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Debt

VIEWS: 8 PAGES: 42

									Debt Sustainability in Low-Income Countries




                                                   World Bank
                          Economic Policy and Debt Department
                                                    May 2006
  Debt and Debt Relief in the World Bank

                              “Sector Units”

 Environment and                                            Poverty Reduction
Socially Sustainable   Finance, Private         Human        and Economic
   Development       Sector, Infrastructure   Development     Management


                                                            Economic Policy
                                                               and Debt




                                                                                2
Outline



1. Why is debt relief a global issue?


2. What led to debt distress in the 1990s?



3. How did the international community respond?



4. How can we avoid debt distress in future?
Why is debt relief to low-income countries a
global issue?

 Despite access to highly concessional financing,
  many low-income countries have needed
  significant debt relief


 The need to meet the MDGs has led many to
  question why the poorest countries should pay
  debt service to rich creditors



                                                     4
The Main Arguments for Debt Relief*


 Moral argument
 Financing argument

 Debt overhang or growth argument

 “Evergreening” or efficient lending argument


* Acknowledgement: the following 8 slides are adapted from work by Christina Daseking; all views expressed are
those of the current presenter and should not be attributed to the IMF, its Executive Board, or its management.
                                                                                                                  5
          The Moral Argument

 Poor countries should not devote scarce
  resources to pay rich creditors
 But...
   No debt service means no borrowing
   Smaller overall aid envelope
   How pessimistic should we be?




                                            6
Are poor countries doomed to stay poor?

                                      Per Capita Income in U.S. dollars
 8,000



 7,000



 6,000



 5,000



 4,000                                                    Thailand


 3,000



 2,000
                                                          Ghana
 1,000



    0
         1975   1977   1979   1981   1983   1985   1987     1989     1991   1993   1995   1997   1999   2001   2003
                                                                                                                      7
           The Financing Argument

 Debt relief generates additional predictable
  resources in support of the MDGs
 But...
   Additionality cannot be taken for granted
   There may be better ways to provide MDG
    financing, as debt relief is:
      Backloaded
      Allocated based on past lending decisions
      Small relative to new development assistance


                                                      8
Debt Service and ODA for 28 Post-Decision-
         Point HIPCs, 1999-2003

   80,000



   70,000



   60,000



   50,000
                                 Total Official
   40,000
                                 Development
                                  Assistance
   30,000                        ($68 billions)
            Total Debt Service
   20,000      ($14 billion)

   10,000



       0




                                                  9
  The Debt Overhang or Growth Argument

 As a high debt burden weakens incentives to
  invest, debt relief will foster growth
 But...
   Growth effect beyond financing controversial: Is high
    debt ratio cause or symptom of low growth?
   HIPC Initiative has already removed large portion of
    debt
   Other factors are likely to be much more important
    (trade deal, policies, institutions)



                                                            10
              The “Evergreening” or
           Efficient Lending Argument
 Debt relief removes roll-over concerns,
  allowing creditors to allocate new resources
  more efficiently
 But...
   Allocation of debt relief resources itself benefits
    heavy borrowers
   Performance-based lending already possible
   Debt relief may create incentive problems of its
    own by raising expectations for more
                                                          11
             “Caveat Emptor”

 All arguments for debt relief have some
  appeal and merit…
 … but none is without caveats
 Bottom line: don’t expect too much!
 Debt relief generates predictable aid, but it
  cannot generate sustainable growth


                                                  12
What led to debt problems in
        the 1990s?
Debt burdens in some low-income countries
rose dramatically from 1973 to 1993
              The Share of External Debt to GDP (in NPV terms)
250%



200%


                                                                      HIPC Countries
150%



100%



 50%

                                                                 Low-Income Countries

  0%

       1970   1974    1978     1982    1986    1990     1994        1998        2002




                                                                                        14
Low Growth is the Main Cause of Debt Distress
                                   Average External Public Dyanamics, 1980-2002
                                              (NPV, percent of GDP)

          120


          100
                                                               Actual
           80


           60
                                                                   Simulated
                                                                   5% growth
           40


           20


             0
              80
              81
              82
              83
              84
              85
              86
              87
              88
              89
              90
              91
              92
              93
              94
              95
              96
              97
              98
              99
              00
              01
              02
            19
            19
            19
            19
            19
            19
            19
            19
            19
            19
            19
            19
            19
            19
            19
            19
            19
            19
            19
            19
            20
            20
            20
Note: Source: World Bank Global Development Finance Statistics. The graph shows the actual unweighted average of debt-to-GDP
ratios across LICs versus the simulated ratio had all countries grown at 5% in dollar terms, a performance achieved by just over one
in three LICs during the period.                                                                                                       15
Developing countries are dependent on
commodities

                                                              400
                                                                           Commodity Price Trends

                                                              350


                                                                           Crude oil
                                                              300
                 Commodities’    Commodities’      Major
                Share of Exports Share of GDP    Commodity
                                                              250
Zambia              99.8%           23.4%         Copper
Mauritania          99.5%           39.4%         Iron Ore    200
                                                                                       Coffee
Guinea Bissau       97.7%           23.7%       Cashew Nuts
Benin               93.7%           16.1%         Cotton      150
Uganda              90.5%           11.1%         Coffee
                                                              100
                                                                                  Cotton

                                                               50

                                                                                       Copper
                                                                0
                                                                    1970   1975     1980        1985   1990   1995   2000




                                                                                                                            16
Other factors played a part…


 Waste of resources due to weak institutions,
  poorly designed projects, corruption
 Poor debt management and unrestrained non-
  concessional borrowing; “loan pushing” by
  creditors
 Wars, civil strife, conflict



                                                 17
How did the international
 community respond?
Bilateral creditors have forgiven increasing
amounts of debts owed to them
                Proportion of Grant Element in Paris Club Forgiveness




                                                                                                          90%
                                                                                 80%
                                                        67%
                               50%
      33%




   Toronto                  London                    Naples                    Lyon                   Cologne
   (1988)                   (1991)                    (1994)                   (1996)                  (1999)

  Note: The forgiveness listed is the reduction in the NPV of the rescheduled debts owed to the Paris Club members.
                                                                                                                      19
Traditional debt relief reduced bilateral and
commercial debt; not multilateral debt

                            Share of Multilateral Debt of Overall External Debt
  40%


  35%


  30%


  25%


  20%


  15%


  10%


  5%


  0%
        1970         1974          1978         1982         1986          1990         1994          1998         2002



  Note: “Traditional Debt Relief” includes that of the Paris Club (bilateral debt owed to donor governments) and the
  London Club (commercial debt). Source: World Bank Global Development Finance 2005.
                                                                                                                          20
HIPC Was the First Comprehensive Global Debt
Reduction Initiative to Include Multilateral Debt

Objectives
  Reduce external debts owed by HIPC governments
  Finance increase in government spending on poor people

Design
  Eligibility is based on external debts and income per
   capita
  Requires government to formulate a poverty reduction
   strategy paper (PRSP) through local consultation
  Requires satisfactory performance based on an IMF
   program
  Then irrevocably provides debt relief – up to a pre-defined
   threshold
                                                                 21
Multilateral Institutions Have Provided Half of
All HIPC Debt Relief Committed

                                       Total Amount of Debt Forgiven (USD bn)




        13.8


                                                                                9.2
                                                                                                                                7.6
                                 3.6
                                                                                                         3.0
                                                        0.9


     Paris Club          Other Bilaterals           Commercial              World Bank                   IMF                 Other
                                                                                                                           Multilaterals
Note: The figures of committed debt relief are current as of April 2005 measured in end-2004 NPV terms, and include 38 HIPCs as of 2005.
                                                                                                                                           22
                    The HIPC Process




                                                                                Irrevocable debt relief
                Preliminary                Interim period
    Country     Discussion
fulfills HIPC                 Decision                      Completion
  Eligibility                  Point                          Point

     Criteria

                       Determination of:           - Satisfactory Performance
                        - NPV of debt              under PRGF
                        - Debt Relief              - Implementation of
                        - Triggers                 PRSP for one year
                                                   - Meeting triggers

                                                                                                          23
March 2006: 29 Countries are receiving debt relief,
nine countries had yet to benefit…
18   Benin
     Bolivia
     Burkina Faso
                                                 Causes
     Ethiopia                                     Conflict
     Ghana                                        Arrears
     Guyana                                       Weak governance
     Honduras
     Madagascar       11   Burundi
     Mali                  Cameroon
     Mauritania            Chad                    9   Central African Rep.
     Mozambique            Congo, Dem. Rep.            Comoros
     Nicaragua             Congo, Rep.                 Côte d’Ivoire
     Niger                 The Gambia                  Lao PDR
     Rwanda                Guinea                      Liberia
     Senegal               Guinea-Bissau               Myanmar
     Tanzania              Malawi                      Somalia
     Uganda                São Tomé & Principe         Sudan
     Zambia                Sierra Leone                Togo
          Post-HIPC            Interim-HIPC                  Pre-HIPC         24
May 2006: “Ring-Fencing” has identified four
potentially eligible countries that may opt in…
19   Cameroon
     Benin
     Bolivia
     Burkina Faso
     Ethiopia
     Ghana                                            Eritrea
                                              11?     Haiti
     Guyana
     Honduras                                         Kyrgyz Rep.
     Madagascar                                       Nepal
     Mali             10   Burundi
     Mauritania            Chad                     Central African Rep.
     Mozambique            Congo, Dem. Rep.         Comoros
     Nicaragua             Congo, Rep.              Côte d’Ivoire
     Niger               The Gambia
     Rwanda              Guinea                     Liberia
     Senegal             Guinea-Bissau
     Tanzania          Malawi                       Somalia
     Uganda            São Tomé & Principe          Sudan
     Zambia              Sierra Leone               Togo
          Post-HIPC            Interim-HIPC               Pre-HIPC         25
    HIPC has substantially reduced debts
    and pro-poor spending has increased
  Debts have been reduced1…                                                 and so have payments to creditors2…
                                                                                           6
       Before Traditional Relief                              84                                                                     Before HIPC Relief
                                                                                           5




                                                                            USD Billions
 After Add. Bilateral Debt Relief           30                                             4
                                                                                           3
                                                                                           2
                                                                                                                                     After HIPC Relief
                                                                                           1
                                                                                               2001   2002   2003    2004          2005      2006




reducing budget spent on debt payments3… and increasing pro-poor spending4.
                              21.8%                                                                                   47.6%
                                                                                                             40.9%
                                           13.4%




                                    1999    2003                                                              1999          2003


 Notes: 1) Debt stocks of 28 decision point countries, USD billion 2004 NPV terms. 2) Projected debt service obligations of 28 decision point
 countries. 3) Debt service to government revenue for 28 decision point countries. 4) Ratio of poverty-reducing expenditures to government revenue.       26
Pre-Conditions for Effective Debt Relief


                       Donors     1. Additional to
                                     aid inflows
                                  2. Beyond arrears
                        HIPC         clearance
                      Creditors
                                  3. Economically
                                     significant

 Gov’t                Priority
                                          MDGs
Budget                Sectors
           HIPC                   MDRI
         Initiative
                               Preliminary Results:
                     Debt Relief and Priority Sector Spending
                     Debt Relief vs. Poverty-Reducing Expenditures                                                  Debt Relief vs. Education (top) and
                                     (IMF definition)                                                                 Health (bottom) Expenditures
             20.0%                                                                                     10.0%
             18.0%                                                                                     9.0%
             16.0%                                                                                     8.0%
             14.0%                                                                                     7.0%




                                                                                       EDUC/GDP
             12.0%                                                                                     6.0%
   PRE/GDP




             10.0%                              y = 0.9989x + 0.0501                                   5.0%
             8.0%                                   R2 = 0.2329                                        4.0%
             6.0%                                                                                      3.0%                                         y = 0.292x + 0.0349
             4.0%                                                                                      2.0%                                             R2 = 0.1711

             2.0%                                                                                      1.0%
             0.0%                                                                                      0.0%
DR/GDP          0.0%     2.0%    4.0%    6.0%    8.0%     10.0%        12.0%   14.0%                      0.0%    2.0%   4.0%     6.0%        8.0%        10.0%           12.0%    14.0%

                                                                                                        5.0%



               Other measures of
                                                                                                        4.5%

                                                                                                        4.0%



               poverty-reducing                                                                         3.5%
                                                                                          HEALTH/GDP




                                                                                                        3.0%



               expenditures are also                                                                    2.5%

                                                                                                        2.0%


               increasing with debt                                                                     1.5%

                                                                                                        1.0%
                                                                                                                                                   y = 0.2073x + 0.0158
                                                                                                                                                      R2 = 0.2097



               relief                                                                                   0.5%

                                                                                                        0.0%
                                                                                                           0.0%   2.0%    4.0%     6.0%        8.0%         10.0%          12.0%    14.0%
                                                                                                                                          DR/GDP
Institutions and policies are better in
countries that have gone through HIPC
                            HIPCs: Evolution of CPIA ratings (1998 and 2003)
                     3.80

                     3.60

                     3.40

                     3.20
      CPIA ratings




                     3.00

                     2.80

                     2.60

                     2.40

                     2.20

                     2.00
                             Post-HIPC                             Interim-HIPC                          Pre-HIPC

Note: Post, interim and pre-HIPC refer to the countries that are at the pre-decision point (10 countries), decision point (10 countries) and
completion point (18 countries) as of end 2005. The first bars refer to 1998, the second bars to 2003.                                         29
Further Debt Cancellation for HIPCs
1   HIPCs will receive 100 percent debt cancellation from
    IDA, AfDF and the IMF under Multilateral Debt Relief
    Initiative
2   Debt relief is to be provided at HIPC completion point

3   Average debt/export ratios in post-completion point HIPCs
    would fall from about 140 percent to 50 percent in present
    value terms
4   Donors will compensate IDA and AfDF for reflows lost
    due to debt relief. This should result in approximately $50
    billion in additional flows to low-income countries
                                                                  30
  MDRI significantly reduces debt stock ratios in
                      HIPCs
              (18 CPs: NPV of Debt to Exports, Post MDRI)


300



250               Prior to MDRI
                                                            Post MDRI
200



150



100



50



 0




                                                                        31
         Debt service reduction due to MDRI
            (18 completion point HIPCs)
$ billions




                                         IDA
 1.0




 0.5
                     IMF
                                           AfDF


 0.0
       2006   2011         2016   2021         2026   2031   2036   2041


                                                                           32
                             How MDRI Affects IDA Allocations
                            Composition of IDA Assistance to 18 completion point HIPCs, FY07-FY26 (SDR Million)


                    1000                                                                               1900

                    900




                                                                                                              Total New IDA commitment
                                                                                                       1850
                    800
                                                                                                       1800
Total debt relief




                    700
                                                                                                       1750
                    600

                    500                                                                                1700

                    400
                                                                                                       1650
                    300
                                                                                                       1600
                    200                   Total debt relief
                                                                         Total new IDA commitments     1550
                    100

                     0                                                                                 1500



                         Source: IDA staff estimates
                                                                                                                                         33
How do we avoid future debt
       problems?
                         Low debt ratios in HIPCs could result in
                          “free riding” by commercial creditors
                                     Debt Burden Indicators - Post MDRI Debt Relief:
                                   18 CP HIPCs vs. Selected Lower Middle Income Countries
                         400

                         350

                         300
NPV of debt-to-Exports




                                                                         Peru
                         250                                                                                        Syria
                                                                                 Ecuador
                         200
                                                         Brazil
                                                                                                          Jordan
                         150
                                                            Nicaragua
                                                       Bolivia                       Philippines
                         100
                                             Guatemala   Mauritania
                                                      Honduras                                  Guyana
                          50
                                    China Thailand
                          0
                               0     10        20        30        40           50         60        70        80    90     100
                                                                        NPV of debt-to-GDP

18 CP HIPCs                        Lower Middle Income Countries


                                                                                                                                  35
Reaching the MDGs must not create a new
debt problem
  The Debt Sustainability Framework for Low-Income
   Countries (DSF) tries to ensure that countries receive
   financing on terms that are commensurate with their
   ability to service debt
  The DSF determines up front the mix of World Bank
   (IDA) loans and grants
     Countries with high risk of a debt crisis only receive grants
     Over 40 low-income countries will now receive either 100% or
      50% of their World Bank finance in the form of grants
     Countries with low debts receive more resources
  The DSF is an “ex-ante” tool for addressing issues
   related to debt sustainability.

                                                                      36
Sustainable levels of debt burden depend on
a country’s institutions and policies

                                                     Institutional strength and quality of policies
                                                          Weak                      Medium                      Strong
                                                        CPIA<3.25               3.25<CPIA<3.75                 CPIA>3.75

  NPV of debt-to-GDP                                         30                          40                         50

  NPV of debt-to-exports                                    100                         150                        200

  NPV of debt-to-revenue                                    200                         250                        300

  Debt service-to-exports                                     15                         20                         25

  Debt service-to-revenue                                    25                          30                         35

 Notes: Thresholds apply to public and publicly guaranteed (PPG) external debt, only. The Country Policy and Institutional
 Assessment (CPIA) assesses the quality of a country’s present policy and institutional framework. “Quality” means how conducive
 that framework is to fostering sustainable, poverty-reducing growth and the effective use of development assistance.              37
Debt burdens determine the mix of world
bank loans and grants



                     High Risk
                     100% Grants
            +10%
                     Medium Risk
         Threshold
                     50% Grants
            -10%

                     Low Risk
                     100% Soft Loans


                                          38
 From July 2006, grants will be based on debt
  sustainability analyses under the LIC DSF
80                                                                                            250
                            NPV of debt-to-GDP ratio             Baseline                                                NPV of debt-to-exports ratio          Baseline
70
                                                                 Historical scenario          200                                                              Historical scenario
60                                                               Most extreme stress test                                                                      Most extreme stress test
50                                                               Threshold                                                                                     Threshold
                                                                                              150

40

30                                                                                            100

20
                                                                                               50
10

 0                                                                                              0
     2006   2008   2010   2012    2014   2016    2018     2020    2022       2024      2026         2006   2008   2010   2012   2014   2016   2018      2020    2022       2024      2026




40

35
                          Debt service-to-exports ratio          Baseline
                                                                                                Accurate debt data
                                                                 Historical scenario
30

25
                                                                 Most extreme stress test
                                                                 Threshold
                                                                                                Macroeconomic and
20

15
                                                                                                 financing assumptions
10

 5
                                                                                                Baseline scenario and
 0
     2006   2008   2010   2012    2014   2016    2018     2020    2022       2024      2026      standardized stress tests
                                                                                                Staff judgment
                                                                                                                                                                                            39
Conclusions

1   Low-income countries experienced debt repayment difficulties
    due to a variety of factors, both exogenous and endogenous

2   Debt relief is only one part of the solution to financing needs and policy
    dialogue: expectations should be realistic about what it can deliver

3   Debt reduction under the HIPC Initiative has reduced external
    debts (multilateral and other) by two-thirds. It has helped increase
    pro-poor spending and promoted economic reform

4   Debt cancellation under the Multilateral Debt Relief Initiative will
    have a beneficial impact on HIPC debt ratios and provide
    additional resources for all IDA-only borrowers
5   Going forward, the World Bank has adopted an ex-ante framework
    to promote debt sustainability in low-income countries
                                                                            40
A wealth of information is available on the
World Bank website




    http://www.worldbank.org/debt




                                              41
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