Political risks: the “red shift” in debt sustainability analysis

Political stability and economic policy uncertainty can be key determinants of sovereign debt dynamics, and we show how theycan be incorporated in debt sustainability analysis.We distinguish between short-term ambiguity and long-term uncertainty about political risk factors, and using a combination ofnarrative scenarios and calibrated probabilistic scenarios we obtain a comprehensive heatmap of high-risk debt dynamics. Weuse Italy as an interesting case study and demonstrate a “red shift” in the assessment of vulnerabilities when accounting forpolitical risks. Ignoring these risks can lead to excessive optimism and wrong decisions.