Resolving Sovereign Debt Overhang in Emerging Market Economies: A Fiscal Space Quantification Framework Under Stochastic Interest Rate Shocks

Abstract

Sovereign debt overhang remains a structurally destabilizing force in emerging market economies (EMEs), particularly under conditions of tightening global monetary policy and persistent current account deficits. This study develops a stochastic dynamic fiscal space quantification framework that integrates interest rate shock propagation, debt sustainability thresholds, and primary balance adjustment paths. Employing a panel dataset of 47 EMEs spanning 2005–2023, combined with a Bayesian Vector Autoregression (BVAR) model and Monte Carlo debt trajectory simulations, the analysis identifies nonlinear tipping points at which debt servicing costs crowd out productive public investment. Empirical results confirm that fiscal consolidation alone is insufficient without concurrent exchange rate stabilization mechanisms and concessional refinancing facilities. The framework offers a replicable policy tool for multilateral institutions and finance ministries to calibrate debt restructuring interventions with greater temporal precision.