Benin: Joint IMF/World Bank Debt Sustainability Analysis 20071
Author: International Monetary Fund
Publication Date:
16 Jan 2008
eISBN:
9781451803518
Language:
English
Keywords:
ISCR; CR; Benin; PRGF arrangement; government; dynamics equation; DSA result; DSA baseline; public debt-to-GDP ratio; debt indicator; Fiscal stance; Debt sustainability; Government debt management; West Africa
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Benin showed good macroeconomic performance under the Poverty Reduction and Growth Facility (PRGF) program. Executive Directors agreed that strong revenue performance helped to underpin improvement in public finances and economic growth while keeping inflation low. They stressed the need to adhere to prudent fiscal and monetary policies and also to build a sound banking system. They welcomed reforms to enhance the efficiency and competitiveness of the Port of Cotonou. They emphasized the need for the implementation of structural reforms, the improvement of the land tenure system, and the judiciary for growth and economic diversification.

Abstract

Benin showed good macroeconomic performance under the Poverty Reduction and Growth Facility (PRGF) program. Executive Directors agreed that strong revenue performance helped to underpin improvement in public finances and economic growth while keeping inflation low. They stressed the need to adhere to prudent fiscal and monetary policies and also to build a sound banking system. They welcomed reforms to enhance the efficiency and competitiveness of the Port of Cotonou. They emphasized the need for the implementation of structural reforms, the improvement of the land tenure system, and the judiciary for growth and economic diversification.

I. Introduction

1. This note, which updates the November 2006 DSA (Country Report 07/6), projects a lower debt-to-GDP ratio at the end of 2007 than in the 2006 exercise, reflecting three main factors: (i) the full impact of the Multilateral Debt Relief Initiative (MDRI) from the World Bank (US$664 million, against an earlier estimate of US$632 million) and the African Development Bank (US$364 million against US$296 million); (ii) the 2007 cancellation of Benin’s bilateral debt both to China (US$23.2 million) and Russia (US$11.6 million); and (iii) the addition of two publicly guaranteed commercial loans totaling US$56.6 million (Text table 1).

Text table 1.

Benin: Differences Underpining the DSA 2006 and 2007

(Percent, as of end-2006)

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Source: Beninese authorities and staff estimates.

Effective contribution of IDA and ADF.

Additional cancellations from China and Russia.

The 2007 DSA integrates commercial debt that is publicly guaranteed.

2. Recent debt relief—under the Heavily Indebted Poor Countries Initiative in 2003 and MDRI in 2006—have greatly reduced Benin’s debt stock and notably changed its structure. The external public debt-to-GDP ratio fell to 12 percent in 2006, from about 59 percent in 2001 (before HIPC relief). Debt to Paris Club creditors (including Russia) has been cancelled. While the combined share of commitments to the three major multilateral creditors (the IDA, AfDB, and the IMF) has declined from about 71 percent to 36 percent, the portion of debt to other multilateral creditors has risen to 44 percent, from 13 percent before HIPC/MDRI.2

Text table 2.

Benin: External Public and Publicly Guaranteed Debt Structure

(As of end-2006)

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Source: Beninese authorities.

At end-2006 with HIPC relief obtained since July 2000.

All non-Paris Club creditors have provided comparable treatments except Libya, Nigeria and the DRC.

II. External Debt Sustainability Analysis

A. Baseline Scenario: 2007–273

3. The baseline macroeconomic scenario projects a gradual strengthening of real GDP growth, a steady increase in private investment, and a stable inflation outlook. Growth is projected to pick up from 4.2 percent in 2007, to 5.7 percent by 2010 (in CFA francs, see Text table 3), and average 6 percent annually in 2011–27. The projection assumes that key structural reforms and infrastructure improvements are gradually carried out (Country Report 07/213). The cotton industry is expected to reach its full ginning capacity of 600,000 tons by 2027, and long-run growth, underpinned by private-sector-led economic diversification, should be sustained. Private investment is projected to grow a steady 0.1–0.2 percentage point of GDP a year, reaching 17.3 percent of GDP by 2027, up from 13.6 percent in 2006. Inflation should stay below the 3 percent ceiling set by the West African Economic and Monetary Union’s (WAEMU).

Text table 3.

Benin: 2006 and 2007 DSA Comparative Assumptions

(Percent, unless otherwise indicated)

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Sources: Beninese authorities; and IMF staff estimates and projections.

4. The 2007 DSA baseline is built on an updated macroeconomic scenario. Real GDP growth, projected to be 1.4 percentage point above Benin’s historical average, assumes that key structural reforms and infrastructure improvements are gradually carried out (Country Report 07/213). Also, with more ambitious capacity increases at the Port of Cotonou, and more sustained public works activities than earlier anticipated, baseline long-term growth is 0.5 percentage-point higher than assumed in the 2006 DSA.

Benin: Baseline Scenario—Macroeconomic Assumptions for 2006–27 (Estimates and projections are in CFA franc terms, unless otherwise indicated)

Annual real GDP is projected to rise by 5.4 percent in 2007–12 and by 6 percent in 2013–27 (see paragraph 3 and 4 above, for more details).

Inflation, as measured by the consumer price index, is projected to fall gradually from a historical average of 3.2 percent in 2000–06, to below 3 percent thereafter, in line with the relevant WAEMU convergence criterion.

Fiscal performance is projected to remain strong, reinforced by debt relief savings because of strong revenue collection and prudent expenditure management. The overall fiscal deficit, excluding grants, is projected to remain below 5 percent of GDP.

Against a background of improving terms of trade and strengthened domestic policy and reform implementation, the trade deficit would narrow marginally, from 10 percent in 2006 to 9 percent by 2027.

The financing gap is expected to decline gradually from 1.5 percent of GDP in 2008 to 1.2 percent in 2010 and onward, 80 percent of which is assumed to be covered by grants. Furthermore, debt-creating flows that include both identified projects and program loans are projected to average 3 percent of GDP.

As a result, new public borrowing (residual financing gap plus debt-creating flows) is projected to decline from 2.9 percent of GDP in 2007 to 2.4 percent thereafter. Post-MDRI distribution of new loans among creditors would be as indicated in the box table below. With a projected average maturity of 31 years, a grace period of 6 years, and an interest rate of 2.4 percent; and assuming an average discount rate of 5 percent, the new loans are estimated to have an average grant element of about 30.7 percent.

Box table.

Benin: Assumed Shares of New Loans by Creditor, 2006–27 1/

(Percent)

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Source: Staff estimates and projections as of 2007.

Projection as of 2007.

5. The baseline (average) growth scenario is realistic given the country’s structural constraints. It assumes full implementation of medium-term structural reforms with moderate gains in long-run growth (2011–27). Growth would not deviate considerably from recent trends owing to residual institutional and structural weaknesses (e.g., in the cotton sector, the judiciary, and the business environment). Scarcity of land and modest growth of private investment are also likely to limit long-run growth.

uA02fig01

Benin: Comparative DSA and PRSP Baseline, 2006-27

(Percent)

Citation: IMF Staff Country Reports 2008, 019; 10.5089/9781451803518.002.A002

Sources: Beninese Authorities; and IMF and World Bank staff estimates and projections.

6. The scenario assumes continued strong revenue collection and further budget consolidation. Public expenditure is projected to increase steadily by 0.5 percentage point a year, to about 23 percent of GDP in 2010, from 19 percent in 2007. Higher revenue would partially help meet the projected scaling-up of public expenditure, and the average overall fiscal deficit, excluding grants, would stay below 5 percent of GDP.

B. External Debt Sustainability4

7. The DSA results point to a moderate risk of debt distress for Benin. As shown in Appendix Figure 1, all debt indicators remain well below their respective policy-dependent thresholds under the baseline scenario. However, in bound tests, the threshold for the NPV of the external debt-to-exports ratio is breached when (i) real GDP grows at its historically low average rate (which could happen if reforms either lag or cease); (ii) cotton production and exports are lower than in the baseline; and (iii) nonconcessional borrowing is undertaken. Furthermore, relevant stress tests indicate that nonconcessional borrowing or exchange rate shocks could cause debt ratios to approach, but not exceed, some of the indicative debt thresholds. These findings are consistent with the staffs’ 2006 DSA.

Text table 4.

Benin: External Debt Indicators after MDRI, 2006–27

(Percent, unless otherwise indicated)

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Sources: Beninese authorities; and IMF staff estimates and projections.

Simple average.

III. Fiscal Sustainability Analysis5

8. Domestic borrowing—notwithstanding the potential space created by debt relief and the easing of WAEMU restrictions on borrowing on the regional financial market—is expected to increase at a modest pace. This reflects the country’s broadly favorable medium-term fiscal prospects as well as delays in addressing absorption constraints. Domestic debt rose markedly in 2006–07, from about 0.6 percent to 4.0 percent of GDP, largely because of the central government’s issue of treasury bonds on the regional financial market, which amounted to CFAF 96.1 billion (3.7 percent of GDP).6 By 2027, domestic debt is projected to increase to 10 percent of GDP (see Appendix Figure 2).

9. The fiscal cost associated with accelerated domestic borrowing could eventually test budget sustainability, as is the case under a scenario where reforms stagnate, domestic borrowing at high interest rate and shorter maturities surges, or institutional weaknesses in the cotton sector continue.

10. Continued fiscal discipline would help Benin weather economic shocks and keep its public debt sustainable (see Box 2). Even with good fiscal performance, excessive nonconcessional borrowing and other persistent shocks could require Benin to make fiscal adjustments in the future to keep debt dynamics from deteriorating severely. The average fiscal saving required to keep debt sustainable in alternative DSA scenarios are as follows:

  • In the increasing domestic(including regional) borrowing scenario, the average fiscal saving required to keep the debt ratio from rising (relative to the stabilizing primary balance scenario) is about 3.3 percent of GDP a year.

  • In the no reform (status quo) scenario, Benin would need fiscal saving of 3.1 percent of GDP on average a year.

  • In the “instability in the cotton sector” shock, the required savings is estimated at 3.5 percent of GDP per year.

Debt Dynamics and Fiscal Stance

We use standard debt dynamics equations that link the fiscal stance to the debt ratio to answer the following two questions (see Appendix C for more detail):

(i) What ratio of primary fiscal surplus is required to stabilize the public debt (ratio to GDP) at its base year level if policy remains unchanged?

(ii) What primary surplus is associated with (a) a no-reform scenario? (b) a sharp increase in a government T-bill-financed fiscal deficit issued in the regional market? or (c) a non-broad-based growth scenario that assumes continued volatility in both cotton production and international cotton prices.

The figure below suggests that:

  • An average fiscal surplus of 0.2 percent of GDP (per year in 2007-27) is required to bring the ratio of public debt-to-GDP to its 2006 level of 14.7 percent.

  • The primary deficit is higher in the no-reform scenario than in the baseline; the weak growth and cotton sector performance, and increasing domestic debt scenarios would result in a much bigger fiscal deficit.

  • The fiscal saving required to keep the debt ratio from rising relative to the stabilizing primary balance scenario ranges from 3.1 to 3.5 percent of GDP a year.

uA02bx02fig01

Box Figure. Benin: Primary Balance Under Three Shock Scenarios and Required Primary Balance to Stabilize The Debt Ratio, 2007-27

(in percent of GDP)

Citation: IMF Staff Country Reports 2008, 019; 10.5089/9781451803518.002.A002

Source: IMF staff projections and simulations.

IV. Conclusion

11. IMF and World Bank staffs conclude that Benin faces a moderate risk of debt distress. All external debt indicators in the baseline scenario are far below the relevant policy-dependent indicative thresholds. However, the NPV of debt-to-export (indicative) threshold is breached under some alternative scenario and bound tests.

12. The key risks driving the moderate rating are as follows: (i) weak growth; (ii) cotton production and exports being lower than in the baseline; and (ii) nonconcessional borrowing. The authorities could reduce these risks and safeguard debt sustainability through sustained efforts to continue structural reforms (including measures to spur private sector participation in development), address absorption constraints, and pursue prudent debt management policies.

13. Excessive domestic borrowing at high interest rates and shorter maturities would require Benin to make substantial fiscal adjustment down the road to keep debt dynamics from deteriorating. Continued fiscal consolidation and fiscal discipline would, therefore, reduce the potential for fiscal imbalances that put macroeconomic stability at risk.

14. The Beninese authorities concurred broadly with the DSA findings. While recognizing the need to refrain from nonconcessional borrowing, the authorities pointed to difficulties in mobilizing grant and concessional resources, which in their view could slow Benin’s progress toward the Millennium Development Goals.

Appendix A: Figures

Appendix Figure 1.
Appendix Figure 1.

Benin: Indicators of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2007–27

Citation: IMF Staff Country Reports 2008, 019; 10.5089/9781451803518.002.A002

Sources: IMF and World Bank staff projections and simulations.
Appendix Figure 2.
Appendix Figure 2.

Benin: Indicators of Public Debt Under Alternative Scenarios, 2007–27 1/

Citation: IMF Staff Country Reports 2008, 019; 10.5089/9781451803518.002.A002

Sources: IMF and World Bank staff projections and simulations.1/ Most extreme stress test is that which yields highest ratio in 2017.2/ Revenue including grants.
Appendix Table 1.

Benin: External Debt Sustainabilty Framework, Baselne Scenario, 2004–27 1/

(Percent of GDP, unless otherwise indicated)

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Source: Staff simulations.

Includes both public and private sector external debt.

Derived as [r - g - r(1+g)]/(1+g+r+gr) times previous perioc debt ratio, with r = nominal interest rate, g = real GDP growth rate and r = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief), changes in gross foreign assets, and valuation adjustments. Projections also include contribution from price and exchange rate changes.

Assumes that NPV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the NPV of new debt).

Appendix Table 2.

Benin: Sensitivity Analyses for Key Indicators of Public and Publicly Guaranteed External Debt, 2007-27

(Percent)

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Source: Staff projections and simulations.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt-creating flows.

Assumes that the interest rate on new borrowing is 2 percentage points higher than in the baseline, while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assuming an offsetting adjustment in import levels).

Includes official and private transfers and foreign direct investment.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

Appendix Table 3.

Benin: Public Sector Debt Sustainability Framework, Baseline Scenario, 2004-27

(Percent of GDP, unless otherwise indicated)

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Sources: Beninese authorities; and Fund staff estimates and projections.

Public and publicly guaranteed debt.

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues excluding grants.

Debt service is defined as the sum of interest and amortization of medium- and long-term debt.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Appendix Table 4.

Benin: Sensitivity Analysis for Key Indicators of Public Debt, 2007–27

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Sources: Beninese authorities; and Fund staff estimates and projections.

Assumes that real GDP growth and primary balance are at historical averages.

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of 20 (i.e., the length of the projection period).

Assumes increaing government T-bills-based-fiscal-deficit financing at regional level leading to an increasing share of domestic debt from 4 percent in 2007 to 16 percent by 2027.

Assumes that real GDP growth at historical average minus one standard deviation (which accounts for instability in both cotton production and cotton farmer pricing).

Revenues are inclusive of grants.