Understanding Debt Sustainability in Low-Income Countries: The Role of Currency Denomination


July 11, 2023

Amid a severe debt crisis, Ghana defaulted on the majority of its international debt in December 2022. The country requested and received a significant $3 billion USD emergency credit facility from the IMF, and it is currently engaged in negotiating a substantial debt restructuring with its creditors. Similarly, Sierra Leone and Laos have been facing a substantial increase in their external debt due to the sharp depreciation of their currencies over the past two years. These examples underscore the challenges faced by low-income countries in terms of debt sustainability. As discussed in the recently published World Bank Global Economic Prospect report, the combination of record high debt levels in low-income countries, tightened monetary conditions, and elevated global risks have exacerbated the debt sustainability issues of LIC countries. Given these circumstances, it is crucial to thoroughly analyze debt sustainability factors such as the currency denomination of the debt.


In general, developing countries tend to receive a higher proportion of loans denominated in foreign currency compared to developed countries. Borrowing in foreign currency offers the advantage of expanding fiscal space by increasing available funding. Additionally, it enables governments to diversify their funding sources and reduce reliance on vulnerable and underdeveloped local domestic markets. However, foreign currency-denominated borrowing also entails additional risks, particularly currency risk. If the domestic currency depreciates against the foreign currency in which the debt is denominated, the government's debt servicing costs will increase.


To assess the external position, one can calculate the Open FX position by subtracting Gross External Debt from FX reserves. In this respect, the central bank's accumulated reserves can serve as a buffer, helping to mitigate some of the risks       . A negative Open FX position indicates that the gross external debt exceeds the reserves. In the low income countries, the Open FX position tends to be negative, with an average of over -30% of GDP based on the most available data.


A more sophisticated metric would consider a country's net external debt position rather than the gross debt position. However, due to the lack of net external debt data for developing countries, we continue to use gross debt in our index. As low-income countries typically do not have significant claims on external debt, our indicator is accurate enough for them. However, it may underestimate the FX position of advanced countries, which might have substantial claims on external debt, thus improving their overall position.


As mentioned earlier, foreign currency lending to developing countries introduces additional debt sustainability risks due to the potential impact of depreciation. Consequently, it is not a surprise that IMF and World Bank Debt Sustainability Analyses (DSA) evaluations are correlated with the Open FX position. In countries experiencing debt distress, the Open FX position tends to be higher compared to others, particularly in low debt distress countries.1

Note: Open FX position value is from the last available data, usually from 2021. Mozambique is excluded from the sample due to its outlier value in Open FX position.

Overall, our quick snapshot suggests that the Open FX position serves as a valuable indicator to assess sovereign risk arising from external debt and associated FX risks. It emphasizes the vulnerability of a country in terms of depreciation effect on debt.


The Health and Education at Risk (HEAR) ratio is an advanced concept derived from the Open FX position. It quantifies a country's currency risk by relating it to its average annual budget allocated to health and education. This ratio has been developed in collaboration with TCX. For more detailed information, please visit here.

1 It is important to mention that there is a large deviation in Open FX positions among countries, and the correlation is not evident in ‘moderate’ and ‘high’ debt distress categories.