WORKING PAPER 12-12

Sovereign Debt Sustainability in Italy and Spain: A Probabilistic Approach

by William R. Cline, Peterson Institute for International Economics

August 2012

This paper introduces a new probabilistic approach to sovereign debt projections and presents new estimates of debt ratios through 2020 for Italy and Spain. The new approach takes account of likely correlations across 243 alternative scenarios with three states (good, baseline, bad) for five key variables (growth, interest rate, primary surplus, bank recapitalization, and privatization). The 25th and 75th percentile scenarios are reported, as are the baseline and probability-weighted outcomes. The results suggest sovereign debt is sustainable in both Italy (where debt ratios are likely to decline because of a high primary surplus) and Spain (where the ratios rise but at a decelerating pace and from relatively low levels).

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