IMFSurvey Magazine: In the News
Debt sustainability issues
Africa's Improved Debt Outlook Sparks Investor Interest
By Marie-Hélène Le Manchec
IMF Policy Development and Review Department
February 25, 2008
- Debt relief has significantly reduced the debt burden of African countries
- Debt sustainability outlook has improved substantially
- Improvement has triggered growing interest of foreign investors
Strengthened macroeconomic fundamentals and lower debt levels following debt relief from the IMF and other international institutions have increased the attractiveness of low-income African countries to a broader universe of investors.
A larger group of bilateral lenders is now active in Africa, with creditors outside the traditional OECD-based donor community initiating or expanding their operations in the continent.
Private investors have also stepped up their lending markedly. In the past year, two sub-Saharan African (SSA) countries have issued international bonds; and in at least eight, a significant share of domestic securities are held by foreign investors.
Reflecting these trends, more than a dozen SSA economies are now the subject of an international credit rating. Although immature, some African stock markets are also starting to take off.
Emphasis on sustainable borrowing
Investors have been attracted by the improving economic outlook for Africa (see related story). While this development is welcome, it creates new challenges and potentially new vulnerabilities. The IMF is actively promoting sustainable lending and borrowing policies, based on the joint IMF-World Bank Debt Sustainability Framework (DSF) that was introduced in 2005.
This framework, together with continued policy reform, should help sub-Saharan economies take advantage of these new financing opportunities without re-accumulating unsustainable debt.
Sharp decline in debt
The external debt of low-income countries in Africa has declined significantly as a result of debt relief from the enhanced Heavily Indebted Poor Countries Initiative, the Multilateral Debt Relief Initiative (MDRI), and the Paris Club agreement with Nigeria. Reflecting these factors, as well as stronger GDP and export growth, their debt sustainability outlook has improved substantially, with 21 out of 34 countries classified on the basis of the DSF at a low or moderate risk of debt distress at end-2007 (see related story).
Cutting Africa's debt
Debt relief under the two initiatives is projected to reduce the debt stocks of the 26 African countries by more than 90 percent when all the eligible countries reach the HIPC Initiative completion point. Debt service paid by these countries has declined by about 3 percentage points of GDP between 1999 and 2006, while poverty-reducing expenditures have increased by about the same magnitude.
Before the HIPC Initiative, eligible African countries were, on average, spending slightly more on debt service than on health and education combined. Now, they have increased markedly their spending on health, education and other social services (see story on Niger) and, on average, such spending is more than five times the amount of debt-service payments.
Thirty-three African countries are eligible for debt relief of about $80 billion (in end-2006 net present value terms) under the two initiatives. So far, some $42 billion is being delivered to 19 countries that have already reached the final stage of the debt relief process. Seven other countries are receiving interim relief (see box).
New policy challenges
The new financial landscape raises new policy challenges. The widening of the investor base brings new opportunities to meet Africa's large investment needs and support the development of domestic financial markets.
However, a high share of commercially-based inflows (compared to concessional resources) would increase the volatility and cost of external finance. Lending modalities are also often more complex and may involve explicit or implicit contingent liabilities, complicating the resolution of servicing difficulties should they emerge. The resulting increase in financial vulnerabilities, particularly in countries that remain exposed to large and frequent external shocks, needs to be mitigated to avoid a new buildup of unsustainable debt.
The Debt Sustainability Framework can help countries contain the risk of debt distress. The aim of the framework is to guide borrowing decisions on the basis of a forward-looking analysis of debt-related vulnerabilities. The framework rests on three pillars:
1. indicative debt burden thresholds that are linked to the quality of a country's policies and institutions;
2. a standardized forward-looking analysis of debt and debt-service dynamics under a baseline scenario and in the face of plausible shocks; and
3. an associated financing strategy.
The framework is flexible enough to take into account country-specific circumstances and allow countries to assess, for example, the impact of a large upfront scaling up of non concessional loans. It also captures the vulnerabilities arising from a high or quickly increasing domestic debt.
Policy reforms can help mitigate debt-related vulnerabilities. Low-income countries need to increase domestic revenue mobilization and diversify their production and export bases to lessen their vulnerability to shocks. The regulatory and institutional framework of their financial systems must be strengthened in the face of rising private inflows to allow a close monitoring of exchange, liquidity and rollover risks. Public investment selection and debt management capabilities must also be enhanced to ensure the efficient use of foreign resources.
Concessional external resources remain the most appropriate source of financing for low-income African countries. A large share of their needs related to the Millennium Development Goals are in education, health, or other investments that do not generate the cash flows necessary to service commercial debt. Reducing their vulnerability to shocks requires the deepening and diversification of their economic structures and strengthening of their institutions, objectives that can only be achieved over the medium term.
Thus, high volumes of aid remain necessary to finance the development agenda in sub-Saharan Africa. Nonconcessional finance is better fitted for specific high-return projects, especially when no or limited concessional resources are available and debt sustainability is not at risk. As countries build experience in managing commercial borrowing, its use would be expected to expand. Different countries will progress at a different pace on that road.
What is the IMF doing?
Debt sustainability analyses are at the center of the IMF's policy discussions and advice. The DSF can guide the elaboration and implementation of sustainable fiscal policies and sound borrowing policies. It can also facilitate communication between creditors and debtors, and help debtors negotiate financing terms that are in line with their future repayment capacity. Efforts are being made to familiarize debtors with the DSF as a policy formulation tool. The IMF—in collaboration with the World Bank—is providing training to country officials and technical assistance to build effective debt management capacities.
IMF staff—also in collaboration with World Bank staff—is reaching out to creditors to encourage them to use debt sustainability analyses to inform their lending decisions. Debt sustainability analyses can provide creditors with valuable data as well as a tool for assessing prospective financial difficulties. In this context, the IMF maintains active contacts with a wide range of creditors to raise their awareness of debt sustainability risks and support those that wish to design sustainable lending practices based on debt sustainability analyses.
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