A DSA is an assessment of the sovereign’s capacity to meet its scheduled debt payments. Any DSA is a forward­looking exercise: it requires forming expectations about the future debt-repayment capacity. These expectations will, in turn, depend on the(expectations of) actions of economic agents, which in turn depend on beliefs about the beliefs of those agents. Thus, any DSA entails judgments regarding the evolution of the economy of the country under analysis, including the expectations of others whose behaviours and decisions determine the country’s financing capacity(Guzman and Heymann, 2015). The concept of debt sustainability is intricate, as it depends on heterogenous beliefs about the future and views on the functioning of the economy under analysis over which major conflicts during negotiations among different stakeholders are common. 3 Debtors and different groups of creditors tend to have different views in debt restructuring negotiations. Those differences in views are often not just based on discrepancies over technical criteria but on competing interests, with creditors wanting less restructuring arguing that countries have a greater capacity to repay than they may really have. Generally, they want the DSA to employ assumptions that show that that is the case. 3. Debt sustainability in an environment of incomplete contracts There are two different literatures regarding why defaults may occur. In one strand, defaults are the consequence of lack of commitment to or enforcement of debt contracts. A default is an optimal decision for a utility maximiser sovereign – and may occur even when there is capacity to pay(Eaton and Gersovitz, 1981; Aguiar and Gopinath, 2006; Guzman, 2014). In the other strand, defaults are the consequence of a lack of capacity to pay – a problem of sustainability(Guzman and Stiglitz, 2020; Roubini, 2001; Wyplosz, 2007). However, the distinction between the two perspectives, between commitment and sustainability, is not as clear as this discussion might suggest. Typically, a country could repay more, but with a high expected but uncertain cost, e.g. the political unrest may be so great that future output will be reduced, and given these uncertain outcomes, the expected repayment actually received by the creditor may be reduced. In other cases, the expected repayment by the creditor might be increased, but the costs borne by the debtor are judged to be unacceptable. Only where there is a“Laffer curve” – where any actions designed to increase repayment actually result in reduced repayments, so that there is an absolute maximum expected repayment – is“capacity” well­defined. Otherwise, the capacity to pay becomes ambiguous. The feature common to both literatures is that debt contracts are incomplete, as they do not stipulate the transfers between the debtor and its creditors according to the realization of every possible state of the economy. If there were complete debt contracts, there would not be sustainability problems. Each contingency would be considered and implicitly resolved in the debt contract, and it would never be necessary to restructure contracts to satisfy transversality conditions; there would be no insolvencies. In practice, however, with incomplete contracts, expectations about future outcomes determine the sustainability assessment(Guzman and Heymann, 2015). The incompleteness of sovereign debt contracts is a defining characteristic of sovereign debt. It will always be that way, as it is simply impossible to even know the full space of states, let alone to write contracts that are indexed to every known possible state, especially so because of problems of verification ex-post. The existence of a positive risk market premium implies that creditors do not expect full repayment according to the schedule of debt payments established in the bonds or loans in every state of nature. However, debt 3 There are conflicts in views about what the policies should be, what they will be, and what the consequences of alternative policies would be. Series: Debt Sustainability Assessments& Their Role in the International Financial Architecture 2