Download Applying the Debt Sustainability Framework for Low

Debt Sustainability and
Fiscal Risk Analysis
Using the LIC Templates
PFAM Course
April 24, 2007
Mark Roland Thomas, PRMED
[email protected]
Outline
1.
2.
3.
4.
5.
Introduction
The External Template
The Fiscal Template
Operational Factors
Beyond the LIC DSF
2
Introduction
Debt sustainability concepts and
the Bank
When is Debt Sustainable?

Liquidity: can the country pay today?
– The answer depends on what “can” is

Solvency: is the country likely to be able to pay
at all points in future?
– The answer depends on the current debt
– It also depend on current economic policies
– And it also depends on broader institutional strength

Any solvency problem must eventually manifest
itself as a liquidity problem
– Analyze vulnerability: identify relevant risk concepts
– In LICs, it is important to account for loan terms
 Present value, concessionality, grant element
4
The Joint (Bank-Fund) DSF

An operational approach to debt sustainability in LICs
– External
– Fiscal

A DSA is a 20-year forecast of debt burden indicators
under baseline assumptions and stress tests
– Conducted jointly by IMF and WB teams but the tool can be
used by authorities, others

DSA forecasts, combined with policy specific debt
thresholds, lead to a risk rating
– Used by IDA: 0/50/100 grant rule
– Joint LIC-DSF analysis is a core element of WPAs
5
DSA Output
NPV of debt-to-GDP ratio (%)
70
60
50
40
30
Baseline
Historical scenario
Most extreme stress test
20
10
0
2003
2005
2007
2009
2011
2013
2015
2017
2019
2021
2023
6
The DSF: what it is and isn’t
The DSF is part of our due diligence as a
responsible creditor
 It tells us whether current debt levels and
policies pose a risk of debt distress
 If they do, we move towards grants
The DSF is not a needs assessment
The DSF is not a binding framework on the
borrower
The DSF is not imposed on other creditors

7
Timeline


April 05: DSF adopted; first joint Bank-Fund DSAs
March 06: 1st Board Review
– Confirmed design and asked for 2nd paper addressing:
 Pace of new borrowing post debt relief
 Domestic debt
 Moderate risk category

November 06: 2nd Board Review
– Reported to EPSB, November 29

April 07: Staff guidelines and web publication of DSAs
– Improved framework for collaboration with IMF


June 07: Full rollout of DSA-based approach to IDA grant
allocation
FY08: DSF mainstreamed in budgets and WPAs and sent
stand-alone for information to the Board of IDA
8
The External Template
External DSA

Focus on external public debt
– Private debt is a consideration but not an integral part
of the analysis
 Low levels in LICs and data constraints

External DSA is built on relatively rich empirical
underpinnings
– Kraay and Nehru (WBER, 2007)

IDA bases decisions on the external picture
– Moral hazard concerns
10
External debt: definitions
Gross Total
External Debt
Public and Publicly
Guaranteed
PPG
Private Non
Guaranteed
PNG
Short-term
(Public + Private)
Central Government
Local Government
Public Enterprises
11
Indicative External Debt Thresholds
Institutional strength and quality of policies
Poor
Medium
Strong
CPIA<3.25
3.25<CPIA<3.75
CPIA>3.75
Debt service-to-exports
15
20
25
Debt service-to-revenue
25
30
35
NPV of debt-to-GDP
30
40
50
NPV of debt-to-exports
100
150
200
NPV of debt-to-revenue
200
250
300
12
External Template: Structure
Inputs
Input External
Outputs
SR_Table_Baseline


Historic values and
projections of
macroeconomic variables:
–
–
–
–
–
Current account balance
XGNF
FDI
GDP
Exchange rate

SR_Table_Stress

Inp_Out_Debt


Projected debt burden indicators:
NPV/GDP, NPV/X, DS/X
Decomposition of debt dynamics
into its driving forces
Projected debt burden indicators
under stress test
Risk of debt
distress
Relevant indicative
thresholds
Debt service projections on
the stock of debt at the base
year
Levels and terms of projected
new borrowing
Other considerations


Domestic debt
Remittances
13
Evolution of External Debt
Evolution of
DEBT/GDP
Current account
deficit
Changes in prices
and exchange rates
Identified factors
Residual
Net FDI
Endogenous debt
dynamics
Real GDP growth
Change in nominal
interest rate
14
Standardized Risk Analysis

Stress tests and alternative scenarios
– Alternatives: cost of finance and historical
– Stress: GDP growth, export growth, inflation, net nondebt creating flows, combination, exchange rate
– Trade-off: comparability and transparency with
specificity and realism
Variables at historical
levels
Real GDP growth
GDP Deflator
Non-Interest CA
Net FDI
Endogenous variables
Nominal GDP
Identified Debt creating flows
Nominal Interest Rate
Debt Stock
Unchanged Variables
Exports
Imports
Exchange Rate
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Risk Ratings
1.
Low Risk
– Policy dependent indicative thresholds not breached under
baseline or stress tests
2.
Moderate Risk
– Thresholds breached only under stress tests
– If only one threshold, briefly, there is room for debate
3.
High Risk
– Baseline breaches thresholds, although no existing payment
difficulties
4.
In Debt Distress
– Either, debt service thresholds persistently or significantly
breached…
– Or, significant existing arrears


NB: the risk rating takes into account all scenarios,
baseline and alternatives, plus country knowledge
IDA grants response should not affect risk rating
16
The Fiscal Template
Fiscal Analysis
Adds public domestic debt
 Fiscal deficit becomes the key driver

– Long-run government budget constraint

Nuances when considering domestic debt
– Term structure: domestic is shorter term
– Domestic market interest rates
– Inflation and indexation
– Concentration and financial repression?
18
Domestic Debt (PPG)
Obligations to domestic (resident) creditors
 Usually refers to debt payable in domestic
currency, although the actual payment may be
indexed to inflation or a foreign currency
 In LICs, domestic debt usually refers to debt of
the central government
 Domestic debt may also include wage and
supplier arrears

19
Contingent Liabilities
Explicit
Guarantees
for borrowing and obligations of sub-national
governments and public or private entities
Umbrella guarantees for various loans (e.g. agriculture loans,
small business loans)
State insurance schemes (e.g. crop insurance, flood insurance)
Implicit
Defaults
of sub-national governments and public or private entities
on non-guaranteed debt and other obligations
Liability clean-up in entities being privatized
Bank failures
Failures of non-guaranteed pension funds or other social security
funds
20
Fiscal Template: Structure
Inputs
Input Fiscal

Historic values and
projections of
macroeconomic
variables:
– Public sector debt data
– Fiscal variables
– Privatization Receipts
– Recognition of implicit
contingent liabilities
– Financing assumptions
Outputs
Table_Baseline


Projected debt burden
indicators: NPV/GDP, NPV/X,
DS/X
Decomposition of debt
dynamics into its driving
forces
Revise risk of
debt
distress?
Table_Stress

Projected debt burden
indicators under stress test
21
Evolution of Public Debt
Domestic debt
dynamics
Primary Balance
Changes in prices
and exchange rates
Identified factors
Residual
Additional Factors
Endogenous debt
dynamics
Real GDP growth
Change in nominal
interest rate
22
Illustration
Domestic Debt
Dynamics
Identified Factors
Primary balance
Endogenous debt
dynamics
Change in real
interest rate
Real GDP growth
Changes in prices
and exchange
rates
23
Operational Factors
Board Reviews and Staff Guidance
Direct Responses to the Board’s
Requests in a “DSF2” Paper
1.
The Pace of New Borrowing
–
2.
Domestic Debt
–
–
3.
A 5 percent of GDP in-a-year caution flag
Public Sector DSA requirement
Possibility of “splitting the risk rating”
Risk Ratings
–
–
Use of a three-year moving average to set the
indicative debt burden thresholds
No change in the moderate risk category
25
Economic Projections in DSAs

The battle against optimism
– Active use of the historical scenario
– Referral to past DSAs and their projections
– “High-investment low-growth” check
 Particularly under caution flag
– Rigor in financing assumptions as well as
growth and exports
26
The New Landscape

Nonconcessional borrowing by LICs is a reality
– Including MRDI recipients

Realism about financial flows is needed in DSAs
– Need not imply endorsement of borrowing plans
Active modeling can signal costs and risks
 Other vulnerability indicators may be brought in
where private credit is large

– List of indicators is suggestive only
– Economical approach recommended
27
Other Institutions

IMF
–
–
–
–
–
–

Despite some breakdowns, overall collaboration has been good
Joint work commences prior to briefing paper stage
Bank participation in IMF mission is encouraged
IMF: early agreement on timing and full file sharing
WB: early, full participation and prompt review and clearance
Guidelines provide more detailed step-by-step
Main RDBs
– Suggested approach sent to RDBs at working level
 Inputs based on preliminary tables and charts
 Attendance at meetings at government invitation
 Bank responsible for sharing final document
28
The Role of PRMED



Support
–
–
–
–
Staff training (e.g., hub training events)
Online materials and guidance notes
Ad hoc advisory services
Regional priority DSAs
–
–
–
–
–
Clearance is in conjunction with Regional PREM director
Country interpretation versus DSF-wide concerns
See the Guidance Note
Price setting for FRM
Submission to Board
Review and clearance
R&D
– Domestic debt
– Risk ratings vis-à-vis outcomes


Creditor outreach including database maintenance
Borrower training
29
Staff Guidelines







Definitions and departures from previous
practice
Design of macroeconomic scenarios
Treatment of domestic and private external debt
Description of responsibilities and timeline
Review process
HIPCs
Model outline
30
Beyond the DSF
Fiscal Sustainability in MICs
Tailored Middle-Income Analysis

MIC features:
– Greater variety of debt instruments
 But concessionality and grant element less germane (no
need to use present value)
– Emerging markets’ participation in international
capital markets
 Market risks in addition to exogenous shocks
 Shorter time horizon
– More, higher-quality data
 Option for modeling covariance, monte-carlo simulation,
value-at-risk analysis
32
Thank You
Questions…