Joint IMF/World Bank Debt Sustainability Analysis 20091
Author: International Monetary Fund
Publication Date:
14 Aug 2009
eISBN:
9781451803600
Language:
English
Keywords:
ISCR; CR; staff advice; fertilizer subsidy; deficit; debt; policy intervention rate; ratio; sustainability framework; GDP deflator; creating flow; debt stock; service-to-revenue ratio; Debt sustainability; Debt sustainability analysis; Public and publicly-guaranteed external debt; Global; debt vulnerability
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This paper discusses key findings of the Sixth Review under Poverty Reduction and Growth Facility (PRGF) for Benin. The macroeconomic outlook is weaker for 2009–10, reflecting the impact of the crisis. Real GDP growth is expected to slow down to about 3–4 percent in 2009–10. The authorities’ policy response of allowing automatic fiscal stabilizers to work is appropriate. The implementation of structural reforms needs to be accelerated to enhance the competitiveness of Benin’s economy and increase its resilience to exogenous shocks.

Abstract

This paper discusses key findings of the Sixth Review under Poverty Reduction and Growth Facility (PRGF) for Benin. The macroeconomic outlook is weaker for 2009–10, reflecting the impact of the crisis. Real GDP growth is expected to slow down to about 3–4 percent in 2009–10. The authorities’ policy response of allowing automatic fiscal stabilizers to work is appropriate. The implementation of structural reforms needs to be accelerated to enhance the competitiveness of Benin’s economy and increase its resilience to exogenous shocks.

This update of the joint Bank-Fund debt sustainability analysis (DSA) confirms that Benin’s risk of debt distress remains moderate. Under baseline projections, all external debt indicators remain below their indicative thresholds over the long run. However, debt ratios move rapidly toward the thresholds or breach them under less favorable scenarios. In particular, debt vulnerabilities would increase if the negative impact of the global crisis (on growth, exports, and fiscal revenue) turned out to be stronger than projected, or in the absence of structural reforms aimed at enhancing competitiveness. The prompt implementation of these reforms is therefore critical. Benin should continue to finance its fiscal deficit primarily through external grants and highly concessional loans.

I. Introduction

1. This analysis updates the DSA performed In November 2008 (IMF Country Report No. 08/374; IDA/SecM 2008-0707), to take account of the negative impact of the global economic crisis on Benin. The crisis is expected to reduce growth in 2009 and 2010, weaken demand for exports and trade with Nigeria, and reduce inflows of remittances and foreign direct investments. The associated revenue shortfall and the use of automatic fiscal stabilizers to mitigate the impact of the crisis are expected to result in a financing gap of about CFAF 100 billion over two years, which is expected to be covered with highly concessional external financing.

II. Methodology

2. This DSA uses the debt sustainability framework for low-income countries.2 Debt sustainability is assessed in relation to policy-dependent thresholds for debt stock and debt service burden indicators. The policy-dependent thresholds depend on the average of the rating of the Country Policy and Institutional Assessment (CPIA) index for 2005–07. According to this rating, Benin is classified as a medium performer in terms of the quality of policies and institutions.3

3. Except for the estimated impact of the crisis in 2009–10, this DSA maintains the main macroeconomic and policy assumptions used in the previous DSA (Box 1). In particular, the baseline projections are anchored on the assumptions that: (i) key structural reforms aimed at enhancing competitiveness and growth (most notably through the restructuring of the energy and telecommunication sector) would be adopted over the medium term; (ii) the authorities would proceed with their plans to improve public infrastructure; and (iii) fiscal policy would aim at maintaining macroeconomic stability. Under these conditions, real GDP growth is expected to recover after the crisis period 2009–10 to a sustainable annual rate of 6 percent from 2012 onwards, consistent with the assumptions of the World Bank 2008 Country Economic Memorandum (CEM).

4. The global economic crisis is projected to slow down growth and put pressure on fiscal accounts in 2009 and 2010. Real GDP growth is projected to drop to 3.8 and 3.0 percent in 2009 and 2010, respectively, as global demand for Benin’s exports declines, trade relations with Nigeria weaken, and inflows of workers’ remittances and foreign direct investment fall; as a result, the external current account deficit is projected to widen to 10.3 percent of GDP in 2009 and to 9.7 percent of GDP in 2010. Lower food and commodity prices will reduce customs revenue, while the slowdown in economic activity will reduce direct and indirect taxation.

Macroeconomic Assumptions

Medium term (2009–14): The projections are consistent with the macroeconomic framework of the sixth PRGF review and reflect: (i) the impact of the crisis, and (ii) fiscal policies aimed at maintaining macroeconomic stability, protecting vulnerable groups, and enhancing investment in public infrastructure. It also assumes the implementation of structural reforms aimed at increasing efficiency and competitiveness and improving the business climate. Consequently, after slowing down to 3–4 percent in 2009-10, real GDP growth is projected to go back to its long-term sustainable level of 6 percent, while fiscal prudence and the anchor of the fixed exchange rate peg gradually are expected to reduce inflation to 3 percent. After the initial fiscal expansion to mitigate the impact of the crisis, the primary deficit would be reduced to about 1 percent of GDP by 2014, reflecting improvements in public fiscal management and efforts to contain recurrent expenditures. The current account deficit is expected to narrow to 7 percent of GDP by 2014, as export receipts recover.

Long term (2015–29): long-term projections reflect the impact of the structural reforms implemented in previous periods and the continuation of policies aimed at maintaining macroeconomic stability. Under these assumptions:

  • Real GDP growth would average 6 percent;

  • Inflation would remain at or below 3 percent;

  • The primary fiscal deficit would stabilize at about 1 percent of GDP, following improvements in revenue collection (to above 20 percent of GDP, excluding grants) and continued efforts to contain nonpriority recurrent expenditures;

  • The current account deficit would remain at about 5 percent of GDP, reflecting growing imports associated with economic expansion and foreign direct investment (FDI), as well as continuing inflows of remittances;

  • Improved infrastructure and a more favorable business climate would attract net foreign direct investment averaging about 1 percent of GDP annually.

  • Reflecting donors’ support for Benin’s infrastructural development and reform efforts, about one half of total gross financing needs are assumed to be covered by external grants.

5. The impact of the crisis is however expected to be temporary. With the expected recovery in the global economy in the second half of 2010, and prompted by continued structural reforms to improve competitiveness, investments in infrastructure, and a more efficient public administration, real GDP growth could recover to its full potential of 6 percent by 2012. Inflation would remain below 3 percent, and the current account deficit (excluding grants) would narrow to 7.1 percent of GDP by 2014, reflecting increasing exports and remittances. Ongoing inflows of public and private capital would help keep reserves above 5 months of imports of goods and services. Long-term downside risks associated with weaker reform efforts or a slower global recovery are captured in an alternative “no reform” scenario.

6. A key assumption is that, in support of the implementation of the above-mentioned reforms, concessional financing from external donors would continue to be available throughout the projection period. In particular, sufficient concessional funds would be available to fill the financing gaps in 2009 and 2010, permitting the use of automatic fiscal stabilizers to contain the impact of the crisis without compromising debt sustainability. Moreover, the average grant element on new external financing is assumed to remain at about 35 percent in the long term.

III. Background

7. Following debt relief under the HIPC and MDRI initiative, Benin’s external debt remains at comfortable levels. Benin reached the completion point under the Enhanced HIPC initiative in 2003, and benefited from further debt relief under the MDRI initiative in 2006. As a result, Benin’s external debt stock declined from 47.7 percent of GDP at end-2002 to 14.6 percent of GDP at end-2008. In line with this reduction, external debt service was reduced from 2.2 percent of GDP to less than 0.6 percent over the same period.

8. Government borrowing from the regional market increased significantly since 2006. Outstanding regional government debt at end-2008 amounted to 4.3 percent of GDP. Net government borrowing in the regional market averaged 3.5 percent of GDP in 2007–08 and is expected to increase somewhat in the future, reflecting the authorities’ interest in promoting the expansion of this market. Nevertheless, as borrowing conditions on this market are nonconcessional and the authorities are committed to a prudent borrowing strategy, it is assumed that—as has been the case in the past—borrowing from the regional market will continue to cover only a small fraction of overall financing needs, that will be primarily met with highly concessional external financing.

IV. Assessment of External Debt Sustainability

9. Under baseline assumptions, all external debt and debt service ratios remain below the policy-dependent thresholds throughout the projection period (Figure 1). The NPV of external debt is projected to stabilize at 15 percent of GDP in the long run, and debt service payments would remain below 8 percent of exports; the NPV of debt-to-exports ratio would remain well below the threshold of 150 percent and decline after 2014.

Figure 1.
Figure 1.
Figure 1.
Figure 1.
Figure 1.
Figure 1.
Figure 1.

Benin: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2009–2029 1/

a. Debt Accumulation

Citation: IMF Staff Country Reports 2009, 252; 10.5089/9781451803600.002.A002

Source: Staff projections and simulations.1/ The most extreme stress test is the test that yields the highest ratio in 2019. In figure b. it corresponds to a One-time depreciation shock; in c. to a Exports shock; in d. to a One-time depreciation shock; in e. to a Exports shock and in picture f. to a One-time depreciation shock

10. Alternative scenarios and stress test indicates that Benin’s external debt situation would worsen substantially in the event of shocks. If exports in 2010–11 were to grow at one standard deviation below the historical average, the NPV of debt-to-exports ratio would rise well above the sustainability threshold in the medium term, peaking at 200 percent in 2014, before declining in the long run. If new public sector borrowing were obtained on less favorable terms, the NPV of debt-to-exports ratio would constantly increase over time and cross the sustainability threshold, but only after 2026.

11. The risk of debt distress would increase markedly in the absence of structural reforms, particularly in the long run. Under a “no reform scenario” characterized by real GDP growth rates, export growth rates, and primary fiscal deficits close to historical averages,4 the NPV of debt-to-exports ratio would cross the sustainability threshold in 2018 and continue to increase thereafter. This scenario could also materialize if the global economic crisis were to have a permanent impact on Benin.

V. Assessment of Public Debt Sustainability

12. Public debt indicators are projected to worsen markedly over time but would stabilize in the long run (Figure 2). While no explicit thresholds are defined for these indicators, the NPV of government debt would double in proportion to GDP (from 12 percent in 2008 to 24 percent in 2029) and to revenue and grants (from 54 percent in 2008 to 104 percent by 2029), while public debt service would increase from 7 percent of revenue and grants in 2008 to about 16 percent in 2029.

Figure 2.
Figure 2.
Figure 2.
Figure 2.

Benin: Indicators of Public Debt Under Alternative Scenarios, 2009–2029 1/

Citation: IMF Staff Country Reports 2009, 252; 10.5089/9781451803600.002.A002

Sources: Country authorities; and Fund staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in 2019.2/ Revenues are defined inclusive of grants.

13. Stress tests highlight increased vulnerabilities under less favorable conditions. If the primary fiscal balance were maintained at the level projected for 2009, the NPV of public debt would rise to 38 percent of GDP and 166 percent of revenue by 2029, raising concerns about the sustainability of public debt. Under a no-reform scenario (with key variables at their historical average), the NPV of public debt would rise to 28 percent of GDP and 121 percent of revenue and grants by 2029.

14. Public debt indicators would worsen under an alternative financing scenario. If the share of government financing needs covered by borrowing in the regional market were 20 percentage points larger than in the baseline (under unchanged fiscal deficit projections),5 government debt would rise to 32 percent of GDP by 2029, the NPV of government debt would rise to 113 percent of revenue and grants; most notably, public debt service would rise to 22 percent of GDP. These results reconfirm the ones in the previous DSA about the need for a prudent borrowing policy to limit the net issuance of nonconcessional domestic debt in the regional market to less than 0.5 percent of GDP annually.

VI. Conclusions

15. Altogether, this DSA confirms that Benin faces a moderate risk of debt distress and underlines the importance of proceeding with the structural reform agenda. In particular, the impact of the global economic crisis is not expected to significantly worsen the outlook for debt sustainability, provided the authorities stick to highly concessional financing to close the financing gaps. The prompt implementation of structural reforms will be critical to enhance growth, expand exports, attract foreign direct investments and contain the fiscal deficit, thus improving long-term debt dynamics. The authorities should also continue to cover their financing needs primarily with highly concessional external assistance. In the absence of such assistance, the government should consider reducing nonpriority public spending.

Table 1a.:

External Debt Sustainability Framework, Baseline Scenario, 2006–2029 1/

(In percent of GDP, unless otherwise indicated)

article image
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.

Residuals include changes in gross foreign assets, disbursements of capital grants, valuation adjustments, and, for projections, contribution from price and exchange rate changes. Projected values reflect the assumptions of the DSA performed in November (IMF Country Report No. 08/374; IDA/SecM2008-0707).

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

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

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.

Benin: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2009–2029

(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.

Table 2a.

Benin: Public Sector Debt Sustainability Framework, Baseline Scenario, 2006–2029

(In percent of GDP, unless otherwise indicated)

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

Gross debt of the central government.

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.

Residuals include the net accumulation of government deposits at banks. Projected values reflect the assumptions of the DSA performed in November (IMF Country Report No. 08/374; IDA/SecM2008-0707), incorporating an accumulation of deposits associated with the growth in nominal current expenditure.

Revenues excluding grants.

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

Table 2b.

Benin: Sensitivity Analysis for Key Indicators of Public Debt 2009–2029

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

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period.

Revenues are defined inclusive of grants.