Construction of a Composite Indicator for Debt Sustainability Analysis

Abstract

The size of fiscal deficits and sustainability of public debt levels remain a key macroeconomic policy problem in all emerging economies following the global financial crisis of 2008-09. In addition, the COVID-19 pandemic poses a considerable challenge to fiscal sustainability in developed and developing countries. Although the sustainability of public finances has been discussed for more than a century and studies have proposed several methods to define and assess debt sustainability, it remains an imprecise concept. This study proposes a new framework for public debt sustainability analysis by constructing a composite indicator, that is, a debt sustainability index. We emphasise the need for an explicit conceptual framework for constructing a composite index and usefulness of multivariate statistical analysis prior to the aggregation of individual indicators. The proposed approach can be used to analyse the debt sustainability of state governments (sub-nationals) in India.