A. Strategy for Managing the Level of External Debt and its Composition

External borrowing is inherently a dynamic activity. While it increases resources available in the disbursement period, it has long-term repercussions associated with the call on future productive resources to service it. The growth of external debt should, therefore, be planned. The level of new external borrowing and the terms on which it may be contracted should be clearly established and made public. The primary rationale for establishing conditions or limits on the extent of new external borrowing, which are customary under IMF arrangements, are to ensure the overall consistency of economic management. They also serve to prevent an undue build-up of external debt leading to debt-servicing problems in the medium term.

The assessment of borrowing requirements is a basic macroeconomic policy issue involving projections of economic activities covered in the balance of payments and government fiscal operations. These projections have to reflect the most likely outcome of domestic conditions as well as assumptions concerning the external environment to ensure realistic projections of the appropriate financing requirements. Since by definition HIPCs already have a high external debt burden and are often particularly vulnerable to external macroeconomic shocks, they need to exercise particular caution in establishing borrowing levels. In the past, overly optimistic projections of economic activity and the external environment have been a factor in leading to excessive borrowing in many LICs.⁸ Assumptions should, therefore, be made cautiously and prudently. As new borrowing levels should be established within the framework of countries’ capacity to service debt in the future, forward-looking analysis of the country’s external debt-servicing capacity should be an integral component of the external debt management process.

This involves analysis of the existing stock of external debt and the streams of future debt service obligations in relation to the country’s economic performance, taking into account its GDP growth, export growth, import requirements and the level of reserves in the medium term. The objective of such analysis is to ensure that external borrowings are undertaken only within sustainable levels. Each country should establish its own guidelines on what it considers to be prudent borrowing levels, or excessive or unsustainable debt. In practice, the level of sustainable debt in each country will also depend on the expected level and form of future financing flows, including aid flows. The thresholds established by the international community in the context of the HIPC Initiative could serve as guideposts for acceptable levels of debt in LICs. Debt indicators should preferably be kept below these levels, and borrowing that would cause debt indicators to rise above these levels should be avoided.

The standard approach in undertaking this assessment is to have a simple model that helps in projecting balance of payments flows, debt-servicing requirements and generating the indicators that provide warning signals of impending debt-servicing problems. This should allow the calculation of the most common debt indicators: the debt-service ratio, the present value of debt outstanding to exports of goods and services, external debt to GDP ratio, the reserves to import ratio (reserve coverage), and reserves to short-term debt ratio. Having established the underlying macroeconomic assumptions and calculating the relevant medium-term balance of payments and budget projections which establish the projected financing requirements, the other key issue to be considered is how these requirements can be filled—by grants, concessional loans or commercial borrowing. Although some LICs have access to commercial borrowing such as export credits or loans from commercial banks, for most LICs, the goal is to reduce non-concessional loans⁹ to a minimum, obtain the most concessional terms possible, and maximize grant receipts from donors. In the context of borrowing limits under Fund arrangements, a minimum grant element of 35 percent is typically required for a loan to be considered concessional.¹⁰ For Least Developed Countries (LDCs), the OECD consensus on export credits requires a 50 percent concessionality level.

A loan portfolio review should be undertaken regularly, analyzing the existing debt stock with respect to the currency composition, the maturity profile and the interest rate structure in order to support the establishment of guidelines on the appropriate level and terms of new borrowing. The analysis of the interest rate structure should focus on the optimal balance between floating and fixed interest rates loans in the portfolio. It should also seek to identify the major base rates (e.g., U.S. prime rate, LIBOR) applicable to the loan portfolio and identify any form of over-exposure to any single base interest rate. The currency composition of the loan portfolio, as much as possible should avoid undue foreign currency risk taking into account the currency composition of foreign earnings and of reserves to identify any form of foreign exchange exposure. Financial derivatives could be considered as an efficient way of hedging risk e.g. if export earnings were in one type of currency but because of market conditions, the country borrows in another currency, derivative contracts could help match the foreign currency cashflows.

The remaining maturities of loans in the portfolio should be analyzed regularly to identify any bunching of payments due. A portfolio review could also include review of projects, assessing their performance over the years of implementation. Low performing and non-performing projects could be cancelled, stopping disbursements and thus saving on future debt servicing.

In many LICs, financing of inefficient public investments and lack of sustained implementation of sound macroeconomic and structural policies to support investment and export growth have in the past contributed to the build-up of unsustainable external debt. These failures provide important lessons and guidelines for planning the future use of borrowed funds. The choice of appropriate projects and programs to which borrowed resources are channeled is important in articulating borrowing decisions especially in HIPCs. A Public Investment Program (PIP) could be enunciated to support the choice of appropriate projects, which require external financing. This program should form the basis for appraising and prioritizing desired investment projects, which need to meet certain criteria. The PIP should be consistent with the Government’s stated policy of resource allocation and terms of borrowing and projections for debt burden indicators. Several factors should be taken into account when making borrowing decisions, among are:¹¹

1. Projects to be financed by the borrowed funds should be in line with the sectoral strategies and national priorities, which, ideally should be articulated in the Public Investment Plan (PIP).

2. The efficiency of resource use relating the benefit of inflows to the cost of borrowing, that is, whether the economic rate of returns on investment programs are expected to exceed the rate of interest payable;

3. The growth of output and exports as they relate to the cost of borrowing in real terms.

While an appropriate project choice is crucial in contracting new loans, the policy environment needed to support appropriate investment decisions should not be unduly distorted by inappropriate economic policies. A project that appears to have high returns in the planning stage when distortions exist may prove not to be so in the absence of distortions. Overvalued exchange rates, tariffs that protect inefficient industries and inappropriate administered prices are examples of such distortions. The elimination of such distortions is important for the successful utilization of borrowed funds.

Debt reorganization may take different forms. It may be debt rescheduling in which payments of principal and/or interest due during a specified period (known as the consolidation period) are restructured with a new repayment schedule and terms. It can also take the form of refinancing, which is new borrowing primarily aiming to meet specific payment obligations on existing debt. Refinancing options are not typical in LICs because of their limited market access. Eventually, however, LICs need to manage their external debt in a way that strengthens their relations with all creditors and enhances their use of other tools of external debt management. Within the framework of effective debt management, rescheduling of debt should be considered only as a temporary and exceptional measure occasioned by temporary constraints faced by countries in meeting debt-servicing obligations. Partly related to the fact that rescheduling of debt to bilateral creditors in the Paris Club has involved an increasing element of debt reduction, rescheduling has become a regular element of the debt management strategy in many LICs, and has been used as a regular means to assist in filling external financing requirement. Notwithstanding the immediate foreign exchange cash flow relief provided by rescheduling, an effective debt management strategy cannot be based on continuous rescheduling. The aim should be for a country to exit from the rescheduling process and restore regular relations with all creditors. This objective has been a key focus under the HIPC Initiative.

B. Monitoring and Maintaining Information on External Debt

The previous section covers the issues and activities involved in the formulation of strategies for contracting external debt. In addition, the loan agreements have to be implemented. Disbursements of funds and servicing of external debt obligations have to be monitored. This involves step-by-step follow-up of operations in the loan cycle, covering detailed transaction-by-transaction information on loan commitments, disbursements and debt-service obligations. From the debtor perspective, external debt can be broadly classified as public, publicly guaranteed, and private sector debt. The external debt may be long term, medium term, or short term. Also, public sector and publicly guaranteed external debt can be further disaggregated into the following categories:

1. Central government direct debt, that is, borrowing undertaken by the central government or a local government, which is serviced from the budget of the central government;

2. Central government-guaranteed debt, that is, borrowing undertaken by a private or public enterprises or local governments, that is guaranteed by the central government. The local governments and public enterprises service their debt obligations, but these obligations may be a contingent liability of the central government budget in the case of default;

3. Unguaranteed public enterprise direct debt, that is, borrowing undertaken directly by public enterprises, serviced by public enterprises and not guaranteed by the central government. It could also include direct borrowing by a local government and not guaranteed by the central government. However, in case the local government or public enterprise defaults, the contingent liability may fall on the central government, depending on the legal provision covering external borrowing of the country concerned.

Under the HIPC Initiative, external debt coverage is limited to public and publicly-guaranteed external debt, including all medium-and long-term borrowing of the central government, central bank and parastatals from multilateral institutions, bilateral governments and commercial creditors whether or not the government directly guaranteed them. Private sector borrowings not guaranteed by government are also important for debt management as they may make a country vulnerable to a financial crisis.

The central government has direct responsibility for managing two types of debt obligations: (1) direct debt for which the government is solely liable, and (2) guaranteed debt for which it has a contingent liability if the primary borrower defaults. The central government, therefore, has to have full knowledge of such guaranteed borrowings. A comprehensive inventory of all loan agreements with detailed information on each loan needs to be compiled and centrally maintained in the debt unit, specifically set up for monitoring and maintaining debt information. Basic loan details required are generally available from the original loan agreements. They should include:

• The type of instrument, the creditor institution, country (for bilateral creditors), e.g., loan (bilateral, multilateral, commercial bank); suppliers’ credit; and other loans.

• The debtor, that is, whether the funds are for the central or local government or state enterprise and whether it is guaranteed by the central government or not;

• The amount committed and currency of the loan, commitment fees, rate of interest, grace period, repayment period, number of installments per year and special features such as options;

• The agreement date, the date from which commitment fees accrue, date of effectiveness, events of default and the terminal date for disbursements;

• Also, the purpose for which funds have been borrowed and prior conditions for the loan to be effective or drawn down.

Agreements on all central government borrowing should be available in the ministry of finance or the agency designated for authorizing foreign borrowing as the case may be. In the case of central government guaranteed debt, the debt unit should get copies of loan agreements immediately after signature. In many LICs this has not been the case in the past. Recently, as the requirements of the HIPC Initiative have forced a more complete reconciliation of debtor and creditor data, many HIPCs have had to contact creditors to assist in building such a comprehensive debt inventory. To allow a continuous updating of the loan inventory, procedures should be in place for the debt unit to obtain all loan contracts from borrowing agencies, and maintain contact with loan negotiations to keep abreast of pending new borrowing.

After a loan agreement has been concluded, steps should be taken by all concerned agencies to fulfill the conditions necessary for effectiveness of the loan. After a loan becomes effective, contracts have to be concluded for the supply of machinery, equipment and services, etc., and for the cash transfers under the agreement. The next step is monitoring loan disbursements in a systematic and orderly manner, updating the loan status and information, and reviewing the progress of loan utilization at regular intervals.

The debt unit is unlikely to be directly involved in the process of loan utilization. This is usually handled by project executing agencies, the central bank or the commercial banks designated for operating project accounts, and the central government accounting or budget division. However, the debt unit should maintain information on disbursements (both forecast and actual) to able to advise on the management of the budget, the balance of payments and the public investment plan implementation.

It is often the case in LICs that funds allocated under loan agreements may not be used on the schedule specified in the loan agreement because of weaknesses in project administration and delays involved in fulfillment of the conditions of loan disbursements. Delays can result in a build-up of commitment charges, and have implications for both budgetary and balance of payments management. There should be a system of following up on loan disbursements. The pace of loan disbursements should be reviewed from time to time and compared with estimates in the budget and necessary actions taken to expedite loan utilization. The data required on disbursements (actual and forecast) should include:

• Amount and currency of disbursement, and undisbursed balance;

• The method of disbursement, that is, whether it is by direct payment to suppliers, on a reimbursement basis, or by other means such as advances;

• A disbursement schedule.

The procedures for disbursements vary, depending on whether it is a loan for balance of payments support, a project loan or export credits. Disbursement notices may be sent by creditors for each disbursement or at periodic intervals covering disbursements on a single loan or a group of loans. These statements are often a good source of information, though in some instances difficulties may arise when creditors do not identify disbursements on different loans separately. On the other hand, if disbursements are made on a reimbursement basis, the central bank or commercial banks maintaining project accounts could report disbursement information to the debt office each time remittances are received. In cases where disbursements do not lead to the inflow of foreign exchange but instead to physical imports following direct payments to suppliers by the creditor, disbursement notices from creditors would remain the main source of information for the debt unit of the debtor government. As these notices may not always be readily available, the debt unit may need to follow up with the implementing agencies and/or with the creditors. The cooperation of both creditors and implementing agencies is, therefore, essential to ensure efficient procedures for collecting disbursement information.

Noting that various methods of disbursements exist and therefore the varying sources of capturing disbursement information, the challenge for the borrowing government is to ensure that its figures on disbursements are consistent with those reflected in government expenditure records and in the balance of payments accounts. An important task of the debtor government is to ensure that debt-service payments are made on schedule, in the form required by individual creditors and that accurate records of such payments are maintained. This task has implications both for the fiscal budget and the management of foreign exchange reserves. Thus a forecast of the complete schedules of annual debt-service obligations to all external creditors should be prepared to facilitate budgetary and foreign reserve programming in the ministry of finance and the central bank.

For central government debt, servicing typically involves three main agencies—the debt unit, the central government accounting department (normally in the ministry of finance), and the central bank. Payment instructions for monthly debt service typically emanate from the debt unit, which at the beginning of any fiscal year should ensure that budgetary and foreign exchange provisions have been made for the obligations coming due. These instructions should be crosschecked against invoices or billing statements for debt service from creditors. Payment instructions have to spell out to the central government accounting department, the foreign currency and its local currency equivalent of payments due, the account particulars of the creditors, and the due date of payments. The accounting department typically transmits local currency payments to the central bank and requests for equivalent foreign currency remittances to be paid to the creditor’s account abroad. This process can be swift or protracted, depending on the level of collaboration between these agencies. In cases where this process results in significant delays, it may be useful for the central bank to have blanket authority within the budgetary limits for direct debt servicing, and a periodic reconciliation of accounts with the government’s accounting department would be undertaken. This could help minimize penalty charges, but should not compromise accounting and budgetary requirements, or passing the relevant information to the debt unit and/or to the ministry of finance.

In addition to procedures established for ensuring that creditors receive debt-service payments in time, proper records of all principal repayments, interest payments, commitment fees, services fees and other charges should be maintained. These help in minimizing the build-up of arrears or penalty charges in cases of delayed payments. Any changes resulting from modifications of loan agreements such as enhancements or cancellations of the original loan amount, refinancing, rescheduling, prepayment and write-offs should be recorded since these will affect debt-service profiles. The debt unit should pay particular attention to multi-currency and variable interest rate loans that are affected by both exchange rate and interest rate adjustments, since these changes may also affect projected debt service.

Information on actual cash debt-service payments for direct central government debt normally is obtained by the debt unit from the central government accounting department and the central bank. Sometimes, due to administrative bottlenecks, it may take time for payments authorized by the debt unit to be effected. In such cases the debt unit may need to follow up payment transactions and reconcile actual debt service with the central bank and the general accounting department on a regular basis.

It is sometimes difficult to obtain information on direct payments by public enterprises for debts guaranteed by the government, and more so, if such enterprises that initially took on the debt have been privatized. While the central government may not have the obligation to budget for these payments, as the guarantor it would have to assume the contingent liability if default occurs; thus the debt unit should monitor and, to the extent it can, ensure that debt-service payments are made on due dates by the primary borrowers. It may be helpful for the debt unit to maintain a calendar of returns to ensure the payments of guaranteed debts on scheduled dates and establish reporting requirements for state enterprise loan obligations, both guaranteed and unguaranteed.

Private non-guaranteed debt is typically not high in most LICs. Where possible it should be monitored because servicing of obligations on private non-guaranteed debt may also have significant macroeconomic implications. Ideally, the level of detail obtained on private non-guaranteed debt need not be the same as for public and publicly guaranteed debt. Data on private non-guaranteed debt is often difficult to obtain since the government is not normally involved in loan negotiations or implementation. The data collection process may be more readily facilitated when a country has an exchange control system in place.¹² In this case, the central bank may have data on private debt transactions through its exchange control authorities and this can serve the needs of the debt unit.

In the situation where there are no exchange controls, data may have to be obtained either through commercial bank records and/or by a survey of private companies. Surveying banks and private companies for information on external debt requires a range of skills that do not fit naturally with a debt office whose main function is to monitor and compile data on external debt of the public sector. These skills include survey design, and developing a register of enterprises to approach. Also, encouraging the cooperation of enterprises that maybe reluctant to report can be resource intensive. For these reasons, the debt office is encouraged to cooperate with other agencies that are more familiar with dealing with private enterprises.

Commercial banks are typically required to file periodic balance sheet reports with information on their foreign assets and liabilities. Such reports may be required to separate long-term from short-term assets and liabilities. This may be a major source of information for the debt unit in monitoring outstanding foreign debt of banks. The Central Bank may, therefore, need to include external debt reporting in its reporting requirements from commercial banks. In the case of a survey being undertaken, the private sector would need to be assured that information is used for statistical purposes only. Effective legislation to guarantee the confidentiality of information may help to overcome resistance by private enterprises in responding to questionnaires. Commercial banks and private enterprises would need to cooperate in providing information on transactions to the statistical agency, central bank and/or the debt unit.

The Bank for International Settlement (BIS) and the OECD publish data on external liabilities of private sector entities to international banks. Given the likely paucity of data domestically in LICs, some effort should be made to reconcile information gathered on private sector borrowing to improve the information on private sector exposure. Full reconciliation is rarely possible and in most cases requires very specialized technical assistance.

The above discussion on debt monitoring has concerned long-term debt. Short-term debt (loans with maturity of one year or less) can be volatile and can create major problems for a country’s debt management. A particular problem for many LICs is that the build up of short-term may go unobserved until it becomes a problem, at which point the options for dealing with this source of vulnerability may be limited. Instruments involved typically include inter-bank lines, direct suppliers credits, letters of credit, and non-resident deposits in domestic banks. Debt management in LICs should include putting regulations and procedures in place to monitor this category of debt. Central banks are best placed to organize information on short-term debt because—with the exception of suppliers’ credits—most of the transactions take place through the banking system.

A. Computerized Tools for Debt Recording and Analysis

Most HIPCs maintain computer-aided systems for debt management. The Commonwealth Secretariat-Debt Recording and Management System (CS-DRMS) and the UNCTAD Debt Management and Financial Analysis System (DMFAS) have been the two most commonly used software packages. Countries may reduce both costs and risks by adopting one of the two systems as their core system rather than trying to re-invent their own. A few countries use self-designed spreadsheet programs and a number of LICs have projects in the pipeline to establish a computer-based debt recording and management system (Table 1 below). ^{13 14}

Table 1.

Computerized Debt Management Systems in HIPCs

Sources: UNCTAD DMFAS; and World Bank Debtor Reporting System.Note: * DMFAS installation planned   **DMFAS projects being negotiated

Table 1.

Computerized Debt Management Systems in HIPCs

CS-DRMS	DMFAS	Other Systems
1 Benin	11 Bolivia	32 Angola
2 Cameroon	12 Burkina Faso*	33 Congo—Brazzaville
3 Gambia	13 Burundi	34 Guinea
4 Ghana	14 Central Africa Rep.	35 Lao People’s Dem. Rep.
5 Guyana	15 Chad**	36 Liberia
6 Kenya	16 Cote d’Ivoire	37 Myanmar
7 Mali	17 Ethiopia	38 Niger
8 Nigeria	18 Guinea-Bissau*	39 Somalia
9 Sierra Leone	19 Honduras	40 Congo—Kinshasa
10 Tanzania	20 Madagascar*	41 Gambia, The
	21 Mauritania
	22 Nicaragua
	23 Rwanda
	24 Sao Tome & Principe
	25 Senegal
	26 Sudan
	27 Togo
	28 Uganda
	29 Vietnam
	30 Yemen**
	31 Zambia

Sources: UNCTAD DMFAS; and World Bank Debtor Reporting System.Note: * DMFAS installation planned   **DMFAS projects being negotiated

View Table

Table 1.

Computerized Debt Management Systems in HIPCs

CS-DRMS	DMFAS	Other Systems
1 Benin	11 Bolivia	32 Angola
2 Cameroon	12 Burkina Faso*	33 Congo—Brazzaville
3 Gambia	13 Burundi	34 Guinea
4 Ghana	14 Central Africa Rep.	35 Lao People’s Dem. Rep.
5 Guyana	15 Chad**	36 Liberia
6 Kenya	16 Cote d’Ivoire	37 Myanmar
7 Mali	17 Ethiopia	38 Niger
8 Nigeria	18 Guinea-Bissau*	39 Somalia
9 Sierra Leone	19 Honduras	40 Congo—Kinshasa
10 Tanzania	20 Madagascar*	41 Gambia, The
	21 Mauritania
	22 Nicaragua
	23 Rwanda
	24 Sao Tome & Principe
	25 Senegal
	26 Sudan
	27 Togo
	28 Uganda
	29 Vietnam
	30 Yemen**
	31 Zambia

Sources: UNCTAD DMFAS; and World Bank Debtor Reporting System.Note: * DMFAS installation planned   **DMFAS projects being negotiated

B. Staff and Training Requirements

Countries face problems in recruiting and retaining trained personnel for handling external debt management issues. Experience suggests that there is usually a high rate of turnover of external debt management staff, and training would need to be an on-going task. Well-trained, highly motivated staff can go a long way to minimize borrowing costs and help manage loan proceeds in an optimal manner. The saving that a country can make from an effective debt management system operated by trained personnel can more than compensate for the cost of operating a debt unit. While technical assistance can be obtained to undertake debt strategy formulation and analysis, the expertise and capabilities required for good debt management should eventually be developed in-house. In the event that this cannot be done in-house, the Government should consider alternatives like itinerant contractual staff or even permanent external staff. A government should have a technically competent debt management team with a practical knowledge of loan instruments, which keeps abreast of developments taking place in creditor markets (bilateral, multilateral and commercial banks).

The most fundamental training requirements are in the areas of interpretation of loan agreements relevant to the country’s loan portfolio; extracting loan particulars from creditor statements of importance to the database; the use of debt software for data recording and producing reports and debt (re)negotiations, payments and disbursements. UNCTAD and the Commonwealth Secretariat provide training in some these areas. Debt Relief International¹⁶ (DRI) has provided many HIPCs with training on debt management issues and has contributed to the build-up of regional expertise and training facilities. These are very important due to staff turnover in HIPCs and regular training is likely to be required locally.

Training in the use of the computerized systems for debt policy analysis is particularly important for LICs. This should include the capacity to undertake debt data analysis of a country’s portfolio covering the key characteristics of its portfolio such as the currency composition, interest rate structure, maturity structure, purpose and key sectors that use borrowed funds. Another important area will be sensitivity analysis on individual loan of changes in interest rates and in exchange rates on debt service.

The HIPC Initiative requires that debt sustainability analysis is done on a regular basis for all HIPCs, in the first place, to determine countries’ eligibility for assistance and secondly, to help countries in their future debt management strategy. This requires use of a debt database to generate debt sustainability indicators, simulate Paris Club and other rescheduling options, and alternative ways of filling countries’ financing gaps. In this area, Debt Relief International (DRI) runs a capacity building training program supported by a number of bilateral donors.