How various forms of debt relief affect measures of the debt burden
Over the past three years, external creditors have strengthened the debt strategy by expanding the number of channels of support for countries with debt-servicing difficulties. These channels now encompass the provision of new financing, various forms of debt restructuring, including debt and debt-service reduction, and in the case of low-income economies, aid on highly concessional terms. Because some of these measures are very complicated, and are at times applied only conditionally, their effect on debt indicators, such as ratios of debt to GDP and to exports, and the ratios of debt service and interest payments to exports of goods and services, may differ depending upon the type of debt relief applied. (These indicators are regularly published in the IMF’s World Economic Outlook and in the World Bank’s World Debt Tables.)
Further, these debt indicators are likely to give an incomplete picture of progress in returning to external viability and can even be misleading when used in cross-country comparisons, because an increase or decline in the indicators of debt burden need not necessarily represent an actual change in the burden of debt. For instance, the action taken by the Paris Club creditors to reduce the present value of Egypt’s and Poland’s official bilateral debt by 50 percent would not be fully captured by such conventional debt indicators.
The group of 15 heavily indebted countries comprises: Argentina, Bolivia, Brazil, Chile, Colombia, Cote d’lvoire, Ecuador, Mexico, Morocco, Nigeria, Peru, the Philippines, Uruguay, Venezuela, and Yugoslavia.
Countries with recent debt-servicing difficulties (75 countries) are defined as those countries that incurred external payments arrears or entered official or commercial bank debt rescheduling agreements during 1986-90. Information on these developments is taken from relevant issues of the IMF’s Annual Report on Exchange Arrangements and Exchange Restrictions.
In order, therefore, to properly assess changes in the debt burden of a country and to facilitate cross-country comparisons of the debt burden, it is important to understand the content and purpose of specific debt relief measures. It is also important to take into account the fact that many low-income countries have obtained financial assistance on highly concessional terms and that a number of developing countries have concluded comprehensive debt-restructuring agreements that provide debt relief under a menu of concessional options.
Impact on debt indicators
In general, measures that lead to new lending increase the debt indicators, while debt and debt-service reduction operations contribute to their decline. A considerable decline in various debt burden indicators has been the most visible result of the current debt strategy (see charts). For example, for the group of net debtor developing countries, the debt-GDP ratio fell by nearly 2 percentage points from its peak in 1986 to 28 percent in 1990. Debt-GDP ratios in the group of countries with recent debt-servicing difficulties and the group of 15 heavily indebted middle-income countries declined by 4-6 percentage points. Over the same period, the 15 heavily indebted countries also experienced a large decline in the ratio of interest to exports of goods and services. The improvement in the aggregate indicators reflects largely the progress made in the highly indebted middle-in-come countries with large commercial bank debts. In contrast, the small low-income economies—including those in Sub-Saharan Africa—experienced a considerable increase in their debt-GDP ratios over the past five years, while their interest-service ratios have remained broadly unchanged.
Differences in the growth rate of the debt stock are key in explaining the difference in the evolution of debt burden indicators for the small low-income countries and the middle-income highly indebted countries. Although both groups of countries have experienced comparable rates of economic growth and similar increases in the volume and value of exports, the debt-export and debt-GDP ratios of the low-income countries have continued to rise while those of middle-income countries have declined. In contrast to the small low-income economies, the highly indebted middle-income countries have experienced relatively little increase in their debt, especially over the past two years, largely because of debt and debt-service reduction and market-based debt conversions. In fact, for the 15 heavily indebted countries, the impact of debt-reduction operations has offset roughly one half the increase in debt attributable to net borrowing.
Developing countries: interest service and debt-GDP ratios1
Citation: 29, 1; 10.5089/9781451953060.022.A014
Source: imf,World Economic Outlook, October 1991.
1 Shaded areas indicate imf staff projections.
2 Interest due, in percent of exports of goods and services.
In some cases, however, the provision of additional financing or the implementation of various debt reduction schemes resulted in a temporary deterioration in the debt burden indicators. This occurred, for example, when amortization payments associated with debt-equity swaps or debt buybacks added to the amount of originally scheduled debt-service payments, hence increasing the debt-service ratio. Similarly, the repayment of arrears (e.g., through refinancing) can boost the debt service ratio in a given year. In both cases, these transactions are financed by additional resources that would not have been otherwise available to the country.
Measures of debt burden
There are three main forms of concessional debt relief: (1) debt-stock reduction or forgiveness, (2) debt-service reduction, and (3) a lengthening of the repayment period on debt with concessional interest rates. Only the first two options affect conventional measures of the debt burden. Debt-stock reduction results directly in a lower debt-GDP ratio, while both debt and interest-service reduction lower the debt-service ratio. By contrast, a lengthening of the repayment period on concessional debt has no effect on either the debt-service ratio or the debt-GDP ratio.
However, all three forms of debt relief have an impact on the net present value of debt, which provides a more accurate measure of the effective debt burden (see box). The advantage of the present value measure is that it summarizes complex loan terms in a single number that allows comparison across debts with different term structures. One disadvantage is that present value calculations require more detailed and less readily available data than conventional measures. They also require judgments regarding the appropriate discount rate; for example, it could be argued that the relevant rate for a developing country borrower would be the interest rate on its commercial debt rather than the interest rate prevailing in the lending countries, which would probably be lower.
Of course, no single measure can capture all aspects of the debt burden. For example, two debts can have the same present value, even though one has a short maturity and the other a long maturity. If it is costly to amortize or roll over loans, then the short-term debt may be more burdensome. There may also be cases in which the entire time profile of debt-service payments is relevant, for example, when the aim is to match the debt-service profile to the projected cost and revenue stream of investment projects.
Debt relief, concessionality, and the present value of debt
The chart illustrates three different ways of achieving a reduction in the present value of the debt, assuming that the relevant market interest rate is 9 percent and that the debt is payable upon maturity. The two downward sloping lines show the impact on the present value of the debt of reducing the interest rate below the market rate for two different maturities; for example, a 2 percent rate of interest on 10-year debt reduces the present value of the debt to 55 percent of face value. If the debt is contracted at the market interest rate and is repayable in 10 years, debt relief equal to 50 percent of the present value can be achieved by cutting the stock of debt in half (point A in the chart), or by reducing the interest rate to just over 1 percent (point B). In the case of debt with a concessional interest rate of 2 percent, a 50 percent reduction in the present value of debt can be achieved by extending the term from 10 years (point C) to 30 years (point C’). As the interest rate is concessional, the effective debt burden is reduced even though the stock of debt and the amount of annual interest payments remain unchanged. This is because the implicit subsidy (that is, the gap between market and concessional interest rates) accumulates over a longer repayment period. (Of course, a lengthening of the repayment period of debt contracted at the market rate of interest would not reduce its present value.)
Present value of debt1
Source: IMF, World Economic Outlook, October 1991.
1 These present value calculations use a discount rate of 9 percent and assume that principal is repaid in full at the end of the term. If repayments are made earlier, the degree of concessionality involved in lower interest rates would be less and therefore the siope of the lines in the diagram would be less steep.
An implication of the analysis presented in the box is that the higher the degree of concessionality of debt, the lower the effective debt relief provided by a given amount of debt or debt-service reduction. This reflects the fact that the present value of concessional debt is always less than the face value. Therefore, in the case of concessional debt, a reduction in the face value will not result in a one-to-one reduction in the present value—that is, in the effective debt burden—but rather the decrease will be less.
The concessionality of debt also affects the comparability of debt-GDP ratios across countries, even where the debt has never been restructured. Debt-GDP ratios generally have been higher for low-income countries than for other developing countries. For example, in Sub-Saharan Africa the average debt-GDP ratio in 1990 was 84 percent, approximately double the ratio of the 15 heavily indebted middle-income countries. The debt-GDP ratio, however, overstates the debt burden of Sub-Saharan Africa because nearly 40 percent of the region’s debt is at highly concessional interest rates (approximately 2 percent). After adjusting for the degree of concessionality—that is, expressing the debt in present value terms—the debt-GDP ratio in Sub-Saharan Africa would decline to 68 percent, while it would remain broadly unchanged for middle-income countries, where debt is mainly on commercial terms.
Similarly, the evolution of debt-export and debt-service ratios over time for an individual country (or a group of countries) would accurately indicate the change in the country’s effective debt burden only if there are no major changes in the degree of concessionality over time. For example, if a country refinanced its existing nonconcessional debt with loans on concessional terms, the observed debt-export ratio would not reveal the reduction in the effective debt burden. Alternatively, if a country rescheduled its existing concessional debt with a longer grace or repayment period, the reduction in the present value of debt-service payments would not be reflected in a lower debt-service ratio. Thus, the observed change in conventional debt indicators may not fully reflect the benefits of debt restructuring.