Download A Review of the LIC DSF

Bank-Fund Debt Sustainability Framework (DSF)
A Review of the LIC DSF
MDB Meeting
Washington DC, July 8
Bank-Fund Debt Sustainability Framework (DSF)
Outline
I. Introduction
II. Meeting Flexibly Members’ Financing Needs
III. Adding Flexibility to the Analytical Tool
Bank-Fund Debt Sustainability Framework (DSF)
I.
INTRODUCTION
Bank-Fund Debt Sustainability Framework (DSF)
Introduction
• The DSF was introduced in 2005 and reviewed
in 2006
• Its aim is to inform Bank-Fund analyses on
debt vulnerabilities and allow better informed
decision making by lenders and borrowers
• Over the past four years its use has increased
significantly
Bank-Fund Debt Sustainability Framework (DSF)
Introduction
• The DSF has been criticized as being procyclical and too restrictive on countries’
borrowing needs to meet their development
goals
• The G20 and the IMFC called on the Bank and
the Fund to review the DSF seeking for ways
to increase its flexibility
Bank-Fund Debt Sustainability Framework (DSF)
II.
MEETING FLEXIBLY MEMBERS’
FINANCING NEEDS
Bank-Fund Debt Sustainability Framework (DSF)
Meeting flexibly members’ financing needs
• The DSF, an analytical tool, is used to assess a
country’s debt burden (i.e., its probability of
debt distress): the thermometer.
• Policies set by the Bank and the Fund on nonconcessional borrowing, as well as grant
allocation decisions, use the analytical tool as
an input: the treatment.
Bank-Fund Debt Sustainability Framework (DSF)
Meeting flexibly members’ financing needs
• In reviewing the DSF staffs have been mindful
that the integrity (reliability) of the analytical
tool must be preserved.
• The non-concessional borrowing policies are
better suited to respond flexibly to members’
financing needs.
• There is scope for flexibility in the borrowing
policies of the institutions, and flexibility has
been applied in many instances.
Bank-Fund Debt Sustainability Framework (DSF)
III.
ADDING FLEXIBILITY TO THE DEBT
SUSTAINABILITY FRAMEWORK
Bank-Fund Debt Sustainability Framework (DSF)
How the DSF Works
• The DSF consists of the following set of policydependent indicative debt thresholds.
• 20 year projections of debt burden indicators in a
baseline and alternative scenarios, and subjected to
stress tests, are compared against these thresholds
to determine a country’s risk of debt distress rating
Table: Debt Sustainability Framework Thresholds
PV of debt in percent of
Exports
GDP
Revenue
Weak Policy (CPIA < 3.25)
Medium Policy (3.25 < CPIA < 3.75)
Strong Policy (CPIA > 3.75)
100
150
200
30
40
50
200
250
300
Debt service in percent of
Exports
Revenue
15
20
25
25
30
25
Bank-Fund Debt Sustainability Framework (DSF)
How the DSF Works
•
•
•
•
In assigning one of the four risk of debt distress ratings the staffs
are expected to exercise judgment and not follow a mechanistic
approach.
Low risk: all debt burden indicators are well below the thresholds.
Moderate risk: debt burden indicators are below the thresholds in
the baseline scenario but thresholds could be breached in stress
tests and alternative scenarios.
High risk: one or more debt burden indicators breach the
thresholds on a protracted basis under the baseline scenario.
Debt distress: the country is already experiencing difficulties in
servicing its debt (i.e., is in arrears) irrespective of its capacity to
repay based on a forward looking analysis.
Bank-Fund Debt Sustainability Framework (DSF)
How the DSF Works
Note that the thresholds imply different probabilities of debt
distress for countries with different CPIAs.
Probability of Debt Distress
35%
30%
25%
20%
15%
10%
2.50
2.75
3.00
3.25
3.50
CPIA
3.75
4.00
4.25
4.50
Bank-Fund Debt Sustainability Framework (DSF)
Adding flexibility to the DSF
The potential to enhance flexibility in the
following five areas could be considered:
a) Investment-growth nexus
b) Remittances
c) Threshold effects
d) Discount rate
e) SOE debt
Bank-Fund Debt Sustainability Framework (DSF)
The investment-growth nexus: 2006 Advice
• The (public) investment growth dividend problem
was acknowledged in 2006 and a country specific
approach recommended.
• The empirical literature still does not provide a clear
cut answer allowing a general way to quantify the
effect of investment on growth.
• The indicators proposed then to operationalize this
approach remain largely valid (historical rates of
return, structural/macro constraints, etc.)
Bank-Fund Debt Sustainability Framework (DSF)
The investment-growth nexus:
What more might be done?
• Using a more complete growth-diagnostic approach
to uncover the main constraints to growth could
enhance the country-specific analysis.
• Emphasizing more country efforts to “invest in the
investment process”, i.e., efforts to improve the
policy making and institutional environment, would
be helpful.
• Assessing countries’ capacity to capture financial
returns on investments is important as it affects fiscal
solvency in the long run.
Bank-Fund Debt Sustainability Framework (DSF)
The investment-growth nexus:
What more might be done?
• Where a significant up scale in investment is taking
place and where policy and institutional capacity
appears strong, a country specific model-based
analysis (using a dynamic stochastic general
equilibrium model) or a micro-level study may be
warranted.
Bank-Fund Debt Sustainability Framework (DSF)
Remittances
An important source of FX for LICs
Figure 1: Workers' remittances
and other inflows in low-income countries (% of GDP)
Gross official development assistance
Foreign direct investment (net)
Workers' remittances
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
1980
1983
1986
1989
Source: World Bank, World Development Indicators (2009)
1992
1995
1998
2001
2004
2007
Bank-Fund Debt Sustainability Framework (DSF)
Figure 2: Workers' remittances as a percentage of exports and GDP (average 2002-2007) for PRGF-eligible and IDA-only countries 1/
as a percentage of exports
as a percentage of GDP
Haiti
Tonga
Nepal
Bangladesh
Tajikistan
Uganda
Cape Verde
Sudan
Gambia, The
Nicaragua
Guinea-Bissau
Honduras
Senegal
Moldova
Sri Lanka
Kyrgyz Republic
Guyana
Togo
SierraLeone
Benin
Mongolia
Mali
São Tomé & Príncipe
Nigeria
Ethiopia
Kenya
Niger
Guinea
Rwanda
Cambodia
Solomon Islands
Myanmar
Ghana
Cameroon
Zambia
Lesotho
Mozambique
Djibouti
Madagascar
Tanzania
Malawi
Vanuatu
Congo, Republic of
Burundi
Côte d'Ivoire
Tonga
Haiti
Tajikistan
Guyana
Honduras
Nepal
Albania
Gambia, The
Cape Verde
Moldova
Nicaragua
Kyrgyz Republic
Guinea-Bissau
Sri Lanka
Mongolia
Togo
Bangladesh
Senegal
Grenada
Dominica
Uganda
Sudan
St. Vincent & Grens.
Nigeria
Bolivia
St. Lucia
Mali
Sierra Leone
Cambodia
Benin
Georgia
Kenya
São Tomé & Príncipe
Guinea
Ethiopia
Solomon Islands
Niger
Armenia
Lesotho
Ghana
Zambia
Rwanda
Cameroon
Djibouti
Mozambique
Papua New Guinea
Congo, Republic of
Madagascar
Vanuatu
Tanzania
Malawi
Burundi
Côte d'Ivoire
0%
25%
50%
Source: World Bank, World Development Indicators (2009)
1/ Average over 2002-2007 of available data.
75%
100%
125%
150%
175%
200%
0%
5%
10%
15%
20%
25%
30%
Bank-Fund Debt Sustainability Framework (DSF)
Remittances: How are they treated in the DSF?
• Remittances were not included in the
empirical model used to derive the thresholds
• The DSF currently allows some flexibility in
recognizing remittances in assessing a
country’s risk of debt distress, although it has
seldom been used
Bank-Fund Debt Sustainability Framework (DSF)
Remittances: What more might be done?
• Limitations related to the quality and coverage
of data preclude re-estimating the empirical
model (thresholds) including remittances
• Expanding the scope for flexibility in
recognizing remittances in the assessment of a
country’s risk rating could be considered
Bank-Fund Debt Sustainability Framework (DSF)
Threshold effects: What is the problem?
• For countries close to the cut off points of CPIA
ranges, small changes in a country’s CPIA may imply
“large” changes in debt thresholds (50 pp of PV
Debt/Exports; 10 pp of PV Debt/GDP)
• This is hard to relate to the country’s underlying
capacity to service its foreign debt
• Resulting changes in debt distress ratings could make
it harder for countries to borrow.
Bank-Fund Debt Sustainability Framework (DSF)
Threshold effects: What might be done?
• Add granularity to the DSF: This implies introducing
more CPIA cut offs, adjusting thresholds accordingly.
• In choosing among options the following criteria
should be considered:
a) Tolerance for risk of debt distress: threshold levels should
maintain this risk at levels considered tolerable by Boards
b) Consistent treatment of countries: thresholds applicable to
each country should imply similar probabilities of debt
distress
•
Ideally, greater granularity should not imply thresholds
that are more stringent than the current ones.
Bank-Fund Debt Sustainability Framework (DSF)
Discount rate
• The current rule establishes that the discount rate (used to
calculate PV of Debt) needs to be adjusted (with a lag)
following market trends. A lowering of the rate by 100 basis
points is now due.
• Consideration as to whether mechanical (inflexible)
application of this rule might lead to a significant change in
risk of debt distress assessments is needed.
• Simulations show that a change in the discount rate to 4
percent would generally result in relatively small increases in
PV of debt.
• And a very small number of countries would experience small
and temporary breaches of their respective thresholds.
Bank-Fund Debt Sustainability Framework (DSF)
SOE debt
• The current rule is that all SOEs external debt is included
in the DSA, although exceptions have occurred.
• Critics argue that this treatment is too rigid and staffs
should consider increasing flexibility.
• Staffs are proposing to exclude SOE debt whenever
firms can borrow without government guarantee and
their operations pose a limited fiscal risk.
• Going forward, staff will consider if it may be feasible to
include SOEs debt in DSAs in the same proportion as the
government’s equity share (instead of 100%).
Bank-Fund Debt Sustainability Framework (DSF)
Other issues: Streamlining DSAs
• Staffs are also considering how to streamline the
production of DSAs.
• One possible option could be to do full DSAs less
often, with lighter annual updates in the interim.
Bank-Fund Debt Sustainability Framework (DSF)
A Review of the LIC DSF
MDB Meeting
Washington DC, July 8