvency risk and liquidity risk as the medium-term risk index, and cooperates with the stress test results to obtain the medium-term risk level.
In the forward analysis, the risk level is determined by a qualitative analysis of the relationship between the increase in debt scale and the growth of solvency.
In terms of rating conclusions, the overall risk level will be selected from the results that have been achieved after determining the risk levels for the short-term, medium-term and long-term. If the risk level of short-term, medium-term and long-term assessment is the same, this level will be used as the overall risk level; If the short-term, medium-term and long-term assessment results are different, the short-term and medium-term assessment results are mainly considered to give a judgment on the overall debt risk level.
Unlike the framework for low-income economies, the framework for market-financed economies not only sets absolute thresholds for indicators, but also introduces a method of setting relative thresholds based on historical quantiles. In the process of risk level revision, when the expected default loss ratio is lower than the historical 25% quantile, the framework allows the risk level to be downgraded; When the expected default loss ratio is higher than the historical 75% percentile, the framework allows for an upward adjustment of the risk level; Otherwise, no adjustment is required.
Market financing economies have stronger overall debt servicing capacity than low-income economies and are less likely to be in distress. Therefore, this framework strengthens the focus on debt sustainability, and clarifies that the content of debt sustainability assessment should consider factors such as debt risk level, debt evolution trend (rising, stable, and declining), the fiscal balance to ensure debt stability, and whether the debt service arrangement is economically and politically viable, and the conclusions should include three types of conclusions: high probability sustainability, low probability sustainability, and unsustainability.
In the second quarter of 2024, trade between the mainland and economies along the "Belt and Road" will recover to a record high. As of the end of May 2024, the Belt and Road trade volume index rose to 206, up 22% from the end of the first quarter; The Maritime Silk Road freight index fluctuated in a range, down 6% from the end of the first quarter. In terms of regions, in the second quarter of 2024, the mainland's trade volume index with economies along the "Belt and Road" rebounded as a whole, with Central Asia leading the recovery.
In terms of investment cooperation, from January to May 2024, the mainland's non-financial direct investment in economies along the Belt and Road reached RMB90.99 billion, up 16.3% year-on-year (US$12.81 billion in US dollars, up 12.7%).
In terms of foreign contracted projects, from January to May 2024, the turnover of contracted projects in mainland China to economies along the "Belt and Road" was 495.15 billion yuan, an increase of 24.1% (US$69.71 billion in US dollars, an increase of 20.2%); Turnover was RMB341.02 billion, up 12.9% (US$48.01 billion in US dollars, up 9.5%).