Benin: Third Review Under the Extended Credit Facility Arrangement and Request for Waiver of Nonobservance of Performance Criterion—Debt Sustainability Analysis

Third Review Under the Extended Credit Facility Arrangement and Request for Waiver of Nonobservance of Performance Criterion-Press Release; Staff Report; and Statement by the Executive Director for Benin

Abstract

Third Review Under the Extended Credit Facility Arrangement and Request for Waiver of Nonobservance of Performance Criterion-Press Release; Staff Report; and Statement by the Executive Director for Benin

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

1. Benin’s public debt has been on a rising path since 2014. Total public debt (external plus domestic) increased from 30.5 percent in 2014 to 54.4 percent in 2017.2 The increase was primarily due to higher domestic debt, which tripled over three years, growing from 10.6 percent of GDP in 2014 to 32.4 percent of GDP in 2017. As for external debt, the increase was relatively small (2.2 percent of GDP) over the same period, reaching 22.0 percent of GDP in 2017.

2. Domestic public debt has recorded a steady increase driven by the public investment scaling-up. Starting in 2017, the authorities have undertaken an investment scaling-up plan with the aim of addressing infrastructure bottlenecks and accelerating growth. The government adopted a public investment envelope of CFAF 1,400 billion (equivalent to 26 percent of 2017 GDP) to be spent over a period of three years. The investment started off high in 2017 at CFAF 500 billion and is expected to decrease gradually to CFAF 450 billion in 2019. Over 2015-17, the authorities have increasingly relied on the domestic and regional financial market to finance public investment projects at non-concessional terms.

3. The debt service burden is relatively high in Benin. The ratio of debt service to revenue stands at 66 percent in 20183 and is expected to decrease around 37 percent on average in the medium term and 25 percent in long run. By comparison, the debt service is projected to account for 28 percent of revenue, on average, in WAEMU countries and 21 percent in all low-income developing countries in 2018.

4. Fiscal risks also arise from state-owned enterprises (SOEs), which entail contingent liabilities for the government.4 The Beninese authorities have made some progress in monitoring SOEs debt in recent years. They have collected information on all 22 SOEs and 140 autonomous agencies to assess their indebtedness. Such exercise allowed the authorities to measure the debt of state-owned companies to commercial banks. However, further work is needed to identify and analyze other SOEs liabilities and increase the debt coverage in the next DSA5. Few enterprises submit their budgets and financial statements to the government as required by law, making it challenging to monitor accurately SOEs debt. Also, public enterprises continue to weigh on the government budget. Over 2014-2017, they contributed – taxes, fees, and dividends – 0.3 percent of GDP to the national budget and, in return, received 1.5 percent of GDP in grants and subsidies. Ad hoc cross-debt offsetting settlements between the government and these enterprises, and their poor economic and financial performances are the main drivers of the reliance of SOEs on public resources. To address some of these issues, the authorities are in the process of adopting a new law on SOEs that aims at improving their governance and indirectly their economic and financial performance.

5. Another risk to the public debt trajectory relates to the ongoing audit about the stock of unpaid claims held by the private sector on the government. The authorities are in the process of preparing an audit to estimate the stock of unpaid services provided by suppliers (the payments were made outside the traditional budget cycle). The audit will be available at the beginning of 2019. If some of these claims are considered as arrears by international statistical standards, they will have to be included in the 2019 debt stock. However, the amount at stake is likely to remain limited, since the total amount of claims is 0.9 percent of GDP. To account for this risk, the public debt sustainability analysis includes a scenario with a contingent liability shock equivalent to 0.9 percent of GDP.

6. Borrowing conditions eased substantially on the WAEMU financial market in the first half of 2018. Due to lower demand, subscription rates for sovereign securities’ auctions recovered in the second quarter of 2018. The average subscription rate rose to 104 percent in the second quarter of 2018, up from 69 percent in both the first quarter of 2018 and second quarter of 2017. This is due to a sharp decline in sovereign demand for financing on the regional debt market, following the tapping of international markets in March 2018 by Côte d’Ivoire and Senegal. The average yield curve flattened for all sovereigns that accessed the regional financial market in the first half of 2018. Renewed liquidity pressures are not anticipated for the remainder of 2018.

Text Figure 1.
Text Figure 1.

Benin: Central Government Debt 2010–17

(in percent of GDP)

Citation: IMF Staff Country Reports 2018, 364; 10.5089/9781484389911.002.A002

Sources: Authorities’ data and staff calculations.

Structure of Debt

7. In the Debt Sustainability Analysis (DSA) of Benin, public debt covers both the debt of the central government as well as the guarantees provided by the central government. Due to data availability constraints, the debt of SOEs and subnational governments are not included in the baseline analysis but are captured in the contingent liability shock. The DSA of Benin classifies external and domestic debt based on the currency criterion.6 Debt to the IMF owed by the Central Bank is included in external debt.

8. Benin’s external public debt is essentially owed to multilateral and bilateral creditors. Since 2016, Benin’s external public debt has been outweighed by domestic debt and represented at end 2017 about 40 percent of total debt. The external public debt, essentially owed to multilateral and bilateral creditors, is most of the time provided on concessional terms. Only 5 percent of the current external debt stock is non-concessional (as of October 2018).

9. Domestic public debt is dominated by government securities issued in the regional financial market. Benin’s domestic public debt has increased significantly since 2014, driven mainly by the increasing reliance on the regional bond market to raise funds. About 75 percent of domestic liabilities consist of government securities issued on the regional financial market. Such debt is non-concessional and is associated with roll-over and interest rate risks.

Debt Reprofiling Operation1

The authorities conducted a debt reprofiling operation in October 2018. The government borrowed from an international private bank EUR 260 million (equivalent to 3 percent of GDP) with a guarantee provided by the World Bank. The funds were used to buy back domestic syndicated loans, including a loan owed to a regional development bank. The operation was done on a voluntary basis. The government did not pay any penalty or other type of fee (no contract, except the one with the regional development bank, included early-repayment penalties2).

The main purpose of the operation was to lower and spread out debt service costs. The operation replaced costly and short-maturity domestic debt (with an average interest rate of 7 ½ percent and a residual maturity of 5 ½ years) with external debt at better conditions (interest rate of 3 ½ and 12-year maturity). Text Table 1 illustrates the medium-term gains generated by the reprofiling, which are significant in light of the overall size of the debt exchange. The effect on the debt service is initially beneficial over 2018-2022, and then becomes negative over 2023-2030 (when the external debt with longer maturity is repaid). Overall, there is a net positive gain over the whole period.3

Another advantage of the debt reprofiling is the injection of liquidity in the domestic banking sector. This liquidity will be partly used by banks to grant additional loans to the private sector. The operation’s first round impact on regional reserves will also be positive.

1Given that the loan is denominated in Euro and that there is a fixed exchange rate between Euro/CFAF, this box does not consider the foreign exchange risk.2The regional development bank waived the penalty in the context of negotiations with the Beninese government.3The finding that the overall effect is positive continues to hold, even after considering the opportunity cost related to the use of the International Development Association (IDA) allocation. Indeed, $45 million out of the $60 million IDA allocation was used to guarantee the external loan but this amount could have been used otherwise to finance the budget of Benin on concessional terms.
Text Table 1.

Benin: Impact of The Debt Reprofiling on Public Debt Service

(in CFAF million)

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Sources: Beninese authorities and IMF staff calculations.

Data are computed on a cumulative basis.

Text Table 2.

Benin: Structure of External Debt, Projected at end 2018

(in CFAF billion)

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Sources: Beninese authorities and IMF staff calculations.
Text Table 3.

Benin: Structure of Domestic Debt, Projected at end 2018

(in CFAF billion)

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Sources: Beninese authorities and IMF staff calculations.

Background on Macroeconomic Forecasts

10. Macroeconomic assumptions have been updated compared to the December 2017 DSA. The main changes relate to the primary balance, the non-interest current account balance and the real GDP growth for the medium term (Text Table 4).

  • The 2019 real GDP growth forecast was revised up (from 6.3 to 6.5 percent) to reflect a stronger contribution of private sector investment and external demand to growth. Medium-term prospects remain strong, because of the booming cotton production, the lagged effect of the public investment scaling-up, and the recovery of Nigeria.

  • On the fiscal front, the medium-term primary surplus has been revised downward due to more conservative revenue projections, motivated by the shortfall of tax revenues in the first semester of 2018 as well as more prudent assumptions related to the potential gains of revenue administration reforms in the future. The primary surplus is estimated at 0.4 percent of GDP on average in the period 2019-23 compared to 0.9 percent in the previous DSA.

  • The non-interest current account deficit is expected to decline gradually in the medium to long term, thanks to better exports resulting from higher cotton production. Imports should also remain contained due to the scaling-down of public investment.

11. Risks to the baseline are to the downside. On the fiscal position, the main risks include extra spending pressures related to the 2019 and 2020 elections as well as failures to implement key reforms, in particular in the area of revenue administration and the elimination of tax expenditures. On growth, achieving the expected performance will require that the authorities rigorously implement structural reforms that aim at improving business environment and governance. A delay in the expected recovery in Nigeria would also have a negative effect on trade and growth.

Text Table 4.

Benin: Macroeconomic Projections

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Sources: Beninese authorities and IMF staff calculations.

Country Classification and Determination of Scenario Stress Tests

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Note: Until the October 2018 WEO vintage is released, the previous vintage classification and corresponding score are based solely on the CPIA per the previous framework.

Applicable Thresholds

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Cut-off Values of the CI

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Calculation of the CI Index

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Realism Tools

12. The growth projections for 2018 and 2019 are more optimistic than the growth path predicted by the growth and fiscal adjustment tool (Figure 4). Preliminary data for the first half of the year confirm the 2018 growth projection. More generally, the deviation between baselines projections and the growth path with LIC’s typical multiplier of 0.4, can be explained by several factors:

  • The authorities are implementing an ambitious investment scaling plan, which is expected to peak in in 2017-18. Given the traditional long lags of investment multipliers, we expect the positive growth effects to persist at least until 2019.7

  • The revitalizing of the cotton production (a record high growth of 67 percent and 33 percent of cotton production, in 2016 and 2017 respectively) will be transmitted to the secondary sector in 2018 through the ginned cotton activity, as well as higher export revenues. The cotton activity should remain dynamic in 2018, impacting exports revenue and growth in 2019.

  • A number of large infrastructure projects of the PAG are expected to start in 2019.

  • The Nigeria’s economy is projected to accelerate in 2018 and 2019.

13. The fiscal adjustment path is assessed to be realistic despite being in the upper end of the historical distribution. Fiscal consolidation is expected to amount to about 4 percent between 2017 and 2020. This is high by historical standards (Figure 4). However, the adjustment will be mostly achieved through a scaling down of public investment, which increased by about 3 percent of GDP between 2016 and 2017-18 and will revert to its 2016 level in subsequent years.

Risk Rating and Vulnerabilities: External Debt Sustainability Results

14. The external debt burden indicators remain below the policy-dependent thresholds in the baseline, but the ratio of the present value of external debt to exports exceeds its threshold in the case of an extreme shock to exports. In the baseline, all debt indicators remain below their relevant policy-dependent thresholds. The PV of total PPG external debt is expected to stabilize at about 21 percent of GDP on average over 2019–23, achieving 13.5 percent of GDP in 2038. Thus, the ratio would remain below the corresponding threshold of 40 percent of GDP throughout the projection period. Nonetheless, one indicator—the ratio of the PV of external debt to exports—exceeds its threshold in the case of an extreme shock to exports, while the debt-to-GDP ratio and all debt service indicators remain below thresholds. This breach is what motivates the assessment of moderate risk for external debt.

Risk Rating and Vulnerabilities: Public Debt Sustainability Results

15. Total PPG debt (external plus domestic) remains below its respective benchmark in all scenarios. Total debt does not show any breach in baseline and shock scenarios. However, the past evolution and size of domestic debt, the relatively high ratio of debt service to revenue, as well as the existence of contingent liabilities of SOEs and the moderate risk of external debt distress motivate the assessment of a moderate overall risk of debt distress.

Conclusion

16. The updated DSA confirms that Benin stands at moderate risk of external and overall debt distress. The ratings are unchanged relative to the Staff Report of March 2018 (EBS/18/56). Medium-term fiscal consolidation and improved debt management are needed to maintain the debt sustainability.

17. The authorities concur broadly with staff’s assessment. Consistent with the main findings of the DSA, the authorities remain committed to strengthening debt sustainability by adhering to medium-term fiscal consolidation, conducting sound public investment management, and enhancing debt management capacity.

Table 1.

Benin: 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.

The peak in 2018 partly reflects the reprofiling operation.

Table 2.

Benin: 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, state, and local governments, central bank, government-guaranteed debt. Definiton 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.

Figure 1.
Figure 1.

Benin: Indicators of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2018–281

Citation: IMF Staff Country Reports 2018, 364; 10.5089/9781484389911.002.A002

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in or before 2028. Stress tests with one-off breaches are also presented (if any), while these one-off breaches are deemed away for mechanical signals. When a stress test with a one-off breach happens to be the most exterme shock even after disregarding the one-off breach, only that stress test (with a one-off breach) would be presented.2/ The magnitude of shocks used for the commodity price shock stress test are based on the commodity prices outlook prepared by the IMF research department.
Figure 2.
Figure 2.

Benin: Indicators of Public Debt Under Alternative Scenarios, 2018–28

Citation: IMF Staff Country Reports 2018, 364; 10.5089/9781484389911.002.A002

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in or before 2028. The stress test with a one-off breach is also presented (if any), while the one-off breach is deemed away for mechanical signals. When a stress test with a one-off breach happens to be the most exterme shock even after disregarding the one-off breach, only that stress test (with a one-off breach) would be presented.
Table 3.

Benin: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2018–28

(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.