Debt sustainability analyses (DSAs) are generally done in contexts of distress that feature large revisions of pre-established perceptions. Those contexts are usually largely uncertain. Much of the information from the past becomes obsolete as a guide for forecasting the debtor’s payment capacity. In those environments, there is not an obvious superior approach for assessing sovereign debt sustainability. However, there are elements that must be part of the analysis regardless of the chosen approach. This paper offers clarifications on the foundations of a DSA and the elements that constitute it. It is argued that any framework for DSA must take three elements into account: First, the framework for DSA has to define the relevant constraints for assessing what is a state of sustainable debt. Second, it must define a model for projecting the capacity for stabilizing debt that incorporates the relevant endogenous feedback effects associated with the implementation of fiscal and debt policies. Third, it has to make assumptions about the distribution of shocks that affect the capacity of debt payment and has to deal with the heterogeneity of beliefs that underlie any DSA. The paper discusses the practice of DSA and how those elements are dealt with and analyzes the interplay between those three elements in an analysis of debt sustainability.
