Although low-income countries are a diverse group, most rely mainly on official financing. Nevertheless, excessive debt in low-income countries poses serious problems. A debt overhang may undermine urgently needed progress on policy reforms and discourage private investment. And lenders may be forced to allocate scarce concessional resources to keep high debtor countries afloat, often at the expense of other deserving countries.
Donors and creditors can help low-income countries achieve debt sustainability, but the primary responsibility lies with the countries themselves. As they strive to reach the MDGs, low-income countries will need to preserve debt sustainability by keeping new borrowing in step with their ability to repay, adopting better policies and institutions that help accelerate growth, and gradually increasing resilience to exogenous shocks.
What the IMF-World Bank paper proposes is a framework that aims to guide the borrowing decisions of low-income countries in a way that matches their need for funds with their current and prospective ability to service debt. At the same time, the framework also provides guidance for the lending and grant-allocation decisions of official creditors and donors. It is designed to serve as a forward-looking analytical tool beyond the Heavily Indebted Poor Countries (HIPC) Initiative and will have no bearing on the implementation of the initiative itself.
Main elements of proposed framework
The proposed debt sustainability framework is based on two pillars: an analysis and careful interpretation of actual and projected debt-burden indicators in a baseline scenario and in the face of plausible shocks, and indicative country-specific external debt-burden thresholds related to the quality of the country’s policies and institutions. These two pillars, in combination with other relevant country-specific considerations, provide an informed basis for the design of an appropriate borrowing strategy.
The proposed framework also suggests important policy implications for donors and creditors. First, creditors and donors would need to review current financing policies to ensure that they appropriately reflect countries’ risk of debt distress. An increase in the overall concessionality of financing to low-income countries, including a larger volume of grants, is almost certainly required. Second, since an appropriate mix of concessional loans and grants may improve a country’s ability to absorb large, unforeseen exogenous shocks only to a limited extent, creditors and donors may also wish to consider new or modified instruments to deal with such eventualities.
Excerpts of Executive Board assessment
Executive Directors viewed the development of the proposed framework as an important step toward ensuring that borrowers and lenders share a common approach that maintains low-income country indebtedness on a sustainable track, while contributing to the achievement of sustainable growth and the MDGs.
Directors broadly endorsed the key elements of the debt sustainability framework. In view of the heterogeneity of low-income countries, they saw the ability of the framework to incorporate country-specific information and judgments in the assessments as one of its key merits. Overall, most believed that the proposed framework could strike an appropriate balance between rules and discretion, provided that care is taken to ensure that the indicative debt-burden thresholds are used as a guide and not as a rigid ceiling.
While supporting the general thrust of the framework, Directors noted a number of issues on which further consideration would be needed before the framework could become fully operational. These issues fall in three main categories: the modalities for implementing debt sustainability analyses, the specification of indicative thresholds, and the operational implications for the IMF and for other international financial institutions and donors. Directors stressed that, in applying the framework to lending decisions and program conditionality, it would be important for the IMF and the World Bank to reach consistent positions and, more generally, to coordinate their work closely and to involve other multilateral development banks in their work.
Directors had a wide-ranging discussion of the broader implications of the proposed framework. A key implication of the debt sustainability framework for donors is that they will be expected to tailor the terms of new external financing to countries’ risk of debt distress. Directors called on donors to make a stronger effort to provide good performers at high risk of debt distress with the necessary grant financing, in line with the Monterrey Consensus.
Directors noted that the treatment of shocks is an important issue requiring further consideration. They generally supported the ex ante approach discussed in the paper: prudent planning on the basis of stress tests, complemented by various other policies to increase economic resilience to shocks. At the same time, a number of Directors encouraged the staff to explore the feasibility of complementary ex post mechanisms, including innovative financial instruments, that would strengthen countries’ ability to deal with those shocks that occur.
Directors shared the view that low-income countries themselves bear the primary responsibility for achieving their development objectives without compromising debt sustainability. Besides a careful approach to new borrowing and improvements in debt management, they believed that countries could best boost their resilience to debt distress by strengthening policies and institutions. In this context, Directors highlighted the importance of providing the right incentives and resources, including technical assistance, for countries to become strong policy performers.
Directors also addressed the relationship between the proposed debt sustainability framework and the HIPC Initiative. They stressed that the HIPC Initiative, which establishes a uniform set of rules for coordinating action to deal with an existing debt overhang, should be implemented in full. In contrast, they noted, the proposed new framework serves as forward-looking country-specific guidance on new borrowing policies.
Finally, Directors asked staff to prepare papers for further discussions, including one giving further consideration to issues related to the sustainability framework itself, and one examining the operational implications for the IMF especially in setting debt limits in IMF-supported programs.