The simulations underlying the BWI debt sustainability assessment (DSA) being perhaps the most suitable example in this context (see Chapter 3).

In sum , w e fail to find the GT-scheme to be particularly com pelling on the basis of its

com parative perform ance against the alternative T O T -instrum ent analysed above.

O n the basis of o u r U gand a country study, we find the in stru m en t's rigid p aram eter

calibration to u n d erm in e its capacity to adequately adjust to a specific p attern of

term s of trad e evolution. Thereby, the GT-scheme lacks the desirable flexibility of the

alternative TO T-instrum ent, including its potential for achieving the desirable

variance-m inim ising effect. Furtherm ore, as the central feature of the G ilbert and

Tabova (2004) approach, the trade w eighted term s of trade index exhibits the severe

shortcom ing of excluding m etals an d oil prices, w hich m akes it unsuitable for

application across LICs, thus foregoing its potential as a useful w orld-price-based

alternative to the sim ple barter term s of trade index.

4.4 Concluding remarks

A gainst the back grou nd of a long-standing reluctance to even contem plate the

potential role of contingency schem es in add ressing low -incom e countries'

vulnerability to exogenous shocks, the ex-ante instrum ents envisaged by the recent

IDA rep o rt m ark an im p o rtan t step forw ard in the m ultilateral approach. The general

schem e w e have analysed in this section, as a surrogate for those pro po sed by the

background pap ers un derlying the report, offers a sim ple in stru m en t that can be

tailored to include a variety of alternative indexing variables.

A m ong the in strum ents considered in the context of ou r U gan da country stu d y

sim ulations, the term s of trade indexing schem es seem to be best suited to adjusting a

country's d ebt service to capacity to pay. The basic T O T -instrum ent also appears to

have a greater potential to reduce TDS-XGS volatility, p ro v id ed th a t the ID A 's

requirem ent of creditor-cost m inim isation is n ot m ade binding. In contrast, GDP

schem es seem to perform less well, and are also boun d to p resen t greater calibration

difficulties d u e to the disparate factors affecting GDP g ro w th across countries.

H ow ever, w hile p aram eter calibration in the case of one country has been show n to

be problem atic, the IDA requirem ent of uniform p aram eter setting across low -incom e

countries app ears to be largely im practical. For, there is no possible w ay of

determ ining an optim al param eter setting that w o u ld ensure the instrum ents'

suitability for beneficial application across all the LICs. Instead, the ID A 's prerogative

of m inim ising creditor costs w ould probably lead to a w eak calibration of any

in stru m ent envisaged, w ith focus on risk-pooling characteristics across creditors'

portfolios, and negligible liquidity effects for individual debtor countries.

M ore fundam entally, the pro po nen ts of these instrum ents seem to disregard the

conceptual difference betw een a country's repaym ent capacity and the state of natu re

th at influences it. The im portance of such a distinction being m ade in order to ensure

an insurance schem e's incentive com patibility has long been in the dom ain of our

und erstan d in g in relation to these issues, as w as extensively discussed in C hapter 2

of this study. H ow ever, rather than addressing these instru m en ts' m ore profound

incentive im plications, the IDA' em phasis seems to be placed on the m ore superficial,

and arguably less decisive, aspects of distortions, such as a borro w er's scope for

m isreporting or even tilting its exports to reap some short-sighted benefits. While

failing to even appropriately address the latter, e.g. by w ro ng ly assum ing the

incentive com patibility of indices based on m oving averages, the IDA fails to realise

the b roader shortcom ings of its approach in relation to contingency schemes.

Ultimately, none of the schemes analysed in this section is fully appropriate for

assessing the various sources of vulnerability affecting a cou ntry 's capacity to pay,

nor to address the actual financial needs arising from shocks. For, indexing faces a

trade-off betw een capturing the shocks from a lim ited, w ell-defined source (e.g. the

term s of trade), thus ignoring all other im portant sources of shocks to an economy,

and the insurm ountable com plications from disentangling exogenous from

endogenously determ ined shocks w hen indexing to bro ader proxies of repaym ent

capacity (e.g. nom inal GDP grow th). Also, debt service adjustm ent constitutes b u t

one of the item s constituting overall n et official financial transfers to a debtor

economy, w hich, as a w hole, w ou ld have to represent the m o du latin g variable. P ut

differently, in order to m odulate effectively a country's liquidity, a financing scheme

w o uld need to adjust financial flows beyond debt service scheduled, w ith a broader

objective of m o dulating flows in response to financial requirem ents and involving at

least some degree of new financing and /o r relief of existing debt.

We conclude our analysis w ith a final reflection in relation to the IDA ex-ante

schem e's proposed allocation w ithin the overall D ebt Sustainability Fram ew ork (i.e.

the third pillar in C hart 3.1 of the preceding chapter). It will be recalled from the

discussions in C hapter 3 th at the DSF's debt sustainability assessm ent is crucially

focussed on the evolution of external debt in relation to debto r's GDP. M oreover, it

has been pointed out th at the rationale for the integration of IDA ex-ante schemes

into the DSF arises out of its failure to protect countries against the large,

unforeseeable shocks occurring w ith relatively low frequency. In light of these

considerations, it w o u ld appear th a t for reasons of internal consistency, the DSF

w ould have to be integrated w ith an ex-ante scheme indexing to countries' nom inal

GDP grow th, m irroring the accounting m ethod underlying the DSA. As a result, the

DSF's extant shortcom ings w ould be likely to be further exacerbated by add ing those

identified in relation to the G DP-indexing scheme. Besides, as already m entioned in

C hapter 3, even if w e w ere to assum e aw ay the flaws affecting the indexing scheme,

the overall constellation of the DSF w ou ld still represent an inconsistent patchw ork

of interrelated m odules. For, the central th ru st of the CPIA-centred IDA14/DSF

regim e w ou ld continue to determ ine the fundam ental aspects relating to LICs' debt

sustainability, nam ely volum e and type of aid allocation, w hile the contingency

scheme w ould h ave no bearing other than on debt service rescheduling. H ow ever, to

the extent th at debt service stream s are of mostly trivial m agnitude com pared to the

bulk of financial flows involving a LIC's aid-dependency on donors, the potential

benefits from indexing w o uld be proportionally small.

In sum, w e confirm our assessm ent of the extant DSF as leading to particularly

negative and w orrisom e conclusions, also w ith regard to the outlook of its

im plications after the inclusion of a contingent facility along the lines of the IDA

schemes considered in this chapter. As w e will extensively dem onstrate in the third

and final p art of this study, a m ore positive outlook for low -incom e countries' debt

sustainability over tim e will only be achieved by entirely rethinking the current aid

allocation and debt sustainability fram eworks, on the basis of a m ore central role

assigned to contingency schem es inform ing the donors' response to those countries'

vulnerability to exogenous shocks.