Race to the Next Income Frontier
Chapter

Chapter 10. The Sustainability of Senegal’s Public Debt

Author(s):
Ali Mansoor, Salifou Issoufou, and Daouda Sembene
Published Date:
April 2018
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Author(s)
Birahim Bouna Niang

Taxes and debt are mechanisms for financing public expenditure when the state cannot resort to monetary creation. In the context of developing countries characterized by a narrow tax base and undeveloped domestic capital markets, budget deficits are essentially financed with external debt. More generally, there are several arguments that support the use of debt for a developing country (Gill and Pinto 2005). Debt facilitates production of public assets (infrastructure and public services), the establishment of tax systems, and the implementation of countercyclical policies that limit production volatility. The relationship between debt and growth is widely documented in the literature (Eberhardt and Presbitero 2015; Panizza and Presbitero 2013; Patillo, Poirson, and Ricci 2011, 2004).

However, when debt exceeds a critical level, it becomes a burden (debt overhang) and exerts negative pressure on investment and growth. Rather than becoming indebted in order to grow, overindebted countries must forgo growth in order to repay their debts (Ominami 1986). Furthermore, in the case of developing countries, a debt crisis can occur even without high levels of indebtedness, as a result of debt intolerance (Reinhart and Rogoff 2010). Accordingly, debt sustainability analysis is a crucial issue, as it provides information on the conditions under which a country can advantageously have recourse to debt and avoid falling into the trap of overindebtedness.

Like many developing countries, Senegal faced a severe external debt crisis, which led the authorities to sign 13 debt rescheduling arrangements with the Paris Club creditors between 1981 and 2000 (Niang 2003). In the aftermath of that crisis, initiatives taken by the international community during the 2000s, especially the Heavily Indebted Poor Countries (HIPC) Initiative and Multilateral Debt Relief Initiative (MDRI), enabled Senegal to benefit from more than CFAF 100 billion in debt forgiveness. While the country’s debt profile has improved as compared with the situation that prevailed until the mid-2000s, it is important to assess the current situation in regard to public debt in a context in which the authorities are implementing an ambitious economic and social development program known as the Plan Sénégal Émergent, much of which is being financed through external debt.

In this chapter, we present the changes in the structure of Senegalese public debt and indebtedness conditions, then analyze the country’s public debt sustain-ability, and finally discuss implications for debt, growth, and fiscal rules.

Senegal’s Debt: Some Stylized Facts

Senegal’s public debt has been increasing since 2006, after the HIPC and MDRI debt relief initiatives. As a share of GDP, its debt increased from 20.9 percent in 2006 to 45.3 percent in 2013 and then further increased to 59.3 percent in 2016, a level higher than in 2003, before the country reached the HIPC completion point (see Figure 10.1).1 Commercial debt, that is, bank loans and eurobonds, started to be acquired in 2009 and by 2015 had reached 7.3 percent of GDP.

Figure 10.1.Public Debt as a Share of GDP, Senegal

(Percent)

Sources: Senegalese authorities; and IMF staff estimates.

Changes in Senegal’s external debt structure are shown in Table 10.1. Senegal’s external debt is predominantly multilateral and bilateral. Public external debt represented 98 percent of total external debt in 1996, declining to 80 percent in 2014. By contrast, private external debt increased regularly to reach approximately one-fifth of total external debt in 2014. Senegal’s external debt strategy assigns an increasingly important role to the search for financing on the international capital markets.

Most of the recent increase in public debt has been driven by domestic borrowing. Domestic debt almost doubled between 2011 and 2016, while the share of concessional borrowing declined. This compositional shift implies an increase in the average cost of borrowing, since Treasury bills were issued at about 5 percent in 2015 and carried interest rates higher than 6 percent, which was higher than the average interest rate on foreign borrowing from 2010 to 2015. In addition, the government has been borrowing in domestic currencies from other lenders, such as the West African Development Bank, at rates as high as 8.5 percent. Domestic debt peaked at 29 percent of total debt, and during the 2010–14 period it averaged 25 percent of total debt.

TABLE 10.1Evolution of the External Debt Structure(Percent)
Multilateral

Debt
Bilateral

Debt
Total External

Public Debt
Trade

Debt
Nonconcessional

Debt
Total External

Debt
199661.436.998.31.70.0100
199761.237.598.71.30.0100
199862.437.6100.00.00.0100
199962.137.899.90.10.0100
200060.838.899.60.40.0100
200163.736.099.70.30.0100
200265.534.199.60.40.0100
200367.432.299.60.40.0100
200480.918.799.70.30.0100
200581.018.799.70.30.0100
200656.742.899.50.50.0100
200763.236.599.70.30.0100
200861.138.799.90.10.0100
200960.034.494.40.15.5100
201064.829.594.30.05.7100
201164.023.887.80.012.2100
201262.226.989.00.010.9100
201363.726.189.90.010.1100
201454.425.680.00.319.8100
Sources: Ministry of Economy, Finances, and Planning; and author’s estimates.
Sources: Ministry of Economy, Finances, and Planning; and author’s estimates.

Two trends emerge in terms of changes in Senegal’s total public debt: an increase in external trade debt and an increase in the share of domestic debt arranged under market conditions. The new public debt profile has implications for indebtedness conditions. These conditions can be assessed by examining the interest rate, the trends of which are shown in Table 10.2.2 With the dominant weight of concessional debt, the interest rate on external debt did not reach substantial levels and varied between 1.4 and 2.3 percent during the period 2002–14. Interest rates on domestic debt arranged under market conditions varied between 2.1 and 9.6 percent and averaged 5.6 percent.

Moreover, interest rate fluctuations on domestic debt were more pronounced than those for external debt, with standard deviations equal to 2.5 and 0.5, respectively. However, over the period 2010–14, the average interest rate on debt was higher, at 2.7 percent, 7.7 percent, and 4.0 percent for external debt, domestic debt, and total public debt, respectively.

TABLE 10.2Evolution of the Apparent Interest Rate on Public Debt(Percent)
Apparent Interest Rate

on External Debt
Apparent Interest Rate

on Domestic Debt
Apparent Interest Rate

on Total Debt
20021.42.11.5
20031.72.91.8
20042.03.62.1
20051.93.22.0
20061.84.22.2
20072.54.73.0
20082.44.92.9
20092.08.53.1
20102.36.33.1
20113.59.64.9
20122.58.64.1
20132.47.23.8
20142.67.03.8
Average2.35.63.0
Minimum1.42.11.5
Maximum3.59.64.9
Standard Deviation0.52.41.0
Sources: Ministry of Economy, Finances, and Planning; and author’s estimates.
Sources: Ministry of Economy, Finances, and Planning; and author’s estimates.

Public Debt Sustainability Analysis

Debt sustainability can be analyzed using different approaches (Cassimon, Moreno-Dodson, and Wodon 2008; Ley 2010; Presbitero and Arnone 2006). In this chapter we use the budget and solvency approaches.

Budget Sustainability Approach

In the budget sustainability approach, the state is an economic actor with the special feature of having an unlimited life expectancy. Accordingly, it cannot justify not repaying all of its debt. Public debt sustainability is assured if the economy grows sufficiently to avoid a debt explosion and if the debt-to-GDP ratio is stabilized (Ley 2010; Cassimon, Moreno-Dodson, and Wodon 2008).

The conditions for debt sustainability have been established in a number of empirical works based on a state’s budget constraints. If we consider the budget deficit to be financed exclusively with public debt, as is the case in countries belonging to the West African Economic and Monetary Union (WAEMU), we can use the following equation (Ley 2010):

in which d is the debt-to-GDP ratio, r is the real interest rate on the debt, g is the real GDP growth rate, and b is the primary budget balance (as a percentage of GDP).

However, if domestic debt accounts for a significant proportion of total debt and is arranged under different conditions than external debt, the condition of sustainability should be established by distinguishing the interest rate on external debt from the interest rate on domestic debt. In this case, equation (10.1) should be rewritten as follows (Presbitero and Arnone 2006):

in which dt is total debt as a percentage of GDP, dp is the primary budget balance as a percentage of GDP, α is the share of external debt in total debt, g is the real GDP growth rate, rI is the interest rate on domestic debt, rE is the interest rate on external debt, and z is the real exchange rate.

The interest rate on total debt is therefore a weighted average of the interest rate on external debt and the interest rate on domestic debt. The primary balance compatible with the stabilization of total debt corresponds to

Moreover, according to the World Bank (2004), equation (10.2) can be broken down as follows:

in which af represents other factors.

Equation (10.4) indicates that debt trends can be broken down into four factors: (1) primary budget balance, (2) GDP growth, (3) interest rate on domestic debt, and (4) interest rate on external debt and exchange rate. The other factors are calculated as residuals, that is, as the difference between the change in the overall indebtedness rate and the total contribution of the four components, and measure the effects of the debt restructuring and other liability items net of revenue from privatization, grants, and measurement errors.

There was a downward trend in total public and external debt between the mid-1990s and the mid-2000s (Figure 10.2) when Senegal benefited from debt relief programs. The total indebtedness rate reached its minimum level (approximately 21 percent) in 2006. Beginning in 2007, we observe a rapid change in external and domestic indebtedness. Accordingly, the domestic, external, and total indebtedness rates were multiplied by 4.26, 2.23, and 2.54, respectively, between 2006 and 2014. Accordingly, the overall indebtedness rate increased at an annual average rate of 12.4 percent during the period. In other words, between 2006 and 2014, indebtedness doubled every six years. If this trend continues, Senegal’s indebtedness rate will reach approximately 84 percent in 2018 and 107 percent in 2020.

Figure 10.2.Indebtedness Rates, Senegal, 1996–2014

(Percent)

Sources: Senegal, Ministry of Economy, Finance, and Planning; and author’s calculations.

Trends in the primary budget balance seem to play a decisive role in the dynamics of Senegal’s public debt. In fact, Figure 10.3 indicates clearly that the observed primary deficit was systematically higher than the deficit that would have allowed the indebtedness rate to stabilize. Moreover, trends in the debt components (Figure 10.4) reveal that growth helped reduce the indebtedness rate, while interest rates (on domestic and foreign debt) and the exchange rate contributed positively to the increase in indebtedness, even though the growth, interest rate, and exchange rate effects were relatively limited. By contrast, the primary budget deficit is the component that contributed most to the increase in debt.

Figure 10.3.Trends in the Observed Primary Balance and the Balance Compatible with a Stable Debt-to-GDP Ratio, Senegal, 2003–14

(Percent of GDP)

Sources: Senegal, Ministry of Economy, Finance, and Planning; and author’s calculations.

Figure 10.4.Public Debt Dynamics, Senegal, 2003–14

(Percent)

Sources: Senegal, Ministry of Economy, Finance, and Planning; and author’s calculations.

Note: Time is represented on the axis as 2003–14 and the value of the components of debt on the ordinates. Negative values in the components mean that they help reduce the indebtedness rate (such as in the case of growth), while positive values mean that the component contributes to an increase in indebtedness (primary deficit, increase in interest rates, or depreciation in the exchange rate, for example). CAF = contribution from other factors; CCPIB = contribution of GDP growth; CSP = contribution of the primary deficit; CTID = contribution of the interest rate on domestic debt; CTIE_TC = contribution of the interest rate on external debt and the exchange rate; VDT = change in the rate of indebtedness.

Approach of Sustainability through Solvency

The approach of sustainability through solvency consists of assessing the state’s future capacity to generate resources to cover debt service. Accordingly, the state is considered solvent when the present value of the resources it will mobilize in the future exceeds the present value of debt service flows payable to its creditors (Cassimon, Moreno-Dodson, and Wodon 2008). Under the operational framework for assessing debt sustainability proposed by the IMF and World Bank (2005), countries can be classified to reflect their institutional and economic policy performance in connection with the maximum indebtedness ratios.

The World Bank/IMF’s debt sustainability analysis (DSA) uses a baseline and alternative scenarios that reflect shocks in the international environment affecting the terms of trade, exports, and so on.3 Stress tests are used to classify countries into three risk categories (low, moderate, and high risk), depending on whether the indebtedness thresholds are exceeded in different scenarios or in the baseline scenario or whether they are systematically exceeded regardless of the scenario used. However, one limit of this approach is that it’s a forward one. Key exogenous variables such as GDP growth, interest rates, and exchange rates interact with the level of indebtedness, and simulations are based on what the future is supposed to be (Loser 2004; Rocher 2007). As the future is by definition unknown, one is confronted with the impossibility principle (Wyplosz 2005).

According to the most recent debt sustainability assessment for Senegal (IMF 2015; MEF 2015), the country’s risk of debt distress is low. It did not exceed the overindebtedness ceilings in any of the scenarios considered. However, this analysis is based on relatively optimistic assumptions about economic growth, reforms to be implemented, and external debt strategy. While debt levels are still below the relevant debt sustainability thresholds, adverse debt dynamics could signal future risks for debt sustainability in the absence of continued fiscal consolidation.

Senegal’s favorable debt sustainability analysis must be considered with caution. Plans to finance significant infrastructure projects relying on commercial external borrowing would put further pressure on debt sustainability, raising debt service in the medium term. Debt service on total public debt is expected to reach 25.4 percent of government revenues in 2016, and it is projected to be above 35 percent in 2017 and 2018, largely because of the additional relatively expensive domestic borrowing undertaken in 2016. To maintain its low risk of debt distress under the IMF/World Bank DSA, Senegal will need to ensure that projects provide a sufficient growth dividend and that concessional and semiconcessional financing is used whenever possible.

The rapid accumulation of debt observed in Senegal during the past 10 years, attributable primarily to the relatively high and persistent primary budget deficit, would suggest the adoption of new fiscal rules and the broadening of the fiscal space through improved fiscal performance. Accordingly, the fiscal potential of insufficiently taxed activities (the informal sector and revenue from property) must be exploited.

Beyond Sustainability: Debt, Growth, and Fiscal Rules

While debt sustainability should be a major concern of public decision makers, indebtedness is supposed to contribute to growth and to economic and social development through the financing of investment projects with the potential to have a positive impact on productivity and human capital and a stimulating effect on the private sector. Figures 10.5 and 10.6 illustrate trends in the indebtedness rate compared to, on the one hand, the public investment rate and, on the other hand, economic growth. They point to a rather loose relationship among debt, the state’s investment efforts, and performance in terms of economic growth. Indeed, Figure 10.5 shows a counterintuitive phenomenon, which is a negative correlation between the indebtedness rate and the public investment rate. This suggests that the quality of spending is more important than the amount. In this context, inefficiencies may arise from poor procurement practices that allow favors and payoffs rather than value for money as well as misclassification, with a significant share of recurring costs in public investment projects.

Figure 10.5.Trends in the Indebtedness Rate and Public Investment Rate, Senegal

(Percent of GDP)

Sources: Senegal, Ministry of Economy, Finance, and Planning; and author’s calculations.

Figure 10.6.Trends in the Indebtedness Rate and GDP Growth Rate, Senegal

Sources: Senegal, Ministry of Economy, Finance, and Planning; and author’s calculations.

Furthermore, Figure 10.6 shows no correlation—or only a slightly positive correlation—between the indebtedness rate and the economic growth rate. Given that investment is one of the principal channels through which debt acts on growth, this result reveals problems related to the quality of public investment or the choice of profitable investment projects and the inefficiency of public spending (World Bank 2012). The quality of public investment financed by debt is crucial for any country that raises funds in international markets, because in the event of deficiencies in the management of resources, the country will face sanctions by the markets, which will be reflected in a downgrading of its rating, an increase in its cost of access to financial resources, and a higher risk of default. The experience of Belize during the first decade of the 2000s is an illustration of this specific case (World Bank Development Committee 2006).

The sustainability of public debt can be reconciled with growth and economic and social development targets through the adoption of fiscal rules. These rules should be flexible in nature so as to allow for the implementation of a countercyclical fiscal policy that limits macroeconomic volatility (Ray, Velasquez, and Islam 2015).

Indebtedness policy is a component of fiscal policy, which for a developing country should have the ultimate objectives of promoting economic and social progress. This is why a rule that governs public debt and fiscal policy is not an end in itself and should not hinder the achievement of economic and social development goals, in particular through investment in physical and human capital. The fiscal rules adopted by the WAEMU countries since 1994 have the disadvantage of having heightened the procyclical nature of public investment. Thus, in this subregion, public investment spending plays more of a shock absorption or residual fiscal variable role than current spending, and this has an adverse effect on economic growth (Dessus and Varoudakis 2013).

The fiscal rules in force in the WAEMU countries would benefit from a revision in order to provide for greater reconciliation between the sustainability of public finances and the imperatives of high-quality growth. The new rules should allow for the implementation of a countercyclical fiscal policy, one that provides protection for vulnerable groups, maintains investment efforts, and smooths GDP.

The establishment of a solidarity fund among the WAEMU countries—or “fiscal federalism”—is one of the most appropriate responses (Dessus and Varoudakis 2013) to their procyclical fiscal policy. The challenge in terms of favoring transfers is therefore the moral hazard issue. To avoid any attempt at manipulation, the eligibility conditions (the occurrence of idiosyncratic shocks) should be defined unambiguously. This would also require the establishment of an institution, such as a subregional agency, that would be responsible for managing the mechanism that has been put into place.

To ensure the sustainability of public debt while allowing for a countercyclical fiscal policy, the current rule pertaining to the basic budget balance, which does not consider all the resources and public spending, should be replaced with a rule pertaining to the overall budget balance. The new rule, capping the overall budget as a percentage of GDP, should be flexible, however; that is, it should be adjusted depending on the state of the economy. During periods of slow growth, the authorized deficit could be set at a higher level in order to avoid a stronger downturn or a loss of growth, like that experienced by European Union countries (Ray, Velasquez, and Islam 2015).

The adoption of a British-type golden rule, which states that borrowing should be undertaken for investment purposes only, serves as a safeguard for the appropriate use of public debt.

To avoid a situation in which debt repayment charges crowd out investments in the future, including investments in infrastructure, education, and health, the share of debt service in budget resources could be capped. This is the case in Argentina, where the ceiling is set at 15 percent (Berganza 2012).

Fiscal space could also be provided by improving the technical efficiency of public spending, in particular on education and health (Diagne, Sy, and Thiam 2014).

Conclusion

Trends in Senegal’s public debt are characterized by a substantial decline in the rate of indebtedness around mid-2006 owing to debt relief initiatives by the international community. The resulting fiscal space was immediately exploited, leading to rapid reindebtedness. Accordingly, between 2006 and 2014, the indebtedness rate increased an average of more than 12 percent per year and doubled every six years. If that trend continues, the indebtedness rate will reach 107 percent by 2020.

Analysis of public debt dynamics implies that, among the components of debt, the primary deficit made the greatest contribution to increasing the rate of indebtedness. The public debt profile also changed, with greater shares of domestic debt and external trade debt constituting a heavier fiscal burden (with higher interest rates and shorter maturities) than concessional debt.

Although the analysis indicates that the risk of overindebtedness is substantially low, this result must be considered with caution owing to the imperfections of the financial markets, the uncertainty characterizing the future, and the problem of debt intolerance, which make forecasting the occurrence of sovereign debt a difficult matter.

New fiscal rules need to be adopted to reconcile debt sustainability with the imperatives of growth and human development. Some of these rules would fall under the authority of WAEMU and include, on the one hand, the institution of fiscal federalism and, on the other hand, the setting of an overall budget deficit ceiling instead of the current convergence criterion with regard to the basic balance. Furthermore, the deficit ceiling should be shifted in the event of a poor economic climate to allow fiscal policy to play a countercyclical role.

New fiscal space could also be created by improving the efficiency of public spending, in particular in the education and health care sectors, and by enhancing fiscal performance through better revenue collection from informal activities and real estate assets.

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The HIPC Initiative was launched in 1996 by the International Monetary Fund and the World Bank. Its aim was to reduce the debt of the beneficiary countries and simultaneously support programs to combat poverty.

The apparent interest rate (TIA) was calculated for external debt and domestic debt using the following formula: TIA = debt interest (t)/outstanding debt balance (t–1). The apparent interest rate for total public debt is a weighted average (using the weight in the total) of the interest rates on external and domestic debt.

The DSA does not take into account the growth multiplier from increased investment.

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