## 14. Swaps (especially buyback swaps) are complex to analyze, record, and report on.

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---

### Aim and scope
- Purpose: help stakeholders optimize when, where, and how to use debt-for-development swaps (“debt swaps”), ensure intended benefits to all parties, and propose approaches to make them less transaction-heavy and more sustainable while maintaining accountability.
- Definition: debt swaps are agreements between a government and one or more of its creditors to replace existing sovereign debt with one or more liabilities that include a spending commitment towards a specific development goal (examples: nature conservation, climate action, education, nutrition, support for refugees).
- Focus: (1) appropriateness of use (in what debt situations and countries are debt swaps useful) and (2) adequate and enhanced design of expenditure program commitments from the standpoint of fiscal policy and sectoral programs.

### Key findings on appropriateness of use
- Candidate evaluation criteria:
  - country’s initial debt position and the swap’s effects on debt sustainability;
  - net financial gains for the debtor;
  - country’s debt management capacity and commitment to transparency;
  - opportunity costs for the borrower and donors.
- Countries potentially good candidates:
  - those at “moderate” or “high” risk of debt distress with a sustainable outlook facing temporary liquidity pressures;
  - usually smaller economies where transactions can be impactful in providing critical short-term relief and improving debt sustainability prospects.
- Requirements for candidate countries:
  - strong debt management capacity to record and report on the swap and understand financial, fiscal, spending management, legal, and operational implications;
  - high levels of transparency and commitment from all parties, including scrutiny by civil society.
- Not appropriate:
  - countries with unsustainable debt levels or those requiring (or already undergoing) comprehensive debt restructuring — swaps are not appropriate tools for restoring debt sustainability and could obstruct restructuring processes.
- Possible roles:
  - swaps can be a "top-up" measure after restructuring or integrated in a restructuring process as a top-up to the debt reduction required to restore debt sustainability.
- For countries with strong credit and low risk of debt distress:
  - buyback swaps are likely inefficient because cost differences are small while transaction costs are high;
  - bilateral swaps (official bilateral debt written off or exchanged) may still be viable.

### Transaction characteristics, scale, and recent experience
- Complexity and costs:
  - swaps are often complex, administratively costly, with upfront financial arrangement fees, and heavily reliant on donor subsidies (grants, concessional financing, guarantees/credit enhancements), which typically limited their size.
- Historical scale:
  - the total face value of debt treated with swaps annually between 1987 and 2021 averaged 100 million a year, with many of the transactions below USD10 million.
- Recent activity:
  - interest in swaps has been growing; the last three years has seen more transactions, including in Barbados, Belize, Ecuador, and Gabon.
- Swap categories (by creditor type):
  - bilateral debt swaps — official bilateral debt is written-off or swapped in exchange for a commitment toward expenditures;
  - commercial debt (buyback) swaps — target debt held by private creditors, may include bonds or commercial loans; typically exchange one unsecured liability for two or more new liabilities (new guaranteed debt and expenditure commitments).

### Complexity, capacity, and recording requirements
- Swaps (especially buyback swaps) are complex to analyze, record, and report on.
- Countries undertaking swaps need to have strong debt management capacity.
- The cash management component is time-consuming; depending on the structure, multiple accounts need to be maintained.
- In low-capacity environments, swaps may divert resources from core debt management functions.
- Swaps are more appropriate where the debt management office (DMO) has or is committed to build sufficient capacity.
- Countries will often need to report on both the debt aspects of the swap and the development commitments (e.g., expenditures and outcomes of conservation projects) on an ongoing basis.
- Authorities must ensure coordination among relevant ministries to make data available to different parties in the swap.
- DMOs undertaking swaps must be capable of designing and implementing adequate debt management strategies (DMS) and ensuring the swap is aligned with its medium-term DMS.

### Transparency, opacity risks, and opportunity costs
- Transparency and opacity risks:
  - the sheer complexity of swaps may introduce opacity; highest level of transparency is essential on structure and related costs including fees, commissions, and interest differentials.
  - lack of transparency makes it impossible to adequately assess true benefits of swaps.
  - historically, buyback swaps have arguably lacked sufficient transparency (example: repurchased marketable debt with detailed public prospectuses swapped with a privately placed bond issued by a special purpose vehicle).
- Opportunity costs for borrower and donors:
  - need to evaluate against alternative support by the sponsor (official bilateral creditor or provider of credit enhancement).
  - a bilateral debt-for-development swap is, to a first order approximation, financially equivalent to:
    - (a) the debtor repaying the bilateral debt in full; and
    - (b) the bilateral creditor simultaneously giving a series of grants to the creditor over time equivalent to the amount of debt service, some fraction tied to specific development outcomes and the remaining fraction untied.
  - such grant-plus-repayment combinations carry fewer transaction costs but may not be preferred for political economy reasons.
  - swaps compete for scarce donor and MDB resources. Additional resources provided by swaps are typically generated by a subsidy—direct donor subsidies or indirect MDB participation (e.g., credit guarantees).
  - subsidies mobilized for swaps represent opportunity costs if they could be used elsewhere, especially when higher-return projects exist.
  - for the borrower, a key consideration is whether the guarantee reduces a predetermined country envelope made available by the guarantor.

### Credit enhancements: risks and benefits
- Credit enhancement is necessary for swaps to generate debt service reductions and to enlarge the investor base (many investors require investment-grade ratings).
- Benefits:
  - larger volumes of financing, crowding in green/blue investors, potential for larger nominal savings.
- Costs/risks:
  - guarantees can reduce instrument liquidity so full value is not realized; direct lending may sometimes be more efficient.
- The benefits of credit enhancements must be weighed against direct financing possibilities and efforts to develop sustainability-linked financing.

### Net financial gains: measurement and risks
- Proper measurement:
  - net benefits should be calculated as the present value of debt service savings including all transaction costs, and considering possible positive or negative financial spillovers and the risk that eventual restructuring would impact realized benefits.
- Limitations of naive measures:
  - measuring benefits solely as total debt service savings (nominal savings) is simplistic; it ignores time value of money, default risk on new instruments, and high transaction costs.
- Market considerations:
  - meaningful benefits require new instruments trading at a premium relative to the debt being bought back commensurate with the value of the guarantee provided.
  - for countries with low risk of debt distress, discounts in market securities would be insignificant and potential savings of a buyback swap are likely to be exceeded by transaction costs.
- Credit rating and spillovers:
  - swaps can have positive spillovers (reduced debt vulnerabilities and lower future borrowing costs) or negative spillovers (perception as a distressed exchange leading to negative rating actions).
  - a debt exchange is classified as distressed by rating agencies when two criteria are met simultaneously: (i) material reduction in terms (investor receives less value than promised originally), and (ii) the exchange is designed to avoid a conventional payment default.
  - careful market soundings and communication are key to avoid negative consequences.

### Implementation framework and decision tools
- A decision tree can guide the appropriateness of debt-for-development swaps for specific countries; quantitative inclusion criteria supplement the decision tree.
- The decision tree helps identify deals with unambiguously positive or negative impact and those needing improved design.
- Quantitative assessment framework provided:

  Net Benefits (NB) =   [ PV (N - N’)]     +  Ʃt+1..t+3 PV n (y-y’) ]  *   (1-PD’)    +  [∆PD (CD – PV(N)]  

  (i) Direct benefits     (ii) Financial Spillover   (iii) Non-default    (iv) Lower PD

  Where:
  - N= cash flows pre-swap (debt service)
  - N’ = cash flows post-swap, including debt service and all one-off and recurrent transaction costs and fees
  - y= yield pre-swap
  - y’= yield post-swap
  - n = net commercial borrowing (per year)
  - PD’= probability of default post-swap
  - ∆PD = difference in probability of default post-swap
  - CD = costs of default

- Indicative criteria for inclusion (thresholds are indicative; each transaction needs separate evaluation):
  - Bonds / Loans: Meaningful savings from credit-enhanced financing after transaction costs (i).
  - Spreads above 200 bps.
  - Original interest rate higher than 6% (cost of the new instrument) in case of prepayment AND market price well below face value for buyback.
  - Possible positive impact on probability of default / future cost of funding (ii) and (iv); preference given to countries closer to rating upgrade.
  - Transaction would alleviate liquidity pressures (ii) and (iv); Bonds or loans falling due in the coming years.
  - Minimum size to offset transaction costs and improve sustainability (i), (ii) and (iv): USD [50] million (indicative minimum size to trigger spillover will depend on total debt volumes); size considerations balanced with instrument and spending goals.
  - Risk of default not too elevated (iii): Spreads below 1000 bps; Rating B- or above.

### Institutional assessment and transparency criteria
- Institutional assessment considers debt management capacity, transparency, and governance arrangements.
- Inclusion thresholds / expectations include:
  - Debt Management capacity: Swap aligned with debt strategy objectives; IT systems in place to record and report on the swap; preference for countries with previous liability management experience.
  - Transparency: Regular debt data disclosure to the World Bank’s Debtor Recording System and publication of debt statistics over the last two years (source: World Bank Debt Reporting Heat Map).
  - Governance: Solid governance required to minimize risks of default on expenditure commitments, as assessed by World Bank and IMF instruments.

### Design of expenditure commitments, earmarking, and SPVs/TFs
- Recent swaps focused on climate and nature investments but swaps can cover broader priorities: education, health, nutrition, refugees, infrastructure, etc.
- Design reflects donor/debtor priorities and debtor implementation capacity, including Public Financial Management (PFM) and fiduciary arrangements.
- Historically, programs have been heavily ringfenced, often using trust funds administered outside the debtor country—these arrangements substantially affect transaction costs and cost-benefit analysis.
- Continuum of design options from strict earmarking and ring-fencing outside the country to flexible earmarking using country programs or non-earmarking; the note supports more frequent use of the latter two.
- SPVs/TFs:
  - used to issue new bonds, finance buybacks, and manage funds for spending commitments.
  - place key fund flows outside debtor country control but can be jointly managed and offer independent administration.
  - TFs typically have strict access rules and are separate from national budgets, creating PFM fragmentation challenges.
- Choice of earmarking level driven by implementation capacity and country ownership: greater capacity argues for less ringfencing and more reliance on country systems; TA and CD can fill capacity gaps.
- Treasury and DMO should always be involved in swap negotiation and able to monitor transactions if failure to deliver commitments could trigger guarantees or default events.

### Assessing expenditure program adequacy
- Key assessment dimensions:
  - (i) Alignment with national priorities.
  - (ii) Adequacy from expenditure efficiency perspective, including allocative efficiency.
  - (iii) Fiscal sustainability of the broader expenditure envelope.
  - (iv) Degree of expenditure earmarking (from fully earmarked to policy/outcome-based disbursement).
  - (v) Implementation arrangements (ringfenced vs integrated).
  - (vi) Mechanisms for monitoring, verification and accountability.
- Specific considerations:
  - ensure new spending commitment is fiscally sustainable and does not obstruct expenditure-based fiscal consolidation.
  - assess sector absolute and relative spending levels, efficiency, balance between current and capital spending, budgetary rigidities, and implementation capacity (failure to meet commitments may be treated as sovereign default).
  - consider global public goods benefits (e.g., conservation) that may justify swaps even if country priorities differ.

### Monitoring, verification, and accountability mechanisms
- Success—especially for more flexible arrangements—depends on attainment of targeted program goals and results.
- Extensive use of third-party verification systems has characterized recent swaps.
- Considerations for monitoring/verification design:
  - a. Appropriate budget nomenclature to show fund use.
  - b. Appropriate internal controls and internal audit.
  - c. External oversight: reporting to public, partners, creditors, and parliament.
  - d. Third-party verification of results (if KPIs are outcome-related), potentially connecting to output-based aid or World Bank Program for Results Operations (PforRs) or equivalent.
  - e. Defined mechanisms in case of accountability issues, including when fiscal space is not helping the climate, education, or nature objective of the swap.

### Design recommendation summary
- Favor program designs focused on results rather than inputs and that rely more on country systems where capacity and track record allow.
- Use external monitoring and supervision (e.g., World Bank PforRs) to strengthen accountability while minimizing costly ringfencing.
- Evaluate design options using World Bank and IMF assessments (DeMPA, PEFA, CPIA) in relevant public management and governance areas.
- Less heavy-handed earmarking and greater use of country systems, with support from International Financial Institutions and NGOs, would lower transaction costs and improve the value proposition of debt swaps.

*Source: ppea2024038 - 14. Swaps (especially buyback swaps) are complex to analyze, record, and report on.*

### Executive Summary

### Executive Summary

### Aim and scope
- The note aims to help stakeholders optimize when, where, and how to use debt-for-development swaps (“debt swaps”), ensuring they bring intended benefits to all parties and proposing new approaches to make them less transaction-heavy and more sustainable while maintaining accountability.
- Definition: debt swaps are agreements between a government and one or more of its creditors to replace existing sovereign debt with one or more liabilities that include a spending commitment towards a specific development goal (examples: nature conservation, climate action, education, nutrition, support for refugees).
- Focus: (1) appropriateness of the use of debt swaps (in what debt situations and countries are debt swaps useful) and (2) adequate and enhanced design of expenditure program commitments from the standpoint of fiscal policy and sectoral programs.

### Key findings on appropriateness of use
- Each proposed debt swap should undergo comprehensive evaluation for viability and country benefit; key debt/financial criteria include:
  - the country’s initial debt position and the swap’s effects on debt sustainability;
  - the net financial gains for the debtor;
  - the country’s debt management capacity and commitment to transparency;
  - the opportunity costs for the borrower and donors.
- Countries potentially good candidates:
  - those at “moderate” or “high” risk of debt distress with a sustainable outlook facing temporary liquidity pressures;
  - usually smaller economies where transactions can be impactful in providing critical short-term relief and improving debt sustainability prospects.
- Requirements for candidate countries:
  - strong debt management capacity to record and report on the swap and understand financial, fiscal, spending management, legal, and operational implications;
  - high levels of transparency and commitment from all parties, including scrutiny by civil society.
- Not appropriate:
  - countries with unsustainable debt levels or those requiring (or already undergoing) comprehensive debt restructuring — swaps are not appropriate tools for restoring debt sustainability and could obstruct restructuring processes.
- Possible roles:
  - swaps can be a "top-up" measure after restructuring or integrated in a restructuring process as a top-up to the debt reduction required to restore debt sustainability.
- For countries with strong credit and low risk of debt distress:
  - buyback swaps are likely inefficient because cost differences are small while transaction costs are high;
  - bilateral swaps (official bilateral debt written off or exchanged) may still be viable.

### Transaction characteristics, scale, and recent experience
- Complexity and costs:
  - swaps are often complex, administratively costly, with upfront financial arrangement fees, and heavily reliant on donor subsidies (grants, concessional financing, guarantees/credit enhancements), which typically limited their size.
- Historical scale:
  - the total face value of debt treated with swaps annually between 1987 and 2021 averaged 100 million a year, with many of the transactions below USD10 million.
- Recent activity:
  - interest in swaps has been growing; the last three years has seen more transactions, including in Barbados, Belize, Ecuador, and Gabon.
- Swap categories (by creditor type):
  - bilateral debt swaps — official bilateral debt is written-off or swapped in exchange for a commitment toward expenditures;
  - commercial debt (buyback) swaps — target debt held by private creditors, may include bonds or commercial loans; typically exchange one unsecured liability for two or more new liabilities (new guaranteed debt and expenditure commitments).

### Fiscal and budgetary implications
- Typical design feature:
  - spending commitment funds are usually required to be ringfenced, typically via a new government trust fund or entity to manage projects funded by the earmarked commitment.
- Potential benefits:
  - debt stocks are reduced and, if new expenditure commitments are lower than original debt service, claims on budgetary resources (and liquidity pressure) are reduced;
  - replacing foreign-currency debt service by expenditures with high local content can improve the Balance of Payments and stimulate the local economy.
- Risks and drawbacks:
  - expenditure earmarking increases budgetary rigidity, can complicate fiscal consolidation and reform, and may divert policymaker attention from root causes of debt distress;
  - budget fragmentation from Special Purpose Vehicles and fully ring-fenced offshore trust funds can reduce transparency and complicate monitoring of budget execution.

### Net financial gains: measurement and risks
- Proper measurement:
  - net benefits should be calculated as the present value of debt service savings including all transaction costs, and considering possible positive or negative financial spillovers and the risk that eventual restructuring would impact realized benefits.
- Limitations of naive measures:
  - measuring benefits solely as total debt service savings (nominal savings) is simplistic; it ignores time value of money, default risk on new instruments, and high transaction costs.
- Market considerations:
  - meaningful benefits require new instruments trading at a premium relative to the debt being bought back commensurate with the value of the guarantee provided.
  - for countries with low risk of debt distress, discounts in market securities would be insignificant and potential savings of a buyback swap are likely to be exceeded by transaction costs.
- Credit rating and spillovers:
  - swaps can have positive spillovers (reduced debt vulnerabilities and lower future borrowing costs) or negative spillovers (perception as a distressed exchange leading to negative rating actions).
  - a debt exchange is classified as distressed by rating agencies when two criteria are met simultaneously: (i) material reduction in terms (investor receives less value than promised originally), and (ii) the exchange is designed to avoid a conventional payment default.
  - careful market soundings and communication are key to avoid negative consequences.

### Design of expenditure program commitments
- Key criteria for adequate spending commitments:
  - alignment with national priorities;
  - adequacy from an expenditure efficiency perspective (including allocative efficiency);
  - fiscal sustainability within the country's broader expenditure envelope.
- Global public goods consideration:
  - it may be warranted in some cases to examine benefits from a global public goods perspective, especially when selected spending would not occur without the swap.
- Application scope:
  - debt-for-development swaps can apply to a wide range of public expenditure programs; a key objective is ensuring spending commitments are fully aligned with the country's development goals and strategies.
- Three aspects to evaluate to reduce debtor burden while maintaining accountability:
  - the degree of expenditure earmarking;
  - implementation arrangements;
  - mechanisms for monitoring, verification, and accountability.

### Proposed enhancements and policy recommendations
- Shift in focus:
  - propose a more flexible approach to spending commitments that aims at development results and outcomes rather than inputs.
- Greater reliance on country systems:
  - advocate for greater reliance on country systems for supervision and monitoring and more frequent use of non-earmarking modalities based on results achieved.
- Continuum of design options:
  - range from strict spending earmarking and ring-fencing (common to date) to more flexible, "softer" earmarking under country programs and non-earmarking based on results; the note supports more frequent use of the latter.
- Rationale:
  - many countries have made significant progress in public financial management governance and monitoring systems; recognizing this progress and depending more on country systems can enhance country ownership, improve implementation and results, and increase sustainability beyond the contractual period.
- Cost-effectiveness:
  - less heavy-handed earmarking and greater use of country systems, with support from International Financial Institutions and NGOs, would lower transaction costs and improve the value proposition of debt swaps.

*Prepared by the staff of the World Bank and the International Monetary Fund. The views expressed in this report do not necessarily reflect those of the IMF and World Bank Executive Boards.*

### 14. Swaps  (especially  buyback  swaps)  are  complex  to  analyze,  record,  and  report  on.

### ppea2024038 - 14. Swaps  (especially  buyback  swaps)  are  complex  to  analyze,  record,  and  report  on.

### Complexity, capacity, and recording requirements
- Swaps (especially buyback swaps) are complex to analyze, record, and report on.  
- Countries undertaking swaps need to have strong debt management capacity.  
- The cash management component is time-consuming; depending on the structure, multiple accounts need to be maintained.  
- In low-capacity environments, swaps may divert resources from core debt management functions.  
- Swaps are more appropriate where the debt management office (DMO) has or is committed to build sufficient capacity.  
- Countries will often need to report on both the debt aspects of the swap and the development commitments (e.g., expenditures and outcomes of conservation projects) on an ongoing basis.8  
- Authorities must ensure coordination among relevant ministries to make data available to different parties in the swap.  
- DMOs undertaking swaps must be capable of designing and implementing adequate debt management strategies (DMS) and ensuring the swap is aligned with its medium-term DMS.

### Transparency and opacity risks
- The sheer complexity of swaps may introduce opacity; highest level of transparency is essential on structure and related costs including fees, commissions, and interest differentials.  
- Lack of transparency makes it impossible to adequately assess true benefits of swaps.  
- Historically, buyback swaps have arguably lacked sufficient transparency (example: repurchased marketable debt with detailed public prospectuses swapped with a privately placed bond issued by a special purpose vehicle).

### Opportunity costs for borrower and donors
- Opportunity costs of debt-for-development swaps need evaluation against alternative support by the sponsor (official bilateral creditor or provider of credit enhancement).  
- A bilateral debt-for-development swap is, to a first order approximation, financially equivalent to:  
  - (a) the debtor repaying the bilateral debt in full; and  
  - (b) the bilateral creditor simultaneously giving a series of grants to the creditor over time equivalent to the amount of debt service, some fraction tied to specific development outcomes and the remaining fraction untied.  
- Such grant-plus-repayment combinations carry fewer transaction costs but may not be preferred for political economy reasons.  
- Swaps compete for scarce donor and MDB resources. Additional resources provided by swaps are typically generated by a subsidy—direct donor subsidies or indirect MDB participation (e.g., credit guarantees).  
- Subsidies mobilized for swaps represent opportunity costs if they could be used elsewhere, especially when higher-return projects exist.  
- For the borrower, a key consideration is whether the guarantee reduces a predetermined country envelope made available by the guarantor.

### Credit enhancements: risks and benefits
- Credit enhancement is necessary for swaps to generate debt service reductions and to enlarge the investor base (many investors require investment-grade ratings).  
- Benefits: larger volumes of financing, crowding in green/blue investors, potential for larger nominal savings.  
- Costs/risks: guarantees can reduce instrument liquidity so full value is not realized; direct lending may sometimes be more efficient.  
- The benefits of credit enhancements must be weighed against direct financing possibilities and efforts to develop sustainability-linked financing.

### Implementation framework and decision tools
- A decision tree can guide the appropriateness of debt-for-development swaps for specific countries; quantitative inclusion criteria supplement the decision tree.  
- The decision tree helps identify deals with unambiguously positive or negative impact and those needing improved design.  
- Quantitative assessment framework provided:

  Net Benefits (NB) =   [ PV (N - N’)]     +  Ʃt+1..t+3 PV n (y-y’) ]  *   (1-PD’)    +  [∆PD (CD – PV(N)]  

  (i) Direct benefits     (ii) Financial Spillover   (iii) Non-default    (iv) Lower PD

  Where:  
  - N= cash flows pre-swap (debt service)  
  - N’ = cash flows post-swap, including debt service and all one-off and recurrent transaction costs and fees  
  - y= yield pre-swap  
  - y’= yield post-swap  
  - n = net commercial borrowing (per year)  
  - PD’= probability of default post-swap  
  - ∆PD = difference in probability of default post-swap  
  - CD = costs of default

- Indicative criteria for inclusion (thresholds are indicative; each transaction needs separate evaluation):

  - Bonds / Loans: Meaningful savings from credit-enhanced financing after transaction costs (i).  
  - Spreads above 200 bps.  
  - Original interest rate higher than 6% (cost of the new instrument) in case of prepayment AND market price well below face value for buyback.  
  - Possible positive impact on probability of default / future cost of funding (ii) and (iv); preference given to countries closer to rating upgrade.  
  - Transaction would alleviate liquidity pressures (ii) and (iv); Bonds or loans falling due in the coming years.  
  - Minimum size to offset transaction costs and improve sustainability (i), (ii) and (iv): USD [50] million (indicative minimum size to trigger spillover will depend on total debt volumes); size considerations balanced with instrument and spending goals.  
  - Risk of default not too elevated (iii): Spreads below 1000 bps; Rating B- or above.

### Institutional assessment and transparency criteria
- Institutional assessment considers debt management capacity, transparency, and governance arrangements.  
- Inclusion thresholds / expectations include:  
  - Debt Management capacity: Swap aligned with debt strategy objectives; IT systems in place to record and report on the swap; preference for countries with previous liability management experience.  
  - Transparency: Regular debt data disclosure to the World Bank’s Debtor Recording System and publication of debt statistics over the last two years (source: World Bank Debt Reporting Heat Map).  
  - Governance: Solid governance required to minimize risks of default on expenditure commitments, as assessed by World Bank and IMF instruments.

### Design of expenditure commitments and earmarking
- Recent swaps focused on climate and nature investments but swaps can cover broader priorities: education, health, nutrition, refugees, infrastructure, etc.  
- Design of spending commitments reflects donor/debtor priorities and debtor implementation capacity, including Public Financial Management (PFM) and fiduciary arrangements.  
- Historically, programs have been heavily ringfenced, often using trust funds administered outside the debtor country—these arrangements substantially affect transaction costs and cost-benefit analysis.  
- Proposed more flexible approach: rely more on country systems with external monitoring and supervision, recognizing PFM progress in some countries; less heavy-handed earmarking can be more effective and less costly.  
- Debt swaps should focus on achieving sector or program results rather than only meeting spending commitments.

### Assessing expenditure program adequacy
- Key assessment dimensions:  
  - (i) Alignment with national priorities.  
  - (ii) Adequacy from expenditure efficiency perspective, including allocative efficiency.  
  - (iii) Fiscal sustainability of the broader expenditure envelope.  
  - (iv) Degree of expenditure earmarking (from fully earmarked to policy/outcome-based disbursement).  
  - (v) Implementation arrangements (ringfenced vs integrated).  
  - (vi) Mechanisms for monitoring, verification and accountability.

- Specific considerations:  
  - Ensure new spending commitment is fiscally sustainable and does not obstruct expenditure-based fiscal consolidation.  
  - Assess sector absolute and relative spending levels, efficiency, balance between current and capital spending, budgetary rigidities, and implementation capacity (failure to meet commitments may be treated as sovereign default).  
  - Consider global public goods benefits (e.g., conservation) that may justify swaps even if country priorities differ.

### Earmarking, implementation arrangements, and SPVs/TFs
- Continuum of design options from strict earmarking and ring-fencing outside the country to flexible earmarking using country programs or non-earmarking; the note supports more frequent use of the latter two.  
- Ringfenced SPVs and trust funds (TFs) established outside debtor countries have been used to issue new bonds, finance buybacks, and manage funds for spending commitments.  
- SPVs/TFs place key fund flows outside debtor country control but can be jointly managed and offer independent administration; TFs typically have strict access rules and are separate from national budgets, creating PFM fragmentation challenges.  
- Choice of earmarking level driven by implementation capacity and country ownership: greater capacity argues for less ringfencing and more reliance on country systems; TA and CD can fill capacity gaps.  
- Treasury and DMO should always be involved in swap negotiation and able to monitor transactions if failure to deliver commitments could trigger guarantees or default events.

### Monitoring, verification, and accountability mechanisms
- Success of swaps—especially more flexible arrangements—depends on attainment of targeted program goals and results.  
- Extensive use of third-party verification systems has characterized recent swaps.  
- Considerations for monitoring/verification design:  
  - a. Appropriate budget nomenclature to show fund use.  
  - b. Appropriate internal controls and internal audit.  
  - c. External oversight: reporting to public, partners, creditors, and parliament.  
  - d. Third-party verification of results (if KPIs are outcome-related), potentially connecting to output-based aid or World Bank Program for Results Operations (PforRs) or equivalent.  
  - e. Defined mechanisms in case of accountability issues, including when fiscal space is not helping the climate, education, or nature objective of the swap.

### Design recommendation summary
- Favor program designs focused on results rather than inputs and that rely more on country systems where capacity and track record allow.  
- Use external monitoring and supervision (e.g., World Bank PforRs) to strengthen accountability while minimizing costly ringfencing.  
- Evaluate design options using World Bank and IMF assessments (DeMPA, PEFA, CPIA) in relevant public management and governance areas.

*Source: ppea2024038 - 14. Swaps (especially buyback swaps) are complex to analyze, record, and report on.*

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_Source: https://www.imf.org/-/media/files/publications/pp/2024/english/ppea2024038.pdf_