A Comprehensive Scorecard for Assessing Sovereign Vulnerabilities

28 Pages Posted: 18 May 2017

See all articles by Alvise Lennkh

Alvise Lennkh

European Stability Mechanism

Edmund Moshammer

European Stability Mechanism

Vilem Valenta

European Stability Mechanism

Date Written: April 1, 2017

Abstract

This paper aims to contribute to the ESM’s capacity to monitor sovereign vulnerabilities in the EFSF/ESM programme countries. The purpose is to early identify a build-up of sovereign vulnerabilities, which may threaten countries’ repayment capacity. The assessment is based on a wide set of indicators comprising (i) government borrowing needs, conditions and debt structure, (ii) economic strength, (iii) fiscal position, (iv) financial sector and other contingent liabilities, (v) institutional parameters, and (vi) private sector leverage, credit flows and real estate developments. We apply a scoring system based on thresholds from the literature, where available, or derived from the historical distribution of a pool of OECD and EU countries. The aggregation scheme for an overall vulnerability score is informed by the available literature, correlation and principal component analyses, as well as expert judgement. The results of the framework as such are, however, free of judgement. We complement the numerical results with a system of traffic lights that allows assigning individual countries one of four broad categories reflecting degrees of their vulnerabilities.

The framework can be used for a real-time vulnerability assessment, for an analysis of the evolution over time, as well as for an identification of areas where policy action may be needed. Back-tests for the countries that eventually requested EFSF/ESM financial assistance show that, with the benefit of hindsight, the tool would have identified the build-up of vulnerabilities well ahead of the onset of the crisis. The assessment, summarised in the form of a heat map and a scorecard, can be regularly updated.

Keywords: Early warning system, sovereign risk, euro area crisis

JEL Classification: E02, F34, G15, G24, H63

Suggested Citation

Lennkh, Alvise and Moshammer, Edmund and Valenta, Vilem, A Comprehensive Scorecard for Assessing Sovereign Vulnerabilities (April 1, 2017). European Stability Mechanism Working Paper No. 23. Available at SSRN: https://ssrn.com/abstract=2969745 or http://dx.doi.org/10.2139/ssrn.2969745

Alvise Lennkh

European Stability Mechanism ( email )

6a Circuit de la Foire Internationale
L-1347
Luxembourg

Edmund Moshammer (Contact Author)

European Stability Mechanism ( email )

6a Circuit de la Foire Internationale
L-1347
Luxembourg

Vilem Valenta

European Stability Mechanism ( email )

6a Circuit de la Foire Internationale
L-1347
Luxembourg

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