Chad: Joint Fund-Bank Debt Sustainability Analysis Under the Debt Sustainability Framework for Low-Income Countries

The staff report for Chad’s 2008 Article IV Consultation presents economic developments and policies. The global economic crisis has affected the budget and reserves through lower oil prices. Chad’s limited financial and trade integration has insulated it from the financial crisis and ensuing global recession. Risks include lower demand for exports and weaknesses in the foreign banks that own most of Chad’s banking system. Chad is seriously affected by declining oil prices, which will require substantial fiscal adjustment and will lower reserves, albeit not to critical levels.

Abstract

The staff report for Chad’s 2008 Article IV Consultation presents economic developments and policies. The global economic crisis has affected the budget and reserves through lower oil prices. Chad’s limited financial and trade integration has insulated it from the financial crisis and ensuing global recession. Risks include lower demand for exports and weaknesses in the foreign banks that own most of Chad’s banking system. Chad is seriously affected by declining oil prices, which will require substantial fiscal adjustment and will lower reserves, albeit not to critical levels.

I. Background

Recent Developments in external debt

1. Chad’s external debt situation has improved considerably over the past few years, thanks to the strong growth in overall GDP stemming from the oil sector, reduced external financing, and continued debt servicing. By end-2005—the basis for the last DSA2—the stock of debt had already declined to below 30 percent of GDP, from over 60 percent at the HIPC Initiative decision point. Since then, it has declined further to 23 percent of GDP at end-2007. All of Chad’s external debt is public debt, and the bulk is owed to the multilateral creditors IDA and the African Development Bank (AfDB) (see Text Table 1). Nominal debt levels are sensitive to exchange rate changes, mainly through the Euro-dollar rate given that the CFA franc has a fixed parity with the Euro (about one quarter of debt is denominated in Euro or CFA). Debt levels have been reduced further because Chad made principal payments as scheduled while contracting only moderate amounts of new debt. Moreover, disbursements suffered when creditors started encountering problems in project execution. In 2008, the debt stock declined significantly after Chad prepaid to the IBRD the balance on the loan that financed the government’s equity share in the oil pipeline plus to IDA the two associated credits for capacity building (around CFAF 31 billion in total).

Text Table 1.

Chad: Recent Developments in Debt, 2001-08

(Billions of CFA francs)

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Source: Chadian authorities.

2. Chad’s debt management is guided by the framework adopted in March 2007 by the Economic and Monetary Community of Central Africa (CEMAC) to which it belongs.3 In that context, Chad’s debt management capacity has been significantly strengthened. A new software introduced in 2008 permits the integration of domestic and external debt. It will also be used to publish a new statistical bulletin, and the debt department is planning its own website. Starting 2009, to get a better grip on treasury arrears (arrierés comptables) any unpaid bills at the end of the complementary period of the budget year will be formally recognized as debt and transferred to the debt department.

External debt relief—HIPC Initiative and MDRI

3. Chad is eligible for the enhanced Heavily-Indebted Poor Countries (HIPC) Initiative. The decision point was reached on May 24, 2001, and HIPC Initiative debt relief was estimated at US$170 million in 2001 NPV terms (of which US$68 million by IDA and US$18 million by the IMF). Part was to be delivered as interim assistance with the remainder at the completion point. Creditors delivering interim assistance to Chad include IDA, IMF, AfDB, the Paris Club, and other bilateral creditors. However, in the seven years that elapsed, most creditors have reached the limit of their interim relief (the IMF in 2005, the AfDB in 2006 and IDA in 2007).4

4. Macroeconomic performance and political obstacles have prevented Chad from reaching the HIPC Initiative completion point. Specifically, Chad’s inability to meet agreed fiscal targets and satisfactorily implement a program under the IMF’s Poverty Reduction and Growth Facility (PRGF)—a key completion point trigger—has been the principal obstacle. The 2005 PRGF expired in 2008 without any reviews being concluded. Subsequent efforts in 2008 to develop a policy track record to a new PRGF through a Staff-Monitored Program were derailed by further fiscal slippages. The timing of the completion point will depend on the authorities’ efforts to progress to a new PRGF arrangement, and satisfactory performance under the PRGF-supported program. Besides this, the completion point requires one year satisfactory implementation of the Poverty Reduction Strategy Paper (PRSP), and meeting a number of floating completion point triggers in governance and five Priority sectors.5 The Government of Chad adopted a new PRSP in April 2008.

5. Upon reaching the HIPC Initiative completion point, Chad would also become eligible for debt relief under the Multilateral Debt Relief Initiative (MDRI). MDRI relief covers the full stock of debt owed to three multilateral creditors, IDA, IMF, and the African Development Fund (AfDF) that remains at the time of the completion point on disbursements before end-2004 in the case of IMF and AfDF and before end-2003 in the case of IDA. For Chad, MDRI debt relief would be equivalent to approximately US$1 billion in nominal terms over 45 years or US$567 million in end-2006 NPV terms.

Public domestic debt

6. Chad has no public domestic debt instruments. CEMAC plans for creating a domestic securities market have been slow in coming to fruition. Nonetheless Chad has a stock of domestic debt resulting from past arrears. Building on the work of several government debt commissions, an independent auditor identified in 2006 claims worth CFA 142 billion (4.6 percent of GDP) as of end-2005, to be paid either immediately or upon further verification. The debt is reported in three categories: treasury arrears (arrierés comptables), from the current or previous budget years; rescheduled debt (debt conventionnées); and legal obligations (engagements juridiques) (see Text Table 2).

Text Table 2.

Chad: Stock of Public Domestic Debt, 2005–08

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Source: Chadian authorities.

7. Since 2005, public domestic debt has fallen as a result of repayments even though new debts were added. All domestic debt is in national currency. Only a small portion of the rescheduled debt earns interest. The authorities view settlement of all verified arrears and debts as an opportunity to improve the public sector’s credit standing and increase private sector confidence. A partial domestic debt repayment plan envisaging payment of CFAF 40 billion over 2008-10 was adopted in April 2008. In July 2008, a government commission started to update the stock of debt as of end-2007 and complete the necessary verification to enable the government to adopt a final arrears clearance and domestic debt settlement plan in early 2009. No public debt guarantees are registered in the debt department.

II. Underlying Dsa Assumptions

8. Over the 20 year period covered by the DSA, Chad’s macroeconomic performance will be much affected by the gradual depletion of its current oil resources and the policy reactions to its economic implications. The basic macroeconomic assumptions underlying the baseline scenario are summarized in Text Table 3.

Text Table 3.

Chad: Macroeconomic Assumptions for the Baseline DSA 2008–2028

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Sources: Chadian authorities; and staff projections.

9. Oil is a critical determinant of Chad’s economic outlook. While exploration is ongoing, Chad’s “proved” oil reserves have not changed since the commencement of production in the Doba field. To be conservative, no new discoveries have been factored in. Long-term oil production projections are therefore based on the gradual depletion of the Doba field, with annual production declining from 46 million barrels in 2008 to 11 million in 2028. Due to its quality, Chad’s oil sells at a discount of $10–15 per barrel relative to international reference prices such as Brent. For the medium term, the base line assumes the reference oil price behaves in line with the latest IMF projections used for the World Economic Outlook; for the long term, the baseline assumes oil prices will trend in real terms towards the price level attained in 2006 of about $60 per barrel.6 For the outer years oil revenue—the government “take”—is assumed to be 50 percent of gross oil revenues.

10. As oil production trends down, non-oil real growth is assumed to pick up to 4–5 percent, resulting in overall GDP growth of 3–4 percent. This economic diversification will have benefited from the productivity-enhancing investments in human and physical infrastructure financed with the oil revenues. But it is also predicated on a general improvement in the private sector business climate. The balance of payments reflects these trends with growing non-oil exports gradually substituting for declining oil exports.

11. The assumed fiscal policy reaction to the decline in oil revenues is a combination of adjustment—reducing expenditures—and financing—raising revenues through the broad-based taxation of the growing non-oil sectors, targeting a non-oil primary deficit of below 4 percent which a permanent income analysis suggests would be sustainable. It is highly preferable that this adjustment comes about through a forward-looking medium-term budget policy that respects the government’s anti-poverty objectives. If not, then a more costly adjustment will be forced by the inevitable decline in oil revenue absent other financing possibilities.

12. Assumed in the baseline is that Chad, currently one of the ten poorest countries in the world, will remain over the projection period, an IDA-eligible country. It should therefore continue to receive external financial support through project and program grants and loans on a concessional basis. Presently total grants and loans are at an unusually low level: in terms of GDP, the 2007 level was only half that of 2004. As oil revenue declines and Chad improves its governance and relations with development partners, this level is projected to pick up somewhat. Of new borrowing, 70 percent is assumed to have a grant element of around 60 percent (IDA terms) and 30 percent a grant element of 35 percent. The combined effect of the grants and concessional borrowing is to raise the grant-equivalent financing to 3.6 percent of GDP in the outer years. Following the settlement of current domestic debt by 2010, a small build-up of new debt is projected, in line with CEMAC plans for stimulating domestic government securities. In the absence of a PRGF arrangement, there is no target date for the HIPC completion point, and the baseline therefore does not take into account possible debt relief.

III. External Dsa

A. Baseline

13. A standard component of a LIC DSA is to assess the external debt burden indicators in relation to policy-dependent thresholds because of the key empirical finding that LICs with better quality policies and institutions can sustain a higher level of external debt. Policy performance is classified as strong, medium and weak depending on the country’s rating on the World Bank’s Country Policy and Institutional Assessment (CPIA). Chad’s rating is very low, 2.77 on average for 2005-07, which puts it in the Weak Policy category. Moreover, Chad’s CPIA declined from 2.9 in 2005 to 2.6 in 2007.7 The corresponding thresholds together with Chad’s performance under the baseline are shown in Text Table 4; the debt ratios are in present value (PV) terms. Under the baseline scenario the indicators of Chad’s public- and publicly-guaranteed debt are always comfortably below the threshold values. Moreover, the ratios are either stable or declining, suggesting the outlook is favorable.

Text Table 4.

Chad: Thresholds for “Weak Policy Performance” and External Debt Burden Indicators

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Simple average.

B. Alternative Scenarios and Stress Tests

14. The LIC DSA template subjects the baseline external debt projections to a number of standard stress tests, namely two alternative scenarios and six bound tests (see Table 2a). The charts in Figure 1 show how the ratios behave under the baseline and the most extreme of the stress tests relative to the thresholds. The alternative “historical” scenario assumes key variables stay at their historical averages. In Chad’s case this implies that the fairly large current account deficits of the past—on account of oil sector imports—continue, financed mostly by large foreign direct investment inflows, but still generating a debt build up. As a result in Figure 1, panel c the historical ratio crosses the performance-based threshold. Given that larger current account deficits could derive from several factors, including lower oil prices, this scenario indicates the sensitivity of the baseline to balance of payments shocks.

Table 1a.

Chad: External Debt Sustainability Framework, Baseline Scenario, 2005–2028 1/

(In 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 period 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. For projections also includes contribution from price and exchange rate changes.

Assumes that PV 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 PV of new debt).

Table 1b.

Chad: Public Sector Debt Sustainability Framework, Baseline Scenario, 2005–2028

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

The public sector is defined as central government and debt is on a gross basis.

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.

Table 2a.

Chad: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2008–2028

(In 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.

2/ Assumes that the interest rate on new borrowing is by 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 FDI.

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.