Appendix V. Heavily Indebted Poor Countries (HIPC) Initiative and Debt Sustainability Analysis
- International Monetary Fund
- Published Date:
- June 2003
1. The Heavily Indebted Poor Countries (HIPC) Initiative is a major initiative of consequence to the monitoring of external debt position. The objective of this Initiative is to reduce external debt positions of some low-income countries to sustainable levels—that is, to levels that enable them to meet their current and future external debt-service obligations in full, without recourse to debt rescheduling or accumulation of arrears, and without compromising growth. Among other things, this requires accurate measurement of the external debt position. In this appendix, the HIPC Initiative is described, along with Debt Sustainability Analysis (DSA), a building block of the HIPC Initiative.
Origin and Description of the HIPC Initiative
2. For a number of low-income countries, it was recognized in the second half of the 1990s, by official creditors in particular, that the external debt situation was becoming extremely difficult. For such countries, even full use of traditional mechanisms of rescheduling and debt reduction—together with continued provision of concessional financing and pursuit of sound economic policies—would not be sufficient to attain sustainable external debt levels within a reasonable period of time and without additional external support. The HIPC Initiative is a comprehensive, integrated, and coordinated framework developed jointly by the IMF and the World Bank to address these external debt problems of the HIPCs. The framework was adopted in September 1996, through its endorsement by the Interim and Development Committees of the IMF and World Bank. Following a comprehensive review launched in early 1999, the Initiative was enhanced in September 1999 to provide faster, deeper, and broader debt relief, and to strengthen the links between debt relief, poverty reduction, and social policies.
3. The Initiative is designed to enable HIPCs that have a strong track record of economic adjustment and reform to achieve a sustainable debt position over the medium term. Central to the Initiative are the country’s continued efforts toward macroeconomic and structural adjustment and social reforms, with an emphasis on poverty reduction. Thus, all countries requesting HIPC Initiative assistance must (1) have adopted a Poverty Reduction Strategy Paper (PRSP) through a broad-based participatory process, by the decision point (see below), and (2) have made progress in implementing this strategy for at least one year by the completion point (see below).1 These efforts are complemented by a commitment from the international financial community to tackle the country’s external debt problem in a comprehensive and coordinated fashion. Indeed, the Initiative requires the participation of all creditors—bilateral, multilateral, and commercial.
Eligibility Criteria and the Structure of the HIPC Initiative
4. To receive assistance under the HIPC Initiative, countries need to be both eligible and face unsustainable external debt positions. To be eligible, a country needs to have satisfied a set of criteria. Specifically, it must:
Be eligible for concessional assistance from the IMF and World Bank;
Face an unsustainable debt burden, beyond existing, traditional debt-relief mechanisms;2 and
Establish a track record of reform and sound policies through IMF- and World Bank-supported programs.
5. The sustainability of the external debt position is determined by comparing the outcome of a comprehensive loan-by-loan DSA, agreed both with the authorities and creditors, with the HIPC targets. At the time of writing, these targets are set at 150 percent for the present value of the ratio of debt to exports, and 15 percent for the ratio of debt service to exports. For very open economies (with an exports-to-GDP ratio of at least 30 percent) that have a heavy fiscal burden of debt despite strong efforts to generate revenue (indicated by a ratio of fiscal revenue to GDP of at least 15 percent), the present value of debt-to-exports target can be lower than 150 percent and is set so as to achieve a 250 percent ratio of the present value of debt to fiscal revenue at the decision point.3
6. The IMF and World Bank Executive Boards determine need, and commit assistance, at the decision point. Those institutions and some other creditors also start delivering part of their assistance between the decision and completion points (interim relief).4 Assistance is provided, irrevocably by all creditors, at (or before) the completion point—subject, as mentioned above, to the country implementing a set of key, predefined structural reforms.5 Thus, there is an incentive for countries to implement reforms quickly, and so develop ownership over the timetable. Figure A5.1 sets out the process in diagrammatical form.
Figure A5.1.Enhanced HIPC Initiative Flow Chart
1Recognizing the need for flexibility in exceptional cases.
Calculations of Overall Assistance
7. Assistance under the HIPC Initiative is defined as the present value reduction required to lower external debt at the decision point to the Initiative’s targets. Total assistance is defined as assistance at the completion point plus the action provided during the interim period. The external debt position calculation under the HIPC Initiative (or net present value, NPV, calculation of external debt as it is described in HIPC terminology)6 is the sum of all future debt-service obligations (interest and principal) on existing debt on a loan-by-loan basis, discounted at the market interest rate (the Commercial Interest Reference Rate, CIRR, from the OECD). So for concessional lending, the calculation results in a present value of debt less than its nominal value, because the interest rate on the loan is less than the market rate. The calculation of the external debt position at the decision point uses the latest actual end-of-period data available, measured after assuming a hypothetical Paris Club stock-of-debt operation on Naples terms (67 percent reduction on eligible debt) and comparable treatment on other official bilateral and commercial claims.
Burden-Sharing Among Creditors and Delivery of Assistance
8. One of the Initiative’s guiding principles is broad and equitable participation of all creditors (multilateral, official bilateral, and commercial) in providing assistance sufficient for the country to achieve debt sustainability. For the Paris Club, this generally involves a stock-of-debt operation with a reduction of up to 90 percent in the present value of eligible claims. The country is required to seek at least comparable treatment from its other official bilateral and commercial creditors.
9. Multilateral creditors take action proportional to bilateral creditors to reduce the present value of their claims on the country. Each multilateral institution chooses the vehicle to deliver its share of assistance (derived in proportion to its share in the present value of multilateral claims at the decision point). The IMF’s contribution is made in the form of grants financed from Poverty Reduction and Growth Facility (PRGF) resources7 and is used only to meet debt-service obligations to the IMF. The European Union provides grants.
10. The World Bank is committed to take action after the decision point—through the selective use of IDA grants and allocations—and at the completion point. The principal vehicle for the Bank’s participation, together with some other multilateral creditors, is the HIPC Trust Fund. This Trust Fund provides relief to eligible countries on debt owed to participating multilaterals and is administered by IDA, with contributions from participating multilateral creditors and bilateral donors. To provide relief on debt owed to IDA, the Bank made transfers from its IBRD net income and surplus to the HIPC Trust Fund.
11. The debt contracted with multilateral and bilateral creditors, covered by the HIPC Initiative, is limited to public and publicly guaranteed debt—that is, external obligations of a public debtor including national government and autonomous public bodies and external obligations of a private debtor that are guaranteed for repayment by a public entity. The debt comprises:
All medium- and long-term government and government-guaranteed external debt;
Short-term debt8 only if it has long been in arrears;
Debt of public enterprises defined as “at least 50 percent owned by the government”; and
Debt of public enterprises being privatized, if the debt remains with the government.
Treatment of Arrears
12. Countries seeking assistance under the HIPC Initiative need to work toward elimination or reduction of existing arrears and the nonaccumulation of new external payments arrears. All arrears to multilateral creditors are expected to be cleared, or included in an agreement on a schedule for their clearance before the decision point is reached. However, clearance of such arrears needs to be consistent with a country’s financing constraint. In addition, concessionality that is granted in arrears-clearance operations by multilateral banks can count toward assistance required under the Initiative, on a case-by-case basis.
Debt Sustainability Analysis (DSA)
13. DSAs are central to the work of the HIPC Initiative. DSAs are prepared, on a tripartite basis, jointly by the country authorities, the World Bank, and the IMF and, where appropriate, by the relevant regional development banks, such as the African Development Bank and the Inter-American Development Bank. Figure A5.2 sets out the DSA process in diagrammatical form.
Figure A5.2.Steps Toward a Debt Sustainability Analysis (DSA)
14. In preparation for the decision point discussion, a DSA is carried out to determine the current external debt situation of the country. This is essentially a medium-term balance of payments projection that assesses the debt burden of the country and its capacity to service those obligations. If external debt ratios for that country fall above applicable targets after application of traditional debt-relief mechanisms, HIPC Initiative assistance is considered.
15. The DSA is undertaken on the basis of debt stock and flow projections. All the information needs to be obtained on a loan-by-loan basis, disaggregated by creditor and currency. The stock of debt is the amount outstanding at the end of the latest available fiscal or calendar year, depending on whether the country operated on a fiscal or calendar year basis. Projections of financial flows consist of expected amortization payments, disbursements on existing debt, and new loans.
16. Countries seeking assistance under the HIPC Initiative are expected to fully reconcile all debt data on a loan-by-loan basis with the creditor billing records before the decision point.9 The reconciliation process refers to the position and flows. If a loan is amortized according to its original schedule (if there are no adjustments such as rescheduling, forgiveness, cancellations, supplemental commitments, arrears, or prepayments), the periodic flows depend mainly on the original terms of the loan. Any adjustments to the loan amount, such as write-offs or rescheduling, have to be taken into account, so that a reconciled debt service is agreed (and, by extension, the present value of the debt). The information needed by a HIPC country compiler is set out in Table A5.1.
|— Debtor type (central bank, public enterprises, etc.)|
|— Creditor type (official, bilateral, commercial banks)|
|— Debtor loan identification|
|— Creditor loan identification|
|— Project title|
|— Loan type (supplier’s credit, export credit, etc.)|
|— Date of signature|
|— Committed amount and currency of the loan|
|— Disbursed amount|
|— First and last date of amortization|
|— Grace period|
|— Interest rate and other charges (fixed or variable interest rate)|
|— Penalty on arrears|
|— Repayment schedule (equal installments, annuity, etc.)|
|— Cutoff date|
|— Grant element|
|— Identification of ODA loans|
|At the end of a period|
|— Stock of debt|
|— Arrears on principal (on a loan-by-loan basis)|
|— Arrears on interest|
|— Exchange rates at the end-of-period and average exchange rate of the year|
|— Average six-month CIRR rates|
|— On “pipeline” debt|
|— New debt|
|— Gross domestic product|
|— Balance of payments|
|— Government finance statistics|
17. The consistency of stock and flow data on existing debt needs to be assessed. Simple equations can help the data compiler to complete this task, such as:
The sum of future repayments of loan principal equals the outstanding debt (assuming no accrual of interest costs);
The sum of future disbursements of loan principal equals the undisbursed balance; and
For interest projections, egregious errors could be checked by calculating the implied interest rate (interest t/stock of debt t − 1) for a reference year and comparing it to the interest rate recorded in the original terms. For each loan there is a declining interest charge as the years progress and the debt stock is being reduced with each amortization.
18. Regarding new loans, given certain underlying assumptions, the expected financing gap on the balance of payments is projected. This is the baseline scenario. Assumptions have to be made about how the gap is to be filled—by grants, concessional loans, or commercial borrowing. The terms of any gap-filling loans can be assumed to be the same as the assumptions on new disbursement terms, or they can vary according to the assessment of willingness to fill the financing gap—if this is possible to assess. For instance, new borrowing to finance the gap can be introduced into the DSA framework as two separate loans for each year. The first might be assumed to be available on IDA terms, while the remainder is secured at less concessional terms, but still at a concessional rate.
19. Interest charges on new borrowing enter the debt-service stream six months to one year after they are assumed to be committed, and the repayments of the principal become due after the grace period ended. So, for each year, the balance of payments financing gap is established, with any resultant new borrowing being fed back into DSA as a new loan. Hence, the balance of payments and the DSA data are obtained interactively over the projection period, and the new debt-service flows taken into account in calculating the present value10 and debt-service indicators that are presented in the decision point document. This document is the basis for the Bank and IMF Boards’ decisions on the eligibility and amount of assistance for the country.
20. Furthermore, sensitivity analysis is undertaken—the decision point document includes the results of alternative macroeconomic scenarios, thus providing a quantitative assessment of the impact of downside risks of the baseline balance of payments scenario. Modified assumptions are applied to external sector variables, such as international prices and trade volumes, and availability and terms of the financing items in the balance of payments. A modification to an assumption may have numerous direct and secondary effects on the balance of payments projections and the whole macroframework. In principle there are two ways for reflecting the impact of the envisaged shock. The first would be to capture only the immediate direct effect of any adverse shock on the balance of payments, which is reflected in lower credit entries or higher debit entries along with a higher additional financing gap. The additional financing gap would then be covered by new borrowing, which in turn would raise the debt ratios. This is normally the preferred approach for HIPC alternative scenarios.
21. The alternative approach takes into account secondary effects, such as slower economic growth, which would typically dampen the initial increase in the financing gap. For example, a significant short-fall in coffee exports would, in the first instance, cause a higher balance of payments financing gap. In addition, however, it would also lead to slower GDP growth and lower import demand, which would partially compensate for the initial increase in the financing gap. However, this approach is applied only in cases where the first approach implies highly unrealistic outcomes.
Interest Rate and Currency Assumptions Under the DSA
22. The currency-specific CIRR discount rates used in DSAs to calculate the present value of external debt are averages over the six-month period up to the reference date. For those currencies for which no CIRR rates are available but that are pegged to another currency, such as the U.S. dollar, the CIRR for the latter is used. In the absence of an exchange rate arrangement, as well as for the units of account used by various multilateral institutions, the SDR rate should be applied.
23. The present value of external debt is converted from its currency components into U.S. dollars using the actual end-of-period exchange rates—the same date as the reference date for the gross external debt position. These rates are applied to base-year calculations, as well as to projections. The conversion of debt-service payments in the numerator of the debt-service ratio is performed on the basis of average exchange rates using actual rates for the past and projections for the future taken from the IMF’s World Economic Outlook.
24. For the purpose of determining a country’s eligibility for the fiscal/openness criteria, central government revenue and GDP used in the revenue-to-GDP ratio (the three-year average) at the decision point are converted into U.S. dollars on the basis of actual average exchange rates in each of the three years. Projected central government revenue used to determine the NPV of the debt-to-revenue ratio at the completion point are converted by applying the latest end-of-period exchange rate available at the decision point.
On a transitional basis, given the time country authorities need to prepare a participatory PRSP, countries can reach their decision points based on an interim PRSP (I-PRSP), which sets out the government’s commitment to and plans for developing a PRSP.
Such as a Paris Club stock-of-debt operation on a Naples terms 67 percent present value reduction with at least comparable action from bilateral creditors. Table 8.2 in Chapter 8 sets out the evolution of Paris Club rescheduling terms.
The export denominator is derived as the “backward-looking” three-year average of exports of goods and services (BPM5 definition) over the latest actual data that will be available at the decision point. The fiscal revenue denominator, if used, is the latest actual end-of-period figure, and is defined as central government revenue (excluding grants).
Bilateral and commercial creditors are generally expected to reschedule obligations coming due. There are limits to the maximum assistance that the IMF and World Bank can provide during the interim period.
A number of key elements or triggers are identified that would adequately represent overall progress in macroeconomic, structural, and social areas, and that would eventually translate into durable growth, debt sustainability, and poverty reduction.
While the term NPV is commonly used, frequently it would be more accurate to describe the calculation as present value—discounting future interest and principal payments by an interest rate—and this is the approach taken in the Guide.
The PRGF is available to those countries that are facing protracted balance of payments problems and are eligible to borrow on concessional terms under the International Development Association (IDA). Previous to November 1999, the PRGF was known as the Enhanced Structural Adjustment Facility (ESAF).
Debt that has an original maturity of one year or less.
The preliminary HIPC document data might be on the basis of partially reconciled data.
Debt service on new borrowing did not affect the external debt position in the reference year used for decision point calculation of assistance.