Debt Limits in IMF-Supported Programs Annual MDB Meeting on Debt Issues Dominique Desruelle Washington, DC July 8, 2009

Outline Objectives of the policy on debt limits in Fund-supported programs Why review the policy at this time? How to introduce greater flexibility? Maintaining donor incentives to provide concessional financing

5/24/2019 Policy Objectives Helping low-income countries meet their development objectives, while maintaining a sustainable debt position How has this been done so far? Promoting recourse to concessional external resources, with exceptions made on a case-by-case basis Fostering use of debt sustainability analyses (DSAs) to help guide borrowing and lending decisions 1. DSAs are conducted using the Low-Income Country Debt Sustainability Framework (LIC DSF)--which was jointly developed with the World Bank and introduced in 2005. 2. In Fund-supported programs with LICs, minimum grant element has been set at 35 percent. The application of the debt limit and concessionality policy was refined with the adoption of the LIC DSF. As such, a deterioration in the debt distress rating should be associated with an increased grant element.

5/24/2019 Why a Review Now? The world has changed; LICs are more diverse than before Is a single design for concessionality requirements still appropriate? A number of LICs view current policy as too rigid, preventing the financing of some critical projects Need to link better the design of debt limits with the results of DSAs 1/ The LIC universe comprises countries with very different characteristics with regard to external financing and debt, ranging from the very poor, heavily indebted, and highly aid-dependent countries to countries that have established a strong track record of macroeconomic performance and have had market access.

Main Tenets of the Review 5/24/2019 Main Tenets of the Review Continued preference for concessional financing Debt vulnerabilities remain high; the ongoing financial crisis will not help Room for more flexibility in limits on non-concessional borrowing 1/ DSAs show that, while the debt sustainability outlook has improved in past years, debt vulnerabilities remain pervasive in many LICs. As a result of generous debt relief under various initiatives and strengthened macroeconomic management, about 30 percent of LICs are currently considered at a low risk of debt distress. However, debt sustainability remains a major concern for 40 percent of LICs (those rated at high risk or in debt distress). 2/ Debt vulnerabilities are likely to increase with the ongoing financial crisis by reducing LICs’ export earnings and external financing (including grants). Both factors will also have an adverse impact on economic growth and fiscal revenues. The scope for countercyclical policies by LICs depends crucially on the availability of donor assistance on sufficiently concessional terms to avoid aggravating concerns of debt distress.

How to Apply Flexibility? 5/24/2019 How to Apply Flexibility? Taking account of two aspects of LIC diversity The extent of debt vulnerabilities, as assessed in debt sustainability analyses Macroeconomic and public financial management capacity 1. DSAs are conducted using the Low-Income Country Debt Sustainability Framework (LIC DSF)--which was jointly developed with the World Bank and introduced in 2005. 2. In Fund-supported programs with LICs, minimum grant element has been set at 35 percent. The application of the debt limit and concessionality policy was refined with the adoption of the LIC DSF. As such, a deterioration in the debt distress rating should be associated with an increased grant element.

5/24/2019 A Menu of Options For lower capacity countries, the current approach would continue to be applied, albeit with more flexibility and a more systematic link to DSAs. Countries with a low or moderate DSA risk rating would be in the lower vulnerability category, while those with a high risk rating (or in debt distress) would be in the higher vulnerability category: For countries with lower vulnerabilities, the concessionality level would be 35 percent and nonzero limits on nonconcessional borrowing could be considered more systematically—or set higher—than current practice and/or be more frequently untied. Higher limits would allow countries to undertake more infrastructure investment, while untied limits would give the authorities more freedom in choosing projects and financing. The size of these limits could be based on the results of DSA tests. • For countries with higher vulnerabilities, the concessionality requirement would generally be set at 50 percent or above. The presumption would be that there would be 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). For higher capacity countries, more flexible and sophisticated options, eschewing the debt-by-debt approach of the current policy, could be considered:

Benefits of the Proposed Reform 5/24/2019 Benefits of the Proposed Reform Three of these four options would provide more flexibility than current practice Exception: countries with high debt vulnerabilities and lower management capacity Over time, an increasing number of LICs would be expected to move to the more flexible approaches as capacity improves and debt vulnerabilities recede

5/24/2019 Measuring capacity Macroeconomic and public financial management capacity encompasses a range of dimensions from policy design to implementation To ensure a uniform treatment of countries, a two-step process is envisaged Pre-identify stronger-capacity countries based on quantitative indicators Use all relevant information for a final assessment

Measuring capacity (II) 5/24/2019 Measuring capacity (II) Two sets of indicators seem particularly relevant: Components of the CPIA: Fiscal policy, debt policy, quality of budgetary and financial management, quality of public administration, transparency and accountability in the public sector PEFA: The framework measures performance of a country’s public financial management Complementary sources of information include: Fiscal ROSCs, Debt Management Performance Assessment (DeMPA), Project Performance Assessments (PPA), and self-assessments under the HIPC Capacity Building Program (CBP) Views on relevant recent macroeconomic developments or ongoing capacity-building reforms (e.g., in the context of MTDS technical assistance)

Maintaining donor incentives 5/24/2019 Maintaining donor incentives Some donors may have concerns about greater flexibility Flexibility could be used unwisely Own efforts to provide highly concessional financing could ultimately benefit a less concessional donor/creditor rather than the recipient country These concerns should be mitigated by the following considerations Risk of excessive borrowing addressed through the tight link to DSAs Scope for nonconcessional borrowing limited by targets on the present value of new borrowing (or average grant element) “Cross subsidization” already arises under the current approach More flexible options would be available only to stronger-capacity countries Concessional resources remain the most appropriate mode of financing for most activities in LICs. More such resources are needed, including to address the implications of the ongoing financial crisis

To Wrap Up Objective: Helping LICs meet development needs while maintaining a sustainable debt position Continued preference for concessional financing for LICs. More concessional resources are needed. Possibility to introduce more flexibility on non-concessional financing in Fund-supported programs to take better account of the diversity of LICs Key dimensions for flexibility: Extent of debt vulnerabilities; macroeconomic and public financial management capacity Closer link to debt sustainability analyses in setting country-specific debt limits Timeline: Discussion by the IMF Executive Board in late summer

5/24/2019 Thank you