Liberia: Staff Report for the 2019 Article IV Consultation—Debt Sustainability Analysis
Author: International Monetary Fund. African Dept.
Publication Date:
19 Jun 2019
eISBN:
9781498320467
Language:
English
Keywords:
ISCR; CR; government; monetary policy; CBL financing; financing gap; exports threshold; debt dynamics; sustainability framework; dynamics equation; debt distress; Stress testing
Download PDF (1.3 MB)

2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Liberia

Abstract

2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Liberia

Public Debt Coverage

1. The DSA covers central government debt, central government guaranteed debt, and central bank debt contracted on behalf of the government (Text Table 2).1 The bulk of State-Owned Enterprise (SOE) debt is guaranteed by the central government and is included in DSA. Government borrowing from the Central Bank of Liberia (CBL) has been included in the current DSA analysis, consisting of $254.5 million (7.8 percent of GDP) in legacy U.S. debt from the war time and $65 million (1.5 percent of GDP) in credit from the CBL in the form of bridge loans and advances used to cover the fiscal financing gap of FY2018. In addition, the DSA includes $65 million in arrears to the construction sector, which took advances from banks to carry out public road projects. The largest debt of SOEs is a World Bank loan to the Liberia Electricity Corporation (LEC) for the rehabilitation of Mt. Coffee hydropower station. Other elements of public sector debt are not included in the analysis because of data constraints.2

Text Table 2:

Liberia: Coverage of Public Sector Debt

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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

2. This DSA is being conducted in the context of the 2019 Article IV consultation. The last Low-Income Country DSA (LIC-DSA) was considered by the Executive Board in June 2018 as part of the 2018 Article IV consultation.3 Liberia does not currently have a Fund-supported program but continues to be subject to the IDA Non-Concessional Borrowing Policy (NCBP) regardless of the risk of debt distress.4

3. A year after taking office, policy uncertainty is besetting President George Weah’s efforts to meet the expectations of the Liberian population. The government launched an ambitious pro-poor agenda aimed primarily at closing the country’s infrastructure gap and raising the income level of the poor, but financing remains uncertain. On the macroeconomic front, large policy slippages have emerged, widening macroeconomic imbalances: i) the fiscal policy stance has been loose and coupled with big revenue shortfalls and financing gaps; ii) the monetary policy stance has been passively accommodative; and iii) the CBL has intervened in the foreign exchange market depleting international reserves. As a result, the medium-term outlook is less optimistic than at the time of the 2018 Article IV consultation.

4. Identifying viable external financing to fulfill the pro-poor agenda has proved challenging. The authorities’ efforts to secure financing from non-traditional donors, mostly on non-concessional terms, have not been successful. In a fast-tracked process that lacked transparency, the government of Liberia (GOL) ratified two separate external loan agreements totaling US$957.2 million (29 percent of GDP) in May of 2018.5 More recently, the authorities have indicated that they are in the process of cancelling them. Yet, the authorities remain tolerant to the possibility of contracting large loans on non-concessional terms beyond the limits of Liberia’s absorptive capacity. Meanwhile, external grants inflows are on a declining trend—expected to decrease from 16.7 percent of GDP in FY2017 to 13.4 percent of GDP in FY2024—and the authorities’ capacity to mobilize domestic revenue remains limited for the size of the need. Therefore, a shrinking revenue envelope prevents the authorities’ from effectively delivering the much-needed public services in a manner that is consistent with macroeconomic stability and conducive to long term growth.

5. Following the completion of HIPC in 2010, debt accumulated rapidly due to scaled-up infrastructure spending and the government’s response to a series of adverse shocks. The total public external debt stock was $859 million (29.3 percent of GDP)6 at end-FY2018, comprising mostly of multilateral loans (Text Table 3). The recent uptick in domestic debt in the form of credit from the CBL raises concerns about macroeconomic stability as the Central Bank is absorbing the losses of the lending extended to the GOL. Total public and publicly guaranteed debt at end-FY2018 is estimated at 42 percent of GDP (Text Figure 1).

Text Figure 1.
Text Figure 1.

Liberia: Stock of External Public and Publicly Guaranteed Debt, FY2015–18 1/

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 169; 10.5089/9781498320467.002.A003

Sources: Liberian authorities and IMF staff calculations.1/ The debt to GDP ratios are calculated using external debt (in USD) evaluated at the end of period exchange rate over GDP (in USD) evaluated at the period average exchange rate.
Text Table 3.

Liberia: Structure of External Public Debt as of June-20181/

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Sources: Liberian authorities and IMF staff calculations.

Debt stock on disbursement base, excluding debt to Taiwan Province of China (85.4 mil) that is not servicing due to the lack of diplomatic relationship.

The debt to GDP ratios are calculated using external debt (in USD) evaluated at the end of period exchange rate over GDP (in USD) evaluated at the period average exchange rate, to ensure consistency with the DSA template.

Underlying Assumptions

6. The key macroeconomic assumptions are in line with the baseline scenario described in the Policy Note. The near- and medium-term outlook is challenging and less optimistic than at the time of the 2018 Article IV consultation. Changes to the underlying assumptions are as following (Text Table 4):

  • The real GDP growth path has been revised down from 4.7 percent to 0.4 percent in 2019 due to continued policy uncertainty and slowing down of credit growth. Under the baseline scenario the authorities are expected to muddle through initially but face a forced adjustment in year 2022. Growth in the short-to-medium term is supported by agriculture and mining. Real GDP is projected to contract by 1.3 percent in 2022 and 0.5 percent in 2023. Medium-term growth has been revised down from 5.3 percent to 3.7 percent in line with factor accumulation (Annex I in Staff Report). In the long-run, growth is estimated to increase to 4.3 percent by 2028—owing mostly to improvements in total factor productivity and growth of the working-age population—and remaining stable thereafter.

  • The inflation outlook deteriorated significantly in the second half of 2018. Closely following developments in the foreign exchange markets, average headline inflation increased to 20.4 percent in 2018 (compared to 11.7 estimated previously) and is expected to remain in double digits in the medium-term.

  • The fiscal position of the central government is set to remain loose. The fiscal deficit widened to 5.5 percent of GDP in FY2018, partially financed by credit from the central bank. An overoptimistic revenue envelope driven by the pressure to address high spending needs means that—in the absence of additional budget support—the authorities will continue to rely on borrowing from the central bank in both U.S. and Liberian dollars to close the financing gap.

  • The current account deficit estimates for 2019 widened from 22.3 to 23.3 percent of GDP. The trade balance improved modestly in 2018, but it was more than offset by a decline in net transfers following the United Nations Mission in Liberia (UNMIL) withdrawal and a decline in net income. Over the medium term, the current account deficit is expected to remain high during the next few years but then decline in subsequent years in response to the forced adjustment. The external sector assessment shows that Liberia’s external sector position is substantially weaker than implied by fundamentals and desirable policies.

  • The CBL’s foreign reserves continued to decline. Staff estimate that the CBL will use around US$80 million of its reserves to finance fiscal deficits, its operations, and interventions in the foreign exchange market in 2019. They are expected to decline in the medium-term to below 1 months of imports.

Text Table 4.

Liberia: Underlying DSA Assumptions

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Sources: Liberian authorities; and IMF staff projections.

7. The assumptions for the financing mix and borrowing terms are as follows:

  • External borrowing. The DSA assumes that public external debt would increase by about $1.24 billion in the medium-term. Even if the two external loans ratified in May 2018 (for US$957.5 million) were to be officially canceled, the baseline assumes large non-concessional loans. The average grant element of new borrowing is estimated to decline from 43.6 percent FY2019 to 31.2 percent in FY2022, and subsequently increasing as the authorities increase engagement with and borrow more from traditional donors. This is in contrast with an average grant element of the new borrowing of 45 percent assumed at the time of the 2018 Article IV consultation.

  • Domestic borrowing. The baseline scenario assumes central bank credit during 2019–21 at a negative real interest rate to fulfil central government’s budget needs (e.g., the government currently pays -2.2 percent in real terms on the legacy debt of $250 million and zero nominal interest rate on the credit extended in 2018). The baseline also assumes that the financing gap will be filled with additional central bank financing. As the central government faces high spending pressure, amortization of CBL credit for budget support will be deferred to the long-term.

Realism of the Baseline Assumptions

8. Drivers of the debt dynamics seem to reflect the past well (Figure 3).

  • The DSF shows the evolution of the past and projections of external and public debt to GDP ratios for the current DSA, the previous year DSA (the 2018 Article IV DSA), and the DSA from 5 years past. The current DSA shows a significantly different evolution from the past, which reflects the latest revisions to the medium-term outlook and policy direction of the authorities. The downward revisions to real GDP growth explain most of the increase in the ratio of external-debt-to GDP in coming years. Some additional financing on non-concessional terms was added relative to the 2018 Article IV DSA, as the authorities have continued to seek financing from non-traditional donors, mostly on non-concessional terms, though non-financing has been disbursed yet. The inclusion of CBL credit in the current DSA and the assumption that the financing gap will be filled with additional CBL credit explain the differences in domestic debt dynamics outlined in the previous DSA.

  • A high contribution of unexpected non-interest current account deficits to past debt accumulation and an equally large unexpected residual to the past debt accumulation in the opposite direction are observed (Figure 3). These debt dynamics are plausible since residual financing (i.e., net private financing under other investment flows in the Balance of Payments, Table 2), which is enabling the large current account deficit, includes current transfers (remittances) that are not captured by the official statistics. In other words, the residual financing shown in the realism tool is unlikely to have been debt creating flows. Indeed, the Other Depository Corporations (ODCs) survey does not show such an accumulation.

  • The significant adverse shocks the country has gone through (the Ebola epidemic and the commodity price shock) are well captured in the chart showing unexpected changes in debt accumulation in the past 5 years. The unexpected increase in debt was about 12 percent of GDP, which is above the median of the countries producing LIC DSA and is towards the upper end of the interquartile range (25 percent-75 percent). As expected in countries that go through major macroeconomic shocks, drivers of this unexpected debt accumulation are equally shared among three factors: unexpected increases in primary fiscal deficits, an unexpected decline in growth, and an unexpected depreciation of the real exchange rate.

Figure 3.
Figure 3.

Liberia: Drivers of Debt Dynamics – Baseline Scenario

Citation: IMF Staff Country Reports 2019, 169; 10.5089/9781498320467.002.A003

1/ Difference betw een anticipated and actual contributions on debt ratios.2/ Distribution across LICs for which LIC DSAs 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.
Table 2.

Liberia: Public Sector Debt Sustainability Framework, Baseline Scenario, 2016–39

(Percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Coverage of debt: The central government, 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.

9. The widening of the primary fiscal deficit in the next three years is within the range of countries producing the LIC DSA.

  • The second DSF realism tool assesses the realism of the fiscal projection. The fiscal primary deficit is projected to increase by about 1.0 percentage point of GDP in the next three years. This is just below the mode.

10. The consistency of the fiscal deficit and growth projections for 2019 and 2020 is evident in Figure 6 for a couple of reasons.

  • The growth path shown in the figure captures overall growth, but the impact of fiscal adjustment/slippage is assumed to impact the non-mining sector growth. The fiscal multiplier used is 0.67.

  • The fiscal widening in 2019 is projected to have a small stimulus impact relative to the adverse impact of the terms-of-trade shocks and the sharp contraction of imports of key commodities (fuel and rice) (Figure 3).

Figure 6.
Figure 6.

Liberia: Probability of Debt Distress of Public and Publicly Guaranteed External Debt under Alternative Scenarios, 1/

Citation: IMF Staff Country Reports 2019, 169; 10.5089/9781498320467.002.A003

Sources: Country authorities; and staff estimates and projections.1/ The probability approach focuses on the evolution of the probability of debt distress over time, rather than on the evolution of debt burden indicators.

11. The growth and fiscal adjustment tool (Figure 5) shows that growth projections for the 2018 Article IV DSA were on the optimistic side, whereas the downward revision to growth reflected in the current DSA is in line with past experience.

Figure 5.
Figure 5.

Liberia: Realism Tools

Citation: IMF Staff Country Reports 2019, 169; 10.5089/9781498320467.002.A003

Country Classification and Model Signal

12. Liberia’s debt carrying capacity is classified as medium, based on a Composite Indicator (CI) of 2.77 (Text Table 4).7 The country’s capacity was assessed at the same level in the previous DSA (Text Table 5). However, subsequent revisions to the deteriorating macroeconomic outlook could affect the CI in the next 1–2 years, significantly reducing the borrowing space. In addition, Liberia was recently downgraded to “weak quality of debt monitoring” in line with the country’s debt recording capacity.

Text Table 4.

Liberia: Composite Index

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Text Table 5.

Liberia: Debt Carrying Capacity and Thresholds

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13. Standard scenarios stress test and a contingent liability test are conducted and discussed below.

External Dsa

14. Liberia remains at moderate risk of external debt distress. The PV of debt-to-GDP and the PV of debt-to-export ratios are set to remain below their policy dependent threshold, with the former peaking at 34.6 percent in 2027 and the later remaining below 150 percent in the medium-to long-term (Figure 1). The debt-service to revenue ratio will reach levels just below the threshold of 18 percent in 2023 and 2024 potentially crowding out much needed spending and running the risk of a buildup of arrears. The debt-service to exports ratio remains below the threshold, peaking in 2023 and 2024 when the economy is forced to adjust. The evolution of the probability of debt distress over time, shows that the probability of debt distress increases substantially if there is a shock to exports or depreciation (Figure 6).

Figure 1.
Figure 1.

Liberia: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2019–29

Citation: IMF Staff Country Reports 2019, 169; 10.5089/9781498320467.002.A003

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in or before 2029. 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.

15. Standard stress tests show that a further deterioration of the macroeconomic outlook will lead to breaches of the policy dependent thresholds (Table 3). All standard stress tests, namely, a shock of one-standard deviation in the primary balance, nominal export growth, other non-debt creating flows, and a one-time depreciation of the size needed to close the real exchange overvaluation (which is the most extreme shock) will all result in breaching the thresholds on the stock of debt (the PV of debt-to-GDP ratio and the PV of debt-to-exports ratio). A one-standard deviation shock to real GDP growth will not breach the threshold on the stock of debt, but it will breach the threshold on debt services.

Table 3.

Liberia: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2019–29

(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.

Public Dsa

16. Public sector debt indicators also show that Liberia remains at moderate risk of public debt distress. The PV of public debt-to GDP ratio is projected to increase from an estimate of 35.3 percent in FY2019 to 46.6 percent in FY2023 and continue on an upward trend thereafter (Table 2 and Figure 2). The PV of debt-to-revenue ratio will peak at 168.5 percent in FY2025 and decline slowly to 156.9 percent in the long-term, while the debt-service-to-revenue ratio will peak at 16.8 percent in FY2023 and decline in subsequent years.

Figure 2.
Figure 2.

Liberia: Indicators of Public Debt Under Alternative Scenarios, 2019–29

Citation: IMF Staff Country Reports 2019, 169; 10.5089/9781498320467.002.A003

* Note: The public DSA allows for domestic financing to cover the additional financing needs generated by the shocks under the stress tests in the public DSA. Default terms of marginal debt are based on baseline 10-year projections.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 2029. 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.

17. Under standard sensitivity analysis, the PV of Debt-to-GDP breaches the relevant threshold. Based on standard stress tests, a deterioration of real GDP, the primary balance, exports, and other flows results in a breach of the threshold on the PV of debt-to-GDP ratio (Table 4). Moreover, the debt service-to-revenue ratio reaches close to 20 percent (or above 20 percent in some cases). Additionally, the contingent liability stress test is estimated to lead to a one-off increase in the debt-to-GDP ratio of 10.5 percent, capturing the combined shock of SOE’s external debt default, PPPs’ distress, and financial market vulnerabilities that are not included in the covered data.

Table 4.

Liberia: Sensitivity Analysis for Key Indicators of Public Debt, 2019–29

(Percent)

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Sources: Country authorities; and staff estimates and projections.

A bold value indicates a breach of the benchmark.

Variables include real GDP growth, GDP deflator and primary deficit in percent of GDP.

Includes official and private transfers and FDI.

18. An alternative scenario in which an increase in interest payments does not crowd out primary expenditure is also considered. A case in which debt service increases because of a rise in the interest rate or additional borrowing that must be serviced, but the GOL does not adjust primary expenditure accordingly is analyzed. Under this scenario, Liberia will eventually breach the PV of debt-to-GDP ratio if additional revenue is not mobilized and the GOL is forced to borrow to meet its increased debt service obligations.

Risk Rating and Vulnerabilities

19. Liberia’s borrowing space is limited, and careful consideration to the terms of new external borrowing and the country’s absorptive capacity is needed (Figure 4). The authorities’ ambitious infrastructure program to rehabilitate the national road network will undoubtedly raise the PV of debt relative to its foreign exchange earning capacity. The projected disbursement path for the period of FY2019–24 is beyond what the authorities have been able to absorb in the past but reflects their ambition to secure large infrastructure loans that promise to be disbursed in the short-term. Yet, under this scenario, the limited space to absorb shocks is almost non-existent for debt-service-to-revenue ratio. Moreover, borrowing beyond capacity will not generate enough GDP growth to compensate for the increase in nominal debt levels. Indeed, the effect of the rehabilitation of roads on aggregate demand from the financing options under consideration is expected to be limited, as only a small part of the total cost of rehabilitation of the roads would be likely to be sourced locally.

Figure 4.
Figure 4.

Liberia: Qualification of the Moderate Category, 2019–291/

Citation: IMF Staff Country Reports 2019, 169; 10.5089/9781498320467.002.A003

Sources: Country authorities; and staff estimates and projections.1/ For the PV debt/GDP and PV debt/exports thresholds, x is 20 percent and y is 40 percent. For debt service/Exports and debt service/revenue thresholds, x is 12 percent and y is 35 percent.

20. Moreover, while most of the domestic debt is intra-government borrowing, fiscal adjustment is warranted to ensure macroeconomic stability and solvency of the Central Bank. Currently, the CBL is absorbing the losses of the credit it is providing to the GOL and no repayment plan has been agreed, while the resources of the Central Bank are being depleted. A repayment profile of domestic debt with a positive real interest rate will put additional pressure on spending needs, crowding out primary expenditure or leading to a further increase of the fiscal imbalance.

21. Risks to the outlook are titled to the downside. On the upside, an increase in commodity prices, an increase in iron ore production, and an increase in donor grants could ease some of the macroeconomic pressures. Moreover, if the non-concessional borrowing planned in the baseline scenario beyond absorptive capacity does not materialize debt will remain at more sustainable levels. However, on the downside, a drop-in commodity prices, or a failure to mobilize fiscal resources to close the financing gap could lead to a further deterioration of macroeconomic conditions and increase the risk of debt distress.

Authorities’ Views

22. The authorities broadly agreed with the importance of maintaining debt sustainability in the medium term. The authorities reiterated their preference for concessional financing as it recognizes that borrowing space is limited and sensitive to the terms of new loans; and noted that they are in the process of cancelling the non-concessional ETON and EBOMAF loans. However, given its stated commitment to fulfill its Pro-Poor Agenda, if assistance from traditional donors is delayed, it remains tolerant to the possibility of contracting non-concessional loans and securing financing from non-traditional donors. The authorities emphasized the pressing need to move forward with their development agenda, and expressed the hope that the international community would provide the current administration with assistance in meeting these needs through provision of budget support, project grants, and financing for infrastructure projects.

Table 1.

Liberia: External Debt Sustainability Framework, Baseline Scenario, 2016–39

(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) + Ɛα (1+r)]/(1+g+ρ+gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, ρ = growth rate of GDP deflator in U.S. dollar terms, Ɛ=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.