Benin: Joint IMF/World Bank Debt Sustainability Analysis 20101

International Monetary Fund

doi:10.5089/9781455203239.002.A002

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Benin: Joint IMF/World Bank Debt Sustainability Analysis 2010¹

Author: International Monetary Fund

Publication Date:: 08 Jul 2010

eISBN:: 9781455203239

Language:: English

Keywords:: ISCR; CR; deficit; ECF arrangement; financing; financing gap; real GDP; financing needs; long-term debt; debt risk profile; trajectory implication; Non-interest current account deficit; Debt sustainability analysis; Public and publicly-guaranteed external debt; Debt sustainability; Global; debt service payment ratio

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The goal of the last ECF arrangement (2005–09) was to support Benin’s strategy to achieve higher sustainable growth and reduce poverty while preserving macroeconomic stability and reducing vulnerabilities to external shocks. The program achieved most of its objectives. The main macroeconomic challenge ahead is to mitigate the impact of the crisis in the short term, while reaching higher sustainable growth over the medium term. The government’s economic program is geared properly to pursue these objectives. The structural reform agenda is appropriately ambitious.

Abstract

I. Background

1. Using the debt sustainability framework for low-income countries, this DSA assumes financing needs to be covered primarily with concessional external financing. Debt sustainability is assessed in relation to country-specific policy-dependent thresholds for debt stock and debt service burden.² This DSA is conducted on a gross basis.³

2. Benin’s risk of debt distress was classified as moderate in the previous DSA in June 2009. ⁴ Under the baseline scenario, all external debt indicators were projected to remain below their indicative thresholds over the long run. However, it was noted that debt ratios move rapidly toward the thresholds or breach them under less favorable scenarios.

3. 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 43.0 percent of GDP at end-2002 to 15.1 percent of GDP at end-2009.⁵ In line with this reduction, external debt service was reduced from 2.2 percent of GDP to 0.6 percent of GDP over the same period. At end-2009, 88.5 percent of the external public debt was to multilateral creditors and 11.5 percent to bilateral creditors.

4. Government borrowing from the regional market increased significantly since 2006. Outstanding regional government debt amounted to 11.1 percent of GDP at end-2009, compared to 1.5 percent at end-2006. This increase partly reflects the authorities’ interest in promoting the expansion of the regional debt market and, in 2009, the need to cover the financing gap. Borrowing conditions on this market are, however, nonconcessional and the authorities are committed to a prudent borrowing strategy. Domestic borrowing is therefore expected to decrease as share of GDP. Just over 40 percent of the regional public debt is accounted for by central bank secured bonds, while the remainder comprises treasury bills and securitized wage arrears.

II. Underlying DSA Assumptions

5. This updated DSA is affected by the weaker fiscal position in 2009. The higher deficit was financed both by external resources and increased borrowing on the regional market. In addition, the authorities have revised upward their estimation of non-cotton exports in 2008 and 2009, and recategorized financial inflows, which results in higher foreign direct investments from 2000 to 2005 compared to the previous DSA.⁶

6. Except for an update in the medium-term macroeconomic framework following the developments in 2009, 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: 1) key structural reforms aimed at enhancing competitiveness and growth would be adopted over the medium term,⁷ 2) the authorities would proceed with their plans to improve public infrastructure, and 3) 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 over the medium- to long-term, and average annual inflation would not exceed 3 percent in the long run, consistent with the assumptions of the World Bank Global Economic Prospects 2009 and the Benin Country Economic Memorandum.⁸

7. The fiscal deterioration in 2009 is expected to be partly reversed in 2010. Large expenditure overruns amid a weak revenue performance led to a widening of the overall fiscal deficit (on a payment-order basis) from 3.5 percent of GDP in 2008 to 7.3 percent in 2009. A strong fiscal adjustment effort, supported by measures aimed at strengthening revenue collection⁹ and controlling expenditure execution, are projected to reduce the overall deficit to 5.9 percent of GDP, and the basic primary deficit to 0.3 percent of GDP in 2010.

Box 1.

Macroeconomic assumptions

Medium term (2011-15): The projections are consistent with the macroeconomic framework of the IMF Article IV Consultation 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. A key assumption is that 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 gap in 2010, creating a fiscal cushion to contain the impact of the crisis without compromising debt sustainability. The analysis also assumes the implementation of structural reforms aimed at increasing efficiency and competitiveness and improving the business climate. As a result, after slowing down to 2 ½-3½ percent in 2009–10, real GDP growth is projected to recover to its long-term sustainable level of 6 percent, while fiscal prudence and the anchor of the fixed exchange rate peg are expected to keep inflation to below 3 percent. After the fiscal deterioration in 2009, the primary fiscal deficit would be reduced to 0.2 percent of GDP by 2015, reflecting improvements in public fiscal management and efforts to contain recurrent expenditures. The current account deficit is expected to narrow in the medium term as exports recover and the fiscal adjustment reduces the demand for imports.

Long term (2015-30): 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 following its growth potential;
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 and continued efforts to contain nonpriority recurrent expenditures, in particular the wage bill;
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 equivalent to about 2 percent of GDP per year.
Reflecting continued support from donors for Benin’s infrastructural development and reform efforts, about 60 percent of total gross financing needs are assumed to be covered by external grants.
Over the medium- and long-term, the DSA assumes that the authorities will continue to benefit from concessional borrowing mainly from multilateral donors, with a grant element equivalent to the average of the last 5 years.¹⁰
Reflecting the authorities’ commitment to a prudent borrowing strategy, government borrowing on the regional market is expected to decrease somewhat from 11.1 percent of GDP at end-2009 to 4.5 percent of GDP at the end of the period.
The real interest rate on domestic currency debt is expected to average just over 4 percent.

III. External DSA

8. Under baseline assumptions, all external debt and debt service ratio remain well below the policy-dependent thresholds throughout the projection period (Figure 1). The PV of external debt is projected to decline to just over 9 percent of GDP in the long run, and debt service payment ratios would remain below 3 percent. The PV of debt-to-exports ratio would remain well below the 150 percent threshold.

9. External vulnerability indicators worsen only slightly under standard stress test conditions. In particular, a shock to exports would lead to a marginal breach over three years of the threshold for the debt-to-exports ratio. However, all other indicators would stay under their respective thresholds with a large margin under the different alternative scenarios.

10. The risk of debt distress would increase markedly in the absence of structural reforms. The baseline scenario assumes GDP growth to average 6 percent in the long run, which is motivated by the continued implementation of structural reforms. Should these reforms not materialize, a “no reform scenario” characterized by slower real GDP and exports growth; as well as foreign direct investment and primary fiscal deficits close to historical averages, would lead to a breach of the debt-to-exports criteria by 2022.¹¹ Also the debt-to-GDP and the debt-to-revenue ratio would increase markedly over the long term.

11. This DSA also tests the debt trajectory implication of a limited amount of nonconcessional borrowing. In August 2009, the IMF Executive Board approved new guidelines on external debt limits in Fund supported programs.¹² The new framework moves away from a single design for concessionality requirements towards a more flexible approach, taking into account members’ debt vulnerabilities and their macroeconomic and public financial management capacity.¹³

12. In the classification of low-income countries for the purpose of debt limits conducted in December 2009, Benin was classified as a low capacity country. According to the new guidelines concessionality requirements for lower capacity countries will continue to apply on a debt by debt basis with a minimum concessionality requirement of 35 percent. However, a certain amount of nonconcessional borrowing could be exempted from this requirement provided that it does not push the country into a higher debt vulnerability category. Any such borrowing should only be undertaken to finance projects whose financial viability and profitability have been evaluated and approved by a reputable institution and be accompanied by continued strengthening of project selection systems and institutions.

13. Allowing for a limited amount of nonconcessional borrowing does not significantly alter the debt risk profile. Given the substantial margins from breaching any of the thresholds, and in line with the new guidelines on external debt limits, this analysis tests for a limited amount of non-concessional borrowing.¹⁴ The addition of CFAF 150 billion of nonconcessional borrowing during the period 2010-12 does not lead to any breach of the thresholds and, therefore, does not cause a change of debt vulnerability category.

IV. Public DSA

14. Public debt indicators are projected to decline somewhat over time (Figure 2). Under the baseline scenario, the debt-to-GDP ratio is set to fall to around 14 percent and the debt-to-revenue ratio to under 60 percent. The debt service-to-revenue ratio is expected to stabilize close to 3 percent in the long term.

15. Stress tests show a somewhat less favorable development. Under the most extreme shock scenario¹⁵ the debt-to-GDP would increase to 22 percent and the debt-to-revenue ratio to 89 percent, while the debt service-to-revenue would decrease somewhat to 4.6 percent by 2030. The stress test therefore shows the largest sensitivity to lower growth of GDP, which again underlines the importance of continued structural reforms.

V. Debt Distress Classification and Conclusions

16. Altogether, this DSA confirms that Benin faces a moderate risk of debt distress, which underlines the importance of proceeding with fiscal adjustment and structural reforms. The analysis highlights the need to address the fiscal slippages in 2009, and put the fiscal situation back onto a sustainable path over the medium term. The prompt implementation of structural reforms will also be critical to enhance growth, expand exports, attract foreign direct investments and contain the fiscal deficit, thus improving the long-term debt dynamics. The authorities should also continue to cover their financing needs primarily with external concessional assistance. However, given a large margin to the debt sustainability thresholds, a limited amount of nonconcessional borrowing could be accommodated without risking a marked change in the overall debt risk profile.

17. The authorities concur with the overall conclusions of the DSA, which is in line with their own debt sustainability analysis. As in the past, the authorities continue to be committed to a prudent borrowing strategy according to which financing needs will be covered primarily through the mobilization of grants and highly concessional borrowing, with only limited use of regional borrowing as a last source of financing. The authorities also share the view that a prudent fiscal policy will be necessary to preserve fiscal and debt sustainability over the medium- to long- term.

Table 1a.

External Debt Sustainability Framework, Baseline Scenario, 2007-2030 ^1/

(In percent of GDP, unless otherwise indicated)

Sources: Country authorities; and staff estimates and projections.

^{^1/}Includes both public and private sector external debt.

^{^2/}Derived as [r - g - ρ(1+g)]/(1+g+ρ-gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and p = growth rate of GDP deflator in U.S. dollar terms.

^{^3/}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. It does not include external project grants that are assumed to cover about 60 percent of total gross financing needs.

^{^4/}Assumes that PV of private sector debt is equivalent to its face value.

^{^5/}Current-year interest payments divided by previous period debt stock.

^6/Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

^{^7/}Defined as grants, concessional loans, and debt relief.

^{^8/}Gant-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 1a.

External Debt Sustainability Framework, Baseline Scenario, 2007-2030 ^1/

(In percent of GDP, unless otherwise indicated)

				Actual					Projections
				2007	2008	2009	Historical 0 Average 0	Standard Deviation	2010	2011	2012	2013	2014	2015	2010-2015 Average	2020	2030	2016-2030 Average
External debt (nominal) ^1/				11.7	16.7	15.1			16.0	17.4	18.5	19.5	20.3	21.1		17.5	13.3
	o/w public and publicly guaranteed (PPG)			11.7	16.7	15.1			16.0	17.4	18.5	19.5	20.3	21.1		17.5	13.3
Change in external debt				0.7	5.0	-1.7			0.9	1.4	1.1	1.0	0.8	0.8		-0.6	-0.3
Identified net debt-creating flows				3.8	3.4	7.3			5.2	5.3	4.4	4.0	3.7	2.4		2.5	2.6
	Non-interest current account deficit			9.6	7.9	8.3	6.6	2.1	7.6	7.4	7.0	6.7	6.5	5.2		5.3	5.4	5.3
		Deficit in balance of goods and services		15.5	13.3	14.5			13.6	12.3	12.0	11.6	11.2	11.7		12.6	14.9
			Exports	16.8	17.6	15.3			15.0	15.1	15.3	15.6	15.9	16.2		17.3	20.0
			Imports	32.4	30.9	29.8			28.6	27.4	27.3	27.2	27.1	27.9		30.0	34.9
		Net current transfers (negative = inflow)		-5.6	-5.4	-6.1	-5.8	0.8	-5.6	-4.5	-4.6	-4.5	-4.4	-6.0		-6.0	-6.0	-6.0
			o/w official	-2.8	-3.0	-4.0			-3.6	-2.4	-2.3	-2.2	-2.1	-3.0		-5.3	0.5
		Other current account flows (negative = net inflow)		-0.3	0.0	-0.1			-0.4	-0.4	-0.4	-0.3	-0.3	-0.5		-1.3	-3.5
	Net FDI (negative = inflow)			-4.7	-2.6	-1.4	-1.8	1.2	-2.2	-1.7	-2.0	-2.0	-2.0	-2.0		-2.0	-2.1	-2.1
	Endogenous debt dynamics ^2/			-1.2	-1.9	0.4			-0.2	-0.4	-0.6	-0.7	-0.8	-0.8		-0.8	-0.6
		Contribution from nominal interest rate		0.5	0.1	0.3			0.3	0.3	0.3	0.3	0.3	0.3		0.2	0.1
		Contribution from real GDP growth		-0.4	-0.5	-0.5			-0.4	-0.7	-0.9	-1.0	-1.1	-1.1		-1.0	-0.7
		Contribution from price and exchange rate changes		-1.2	-1.6	0.6			…	…	…	…	…	…		…	…
Residual (3-4) ^3/				-3.0	1.7	-8.9			-4.3	-3.9	-3.3	-3.0	-2.9	-1.6		-3.1	-2.9
	o/w exceptional financing			0.0	0.0	0.0			0.0	0.0	0.0	0.0	0.0	0.0		0.0	0.0
PV of external debt ^4/				…	…	10.8			12.2	12.9	13.6	14.2	14.7	15.2		12.6	9.2
	In percent of exports			…	…	70.4			81.3	85.7	88.9	91.2	92.6	93.8		72.5	46.2
PV of PPG external debt				…	…	10.8			12.2	12.9	13.6	14.2	14.7	15.2		12.6	9.2
	In percent of exports			…	…	70.4			81.3	85.7	88.9	91.2	92.6	93.8		72.5	46.2
	In percent of government revenues			…	…	58.6			59.1	63.2	64.9	66.7	68.9	71.2		56.6	41.6
Debt service-to-exports ratio (in percent)				2.8	-0.7	-0.2			6.5	5.7	5.4	5.1	4.1	3.3		3.8	2.6
PPG debt service-to-exports ratio (in percent)				2.8	-0.7	-0.2			6.5	5.7	5.4	5.1	4.1	3.3		3.8	2.6
PPG debt service-to-revenue ratio (in percent)				2.3	-0.6	-0.2			4.7	4.2	4.0	3.7	3.1	2.5		3.0	2.3
Total gross financing need (Billions of U.S. dollars)				0.3	0.3	0.5			0.5	0.5	0.5	0.5	0.5	0.4		0.6	1.4
Non-interest current account deficit that stabilizes debt ratio				8.9	2.8	9.9			7.3	6.0	5.9	5.7	5.6	4.4		5.9	5.6
Key macroeconomic assumptions
Real GDP growth (in percent)				4.6	5.0	2.7	4.2	1.1	3.2	4.4	5.5	6.0	6.0	6.0	5.2	6.0	6.0	6.0
GDP deflator in US dollar terms (change in percent)				11.9	15.3	-3.3	6.3	9.3	7.8	1.7	1.6	1.5	1.3	1.3	2.5	2.5	2.4	2.5
Effective interest rate (percent) ^5/				4.8	1.5	1.7	1.7	1.2	2.0	1.9	1.8	1.7	1.6	1.6	1.8	1.2	1.1	1.2
Gowth of exports of G&S (US dollar terms, in percent)				49.1	26.9	-13.8	11.6	19.0	9.1	7.0	8.6	9.6	9.4	9.4	8.8	10.2	10.2	10.2
Gowth of imports of G&S (US dollar terms, in percent)				56.9	15.7	-4.2	12.5	18.8	6.7	1.6	6.7	7.1	7.1	10.3	6.6	10.3	10.3	10.3
Grant element of new public sector borrowing (in percent)				…	…	…	…	…	37.5	36.1	34.0	33.4	33.6	33.4	34.6	32.7	32.7	32.7
Government revenues (excluding grants, in percent of GDP)				20.6	19.4	18.4			20.6	20.5	21.0	21.3	21.3	21.3		22.2	22.2	22.2
Aid flows (in Billions of US dollars) ^7/				0.2	0.1	0.2			0.4	0.4	0.4	0.4	0.4	0.4		0.6	1.3
	o/w Grants			0.2	0.1	0.2			0.3	0.3	0.3	0.3	0.3	0.3		0.4	1.0
	o/w Concessional loans			0.0	0.0	0.0			0.1	0.1	0.1	0.1	0.1	0.1		0.1	0.3
Grant-equivalent financing (in percent of GDP) ^8/				…	…	…			5.3	4.2	4.1	4.0	3.9	3.8		3.3	3.3	3.3
Gant-equivalent financing (in percent of external financing) 8/				…	…	…			88.2	69.9	69.0	68.7	70.0	70.6		76.7	76.7	76.6
Memorandum items:
Nominal GDP (Billions of US dollars)				5.5	6.7	6.7			7.4	7.9	8.4	9.1	9.7	10.5		15.9	36.4
Nominal dollar GDP growth				17.1	21.1	-0.7			11.3	6.2	7.1	7.5	7.3	7.3	7.8	8.7	8.6	8.7
PV of PPGexternal debt (in Billions of US dollars)						0.8			0.9	1.0	1.1	1.3	1.4	1.6		2.0	3.3
(PVt-PVt-1)/GDPt-1 (in percent)									2.1	1.5	1.6	1.7	1.6	1.6	1.7	0.6	0.6	0.6
Goss remittances (Billions of US dollars)				0.2	0.2	0.2			0.2	0.2	0.2	0.2	0.2	0.3		0.4	0.9
PV of PPG external debt (in percent of GDP + remittances)				…	…	10.5			11.9	12.6	13.3	13.9	14.4	14.8		12.3	9.0
PV of PPG external debt (in percent of exports + remittances)				…	…	59.9			70.6	74.2	76.6	78.8	80.3	81.4		63.4	41.0
Debt service of PPG external debt (in percent of exports + remittances)				…	…	-0.2			5.7	4.9	4.7	4.4	3.6	2.9		3.3	2.3