Togo: Third Review Under the Extended Credit Facility Arrangement and Request for Modification of Performance Criteria—Debt Sustainability Analysis

Third Review under the Extended Credit Facility Arrangement and Request for Modification of Performance Criteria-Press Release; Staff Report; and Statement by the Executive Director for Togo

Abstract

Third Review under the Extended Credit Facility Arrangement and Request for Modification of Performance Criteria-Press Release; Staff Report; and Statement by the Executive Director for Togo

PUBLIC DEBT COVERAGE

1. Togo public debt includes obligations of the central government and public entities. Debt data includes external and domestic obligations of the central government, including arrears and guaranteed debt, as well as external and domestic debt of state-owned enterprises (SOEs). Domestic debt is defined as debt denominated in franc de la Communauté Financière d’Afrique (FCFA), while external debt is defined as debt contracted or serviced in a currency other than the CFAF. The choice of coverage based on currency, rather than residency is due to the difficulty of monitoring the residency of creditors for debt traded in the WAEMU regional market.

Text Table 1.

Togo: Public Debt Coverage

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The default shock of 2% of GDP will be triggered for countries, whose government-guaranteed debt is not fully captured under the country’s public debt definition (1.). If it is already included in the government debt (1.) and risks associated with SoE’s debt not guaranteed by the government is assessed to be negligible, a country team may reduce this to 0%.

BACKGROUND ON DEBT

2. Public debt increased substantially during 2010-16, reflecting public infrastructure investments financed by both domestic and external borrowing. Total public debt exceeded 80 percent of GDP in 2016, up from 47 percent of GDP in 2010. A key driver of the increase in public debt was the rise in recourse to the regional financial market and investment pre-financing. The stock of government securities in the regional market increased from 15.2 percent of GDP to 28.8 percent between 2013 and 2016, with an increasing use of both Treasury bills and bonds. In addition, the stock of domestic arrears, which is included in domestic debt, remained relatively high during this period, amounting to CFAF 334 billion (12.6 percent of GDP) by end-2016.2

3. The government halted investment pre-financing and replaced the related obligations with bonds at more favorable conditions. Beginning in 2013, the government initiated a new financing tool that consisted of private sector contractors pre-financing public infrastructure development through domestic commercial bank loans to be repaid by the government. The ensuing debt obligations were not included in public debt. The pre-financing contracts were generally obtained through direct negotiations (instead of competitive bids). The government has now discontinued this problematic public financial management practice and has exchanged the outstanding obligations with bonds at a lower interest rate and longer maturity. The profile of domestic debt has been revised accordingly.

4. Following the fiscal consolidation started with the ECF program, total public debt begun to decline in percent of GDP in 2017, which continued in the first half of 2018. The fiscal consolidation initiated in 2017 was aimed at putting the debt-to-GDP ratio on a downward trajectory. By end-2017, total public debt dropped by 5.8 percentage points of GDP from the previous year, reaching 75.3 percent, and the domestic debt stock fell by 5.5 percentage points from 2016, reaching 55.5 percent. 3 By June 2018, total public debt declined to 75 percent of GDP. However, Togo still has the highest levels of total debt-to-GDP and domestic debt-to-GDP ratios within the WAEMU.4

Text Table 2.

Togo: Composition of Public Debt, 2013 - 2018

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Sources: Togolese authorities and Staff calculations.

Figures for 2013 and 2016 differ from the previous DSA, since borrowing from some lenders that was subsequently classified as commercial was instead reported as bilateral.

Includes SUKUK.

5. Togo’s external debt sustainability has been assessed as moderate in recent past with high overall risk of debt distress. While the external debt burden indicators have been below the thresholds in the baseline scenario, stress tests have indicated that thresholds could be breached if there are external shocks or abrupt changes in macroeconomic policies. The risk of overall public debt distress has been high because of Togo’s large public domestic debt.

BACKGROUND ON MACRO FORECASTS

6. The baseline macroeconomic assumptions for the present DSA rely on sustainable real GDP growth, price stability with inflation below the WAEMU criterion of 3 percent, improvement in external current account balance, and continuing fiscal discipline. The short-term growth projections have been lowered due to socio-political tensions putting the economy on an annual average growth rate of 4.7 percent over 2017-19. However, the recent public infrastructure investments are expected to enhance competitiveness and support growth, notably by helping increase productivity and fostering stronger private sector activity. This would drive potential growth over 2020-38 to reach an annual average of 5.4 percent. The overall primary balance (commitment basis, including grants) is anchored on a surplus of 1 percent of GDP over 2019-28, after which it would decrease and approach a deficit of 2 percent of GDP by 2038. Total PPG debt declines below the new benchmark (NPV of debt-to-GDP ratio of 55 percent) in 2021.5 The current account deficit is projected to converge at around 5 percent of GDP over the medium term, reflecting reduced imports related to public investments, and increase again to over 6 percent of GDP over the long term in line with growing public investment. Inflation is projected to remain well below the WAEMU regional convergence criterion of 3 percent.6

7. Togo’s debt is financed through a mix of domestic, regional and external markets. The authorities aim to deepen and diversify the domestic and regional creditor base, including through working with the regional institutions to develop the secondary bond market. In the regional market, the government has extended the range of debt instruments by placing Sukuk bonds. In 2017, for instance, budget financing needs were covered through recourse to regional money and financial markets, particularly through bond borrowing and Sukuk bonds, and to assistance from international development partners. The ECF program sets a zero ceiling on the contracting or guaranteeing of new non-concessional external debt. As of June 2018, given the ‘moderate’ risk of external debt distress, and to alleviate the heavy debt service burden, the program conditionality on non-concessional borrowing was modified on the basis that Togo can accommodate non-zero non-concessional borrowing limits if they are related to debt management operations and do not lead to an external risk rating downgrade. Even assuming a debt reprofiling operation in 2019, the program still aims at keeping Togo’s external debt burden indicators comfortably below 40 percent of GDP at end-December 2019. Nonetheless, despite any debt management operation, the ongoing fiscal consolidation needs to be preserved to fundamentally address the debt burden.

Main Assumptions in the Macroeconomic Framework

  • Real GDP growth is currently expected to be lower in the medium term while reverting gradually to its potential. Growth projections for 2017-19 were lowered to 4.7 percent due to continuing socio-political tensions in the country. For 2020-37, growth is expected to reach 5.4 percent on average, provided that the effects of the political shock dissipate and the current structural reforms bear fruit.

  • Public investment is estimated to have dropped to 6.3 percent of GDP in 2017 and is projected to reach 8 to 10 percent of GDP in the medium and long terms. External financing is expected to remain around current levels.

  • Key commodity price projections (i.e., for oil, phosphates, cotton, cocoa, and coffee) through 2023 are sourced from the WEO prepared in August 2018 and are assumed to remain constant in real terms for the remainder of the forecast period.

  • Inflation projections are the same in the medium term compared to the previous DSA. Average inflation declined to -0.7 percent in 2017 from 0.9 in 2016 primarily due to a sharp decline in food and energy prices, and possibly to slowing domestic demand. It is expected to increase slightly to 0.7 percent in 2018 and reach 2 percent in the medium-term, below the WAEMU convergence criteria.

  • Projections of total revenue including grants are broadly the same compared to the previous DSA and expected to be 23.2 percent of GDP for 2017-19. Provided that the effect of recent socio-political tensions on growth dissipate, revenue is projected to increase to 25 percent in the long term.

  • The overall primary fiscal balance (commitment basis, including grants) is expected to reach a deficit of 0.7 percent of GDP in 2018 down from a surplus of 1.5 percent in 2017, but with fiscal consolidation resuming in 2019. Over 2019-28, the overall primary fiscal balance (commitment basis, including grants) is anchored on a surplus of 1 percent of GDP, after which it would decrease and approach a deficit of 2 percent of GDP by 2038.

  • The current account deficit remains broadly the same as in the previous DSA at 8 percent of GDP in 2018. The balance will continue narrowing over the medium term, reflecting reduced imports of capital goods, reaching a deficit of about 5 percent of GDP in 2021.

    Foreign direct investment, which has been very volatile, is expected to stabilize around an inflow of 1.5 percent of GDP per year in the long run. However, these flows, as well as grants, are subject to significant risks, which may consequently alter the debt dynamics assumed in the baseline.

Togo: Key Macroeconomic Assumptions (DSA December vs DSA June 2018)

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Sources: Togolese authorities and Staff calculations.

Total revenue, including grants.

8. The realism of baseline scenarios for external and public debt do not indicate any peculiarity compared to cross-country distributions or Togo’s historical experience.

i. Drivers of debt dynamics. The evolution of projection of external and public debt to GDP ratios are consistent for the current and previous DSA vintages, while they reflect major deviations from the DSA from 5 years past. This is due to the fact that public debt ratio increased significantly post-2013 and reached the highest level by 2016 which raised sustainability concerns. In terms of projections, the ECF program which aims at putting debt on a sustainable path is the main driver of divergence between the current and previous DSA vintages, and the DSA prepared in 2013. The debt creating flows for external debt is mostly comparable with respect to projections and historical change, as well as distribution across LICs. However, the debt creating flows and unexpected change in debt stands out for Togo due to the structural changes required as part of the program which aims at significant fiscal adjustment, improvement in potential growth and major debt reduction. Going forward, primary balance and real GDP growth are key contributing factors for the change in the debt ratio (Figure 3).

ii. Planned fiscal adjustment. In comparison to the LICs that have requested Fund-supported programs, as these countries generally have faced a need to adjust their fiscal positions, Togo’s planned primary fiscal adjustment during 2018-20 is around the median of distribution implying that this realism do not flag any potential optimism (Figure 4).7

iii. Fiscal adjustment and possible growth path. While the ongoing program conditionality includes ambitious fiscal consolidation, both economic activities and the fiscal balance are projected to be weaker in 2018 than initially envisaged. In 2019, despite fiscal consolidation, growth performance is expected to slightly improve supported by the recent infrastructure upgrade that may boost productivity and encourage private investment. Therefore, the current-year fiscal expansion and projected consolidation do not lead to a significant deviation of the growth rate from its potential under a range of plausible fiscal multipliers (Figure 4).

iv. Public investment and growth. Public and private investment projections under the previous DSA and the current DSA do not deviate while projected contribution of public investment to growth is slightly lower than the historical average. The ongoing program aims at streamlining public investment while growth-enhancing structural reforms, including opening up some key sectors to foreign investors and improvement of the business environment, are expected to enhance domestic and foreign private investments (Figure 4).

COUNTRY CLASSIFICATION AND DETERMINATION OF SCENARIO STRESS TESTS

9. Togo’s debt carrying capacity is medium. The introduction of a composite indicator (CI), which captures the impact of various factors through a weighted average of an institutional indicator8, real GDP growth, remittances, international reserves, and world growth, shows that the debt carrying capacity has improved from ‘weak’ to ‘medium’ from the previous to the current DSA vintages. Following two consecutive designations in the new category, Togo’s debt carrying capacity is now reclassified to ‘medium’ in this DSA. The debt carrying capacity, in turn, determines the PPG external debt thresholds and total public debt benchmarks.

10. Standardized stress tests indicate that external debt is resilient while public debt is under distress. Under standardized stress tests, all PPG external debt indicators remain below the policy relevant thresholds in the external DSA (Table 3 and Figure 1). However, using the benchmark of 55 percent, PV of public debt to GDP only falls below the threshold in 2021 in the public DSA (Table 4 and Figure 2). Togo does not have prominent economic features such as natural disasters, significant reliance on commodity exports, market financing, etc. that require additional tailored stress tests or other modules. Regarding the contingent liability stress test, we use a default value of 5 percent for financial markets, but we tailor private-public partnership (PPP) debt at 6.8 percent of GDP and SOE debt at 0 percent of GDP given that it is already included in public debt (Text Table 1).

Text Table 3.

Togo: Debt Carrying Capacity and Applicable Thresholds

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EXTERNAL DEBT SUSTAINABILITY ANALYSIS

Baseline

11. Under the baseline scenario, all Togo’s external debt indicators continue to remain below their indicative policy-relevant thresholds (Table 1, Figure 1). The present value of PPG external debt is projected at 17.2 percent of GDP in 2018 and should decrease to 12.9 percent by 2038. The ratio will remain below the 40 percent threshold under the baseline throughout the projection period. 9 Similarly, debt service measures remain well below their respective thresholds and on a broadly downward trend. Improvements in debt-management practices envisaged in the authorities’ ECF-supported program will give further resilience to shocks affecting debt service needs (Figure 1).10

Alternative Scenarios and Stress Tests

12. Alternative scenarios do not reveal any breaches of relevant thresholds (Figure 1). Under the most extreme shock scenario, the present value of PPG external debt-to-GDP as well as PPG external debt-to-exports ratio remain below the relevant thresholds over the projected period. This is also the case for debt service-to-export and to-revenue ratios. A tailored stress test for the combined contingent liability shock also does not cause breach of relevant thresholds. Under the historical scenario, which sets key macroeconomic parameters to their 10-year historical averages, all indicators remain below their relevant policy dependent thresholds. except that the present value of debt-to-GDP breaches the threshold after 2024. These outcomes highlight the importance of sound macroeconomic policies.

PUBLIC DEBT SUSTAINABILITY ANALYSIS

13. The inclusion of Togo’s domestic public debt in the analysis emphasizes the vulnerability of the baseline scenario and leads to an assessment of high overall risk of debt distress for total public debt (Table 2, Figure 2). Togo’s domestic debt burden reflects persistent high deficits in recent years, recognition of government debt of accumulated liabilities from liquidated loss-making SOEs and arrears accumulation. Weak public fiscal management, including limited debt management capacity, has played a role in these developments. Domestic debt is projected to keep declining gradually from a record high of 61 percent of GDP in 2016. By the end of the projection period, repayment of arrears coupled with significant fiscal consolidation is expected to substantially reduce domestic debt and total PPG debt.

Baseline Scenario

14. Under the baseline and alternative scenarios, indicators of the overall public debt burden (external plus domestic) show significant vulnerabilities. The PV of public debt–to-GDP in 2017 stands above the benchmark level of 55 percent. The authorities’ ECF-supported program includes a substantial fiscal adjustment with a combination of spending restraint and revenue mobilization. The overall fiscal primary balance will reach 1 percent of GDP by 2019 and, if maintained, would allow Togo’s PV of total public debt-to-GDP to reach the new 55 percent benchmark by 2021 and to decline gradually below this benchmark thereafter (Figure 2). However, under the historical scenario and several standardized stress tests, the PV of public debt-to-GDP stays above the benchmark throughout all or most of the projection period as the country accumulates more debt to finance larger fiscal deficits. Such scenarios (essentially positing minor change from historic and present performance) highlight the risks to debt sustainability facing the authorities in the absence of needed policy reforms. A significant shock to SOEs could also result in the realization of contingent liabilities that could increase debt levels notably, though such risks are difficult to quantify.

RISK RATING AND VULNARABILITIES

15. Togo is assessed to remain at moderate risk of external public debt distress and high risk of overall public debt distress. Togo had the largest overall debt-to-GDP ratio in WAEMU in 2017, at 75.3 percent of GDP (72.1 percent excluding SOEs’ debt). The ratio of NPV of overall public debt-to-GDP stands above the prudential levels, remaining above such indicative benchmark through 2021—but on a steady declining trend, on the assumption of a continued fiscal consolidation path and substantial reduction in the domestic debt. For the external debt, under the baseline scenario, all PPG external debt sustainability indicators are expected to remain well below their indicative thresholds throughout the projection period (2018–28). However, the final rating of external debt distress is also influenced by the risk of overall public debt distress, which is judged to be high, and the external debt distress rating is therefore assessed to be moderate. The reason is that public debt distress and high overall debt service costs could lead to situations when the payment of external debt service is crowded out by priority primary spending and payment of domestic debt service.

AUTHORITIES’ VIEWS

16. The authorities broadly agreed with staff’s assessment of Togo’s public debt situation and recommendations on debt management policy. They concurred with staff that progress has been made in reducing the total public debt (as a share of GDP) since the inception of the ECF-supported program. Nonetheless, they recognized that Togo’s current level of debt is still the highest among WAEMU members and the overall risk of debt distress continues to be high, and hence, the fiscal consolidation must continue to bring public debt down to sustainable level. While the authorities highlighted the progress on debt management, they recognized that more improvements are called for. They intend to make full use of IMF technical assistance and training resources to strengthen their capacity in this area. The authorities reiterated that they would prefer to exclude public institutions from public sector debt considering that this debt does not represent a fiscal risk to the central government. Staff will review the definition of Togo’s public debt to ensure that the classifications used are in line with Fund guidelines.

Table 1.

Togo: External Debt Sustainability Framework, Baseline Scenario, 2015-38 (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.

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).

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

Historical averages are generally derived over the past 10 years, subject to data availability, whereas projections averages are over the first year of projection and the next 10 years.

Table 2.

Togo: Public Sector Debt Sustainability Framework, Baseline Scenario, 2015-38

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Coverage of debt: The central government, government-guaranteed debt, non-guaranteed SOE debt. Definition of external debt is Currency-based.

The underlying PV of external debt-to-GDP ratio under the public DSA differs from the external DSA with the size of differences depending on exchange rates projections.

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

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 and other debt creating/reducing flows.

Defined as a primary deficit minus a change in the public debt-to-GDP ratio ((-): a primary surplus), which would stabilizes the debt ratio only in the year in question.

Historical averages are generally derived over the past 10 years, subject to data availability, whereas projections averages are over the first year of projection and the next 10 years.

Table 3.

Togo: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2018-2028

(In percent)

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Sources: Country authorities; and staff estimates and projections.

A bold value indicates a breach of the threshold.

Variables include real GDP growth, GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Includes official and private transfers and FDI.