Public Information Notice: IMF Executive Board Concludes First Review of Low-Income Country Debt Sustainability Framework and Implications of the Multilateral Debt Relief Initiative

June 2, 2006

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

Public Information Notice (PIN) No. 06/61
June 2, 2006

On April 17, 2006 the Executive Board concluded its first review of the low-income country debt sustainability framework for low-income countries (DSF) and discussed the implications of the Multilateral Debt Relief Initiative (MDRI) for the DSF. The discussion was based on a report prepared jointly by the staffs of the World Bank and the IMF.


The DSF was endorsed by the Executive Boards of the IMF and the World Bank in April 2005. The framework seeks to ensure that external financing in support of low-income countries' development efforts and the achievement of the Millennium Development Goals (MDGs) does not lead to unsustainable debt burdens. The joint paper reviews the experience with the new DSF. Since the endorsement of the DSF, the staffs of the Bank and the Fund have produced 23 joint debt sustainability analyses (DSAs). The paper also studies the possibility of further improvements, including further analysis on the integration of domestic debt in the DSF, the refinement of DSA risk of debt distress ratings, and the expansion of the range of stress tests and alternative scenarios employed in the analysis.

The IMF implemented debt relief under the MDRI for 19 countries in January 2006. MDRI debt relief--from the Fund, the World Bank, and the African Development Bank--will provide recipient countries with additional resources to achieve the MDGs, and will create space for them to borrow in support of their development programs. The IMF and World Bank staff paper examines how MDRI impacts the DSF, and explores possible ways of assisting recipient countries to avoid unsustainable accumulation of debt, without preventing them from realizing their development potential. The options considered include lowering DSF thresholds, creating a rules-based approach to constraining new borrowing, and establishing a case-by-case approach to constructing a country's borrowing strategy based on its specific circumstances. The role of non-concessional debt and its treatment in the DSF are also considered.

Executive Board Assessment

Executive Directors welcomed the opportunity to review the DSF for low-income countries, and to discuss the implications of the MDRI for the application of the DSF. They noted that the first-year experience with the DSF has been encouraging. The framework has become an effective tool for assessing and monitoring countries' debt burdens and sustainability in the context of Fund surveillance, as well as for informing program design for low-income countries. Directors considered that the forward-looking DSF will become an even more important tool for helping countries avoid unsustainable debt re-accumulation post-MDRI while seeking additional financing to attain the MDGs. They emphasized that the primary responsibility to avoid new debt problems rests with the countries themselves, with technical assistance from the Fund and the World Bank. Directors acknowledged that a large number of low-income countries are increasingly aware of debt issues and have made significant progress toward strengthening their debt management capacity.

Review of the Low-Income Country Debt Sustainability Framework

Directors agreed that the DSF remains broadly appropriate and that no major changes are warranted at this stage. Nevertheless, they saw scope for improvement to enhance the usefulness of the framework both for country authorities and for donors and creditors.

Directors noted that the DSF's standardized tests and indicative thresholds that depend on the quality of a country's policies and institutions have enhanced debt sustainability assessments DSAs and made them more comparable across countries. At the same time, they recognized that, given country diversity, the customization of the DSAs on the basis of country-specific circumstances and risks is important. In this regard, Directors endorsed a balanced approach taken by staff teams, which takes account of quantitative debt-burden indicators and thresholds of debt distress risk, as well as informed judgment. They noted that disseminating best practices for DSA design and presentation provides useful guidance for country teams, and that such practice should be continued.

Directors expressed diverse views on the proposed introduction of a more calibrated risk assessment. Many saw merit in adding one or more categories within the moderate risk of debt distress to help the World Bank's International Development Association and other donors better tailor the mix of their financial assistance to countries. Other Directors felt that the current four categories--low, moderate, high, and in distress--are sufficient as indicative ratings, the determination of which involves appropriate staff judgments. Generally, Directors stressed that finer calibration should be considered carefully to avoid weakening the DSF and facilitating excessive optimism about the capacity for further debt accumulation. They noted that this issue requires further examination to determine if any refinement to the risk classification is indeed warranted.

Directors noted with some concern that baseline projections in DSAs had tended to be more optimistic than historical averages. They suggested that further refinements to the DSF should also aim to reduce the apparent upward bias in staff estimates. A more systematic use of alternative scenarios and stress tests could usefully help qualify the conclusions of the baseline projections.

Directors emphasized the importance of accounting for domestic debt and contingent liabilities in the DSA, especially in cases where they account for a significant portion of the country's debt. They concurred that DSAs should flag the cases where the debt distress classification would be different on the basis of external debt alone, and encouraged staff to pursue further work on integrating external and domestic debt into the DSF. Directors also saw the need for more analytical work on the relationship between public investment and growth.

Directors welcomed the wide use of the DSF by multilateral development banks in their lending decisions. They saw room for making DSAs more useful for bilateral creditors, with a view to facilitating donor coordination. Directors noted that one way to promote wider acceptance of the DSF is to allow easier access to stand-alone DSAs.

Directors welcomed the fact that Bank-Fund collaboration on DSAs has worked well. They noted the difficulties on the timing of the joint DSAs, given the different needs of the two institutions, and suggested that staffs improve the scheduling of each year's DSAs to address the problem.

The DSF in Light of the MDRI

Directors noted that the MDRI provides recipient countries with considerable space to strengthen their financial position and with additional resources for use toward the MDGs. They underscored the importance of using the new borrowing space prudently. Directors considered that, for these countries to achieve the MDGs, substantial grant resources will still be required to preserve debt sustainability. In this regard, they stressed that the DSF should be used as a tool to avoid an excessive build-up of debt while not unnecessarily constraining access to resources for development. The important role of the DSF in raising donors' awareness of the need to increase grant financing and to deliver on their commitment was also noted.

Directors discussed the advantages and disadvantages of lowering the indicative DSF debt thresholds in light of the MDRI. They considered that, while lowering the thresholds could help to avoid future debt distress, such an approach would limit countries' ability to mobilize resources for the MDGs, and could re-open questions related to HIPC eligibility. Furthermore, applying lower thresholds selectively to MDRI countries would run counter to the principle of uniformity of treatment. For these reasons, Directors agreed that the indicative debt thresholds should not be revised. In this connection, they stressed that a prudent debt strategy and improved debt management capacity will be important to avoid an excessive accumulation of debt. They looked forward to further work on the role the Fund could play in helping low-income member countries in these areas, as described in the Managing Director's Medium-Term Strategy.

Directors had mixed views on the appropriate approach to debt accumulation for countries with debt below the DSF thresholds. Most Directors supported a case-by-case approach, given the difficulties in determining an optimal path of debt accumulation across countries with different circumstances. They also pointed to the benefits of the case-by-case approach in guarding against over-optimism and over-pessimism, based on careful assessments of countries' absorptive capacity, productivity growth rates, spending, and revenue trajectories. Some Directors favored an alternative approach that would guard against the risk of a rapid return to debt distress, facilitate the development of a sustainable long-term credit culture, and allow more time to analyze the appropriateness of the current Bank/Fund debt distress thresholds.

On balance, Directors supported the development of specific recommendations and guidelines on the implementation of a case-by-case approach, within the broad common framework of the DSF. They urged staff to examine how to facilitate cross-country comparisons and to ensure evenhandedness in implementing the approach. In this connection, Directors supported the staff's proposal to include systematically in the DSAs comparisons of actual outcomes against past DSA projections, and an evaluation of deviations between them.

Directors emphasized that solutions to the "free rider" problem, and, more broadly, to the challenges posed by nonconcessional debt, hinge critically on countries' adoption of prudent borrowing policies and debt management strategies. To deal with the possible adverse consequences of nonconcessional borrowing, Directors considered that Fund-supported programs should continue to discourage nonconcessional borrowing--with several Directors recommending a zero ceiling on such borrowings--except when the projects to be financed by those resources are judged to be sound, and countries have strong public expenditure and debt management capabilities. For countries without a Fund arrangement or a Policy Support Instrument, Directors urged staff to raise concerns about nonconcessional borrowing in the context of Fund surveillance. It was suggested, in this context, that the Fund's policy with respect to limits on nonconcessional borrowing in Poverty reduction and Growth Facility-supported programs be clarified with the aim of ensuring consistency in its application.

Directors encouraged all creditors to keep the terms and volume of their lending congruent with debt sustainability. This could be facilitated by the adoption of a common approach toward concessionality by all creditors. Directors underlined the importance of tracking nonconcessional borrowing--both actual and planned--as well as of close cooperation and exchange of information among all creditors--both traditional Paris Club and OECD/DAC, and "emerging donors." They saw room for a more proactive role of the Fund and the World Bank in coordinating with other donors and creditors, including export credit agencies, and looked forward to the recommendations of the External Review Committee on Bank-Fund Cooperation. The Fund's outreach activities could help publicize the DSF and its role as a framework for ensuring debt sustainability in low-income member countries.

Next Steps

Directors asked staff to prepare a paper, before the end of the year, dealing with: (i) a case-by-case approach to debt accumulation below the debt thresholds; and (ii) better integration of domestic debt in the DSF. Further work should also be done on refinements to the DSF classifications.


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