Joint Debt Sustainability Analysis Under the Debt Sustainability Framework for Low-Income Countries

This paper presents Guinea’s 2011 Article IV Consultation and requests for a three-year arrangement under the Extended Credit Facility. The macroeconomic improvement in 2011 has been mainly owed to sharp fiscal adjustment. The deficit on the budget’s basic balance has been reduced from 13 percent of GDP in 2010 to an estimated 2.5 percent of GDP, while monetary financing of the budget has been avoided in an effort to reduce excess liquidity stemming from large central bank advances in 2009–10. Key medium-term challenges are to reduce inflation while preparing the economy for an expected substantial increase in mining activity.

Abstract

This paper presents Guinea’s 2011 Article IV Consultation and requests for a three-year arrangement under the Extended Credit Facility. The macroeconomic improvement in 2011 has been mainly owed to sharp fiscal adjustment. The deficit on the budget’s basic balance has been reduced from 13 percent of GDP in 2010 to an estimated 2.5 percent of GDP, while monetary financing of the budget has been avoided in an effort to reduce excess liquidity stemming from large central bank advances in 2009–10. Key medium-term challenges are to reduce inflation while preparing the economy for an expected substantial increase in mining activity.

I. Background

1. This DSA updates the analysis of the external and public debt of Guinea that was considered by the Board in December 2007.2 The 2007 DSA found that Guinea was in debt distress, as evidenced by the accumulation of external debt service arrears. Since then, Guinea has continued to accumulate arrears. In the baseline scenario, it is assumed that these arrears and debt service obligations falling due are rescheduled and debt service payments resume. In this case, the risk of debt distress would be high, although debt dynamics would improve over the medium and long terms.3 Staffs’ projections now include a new large mining project, which is expected to generate a significant increase in output growth and fiscal revenues. In addition, the projections assume Guinea will reach a new Paris Club agreement, following the approval of the proposed new ECF arrangement with the Fund.

2. Guinea reached the decision point under the Enhanced HIPC Initiative in December 2000, qualifying for US$545 million (in NPV terms) in debt relief. Since then interim debt relief has been provided intermittently by most major creditors, reflecting performance under the 2001 and 2007 ECF arrangements. Following the approval of the ECF arrangement in December 2007, Guinea concluded an agreement with Paris Club creditors in January 2008, and interim debt relief resumed. However, by 2008 the African Development Bank (AfDB) had exhausted resources allocated for interim debt relief, and in May 2008 interim relief from IDA stopped after the statutory limit was reached. Moreover, interim relief from Paris Club creditors was not activated during 2009–10, and was suspended by the IMF and other creditors following the military coup in December 2008.

3. At end-2010, Guinea’s public and publicly guaranteed external debt was US$3,144 million, or 64 percent of 2010 GDP. The level of debt in nominal terms has been broadly stable in recent years, reflecting a low level of new loans and debt service paid, but with arrears accounting for a growing share (amounting to 10 percent of end-2010 debt outstanding) Multilateral creditors accounted for 66 percent of the total, with the AfDB group and IDA accounting for almost four-fifths of the multilaterals’ share. Paris Club creditors accounted for 25 percent of total, while official bilateral non-Paris Club and commercial creditors made up the rest.4

4. External debt service arrears reached US$315 million at end-2010. Paris Club creditors accounted for 33 percent of the arrears and multilateral financial institutions for a further 30 percent, including 19 percent for IDA (there were no overdue obligations to the IMF). Arrears to the Paris Club members accrued on both pre-cut-off and post-cut-off debts; the cut-off date is January 1, 1986. HIPC interim assistance was discontinued by a majority of creditors in 2009–10. During 2011, the government cleared its arrears with all multilateral creditors, except the European Investment Bank, and resumed debt service payments to them.5

Guinea: Structure of External Public Debt (end-2010, nominal)

Text Table 1
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Sources: Guinea authorities, and AfDB, World Bank and IMF staff estimates.

5. Public domestic debt increased considerably in 2009–10, mainly reflecting advances by the central bank to the government. During the military regime, soaring expenditures were financed by borrowing from the domestic banking system. The liabilities of the government to the domestic banking system increased sharply from 13 percent of GDP in 2008, to 19 percent in 2009, and 30 percent in 2010. Some three-quarters of domestic debt were owed to the central bank, and the remainder in short-term treasury bills to domestic banks.

II. Baseline assumptions

6. The baseline macroeconomic framework assumes a sizeable expansion in economic activity, reflecting the impact of the start of large mining investments (Box 1). The baseline assumes political stability, sound macroeconomic management, prudent borrowing policies, and advancement in structural reforms over the medium term. It also assumes a substantial rise in public investment, especially in long-neglected infrastructure and the energy sector, as well as government support to develop agriculture and improve the business climate. These policies would provide a foundation for an increase in private investment, and would contribute to diversification of the economy and unlocking Guinea’s long-run economic growth potential. Risks with regard to the macroeconomic projections include renewed political instability, especially in the run-up to parliamentary elections expected in 2012, developments in the global economic outlook and mineral prices, and the possibility of projected mining production and revenues not materializing.

Macroeconomic Assumptions for 2011–31

Real GDP growth: Reflecting the political crisis, real GDP growth stagnated during 2009–10 before rebounding to 3.6 percent in 2011. Real output growth is projected to increase to almost 5 percent on average during 2012–14, reflecting investor confidence and the start-up of construction-phase activities in the mining sector. Growth is projected to jump to 18 percent on average during 2015–17, as production from a major mining project begins and ramps up. Once mining production reaches full capacity, growth tails off and after 2020 is expected to return to about 3 percent per year.

Mineral prices: For bauxite and gold, projections for 2012–17 are based on the Fund’s World Economic Outlook (WEO), and for the long-run an average annual price increase is assumed of 1 percent for bauxite and 2 percent for gold. The iron ore price projections are based on industry estimates, beginning 2015 when the SIMFER mine comes on stream (Text Figure 2). While WEO historical data for iron ore prices show a steady upward trend to 2009 and a very sharp increase in 2011, they are projected to subsequently decline by about 40 percent by 2015.

Inflation: As measured by the GDP deflator in U.S. dollar terms, inflation is projected to be around 3 percent in the long term, close to CPI inflation projections in Guinea and in neighboring countries.

Fiscal policy: Following a large deterioration in the primary balance in 2009–10, reaching 12 percent of GDP in 2010, a sharp policy-induced correction reduced it to 1.3 percent in 2011. Thereafter the primary deficit steadily declines and moves into surplus in 2023, leveling off at around 1.5 percent. Total revenues (excluding grants) are projected to rise from 15.3 percent of GDP in 2010 to 19.8 percent in 2014; thereafter revenues from the mining sector rise sharply as new production comes on line, although given the mining-related increase in GDP, revenues in terms of GDP rise only slightly. Following a sharp contraction, from 27.7 percent of GDP in 2010 to 22.4 percent in 2011, total primary expenditure rises to around 25.2 percent by 2016, reflecting a rapid pick up in capital expenditures, and then gradually falls to around 19 percent of GDP as capital expenditure level off and current spending as a share of GDP declines slightly.

External current account balance (excluding official transfers): The current account deficit is expected to expand sharply to 32.7 percent of GDP on average during 2012–15, as imports for the mega mining project ramp up during its construction phase. Subsequently, the current account swings into a small surplus by 2017 as mining sector investment declines and exports come on stream. In 2023 the balance moves back into deficit, rising gradually to about 3 percent by 2031 as mining exports and imports stabilize, while other imports continue to rise gradually.

External financing: After the suspension of virtually all official financing in 2009–10, loan and grant disbursements resumed in 2011 and are projected to reach 5 percent of GDP in 2012, of which half takes the form of grants. Although a scaling up is not foreseen, official financing is expected to continue at a relatively high level in the medium term, averaging 5 percent of GDP per year, and is assumed to provide financing for investment projects. Over time, the share of concessional loans is expected to decline, from 80 percent during 2011–15 to 60 percent during 2023–31.

Foreign direct investment: Net FDI is expected to surge temporarily to 32.8 percent of GDP per year on average during 2012–15, owing to the rapid buildup in mining related activities. Subsequently net FDI falls and over the long-run shifts between small net inflows and outflows. At the same time, net outflows on the income account increase, as the repatriation and distribution of profits from the mining sector rises.

Text Figure 2:
Text Figure 2:

Guinea: Mineral Prices Development and Projections

Citation: IMF Staff Country Reports 2012, 063; 10.5089/9781475502602.002.A003

Sources: Guinean authorities and IMF staff estimates and projections.

7. The baseline scenario assumes interim HIPC assistance from Paris Club creditors and the IMF. The debt burden would be reduced with attainment of a new Paris Club agreement, covering the period 2012–14, on terms similar to those in the 2008 agreement; 6 debt relief on comparable terms is assumed for other bilateral non-Paris Club creditors, including on arrears.

8. An important element underpinning the baseline macroeconomic framework and the surge in growth and mining exports is the SIMFER mining and infrastructure project. The development of the SIMFER iron ore mine7 also includes the construction of a railway and port to ship the iron ore. The ownership of the mining project and of the infrastructure project involves two separate consortia, both including the government, that are responsible for financing the total cost, estimated at about $13 billion (one-third mining and two-thirds for infrastructure) in proportion to each shareholder’s equity stake. The mine is projected to come on stream in 2015 and attain a maximum production capacity of 95 million tons by 2018. The government will receive a 15 percent stake in the mine at no cost. It also has options to hold an additional 20 percent fully-contributing stake in the mine and up to 51 percent in the infrastructure project. As of now the government has not exercised either of the options for fully-contributing stakes. In the baseline and the first alternative scenarios it is assumed that the government does not exercise these options, and/or that it arranges financing through a PPP operation in which investment cost is born by the private partner, with no contingent liabilities for the government. As a result, both projects would not generate a financing need and additional borrowing, which is unlikely to be available in the amounts needed (up to a maximum of about $4.6 billion) on concessional terms.

III. External Debt Sustainability under the Baseline Scenario

9. Under the baseline scenario, which assumes no HIPC completion point, Guinea is at high risk of debt distress (Table 1a, Figure 1a). At end-2011, the debt burden indicators related to PV of external debt are estimated to be above the policy thresholds. More precisely, the PV of external debt-to-GDP ratio is 41.3 percent (threshold: 30 percent); the PV of debt-to-exports ratio is 137 percent (threshold: 100 percent); and the PV of debt-to-revenue ratio is 234 percent (threshold: 200 percent). The indicators relating to debt service were just below the policy thresholds. In the baseline scenario, the PV of external debt-to-GDP and PV of external debt-to-exports ratios are projected to remain above the threshold for four years. Liquidity indicators embodying debt service fall, reflecting a strengthening of revenue collection and debt relief from the assumed Paris Club agreement, although the fall levels off as payments rise at the end of the consolidation period, and then decline rapidly to 2020 as deferred post-cut-off date arrears and debt service is repaid rapidly.

Table 1a.:

External Debt Sustainability Framework, Baseline Scenario, 2008-2031 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.

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 ρ = 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.

Guinea: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2011-2031

(In percent)

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Sources: Country authorities; and staff estimates and projections.

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.

Figure 1a.
Figure 1a.

Guinea: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2011-2031 1/

Citation: IMF Staff Country Reports 2012, 063; 10.5089/9781475502602.002.A003

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in 2021. In figure b. it corresponds to a Combination shock; in c. to a Combination shock; in d. to a Combination shock; in e. to a Combination shock and in figure f. to a Combination shock

10. Stress tests show that the external debt burden indicators are vulnerable to adverse shocks (Figure 1a). If the main economic variables remain at their historical level, and policy improvements and the expected growth dividend assumed under the baseline do not materialize, the PV of debt-to-GDP ratio would remain above the policy threshold until 2027, and thereafter follow a declining trend. The other debt burden indicators also deteriorate early in the projection period, exceeding their respective thresholds, before declining below their respective policy thresholds over the longer run. The indicators are also highly sensitive to exogenous shocks. Under most of the shocks considered in this analysis the debt burden indicators would deteriorate significantly,8 the shocks on exports and on non-debt creating flows (such as net foreign direct investment) are particularly important. This reflects the fact that the improvement in macroeconomic prospects depends heavily on the projected large inflow of foreign direct investments in the mining sector and related jump in mining exports.

IV. Public sector debt sustainability

11. The inclusion of domestic debt in the debt sustainability analysis worsens the debt burden indicators, although the domestic debt burden is expected to decrease over time. Following the large increase in borrowing from the domestic banking system in 2009–10, the authorities virtually eliminated new borrowing in 2011, and in 2012 there is no bank financing planned for the budget. In addition, net repayments of domestic debt are expected to continue in the future.9 As a result, the PV of public debt-to-GDP ratio (estimated at 51 percent at end-2011) is projected to decline in the medium term (Table 2a and Figure 1b).

Table 2a.

Guinea: Public Sector Debt Sustainability Framework, Baseline Scenario, 2008-2031

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Public sector refers to general government. This analysis uses net.

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 1b.
Figure 1b.

Guinea: Indicators of Public Debt Under Alternative Scenarios, 2011-2031 1/

Citation: IMF Staff Country Reports 2012, 063; 10.5089/9781475502602.002.A003

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in 2021.2/ Revenues are defined inclusive of grants.

12. The public debt position is vulnerable to shocks, particularly to policy reversals (Table 2b and Figure 1b). Under the fixed primary balance and the most extreme shock scenarios, the public debt burden indicators would be at least twice as high compared to the trajectories under the baseline scenario in the long term.

Table 2b.

Guinea: Sensitivity Analysis for Key Indicators of Public Debt 2011-2031

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Sources: Country authorities; and 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.