Benin: Staff Report for the 2019 Article IV Consultation, Fourth Review Under the Extended Credit Facility Arrangement, and Request for Modification of Performance Criteria—Debt Sustainability Analysis

2019 Article IV Consultation, Fourth 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 Benin

Abstract

2019 Article IV Consultation, Fourth 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 Benin

Benin: Joint Bank-Fund Debt Sustainability Analysis

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Benin remains at moderate risk of external debt distress. The rating is unchanged from the previous November 2018 DSA. All the projected external debt burden indicators remain below their thresholds under the baseline, but the ratio of the present value (PV) of external debt to exports exceeds its threshold in the case of an extreme shock to exports.1

With regard to total public and publicly guaranteed (PPG) debt (external plus domestic), the overall risk of debt distress remains also moderate. The public debt-to-GDP ratio is below its prudent benchmark in the baseline scenario; however, the PV of public debt-to-GDP rises very slightly above its benchmark from 2024 until the end of the projection period under the real GDP shock scenario. Other factors motivating the overall rating include: the past evolution of domestic debt, the relatively high debt service burden, as well as the existence of contingent liabilities. Medium-term fiscal consolidation, sound public investment management, and enhanced debt management capacity are needed to reduce debt vulnerabilities.

Public Debt Coverage

Text Table 1.

Benin: Subsectors of the Public Sector

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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%.

1. 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 government2. The DSA classifies external and domestic debt based on the currency criterion, given data constraints that prevent the use of the residency criterion. Debt to the IMF owed by the Central Bank is included in external debt.

2. The authorities completed an audit about the stock of unpaid claims held by the private sector on the government in January 2019. The authorities found a stock of arrears to suppliers of 0.3 percent GDP. This amount of arrears was added to the 2019 debt stock. The current fiscal projections also assume a gradual clearance of the arrears over 2020–22 at a pace of 0.1 percent of GDP per year.

3. Due to methodological constraints, the debt of state-owned enterprises (SOEs) and subnational governments are not included in the baseline analysis but are captured in the contingent liability shock. SOEs can entail contingent liabilities for the government and create fiscal risks.3 It is important to have an exhaustive overview of the situation of SOEs debt in Benin. The authorities have made progress in the area of monitoring in past years, by collecting financial information on SOEs. They recently produced an estimate of 0.9 percent of GDP for the non-guaranteed commercial debt of 13 state-owned companies at end-2018.4 Also, to address contingent liability risks, 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. In the context of the current DSA, the contingent liability shock was increased by 0.9 percent of GDP (to reflect the new information on SOE debt), which comes on top of the standardized 2 percent of GDP shock. Further work is needed to properly incorporate SOEs in the DSA. This will entail (i) reconciling various sources of information on guarantees and non-guaranteed debt to come up with a total amount of SOEs debt; and (ii) assessing the scope for consolidating the general government fiscal accounts with the financial statements of the SOEs (both on the revenue and expenditure sides).

Background on Debt

4. Benin’s public debt has been increasing rapidly since 2014. Total public debt (external plus domestic) increased from 30.5 percent in 2014 to 56.8 percent in 2018.5 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. Such a rise in the domestic debt was essentially driven by the scaling-up of public investment. Over 2015–17, the authorities have increasingly relied on the domestic and regional financial market to finance public investment projects at non-concessional terms. With the debt reprofiling, the stock of domestic debt declined in 2018, and is estimated at 30.3 percent of GDP. As for external debt, the increase was relatively small over the 2014–18 period (6.7 percent of GDP), reaching 26.5 percent of GDP in 2018.

5. The debt service burden is relatively high in Benin. The ratio of debt service to revenue stands at 65 percent in 20186 and is expected to decrease to around 45 percent on average in the medium term and 21 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 20187.

6. Financial conditions in the regional financial system have eased due to Eurobond issuances and despite a firmer monetary policy. Between early 2017 and end-2018, the BCEAO reduced its refinancing volume to banks by about 24 percent. Regional liquidity nonetheless gradually improved in the wake of the Eurobonds issued by Côte d’Ivoire and Senegal—equivalent to 87 percent of the WAEMU’s aggregate fiscal deficit in 2018—which led to a substantial reduction in sovereign bond issuances on the regional market As a result, the average rate at the BCEAO weekly refinancing auction, which had remained at its 4.5 percent ceiling from November 2017 to June 2018, declined to below 3 percent. It crawled back up to its 4.5 percent ceiling in late 2018, though, on the back of seasonal liquidity needs.

Text Figure 1.
Text Figure 1.

Benin: Central Government Debt 2010–18

(in percent of GDP)

Citation: IMF Staff Country Reports 2019, 203; 10.5089/9781498323802.002.A003

Sources: Authorities’ data and staff calculations.

Structure of Debt

7. Benin’s external public debt is essentially owed to multilateral and bilateral creditors. In 2016 and 2017, Benin’s domestic debt surpassed external debt It represented about 60 percent of total debt at end-2017. The October 2018 debt reprofiling operation, which exchanged cheap and long-term external debt against more expensive and shorter-maturity domestic debt allowed a rebalancing of the composition of the total debt stock. As of end-December 2018, external debt represented around 47 percent of the total debt while the domestic debt accounted for 53 percent of the debt. External public debt essentially owed to multilateral and bilateral creditors, is most of the time provided on concessional terms.

8. Domestic public debt is dominated by government securities issued in the regional bond market. Benin’s domestic public debt has increased significantly between 2014 and 2017, driven mainly by the increasing reliance on the regional bond market to raise funds. About 80 percent of domestic liabilities consisted of government securities issued on the regional financial market at end-2018. Such debt is non-concessional and is associated with roll-over and interest rate risks.

9. Benin issued its first Eurobond in March 2019, which is expected to change significantly the structure of the debt portfolio. The Eurobond amounts to EUR 500 million (equivalent to 5.2 percent of 2019 GDP) and was issued at favorable terms (see Box for 1 details). The authorities have decided to reduce, by the same amount the domestic financing projected for the year, leaving the 2019 borrowing plan unchanged. As a result, external debt should, for the first time since 2015, exceed domestic debt with respective shares projected at 58 percent and 42 percent of total debt for 2019.

Benin’s First Eurobond Issuance

Accommodative global financial conditions have narrowed spreads and boosted capital inflows to sub-Saharan Africa’s (SSA) frontier markets since 2009–10. Unconventional monetary policies in advanced economies have produced a prolonged episode of ultra-low global interest rates and extremely low volatility in financial markets, since 2009–10. This, in turn, has contributed to a revival of favorable global funding conditions and widespread financial risk-taking, as developed market investors searched for yield to meet targeted return.

Taking advantage of the benign global financial environment, Benin issued its first Eurobond and became the 17th country in SSA to tap international capital markets to meet its financing needs (Text Figure 2). The Eurobond was issued in March 2019, for an amount of EUR 500 million at a yield of 6 percent with a weighted maturity of 6 years. The issuance was two times oversubscribed, attracting EUR 1.1 billion in demand. Terms compare very favorably to recent issuances by Benin on the regional market (7.0 percent for a 5-year bond issued in early-March 2019).

Text Figure 2:
Text Figure 2:

Sub-Saharan African Frontier Market: International Sovereign Bond Issuances (in US$ Billion)

(Data as of March 20, 2019)

Citation: IMF Staff Country Reports 2019, 203; 10.5089/9781498323802.002.A003

Source: Bloomberg

While Eurobond issuance provides the Beninese government with access to longer-term financing at favorable rates, it also leads to some rebalancing of risks. The exchange rate risk is estimated to be small in the short to medium term given the peg between the FCFA and the euro. The comparison of refinancing risks between the Eurobond and regional issuances, however, is more difficult to assess. On the one hand, the regional market can become very illiquid when bigger WAEMU economies (such as Senegal and Cote d’Ivoire) borrow, leaving limited space for Benin. On the other hand, international markets may shut down for frontier markets in case of a reversal in global risk appetite.1 Nonetheless, the refinancing risk is expected to decrease over the short term, given the improved access to longer-term financing. At the same time, over the medium-term or once the Eurobond comes close to maturity, refinancing risk is expected to increase.

1 Faster-than-expected normalization of monetary policies of advanced economies, a strong growth slowdown in China, or adverse spillover effects of U.S.-China trade tensions are examples of major events that could result in a decompression of spreads and reversals of capital flows going to frontier markets. This could make the rollover of the Eurobond more difficult and could raise debt servicing costs.
Text Table 2.

Benin: Structure of External Debt, Estimated 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, Estimated 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 November 2018 DSA. The main changes relate to the primary balance and the real GDP growth for the medium term (Text Table 4). Benin’s growth is revised upwards to 6.7 percent in 2018, mainly because of higher-than-anticipated agriculture and port activities. The real GDP growth forecasts for 2019 and beyond have also been revised up to reflect new estimates of medium-term growth (see IMF 2019 Article IV Report). Medium-term prospects are strong, driven by the lagged effect of the public investment scaling-up, greater participation of the private sector, strong agricultural production, and the development of new sectors such as tourism and digital economy.

  • The 2018 primary deficit was lower than expected mainly driven by an under execution of the capital expenditure budget. The primary surplus is estimated to reach 0.3 percent of GDP on average in the period 2019–24 and 0.9 percent of GDP on average, in the long run. Beyond 2019, the projections assume a continued scaling-down of public investment, which should bring back the investment ratio to its pre-scaling up level and maintain the deficit below the 3 percent of GDP regional norm.

  • The non-interest current account deficit is expected to decline gradually in the medium to long term, thanks to the implementation of fiscal consolidation plan and structural reforms to boost competitiveness. Higher exports should result from larger cotton production. Imports should also remain contained due to the scaling-down of public investment and the increase in agricultural production.

Text Table 4.

Benin: Macroeconomic Projections

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Sources: Beninese authorities and IMF staff calculations.

11. Risks to the baseline are tilted to the downside. On the fiscal position, the main risks include extra spending pressures related to the political cycle 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 measures that intent to increase the agricultural production capacity and structural reforms that aim at improving business environment and governance.

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 2019 are slightly more optimistic than the growth path predicted by the growth and fiscal adjustment tool (Figure 4). 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 public investment scaling plan, which peaked in in 2017–18. Given the traditional long lags of investment multipliers, we expect the positive growth effects to persist at least until 2019–20.8

  • 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 2018–19 and beyond, through the ginned cotton activity, as well as higher export revenues. The cotton activity should remain dynamic in 2019, impacting export revenues and growth in 2020. Furthermore, port activities have been dynamic in 2018 and are expected to remain strong in the medium term.

  • A number of large public-private infrastructure projects of the Government’s Action Program are expected to start in 2020.

  • Nigeria’s economy is estimated to accelerate in 2018 and growth should be maintained in 2019–20.

Figure 1.
Figure 1.

Benin: Indicators of Public and Publicly Guaranteed External Debt under Alternative Scenarios, 2029

Citation: IMF Staff Country Reports 2019, 203; 10.5089/9781498323802.002.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.
Figure 2.
Figure 2.

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

Citation: IMF Staff Country Reports 2019, 203; 10.5089/9781498323802.002.A003

* Note: The public DSA allows for domestic financing to cover the additional financing needs generated by th 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.
Figure 3.
Figure 3.

Benin: Driver of Debt Dynamics – Baseline Scenario

Citation: IMF Staff Country Reports 2019, 203; 10.5089/9781498323802.002.A003

1/ Difference between 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.
Figure 4.
Figure 4.

Benin: Realism Tools

Citation: IMF Staff Country Reports 2019, 203; 10.5089/9781498323802.002.A003

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 towards its 2016 level in subsequent years.

14. The projections of public and private investment as well as their contribution to real GDP growth remain broadly unchanged compared to the previous DSA. Benin’s medium-term outlook continues to be favorable, with economic growth projected at 6.7 percent over 2019–24, led by rising private investment. At the same time, the public investment ratio is expected to decline over the medium-term to return to its pre-scaling up 2016 level.

15. Relative to the previous DSA, the drivers of debt dynamics show a higher external debt path, compensated by lower domestic debt. The increase in the external debt stock reflects the Eurobond issuance. The reduction by the same amount of the domestic financing projected for the year is expected to leave the 2019 public debt stock unchanged.

Risk Rating and Vulnerabilities:External Debt Sustainability Results

16. The external debt burden indicators remain below the policy-dependent thresholds in the baseline scenario. Under 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 24 percent of GDP on average over 2019–24, reaching 10 percent of GDP in 2039. Thus, the ratio would remain below the corresponding threshold of 40 percent of GDP throughout the projection period.

17. However, the ratio of the present value of external debt to exports exceeds its threshold in the case of an extreme shock to exports. This breach is what motivates the assessment of moderate risk for external debt. The breach of the PV of Public and Publicly Guaranteed (PPG) external debt-to-exports ratio under the most extreme stress test (MX shock, standard and tailored) lasts four years (2021–2024). Such a breach lasts an extra year compared to the November 2018 DSA (in which the breach occurred over 2020–22), and its magnitude is larger (19.4 percent of GDP on average in the current vintage compared to 13.7 percent on average in the previous one). The increase in the stock of PPG external debt explains such a deterioration. Other indicators, the debt-to-GDP ratio and all debt service indicators, remain below their thresholds under the extreme shock scenarios.

18. Sizable breaches are recorded under the historical scenario for two external debt burden indicators. The historical scenario shows breaches for the PV of external debt-to GDP ratio and the external debt service-to-revenue ratio. However, this scenario is unlikely to materialize. The projections for real GDP growth, non-interest current account and net FDI flows are above the historical averages because of the major reforms taken by the authorities to boost economic growth and the revitalization of exports supported by a booming agricultural production.

19. The market financing risk indicators show no breach of the GFN benchmarks, and the potential heightened liquidity needs are low. For the moment, there is no available data for the JP Morgan EMBI spreads. To add granularity to the moderate risk rating, Benin shows “some space” to absorb shocks. This is mainly due to the rise in the debt service-to-revenue indicator over the period 2024–26. The PV of debt to GDP also lies in the ‘‘some space’’ zone.

Risk Rating and Vulnerabilities: Public Debt Sustainability Results

20. Total PPG debt (external plus domestic) remains below its respective benchmark, but the PV of public debt-to-GDP rises very slightly above its benchmark from 2024 until the end of the projection period under the real GDP shock scenario. The overall risk of debt distress remains moderate. Total debt does not show any breach in the baseline scenario. However, the ratio of the PV of public debt-to-GDP exceeds very slightly its benchmark under the real GDP shock scenario from 2024 until the end of the projection period. This breach is more pronounced than the one of the November 2018 DSA, because the current vintage has added some new items to the debt stock, including domestic arrears (0.3 percent of GDP) and additional government guarantees (0.4 percent of GDP). The PV of public debt-to-GDP records also a breach under the historical scenario.

21. Other factors also motivate the rating of moderate risk debt distress for total debt. These factors include: the past evolution of domestic debt; the relatively high ratio of debt service to revenue; the existence of contingent liabilities of SOEs; and the moderate risk of external debt distress.

Conclusion

22. The updated DSA confirms that Benin stands at moderate risk of external and overall public debt distress. The ratings are unchanged relative to the Staff Report of November 2018 (EBS/18/364). Medium-term fiscal consolidation and improved debt management are needed to maintain debt sustainability.

23. 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, 2016–39

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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 2019 and the negative debt accumulation in 2025–26 partly reflect the Eurobond operation.

Table 2.

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

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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 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.

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