6
H IDDEN DEBT
FIGURE O.2 Analytical Framework: Links from Distress to Adjustments to Impacts
Distress • What is the probability? • What are the drivers? • How do public agents differ from their counterparts in their response?
Adjustments
Impacts
• What are the main channels? • What is the channels’ relative intensity? • How soft are the budget constraints?
• What is the effect on fiscal stance? • How are the private sector and local economies affected?
Source: World Bank.
As an indicator of financial distress for SOCBs and SOEs, this report uses the interest coverage ratio (ICR) along with alternatives that serve as robustness checks. The ICR reveals whether the revenue that the agent generates suffices to cover the interest payments on its debt. When the ICR falls below 1, an SOCB or SOE is considered to be distressed. Some PPP projects could be hard to compare with SOCBs or SOEs because they can enter distress early in their investment cycle before they start operating, that is, performing their functions. This distress could occur because the public and private partners disagree and engage in a dispute that cannot be resolved; in such instances, the PPP is canceled or terminated before the PPP contract expires. As the measure of distress for PPPs, this report uses early terminations of PPPs. The empirical data to capture PPP distress is retrieved from the Private Participation in Infrastructure (PPI) database of the World Bank.2 When financial transparency is impaired and accounting data are unavailable or unreliable, econometric methods can be used to determine the distress events empirically. This report uses such an econometric approach to empirically define distress—such as triggering of major contingent liabilities—for SNGs. Because the financial transparency of SNGs— especially concerning their off–balance sheet operations—is inadequate, the report associates SNG distress with an unexpected increase in SNG debt. Here the expected debt
dynamics are determined by past levels of SNG debt and planned fiscal balances. While indirect, this identification by econometric association has been successful and validated by some publicly recognized distress events, such as the unexpected increase in the debt of Indian states through the UDAY scheme. With respect to distress, the analyses in the report tackle questions such as the following: What is the probability of distress for a given public agent? Which factors can help predict nearing distress? How do public agents differ from their private counterparts?
Adjustment in Times of Distress A public agent becomes distressed because its financial situation becomes unsustainable. Something needs to change—and usually several things. These changes concern the public agent’s financials and business operations. They must adjust to resolve the unsustainable financial situation and exit distress. The adjustments could be fast— such as instant recapitalization of the distressed SOCB, SOE, or PPP. Or they can be protracted—such as if the resolution depends on the result of an investigation of a committee tasked with deciding on behalf of the public how to proceed and what adjustments to make. Unresolved and protracted distress may require bailouts and/or adjustments that are ultimately more costly and/or severe. The adjustments in times of distress can occur through various channels. Typically, the
