The drop in demand and commodity prices in Liberia is adversely affecting investment and exports in some key sectors. The staff report examines Liberia’s second review under the Poverty Reduction and Growth Facility and request for Waiver and Modification of Performance Criteria. The global recession is slowing Liberia’s post-war economic recovery. There is limited room for countercyclical fiscal action owing to high debt levels while monetary policy is constrained by high dollarization. In the mining sector, investment continues, and iron ore exports are expected to resume with the global economic recovery.

Abstract

The drop in demand and commodity prices in Liberia is adversely affecting investment and exports in some key sectors. The staff report examines Liberia’s second review under the Poverty Reduction and Growth Facility and request for Waiver and Modification of Performance Criteria. The global recession is slowing Liberia’s post-war economic recovery. There is limited room for countercyclical fiscal action owing to high debt levels while monetary policy is constrained by high dollarization. In the mining sector, investment continues, and iron ore exports are expected to resume with the global economic recovery.

A. Introduction

1. This joint DSA was prepared using the Fund-World Bank debt sustainability framework for low-income countries approved by the respective Executive Boards with some modifications to the stress tests to address data limitations in Liberia.4 It presents the projected path of Liberia’s external and public debt indicators and draws conclusions on the forward-looking sustainability of debt under baseline and alternative scenarios for debt relief and macroeconomic developments. The macroeconomic framework data were updated by Fund and World Bank staff following discussions with the authorities in February 2008. The base year debt stock and debt service data reflect data used at the decision point with updates for interim assistance from multilateral creditors.

2. Three changes to the baseline scenario explain the differences between the current analysis and the previous DSA at the HIPC decision point in March 2008: (i) the path of GDP and export growth has been modified to reflect a delay in the recovery of Liberia’s exports and foreign direct investment resulting from the ongoing global recession but with higher long-term iron ore exports on the basis of investment agreements (ii) the balance of payments data for services are revised upwards reflecting new estimates of receipts and payments; and (iii) government domestic debt owed to the Central Bank of Liberia (CBL) was excluded from the analysis to bring the public DSA in line with the definition of public sector. The macroeconomic impact of the iron ore sector is substantial as indicated in comparisons of debt indicators in relation non-iron ore GDP (Figure 1).

Figure 1.
Figure 1.

Liberia: Comparison to Decision Point DSA—Macroeconomic Assumptions, 2007/08-27/28

Citation: IMF Staff Country Reports 2009, 177; 10.5089/9781451823011.002.A003

Source: Staff projections and simulations.

B. Baseline Scenario

3. The baseline scenario draws historical data from the previous DSA and projections from macro-economic framework underpinning the second review of Liberia’s PRGF arrangement. Average real GDP growth over 2007/08–2012/13 is projected at 9.0 percent, spurred by FDI-financed projects in the mining, forestry, and agriculture sectors and more broadly normalization of economic activities resulting from improved security. Over the longer run, real growth is projected to moderate to 5.5 percent declining to 3.5 percent by the end of the projection period, as the growth of FDI-related output diminishes. Projected growth remains above the pre-conflict average growth rate of 3.0 percent in the early projection period due to the catch-up effect seen in post conflict countries and historically large flows of FDI. Inflation rate measured by GDP deflator (US dollar terms) is projected to increase at an average of 2.8 percent over 2007/08–2012/13 and at 1.9 percent during 2017/18-2027/28.

4. Liberia is assumed to have limited recourse to public sector borrowing over the long-term. The DSA assumes that the cash-based balanced budget is maintained to the completion point at end-2009/10. Starting 2010/11, borrowing commences at a rate of 2 percent of GDP per year, predominantly from external concessional sources. Grants are expected to be the main source of external financing post HIPC completion point, reflecting Liberia’s low income per capita.5 From 2015/16, as revenues are boosted by substantial iron ore royalty payments, borrowing drops to 1½ percent of GDP including a net repayment of outstanding domestic debt.

5. The revenue-to-GDP ratio increases in the short term on account of timber-related revenue and in the medium to long term from taxes and royalties on iron ore mining. The revenue projections are based on two large iron ore projects; in one, the concession agreement has been ratified by the legislature; and in the other rehabilitation of mining facilities is underway.

6. The external position is expected to improve gradually with continued donor support and increasing FDI over the medium term. Nonetheless, the baseline scenario indicates a significant deterioration of the debt ratios in the first few years compared to the last DSA. This is largely due to the impact of the global crisis on FDI and exports in the period through 2012. The non-interest current account deficit is projected to decline from 38 percent of GDP in 2008/09 to about 7 percent of GDP by 2012/13 as iron ore exports come on stream and further improving to average surplus 1 percent of GDP during 2013/14-2026/27. The counterpart to the improving current account is higher private sector savings assumed to result from rising incomes and development of the financial system. Donor transfers are projected to decline in the medium term, coinciding with the eventual drawdown of the UNMIL mission but would remain above 20 percent GDP over the projection period.

7. The baseline scenario assumes full delivery of traditional debt relief, multilateral arrears clearance and interim HIPC assistance. In addition, a financing gap is assumed to be met through additional voluntary interim period assistance beyond HIPC Initiative relief. Consistent with LIC DSA guidelines, the baseline does not reflect the delivery of HIPC, MDRI and IMF beyond-HIPC assistance at the completion point; however, this is presented in an alternative scenario with debt stock declining to about U$262 million (text table).

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Source: http://www.mofliberia.org/externaldebt.htm,04/02/2009

Staff estimates of debt stock (nominal) after completion point.

C. Debt Sustainability Analysis

External Debt Sustainability

8. The baseline scenario indicates that Liberia is in debt distress. With exception of debt-service-to exports ratio, all key debt indicators are well above their policy-dependent indicative thresholds in the baseline scenario (Table 1a, Figure 2). With export growth, the PV of external debt-to-export ratio is expected to fall below the threshold by 2014/15, while the PV of external debt-to-revenue moves below the 200 percent threshold by 20186/17 reflecting the impact of iron ore production royalties on revenue. The ratios of debt service to exports and to revenue rise substantially in the period 2011-18 mainly on account of debt service related to Fund EFF and PRGF credit.

Table 1a.

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).

Figure 2.
Figure 2.

Liberia: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2008-2028 1/

Citation: IMF Staff Country Reports 2009, 177; 10.5089/9781451823011.002.A003

Source: Staff projections and simulations.1/ The most extreme stress test is the test that yields the highest ratio in 2018. In figure b. it corresponds to a Combination shock; in c. to a Non-debt flows shock; in d. to a Combination shock; in e. to a Exports shock and in picture f. to a One-time depreciation shock

9. The alternative scenarios and bound tests reveal significant underlying vulnerabilities and highlight the continuing importance of debt relief (Table 1b). Because of a history of volatile economic indicators the bound tests represent large shocks to the baseline scenario. The tests based on slower export growth, lower non-debt creating flows and combined shocks result in the most significant deterioration of debt ratios, highlighting the potential vulnerability to reversals in FDI and exports. However, assuming that new borrowing is moderate and highly concessional terms, the impact of borrowing is less severe. The historical scenario results should be interpreted with caution owing the paucity of historical data.

Table 1b.

Liberia: 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.

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.

10. Debt relief through the HIPC Initiative, MDRI and IMF beyond-HIPC assistance would significantly improve Liberia’s debt situation (Figure 3). Assuming the full delivery of such assistance at end 2009/10, all three debt-burden indicators (PV of debt-to-GDP ratio, PV of debt-to-exports ratio, and debt service-to-exports ratio) would be significantly below their indicative thresholds. An alternative scenario factoring in modest concessional borrowing pre-completion point shows a minimal impact on ensuing debt ratios (see text chart). This result is also robust to a scenario that assumes no iron ore exports.

Figure 3.
Figure 3.

Liberia: Indicators of Public and Publicly Guaranteed External Debt under Completion Point Scenarios, 2008-2028 1/

Citation: IMF Staff Country Reports 2009, 177; 10.5089/9781451823011.002.A003

Source: Staff projections and simulations.1/ The most extreme stress test is the test that yields the highest ratio in 2018. In figure b. it corresponds to a Combination shock; in c. to a Non-debt flows shock; in d. to a Combination shock; in e. to a Non-debt flows shock and in picture f. to a Combination shock

Public Sector Debt Sustainability

11. Under the baseline scenario, Liberia’s public debt as a share of GDP is expected to decline throughout the projection period though remaining at high levels through to the end of the projection period absent debt relief (Table 2a, Figure 4). The steady decline in the debt-to-GDP ratio is due to strong GDP growth early in the projection period and a near zero primary balance after the completion point. In the outer years, GDP growth of 3 percent is strong enough to continue contributing to the decline in the ratio.

Table 2a.

Liberia: Public Sector Debt Sustainability Framework, Baseline Scenario, 2004/05-2027/28

(In percent of GDP, unless otherwise indicated)

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

Data covers central government debt. Domestic debt data was reconciled in 2006/07.

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.

Figure 4.
Figure 4.

Liberia: Indicators of Public Debt Under Alternative Scenarios, 2008-20281/

Citation: IMF Staff Country Reports 2009, 177; 10.5089/9781451823011.002.A003

Sources: Country authorities; and Fund staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in 2018.2/ Revenues are defined inclusive of grants.

12. Domestic public debt is modest and largely owed to the banking sector and does not play a major role in public debt dynamics. New public sector domestic borrowing, assumed to commence after the completion point is modest and mostly incurred in relation to repaying outstanding government debt to the central bank.6

13. Sensitivity tests suggest that the trajectory of Liberia’s total public debt is particularly sensitive to shocks on the real exchange rate and GDP growth (Table 2b). Although the one-time 30 percent depreciation shock in 2008/09 (bound test B4) has a large adverse impact on debt dynamics, however this shock could be somewhat muted, given that the Liberian economy is highly dollarized and its debt is predominantly denominated in US dollars.

Table 2b.

Liberia: Sensitivity Analysis for Key Indicators of Public Debt 2008-2028