IMF Executive Board Reviews the Low-Income Country Debt Sustainability Framework and Adopts a More Flexible Policy on Debt Limits in IMF-Supported ProgramsPublic Information Notice (PIN) No. 09/113
September 9, 2009
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
On August, 31, 2009, the Executive Board of the International Monetary Fund (IMF) adopted revised guidelines for establishing debt limits in Fund-supported programs, and reviewed some aspects of the joint IMF-World Bank debt sustainability framework (DSF) for low-income countries (LICs).
The review of the DSF and the review of the policy on debt limits are part of the Fund’s efforts to ensure that its policies and instruments remain adapted to the needs of its members, particularly LICs, in the current turbulent times. These reviews come in the wake of the wide-ranging reform of the IMF’s financial facilities for LICs approved in July ( see Press Release No. 09/268)
The DSF was introduced in 2005 with the objectives of guiding LICs’ borrowing decisions and creditors’ lending decisions, consistently with progress towards LICs’ development goals and long-term debt sustainability; improving IMF and World Bank assessments and policy advice on debt issues; and helping detect potential difficulties early so that preventive action can be taken. The DSF was last reviewed in 2006, and a reconsideration of some aspects of the framework is timely. This review focuses on options to enhance the flexibility of the DSF. In doing so, it seeks to address concerns that the DSF has unduly constrained the ability of LICs to borrow and, in light of the current crisis, that the DSF may be too procyclical. Specifically, the review concentrates on recognizing better the impact of public investment on growth and reflecting the importance of remittances as a source of external financing. It also addresses the risk that small changes in assessments of a country’s policy and institutional capacity can lead to more adverse debt distress ratings, and seeks to clarify the appropriate concept of state-owned enterprise debt for the purpose of debt sustainability assessments. Modifications in all of these areas could impact favorably on assessments of LICs’ capacity to borrow.
The review of the policy on external debt limits in Fund-supported programs was initiated in March 2009 (see Public Information Notice No. 09/39) Considering the substantial changes in the patterns of financing of LICs in recent years and the increasing diversity of situations among LICs, the review envisages moving away from a single design of debt limits in Fund-supported programs toward a menu of options. Use of these options allow to better reflect each LIC’s debt vulnerabilities, as assessed in debt sustainability analyses (DSAs), and its macroeconomic and public financial management capacity. Overall, the revised policy helps clarify how and when flexibility in the area of debt limits should be exercised in a consistent and uniform manner while maintaining donors’ incentives to provide highly concessional financing. It offers more flexibility for all countries but those with higher debt vulnerabilities and lower management capacity, and ultimately provides a clear path towards graduation from concessionality requirements.
Executive Board Assessment
Today’s discussion of the policy on external debt limits in Fund arrangements and the review of some aspects of the debt sustainability framework is part of the Fund’s efforts to ensure that its policies and instruments remain well adapted to meet its members’ changing needs. Executive Directors reiterated that both the debt limits policy and the DSF have an important role to play in preventing the build-up of unsustainable debts in low-income countries, while allowing for adequate external financing. Cautious and transparent implementation of the new guidelines and the revised DSF will be critical to help avoid another lend-and-forgive cycle, and ensure adequate incentives for donors to provide highly concessional financing. It will also be important that the flexibility in the new approach, which is desirable given the diversity of LICs, not undermine the uniformity of treatment of member countries.
Debt Limits in Fund-Supported Programs
The Executive Board approved the revised guidelines with regard to external debt performance criteria in Fund arrangements, based on a menu of options and strengthened analytical underpinnings, as discussed in March 2009. The revised guidelines take into account members’ debt vulnerabilities and their macroeconomic and public financial management capacity. For this purpose, capacity will be assessed in accordance with the methodology set forth in Debt Limits in Fund-supported Programs―Proposed New Guidelines. Under the revised guidelines, no member would be subjected to more stringent requirements than under the previous guidelines, and greater flexibility would be applied in all cases except when debt sustainability is a serious concern and the member’s macroeconomic and public financial management capacity is limited. A few Directors considered the new guidelines too restrictive, putting additional borrowing constraints on the most vulnerable countries where external financing is needed the most, which makes it all the more crucial that donors are committed to increasing highly concessional resources to LICs. On the other hand, a few others expressed concern that the new guidelines may provide too much flexibility.
Directors urged staff to remain vigilant to the risk of less concessional finance displacing more concessional finance. Several suggestions were made for staff on the policy’s operational modalities, including with regard to capacity assessment, transparency in program documents, and public communication of the changes, which will be appropriately reflected in a guidance note to staff.
Review of the Low-Income Country Debt Sustainability Framework
Directors noted that the DSF has helped countries monitor their debt burden, guided creditors’ lending decisions, and sharpened the Bank’s and the Fund’s assessments and policy advice. Most Directors considered that the flexibility inherent in the Fund policy on debt limits, as well as the requirement to avoid mechanical assessments under the DSF, had allowed the Fund to design arrangements that took due account of LICs’ financing needs. Directors welcomed the emphasis of this review on further enhancing the flexibility of the DSF. The Executive Board supported the modifications to the DSF as proposed in Review of Some Aspects of the Low-Income Country Debt Sustainability Framework, which include the following key components:
Greater recognition of the impact of public investment on growth. Directors agreed that analyzing the investment-growth nexus requires a country-specific approach, using a broad range of indicators, supplemented with model-based approaches, where appropriate. They supported further empirical work in this area, with a view to making it operational within the DSF as much as possible.
More explicit consideration of workers’ remittances in debt sustainability analyses (DSAs). Noting the increased significance of remittances as a source of external financing in LICs in recent years, Directors agreed that greater flexibility should be applied in taking account of the size of remittances when assigning risk ratings. Most Directors agreed that the absence of remittances data of a suitable quality and coverage precludes a re-estimation of the empirical model underlying the DSF at this juncture. A few Directors, however, saw merit in formally including remittances in the DSF.
An approach to reduce the effects of fluctuations in Country Policy and Institutional Assessment (CPIA) scores on debt distress thresholds and ratings. Directors broadly agreed that Option 1, which introduces greater inertia in policy-dependent debt thresholds, would mitigate the problem of the so-called “threshold effects” more comprehensively, and is easier to implement than an alternative approach.
Application of the rule for setting the discount rate. Directors broadly agreed that the present rule for setting the discount rate effectively balances the requirement of linking the discount rate to market rates with the need to avoid frequent changes in the discount rate. A change in the discount rate to 4 percent, as required by the rule, would have only a limited impact on borrowing countries. A few Directors urged caution in applying the rule mechanistically, especially in light of the ongoing crisis, while a few others called for consideration of an alternative rule.
More flexible treatment of external debt of state-owned enterprises. Most Directors supported the proposal to exclude from DSAs the debt of state-owned enterprises (SOEs) that pose a limited fiscal risk for the government and can borrow without a government guarantee, with many underscoring that such exclusion should be based on well-defined, objective criteria as discussed in SM/09/216. Such SOE debt would also normally be excluded from the external debt performance criterion in Fund-supported programs under the new debt limits policy. A few Directors would have preferred to continue with the current treatment of SOE debt.
Streamlined DSAs. Most Directors supported a streamlining of DSA requirements—full DSAs every three years with streamlined annual updates in the interim, barring a major change in the debt outlook and program-related requirements. They considered that the change in the policy should not be implemented until the global crisis subsides. Some other Directors, however, considered it important that full DSAs be conducted more frequently, given their centrality in guiding Fund and Bank engagement with LICs.