## _022509a

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### Executive Summary — challenges, objectives, and current practice
- LICs need more external resources for development spending, particularly investment in infrastructure and social areas, while maintaining sustainable debt positions.
- International community preference: recourse to concessional external resources (including grants); reaffirmed after MDRI relief.
- Fund practice in Fund-supported programs in LICs:
  - Generally set zero limits on nonconcessional external borrowing while not restricting concessional financing; flexibility has been applied case-by-case.
  - Debt limits policy embodied in IMF Board Decision No. 6230–(79/140); established 1979 and amended three times.
  - Concessional debt excluded from external debt limits; concessionality assessed from creditor’s perspective using currency-specific discount rates based on OECD CIRRs.
  - Minimum grant element for concessionality: at least 35 percent (with higher grant element possible in exceptional cases).

### Why the policy needs review — changes and implementation issues
- Changes in LIC circumstances and financing patterns:
  - Progress in macroeconomic management and debt relief.
  - Official financing from a broader group of creditors; rising private creditor interest until recently.
- Analytical and operational developments:
  - Strengthened debt sustainability analyses (DSAs).
  - Introduction of the joint Bank-Fund Debt Sustainability Framework (DSF).
- Implementation issues requiring reconsideration:
  - Distinction between external and domestic debt blurring as LICs integrate into international financial system.

### Proposed approach and main reform directions
- Move from single concessionality design to a menu of options reflecting LIC diversity.
- Two differentiation dimensions:
  - Extent of debt vulnerabilities.
  - Macroeconomic and public financial management capacity.
- Treatment by country type:
  - Lower capacity countries: continue current practice (easy to implement), with more flexibility for lower debt vulnerabilities.
  - Higher capacity countries: consider flexible/sophisticated options that eschew debt-by-debt approach, including:
    - Use of average concessionality requirements.
    - Targets on the present value (PV) of public external debt (or total public debt).
  - Most advanced LICs: consideration of dropping concessionality requirements.
- Transition dynamics:
  - Over time, more LICs expected to move to flexible approaches as capacity improves.
- Analytical foundations:
  - All options rely on DSAs.

### Historical evolution of concessionality measurement (highlights)
- 1979: Guidelines established; concessionality assessed using OECD DAC flat 10 percent discount rate; minimum grant element 25 percent.
- 1983: Amendments encouraged inclusion of short-term external debt; sometimes extended to longer maturities.
- 1995: Method refined to use currency-specific discount rates from OECD CIRRs; suggested minimum grant element increased to 35 percent; limits on maturities abolished.
- 2000: Definition of debt expanded and clarified as a current liability under a contractual arrangement requiring future payments.

### Institutional coverage of external debt limits
- Performance criteria relate to "official and officially guaranteed foreign debt."
  - Coverage includes official entities for which the government is financially responsible and private debt with official guarantees.
- Purpose: ensure broader public-sector coverage than fiscal accounts to avoid missing public-sector external vulnerabilities.
- Definition of external debt historically based on residency of creditor; guidelines silent on this.

### Implementation in LICs — overall design and practice
- General practice in PRGF arrangements, PSIs, EPCA-supported programs, and ESF high-access component: prohibit nonconcessional external borrowing and not restrict concessional borrowing.
- Fiscal programs often include targets consistent with external debt limits.
- About half of programs (past two years) targeted a fiscal balance measured "from below the line" that either excluded foreign-financed capital expenditures or could be adjusted for additional concessional financing; the other half included targets on domestic budget financing components.
- SBAs examples (2008): minimum concessionality requirement of 35 percent included in recent SBAs (Georgia, Honduras, Pakistan).
  - Honduras SBA: did not allow any nonconcessional borrowing.
  - Georgia SBA: limit of $250 million for nonconcessional borrowing.
  - Pakistan SBA: ceiling of $9.5 billion for nonconcessional borrowing.

### Degree of standard practice and variation (as of mid-January, 2009)
- "Standard" practice (minimum concessionality 35 percent and no nonconcessional borrowing) applied to 17 programs out of 37 (slightly less than half).
- About one fourth of programs had concessionality requirements above 35 percent, ranging from 45 to 100 percent.
- In some cases with debt sustainability concerns, indicative PV targets on PPG external debt were used (encompassing all external debt regardless of concessionality).
- About one third of programs had a nonzero limit on nonconcessional borrowing.
  - Including waivers, some nonconcessional borrowing was permitted in close to 40 percent of programs.
  - Nonzero ceilings mainly used to finance critical large-scale projects (mostly infrastructure) or support gradual shifts to market-based finance.
  - Size of nonzero limits ranged from very small (e.g., Mozambique) to several percentage points of GDP (e.g., Pakistan).

### Concessionality assessment approaches
- In a few cases concessionality assessed using a "financing package" approach rather than debt-by-debt:
  - Integration criteria: same intended use, same borrower, interrelated disbursement schedules and cross-conditions.
  - Overall concessionality calculated as weighted average of grant elements of components.

### Sectoral and institutional coverage variability
- Many countries included only the central government due to data availability and fiscal accounts alignment.
- Some public enterprises included if explicitly part of official sector; commercially viable public enterprises borrowing without government guarantee may be excluded.
- Practical country-specific considerations (e.g., WAEMU secondary-market treatment) influenced coverage.

### Stylized facts on external financing and debt outlook in LICs (key statistics and findings)
- Total external financing flows to LICs increased significantly as a share of GDP in last two decades, driven by private sector-to-private sector flows (mostly FDI and private transfers).
- Official flows remain main source of LIC government financing; private external financing of the public sector limited on average but significant in some LICs through 2007.
- Structure of official flows changed: traditional (DAC) bilateral donors now provide mostly grants; multilateral institutions remain a significant debt source.
- Anecdotal increase in nontraditional bilateral creditors in new debt financing (hard data scarce).
- Debt vulnerabilities:
  - Latest DSAs indicate 40 percent of LICs at high risk of external debt distress or already in debt distress.
  - This share rises to 70 percent if countries at moderate risk are included.
- Implications:
  - Policy focus on preventing unsustainable debt buildup while allowing adequate external financing remains appropriate.
  - For about 30 percent of LICs assessed at low risk of debt distress, more accommodating debt limits warranted.
  - Expanding range of donors/creditors and blurring of external/domestic debt distinctions raise demand for flexibility and reconsideration of residency-based scope.

### Debt Sustainability Framework (DSF) — core components and ratings (Box 2)
- DSAs under DSF:
  - Project external and public sector debt burden and vulnerability under baseline and shock scenarios.
  - Assess risk of debt distress by comparing debt burden indicators to policy-dependent thresholds.
- Risk-of-debt-distress ratings: Low, moderate, high, and in debt distress.
  - Low: all indicators well below thresholds.
  - Moderate: below thresholds in baseline but breach under stress tests.
  - High: one or more indicators breach thresholds under baseline.
  - In debt distress: already having repayment difficulties.
- Policy and institutional quality measured by World Bank CPIA:
  - Strong: CPIA at or above 3.75.
  - Medium: CPIA between 3.25 and 3.75.
  - Poor: CPIA at or below 3.25.
  - Three-year moving average CPIA score used to reduce volatility.
- Concessionality requirement of 35 percent retained since 1995; criticisms include arbitrariness and creditor-perspective measurement.

### Concessionality reform options and menu (summary)
- Guiding principle: link concessionality requirements to DSAs; tailor by debt vulnerabilities and capacity.
- Lower capacity countries:
  - Lower vulnerabilities: maintain 35 percent minimum; consider nonzero limits on nonconcessional borrowing based on DSA tests.
  - Higher vulnerabilities: concessionality generally set at 50 percent or above; presumption of no nonconcessional borrowing except in exceptional circumstances.
- Higher capacity countries:
  - Lower vulnerabilities: measure concessionality on average (six months or fiscal year); target informed by DSA applied to external or total public borrowing.
  - Higher vulnerabilities: PV debt limit may be appropriate; if impractical use higher average concessionality threshold derived from DSA.
  - Most advanced LICs: consider dropping concessionality requirements; if vulnerabilities remain, consider nominal debt ceilings on external or total public debt or sub-ceilings.
- Operational implications:
  - PV-based targets use DSF methodology with a uniform 5 percent discount rate for PV calculations.
  - Data requirements include projected loan disbursements loan-by-loan, conversion using WEO exchange rates, and debt service schedules.
  - PV targets sensitive to timing of disbursements; monitoring and information-sharing challenges suggest PV targets may be better as indicative targets than performance criteria.

### Consistency of financial program and debt-limit options (paras 30–34)
- Any debt-limit option can be consistent with Fund-supported financial programs.
- If sustainability-based debt limits allow too much borrowing from a demand management perspective, combine with an overall fiscal deficit limit.
- Nominal sub-ceilings on certain debt categories can address other vulnerabilities (e.g., limits by original maturity).
- Challenges and drawbacks:
  - Framework dependence and subjectivity (reliance on CPIA, MTDS, PEFA, qualitative judgment).
  - Greater onus on DSAs could make them more contentious; DSAs could be criticized as too conservative for not capturing investment impacts on growth.
  - Moving from PPG external debt to public debt targets offers comprehensiveness but raises operational issues (definition of public debt, DSAs lacking public debt thresholds).
  - Reduced gate-keeping role may weaken donor incentives to provide concessional resources; should be reserved for high-capacity countries.

### Use of residency criterion, safeguards, and alternatives (paras 35–39)
- Residency historically used to define external debt; capital account opening blurs this (nonresidents buying domestic local-currency debt classified as external).
- For advanced LICs, moving to total public debt removes need to distinguish external vs domestic for concessionality.
- For relatively closed capital account LICs, consider excluding nonresident acquisitions of domestically-issued debt in secondary market from concessionality requirements, with case-by-case safeguards.
- Safeguards could include broad fiscal deficit concepts, domestic borrowing in local currency, program design changes (e.g., higher NIR targets), inclusion in DSAs, and improved monitoring/reporting.
- Alternative: use currency denomination as criterion (apply concessionality only to foreign-currency debt), though problematic in dollarized economies; jurisdiction of issuance might be considered.

### Concessionality and public enterprises (paras 40–42)
- Principle: public enterprises and other official sector entities should be covered by debt limits unless explicitly and selectively excluded.
- Selective exclusion possible for entities that can borrow without a government guarantee and pose limited fiscal risk.
- Criteria for exclusion include managerial independence, relations with government, governance structure, financial conditions and sustainability, and other risk factors; application requires judgment.

### Other options explored but not recommended (Annex I)
- Lender-by-lender approach: operational challenges in defining lender, timing, aggregation, and coordination across donor agencies.
- Concessionality-by-expenditure: operational issues in classifying projects, assessing profitability, and potential distortions; not recommended.

### Survey of donors (Annex II) — responses and views
- Response rate: about 35 percent (interpret with caution).
- Creditor lending practices:
  - Loans only: All 23%; Bilateral creditors 8%; Multilateral creditors 50%.
  - Grants only: All 14%; Bilateral creditors 15%; Multilateral creditors 12.5%.
  - Loans and grants: All 62%; Bilateral creditors 77%; Multilateral creditors 37.5%.
- Factors in varying financing terms:
  - IMF or IDA minimum concessionality requirements: All 31%; Bilateral 28%; Multilateral 23%.
  - Debt sustainability situation: All 21%; Bilateral 28%; Multilateral 8%.
  - Type of expenditure: All 13%; Bilateral 8%; Multilateral 23%.
  - Per-capita income: All 8%; Bilateral 8%; Multilateral 8%.
- IMF recommendations importance:
  - Are IMF recommendations important? Yes — All 68%; Bilateral 69%; Multilateral 67%.
  - Specific recommendations taken into account:
    - Minimum concessionality requirements: All 35%; Bilateral 29%; Multilateral 50%.
    - General DSA/staff advice: All 19%; Bilateral 24%; Multilateral 10%.
    - Risk rating in DSA: All 16%; Bilateral 14%; Multilateral 20%.
- Have IMF recommendations led to not financing a project? Yes — All 29%; Bilateral 15%; Multilateral 50%.
  - If yes, frequency in last three years:
    - Between 1/3 and 2/3 of projects: All 17%; Bilateral 50%; Multilateral 0%.
    - Less than 1/3 of projects: All 83%; Bilateral 50%; Multilateral 100%.
- Awareness and use of financing package approach:
  - Aware: All 57%; Bilateral 46%; Multilateral 75%.
  - Usage in last three years:
    - More than 2/3 of projects: All 18%; Bilateral 40%; Multilateral 0%.
    - Between 1/3 and 2/3: All 9%; Bilateral 0%; Multilateral 20%.
    - Less than 1/3: All 73%; Bilateral 60%; Multilateral 80%.
- Views on IMF concessionality policy:
  - Policy serves a useful purpose: Agree — All 81%; Bilateral 75%; Multilateral 89%.
  - Policy should be kept as is: Agree — All 48%; Bilateral 54%; Multilateral 37.5%.
  - Policy should be relaxed to allow more nonconcessional borrowing: Agree — All 33%; Bilateral 23%; Multilateral 50%.
  - 35 percent grant element requirement should be reconsidered: Agree — All 38%; Bilateral 31%; Multilateral 50%.

### Appendix I — stylized facts on trends in LICs’ external financing (through 2007)
- Data sources: Dorsey and others (2008) IMF Working Paper No. 08/51 (updated for 2007), GDF, DAC, BIS.
- Exclusions: Nine PRGF-eligible countries excluded due to data limitations or atypical characteristics.
- Trends:
  - Total net external flows more than doubled in the 1990s compared with previous decade.
  - Peaked in 2007 at about 15 percent of GDP on average.
  - Private flows rose from 1–3 percent of GDP in the 1980s to 11 percent of GDP on average by the 1990s/2000s.
  - Private flows driven mainly by FDI and private transfers (each over a third of total private flows on average).
  - Portfolio investment increased significantly by 2007.
- Official vs private financing:
  - Net official flows as share of GDP on downward trend (data complications due to debt relief).
  - Multilateral net lending to LICs’ official sectors exceeded on average 1 percent of GDP in recent years per GDF.
  - Multilateral lending increasingly concessional by institutions’ own definitions.

### Appendix II — DSA coverage and external debt situation (through end-2007)
- DSA coverage: 194 DSAs completed between DSF introduction in 2005 and December 2008 covering 68 LICs; 160 DSAs published.
- All recent DSAs but three include both external and public debt DSAs.
- Latest DSAs used: those issued and sent to the Board by December 31, 2008.
- External debt averages at end-2007:
  - LICs’ total external debt (PPG external debt + private-sector external debt): 60 percent of GDP on average.
  - PPG external debt (PV terms): about 43 percent of GDP at end-2007 (or 161 percent of exports).
  - Total external debt (PV terms): slightly below 50 percent of GDP on average.
  - Debt service on PPG external debt absorbed 9 percent of export earnings and 12 percent of fiscal revenue in 2007.
  - Focus indicator for many LICs: PV of PPG external debt to exports.

### Distribution, disparities, and domestic/public debt (from para 61 and appendices)
- Wide dispersion in PV PPG external debt-to-exports at end-2007:
  - Standard deviation: 327 percent.
  - Range: 8 percent (Nigeria) to 2,503 percent (Liberia).
- Excluding pre-completion point HIPCs reduces average PV external debt-to-exports ratio to 77 percent.
- PPG external debt ratio averages:
  - Post-MDRI countries: 65 percent at end-2007.
  - Non-HIPCs: 91 percent at end-2007.
- Debt distress ratings distribution:
  - About 30 percent of LICs have low risk of external debt distress.
  - About 30 percent have moderate risk.
  - 40 percent rated high risk or in debt distress (28 countries).
    - 15 are pre-completion point HIPCs (88 percent of pre-completion group).
    - 10 are non-HIPCs (36 percent of non-HIPCs).
    - 3 are post-MDRI countries (13 percent of post-MDRI).
- Domestic government debt (end-2007):
  - Mean domestic debt-to-GDP: 16 percent.
  - Median domestic debt-to-GDP: 13 percent.
  - Range: 0 to 92 percent of GDP.
  - About 30 percent of LICs had domestic debt above 20 percent of GDP.
  - Domestic debt represented, on average, less than 30 percent of total public debt in 2007.
  - Domestic debt service payments ≈ 40 percent of total debt service obligations on public debt.
- Public (total) government debt (end-2007 averages):
  - Nominal total public debt: 74 percent of GDP.
  - PV terms: ratio averaged almost 60 percent.
  - Post-MDRI average public debt-to-GDP: 32 percent.
  - Non-HIPCs average public debt-to-GDP: 47 percent.
  - Countries with low risk ratings had, on average, lower debt ratios than moderate-rated countries by 18 percentage points and lower than high/in-debt-distress countries by 67 percentage points.

*Source: _022509a*

### Executive Summary ......................................................................................................

### Executive Summary

### Challenges, objectives, and current practice
- Low-income countries (LICs) face significant challenges in meeting development objectives while maintaining a sustainable debt position; more external resources will be required for development spending, particularly investment in infrastructure and social areas.
- The international community’s main answer has been to promote recourse to concessional external resources (including grants); this preference was reaffirmed strongly after the delivery of MDRI relief.
- The Fund’s practice in Fund-supported programs in LICs has generally been to set zero limits on nonconcessional external borrowing while not restricting concessional financing, although flexibility has been applied on a case-by-case basis to allow some nonconcessional borrowing when warranted.
- The Fund’s debt limits policy was established thirty years ago and has been amended three times since (see Box 1). The guidelines are embodied in IMF Board Decision No. 6230–(79/140) and apply to all members with a Fund-supported program.
- Concessional debt is excluded from external debt limits as the guidelines state that “flexibility will be exercised to ensure that the use of the performance criterion will not discourage capital flows of a concessional nature by excluding from the coverage of performance criteria debts defined as concessional”.
- Concessionality is assessed from a creditor’s perspective using currency-specific discount rates based on the OECD commercial interest reference rates (CIRRs), and requires “a grant element of at least 35 percent, provided that a higher grant element may be required in exceptional cases.”

### Why the policy needs review
- Changes in LIC circumstances and financing patterns:
  - A number of LICs have made good progress in strengthening macroeconomic management.
  - Debt burdens have been relieved.
  - Official financing has become available from a broader group of creditors.
  - Until recently, external private creditors’ interest in LICs was on the rise.
- Analytical and operational developments:
  - Much work has been done to strengthen debt sustainability analyses (DSAs).
  - The joint Bank-Fund debt sustainability framework (DSF) was introduced since the last policy review of debt limits.
- Implementation issues:
  - The current policy raises implementation issues such as the distinction between external and domestic debt, which require reconsideration as LICs become more integrated into the international financial system.

### Proposed approach and main reform directions
- Move away from a single design for concessionality requirements towards a menu of options to better reflect diversity across LICs.
- Two key dimensions for differentiation:
  - The extent of debt vulnerabilities.
  - Macroeconomic and public financial management capacity.
- Treatment by country type:
  - Continue current practice (easy to implement, well known) for lower capacity countries, with more flexibility for those with lower debt vulnerabilities.
  - For higher capacity countries consider more flexible and sophisticated options that eschew the debt-by-debt approach, including:
    - Use of average concessionality requirements.
    - Targets on the present value (PV) of public external debt (or total public debt).
  - For the most advanced LICs, consideration could be given to dropping concessionality requirements.
- Transition dynamics:
  - Over time, an increasing number of LICs would be expected to move to the more flexible and sophisticated approaches as macroeconomic and public financial management capacity improves.
- Analytical foundations:
  - Consistent with the need for sound analytical underpinnings, all options proposed would rely on DSAs.

### Other issues addressed
- The paper discusses the issue of defining “external” debt (i.e., debt subject to concessionality requirements) as well as the institutional coverage of debt limits.
- Historical evolution of concessionality measurement and guidelines (Box 1):
  - 1979: Guidelines established; concessionality assessed using OECD DAC flat 10 percent discount rate, minimum grant element of 25 percent.
  - 1983: Amendments encouraged inclusion of short-term external debt (maturities less than one year) and in some cases extending limits to longer maturities.
  - 1995: Method refined to use currency-specific discount rates derived from OECD CIRRs; suggested minimum required grant element increased to 35 percent; limits on maturities abolished.
  - 2000: Definition of debt expanded and clarified to mean a current liability created under a contractual arrangement requiring future payments, separating the definition from any particular type of debt instrument.

*Source: Executive Summary, _022509a - Executive Summary*

### 8.      The institutional coverage of external debt limits is expected to be broad.

### 8.      The institutional coverage of external debt limits is expected to be broad.

### Institutional coverage and definition
- Performance criteria "will relate to official and officially guaranteed foreign debt." Coverage includes:
  - Official entities for which the government is financially responsible.
  - Private debt for which official guarantees have been extended and which therefore constitute a contingent liability of the government.
- Purpose: ensure broader coverage of the public sector than fiscal accounts (which often cover only the central government) to avoid missing public-sector sources of external vulnerabilities and domestic demand.
- Consistent with long-standing statistical principles, the definition of external debt has been based on the residency of the creditor. The guidelines are silent on this issue.
- Historical context: when the 1979 guidelines on debt limits were adopted, in practice external debt was typically at the same time debt issued in foreign currency, under foreign law, and to a nonresident.

### Implementation of the policy in LICs — overall design and practice
- Most Fund-supported programs in LICs share the same overall design for external debt limits:
  - General practice in PRGF arrangements, PSIs, EPCA-supported programs, and the high-access component of the ESF has been to prohibit nonconcessional external borrowing and not to restrict concessional borrowing.
  - Fiscal programs include targets consistent with the design of these external debt limits.
- About half of programs in the past two years targeted a fiscal balance measured "from below the line" that either:
  - excluded foreign-financed capital expenditures, or
  - could be adjusted in the event of additional concessional financing.
- The other half included targets on components of domestic budget financing, such as credit to the government.
- Note on SBAs: a minimum concessionality requirement of 35 percent was included in recent Stand-by arrangements (SBAs) in LICs (Georgia, Honduras and Pakistan in 2008). Examples of nonconcessional limits in SBAs:
  - Honduras SBA did not allow any nonconcessional borrowing.
  - Georgia’s SBA had a limit of $250 million for nonconcessional borrowing.
  - Pakistan’s SBA had a ceiling of $9.5 billion for nonconcessional borrowing.

### Degree of standard practice and variation (as of mid-January, 2009)
- The "standard" practice (minimum concessionality requirement of 35 percent and no allowance for nonconcessional borrowing) applied to slightly less than half of Fund-supported programs in LICs: 17 programs (out of 37).
- Debt limits tended to be tighter in countries with higher debt vulnerabilities:
  - About one fourth of Fund-supported programs in LICs as of mid-January, 2009 had concessionality requirements above 35 percent, ranging from 45 to 100 percent.
  - In a few cases with debt sustainability concerns, more comprehensive limits were used, including indicative targets based on the present value (PV) of public and publicly guaranteed (PPG) external debt—these PV limits encompass all external debt regardless of concessionality.
- Debt limits were looser when warranted:
  - About a third of Fund-supported programs in LICs as of mid-January, 2009 had a nonzero limit on nonconcessional borrowing.
  - Including cases where waivers were granted for exceeding the limit, some nonconcessional borrowing was permitted in close to 40 percent of programs.
  - Nonzero ceilings were used mainly to: (i) finance critical large-scale projects, mostly infrastructure, where concessional resources were not available; and (ii) support gradual shifts from concessional to market-based finance.
  - The size of nonzero debt limits varied from very small (e.g., Mozambique) to several percentage points of GDP (e.g., Pakistan).

### Concessionality assessment approaches
- In a few cases, concessionality was assessed using a "financing package" approach rather than debt-by-debt:
  - Key requirement: various parts of a financing package (e.g., a nonconcessional loan and a grant) must be sufficiently integrated to be considered one single debt.
  - Integration is assessed by staff considering whether parts have the same intended use, are provided to the same borrower, and have interrelated disbursement schedules and cross-conditions.
  - Overall concessionality of an integrated package is calculated using the weighted average of the grant elements of its components.

### Sectoral and institutional coverage variability
- Sectoral coverage of debt limits varied significantly, particularly for official entities other than the central government:
  - Many countries included only the central government due to data availability, desire to match fiscal accounts coverage, and because external borrowing by other official entities often requires central government guarantees.
  - In some countries, certain public enterprises are explicitly part of the official sector; in others, commercially viable public enterprises that can borrow externally without a central government guarantee are excluded.
  - Practical country-specific considerations affected coverage (example: in WAEMU, market borrowing from residents of another WAEMU country is not considered external for the purposes of the external debt limit).

### Why aspects of the debt limits policy need review — stylized facts on external financing and debt outlook in LICs
- Stylized facts (based on Appendices I and II; to be interpreted cautiously given serious data limitations):
  - Total external financing flows to LICs have increased significantly (as a share of recipients’ GDP) in the last two decades, driven by private sector-to-private sector flows—mostly foreign direct investment (FDI) and private transfers.
  - Official flows remain the main source of LIC government financing. Private external financing of the public sector is on average still limited but was significant in some LICs through 2007.
  - Structure of official flows changed: traditional (DAC) bilateral donors now provide mostly grants. Multilateral institutions remain a significant source of debt financing for LIC governments.
  - Anecdotal evidence suggests the share of nontraditional (non-DAC) bilateral donors/creditors in new debt financing is rising, though hard data are scarce.
  - Debt vulnerabilities remain significant in many LICs, including some post-MDRI countries:
    - Latest available DSAs indicate that 40 percent of LICs are at a high risk of external debt distress or already in debt distress.
    - This share rises to 70 percent if countries at a moderate risk of debt distress are included.
  - LICs face diverse situations in composition of external financing and debt vulnerabilities.
- Implications and tensions identified:
  - The policy focus on preventing unsustainable debt buildup while allowing adequate external financing remains appropriate given continued fragility and development needs.
  - For about 30 percent of LICs assessed at low risk of debt distress, consideration of more accommodating debt limits is warranted.
  - The expanding range of donors/creditors—some less concessional but willing to finance potentially high-return, cash-generating infrastructure—raises demand for flexibility in access to nonconcessional finance.
  - The distinction between external and domestic debt is blurring with sizable external private financing of governments (e.g., nonresident purchases of domestically issued bonds), weakening the original rationale for residency-based scope of concessionality requirements.
  - The ongoing financial crisis (circa 2009) is expected to affect size and composition of flows (private capital inflows to LICs expected to decrease sharply in 2009), but short-term developments do not remove the case for reviewing aspects of debt limits policy.

### Other analytical and operational issues
- The current debt limits policy does not incorporate recent advances in the Fund’s analytical approach to assessing debt sustainability:
  - The concessionality policy and debt limits predate the Debt Sustainability Framework (DSF) and formal DSAs.
  - The DSF provides a comprehensive approach to assessing debt sustainability and for guiding choices about the type and amount of debt to be contracted prudently.
  - DSA results do not yet systematically inform the design of debt limits; limited correlation is observed between DSA risk ratings and minimum concessionality requirements.

*Source: _022509a - 8.      The institutional coverage of external debt limits is expected to be broad.*

### Box 2. The Main Components of the Debt Sustainability Framework

### Box 2. The Main Components of the Debt Sustainability Framework

### Core components of DSAs under the DSF
- DSAs consist of:
  - An analysis of a country’s projected external and public sector debt burden and its vulnerability to external and policy shocks—baseline and shock scenarios are calculated; and
  - An assessment of the risk of debt distress based on indicative external debt burden thresholds that depend on the quality of the country’s policies and institutions. The assessment is made by comparing external debt burden indicators in the various scenarios against their thresholds. Breaches of thresholds, present or projected, play an important role in the assessment.

### Risk-of-debt-distress ratings
- Four possible ratings of external debt distress: Low, moderate, high, and in debt distress.
- Risk ratings are determined as follows:
  - Low risk, when all the debt burden indicators are well below the thresholds;
  - Moderate risk, when debt burden indicators are below the thresholds in the baseline scenario, but stress tests indicate that the thresholds are breached if there are external shocks or abrupt changes in macroeconomic policies;
  - High risk, when one or more debt burden indicators breach the thresholds under the baseline scenario; or
  - In debt distress, when the country is already having repayment difficulties.

### Measurement of policy and institutional quality
- Quality of policies and institutions is measured by the CPIA index, compiled annually by the World Bank.
- DSF performance categories:
  - Strong: CPIA at or above 3.75
  - Medium: CPIA between 3.25 and 3.75
  - Poor: CPIA at or below 3.25
- To reduce volatility from annual CPIA fluctuations, a three-year moving average CPIA score is used to determine a country’s policy performance under the DSF.

### Concessionality requirement and criticisms
- The minimum concessionality requirement of 35 percent has been used by the Fund since 1995 and is based on a methodology using currency-specific discount rates.
- Criticisms noted:
  - The 35 percent minimum has been criticized as arbitrary; it has nevertheless been retained because it is well known and used by other creditors.
  - Concessionality measured from the creditor’s opportunity cost, not the borrower’s perspective; a borrower perspective would raise practical issues (definition of appropriate benchmarks in countries with shallow domestic markets, exchange rate risk, and unintended outcomes).
  - Prohibition of nonconcessional external financing in countries that could afford it may constrain debt management operations and capacity development, potentially leading to suboptimal choices (e.g., domestic vs. international nonconcessional borrowing, limiting development of debt management capacity).

### Options for reform — guiding principles
- Reforms should link concessionality requirements more closely to DSAs to better achieve debt sustainability objectives and to reflect LIC diversity.
- Two dimensions for tailoring options:
  - Extent of debt vulnerabilities (as assessed by DSAs).
  - Macroeconomic and public financial management capacity.

### Concessionality options and menu (summary of proposals)
- General approach: a menu of options, all relying on DSAs; choice of option based on debt vulnerabilities and capacity. Unless debt sustainability is a serious concern and capacity is limited, options involve more flexibility for LICs.

- Lower capacity countries (retain current approach with more flexibility and linkage to DSAs):
  - Countries with lower vulnerabilities: maintain minimum concessionality requirement of 35 percent and consider nonzero limits on nonconcessional borrowing more systematically—or set higher—and/or be more frequently untied. Size of limits could be based on DSA tests.
  - Countries with higher vulnerabilities: concessionality requirement generally set at 50 percent or above. Presumption of no nonconcessional borrowing except in exceptional circumstances (e.g., financing with a grant element marginally below the minimum requirement, or critical and highly profitable project for which concessional financing is not available).

- Higher capacity countries (more flexible/sophisticated options, moving away from debt-by-debt approach):
  - Lower vulnerabilities:
    - Concessionality could be measured on average over six months or the fiscal year.
    - Target for average concessionality informed by the DSA and consistent with an unchanged risk rating; could be applied to external or total public borrowing.
  - Higher vulnerabilities:
    - A debt limit in PV terms may be more appropriate to limit overall debt accumulation while leaving some margin to authorities.
    - If PV target is impractical, use an average concessionality requirement with a higher threshold derived from the DSA.
  - Most advanced LICs:
    - Consider dropping concessionality requirements. These countries typically have higher per capita income, a strong track record of macroeconomic and public financial management, significant market access, and experience with nonconcessional financing.
    - If debt vulnerabilities remain high, or public sector coverage is narrow, consider debt ceilings on nominal external or total public debt or sub-ceilings on specific types of debt.

### Concessionality options matrix (conceptual)
- Two axes: Extent of debt vulnerabilities (Lower / Higher) and Macroeconomic and public financial management capacity (Lower / Higher).
- Illustrative outcomes:
  - Lower capacity / Lower vulnerabilities: Minimum concessionality requirement based on current system, but with added flexibility on nonconcessional external debt (e.g., higher and untied nonzero limits, if consistent with maintenance of low debt vulnerabilities).
  - Lower capacity / Higher vulnerabilities: Maintain minimum concessionality requirement based on current system, likely higher than 35 percent, with limited or no room for nonconcessional borrowing and possibly nominal limits on concessional borrowing too.
  - Higher capacity / Lower vulnerabilities: Minimum average concessionality requirement over six months or the fiscal year applied to external or total public borrowing; for most advanced LICs, no concessionality requirements and overall nominal debt limit if needed.
  - Higher capacity / Higher vulnerabilities: Overall limit on the PV of external or total public debt or average concessionality at a higher level; for most advanced LICs, ceilings on nominal external or total public debt.

### Operational implications of PV targets (Box 3)
- PV-based targets follow the DSF methodology to calculate and project the PV of debt and are comprehensive and consistent with the DSA.
- Data requirements (as described):
  - Projected disbursements on a loan-by-loan basis, in the original currency of disbursement, over several years.
  - Conversion to U.S. dollars using WEO exchange rates.
  - Debt service generated using the terms and conditions of each loan.
  - A uniform 5 percent discount rate is applied to calculate the PV of debt service obligations, in line with the methodology of the DSF.
- Implementation challenges:
  - Monitoring phased disbursements continuously requires timely information sharing among government agencies; debt management units are often informed late of disbursements on project loans.
  - Aggregation of disbursements on a regular basis is needed to ascertain targets are met.
  - PV targets are highly sensitive to timing of projected disbursements, which can be affected by donors’ internal procedures, limited domestic implementation capacity, or lack of counterpart funds.
  - Higher information-sharing requirements increase the risk of misreporting.
- Practical judgment:
  - PV targets may be more appropriate as indicative targets than as performance criteria (a point previously endorsed by the Board).
  - Similar implementation considerations apply to the average concessionality approach; both may be better used for indicative targets rather than performance criteria.

### Transition and sequencing
- Over time, as macroeconomic and public financial management capacity improves, an increasing number of LICs are expected to move to more flexible and sophisticated approaches.
- At present, a majority of LICs would still be expected to be classified in the lower capacity category and would benefit from more flexible application of the current approach to allow more financing choices while limiting risks to debt sustainability.
- Keeping the current framework in place for lower capacity countries helps maintain donor and creditor alignment with Fund (and Bank) concessionality requirements; movement to more flexible options should follow capacity improvements.

*Source: Box 2. The Main Components of the Debt Sustainability Framework*

### 30.      Consistency of the financial program supported by a Fund arrangement can be

### _022509a - 30.      Consistency of the financial program supported by a Fund arrangement can be

### Consistency of the financial program and debt-limit options
- Consistency of the financial program supported by a Fund arrangement can be achieved with any of the above options for debt limits.
- Where debt limits based solely on sustainability considerations would allow too much borrowing from a demand management perspective, any option could be combined with a limit on the overall fiscal deficit, with the fiscal deficit limit becoming the binding constraint.
- Where debt vulnerabilities other than long-term sustainability exist, nominal sub-ceilings on certain categories of debt could be considered (e.g., limits on debts with an original maturity below a certain threshold).

### Challenges and possible drawbacks with the suggested approach (paras 31–34)
- Framework dependence and subjectivity:
  - The framework would depend heavily on assessments of macroeconomic and public financial management capacity, which would inevitably have a subjective element.
  - A possible starting point would be to look at the CPIA (or one of its sub-components). Use of the CPIA would be consistent with the role played by this index in determining the policy-dependent thresholds in the DSF.
  - CPIA is published and available for almost all LICs.
  - Other indicators to be taken into account include the presence and successful implementation of a Medium-Term Debt Management Strategy (MTDS) and Public Expenditure and Financial Accountability (PEFA).
  - Assessments would rely on these indicators plus relevant qualitative information and therefore would involve judgment.
- Greater onus on DSAs and potential contention:
  - The proposed framework would put a greater onus on DSAs and could make them more contentious.
  - For lower capacity countries, the risk rating (or an overall assessment based on total public debt) would systematically influence the minimum concessionality requirement, and the DSA would be used to determine how much nonconcessional borrowing could be contracted.
  - For higher capacity countries, reliance on DSAs could be even more extensive, particularly for the use of PV targets.
  - Criticism may arise that DSAs are too conservative and do not take adequately into account the impact of additional (debt-financed) public investment on growth and exports.
  - More work on assessing the relationship between investment and growth in LICs’ macroeconomic frameworks would be warranted; consideration could be given to building on recent staff work in the context of aid scaling-up scenarios.
  - DSAs already play a critical role in IDA’s policy on nonconcessional borrowing, with ratings indirectly determining whether a country is subject to this policy.
  - The greater role of DSAs could incentivize country authorities and stakeholders to pay more attention to the framework.
- Moving from PPG external debt to public debt targets (para 33):
  - Public debt is more comprehensive and more relevant for debt management and fiscal sustainability and would address blurring between external and domestic debt.
  - Operational issues would arise, such as definition of public debt (e.g., treatment of domestic arrears) and whether DSAs provide sufficient guidance on setting limits on total public debt.
  - DSAs do not include thresholds for public debt, unlike for PPG external debt.
  - Staff recommends trying public debt targets in specific cases where potential problems are manageable and conducting an assessment of experience after a period of time.
- Reduced gate-keeping and donor incentives (para 34):
  - Increased flexibility under more advanced options reduces the Fund’s traditional “gate keeper” role and may weaken donors’ incentives to provide concessional resources.
  - Under these options, the gate-keeping (or creditor coordinating) function would be performed by country authorities; hence these options should be used only in countries with high capacity.
  - Minimum concessionality requirements can, in some circumstances, strengthen the bargaining power of borrowing countries.
  - Many traditional donors provide financing on terms much more favorable than required, suggesting concessionality requirements are not the main factor influencing financing terms.
  - Traditional donors’ concerns about free riding should be mitigated by the increased focus of concessionality policy on debt sustainability, giving stronger assurances that development finance efforts will not be jeopardized by excessive borrowing from other sources.

### Use of the residency criterion to define external debt (paras 35–39)
- Background and emerging issues:
  - Traditional statistical principle: external debt defined by residency of creditor; historically also meant debt in foreign currency and contracted under foreign law.
  - In countries with opening capital accounts, nonresidents can buy domestically-issued debt in local currency (classifying it as external debt), and residents can buy foreign-currency debt issued abroad (classifying it as domestic debt); the latter may not be less risky.
- Implications for advanced LICs (para 36):
  - Proposed debt limits for more advanced LICs would either drop any debt limits or rely on total public debt, eliminating the need to distinguish external vs. domestic debt for concessionality purposes.
  - Distinguishing debt by characteristics (e.g., currency of denomination) may still be desirable from an external vulnerability analysis standpoint.
- For LICs with relatively closed capital accounts (para 37):
  - The residency criterion remains relevant with amendments.
  - Consideration could be given to excluding systematically from concessionality requirements nonresident acquisitions of domestically-issued debt in the secondary market (expected to be very limited).
  - This exclusion could be complemented with additional safeguards to address vulnerabilities from transactions with nonresidents.
- Safeguards (para 38):
  - Safeguards would be determined case-by-case and could include:
    - (i) program relies on an appropriately broad concept for the fiscal deficit performance criterion to close definitional loopholes;
    - (ii) all new borrowing on the domestic market should normally be in local currency;
    - (iii) relevant changes in program design (e.g., higher NIR targets) if needed to mitigate vulnerabilities from significant nonresident holdings of domestic debt;
    - (iv) such transactions are fully reflected, to the extent possible, in the external debt sustainability analysis, including an explicit assessment of associated vulnerabilities (e.g., higher rollover risk for short-term borrowing, potential threat to exchange rate and/or reserves in the event of sudden withdrawals);
    - (v) authorities report to the Fund the terms of new domestic borrowing, including currency composition, and take steps over time to improve monitoring of secondary market transactions.
- Intermediate cases and alternative criteria (para 39):
  - In intermediate cases, residency with exclusions may lose coherence if excluded debts become large.
  - One option: use currency denomination as criterion — apply concessionality requirements only to foreign-currency denominated debt to mitigate exchange rate risk associated with foreign-currency nonconcessional borrowing.
  - Additional measures may be needed to address risks from large nonresident inflows into domestic-currency debt.
  - Use of currency criterion poses serious problems in dollarized economies where domestic market issuance may be largely or entirely in foreign currency; in highly dollarized economies, consideration could be given to using the jurisdiction of issuance as a criterion.

### Concessionality and public enterprises (paras 40–42)
- Institutional coverage clarification:
  - Benefits exist in clarifying the institutional coverage of debt limits; creditors/donors often query inclusion/exclusion of specific public entities.
- Coverage principle:
  - Public enterprises and other official sector entities should be covered by debt limits, unless an explicit selective exclusion is made.
- Case for selective exclusion:
  - Selective exclusion could apply to public enterprises and official sector entities that can borrow without a government guarantee and whose operations pose limited fiscal risk.
  - Objective: avoid inappropriately constraining operations and potentially hampering investment.
- Criteria for exclusion (paras 41–42):
  - Possible criteria to decide on exclusion:
    - (i) managerial independence, including pricing policy and employment policy;
    - (ii) relations with the government, including existence of subsidies and transfers, quasi-fiscal activities, and nature of the regulatory and tax regime;
    - (iii) governance structure, including periodic outside audits, publication of comprehensive annual reports, and shareholders’ rights;
    - (iv) financial conditions and sustainability, including market access, less than full leveraging (debt-to-asset ratio comparable to the industry average), profitability, and record of past investment;
    - (v) other risk factors, including vulnerabilities from contingent liabilities, and the importance of the public enterprise.
  - Application of these criteria requires judgment, but they should permit adequate distinction between high and low fiscal risks.

### Other options explored but not recommended (Annex I)
- Lender-by-lender approach (para 43):
  - Concessionality determined on average based on overall resource flows from a lender to a country over a given period (e.g., a year).
  - Operational challenges:
    - Timing of contracting of various loans may not be under authorities’ control; raises informational and aggregation issues, making monitoring difficult.
    - Requires precise definition of a lender; bilateral donors often have multiple agencies, creating coordination problems.
    - Definition of the period for averaging may not match lenders’ fiscal years, raising planning and commitment issues.
- Concessionality based on type of expenditure (para 44):
  - Concessionality-by-expenditure would reflect growth/productivity impact of debt-financed expenditures; higher requirements could apply to social projects, lower to infrastructure.
  - Operational issues:
    - Staff cannot assess profitability of each project; approach would need broad expenditure categories.
    - Classification of projects into categories may be challenging; unclear treatment of general budget financing.
    - Could lead to severe distortions in the structure of externally-financed expenditures.

### Survey of donors conducted for this paper (Annex II, paras 45–48)
- Response rate:
  - Response rate was low (about 35 percent); results should be interpreted with caution.
- Creditor lending practices (para 46):
  - 62 percent of respondents provide both loans and grants.
  - 23 percent provide loans only.
  - 14 percent provide grants only.
  - About one third of respondents cited IMF/IDA minimum concessionality requirements as a factor in deciding level of concessionality.
  - Debt sustainability situation was the next most frequently cited consideration; type of expenditure and per-capita income were less frequently cited.
- Lenders’ experience with Fund debt recommendations (para 47):
  - About two thirds indicated IMF recommendations were important in determining financing terms.
  - Of these, 35 percent cited the Fund’s minimum concessionality requirements.
  - Next most frequently cited factors were: (i) the Fund’s general advice (in staff reports or DSAs); and (ii) the risk rating included in the DSA.
  - More than one quarter of all respondents noted that, on occasion, Fund recommendations have led them not to finance a project they were previously considering.
  - A bit more than half were aware of the financing package approach for concessionality calculation; the majority of those have only employed this approach occasionally.
- Creditors’ views on the IMF concessionality policy (para 48):
  - About 80 percent indicated the Fund’s concessionality policy serves a useful purpose.
  - Somewhat fewer than half believed the policy should be kept as is.
  - One fifth thought the policy should be changed.
  - Just over one third believed the policy should allow for more nonconcessional borrowing.
  - Close to 40 percent thought that the requirement of a 35 percent grant element for concessional loans should be reconsidered.

*Source: _022509a - 30.      Consistency of the financial program supported by a Fund arrangement can be (PDF chapter/section).*

### 1. Does your agency provide:

### _022509a - 1. Does your agency provide:

### Provision of financing instruments
- Loans only
  - All: 23%
  - Bilateral creditors: 8%
  - Multilateral creditors: 50%
- Grants only
  - All: 14%
  - Bilateral creditors: 15%
  - Multilateral creditors: 12.5%
- Loans and grants
  - All: 62%
  - Bilateral creditors: 77%
  - Multilateral creditors: 37.5%

### Factors taken into account when varying financing terms to LICs
- Per-capita income of the country
  - All: 8%
  - Bilateral creditors: 8%
  - Multilateral creditors: 8%
- Type of expenditure which is financed
  - All: 13%
  - Bilateral creditors: 8%
  - Multilateral creditors: 23%
- Debt sustainability situation
  - All: 21%
  - Bilateral creditors: 28%
  - Multilateral creditors: 8%
- IMF or IDA minimum concessionality requirements
  - All: 31%
  - Bilateral creditors: 28%
  - Multilateral creditors: 23%
- Other reasons (please specify)
  - All: 18%
  - Bilateral creditors: 20%
  - Multilateral creditors: 23%
- N/A
  - All: 10%
  - Bilateral creditors: 8%
  - Multilateral creditors: 15%

### Your agency’s experience with IMF recommendations in the debt area

- Are IMF recommendations an important consideration in determining your financing terms?
  - Yes
    - All: 68%
    - Bilateral creditors: 69%
    - Multilateral creditors: 67%
  - No
    - All: 32%
    - Bilateral creditors: 31%
    - Multilateral creditors: 33%

- If yes, specific recommendations taken into account
  - Minimum concessionality requirements (if any)
    - All: 35%
    - Bilateral creditors: 29%
    - Multilateral creditors: 50%
  - General advice provided in staff reports or debt sustainability analyses
    - All: 19%
    - Bilateral creditors: 24%
    - Multilateral creditors: 10%
  - Risk rating included in debt sustainability analyses
    - All: 16%
    - Bilateral creditors: 14%
    - Multilateral creditors: 20%
  - Other (please specify)
    - All: 13%
    - Bilateral creditors: 14%
    - Multilateral creditors: 10%
  - n/a
    - All: 16%
    - Bilateral creditors: 29%
    - Multilateral creditors: 10%

- Have IMF recommendations led you not to finance a specific project you were earlier considering?
  - Yes
    - All: 29%
    - Bilateral creditors: 15%
    - Multilateral creditors: 50%
  - No
    - All: 71%
    - Bilateral creditors: 85%
    - Multilateral creditors: 50%

- If yes, frequency in the last three years
  - More than 2/3 of your projects
    - All: 0%
    - Bilateral creditors: 0%
    - Multilateral creditors: 0%
  - Between 1/3 and 2/3 of your projects
    - All: 17%
    - Bilateral creditors: 50%
    - Multilateral creditors: 0%
  - Less than 1/3 of your projects
    - All: 83%
    - Bilateral creditors: 50%
    - Multilateral creditors: 100%

- Awareness that instruments from various donors can be assessed together for concessionality calculations (if sufficiently integrated into one single package)
  - Yes
    - All: 57%
    - Bilateral creditors: 46%
    - Multilateral creditors: 75%
  - No
    - All: 43%
    - Bilateral creditors: 54%
    - Multilateral creditors: 25%

- If yes, usage of this option in the last three years
  - More than 2/3 of your projects
    - All: 18%
    - Bilateral creditors: 40%
    - Multilateral creditors: 0%
  - Between 1/3 and 2/3 of your projects
    - All: 9%
    - Bilateral creditors: 0%
    - Multilateral creditors: 20%
  - Less than 1/3 of your projects
    - All: 73%
    - Bilateral creditors: 60%
    - Multilateral creditors: 80%

### Views on the IMF concessionality policy
- This policy serves a useful purpose
  - Agree
    - All: 81%
    - Bilateral creditors: 75%
    - Multilateral creditors: 89%
  - Disagree
    - All: 5%
    - Bilateral creditors: 0%
    - Multilateral creditors: 11%
  - Neutral
    - All: 14%
    - Bilateral creditors: 25%
    - Multilateral creditors: 0%

- This policy should be kept as is
  - Agree
    - All: 48%
    - Bilateral creditors: 54%
    - Multilateral creditors: 37.5%
  - Disagree
    - All: 19%
    - Bilateral creditors: 0%
    - Multilateral creditors: 50%
  - Neutral
    - All: 33%
    - Bilateral creditors: 46%
    - Multilateral creditors: 12.5%

- The policy should be relaxed to allow for more nonconcessional borrowing by LICs
  - Agree
    - All: 33%
    - Bilateral creditors: 23%
    - Multilateral creditors: 50%
  - Disagree
    - All: 43%
    - Bilateral creditors: 46%
    - Multilateral creditors: 37.5%
  - Neutral
    - All: 24%
    - Bilateral creditors: 31%
    - Multilateral creditors: 12.5%

- The requirement of a 35 percent grant element for a loan to be considered concessional should be reconsidered
  - Agree
    - All: 38%
    - Bilateral creditors: 31%
    - Multilateral creditors: 50%
  - Disagree
    - All: 29%
    - Bilateral creditors: 23%
    - Multilateral creditors: 37.5%
  - Neutral
    - All: 33%
    - Bilateral creditors: 46%
    - Multilateral creditors: 12.5%

### Appendix I — Stylized facts on trends in LICs’ external financing (through 2007)
- Purpose and data limitations
  - Objective: identify stylized facts robust across data sources rather than produce comprehensive quantitative estimates.
  - Primary database: Dorsey and others (2008) “The Landscape of Capital Flows to Low-Income Countries” IMF Working Paper No. 08/51, updated for 2007; other databases used: GDF, DAC, BIS.
  - Nine PRGF-eligible countries excluded from the sample: Afghanistan, Kiribati, Liberia, Somalia, Timor-Leste, Yemen, India, Nigeria, Pakistan (excluded due to data limitations or atypical characteristics).

- Trend in total external financing flows to LICs
  - Total net flows (official and private lending, transfers, and FDI) more than doubled in the 1990s compared with the previous decade.
  - Peaked in 2007 at about 15 percent of GDP on average, almost three times their 1980s level.

- Composition and drivers
  - Massive increase driven by private flows.
    - Private flows in the 1980s fluctuated between 1 and 3 percent of GDP; reached 11 percent of GDP on average in LICs by the 1990s/2000s.
  - Private flows driven mainly by FDI and private transfers; each accounts for over a third of total private flows on average.
  - Portfolio investment increased significantly in the past few years, particularly in 2007.

- Official flows and bilateral lending
  - Net official flows (as share of recipients’ GDP) appear on a downward trend in recent years (noting data complications due to debt relief operations).
  - Decline of official flows reflects a decrease in bilateral net lending; GDF data show bilateral official net lending has almost disappeared.
  - Bilateral official financing not provided as lending (grants and debt relief) has held up; debt relief operations increased significantly in recent years (e.g., Paris Club cancellation for Nigeria).

- Multilateral lending
  - Multilateral institutions remain a significant source of official lending; net lending to LICs’ official sectors exceeded on average 1 percent of GDP in the past few years per GDF.
  - Multilateral lending has become increasingly concessional in past decades according to these institutions’ definitions (which may differ across institutions and from the Fund’s).

- Official vs private as sources of LIC government financing
  - Official flows remain the main source of LIC government financing by far.
  - Borrowing from private external creditors limited on average but significant in some LICs (examples: Nigeria, Malawi, Zambia, Ghana).
  - Foreign banks’ net flows to LICs have been quite volatile.

- Post-MDRI debt structure changes
  - In post-MDRI countries, share of debt owed to non-Paris Club creditors (official or private) has increased; share owed to Paris Club creditors close to zero; share of multilateral debt remains high.

### Appendix II — The debt sustainability outlook in LICs (DSAs under the DSF)
- DSA coverage and timing
  - 194 DSAs completed between DSF introduction in 2005 and December 2008 covering 68 LICs; 160 DSAs were published.
  - All recent DSAs but three include both an external and a public debt DSA.
  - Latest DSAs used are those issued and sent to the Board by December 31, 2008.

- External debt situation at end-2007 (averages)
  - LICs’ total external debt (PPG external debt + private-sector external debt) amounted to 60 percent of GDP on average at end-2007.
  - PPG external debt is the main component of total external debt.
  - PPG external debt in PV terms: on average about 43 percent of GDP at end-2007 (or 161 percent of exports).
  - Total external debt (PV terms) slightly below 50 percent of GDP on average at end-2007.
  - Debt service payments on PPG external debt absorbed 9 percent of export earnings and 12 percent of fiscal revenue in 2007.
  - Focus for many LICs: PV of PPG external debt to exports (the PPG external debt ratio).

*Source: _022509a - 1. Does your agency provide:*

### 61.      The averages mask, however, wide

### _022509a - 61.      The averages mask, however, wide

### External PPG external debt: distribution and disparities
- Wide dispersion in PPG external debt ratios at end-2007:
  - Standard deviation: 327 percent (average at end-2007).
  - Observed range: 8 percent (Nigeria) to 2,503 percent (Liberia).
- Excluding pre-completion point HIPCs reduces the average PV external debt-to-exports ratio to 77 percent (Figure A.II.2).
- Post-MDRI vs non-HIPCs:
  - PPG external debt ratio averaged 65 percent for post-MDRI countries at end-2007.
  - PPG external debt ratio averaged 91 percent for non-HIPCs at end-2007.
  - Distribution of ratios is narrower in post-MDRI countries (Figure A.II.3).
  - Non-HIPCs have stronger export performance over the past 10 years and higher current exports-to-GDP ratios than post-MDRI countries (Table 2).

### Correlates of high external indebtedness
- Countries with higher PPG external debt ratios tend to have one or more of the following characteristics:
  - No or limited natural endowments (hydrocarbons, minerals).
  - Lower GNI per capita (below the IDA cutoff of $1,095).
  - Weaker quality of policies and institutions (lower World Bank CPIA).
  - Less friendly business environment (World Bank ease of doing business indicators).

### Debt distress ratings and vulnerability
- Distribution of risk ratings (based on recent DSAs and ratings):
  - About 30 percent of LICs have a low risk of external debt distress.
    - Non-HIPCs: 39 percent (11 countries) low risk.
    - Post-MDRI: 43 percent (10 countries) low risk.
    - No pre-completion point HIPC has a low risk rating.
  - About 30 percent of LICs have a moderate risk rating.
    - Post-MDRI: 43 percent (10 countries) moderate.
    - Non-HIPCs: 25 percent (7 countries) moderate.
    - Pre-completion point HIPCs: about 12 percent (2 countries) moderate.
  - 40 percent of LICs rated high risk or in debt distress (28 countries).
    - 15 are pre-completion point HIPCs (88 percent of pre-completion group).
    - 10 are non-HIPCs (36 percent of non-HIPCs).
    - 3 are post-MDRI countries (13 percent of post-MDRI).
- Specific country-level movements and causes:
  - Burkina Faso and São Tomé and Príncipe reclassified from moderate to high risk due to a decline in CPIA (Burkina Faso) and revisions to oil production timing/level (São Tomé and Príncipe).
  - The Gambia has had a high risk rating since its completion point.
- Sensitivity and stress tests:
  - Debt dynamics for moderate-rated countries are particularly sensitive to export shocks; export shock is the most extreme stress test for nearly all countries.
  - In about 40 percent of moderate cases sensitivity to export shocks leads to breach of DSA thresholds (Table 3).
- Characteristics of higher-risk countries (excluding pre-completion-point HIPCs):
  - Lower average export performance over the past 10 years than low/moderate-rated countries.
  - Narrower export base, often commodity-concentrated.
  - Lower average CPIA of 3.0 (classified as “poor performers”) versus 3.6 for other countries.
  - Wide economic diversity persists within the higher-risk group:
    - Pre-completion-point countries average GNI per capita of $650.
    - Excluding pre-completion countries, GNI per capita ranges from $320 (The Gambia) to $4,670 (Grenada).
    - Variations in foreign direct investment (e.g., São Tomé and Príncipe with current oil exploration) and business environment (Tonga ranked 43rd, Lao PDR 165th in Doing Business).

### Domestic government debt in LICs
- New analysis based on DSAs using gross domestic debt data (domestically-issued debt definition).
- Data and comparability caveats:
  - Definition and coverage differ across LICs; data may be limited to central or general government.
  - Residency criterion often difficult to apply; DSAs commonly define domestic debt as domestically-issued debt.
- Key statistics at end-2007:
  - Mean domestic debt-to-GDP: 16 percent.
  - Median domestic debt-to-GDP: 13 percent.
  - Range: 0 to 92 percent of GDP.
  - About 30 percent of LICs had domestic debt above 20 percent of GDP.
  - Pre-completion point countries had, on average, the largest domestic debt (Figure A.II.6).
- Domestic debt as share of total public debt:
  - Domestic debt represented, on average, less than 30 percent of total public debt in 2007.
  - This share was higher in post-MDRI countries than in pre-completion-point countries or in non-HIPCs.
  - Domestic debt service payments represented about 40 percent of total debt service obligations on public debt.
- Recent dynamics (2005–2007):
  - Average domestic debt-to-GDP increased marginally from 15 percent in 2005 to 16 percent in 2007.
  - 19 out of 65 countries experienced increases in domestic debt ratios, with a mean increase of 2.6 percentage points.
  - Four countries recorded larger increases: Ghana (+8 percentage points), Sudan (+7 percentage points), St. Lucia (+5 percentage points), and Togo (+3.5 percentage points).
- Attributes of countries with higher domestic debt:
  - Tend to have: (i) higher debt distress risk rating; (ii) higher per-capita income; (iii) weaker policies and institutions; (iv) more developed financial systems (higher broad money-to-GDP).
  - Non-HIPCs with high domestic debt tend to be richer, have stronger policies/institutions, and greater financial intermediation than HIPC counterparts.
  - HIPCs with high domestic debt tend to be poorest of their group with weaker quality of policies and institutions.

### Public (total) government debt
- Levels and composition at end-2007:
  - Nominal total public debt: 74 percent of GDP (average).
  - Present value (PV) terms: ratio averaged almost 60 percent.
  - Post-MDRI average public debt-to-GDP: 32 percent.
  - Non-HIPCs average public debt-to-GDP: 47 percent.
  - Pre-completion point countries have the largest public debt ratios (Figure A.II.7).
- Public debt and risk rating relationship:
  - Countries with low risk ratings had, on average, lower debt ratios than moderate-rated countries by 18 percentage points.
  - Countries with low risk ratings had, on average, lower debt ratios than high and in debt distress countries by 67 percentage points.

*Source: _022509a - 61.      The averages mask, however, wide (IMF PDF).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2009/_022509a.pdf_