DEBT SUSTAINABILITY FRAMEWORK FOR LOW INCOME COUNTRIES

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DEBT SUSTAINABILITY FRAMEWORK FOR LOW INCOME
COUNTRIES

• Nihal Kappagoda

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OBJECTIVES

• Assist Low Income Countries that benefited from
  debt relief to avoid the future accumulation of
  unsustainable external debt levels
• Enable the World Bank to assess current and
  future prospects of debt distress of IDA only
  countries and determine grant eligibility within
  IDA 14 allocations
• Enable the IMF to monitor external debt levels
  and the ceilings on non-concessional borrowing
  set in program countries
• Provide a framework for Joint Debt Sustainability
  Analyses by the Bank and Fund for IDA only, PRGF
  eligible LICs

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ISSUES FOR DISCUSSION

• DSF has become complex due to linkages to
  various policies and institutional changes by the
  IMF, World Bank and LICs. These are
• The conduct of DSAs, the selection of debt
  indicators and threshold values for them
• Country Policy and Institutional Assessments
  performed by the World Bank in LICs
• Estimation of debt distress
• Implementation of the IDA 14 Grant Allocation
  Framework

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ISSUES FOR DISCUSSION (Contd)

• Implementation of the MDRI and HIPC Initiative
  and action remaining after the end of 2006
• Non-concessional borrowing by LICs after
  receiving debt relief and the free rider
  problem
• Implications of the DSF on the IMFs policy
  agenda in LICs and
• Action to be taken by the LICs to improve debt
  management capacity and formulate a Medium Term
  Debt Strategy to guide future borrowings

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DEBT SUSTAINABILITY

• External debt sustainability of a country is its
  ability to service all foreign public and
  publicly guaranteed and PNG debt without
  compromising its longterm goals and objectives
• Causes of debt stress are high levels of the
  stock of debt outstanding measured by the
  absolute amount or NPV as a ratio of GNI, exports
  or government revenue weak policy and
  institutional environment and exogenous shocks
  to the economy
• Outward manifestations of crisis are the
  accumulation of arrears, an application to the
  Paris Club for the restructuring of official debt
  when it is judged that a breakdown in payments is
  imminent and agreement with the IMF on a program

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DEBT INDICATORS

• Use of debt indicators to judge debt
  sustainability raise a number of conceptual
  issues
• Definition of debt public and publicly
  guaranteed external debt, total public debt or
  total external debt
• Stock of debt nominal stock expressed in a
  single currency and NPV of future debt service
  payments
• Capacity to pay size of the economy (GDP or
  GNI), exports of goods and services or government
  revenue

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THRESHOLD VALUES OF DEBT INDICATORSGlobal
Development Finance

Indicator Highly Indebted Moderately Indebted Less Indebted
DOD/GNI gt50 gt30 lt50 lt30
DOD/XGS gt275 gt165 lt275 lt165
TDS/XGS gt30 gt18 lt30 lt18
INT/XGS gt20 gt12 lt20 lt12
NPV/GNI gt80 gt48 lt80 lt48
NPV/XGS gt220 gt132 lt220 lt132
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THRESHOLD VALUES OF DEBT INDICATORS (Contd)

• HIPC Initiative
• NPV of public and publicly guaranteed external
  debt to exports of goods and services 150
  percent
• NPV of public and publicly guaranteed external
  debt to government revenue 250 percent

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THRESHOLD VALUES OF DEBT INDICATORS (Contd)Debt
Sustainability Framework
Debt Indicator Strong Medium Weak
NPV of debt/GDP 50 40 30
NPV of debt/Exports 200 150 100
Debt service/Exports 25 20 15
NPV of debt/Revenue 300 250 200
Debt service/Revenue 35 30 25
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COUNTRY POLICY AND INSTITUTIONAL ASSESSMENTS

• Based on criteria covering policy and
  institutional developments needed for an
  effective poverty reduction growth strategy and
  effective use of development assistance
• Ratings done annually and based on actual
  policies and institutional changes that are
  implemented
• Sixteen criteria in four groups under Economic
  Management, Structural Policies, Policies for
  Social Inclusion and Equity, and Public Sector
  Management and Institutions
• CPIAs used for estimating IDA Country Performance
  Ratings which with per capita income determine
  IDA country allocations and assessing debt
  distress in LICs

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DEBT DISTRESS

• Indicators dependent on government revenue are
  not used for assessing debt distress
• The average of the two stock indicators NPV of
  debt to GDP and exports of goods and services
  and debt service ratio are used to assess debt
  distress of LICs
• Two bands, 10 percent above and below the
  thresholds, are used to assess grant eligibility
• If the operational ratio - the composite stock
  indicator or the debt service ratio - is 10
  percent or more below the threshold, IDA provides
  its assistance as credits. If it is 10 percent
  or more over the threshold, IDA assistance will
  only be provided as grants. A mixture of grants
  and credits is provided when the ratio is between
  the two

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IDA ALLOCATIONS AND GRANTS

• The CPIA has a 80 percent weight in estimating
  the Country Performance Rating used for
  determining IDA allocations for each
  replenishment
• The balance 20 percent is provided by the Banks
  assessment of its performance on its portfolio of
  outstanding loans
• A governance factor is applied to the two ratings
  to determine the CPR
• Governance factor is based on the five criteria
  in the cluster on Public Sector Institutions and
  Management in the CPIA and portfolio performance
• Heavy weightage given to the governance factor
  than is warranted by its share in the CPIA
• Performance based on the CPR and need based on
  per capita GNI are used to determine the
  allocation to each LIC
• Grant eligibility is determined by the debt
  distress assessment

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IMPLEMENTATION OF MDRI AND HIPC INITIATIVES

• HIPC INITIATIVE
• 40 countries met the income and indebtedness
  criteria to receive assistance. 21 reached the
  Completion Point and qualified to receive full
  debt relief. 9 are between the Decision and
  Completion Points and received some debt relief
• 10 are pending agreement on macroeconomic
  reforms, poverty reduction strategies and plans
  to clear arrears. Remaining countries
  grandfathered provided they met the income and
  indebtedness criteria for data at the end of 2004
  and permitted to qualify for debt relief at their
  own pace
• Debt service payments in the 30 countries that
  had debt relief packages approved declined by two
  percent of GDP on the average between 1999 and
  2005.
• Before the Initiative, eligible countries spent
  more on debt service than on health, education
  and social services. Now they spend five times
  the amount on the latter services than on debt
  service

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IMPLEMENTATION OF MDRI AND HIPC INITIATIVES
(Contd)

• MULTILATERAL DEBT RELIEF INITIATIVE
• The MDRI provides full debt relief from the
  participating institutions (IMF, IDA and the
  AfDF) unlike the HIPC Initiative that required
  coordinated action by all creditors to reduce the
  external debt of qualifying countries to
  sustainable levels with each institution
  providing debt relief separately
• The IMF provided debt relief to countries
  reaching the Completion Point on the full stock
  of debt at the end of 2004 from January 2006.
  Two non-HIPCs with per capita incomes of less
  than 380 were also provided assistance
• IDA provided debt relief from July 2006 on all
  debt outstanding at the end of 2003 when
  countries reach the Completion Point

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NON-CONCESSIONAL BORROWING BY LICs

• Debt relief under the two initiatives and grant
  funding by the IDA enabled LICs to keep debt
  burdens below the threshold values in the DSF
• OECD donors and IFIs have coordinated their
  approach in assisting LICs
• Commercial creditors and non-OECD bilateral
  creditors have not done so and begun lending on
  non-concessional terms. This is referred to as
  the free rider problem and reflects differences
  between collective and individual interests of
  creditors
• IFIs have begun a dialogue with other creditors
  based on the DSF and an exchange of information
  on debt relief, grants and the problems created
  by lending by this group of creditors

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CHALLENGES AHEAD

• Review the debt indicators and thresholds used in
  the DSF
• Integrate domestic public debt to the DSAs
  conducted on external public debt
• Monitor the vulnerabilities that could arise from
  non-concessional PNG debt and high levels of
  domestic debt
• Foster creditor coordination and broader use of
  the DSF by both LICs and creditors
• Improve data quality and reporting to the IFIs
• Strengthen capacity for public debt management

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DEBT INDICATORS AND THEIR THRESHOLD LEVELS

• DSF based on threshold levels of three selected
  debt indicators
• Adopt a broad definition of public debt that
  takes account of all the liabilities of the
  public sector
• Develop a methodology to assess the
  sustainability of total public debt
• Assess macroeconomic stability taking account of
  the domestic and external borrowings of the
  public sector
• Include debt indicators that use government
  revenue as a variable in the DSF

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INTEGRATION OF DOMESTIC DEBT IN DSAs

• Domestic public debt is significant in some LICs
• It carries higher risks due to shorter maturities
  and higher interest rates than external public
  debt
• Methodology is being developed to prepare DSAs
  for total public debt
• A DSA for domestic public debt should be done at
  the same time as that for external public debt
  using indicators similar to those used in the DSF
  with government revenue replacing exports of
  goods and services
• Examine vulnerabilities arising from domestic
  debt that may lead to a different classification
  of indebtedness from that obtained by reviewing
  only external public debt

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FOSTERING CREDITOR COORDINATION

• The IFIs have begun listing the countries for
  which external debt DSAs have been done and the
  dates on their web sites. A direct web link is
  provided to the document once the countries agree
• Bank and Fund have begun outreach programs among
  creditors by attending meetings such as those of
  the OECD Export Credit Group. Coordination
  efforts focus on the DSF
• Much needs to be done with the non-OECD official
  creditors called emerging creditors and their
  share is of the order of 10 percent of total
  official assistance
• The largest are Brazil, China, India, Korea,
  Kuwait and Saudi Arabia. China is the largest
  and Kuwait the second
• G7 Finance Ministers have called for greater
  coordination among lenders possibly leading to
  the formulation of a charter for lending

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IMPROVED DATA QUALITY AND REPORTING TO THE IFIs

• Collection of data on domestic debt and
  government revenue and reporting them to the IFIs
• Half the LICs do not report their external debt
  to the World Banks Debtor Reporting System or
  there are moderate to major problems with the
  data submitted
• Country data is checked and supplemented with
  that obtained from the OECD, BIS and Berne Union
• IFIs have included mandatory advance reporting of
  non-concessional loans in grant and credit
  agreements in post-MDRI countries. A web page on
  concessionality including a facility to calculate
  it has been set up

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IMPROVEMENTS IN PUBLIC DEBT MANAGEMENT

• Strength the legal and regulatory framework and
  institutional framework for public debt
  management
• Establish a debt information system for
  recording, retrieving and analyzing public debt
• Formulate a public debt policy and a Medium-Term
  Public and External Debt Strategy with a link to
  the Medium-Term Fiscal Framework
• The MTDS should cover the terms of new borrowing,
  the mix between fixed and variable rates and
  domestic and public debt and the currency mix for
  external borrowing
• Staff of PDMOs need to undertake comprehensive
  debt management functions