Chad: Staff Report for the 2012 Article IV Consultation—Debt Sustainability Analysis

INTERNATIONAL MONETARY FUND

Abstract

INTERNATIONAL MONETARY FUND

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INTERNATIONAL MONETARY FUND

November 30, 2012

Approved By Marcelo Giugale and Jeffrey Lewis (IDA), Mauro Mecagni and Dhaneshwar Ghura (IMF)

Prepared by the staffs of the International Development Association and the International Monetary Fund

Chad’s public domestic and external debt indicators have worsened since 2010 and the large amount of non-concessional borrowing contracted in 2011 entails a high risk of debt distress. The assumptions underpinning the debt sustainability analysis (DSA) have been revised from last year to reflect significant increases in projected oil production, prices, and related government revenues, and higher external borrowing. The latter reflects mainly the expected implementation of the $2 billion non-concessional Master Facility Agreement (MFA) signed with the Eximbank of China in August 2011. The updated baseline scenario shows that, if the MFA is implemented in its current form, all prudential thresholds will be breached within the projection horizon. An alternative scenario shows that all prudential thresholds would be observed if: (i) the MFA were concessional (with a grant element of 35 percent); (ii) it was implemented over ten years (instead of five); and (iii) other external borrowing was drawn mainly from concessional sources and its amount remained moderate.

Background

Recent Developments in Public External Debt

1. Chad’s external public debt burden indicators improved considerably in 2001–09, thanks to the strong oil-driven growth and low borrowing from abroad. Nonetheless, the drop in international oil prices in 2009 pushed the external public debt-to-GDP ratio from about 20 percent in 2008 to 23 percent in 2009, revealing Chad’s vulnerability to a negative oil price shock.

2. In 2010–11, the authorities borrowed abroad on non-concessional terms and external (public and publicly guaranteed) debt increased.1 As a result, the rate of debt accumulation (the year-to-year change in present value (PV) of debt relative to previous year’s GDP) spiked between 2009 and 2010–11, in part due to the low grant element of new borrowing (both from Libya and China). Because of a higher-than-anticipated recourse to external borrowing (including guaranteed debt) and despite a better-than-anticipated overall fiscal situation (a surplus of 1.6 percent of non-oil GDP), helped by the record-high oil revenues, the external public debt-to-GDP ratio exceeded 26 percent at end-2011 (compared to 24 percent anticipated in the 2011 DSA).

3. In August 2011, the authorities signed a Master Facility Agreement with the Eximbank of China (MFA). The MFA is an umbrella contract for individual facilities that would be activated to finance eligible projects for a total amount of up to $2 billion (or 18 percent of the 2012 GDP) over a five-year period. Projects to be funded under the MFA include: (i) a new international airport for N’Djamena; (ii) a gas power plant (100 MW); (iii) construction of 400–500 km of roads; (iv) a two-lane road bridge near N’Djamena; (v) cultivation of 20,000 ha of agricultural land; and (vi) a cement plant (with a capacity of 600,000 tons per year). The financial terms of the MFA are non-concessional. The borrowing terms include: (i) an interest rate of 1.5 percent; (ii) a risk fee of 4.0 percent (a top up of the interest rate); (iii) a management fee (upfront) of 0.6 percent on each individual facility; (iv) a commitment fee of 0.4 percent levied on the unutilized portion of each individual facility; (v) the limit on the tenor of each facility not to exceed 20 years; and (vi) a grace period of five years. The payment obligations under the MFA are collateralized on oil export receipts. Thus, the signing of the MFA is significantly affecting the baseline scenario which was retained by staffs in the 2011 DSA.

Text Table 1.

Chad: External Debt Stock at Year-End, 2001–2011

(Billions of CFA francs)

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Sources: World Bank, Chadian authorities, selected creditors and staff estimates. The end-2011 external public debt stocks are estimated by staff based on World Bank Debt Reporting System (DRS) end-2010 debt stock, Chad’s debt management office’s estimates of 2011 disbursements and amortization, and Ministry of Economy and Planning estimates of 2011 project loan disbursements. The official external debt stock data underestimate the actual level of external debt. Most notably, the debt registry captures the loan from Libya but not the associated debt service, and it does not capture the loans from China for the state’s stakes in the joint-venture refinery and in the Baoré cement factory, and other government-guaranteed debt. Also, project loan disbursements are recognized only after a long lag. Both text tables have discrepancies with corresponding fiscal or balance of payments flow estimates, giving rise to residuals in the sustainability analyses.

Status of Implementation of Debt Relief Initiatives

4. Poor macroeconomic policy performance prevented Chad from reaching the completion point under the Enhanced Heavily Indebted Poor Countries (HIPC) Initiative. Chad reached the Decision Point under the Enhanced HIPC Initiative in May 2001. Its inability to meet agreed fiscal targets and to implement a program under the IMF’s Poverty Reduction and Growth Facility (PRGF) was a principal obstacle to debt relief. The 2005 PRGF arrangement expired in 2008 without any reviews being concluded. Subsequent efforts to resume the path toward debt relief with the support of IMF Staff-Monitored Programs (SMPs) were also hindered by fiscal slippages and, more recently, by the decision to borrow externally in large amounts and on non-concessional terms. Furthermore, Chad has not shown a satisfactory implementation record under the poverty reduction strategy and progress towards other completion point triggers2 has either been slow or inconsistent (with early gains followed by backsliding).

5. Meeting the conditions for debt relief under the Enhanced HIPC Initiative and the Multilateral Debt Relief Initiative (MDRI) would help reduce external debt in half (in nominal terms). MDRI relief would cover the full stock of debt owed to three multilateral creditors (IDA, IMF, and the African Development Fund (AfDF)). In nominal terms, this could total over $1 billion and would imply a reduction in debt service of about $40 million per year, for about 30 years.3

Recent Developments in Public Domestic Debt

6. The stock of public domestic debt has grown, mainly as a result of drawing on central bank statutory advances and the sale of over CFAF 100 billion of five-year savings bonds. Chad’s domestic debt is estimated at about CFAF 474.1 billion (9½ percent of GDP) at end-2011. The stock of public domestic debt includes central bank statutory advances (avances statutaires); rescheduled debt (dettes conventionnées); legal payment obligations (engagements juridiques); and two public bond issues. In addition, CFAF 56.4 billion represent estimated short-term treasury arrears.4 In July 2011, the authorities completed a sale of over CFAF 100 billion of five year savings bonds with a 6 percent coupon.5

Text Table 2.

Chad: Public Domestic Debt Stock at Year-End, 2006–2011

(Billions of CFA francs)

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Source: Chadian authorities.

The 2011 stock is estimated based on data at end-March 2012.

Debt Burden Thresholds under the Debt Sustainability Framework

7. For the purpose of defining debt burden thresholds under the Debt Sustainability Framework (DSF), Chad is a weak policy performer. Chad’s rating on the World Bank’s Country Policy and Institutional Assessment (CPIA) is 2.48 on average for 2007–2011 (on a scale from 1 to 6), down from 2.88 in 2005 to 2.43 in 2011.

Text Table 3.

External Public Debt Burden Thresholds for “Weak Policy Performers” Under the Debt Sustainability Framew ork

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Source: 2012 IDA Country Performance ratings (methodology and results).

DSA Assumptions

8. Oil production and revenue: Chad’s medium- and long-term macroeconomic outlook is characterized by a temporary sharp increase in oil production in 2014–17 and a steady decline of oil production over the subsequent fifteen-year projection period (Box 1).6

  • Oil production is expected to rise from 120,000 bpd in 2011 to about 180,000 bpd in 2015–17. This second oil boom will likely be temporary; proven reserves in the new fields are much smaller than that in the original Doba basin and will also likely be nearly exhausted around 2030. Hence, oil production and exports are projected to decline steadily to negligible levels beyond 2030.

  • Chad’s oil trades below the WEO reference price, reflecting a quality discount and transport cost.7 For the medium term (five-year horizon) the price of Chadian oil is assumed to drop from $103.7 per barrel (all discounts included) in 2012 to about $83.6 per barrel in 2016–17, in line with the trend projected in the IMF’s World Economic Outlook (WEO). From 2018 onward, the price is assumed to increase 3 percent per year in U.S. dollar terms (consistent with the assumption used by the IMF in long-term projections for other sub-Saharan African countries).

9. Fiscal policy: The analysis assumes a buildup of financial savings in the medium term and a sustained fiscal adjustment throughout the entire projection in transition to the post-oil era. The increase in oil production is expected to lead to about $4 billion more in oil revenues for the government by 2017 than projected in the 2011 Article IV report, helping to maintain oil revenues above 25 percent of non-oil GDP until 2016. This would be sufficient to generate savings of about $2 billion by 2019, if the non-oil primary deficit (NOPD) is reduced from about 29 percent of non-oil GDP in 2012 to below 10 percent of non-oil GDP by 2019. Over the longer term, it is assumed that dwindling oil revenues will be offset by a steady decline of total government primary spending from 27 percent of GDP in 2012 to 18 percent in 2032 and the primary balance will be adjusted gradually to reach a small surplus by 2032. This sustained process of adjustment is expected to be achieved mainly by: (i) increasing non-oil revenues (from about 10 percent of non-oil GDP at present to over 15 percent of non-oil GDP by 2032); (ii) reducing total investment outlays from over 20 percent of non-oil GDP to below 10 percent of non-oil GDP; and (iii) cutting recurrent spending, notably, by eliminating exceptional security transfers and subsidies to public enterprises (at present, jointly accounting for about 9 percent of non-oil GDP).

10. The DSA analysis is conducted in two stages reflecting different external financing assumptions. First, a baseline (current policies) scenario reflects the stated intentions of the authorities to implement the MFA on current terms, and therefore assumes that the full amount ($2 billion) is disbursed within a five-year (2012–17) horizon. The baseline scenario also features continuation of the borrowing policy on non-concessional terms beyond the medium term, with gross disbursement of about 3½ percent of GDP per year (approximately the same level as projected for the MFA implementation period). Second, the analysis aims at determining the conditions under which the implementation of MFA would be consistent with debt sustainability. This alternative (prudent) scenario is consistent with the medium-term fiscal framework recommended by staff and presented in the staff report.

Macroeconomic Assumptions, 2012–2032

Baseline Scenario:

Real GDP growth is driven by a sharp growth of oil production in the next five years and a steady decline in oil production over the following fifteen years. Large foreign-financed investments (see below) are assumed to raise non-oil GDP growth in the medium term (6.5 percent in 2013–17). Beyond that, non-oil GDP growth is assumed to stabilize at about 5.0 percent in the long term. Inflation is assumed to stabilize at 3 percent, consistent with the CEMAC convergence criterion. The external current account will turn into a significant surplus in 2014–17, with the increase in oil exports and the drop in imports related to the development of the new oil fields. With the decline in oil exports, the external current account is projected to turn into a deficit.

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Sources: Chadian authorities; and IMF staff estimates and projections.

The fiscal outlook features an increase in oil revenues in the medium term and their decline in the long term. The authorities are assumed to reduce the NOPD to about 15 percent of non-oil GDP by 2017, and to generate savings up to $2 billion, needed as collateral for the MFA.

External financing: (i) a $2 billion MFA with the Eximbank of China on non-concessional terms and its implementation over 2012–17 (investments under the MFA are assumed to raise the non-oil GDP growth up by about one percentage point during the MFA implementation phase and by about 0.5 percentage point beyond 2017); (ii) external project financing (grants and loans) of 5.5 percent of non-oil GDP on average per year beyond 2017. Grants (mainly for social programs) are assumed to stay constant in real terms and will decline to about 1 percent of non-oil GDP by 2030. Loans are assumed to be increasingly from non-traditional (non-Paris Club) creditors, resulting in a decline of the average grant element of borrowing. In the absence of an IMF arrangement, HIPC and MDRI debt relief for which Chad is eligible are not taken into account.

Domestic financing: reimbursements of BEAC statutory advances by 2022 (as per the newly revised agreement) and the 2011 savings bond ( Emprunt obligataire) by 2016. Additional domestic debt is assumed to be issued to meet the residual financing needs during the period when a portion of oil revenue is being set aside as collateral for the MFA. As a result, gross domestic debt rises from 9.5 percent of GDP in 2012 to about 11.5 percent in 2017.

Alternative Scenario:

Growth and inflation profile is broadly the same, with some differences in the first ten years reflecting mainly the implementation of the MFA over ten years (instead of five). The fiscal outlook features the same degree of consolidation over the medium term in NOPD terms (a maximum feasible rate of 2–3 percent of GDP per year). External financing assumptions: (i) MFA with no collateral requirement and on concessional terms (grant element of 35 percent); (ii) borrowing beyond MFA is also assumed to be on concessional terms with borrowing scaled back to approximately a half of the amount projected under the baseline. Since savings are not assumed to be related to the collateral requirements under the MFA, financing needs are met with lower additional domestic borrowing, such that gross domestic debt is projected to decline to 6 percent of GDP by 2017.

External Debt DSA

Baseline (Current Policies) Scenario

11. The evolution of external debt is driven by the large volume of project loans, including the MFA. Going forward, new borrowing is expected to be dominated by non-concessional project financing, mainly from commercial or non-Paris Club official sources. This is predicated on the assumption that, absent a substantial improvement in macroeconomic and public financial management performance, traditional donors (multilaterals and Paris Club) will likely continue to provide roughly the same very low amount of concessional loans (compared to other SSA countries), mainly for humanitarian and development projects. During the period of MFA implementation, the average concessionality of new borrowing (assuming a discount rate of 3 percent) would turn negative and stay so through the projection period (Figure 1a).

12. The comparison of the current baseline scenario with the baseline featured in the 2011 DSA reveals large differences reflecting a significant change in Chad’s borrowing policy (Figures 57). This change was anticipated by staffs in the 2011 DSA. It was presented in a customized alternative scenario featuring large non-concessional borrowing for public investment projects and drawing attention to the need for proper assessment of their consequences for debt sustainability. The signing of the MFA confirmed the importance of the risks anticipated by staffs in 2011.

13. Under the baseline scenario, all external indebtedness indicators exceed their critical thresholds, indicating a high risk of debt distress. The present value of external public and publicly- guaranteed debt exceeds the 30 percent of GDP threshold starting in 2016 through the end of the projection horizon (Figure 1b). With the projected steady decline in oil exports beyond the 2013–16 horizon, the PV of debt and debt service is expected to rise relative to exports, with the former projected to exceed the critical threshold starting in 2018, and the latter in 2026. Both indicators would remain above thresholds through the end of the projection period (Figures 1c and 1e). Similarly, the PV of debt and debt service in percent of revenues exceed their respective thresholds in 2022 and 2025, respectively (Figures 1d and 1f).

Stress Tests

14. Under the shock scenario assuming that key macroeconomic variables will remain at their ten- year average values, the debt burden indicators would quickly breach the sustainability thresholds. This suggests that if the authorities were to incur current account deficits far higher than foreign direct investment (FDI) inflows in the oil sector (e.g., as they did in 2010, when they ran down their official foreign exchange reserves), all three PV-based indicators would quickly breach the applicable thresholds by very high margins (Historical Scenario in Figure 1b, c, d; and Scenario A1 in Table 3b).

15. Chad’s external debt burden indicators are also highly sensitive to a negative shock to exports (e.g., an oil price shock). Across all indicative debt burden thresholds, the most extreme shock is a drop in export growth in 2013–14 (i.e., proportional to a two-standard-deviation lower oil price) (Most extreme shock in Figure 1 and B2 Bound Test in Table 3b); debt would be on a path breaching all indicative debt burden thresholds.

16. Finally, a customized stress test shows that borrowing for other contemplated large capital projects (beyond the 2011 MFA) would increase even further the risk of debt distress. In addition to the $2 billion MFA (signed in August 2011), the authorities have signed a letter of intent with a Chinese contractor for construction of an extensive railroad connection ($7 billion) linking through Chad the Cameroon and Sudan networks. A customized analysis by staff shows that if the railway project started in 2014 and was implemented over the next 10 years in addition to the projects covered in the 2011 MFA, and with no reduction in the baseline level of spending and borrowing, the PV of debt-to-GDP path would breach the 30 percent threshold in 2014 and peak in 2023 at 78 percent, implying a significantly increased risk of debt distress (Figure 1g). All critical thresholds would be breached under the usual commercial terms (5.5 percent interest rate, 5 years grace period, 20 years maturity) and also under the most concessional terms (36 percent grant element; 1.5 percent interest rate, 5 years grace period, 20 years maturity).

Figure 1g.
Figure 1g.

Chad: Present Value of Public and Publicly- Guaranteed External Debt

(Percent of GDP)

Citation: IMF Staff Country Reports 2013, 087; 10.5089/9781484307168.002.A002

Sources: Chadian authorities; and staff estimates and projections.

Alternative (Prudent) Scenario

This scenario is tailored to preserve debt sustainability. To this effect, it is assumed that $2 billion under the MFA would be disbursed over ten years, starting in late 2012. The MFA is assumed to be concessional, with a grant element of 35 percent. The analysis shows that the projected decline in exports beyond the medium term is the most stringent constraint on Chad’s capacity to borrow. To make room for the disbursements under the MFA and, at the same time, ensure that the PV of debt-to-exports ratio remains below 100 percent, other borrowing would need to be scaled back to about one-third of the amount assumed in the baseline scenario even if the grant element of new borrowing is about 20 percent (Figure 3a). With this constraint satisfied, all other indicators remain below their critical thresholds. However, even in that case, shock scenarios point to a moderate risk of debt distress, which must be mitigated by prudent fiscal policy, and by maintaining an adequate savings cushion to ensure debt service capacity in case of a sudden loss of oil revenue.

Public Debt DSA

17. The consideration of domestic debt does not alter fundamentally the assessment of Chad’s debt sustainability. Given the moderate size of Chad’s domestic debt, the baseline adjustment in the non-oil primary balance, and expected oil revenues, the public debt indicators are driven mainly by the external debt component, indicating a high risk of debt distress. The domestic debt component would increase from 9.5 percent of GDP in 2011 to 16.1 percent of GDP in 2032, reflecting the increased residual financing needs, as the portion of oil revenues used as collateral is not available for budget financing. Altogether, the public debt stock increases gradually from about 36 percent of GDP in 2011–12 to 53 percent of GDP in 2032.

18. Stress tests confirm that the current fiscal stance is not sustainable. Even with ample oil revenues, and assuming that financing could be secured, the resulting debt path would increase steeply, leading to an unmanageable debt and debt-service burden (Fixed Primary Balance Scenario in Figure 2). A temporary shock to real GDP growth in 2013–2014 would also impair public debt sustainability (Most Extreme Shock in Figure 2 and Bound Test B1 in Table 2a).

The Authorities’ Views

19. The authorities expressed interest in debt relief through the HIPC process. They urged consideration of Chad’s special post-conflict circumstances, the importance of public investment in infrastructure to long-term growth, and the need for debt relief to create fiscal space for additional development spending (including foreign-financed). At the same time, the authorities are determined to pursue an accelerated development strategy financed through foreign borrowing on non-concessional terms and secured through oil receipts.

20. The authorities downplay concerns about the debt sustainability implications of the MFA. They consider that new oil developments will generate a cash flow sufficient to meet debt obligations under the MFA. The authorities also believe that the contemplated investments will have significant positive economic externalities that would help sustain non-oil growth at a level higher than 5 percent per annum assumed in the DSA projections. The authorities intend to pursue their own debt sustainability analysis, with consultants, to assess the fiscal space for debt-financed public investment.

Debt Distress Classification and Conclusions

21. In staff’s assessment, despite improved oil production and revenue prospects in the next few years, Chad faces a high risk of debt distress. The DSA suggests that under the baseline (current policies) scenario Chad’s overall public and external debt dynamics are not sustainable. This is due to the significant increase in public external debt over the medium term, reflecting the implementation of the MFA on non-concessional terms and continuation with large amounts of non-concessional borrowing for other public investment projects. In this scenario, all public and publicly-guaranteed external debt and debt service indicators breach the critical thresholds. This conclusion holds even if the hypothetical growth impact of the associated projects is taken into account and the underlying fiscal position is assumed to be adjusted to help set aside funds needed to collateralize the disbursements under the MFA.

22. An alternative (prudent) scenario shows that all indicative thresholds would be observed if the MFA were implemented over ten years and on concessional terms. However, to make room for the MFA, all other borrowing would also need to be mostly concessional and its amount scaled back to about a half of the amount projected in the baseline scenario. Even in this case, the DSA underscores Chad’s sensitivity to shocks, especially an oil price shock, and stress test results remain a source of concern.

23. Progress toward the HIPC completion point (including the improvement in the CPIA score) would substantially reduce Chad’s debt vulnerabilities. However, given the current weak record for fiscal policy implementation and the non-concessional nature of the MFA with the Eximbank of China, prospects for re-embarking on the path to debt relief under the HIPC process are remote.

Figure 1.
Figure 1.

Chad: Indicators of Public and Publicly Guaranteed External Debt Under Alternatives Scenarios, 2012–2032 1

Citation: IMF Staff Country Reports 2013, 087; 10.5089/9781484307168.002.A002

Sources: Country authorities; and staff estimates and projections.1 The most extreme stress test is th e test th at yields th e h igh est ratio in 2022.2 Revenue is defined inclusive of grants.
Figure 2.
Figure 2.

Chad: Indicators of Public Debt Under Alternative Scenarios, 2012–2032 1

Citation: IMF Staff Country Reports 2013, 087; 10.5089/9781484307168.002.A002

Sources: Country authorities; and staff estimates and projections.1 The most extreme stress test is the test that yields the highest ratio in 2022.2 Revenue is defined inclusive of grants.
Table 1.

Chad: Public Sector Debt Sustainability Framework, Baseline Scenario, 2009–2032

(Percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estim ates and projections.

[Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or 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.

Revenue excluding grants.

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

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

Table 2.

Chad: Sensitivity Analysis for Key Indicators of Public Debt, 2012–2032

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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.

Revenue is defined inclusive of grants.

Table 3a.

Chad: External Debt Sustainability Framework, Baseline Scenario, 2009–2032 1

(Percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections. 0

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 chan

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 3b.

Chad: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2012–2032

(Percent)

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Sources: Country authorities; and staff estimates and projections.

Variables include real GDP growth, growth of GDP deflator (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.