• In recent years there has been a significant rise in the indebtedness of small states. However, unlike the difficulties of major debtors and heavily indebted poor countries, the emerging debt problems of small states have received little international attention. The purpose of this study is to highlight the debt problems faced by these countries, including their causes and future prospects, and then to propose a framework within which the problems can be addressed.

  • Small middle-income countries in the Indian and Pacific Oceans and the Caribbean are among the most indebted middle-income economies in the world (see Chart 2.1). The ten most indebted countries (with a public debt to GDP ratio of over 90 per cent in 2005) include six Caribbean economies, hereinafter called the Caribbean-6 (St Kitts and Nevis, Jamaica, Grenada, Antigua and Barbuda, Dominica and Belize), and Seychelles in the Indian Ocean, The top 20 also include St Vincent and the Grenadines, Barbados and St Lucia, hereinafter after called the Caribbean-3, as well as Mauritius in the Indian Ocean, Cape Verde in the Atlantic and Marshall Islands in the Pacific, which all have debt ratios of 60–90 per cent of GDP. The top 30 include Tonga and Samoa in the Pacific, the Bahamas in the Caribbean and Maldives in the Indian Ocean, which are all moderately indebted, with public debt ratios of 40–60 per cent of GDP. For completeness, Chart 2.1 also includes two small low-income economies in the Pacific, Solomon Islands and Papua New Guinea; the former is highly indebted and the latter moderately indebted.

  • Box 3.1 provides an analytical underpinning explaining the rise in public debt. It shows how both endogenous dynamics (GDP growth, real interest rate and exchange rate changes) and exogenous factors (including the fiscal balance and other debt creating or reducing factors) play a role. In particular, it demonstrates the debt ratio-increasing role of fiscal deficits, and real interest rate and exchange rate changes and the debt ratioreducing role of growth of GDP.

  • It is now standard practice for the IMF to carry out public and external debt sustainability analysis (DSA) as an addendum to the regular Article IV consultations. These provide a baseline, in addition to some alternative scenarios based on various assumptions (e.g. growth, GDP deflator and interest rate) and adjustment (fiscal) efforts. Baseline or active scenarios generally assume a significant fiscal effort and improved growth prospects, although not all baseline scenarios would do so taking the current government reform effort as given. Alternative scenarios either assume key variables at historical averages (historical scenario) or that primary balances are held constant (no policy change scenario, also referred to as a passive scenario). Sensitivity tests are also carried out on the basis of shocks which can be either permanent or temporary. Usually six such stress or bound tests are carried out, including an interest rate shock, a growth shock, a primary balance shock, a combined shock of the above three, an exchange rate shock (usually taken as 30 per cent depreciation of the currency) and a contingent liability shock (usually taken as a 10 per cent increase in debt creating flows). Some countries have also included a natural disaster scenario.