Sierra Leone: Request for an Arrangement Under the Extended Credit Facility—Debt Sustainability Analysis

Request for An Extended Arrangement Under the Extended Credit Facility-Press Release; Debt Sustainability Analysis; Staff Statement; and Statement by the Executive Director for Sierra Leone

Abstract

Request for An Extended Arrangement Under the Extended Credit Facility-Press Release; Debt Sustainability Analysis; Staff Statement; and Statement by the Executive Director for Sierra Leone

Recent Debt Developments

1. The DSA covers known sources of public debt. External debt of SOEs (for example, loans contracted by the Sierra Leone Cable Co and the Electricity Co) are included in the external debt stock.2 Non-debt obligations, such as arrears, are also included to the extent possible. The stock of budget arrears was preliminarily estimated at 4.7 percent of GDP. The government’s arrears clearance strategy is being finalized based on the findings of the comprehensive audit of arrears claims currently underway. Pending the government strategy, in the baseline scenario it is assumed that the authorities will issue short-term T-bills to pay down arrears.3 Given the relatively small size of domestic debt, the public debt indicators are driven mainly by the external debt component (70 percent of the public debt).

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The default shock of 2 percent 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 I 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%.

2. Total public and publicly guaranteed (PPG) external debt stood at 41.2 percent of GDP in 2017. It is projected to increase to around 46 percent of GDP in 2018. External debt was predominantly owed to multilateral creditors (about 75 percent), mainly due to debt contracted for post-Ebola recovery and infrastructure construction needs. Debt to commercial creditors is estimated at US$195 million (13 percent of total external debt) in 2017.4 Domestic public debt increased to 16.4 percent of GDP in 2017 from 14.4 percent in the previous year.

Text Table 1.

Sierra Leone: Public Debt

(Percent of GDP)

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Source: Sierra Leone authorities.

Key Assumptions Under the Baseline Scenario

3. The macroeconomic assumptions reflect developments through October 2018. The key assumptions are:

  • Growth weakened in 2017–18 to 3¾ percent, largely reflecting weaker performance in the iron ore sector culminating in the shuttering of the main loss-making iron ore mine early this year. Over the medium term, growth is expected to average above 5 percent, driven primarily by non-mining sectors and supported by increased government spending on capital projects and its effort on economic diversification. The projection is based on historical development in the non-mining sector and is less optimistic than the previous DSA.

  • Inflation is projected to fall slowly, averaging around 10½ percent over the medium term. Over the long term, inflation is expected to fall to single digits under a strengthened monetary policy framework and improved fiscal situation.

  • A fiscal deficit of 6.8 percent of non-mining GDP is expected in 2018, compared with a deficit of 8.7 percent in 2017. The medium-term fiscal stance envisages gradual tightening of the structural fiscal deficit, as measured by the domestic primary balance. Underlying this path would be two anchors—stabilizing and reducing public debt, and keeping domestic financing at sustainable levels.

  • The current account deficit is expected to widen to an estimated 14 percent in 2018 and decline over the medium term averaging around 10½ percent, mainly reflecting projected increase in mineral and agricultural exports.

Text Table 2.

Sierra Leone: Key Macroeconomic Assumptions Underlying the DSA

(Percent of GDP, unless otherwise specified)

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Source: IMF staff calculations.

4. Domestic Financing. Given the small size of the banking sector, keeping the domestic financing of the budget consistent with the program’s inflation targets would require that it be gradually reduced from about 4 percent of GDP in 2018 to around 2.2 percent by the end of the program. Domestic debt is projected to decline from about 25 percent of GDP in 2018 to a low level in the long run, consistent with the long-run fiscal deficit target.

5. External Financing. External financing is expected to temporarily fall in 2019 but rebound to around 2½ percent of GDP in the medium term. Grants are expected to gradually decline from 3.1 percent of GDP in 2018 to 1.7 percent of non-iron ore GDP by 2022. External debt is projected to slightly increase from 46 percent of GDP in 2018 to 47½ percent in 2019 and stabilize around 30 percent in the long run.

6. The “realism tool” indicates differences between past and projected debt creating flows and high unexpected changes in public debt over the past 5 years. The changes in public debt dynamics reflect three major revisions incorporating the latest information. First, recently revised data show much weaker imports in 2016 and 2017 than previously estimated and hence a lower current account deficit. Second, growth has been weaker than hoped for in the original program because of anemic performance in the mining sector. Third, the stock of budget arrears (currently estimated at 4.7 percent of GDP) has been included in the current DSA.

7. The “realism tool” flags potential optimism in the projected fiscal adjustment, and between fiscal adjustment and growth. The projected adjustment path is based on reforms efforts taken by the new government in recent months. These include corrective actions to shore up public finances, such as eliminating subsidies on retail fuel, moving toward more fully operationalizing the Treasury Single Account, collecting dividends from profitable SOEs, and reviewing and streamlining duty and tax waivers.5 Indeed, while the projected fiscal adjustment in this DSA is consistent with the program targets that are designed to be achievable under the program’s revenue scenario, the government aims to achieve even more ambitious deficit reduction. Nonetheless, this optimism highlights the critical importance of strong implementation of growth- and revenue-enhancing reforms going forward.6

Country Classification: Debt Carrying Capacity

8. Sierra Leone is classified to have a medium debt-carrying capacity based on the latest Composite Indicator (CI) score. The CI score captures the impact of several factors through a weighted average of the World Bank’s Country Policy and Institutional Assessment (CPIA) score, the country’s real GDP growth, remittances, international reserves, and world growth. Sierra Leone’s CI score is 2.72 in the current Debt Sustainability Framework, based on the IMF’s October 2018 World Economic Outlook (WEO) vintage. The CI score indicates a medium debt-carrying capacity, which is the same classification as in the June 2017 DSA.

Text Table 3.

Applicable Thresholds

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Text Table 4.

CI Cutoffs for Country Classification

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External and Public Debt Sustainability Analysis

9. External Debt Sustainability Analysis. Under the baseline scenario, the debt service-to-revenue ratio breaches the threshold for two years (2022-23) because of the amortization schedule of currently contracted loans. The other external PPG debt indicators remain below the policy relevant thresholds. Sensitivity analysis show that external debt remains sensitive to both export and growth shocks. Unsurprisingly, a large export shock leads to significant increases in the PV of debt-to-GDP, debt to exports, and debt service to exports, while a large growth shock leads to a significant increase in the PV of debt services to revenue (Figure 1).7

10. Overall risk of public debt distress. The PV of public debt is above the threshold of 55 percent of GDP in the baseline scenario and is expected to gradually fall to the threshold by 2022. Sensitivity analysis reveals that public debt sustainability remains vulnerable to shocks, particularly to growth. In the most extreme shock scenario, the PV of debt to GDP ratio will reach over 90 percent of GDP in the medium term, while the PV of the debt to revenue ratio will rise to above 500 percent of GDP and the debt-service-to-revenue ratio to 180 percent of GDP in the medium term (Figure 2).8

Staff Assessment

11. Sierra Leone is assessed to face a “high risk” of debt distress for both external public debt and overall public debt. The designated risk of external debt distress has changed to “high” in the current DSA from a “moderate” risk in the June 2017 DSA. This is largely due to a deterioration of the debt service to revenue ratio (partly owing to a weaker than expected revenue performance) and a tightening of the debt service thresholds under the revised DSF. Under the baseline scenario, all but one indicator for public and publicly guaranteed (PPG) external debt remain below their thresholds. The PV of total public debt is projected to fall but will be above the benchmark by the end of the IMF-supported program. Public debt and external debt have nonetheless been assessed as sustainable since debt is projected to decline gradually under the program’s policy settings. The analysis confirms that public debt sustainability faces important risks and is vulnerable to shocks, particularly growth and exports shocks. Reducing Sierra Leone’s debt burden (bringing its risk of debt distress designation to “moderate”) requires budget deficit reduction, sound public financial management, infrastructure project prioritization, and revenue mobilization. Both domestic and external borrowing should continue to be anchored by the objective of limiting the risk of debt distress.

Authorities’ Views

12. The authorities broadly agreed with the staff assessment. The new government is committed to maintaining debt sustainability and preventing the reemergence of new arrears. They recognize the need to maintain prudent borrowing policy and continue improving debt management capacity. They intend to carefully monitor the build-up in domestic debt to ensure it is within sustainable and affordable limits and emphasize special attention on the clearance of verified arrears owed to suppliers and contractors. They plan to use their cautiously limited external borrowing space, explore donor and concessional financing to support only higher-priority development projects, and avoid contracting debt that worsens the country’s risk of debt distress.

Figure 1.
Figure 1.

Sierra Leone: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2018–28

Citation: IMF Staff Country Reports 2018, 371; 10.5089/9781484391396.002.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.

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

Citation: IMF Staff Country Reports 2018, 371; 10.5089/9781484391396.002.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.
Figure 3.
Figure 3.

Sierra Leone: Drivers of Debt Dynamics, Baseline Scenario, 2013–28

Citation: IMF Staff Country Reports 2018, 371; 10.5089/9781484391396.002.A002

1/ Diference between anticipated and actual contributions on debt ratios.2/ Distribution across LICs for which LIC DBAs were produced.3/ Given the relatively low private external debt for average low-income countries, a ppt change in PPG external debt should be largely explained by the drivers of the external debt dynamics equation.
Figure 4.
Figure 4.

Sierra Leone: Realism Tools

Citation: IMF Staff Country Reports 2018, 371; 10.5089/9781484391396.002.A002

Table 1.

Sierra Leone: External Debt Sustainability Framework, Baseline Scenario, 2015–38

(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) + εα (1+r)]/(1+g+ρ+gρ) times previous period debt ratio, withr = nominal interest rate; g = real GDP growth rate, ρ = growth rateof GDP deflator in U.S. dollar terms, ε=nominal appreciation of the local currency, and α= share of local currency-denominated external debt in total external debt.

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.

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

(Percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Coverage of debt The central government plus social security, central bank, government-guaranteed debt Definition of external debt is Residency-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.

Sierra Leone: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2018-28

(Percent of GDP)

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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.