Togo: Staff Report for the 2019 Article Iv Consultation, Fourth Review Under the Extended Credit Facility Arrangement, and Request for Waiver of Nonobservance of Performance Criterion and Modification of Performance Criteria—Debt Sustainability Analysis

2019 Article IV Consultation, Fourth Review under the Extended Credit Facility Arrangement, and Request for Waiver of Nonobservance of Performance Criterion and Modification of Performance Criteria-Press Release; Staff Report; and Statement by the Executive Director for Togo

Abstract

2019 Article IV Consultation, Fourth Review under the Extended Credit Facility Arrangement, and Request for Waiver of Nonobservance of Performance Criterion and Modification of Performance Criteria-Press Release; Staff Report; and Statement by the Executive Director for Togo

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Togo’s risk of external debt distress continues to be moderate, while the overall risk of debt distress is high—unchanged from the previous Debt Sustainability Analysis (DSA) published in December 2018. While the mechanical results point to a low risk of external debt distress, judgment was applied given vulnerabilities arising from high domestic debt, which could, for example, likely lead to a reprofiling operation that would lead to an increase in external debt. Togo’s public debt is on a downward trajectory despite an increase in 2018 compared with 2017. Togo’s high public debt is the result of, among other factors, high deficits, contingent liabilities, and accumulated arrears. There is very little space to absorb shocks on total public debt. Baseline projections show that Togo’s PV of total PPG debt (external plus domestic)-to-GDP ratio will decline below the new debt distress benchmark of 55 percent starting in 2023, down from 72 percent in 2018—with the bulk constituting domestic debt obligations. This analysis highlights the need for sustained fiscal consolidation, improved debt management, and strong macroeconomic policies to reduce the public debt to prudent levels over the medium term.

Public Debt Coverage

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

Text Table 1.

Togo: Public Debt Coverage

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

Background on Debt

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

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

4. Following the fiscal consolidation that started with the ECF program, total public debt (in percent of GDP) declined in 2017 and remained below pre-program levels in 2018. The fiscal consolidation initiated in 2017 aimed at putting the debt-to-GDP ratio on a downward trajectory. By end-2017, total public debt dropped by 5.8 percentage points of GDP from the previous year, reaching 75.5 percent, and the domestic debt stock fell by 5.4 percentage points from 2016, reaching 55.8 percent.2 Total public debt increased somewhat in 2018 and was reported at 76.2 percent of GDP by December 2018. This slight increase is primarily due to some revenue recorded in accounts receivable (and not in cash) in 2018, resources borrowed in January 2018 to repay arrears connected to the fiscal year 2017, exchange rate depreciation, and capitalization of accrued interest on Sukuk bonds. While Togo’s total debt-to-GDP ratio has started to decline, it remains the highest within the WAEMU.3

5. Togo’s external debt sustainability has been assessed as moderate in recent past with high overall risk of debt distress.

Text Table 2.

Togo: Composition of Public Debt, 2013 – 2018

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Sources: Togolese authorities and Staff calculations.

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

Includes SUKUK.

Background on Macro Forecasts

6. The baseline macroeconomic assumptions for the present DSA rely on sustainable real GDP growth, price stability with inflation below the WAEMU criterion of 3 percent, a stabilizing current account deficit, and continuing fiscal discipline. The short-term growth projections remain moderate— at an annual average of 5.2 percent over 2019–20—as socio-political uncertainties linger. Over the long term (2020–39), potential growth is estimated at an annual average of 5.4 percent supported by stronger private sector activity. The overall primary balance (commitment basis, including grants) is anchored on a surplus of 1.0 percent of GDP over 2021–29 to bring public debt comfortably below the debt distress threshold, after which it would decrease and approach a deficit of 2 percent of GDP by 2039 to provide space for social and investment spending while safeguarding debt vulnerabilities. Total PPG debt will decline below the new benchmark (PV of debt-to-GDP ratio of 55 percent) in 2023; the NPV of debt-to-GDP ratio is projected to decline further to 31 percent by 2029 and 26 percent by 2039.4 The current account deficit is projected to stabilize at around 4½ percent of GDP over the medium term, as lower demand for capital goods and other imports persists, while exports of cotton, phosphates, agriculture, and light manufacturing goods continue to grow. Inflation is projected to remain below the WAEMU regional convergence criterion of 3 percent.5

7. Togo’s debt is financed through a mix of domestic, regional and external markets:

  • The authorities aim to deepen and diversify the domestic and regional creditor base, including through working with the regional institutions to develop the secondary bond market. In the regional market, the government has extended the range of debt instruments by placing Sukuk bonds. In 2017, for instance, budget financing needs were covered through recourse to regional money and financial markets, particularly through bond borrowing and Sukuk bonds, and assistance from international development partners.

  • The authorities plan to proceed with a debt reprofiling in 2019. As discussed in the staff report for the second review of the ECF-supported program, the reprofiling operation will consist of borrowing externally at more favorable terms to repurchase approximately 8 percent of GDP of outstanding domestic debt, which is more expensive and generally short term.6 While the ECF program sets a zero ceiling on the contracting or guaranteeing of new non-concessional external debt, given the ‘moderate’ risk of external debt distress, and to alleviate the heavy debt service burden, the program conditionality on non-concessional borrowing was modified in 2018 on the basis that Togo can accommodate non-zero non-concessional borrowing limits if they are related to debt management operations and do not lead to an external risk rating downgrade. The program still aims at keeping Togo comfortably at moderate risk of external debt distress (i.e. below external debt burden indicators) at end-December 2019. Nonetheless, notwithstanding any debt management operation, the ongoing fiscal consolidation needs to be preserved to fundamentally address the debt burden. The impact of a possible debt reprofiling operation is reflected in a debt reprofiling scenario presented in this DSA.

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

i. Drivers of debt dynamics (Figure 3). The evolution of projection of external and public debt to GDP ratios are consistent for the current and previous DSA vintages, while they reflect major deviations from the DSA from 5 years past. This is because the public debt ratio increased significantly after 2013 and reached its highest level by 2016, which raised sustainability concerns. In terms of projections, the ECF program, which aims at putting debt on a sustainable path, is the main reason why the current and recent DSA vintages deviate from the DSA prepared in 2013. For external debt, projected debt levels remain about constant and the projected debt creating flows deviate from the five-year historical change because of projected smaller current account deficits and smaller residuals. 7 For total public debt, projected debt levels are declining because of real GDP growth and a positive primary balance, while the five-year historical change was a significant increase because of large primary deficits and a positive residual (because of the recognition of government guarantees related to pre-financing agreements).

Figure 1.
Figure 1.

Togo: Indicators of Public Guaranteed External Debt under Alternatives Scenarios, 2019–29 1/

Citation: IMF Staff Country Reports 2019, 205; 10.5089/9781498323925.002.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.

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

Citation: IMF Staff Country Reports 2019, 205; 10.5089/9781498323925.002.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.
Figure 3.
Figure 3.

Togo: Drivers of Debt Dynamics – Baseline Scenario

Citation: IMF Staff Country Reports 2019, 205; 10.5089/9781498323925.002.A003

1/ Difference between anticipated and actual contributions on debt ratios. 2/Distribution across LICs for which LIC DSAswere 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.

ii. Planned fiscal adjustment. The primary balance, estimated at 1.6 percent of GDP in 2018, outperformed program targets. While a deficit of 0.2 percent of GDP is projected in 2019 due to some urgent spending, it is expected to stabilize at a surplus of about 1 percent of GDP in the medium term.

iii. Fiscal adjustment and possible growth path (Figure 4). Projected economic growth of 5.1 percent in 2019 is lower than implied by the multipliers (growth in the range of 5.2–6.7 percent). Growth is projected at 5.3 percent in 2020, which is slightly above the potential growth rate under a range of plausible fiscal multipliers (growth in the range of 4.9–5.1 percent).

Figure 4.
Figure 4.

Togo: Realism Tools

Citation: IMF Staff Country Reports 2019, 205; 10.5089/9781498323925.002.A003

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

Main Assumptions in the Macroeconomic Framework

  • Real GDP growth is expected to remain moderate in the near term at an annual average of 5.2 percent over 2019–20. Over the long term (2020–39), potential growth is estimated at an annual average of 5.4 percent supported by structural reforms and stronger private sector activity.

  • Public investment is estimated to have dropped to 6.8 percent of GDP in 2018 and is projected to grow and reach 10 to 14 percent of GDP in the medium and long terms. Project loans are expected to grow in line with GDP while project grants grow in line with GDP up to 2028 and then remain constant in nominal terms and as a result, the share of domestically-financed investment is growing over time.

  • Key commodity price projections (i.e., for oil, phosphates, cotton, cocoa, and coffee) through 2024 are sourced from the WEO prepared in April 2019 and are assumed to remain constant in real terms for the remainder of the forecast period.

  • Medium-term inflation projections are unchanged from the previous DSA. Average inflation increased to 0.9 percent in 2018 (from deflation of 0.2 percent in 2017) driven by increasing costs for health and education services, restaurants, and transports. Inflation is expected to reach 2 percent in the medium-term, below the WAEMU convergence criteria.

  • Medium-term projections of total revenue and grants have been increased compared to the previous DSA. Tax revenue that is projected at 17.6 percent of GDP in 2019 would meet the WAEMU revenue criterion of 20 percent of GDP in 2025 and then stabilize at 22 percent of GDP starting in 2029. Improved revenue performance is supported by several measures introduced recently by the authorities to bolster permanent revenue, both on tax policy and tax administration reforms. Such measures include the phasing out of reduced VAT rates, enhancement of property taxation, reduction of tax exemptions, cross-check of taxpayers between tax and customs administrations, and control over imports valuation. Total revenue and grants are projected to average about 26.8 percent of GDP over 2020–29.

  • The overall primary fiscal balance (commitment basis, including grants) increased slightly to a surplus of 1.6 percent of GDP in 2018 from 1.5 percent in 2017. Starting in 2021 and up to 2029, the overall primary fiscal balance is anchored on a surplus of 1 percent of GDP, after which it would decrease and approach a deficit of 2 percent of GDP by 2039.

  • The current account deficits for 2017 and 2018 have improved significantly compared to the previous DSA, mainly due to reported lower imports of capital goods and other components. The deficit is projected to increase in 2019 because of urgent spending and to stabilize around 4½ percent of GDP over the medium to long term, ensuring consistency with the fundamentals and desirable policy settings.

  • Foreign direct investment, which has been very volatile, is expected to rise and stabilize around an inflow of 3.8 percent of GDP per year starting in 2025. However, these flows, as well as grants, are subject to significant risks, which may consequently alter the debt dynamics assumed in the baseline.

Box Table 1.

Togo: Key Macroeconomic Assumptions (DSA June 2019 vs DSA December 2018)

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Sources: Togolese authorities and Staff calculations.

Total revenue, including grants.

Country Classification and Determination of Scenario Stress Tests

9. Togo’s debt carrying capacity is medium. The composite indicator (CI), which captures the impact of several factors through a weighted average of an institutional indicator8, real GDP growth, remittances, international reserves, and world growth, confirms that Togo’s debt carrying capacity is classified to be ‘medium’, which is unchanged from the previous DSA. The debt carrying capacity, in turn, determines the PPG external debt thresholds and total public debt benchmarks.

10. Standardized stress tests indicate that external debt is resilient while public debt is under distress. Under standardized stress tests, all PPG external debt indicators remain below the policy relevant thresholds in the external DSA (Table 3 and Figure 1). However, using the benchmark of 55 percent, PV of public debt to GDP only falls below the threshold in 2023 in the public DSA (Table 4 and Figure 2). Togo does not have prominent economic features such as natural disasters, significant reliance on commodity exports, market financing, etc. that require additional tailored stress tests or other modules. Regarding the contingent liability stress test, a shock of 11.8 percent of GDP is used. The shock includes the default value of 5 percent for financial markets, a 6.8 percent for risks associated with private-public partnerships (PPPs) given Togo’s stock of around 20 percent of GDP, and 0 percent for SOE debt given that it is already included in public debt (Text Table 1).

Text Table 3.

Togo: Debt Carrying Capacity and Applicable Thresholds

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External Debt Sustainability Analysis

Baseline

11. Under the baseline scenario, all Togo’s external debt indicators continue to remain below their indicative policy-relevant thresholds (Table 1, Figure 1). Starting in 2020 after the conclusion of the ECF arrangement, new external loan financing will consist of borrowing from multilateral lenders (about 70 percent), Paris Club bilateral lenders (about 10 percent), and commercial lenders (about 20 percent). The present value of PPG external debt is projected at 17.1 percent of GDP in 2019 and should decrease to 11.6 percent by 2029. The ratio will remain below the 40 percent threshold under the baseline throughout the projection period. Similarly, debt service measures remain well below their respective thresholds and on a broadly downward trend. Improvements in debt-management practices envisaged in the authorities’ ECF-supported program will give further resilience to shocks affecting debt service needs (Figure 1).

Table 1.

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

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections

Includes debt of the central government and public entities.

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

Alternative Scenarios and Stress Tests

12. Alternative scenarios reveal breaches of some relevant thresholds (Figure 1). Under the most extreme shock scenario, the present value of PPG external debt-to-GDP as well as PPG external debt-to-exports ratio remain below the relevant thresholds over the projected period. This is also the case for debt service-to-export and to-revenue ratios. A tailored stress test for the combined contingent liability shock also does not cause any breach of relevant thresholds. However, under the historical scenario, which sets key macroeconomic parameters to their 10-year historical averages, the PV of debt-to-exports ratio breaches the threshold under the historical scenario in 2027, and PV of debt-to-GDP in 2023. These outcomes highlight the importance of sound macroeconomic policies.9

Public Debt Sustainability Analysis

13. The inclusion of Togo’s domestic public debt in the analysis worsens the vulnerability of the baseline scenario and yields an assessment of high overall risk of debt distress (Table 2, Figure 2). Togo’s domestic debt burden reflects persistent high deficits in recent years and recognition of government debt of accumulated liabilities from pre-financing, liquidated loss-making SOEs, and arrears accumulation. Weak public fiscal management, including limited debt management capacity, has played a role in these developments. Domestic debt is projected to keep declining gradually from a record high of 61.2 percent of GDP in 2016. New domestic debt is assumed to be issued as a mix of bonds with a maturity of 1–3 years (15 percent of total), 4–7 years (60 percent of total), and over 8 years (25 percent of total). By the end of the projection period, repayment of arrears coupled with significant fiscal consolidation is expected to substantially reduce domestic debt and total PPG debt. The total value of new domestic issuances is projected to decrease as a share of GDP from about 6 percent a year over 2020–24 to slightly less than 3 percent a year over 2035–39. It should be noted that the external and domestic debt definitions are based on the currency denomination. Thus, while external debt should preferably include also local-currency denominated domestic debt owed to non-residents, because of difficulties in record keeping and limited non-resident participation in domestic debt, the definition of external debt is restricted to debt denominated in foreign currency.

Table 2.

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

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

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

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

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

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period and other debt creating/reducing flows.

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

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

Baseline Scenario

14. Under the baseline and alternative scenarios, indicators of the overall public debt burden (external plus domestic) show significant vulnerabilities. The PV of public debt–to-GDP in 2018 stands above the benchmark level of 55 percent. The authorities undertook a substantial fiscal adjustment with a combination of spending restraint and revenue mobilization in 2017–18, but these efforts were not fully reflected in debt numbers in 2018. Togo’s PV of total public debt-to-GDP is expected to reach below the 55 percent benchmark by 2023 and to decline gradually below this benchmark thereafter (Figure 2). However, under the historical scenario and several standardized stress tests, the PV of public debt-to-GDP stays above the benchmark throughout all or most of the projection period as the country accumulates more debt to finance larger fiscal deficits. Such scenarios (essentially positing minor change from historic and present performance) highlight the risks to debt sustainability facing the authorities in the absence of needed policy reforms. A significant shock to state-owned enterprises could also result in the realization of contingent liabilities that would increase debt levels notably, though such risks are difficult to quantify.

Risk Rating and Vulnerabilities

15. Togo remains at moderate risk of external public debt distress and high risk of overall public debt distress:

  • Togo had the largest overall debt-to-GDP ratio in WAEMU in 2018, at 76.2 percent of GDP (73.2 percent excluding SOEs’ debt). The ratio of NPV of overall public debt-to-GDP stands above the prudential levels, remaining above such indicative benchmark through 2023—but on a steady declining trend, under the assumption of a continued primary surplus at about 1 percent of GDP and substantial reduction in the domestic debt.

  • For the external debt, under the baseline scenario, all PPG external debt sustainability indicators are expected to remain well below their indicative thresholds throughout the projection period (2019–29). While the mechanical results point to a low risk of external debt distress, judgment was applied given vulnerabilities arising from high domestic debt, which could, for example, likely lead to a reprofiling operation that would lead to an increase in external debt.

A Debt Reprofiling Scenario

16. The authorities plan to proceed with a debt reprofiling operation in the second half of 2019. Staff prepared a debt reprofiling scenario based on assumptions derived from available information (Tables 5 and 6). Under this scenario, Togo’s debt sustainability improves slightly. The PV of public debt would decline to 23.0 percent of GDP in 2039 compared with 26.5 percent of GDP in the baseline. The PV of external debt would be slightly higher at 14.1 percent of GDP in 2039 compared with 12.7 percent of GDP in the baseline. Alternative scenarios reveal breaches under standard stress tests. Under the most extreme shock scenario, the present value of PPG external debt-to-GDP would breach the threshold of PV of debt-to-GDP ratio but only temporarily (Figure 6). Because of the debt reprofiling, the debt service-to-revenue ratio would decrease rapidly over the next two years and then decline gradually from 33 percent in 2021 to 20 percent by 2029 (Figure 7).

Table 3.

Togo: 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.