## EXECUTIVE SUMMARY ## Source details **Canonical URL:** [EXECUTIVE SUMMARY](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2013/_100413.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2013/_100413.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2013/_100413.pdf.json) --- ### Background and problem statement - Discount rates are used by the Bank and the Fund to calculate the present value (PV) of the external debt of low-income countries (LICs) in debt sustainability analyses (DSAs) and to calculate the grant element of individual loans. - The current discount rate system is complex, producing anomalies and significant operational difficulties. The methodologies used to calculate and update different discount rates vary significantly. - Following an extended period of historically low interest rates in the advanced economies, the discount rate used in DSAs has become a poor measure for discounting cash flows over the longer term. Estimates of the burden of debt service have been inflated, leading to an unjustifiable narrowing of the assessed borrowing space available to countries under the Debt Sustainability Framework for LICs (LIC DSF). ### Key findings and empirical observations - The LIC DSF discount rate has dropped by 200 bps since 2009 to its current level of 3 percent, reflecting an extended period of exceptionally low interest rates in the advanced economies. - Differences as large as 250 bps existed between discount rates used in the LIC DSF and in concessionality assessments, resulting in inconsistent PV calculations for the same underlying loans across Fund and Bank policies. - The U.S. dollar discount rate used for assessing concessionality of loans with a maturity of less than 15 years is currently 3.11 percent, while that used for loans with longer maturities is at least 5.32 percent. - Example of discontinuity: the grant element would be 28.4 percent and 12.9 percent, respectively, for 15- and 14-year loans with a 1.5 percent interest rate and a 5-year grace period. - According to the World Bank’s Global Development Finance database, since 1999, the average loan extended by official creditors has had a maturity of 26 years, with a 7-year grace period and an interest rate of 1.4 percent, with little variation (standard deviations of 2.8, 0.8, and 0.1, respectively). ### Operational problems identified - Multiple discount rates, linked to market rates in different ways and updated with varying frequencies, have led to: - Unwarranted tightening of assessed borrowing space available to LICs. - Frequent, unpredictable fluctuations in assessed concessionality of loans due to semi-annual or annual updates of currency-specific CIRRs. - Sharp discontinuities in concessionality assessment across loan maturities (notably at the 15-year threshold). - Requests for modifications and waivers of non-observance of debt limit performance criteria in Fund-supported programs and exceptions to the Bank’s non-concessional borrowing policy. ### Proposed reforms (summary) - Adopt one unified discount rate to be employed both in the LIC DSF and in the grant element calculator. - Link this unified discount rate to a long-term moving average of the U.S. dollar Commercial Interest Reference Rate (CIRR) published by the OECD, specifically a 10-year average. - Change the unified discount rate only at the time of reviews of the LIC DSF by the Executive Boards of the Bank and the Fund, providing stability in PV and grant element calculations. - Cease using a regime of currency-specific discount rates for concessionality calculations due to convergence of long-term interest rates across major economies and rising share of official credits denominated in currencies without OECD CIRRs. ### Specific proposal details and numeric values - The unified discount rate would be set by reference to the 10-year average U.S. dollar CIRR plus the OECD margin of 1.15 percent used for long maturities. - Using 2013 data for the CIRR, this yields a calculated discount rate of 5.26 percent; for simplicity and consistency with past DSF practice, this would be rounded to 5 percent. - The new discount rate (5 percent) would apply across all Bank and Fund debt-related calculations for LICs—specifically, in the DSF, in the Fund’s debt limits policy, and in the Bank’s Non-Concessional Borrowing Policy (NCBP). - The 10-year averaging period is chosen because it: - ensures smoothing of the discount rate over the business cycle, eliminating fluctuations in PV calculations attributable to temporary factors; and - provides continuity with the averaging method currently applied in deriving discount rates for the bulk of external loans contracted by LICs (all loans with a maturity of 15 years or more). ### Operational and equity considerations - Currency-specific CIRRs were originally motivated by marked differences in donor country interest rates; recent convergence in interest rates has reduced these distortions. - The share of official credits to LICs denominated in currencies for which no OECD CIRR is available has risen; continuing a currency-specific approach would require expanding CIRRs to additional currencies to preserve equity of treatment. - A single CIRR (uniform discount rate) offers merits of simplicity, transparency, and ease of use compared to an expanded system of currency-specific discount rates. *Source: EXECUTIVE SUMMARY, _100413 - EXECUTIVE SUMMARY (October 4, 2013).* ### Proposal: fix discount rate until next LIC DSF review - The discount rate would remain unchanged until the next joint review of the LIC DSF, scheduled for 2015. - The next joint review would provide an opportunity to examine in greater depth the appropriate discount rate to use for debt sustainability analysis. - Rationale: changing the discount rate on an annual or semi-annual basis has created operational difficulties for both country authorities and Bank-Fund teams. ### Benefits of a uniform, fixed discount rate - A uniform discount rate based on a longer-term historical average allows for greater stability and predictability in concessionality calculations. - Protects assessments of concessionality and the PV of debt from cyclical fluctuations of interest rates, identified as a key weakness of the current framework. - Eliminates the sharp discontinuity in assessed concessionality between shorter and longer term loans. - Prevents shifts in the assessment of the concessionality of individual loans over the course of loan negotiations. - Ensures the unified discount rate retains its link to market interest rates while filtering out the impact of short-term changes. ### CIRRs — Six Month Average (2/15/2013 - 8/14/2013) and summary statistics - AUDAustralian Dollar 3.94 - CADCanadian Dollar 2.64 - DKKDanish Krone 1.91 - JPYJapanese Yen 1.43 - KRWKorean Won 3.80 - NZDNew Zealand Dollar 4.64 - NOKNorwegian Krone 2.67 - SEKSwedish Krona 2.58 - CHFSwiss Franc 1.48 - GBPUnited Kingdom Pound 2.51 - USDUnited States Dollar 2.36 - EUREuro 2.24 - SDRSDR 2.25 - Summary Statistics: - Weighted Average 1/ 2.33 - Maximum Spread 3.22 - Standard Deviation 0.98 - Data source: IMF WEO and OECD - 1/GDP weights; excludes SDR. ### Implementation timeline and expected impact - Implementation will be spread over several months as country teams update their regular assessments of debt sustainability under the LIC DSF and as concessionality assessments are made on new loans. - Initial impact on debt distress ratings is expected to be limited: - Based on a review of current debt sustainability analyses, 3 of the 45 countries currently rated as being at high or moderate risk of debt distress could potentially be upgraded from high risk to moderate risk in the next DSA. - 1 country could potentially be upgraded from moderate to low risk of debt distress. - Implications of revised DSAs for external borrowing limits under Bank-Fund supported programs would be assessed in the context of program reviews; the emphasis on containing the risk of debt distress, as evaluated using the DSF, would remain unchanged. - Transitional arrangements: - Pending Board consideration, ongoing DSAs will include an alternative scenario using the proposed new discount rate. - If approved, for DSAs already issued to the Board, staff would issue a short written statement confirming that the change does not affect the thrust of the staff’s assessment where applicable. - For countries where the change would affect staff’s assessment, a revised DSA based on the new discount rate would have to be issued prior to its consideration by the Board. - Upon IMF Executive Board approval, the new unified discount rate would not automatically apply to concessionality assessments under conditionality already established in existing IMF-supported programs unless such conditionality is modified to provide for the use of the new unified discount rate. ### Staff recommendations - A single uniform discount rate should be used in: - calculating the present value of external debt in the joint Bank-Fund Debt Sustainability Framework for Low Income Countries (LIC DSF), and - calculating the grant element of loans in the implementation of the Bank’s Non-Concessional Borrowing Policy and the Fund’s debt limits policy. - The discount rate should be set by reference to a 10-year average of the monthly U.S. dollar CIRR, while including a margin to reflect a term premium for long-term loans. - The discount rate should be re-set in the context of the periodic reviews of the LIC DSF conducted by the Executive Boards of the Bank and the Fund. - The discount rate to be used until the completion of the next review of the LIC DSF, expected in 2015, shall be 5 percent. ### Decision (proposed for adoption by the Executive Board) - The Executive Board endorses the use of the Unified Discount Rate for: - implementation of the Guidelines on Performance Criteria with Respect to External Debt in Fund Arrangements (Decision No. 6230-(79/140), as amended), and - calculation of the present value (PV) of debt in debt sustainability assessments under the Debt Sustainability Framework for Low-Income Countries. - Amendment to Paragraph 8(g)(i) of the Guidelines on Performance Criteria with Respect To External Debt in Fund Arrangements (attached to Decision No. 14416-(09/91)): - For members with lower capacity and higher debt vulnerabilities, the performance criterion would generally preclude any accumulation of non-concessional external debt. Concessional external debt would be excluded from coverage of the performance criterion. For these purposes, concessional debt is defined as debt with a grant element of at least 35 percent, although a higher grant element may be required on a case-specific basis for members in this category. Concessionality would generally be determined on a debt-by-debt basis, using the unified discount rate set out in “Decision No 15462 adopted October 11, 2013”. - Decision No. 11248-(96/38), adopted April 15, 1996, shall remain applicable to any conditionality on external debt that is in place as of the date of this decision unless and until such conditionality is amended to provide for the use of the Unified Discount Rate. *Source: Unification of Discount Rates paper (excerpt).* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### Background and problem statement - Discount rates are used by the Bank and the Fund to calculate the present value (PV) of the external debt of low-income countries (LICs) in debt sustainability analyses (DSAs) and to calculate the grant element of individual loans. - The current discount rate system is complex, producing anomalies and significant operational difficulties. The methodologies used to calculate and update different discount rates vary significantly. - Following an extended period of historically low interest rates in the advanced economies, the discount rate used in DSAs has become a poor measure for discounting cash flows over the longer term. Estimates of the burden of debt service have been inflated, leading to an unjustifiable narrowing of the assessed borrowing space available to countries under the Debt Sustainability Framework for LICs (LIC DSF). ### Key findings and empirical observations - The LIC DSF discount rate has dropped by 200 bps since 2009 to its current level of 3 percent, reflecting an extended period of exceptionally low interest rates in the advanced economies. - Differences as large as 250 bps existed between discount rates used in the LIC DSF and in concessionality assessments, resulting in inconsistent PV calculations for the same underlying loans across Fund and Bank policies. - The U.S. dollar discount rate used for assessing concessionality of loans with a maturity of less than 15 years is currently 3.11 percent, while that used for loans with longer maturities is at least 5.32 percent. - Example of discontinuity: the grant element would be 28.4 percent and 12.9 percent, respectively, for 15- and 14-year loans with a 1.5 percent interest rate and a 5-year grace period. - According to the World Bank’s Global Development Finance database, since 1999, the average loan extended by official creditors has had a maturity of 26 years, with a 7-year grace period and an interest rate of 1.4 percent, with little variation (standard deviations of 2.8, 0.8, and 0.1, respectively). ### Operational problems identified - Multiple discount rates, linked to market rates in different ways and updated with varying frequencies, have led to: - Unwarranted tightening of assessed borrowing space available to LICs. - Frequent, unpredictable fluctuations in assessed concessionality of loans due to semi-annual or annual updates of currency-specific CIRRs. - Sharp discontinuities in concessionality assessment across loan maturities (notably at the 15-year threshold). - Requests for modifications and waivers of non-observance of debt limit performance criteria in Fund-supported programs and exceptions to the Bank’s non-concessional borrowing policy. ### Proposed reforms (summary) - Adopt one unified discount rate to be employed both in the LIC DSF and in the grant element calculator. - Link this unified discount rate to a long-term moving average of the U.S. dollar Commercial Interest Reference Rate (CIRR) published by the OECD, specifically a 10-year average. - Change the unified discount rate only at the time of reviews of the LIC DSF by the Executive Boards of the Bank and the Fund, providing stability in PV and grant element calculations. - Cease using a regime of currency-specific discount rates for concessionality calculations due to convergence of long-term interest rates across major economies and rising share of official credits denominated in currencies without OECD CIRRs. ### Specific proposal details and numeric values - The unified discount rate would be set by reference to the 10-year average U.S. dollar CIRR plus the OECD margin of 1.15 percent used for long maturities. - Using 2013 data for the CIRR, this yields a calculated discount rate of 5.26 percent; for simplicity and consistency with past DSF practice, this would be rounded to 5 percent. - The new discount rate (5 percent) would apply across all Bank and Fund debt-related calculations for LICs—specifically, in the DSF, in the Fund’s debt limits policy, and in the Bank’s Non-Concessional Borrowing Policy (NCBP). - The 10-year averaging period is chosen because it: (a) ensures smoothing of the discount rate over the business cycle, eliminating fluctuations in PV calculations attributable to temporary factors; and (b) provides continuity with the averaging method currently applied in deriving discount rates for the bulk of external loans contracted by LICs (all loans with a maturity of 15 years or more). ### Operational and equity considerations - Currency-specific CIRRs were originally motivated by marked differences in donor country interest rates; recent convergence in interest rates has reduced these distortions. - The share of official credits to LICs denominated in currencies for which no OECD CIRR is available has risen; continuing a currency-specific approach would require expanding CIRRs to additional currencies to preserve equity of treatment. - A single CIRR (uniform discount rate) offers merits of simplicity, transparency, and ease of use compared to an expanded system of currency-specific discount rates. *Source: EXECUTIVE SUMMARY, _100413 - EXECUTIVE SUMMARY (October 4, 2013).* ### 11. Staffs propose that the value of the discount rate be fixed until the next LIC DSF review, ### 11. Staffs propose that the value of the discount rate be fixed until the next LIC DSF review, ### Proposal - The discount rate would remain unchanged until the next joint review of the LIC DSF, scheduled for 2015. - The next joint review would provide an opportunity to examine in greater depth the appropriate discount rate to use for debt sustainability analysis. - Rationale: changing the discount rate on an annual or semi-annual basis has created operational difficulties for both country authorities and Bank-Fund teams. ### Benefits of a uniform, fixed discount rate - A uniform discount rate based on a longer-term historical average allows for greater stability and predictability in concessionality calculations. - Protects assessments of concessionality and the PV of debt from cyclical fluctuations of interest rates, identified as a key weakness of the current framework. - Eliminates the sharp discontinuity in assessed concessionality between shorter and longer term loans. - Prevents shifts in the assessment of the concessionality of individual loans over the course of loan negotiations. - Ensures the unified discount rate retains its link to market interest rates while filtering out the impact of short-term changes. ### CIRRs — Six Month Average (2/15/2013 - 8/14/2013) and summary statistics - AUDAustralian Dollar 3.94 - CADCanadian Dollar 2.64 - DKKDanish Krone 1.91 - JPYJapanese Yen 1.43 - KRWKorean Won 3.80 - NZDNew Zealand Dollar 4.64 - NOKNorwegian Krone 2.67 - SEKSwedish Krona 2.58 - CHFSwiss Franc 1.48 - GBPUnited Kingdom Pound 2.51 - USDUnited States Dollar 2.36 - EUREuro 2.24 - SDRSDR 2.25 - Summary Statistics: - Weighted Average 1/ 2.33 - Maximum Spread 3.22 - Standard Deviation 0.98 - Data source: IMF WEO and OECD - 1/GDP weights; excludes SDR. ### Implementation timeline and expected impact - Implementation will be spread over several months as country teams update their regular assessments of debt sustainability under the LIC DSF and as concessionality assessments are made on new loans. - Initial impact on debt distress ratings is expected to be limited: - Based on a review of current debt sustainability analyses, 3 of the 45 countries currently rated as being at high or moderate risk of debt distress could potentially be upgraded from high risk to moderate risk in the next DSA. - 1 country could potentially be upgraded from moderate to low risk of debt distress. - Implications of revised DSAs for external borrowing limits under Bank-Fund supported programs would be assessed in the context of program reviews; the emphasis on containing the risk of debt distress, as evaluated using the DSF, would remain unchanged. - Transitional arrangements: - Pending Board consideration, ongoing DSAs will include an alternative scenario using the proposed new discount rate. - If approved, for DSAs already issued to the Board, staff would issue a short written statement confirming that the change does not affect the thrust of the staff’s assessment where applicable. - For countries where the change would affect staff’s assessment, a revised DSA based on the new discount rate would have to be issued prior to its consideration by the Board. - Upon IMF Executive Board approval, the new unified discount rate would not automatically apply to concessionality assessments under conditionality already established in existing IMF-supported programs unless such conditionality is modified to provide for the use of the new unified discount rate. ### Staff recommendations - A single uniform discount rate should be used in: - calculating the present value of external debt in the joint Bank-Fund Debt Sustainability Framework for Low Income Countries (LIC DSF), and - calculating the grant element of loans in the implementation of the Bank’s Non-Concessional Borrowing Policy and the Fund’s debt limits policy. - The discount rate should be set by reference to a 10-year average of the monthly U.S. dollar CIRR, while including a margin to reflect a term premium for long-term loans. - The discount rate should be re-set in the context of the periodic reviews of the LIC DSF conducted by the Executive Boards of the Bank and the Fund. - The discount rate to be used until the completion of the next review of the LIC DSF, expected in 2015, shall be 5 percent. ### Decision (proposed for adoption by the Executive Board) - The Executive Board endorses the use of the Unified Discount Rate for: - implementation of the Guidelines on Performance Criteria with Respect to External Debt in Fund Arrangements (Decision No. 6230-(79/140), as amended), and - calculation of the present value (PV) of debt in debt sustainability assessments under the Debt Sustainability Framework for Low-Income Countries. - Amendment to Paragraph 8(g)(i) of the Guidelines on Performance Criteria with Respect to External Debt in Fund Arrangements (attached to Decision No. 14416-(09/91)): - For members with lower capacity and higher debt vulnerabilities, the performance criterion would generally preclude any accumulation of non-concessional external debt. Concessional external debt would be excluded from coverage of the performance criterion. For these purposes, concessional debt is defined as debt with a grant element of at least 35 percent, although a higher grant element may be required on a case-specific basis for members in this category. Concessionality would generally be determined on a debt-by-debt basis, using the unified discount rate set out in “Decision No 15462 adopted October 11, 2013”. - Decision No. 11248-(96/38), adopted April 15, 1996, shall remain applicable to any conditionality on external debt that is in place as of the date of this decision unless and until such conditionality is amended to provide for the use of the Unified Discount Rate. *Source: Unification of Discount Rates paper (excerpt).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2013/_100413.pdf_