External Debt Sustainability in HIPC Completion Point Countries: An Update
Author: Jie Yang and Dan Nyberg

Contributor Notes

Author’s E-Mail Address: jyang2@imf.org; dnyberg@imf.org

Despite substantial debt relief to HIPC Initiative completion point countries, long-term debt sustainability remains a challenge. This paper examines a number of structural factors affecting external debt sustainability. It shows that in HIPC completion point countries (i) the export base broadly remains narrow; (ii) fiscal revenue mobilization lags behind in some countries; and (iii) policy and institutional frameworks are still relatively weak. Achieving and maintaining longterm debt sustainability in completion point countries will require continued structural reforms, timely donor support, and close monitoring of new non-concessional borrowing.

Abstract

Despite substantial debt relief to HIPC Initiative completion point countries, long-term debt sustainability remains a challenge. This paper examines a number of structural factors affecting external debt sustainability. It shows that in HIPC completion point countries (i) the export base broadly remains narrow; (ii) fiscal revenue mobilization lags behind in some countries; and (iii) policy and institutional frameworks are still relatively weak. Achieving and maintaining longterm debt sustainability in completion point countries will require continued structural reforms, timely donor support, and close monitoring of new non-concessional borrowing.

I. Introduction

The Heavily Indebted Poor Country (HIPC) Initiative was launched in 1996 and then “enhanced” in 1999 to provide broader, faster, and deeper debt relief to some of the poorest and most heavily indebted countries. Under the enhanced HIPC Initiative, 41 countries are currently eligible for debt relief.2

As of end-September 2008, 23 countries had reached the HIPC completion point, 10 countries had reached the HIPC decision point, and eight had not yet reached HIPC decision point. The total cost to creditors of providing HIPC Initiative debt relief is estimated at US$71 billion in end-2007 NPV terms. Nearly half of this cost represents irrevocable debt relief to the 23 countries that have reached completion point.

While the external debt stock of HIPC completion point countries has been reduced substantially, exiting from the HIPC Initiative does not guarantee long-term external debt sustainability. Notwithstanding the decline in debt burdens through HIPC debt relief, long-term debt sustainability remains a challenge for many HIPCs. Indeed, of the 23 HIPCs that have reached completion point, only nine are classified as having a low risk of debt distress, with the remainder being at either moderate or high risk.3 This suggests that underlying structural vulnerabilities—e.g., a narrow export base, weak institutions and governance, poor domestic resource mobilization, and inadequate debt management capacity—remain to be addressed. If structural weaknesses persist, completion point countries might slip back into the debt trap.

Building on Sun (2004), this paper uses cross-country comparisons to analyze structural factors and their role in achieving external debt sustainability in post-completion point HIPCs. We divide 77 PRGF-eligible (low-income)4 countries into three country groupings (Table 1): (i) HIPC completion point countries; (ii) other HIPC countries; and (iii) other non-HIPC PRGF countries. The paper is then organized as follows: Section II discusses cross-country comparisons of macroeconomic performance of all PRGF-eligible countries; Section III explores structural differences among the HIPC completion point countries; and Section IV provides some conclusions.

Table 1:

Country Groupings

(Status as of end-September 2008)

article image

II. Cross-Country Comparisons of Macroeconomic Performance

Macroeconomic stability proved elusive for many low-income countries during the 1970s through the mid-1980 (Figure 1). The setbacks in macroeconomic performance were especially pronounced for the group of HIPC completion point countries. As a group, HIPC countries had nearly no growth in real GDP per capita; inflation was persistantly high; fiscal and external deficits remained large; and gross international reserves barely covered 3 months of import bills. Until late 1980s, HIPC completion point countries consistently experienced the lowest real GDP growth, highest inflation, largest fiscal deficits, and biggest external current account deficits, lagging behind other HIPC countries and other non-HIPC low-income countries. During this period of low growth and macroeconomic imbalances, the external debt stock of HIPCs increased significantly.5

Figure 1:
Figure 1:

Macroeconomic Stability and Growth in PRGF Countries by Country Groupings

Citation: IMF Working Papers 2009, 128; 10.5089/9781451872750.001.A001

Data source: various IMF statistics.

In the late 1980s, however, HIPC completion point countries started to improve their macroeconomic performance. Real GDP continued to grow and the medium growth accelerated to above 5 percent per annum in early 2000s. Annual real GDP per capita growth turned from negative to 3 percent. Inflation decelerated from 15 percent in early 1990s to 7 percent by 2006. The fiscal deficit narrowed and gross international reserves rose to 5 months of imports on average.

The improvement in macroeconomic stability in HIPC completion point countries was particularly stark compared with other HIPC countries. Real GDP grew much faster in HIPC completion point countries than other HIPC countries. Inflation, though still slightly higher than other HIPC countries, fell to less than half of the historical levels. Fiscal deficits became much smaller despite a deterioration in the early 2000s. Gross international reserves exceeded other HIPCs and non-HIPC low-income countries. The external current account deficits in HIPC completion point countries, however, remain larger than the comparator groups, partly explained by greater aggregate net transfers to these HIPC completion point countries.

Figure 2a and 2b present aggregate net transfers during 1986-2006 to the three country groups in total amount and in percentage, respectively. Aggregate net transfers are defined as loan disbursements net of amortization and interest payments, FDI net of profit outflows, portfolio equity inflows, and official grants. It serves as an indicator of resource flows into low-income countries. Since mid-1980s, the HIPC completion point countries have seen increasing resource inflows (Figure 2b) relative to other low-income countries. This has led to a rising share in total resource inflows to HIPC completion point countries until 2002.6 Therefore, the widening current account deficits of HIPC completion point countries can be partly attributed to increased resource flows into these countries.

Figure 2a:
Figure 2a:

Aggregate Net Transfers by Country Groupings

Citation: IMF Working Papers 2009, 128; 10.5089/9781451872750.001.A001

Figure 2b:
Figure 2b:

Aggregate Net Transfers by Country Groupings (in percent)

Citation: IMF Working Papers 2009, 128; 10.5089/9781451872750.001.A001

Data source: World Bank Global Development Finance.

Figure 3 compares macroeconomic performance of HIPC completion point countries before and after the completion point. We define time=0 for the year of completion point and calculate the average of the six macroeconomic indicators for the three years before and after the completion point. The result is encouraging. The HIPC completion point countries have experienced improvement since their completion point in that they have achieved faster real GDP per capita growth, lower inflation and fiscal deficits, and more adaquete international reserves.7 Their external current account balances, consistent with previous findings, have deteriorated, reflecting increased resource inflows.

Figure 3:
Figure 3:

Macroeconomic Stability and Growth in HIPC Completion Point Countries

Citation: IMF Working Papers 2009, 128; 10.5089/9781451872750.001.A001

Data source: various IMF statistics.

III. Structural Differences Among HIPC Completion Point Countries

A. Export Diversification

Low-income countries are often dependent on exports of natural resources, such as cotton, petroleum, metal, cocoa, and coffee. Countries with a narrow export base are more vulnerable to terms of trade shocks and face higher risk to their external debt sustainability. This section examines HIPC completion point countries’ export diversification to evaluate their vulnerability to external shocks.

Several indicators are available to measure a country’s export diversification. Sun (2004) used the share of the top three commodity exports in total exports to measure export concentration. In this paper, we use the Herfindahl Index (HI), which is defined as the sum of squared share of each particular export:

HI=i=1NSi2

where Si represents the share of total exports attributed to industry i. By definition, HI ranges from zero to one. A low HI value represents a more diversified export base, and it could result from an increase in the number of products or a more even distribution of the share of the products. Therefore, it captures more information on export diversification than the indicator that uses the share of top three commodity exports in total exports, as the latter will not caputure effects of increased number of export goods. Thresholds to categorize a country’s degree of export diversification are presented in Table 2.8

Table 2:

HI Thresholds for a Country’s Degree of Export Diversification

article image

Based on the HI values, we observe some limited improvement in export diversification in HIPC completion point countries since 1990s (Table 3). The majority of HIPC completion point countries still fall in the category of “more specialized”, while there is no HIPC completion point country that could be classified as “highly diversified”. For other HIPC countries, a slightly smaller proportion in that group is labeled “highly specialized” or “more specialized”, whereas three of the other non-HIPC PRGF countries achieved a “highly diversified” export base.

Table 3:

Export Diversification by Country Groupings

article image
Data source: UN ComTrade staistics.

Since 1990s, there are only three HIPC completion point countries that could successfully move up in such a classification while the majority others remain in their classification. Two countries, Ethiopia and Malawi, have successfully moved from “highly specialized” to “more specialized” for different reasons. Ethiopia has expanded its export base by developing some new manufactured goods other than its traditional coffee export, while Malawi has benefited from a more even distribution of the share of export goods. More impressively, Uganda has jumped from “high specialized” to “less diversified”. Its exports used to be dominated by commodity exports, including coffee, corn, and fish. During the past decade, it has been shifting to other commodity or manufactured exports. By 2006, telecommunication apparatus had become the third largest export goods, counting for about seven percent in the total exports, while petroleum products had also become an important source of export income.

Table 4 confirms that low-income countries still have a relatively narrow export base. The majority of these countries have their top one commodity export account for more than half of the total exports. As a country group, HIPC completion point countries have a slightly higher average of the HI index—implying a less diversified export base—than the other two groups.

Table 4:

Share of Top One Commodity Export in Total Export by Country Groupings10,11

article image
Data Source: UN ComTrade statistics.

In conclusion, most HIPC completion point countries remain weak in their export diversification and vulnerable to terms of trade shocks. Their reliance on a few agriculture products or other commodities, such as gold and petroleum products, provides limited ability to cope with external shocks. Diversification of export remains a key challenge to HIPC completion point countries.

B. Fiscal Revenue Mobilization

A country’s ability to mobilize its fiscal resources to meet its expenditure needs provides a key buffer for coping with shocks. Countries with a low degree of fiscal mobilization may have to rely on external grants or external borrowing at high interest cost, which could challenge debt sustainability.

This paper uses the central government’s revenue-to-GDP ratio to measure a country’s ability to mobilize fiscal revenue. A higher revenue-to-GDP ratio signals the government’s improved ability to generate revenue, and therefore, less reliance on external financing. Figure 4 presents the average revenue-to-GDP ratio by the three country groupings. The HIPC completion point countries have seen a gradual but steady improvement in their fiscal revenue mobilization since early 1990s, from 15¾ percent of GDP in 1992 to 20 percent in 2006.9 However, their performance does not particularly stand out when compared with other low-income countries as both other HPIC and non-HIPC low-income countries. As a result, by 2006, the average revenue-to-GDP ratio of HIPC completion point countries was about 20 percent, only 2 percentage points higher than other HIPC countries, and far below the average of non-HIPC low-income countries. Therefore, in terms of fiscal revenue mobilization, the HIPC completion point countries do not appear to be in a more favorable position relative to other low-income countries.

Figure 4:
Figure 4:

Revenue-to-GDP Ratio by Country Groupings (in percent)

Citation: IMF Working Papers 2009, 128; 10.5089/9781451872750.001.A001

Data source: various IMF statistics.

Table 5 takes a closer look at the revenue mobilization performance by HIPC completion point countries. We observe varied performance among these countries, ranging from a minimum of 11 percent of GDP to a maximum of 38 percent of GDP in 2006. Among these countries, Bolivia stands out with a more-than-doubled ratio during the period. This strong performance is mainly due to a series of successful tax administration reforms and increased hydrocarbon-based revenue in the early 2000s. Besides Bolivia, a few other countries also achieved notably increases in the revenue-to-GDP ratio, including Ethiopia, Ghana, Mauritania, Sao Tomé and Príncipe, and Uganda. Other HIPC completion point countries, however, saw little progress in this respect. In particular, the Gambia, Mozambique, and Zambia experienced a decline in their revenue-to-GDP ratio.

Table 5:

Revenue-to-GDP Ratio in HIPC Completion Point Countries, 1992-2006 (in percent)

article image

C. Governance

Recent research has shown that countries with better institutions, but similar debt burdens, experience a lower probability of debt distress (Kraay and Nehru 2006). This finding points to the importance of improving institutional quality in achieving long-term debt sustainability.

To assess the evolution of institutional quality among PRGF-eligible countries since 1996, two measures of overall governance are used: the Country Policy and Institutional Assessment (CPIA) provided by the World Bank and the KKM composite governance measure constructed by Kaufmann, Kraay, and Mastruzzi (2008).

  • The World Bank’s CPIA index assesses the quality of a country’s present policy and institutional framework. It has 16 indicators in four categories: economic management, structural policies, policies for social inclusion and equity, and public sector management and institutions. Countries are rated on their status with scores from one (lowest) to six (highest). Average annual country ratings from 1996 to 2006 are included.

  • The KKM governance indicators cover 212 countries in six areas: voice and accountability, political stability, government effectiveness, regulatory quality, rule of law, and control of corruption. A country’s rating is presented as a point estimate with a margin of error. The point estimate normally falls between -2.5 (lowest) and 2.5 (highest), with the world average at zero.

Looking at the CPIA measure, completion point and non-HIPC PRGF countries are found to enjoy better policy and institutional frameworks than other HIPC countries for all years in the sample (Figure 5). There is no discernable trend in the ratings among the groups and the rankings have remained relatively stable since the inception of the HIPC Initiative in 1996, indicating the long-term nature of improving policy and institutional frameworks.

Figure 5:
Figure 5:

Average CPIA Index for PRGF Countries

Citation: IMF Working Papers 2009, 128; 10.5089/9781451872750.001.A001

Similar conclusions can be drawn using KKM governance indicators (Figure 6). Completion point and other non-HIPC PRGF countries again have had the highest median indicators, while other HIPCs have the lowest in all six categories from 1996 to 2006. As the average KKM governance indicators are always zero by construction, negative governance indicators of completion point countries in all six areas point to relatively poor institutional frameworks compared to many other countries in the world.

Figure 6:
Figure 6:

KKM Governance Indicators for PRGF Countries

Citation: IMF Working Papers 2009, 128; 10.5089/9781451872750.001.A001

Source: Kaufman, kraay and Mastruzzi (2008).

IV. Concluding Remarks

This paper examines a number of structural factors affecting the external debt sustainability. Looking at broad macroeconomic stability, many HIPC completion point countries have made progress since the 1970s and 1980s: inflation is lower, growth is higher, and the external position has improved significantly. Despite the improvement in macroeconomic stability and debt relief, HIPC completion point countries remain vulnerable to external shocks. In particular, this paper shows that (i) the export base remains narrow; (ii) fiscal revenue mobilization is uneven; and (iii) the policy and institutional frameworks are still below world average.

Completion point countries will continue to face large financing needs for development, which will need to be balanced against efforts to maintain long-term debt sustainability. The analysis in this paper highlights that achieving and maintaining long-term debt sustainability will require continued structural reforms, timely donor support, and close monitoring of the mix between debt and grant financing.

REFERENCES

  • Abrego, Lisandro, and Doris Ross, 2001, “Debt Relief Under the HIPC Initiative: Context and Outlook for Debt Sustainability and Resource Flow,” IMF Working Paper 01/144.

    • Search Google Scholar
    • Export Citation
  • Arslanalp, Serkan, and Peter Blair Henry, 2005, “Is Debt Relief Efficient?The Journal of Finance, Vol. LX, No. 2, pp. 101751.

  • Arslanalp, Serkan, and Peter Blair Henry, 2006, “Policy Watch, Debt Relief,” Journal of Economic Perspectives, Vol. 20, No. 1, pp. 20720.

    • Search Google Scholar
    • Export Citation
  • Beddies, Christian, Marie-Helene Le Manchec, Doerte Doemeland, and Henry Mooney, 2008, “Debt Sustainability in Low-Income Countries - Recent Experience and Challenges Ahead”, Background paper for “Debt Relief and Beyond: A World Bank Conference on Debt and Development,”.

    • Search Google Scholar
    • Export Citation
  • Brooks, Ray, Mariano Cortes, Francesca Fornasari, Benoit Ketchekmen, Ydahlia Metzgen, Robert Powell, Saqib Rizavi, Doris Ross, and Kevin Ross, 1998, “External Debt Histories of Ten Low-Income Countries: Lessons from Their Experience,” IMF Working Paper 98/72.

    • Search Google Scholar
    • Export Citation
  • Cashin, Paul, Luis Cespedes, and Ratna Sahay, 2002, “Keynes, Cocoa, and Copper: In Search of Commodity Currencies,” IMF Working Paper 02/223.

    • Search Google Scholar
    • Export Citation
  • International Monetary Fund, 1999, “Modifications to the Heavily Indebted Poor Country Initiative”.

  • International Monetary Fund 2002a, “External Debt Management in Heavily Indebted Poor Countries (HIPCs)”.

  • International Monetary Fund, 2002b, “The Enhanced HIPC Initiative and the Achievement of Long-Term External Debt Sustainability,” SM/02/95.

    • Search Google Scholar
    • Export Citation
  • International Monetary Fund, 2004a, “Debt-Sustainability in Low-Income Countries—Proposal for an Operational Framework and Policy Implications,” SM/04/27.

    • Search Google Scholar
    • Export Citation
  • International Monetary Fund, 2004b, “Initiative for Heavily Indebted Poor Countries—Statistical Update,” SM/04/109.

  • International Monetary Fund, 2006a, “Initiative for Heavily Indebted Poor Countries—Issues Related to the Sunset Clause,” SM/06/288.

    • Search Google Scholar
    • Export Citation
  • International Monetary Fund, 2006b, “HIPC Initiative List of Ring-Fenced Countries that Meet the Income and Indebtedness Criteria at end-2004.”

    • Search Google Scholar
    • Export Citation
  • International Monetary Fund, 2007, “Initiative for HIPC and Multilateral Debt Relief Initiative (MDRI) — Status of Implementation,” SM/07/310.

    • Search Google Scholar
    • Export Citation
  • Kaufmann, Daniel, Kraay, Aart, and Massimo Mastruzzi (2008), “Governance Matters VII: Aggregate and Individual Governance Indicators, 1996-2007,” World Bank Policy Research Working Paper No. 4645.

    • Search Google Scholar
    • Export Citation
  • Kraay, Aart and Vikram Nehru, 2006, “When is External Debt Sustainable?”, The World Bank Economic Review, 20(3): 341-365.

  • Pattillo, Catherine, Helene Poirson, and Luca Ricci, 2002, “External Debt and Growth,” IMF Working Paper 02/69.

  • Powell, Robert, 2003, “Debt Relief, Additionality and Aid Allocation in Low-Income Countries,” IMF Working Paper 03/175.

  • Sun, Yan, 2004, “External Debt Sustainability in HIPC Completion Point Countries,” IMF Working Paper 04/160.

1

The authors would like to thank Ratna Sahay, Jianhai Lin and our colleagues in the IMF Finance Department for their insightful advice. This paper has greatly benefited from comments received at the IMF Finance Department Economist Seminar.

2

Additional background material on the HIPC Initiative can be found in IMF (1999, 2006a and 2006b).

3

The IMF and the World Bank developed the Debt Sustainability Framework to support low-income countries in their efforts to achieve their development goals without creating future debt problems. The most recent update on the status of implementation of HIPC and MDRI is available at: http://www.imf.org/external/np/pp/eng/2008/091208.pdf. The latest HIPC progress report (http://www.imf.org/external/pp/longres.aspx?id=4278) includes a detailed analysis of the debt outlook in post-completion point countries.

4

The Poverty Reduction and Growth Facility (PRGF) is the IMF’s low-interest lending facility for low-income countries. Therefore, the two terms in this paper, PRGF-eligible countries and low-income countries, are interchangeable.

5

In terms of gross international reserves, the HIPC completion point countries did marginally better than other HIPC countries, but lagged behind non-HIPC low-income countries.

6

In 2003 and 2004, substantial resource flew to Albania and Pakistan, which resulted in the decline in the share of HIPC completion point countries.

7

This may suggest that reaching the completion point causes an improvement in macroeconomic performance or structural features of the economy, while it could also reflect a gradual implementation of an IMF program, other policy changes, technical assistance, or other factors.

8

Export data are from the UN-Comtrade dataset using the SITC-2 (Standard Industry Trade Classification) 4-level. Some countries’ export data are not available and, therefore, these countries are not used in this study. Countries that are excluded from this study due to data insufficiency are (1) among HIPC completion point countries: Mauritania, Sierra Leone, and Tanzania; (2) among other HIPC countries: Chad, Dem. Rep. of Congo, Rep. of Congo, Guinea-Bissau, Kyrgyz Republic, and Somalia; and (3) among non-HIPC low-income countries: Angola, Bhutan, Djibouti, Lao, Lesotho, Myanmar, Solomon Islands, St. Lucia, St. Vincent and the Grenadines, Tajikistan, Timor Leste, Uzbekistan, and Vanuatu.

9

Note that an improvement in revenue collection does not necessarily lead to smaller external financing needs, which depend on expenditure policies as well. In Figure 2, we observe deterioration in the general government balance in HIPC completion point countries, reflecting increasing external financing needs. However, fiscal revenue mobilization reflects a country’s ability to finance its expenditure, and thus is used as a structural indicator instead of the government fiscal balances.

10

Data point varies from 2000 to 2006 depending on the availability of more recent data. Countries whose earliest data point is before 2000 are not selected for study.

11

Petroleum includes various products related to petroleum.

External Debt Sustainability in HIPC Completion Point Countries: An Update
Author: Jie Yang and Dan Nyberg