Maldives: Joint IMF/World Bank Debt Sustainability Analysis under the Debt Sustainability Framework for Low Income Countries
Author: International Monetary Fund
Publication Date:
29 Jan 2010
eISBN:
9781451825534
Language:
English
Keywords:
ISCR; CR; financing; government; deficit; GDP; IMF facility; GDP deflator; debt service; GDP ratio; burden indicator; creating flow; Debt sustainability analysis; Debt sustainability; Public and publicly-guaranteed external debt; Global
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This paper examines the Maldives’ 2009 Article IV Consultation on economic developments and policies. The Maldivian economy is facing large external and fiscal imbalances, resulting from the severe impact of the global financial crisis and exacerbated by an unsustainable fiscal expansion. The global crisis has led to sharp declines in tourism and related investment, other net capital flows, and exports. This has caused a significant fall in fiscal revenue, compounding a large increase in public spending, and pushed the economy into recession. A rising share of the resulting fiscal deficit has been financed by monetization.

Abstract

This paper examines the Maldives’ 2009 Article IV Consultation on economic developments and policies. The Maldivian economy is facing large external and fiscal imbalances, resulting from the severe impact of the global financial crisis and exacerbated by an unsustainable fiscal expansion. The global crisis has led to sharp declines in tourism and related investment, other net capital flows, and exports. This has caused a significant fall in fiscal revenue, compounding a large increase in public spending, and pushed the economy into recession. A rising share of the resulting fiscal deficit has been financed by monetization.

I. The Debt Portfolio

1. The total debt to GDP ratio has increased fast since 2004, and reached almost 110 percent of GDP in 20083. Each major category of debt has shown strong growth rates following the 2004 tsunami. Growth in private external debt, used to finance a rapidly expanding tourism sector, has been particularly fast. An increasing fiscal deficit in the last two years has also led to a build up of public debt, much of it domestic. With external financing sources limited for much of 2009 and a fiscal deficit running close to 30 percent of GDP, a further build-up of domestic debt has been observed so far this year, which largely explains the projected increase in the total debt-to-GDP ratio to about 129 percent in 2009.

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Maldives: Composition of Total Debt

In millions of U.S. dollars (left scale), in percent of GDP (right scale)

Citation: IMF Staff Country Reports 2010, 028; 10.5089/9781451825534.002.A002

2. Public external debt rose rapidly after the 2004 tsunami, as donor funds flowed into the country for reconstruction needs. It reached US$472 million (37½ percent of GDP) in 2008. About 70 percent (or one third of the total debt stock) is from multilateral and bilateral creditors. This fact, and the assumption that new borrowing is expected to be contracted from multilateral and bilateral creditors throughout the projection period, motivates the use of the low-income country (LIC) framework for the DSA.4

II. Macroeconomic Assumptions

3. Maldives is facing severe fiscal and external imbalances. For the first three years after the 2004 tsunami disaster, the authorities pursued a growth strategy based on infrastructure spending and expansion of tourism, financed by both official grants and loans and private sector foreign borrowing. However, the global economic downturn has had a significant negative impact on export and tourism receipts, as well as government revenue. Moreover, private sector financing has contracted sharply. Combined with excessive government spending, this has led to a growing fiscal deficit, much of which has been monetized by the central bank. To address these challenges, the Government of Maldives has adopted a package of economic policy measures as described in their Memorandum of Economic and Financial Policies (MEFP). The DSA that follows builds on the program baseline scenario (Box 1).

Main Assumptions for the Debt Sustainability Analysis (2009-2029)

  • Real GDP growth in 2009-14 is projected to average 2½ percent a year compared with an average of 7¼ percent over the previous five years. Negative growth in 2009, projected at -4 percent, is mainly due to reduced activity in the tourism sector, which has been adversely affected by global economic downturn. Growth is expected to recover thereafter to around 4½ percent, as global and domestic conditions improve, but to remain below the recent historical average. This assumes that resort development takes place at a more sustainable pace than that observed since the tsunami, and that supply constraints will hold back the fisheries sector.

  • Inflation (which drives the GDP deflator) is projected to average 4¼ percent a year in 2009-14, compared with an average of 6½ percent over the previous five years, thanks to a moderation of global prices and the fiscal adjustment effort. Inflation is expected to stay at 3 percent thereafter, in line with trading partners’ rates, reflecting continued fiscal consolidation and a tighter monetary policy.

  • Interest rates on public debt are assumed to increase to 4½ percent by 2011 (compared with an average of 3¼ percent over the previous five years), reflecting a tighter domestic liquidity. They are assumed to decline thereafter.

  • The external current account deficit (including grants) in 2009-14 is projected to average 15½ percent of GDP a year and decline to 5 percent by 2019 reflecting a significant fiscal retrenchment, compared to 51½ percent in 2008. Thereafter, it would remain at below its pre-tsunami level (2003).

  • The overall fiscal deficit (including grants) is projected at 28¾ percent of GDP in 2009, as the full impact of the adjustment effort will only be felt in 2010. The deficit is expected to decline to an average of 5¾ percent of GDP in 2010-14, owing to a strong fiscal consolidation. The budget is expected to remain in balance thereafter. As a result, the volume of domestic borrowing will decline, although its cost may rise somewhat as the stock of outstanding obligations from the government to the MMA are securitized at a slightly higher average market rate than the penal rate charged by the MMA on the government’s overdraft account. Public external debt is assumed to be contracted mainly on concessional terms until the end of the projection period.

  • Government expenditures are expected to decline from 63 percent of GDP in 2008 to 45 percent by 2014, mainly reflecting civil service reforms. The government’s revenue measures—airport tax, ad valorem bed tax, business profits tax, and the general sales tax—are expected to yield about 15 percent of 2009 GDP once their full impact is felt. These new taxes will partly offset steep falls in import duties, lease payments, and profits transfers from SOEs, stemming, respectively, from the fall in public expenditure, a moderation in future lease payments from resorts, and privatization.

III. External Debt Sustainability5

Baseline Scenario

4. Maldives’ external debt has increased rapidly since the Tsunami, reflecting an increase in both public external financing and private foreign-financed investment. As of end- 2008, PPG debt represented 49 percent of total external debt. The external debt path is expected to worsen in the near term, as the Maldivian authorities seek external assistance to tide over the difficult economic situation. In particular, this includes financial assistance from the Indian government totaling US$200 million,6 and borrowing from IFIs (IMF, World Bank, and Asian Development Bank) projected at US$146 million. The authorities are also expecting additional nonconcessional external borrowing through end-2010.7 This borrowing explains the hump in the path of external debt service in 2010–11. The external-debt-to-GDP ratio, however, is projected to decline from 2010 onwards.

5. With one minor and temporary exception, all external debt indicators remain below the debt burden thresholds under the baseline scenario. The PV of external public debt-to- GDP ratio is projected to be slightly above the 40 percent threshold this year, but trend down thereafter as expected program implementation helps reduce the current account deficit to sustainable levels. This marginal and temporary breach of the threshold is due in large part to the extraordinary fiscal and current account imbalances of the past two years, which the Fund- supported program aims to address. The program also places a ceiling on non-concessional public external borrowing going forward. All other public external debt burden indicators remain well below thresholds throughout the projection period. While there is a hump in debt service payments over the next two years as a result of a repayment of a large loan from the Indian government, both debt service ratios remain well within the thresholds.

Stress Tests and Alternative Scenarios

6. Stress tests indicate vulnerability to exogenous export shocks. The PV of debt-to-GDP ratio, debt-to-exports ratio and debt service-to-exports ratios breach the thresholds under the most extreme standard stress test. For the former, the most extreme stress test is the combination shock—a one standard deviation shock to growth, exports, GDP deflator and non-debt flows—while in the latter two cases the most extreme shock is the export shock—an export value growth at historical average minus one standard deviation in 2010–11 relative to the 2008 baseline. This highlights the vulnerability of the economy to the variability of tourism receipts.

7. The historical scenario indicates unsustainable debt dynamics. When key macroeconomic variables are set to their historical averages all stock debt burden indicators breach respective thresholds, while the debt service burden indicators show an increasing trend after 2014. The key factor driving this scenario is the non-interest current account deficit, which averaged 20 percent of GDP over the 10-year period to 2008. This 10-year average contains three rather extreme events that drove the current account deficit to unprecedented highs: the 2004 tsunami, the extraordinary run-up in food and fuel prices in 2007 and 2008, and the rising fiscal deficit of the past few years. To the extent that the magnitudes of these events can be considered unique, the historical scenario may overestimate potential risks of debt distress. Nevertheless, the simulations illustrate that without significant fiscal consolidation the debt path would become unsustainable.

8. Private external debt may increase the risks to debt sustainability. Private external debt accounts for over one half of the external debt-to-GDP ratio. Much of this debt is at maturities of less than 10 years, at market interest rates, and denominated in U.S. dollars. To the extent that private external debt may increase liquidity and re-financing risks for the country as a whole, or entail contingent liabilities for the sovereign, the risks to debt sustainability could be higher than an analysis of external PPG data alone may suggest. Moreover, private external debt may be underestimated in Maldives: non-FDI external inflows to the non-financial private sector—which comprise mainly financing for privatization and tourism projects, and which sum to about 60 percent of GDP over 2009–2012—are treated as non-debt creating in both observed data and projections. Part of these flows, however, could be debt creating.8

9. In the staff’s view, the risk of public external debt distress for Maldives is moderate. With one exception, no external debt burden indicator breaches the thresholds in the baseline scenario. Staff judges the marginal and temporary breach in the external debt-to-GDP ratio to be a function of the severe fiscal and current account imbalances over the past two years that the program aims to address.9 The steady decline in external debt burden indicators under the program indicates that the risk of debt distress declines significantly with the proposed fiscal adjustment. However, stress tests illustrate that the debt path is particularly vulnerable to export shocks and decline in non-debt creating inflows, while the historical scenario shows unsustainable debt dynamics.

IV. Public Debt Sustainability

Baseline Scenario

10. The stock of Maldives’ nominal public debt has increased rapidly since the 2004 tsunami, from 55 percent of GDP in 2004 to around 69 percent in 2008, and is expected to reach 94 percent of GDP (including IMF loans and some transactions of financial entities) in 2009.10 This sharp increase has been driven by an expansionary fiscal policy combined with a dramatic shortfall in fiscal revenue. Much of the fiscal deficit over the next two years has been financed domestically, through MMA credit to the government (which in 2008 represented 75 percent of the central government’s domestic debt and 55 percent of the total public domestic debt stock) and sales of t-bills, held mainly by commercial banks. Total public debt service cost has remained at an average of 7 percent of GDP a year in 2003–2008, and is expected to increase to 17.2 percent by 2010 before shifting to a downward trajectory later in the projection period.

Maldives: Total Public and Publicly Guaranteed (PPG) Debt by Creditor

(In percent of GDP)

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Includes IMF and currency swaps by MMA, but excludes domestic foreign-currency denominated debt.

11. The PV of the public debt-to-GDP ratio is projected to fall sharply under the baseline scenario, from 91 percent in 2009 to 17 percent by 2029, owing to strong fiscal adjustment efforts on both the revenue and expenditure sides (Table 2a). The PV of the public debt-to-revenue (including grants) ratio would decline from a projected 252 percent in 2009 to 39 percent by 2029. The public debt service-to-revenue (including grants) ratio would increase to 28 percent by 2010 before shifting to a downward trajectory later in the projection period (Figure 2 and Table 2a). New public borrowing from all sources in the context of the program, including Fund financing, has been considered, and risks to debt sustainability appear manageable in the context of the programmed fiscal adjustment.

Stress Tests and Alternative Scenarios

12. Maldives’ high level of public debt makes its sustainability vulnerable to exogenous shocks or fiscal policy slippages. The stress tests indicate that the debt path is particularly vulnerable to shocks to the primary balance and long term growth. If the primary deficit remains fixed at the elevated level of 26½ percent of GDP (as in 2009), the debt ratio would continue to expand and would reach 416 percent of GDP by 2029. This, of course, illustrates that the current fiscal stance is not sustainable. It also points to the risks arising from insufficient or delayed implementation of the fiscal adjustment measures envisaged in the program. Sensitivity tests also show that the public debt path is susceptible to shocks to long-term real GDP growth, with a one standard deviation permanent shock to growth leading to a PV public debt ratio of 124 percent of GDP in 2029, compared with a baseline projection of 17 percent.

V. Conclusion

13. Maldives faces a moderate risk of external PPG debt distress. With the exception of a one-time breach in the PV of debt-to-GDP threshold in 2009, no thresholds are breached under the baseline scenario, but the analysis indicates the country’s vulnerability to shocks to the tourism sector (which are also shocks to growth), non-debt creating inflows and the primary balance. This suggests the need to diversify, to the extent possible within the country’s geographical constraints, the structure of the economy. Maldives also faces considerable risks to debt sustainability based on its overall public debt level. This underscores the need for strong fiscal adjustment: should the authorities fall short on their fiscal consolidation efforts, the risk of the public and external debt ratio moving on to an unsustainable trajectory would significantly increase.

Figure 1.
Figure 1.

Maldives: Indicators of Public and Publicly Guaranteed External Debt under Baseline and Alternative Scenarios, 2009-2029 1/

Citation: IMF Staff Country Reports 2010, 028; 10.5089/9781451825534.002.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 Combination shock; in c. to a Exports shock; in d. to a Combination shock; in e. to a Exports shock and in figure f. to a Combination shock
Figure 2.
Figure 2.

Maldives: Indicators of Public Debt Under Baseline and Alternative Scenarios, 2009-2029 1/

Citation: IMF Staff Country Reports 2010, 028; 10.5089/9781451825534.002.A002

Sources: Maldivian 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.
Table 1a.:

External Debt Sustainability Framework, 2006-2029 1/

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Includes both public and private sector external debt.

includes other non-debt creating flows.

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. Very large residuals come from errors & omissions.

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).

The government can contract up to 120 million USD in additional nonconcessional external debt from the beginning of the Fund-supported program to end-2010, as per the PCs on contracting and guaranteeing of new nonconcessional external debt.

Table 1b.

Maldives: 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.

Maldives: Public Sector Debt Sustainability Framework, 2006-2029

(In percent of GDP, unless otherwise indicated)

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Sources: Maldivian authorities; and staff estimates and projections.

Public debt refers here to the debt of the non-financial public sector, comprising the central government and state-owned enterprises, MMA’s currency SWAP and publicly guaranteed debt. Gross debt is used.

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.