How Sustainable Are Public Debt Levels in Emerging Europe?

To assess to which extent public debt positions in four CESEE economies (the Czech Republic, Hungary, Poland and Slovakia) are sustainable in the medium term, we apply a stochastic debt sustainability analysis (SDSA), building on Celasun, Debrun and Ostry (2007). In contrast to conventional debt sustainability analyses, this approach explicitly accounts for the risks surrounding medium-term debt dynamics, e.g. risks stemming from the interaction of (endogenously determined) fiscal and macroeconomic shocks. This is one of the first papers explicitly applying an SDSA to countries in emerging Europe. The baseline projections suggest that, on average, public debt would not get out of control in any of the four countries until 2016. However, when we also account for the risks around the median projection, the primary balance is apparently not responsive enough (with regard to public debt) so that increasing debt paths cover a considerable share of the overall frequency distribution. The probability of reaching, in 2016, a higher debt-to-GDP ratio than in 2011 is largest in the Czech Republic and Slovakia and less pronounced in Hungary and Poland. When confronting the baseline projections with alternative policy scenarios, we can confirm the importance of a timely and continuous response to debt developments; otherwise public debt will quickly get out of control. Furthermore, compliance with the defined Stability and Convergence Programme targets limits the overall risks to the debt outturns.