Concessionality and the Design of Debt Limits in IMF-Supported Programs in Low-Income Countries
Last Updated: April 2015
IMF-supported programs in low-income countries (LICs) typically include limits on nonconcessional external debt. These limits seek to prevent the build-up of unsustainable debt, while allowing for adequate external financing. The main component of these limits is concessionality requirements applying to debt contracted or guaranteed by the official sector.
This page explains the concessionality concept used by the Fund, provides a concessionality calculator, and presents the debt limits framework in place since December 1, 2009 (to be replaced by the new Debt Limits Policy starting on June 30, 2015). This framework allows for different designs of debt limits in IMF-supported programs in LICs depending on country circumstances.
Concessionality of a loan
The degree of concessionality of a loan is measured by its “grant element”. The grant element is defined as the difference between the loan’s nominal value (face value) and the sum of the discounted future debt-service payments to be made by the borrower (present value), expressed as a percentage of the loan’s face value. That is:
Whenever the interest rate charged for a loan is lower than the discount rate, the present value of the debt is smaller than its face value, with the difference reflecting the (positive) grant element of the loan.
The discount rate used to calculate the loan’s present value is a key assumption in the calculation of the grant element. On October 11, 2013, a new unified discount rate of 5 percent per annum was approved by the IMF Executive Board. The new discount rate replaces the previous discount rate system based on currency-specific “commercial interest reference rates” (CIRRs). The new unified discount rate does not automatically apply to concessionality assessments under conditionality that has been already established in existing IMF-supported programs until and unless such conditionality is modified to provide for the use of the new unified discount rate for concessionality assessments. The list of countries in which the new unified discount rate applies to concessionality assessments is available.
Typically, a loan is considered to be concessional if its grant element is at least equal to 35 percent. However, in particular circumstances, this threshold can be set at a higher level as explained below.
The concessionality calculator posted on this website facilitates the calculation of a grant element of a debt instrument. It takes into account commissions and fees as well as alternative standard repayment profiles. It can also calculate the grant element for packages that combine a grant with a nonconcessional loan.1
Current debt limits framework (concessionality requirements)
Over the past three decades, the design of concessionality requirements in IMF-supported programs in LICs had been fairly uniform. In general, contracting of nonconcessional debt, i.e., debt with a grant element of less than 35 percent, was prohibited; while contracting of concessional debt, i.e. debt with a grant element of at least 35 percent, was not subject to any limit. In countries with higher debt vulnerabilities, the concessionality threshold was sometimes raised above 35 percent (and as high as 100 percent). In countries with lower debt vulnerabilities, exceptions to the prohibition on nonconcessional borrowing were granted on a case-by-case basis, typically to finance large-scale infrastructure projects.
The current debt limits framework has been in place since December 1, 2009. This framework accounts for the diversity of situations faced by LICs with regard to their debt vulnerabilities and their macroeconomic and public financial management capacity (“capacity”), which are key determinants of countries’ ability to borrow safely, effectively, and productively.
A country where debt vulnerabilities are relatively high should indeed adopt tighter concessionality requirements. Conversely, if debt vulnerabilities are relatively low, looser requirements can be considered. Similarly, the higher a country’s management capacity, the better a country will be able to implement and benefit from more flexible but also more technically demanding approaches to concessionality requirements.
Under this framework, each of the two above-mentioned factors, namely debt vulnerabilities and capacity, can take two values, “lower” or “higher”. Thus, this framework results in four different types of concessionality requirements, which are described below. Unless debt sustainability is a serious concern (“higher” value) and capacity is limited (“lower” value), the applicable concessionality requirements normally allow for nonconcessional borrowing and, hence, provide generally more flexibility than the previous design of concessionality requirements.
For lower capacity countries, concessionality requirements are set as follows:
• In countries with higher debt vulnerabilities, the concessionality threshold (minimum grant element) should be at least 35 percent. This threshold is applied to each loan separately (loan-by-loan concessionality requirement). Nonconcessional borrowing should be truly exceptional. Under this approach, the Fund may assess on a case-specific basis whether an envisaged combination of financing instruments can be treated as a package for purposes of meeting concessionality requirements. A number of elements are taken into consideration for this determination including but not limited to: (i) identical intended use or purposes for the financing; (ii) inter-related schedules for disbursement; (iii) identical parties to the financing. None of these elements alone is determinative, but packages meeting a number of these elements would tend to show a greater degree of relatedness, supporting a determination of an integrated incurrence of debt.
• In countries with lower debt vulnerabilities, the concessionality threshold is set at 35 percent. Space for nonconcessional borrowing (“nonzero limits”) would normally be allowed. The size of these “nonzero” limits would be derived from debt sustainability analyses so as not to raise significantly debt vulnerabilities. The nonzero limits could be tied to individual projects or not, depending upon a finer assessment of capacity within the “lower” category.
For higher capacity countries, concessionality requirements are set as follows:
• In countries with higher debt vulnerabilities, annual limits would be set on debt accumulation measured in present value terms. For the most advanced LICs, these limits could also be set in nominal terms.
• In countries with lower debt vulnerabilities a minimum average concessionality requirement (grant element would be set for debts contracted or guaranteed over a certain period). For the most advanced LICs, concessionality requirements might be removed altogether.
• Both average concessionality requirements and annual limits on debt accumulation would be based on debt sustainability analyses and, more generally, the Debt Sustainability Framework. These options provide more flexibility to the authorities in the design of their borrowing strategies, as targets allow for averaging or aggregation over a period of time and across the whole range of external creditors/donors. These options allow for setting limits on total public debt, rather than just external public debt.
Country authorities can choose to opt for a less flexible debt limit design than the one they are eligible to if they believe that such an approach is compatible with their policy objectives and is also easier to implement.
Table 1. Concessionality Requirements: Eligibility of Program LICs for the Various Options
(as of October 31, 2014)1/
|Extent of debt vulnerabilities|
Minimum average concessionality requirement applied to external or total public borrowing; for most advanced LICs, no concessionality requirements and overall nominal debt limit if needed
Overall limit on the PV of external or total public debt; for most advanced LICs, ceilings on nominal external or total public debt
Minimum concessionality requirement applying debt by debt, with flexibility on nonconcessional external debt (e.g., untied nonzero limits, if consistent with maintenance of low debt vulnerabilities)
Minimum concessionality requirement applying debt by debt, likely higher than 35 percent, with limited or no room for nonconcessional borrowing
|* Indicates change in classification from last year.|
|1/ Includes LICs with Fund arrangements or Policy Support Instruments (excludes countries with RCF and RFI). While capacity is assessed once a year, the distribution of countries may change depending on the latest DSA results. The authorities could choose to opt for tighter debt limits than implied by the concessionality matrix.|
|2/ Downgraded to lower capacity due to deterioration in sub-CPIA scores.|