Public Information Notice: IMF Executive Board Discusses Operational Framework for Debt Sustainability Assessments in Low-Income Countries
May 4, 2005
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On April 11, 2005, the Executive Board of the International Monetary Fund (IMF) discussed a paper prepared jointly by the staffs of the IMF and the World Bank on an "Operational Framework for Debt Sustainability Assessments in Low-Income Countries—Further Considerations." The Executive Board previously discussed the proposed framework for debt sustainability assessments on February 23 and September 24, 2004.1 The latest paper addresses remaining issues that need to be resolved before the framework can become operational.
In its earlier discussions, the IMF's Executive Board endorsed key elements of the proposed framework for assessing debt sustainability in low-income countries. The framework is intended to help low-income countries avoid the excessive buildup of external debt in their pursuit of the Millennium Development Goals (MDGs). The framework rests on three pillars: (i) an assessment of debt sustainability guided by indicative debt burden thresholds that depend on the quality of a country's policies and institutions; (ii) a standardized forward-looking analysis of debt and debt-service dynamics under a baseline scenario and in the face of plausible shocks; and (iii) an associated borrowing (and financing) strategy that seeks to contain the risk of debt distress.
Concerns about the debt sustainability framework that were not fully resolved in previous Board discussions related to: (i) the choice of the indicative debt-burden thresholds; (ii) the interaction of the framework with the Heavily Indebted Poor Countries (HIPC) Initiative; and (iii) the modalities for IMF-World Bank collaboration in arriving at a common assessment of debt sustainability.
On previous occasions, Directors indicated a preference for more conservative debt-burden thresholds than originally proposed, particularly for strong policy performers. In response, the staffs presented three alternatives for revised threshold ranges. In the option favored by the staffs, the thresholds for the net present value of debt-to-export ratios are 100, 150, and 200 percent for countries' with "weak," "medium," and "strong" policy ratings, respectively. An advantage of this proposal is its consistency with the HIPC Initiative, with the midpoint of the threshold range equal to the HIPC Initiative threshold for the NPV of debt-to-exports ratio of 150 percent.
To minimize the risk of confusion arising from this new forward looking debt sustainability framework and the HIPC Initiative, the staffs propose transitional arrangements for preparing debt sustainability assessments (DSAs) for HIPCs. For HIPCs that have not yet received permanent debt relief, it is proposed that the new DSAs also show the relevant debt-stock indicators under the baseline scenario using the rules of the HIPC Initiative, including currency-specific discount rates and three-year backward-looking averages of exports (or government revenue).
The paper also specifies modalities for collaboration between IMF and World Bank staffs in the preparation of DSAs under the new framework. The aim is to arrive at common assessments of the debt sustainability outlook for individual countries. The paper covers issues such as the timing of DSAs, the division of responsibility between the staffs, documentation requirements, and mechanisms to resolve differences of view. In particular, DSAs will be integrated into the normal operations of the two institutions and generally be prepared annually. In preparing DSAs, the IMF will take the lead on macroeconomic projections and the World Bank on long-term growth prospects. It is proposed that these modalities be reviewed after six months.
Executive Board Assessment
Executive Directors welcomed the opportunity to consider the outstanding issues regarding the joint Fund-World Bank operational framework for the debt sustainability assessments in low-income countries. They underscored the importance of such a framework for helping low-income countries avoid an unsustainable build-up of debt in their pursuit of the Millennium Development Goals. Directors reiterated their broad support for the key elements of the framework: (i) country-specific, policy-dependent external debt-burden thresholds to guide debt sustainability assessments; (ii) forward-looking simulations of debt and debt service under a baseline scenario and in the face of shocks; and (iii) prudent borrowing strategies to contain risks of debt distress. Most Directors agreed that the operational framework is now ready to be incorporated in Fund operations.
Directors endorsed the proposed country-specific thresholds for external debt-burden indicators, including the classification of countries based on policy and institutional performance. They noted that the empirical evidence indicates that a country's ability to carry debt is correlated with the quality of its policies and institutions, and agreed that this should be reflected in the debt-burden thresholds. Directors also maintained that the need for prudence in external borrowing calls for a conservative approach in setting the thresholds. Directors felt that the staffs' preferred option is consistent with these criteria. They also saw centering the thresholds on the operational threshold of the HIPC Initiative as essential to preserve the coherence of the international community's approach to debt sustainability. Directors noted, moreover, that the preferred option does not require as high a share of grant financing, the availability of which is not assured, as the alternatives considered.
Directors again cautioned that the thresholds should be seen as guideposts for informing debt sustainability assessments rather than as rigid ceilings, and that individual country circumstances, including the burden of domestic public sector debt, need to be factored into the assessments. In this regard, some Directors expressed concern that the framework could be implemented rigidly, resulting in foregone development opportunities if additional grant financing or debt relief does not materialize; but some others stressed the need to avoid perceptions that the thresholds can be consistently exceeded because they are only indicative. Directors stressed that the framework does not imply that countries with lower debt should borrow up to their thresholds. A few Directors noted the importance of adequate conditionality being attached to grants, to reduce any moral hazard implicit in the framework. Some Directors also stressed the need to avoid using over-optimistic export projections in the DSAs. Some Directors continued to express some reservations about the use of the World Bank's Country Policy and Institutional Assessment (CPIA) to classify the quality of policies and institutions, but most Directors supported its use, subject to periodic review, and while recognizing that CPIA thresholds should not be used mechanically in country assessments.
Directors welcomed the proposed transitional arrangements for the use of the new DSA framework for HIPCs, while the HIPC Initiative is still under way. They recognized that there are fundamental differences between DSAs under the HIPC Initiative and those under the new framework, the former being a backward-looking calculation for the purpose of determining debt relief, while the latter is a forward-looking exercise to inform future borrowing and policy decisions. While these differences would need to be clarified, Directors felt that applying the new framework to HIPCs as soon as possible is important to guide HIPCs in their borrowing decisions and provide creditors and donors with a clear view of these countries' debt sustainability outlook. Directors also stressed the importance of a well-designed communications strategy to accompany the introduction of the framework.
Directors supported the preparation of a joint DSA for each low-income country and welcomed the proposed modalities of collaboration between Fund and World Bank staffs for achieving these objectives. Most Directors felt that the proposed modalities are in line with previous Board discussions of this topic and the respective mandates of the two institutions. They noted that, in almost all cases, Fund and World Bank staffs are expected to agree on the baseline for the DSA and the assessment of the risk of debt distress; and only in highly exceptional cases would they be unable to reach agreement on the underlying DSA baseline or the assessment of debt distress risks. Directors agreed that in such cases the different views of the staffs should be reported to the country authorities at an early stage, and later to the Boards in the DSA document. They urged the staffs, however, to avoid this outcome to the extent possible, and a number of Directors were of the view that the production of a single DSA is critical for the framework's credibility. Directors noted that minor revisions to DSAs would only be made in cases where both staffs agreed that the revision was minor, and would not in any case change the overall assessment or lead to two separate and inconsistent DSAs. Some Directors urged a clearer definition of what would be considered a minor update under the framework that would not warrant the production of a new joint DSA.
Directors noted that the framework would be an important addition to the Fund's toolkit to assess the appropriate balance between adjustment, lending, grants, and debt restructuring/relief in low-income countries. They also underlined the importance of the Fund and Bank staff working closely with other international financial institutions and donors to allow a coordinated approach to concessionality decisions and to ensure that the proposed framework guides the decisions of donors and creditors, including the Fund. Directors also saw a key role for the Fund and Bank staff in integrating country-led approaches into the process and building broad country ownership of the analytical underpinnings of the framework, which would be essential to enhance its effectiveness.
Directors asked the staffs to report to them after a six- to twelve-month period on the results of the country application of the proposed framework after sufficient experience has been gained and welcomed the staffs' intention to update the framework in light of these results. Directors provided a number of suggestions for guiding the implementation of the proposed framework and the Fund's continuing work in this area, which the staff will take into account.
1 See PIN No. 04/34, April 5, 2004 and PIN No. 04/119, October 15, 2004.