Cabo Verde: Staff Report for the 2019 Article IV Consultation and Request for a Policy Coordination Instrument—Debt Sustainability Analysis

Staff Report for the 2019 Article IV Consultation and Request for an Eighteen-Month Policy Coordination Instrument-Press Release; Staff Report; and Statement by the Executive Director for Cabo Verde

Abstract

Staff Report for the 2019 Article IV Consultation and Request for an Eighteen-Month Policy Coordination Instrument-Press Release; Staff Report; and Statement by the Executive Director for Cabo Verde

Joint Bank-Fund Debt Sustainability Analysis

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Cabo Verde’s risk of external and overall debt distress is rated “high” as in the previous DSA. The present value (PV) of public and publicly-guaranteed (PPG) external debt-to-GDP ratio breaches its threshold in 2019–22 under the baseline and protractedly under stress test scenarios. The PV of total public debt-to-GDP ratio is projected to recede below its threshold from 2026 under the baseline and breaches its prescribed limit under stress test scenarios. The debt sustainability assessment is predicated on sustained fiscal consolidation and successful restructuring of State-Owned Enterprises (SOEs). Prudent borrowing policies and a strengthened debt management strategy are critical to containing debt accumulation. In view of Cabo Verde’s vulnerability to exogenous shocks, growth-enhancing structural reforms remain critical to bringing public debt to sustainable levels.

Public Debt Coverage

1. The coverage of the public sector is in line with the previous DSA (Text Table 1). Consistent with fiscal accounts, social security funds and local governments are excluded from the DSA, while the coverage of extra budgetary funds (EBFs) is focused on government support to State-Owned Enterprises (SOEs) through onlending and capitalization. Government guarantee to SOEs’ external borrowing is included in the baseline stock of debt, while publicly-guaranteed domestic debt and non-guaranteed debt by SOEs are excluded because of limited information on the repayment schedule. However, efforts to broaden the coverage of public sector debt are ongoing, including under a World Bank project focused on SOEs. External debt is defined on a residency basis.

Text Table 1.

Cabo Verde: Coverage of Public-Sector Debt and Design of Contingent Liability Stress Test

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2. The contingent liability tailored stress test is calibrated to account for the debt coverage gaps highlighted above (see Text Table 1). First, the default shock of 0 percent of GDP for other elements of the general government not captured in the baseline stock of debt is raised to 0.4 percent of GDP to account for the size of publicly-guaranteed domestic debt of local governments.1 The strong financial position of the social security fund (INPS) rules out concerns of fiscal risks and obviates the need to adjust the contingent liability stress test for its exclusion. Second, the default shock of 2 percent of GDP for SOEs’ debt is raised to 23.4 percent of GDP to reflect vulnerabilities associated with: (i) publicly-guaranteed domestic borrowing by ELECTRA, TACV, IFH, ENAPOR and CERMI amounting to CVE 11.4 billion (6.1 percent of GDP) at end-2018 and; (ii) non-guaranteed domestic debt of loss-making SOEs totaling CVE 32.1 billion (17.3 percent of GDP) at end-2018.2 Third, the default shock of 1.1 percent of GDP is kept for public private partnerships (PPPs). Fourth, given that most banks are foreign-owned and well-capitalized, Cabo Verde’s financial sector does not exhibit significant vulnerabilities that warrant an upward adjustment of the default minimum value of 5 percent of GDP for the financial market shock.

Background

A. Evolution and Composition of Debt

3. The stock of public debt stood at 123.9 percent of GDP at end-2018 (Text Figure 1). It declined compared with 2017 (127 percent of GDP), reflecting the downward trend in external debt, which accounts for almost 75 percent of the total stock of public debt. Domestic debt rose slightly to 32.9 percent of GDP. Interest and principal payments on domestic debt accounted for 61 percent of total public debt service burden in 2018.

Text Figure 1.
Text Figure 1.

Cabo Verde: Profile of Public Debt and Debt Service, 2002–18

Citation: IMF Staff Country Reports 2019, 255; 10.5089/9781513509402.002.A003

Source: Cabo Verdean authorities and IMF staff estimates.Note: Publicly-guaranteed external debt stock and debt service of SOEs included from 2015.

4. Cabo Verde’s public external debt is highly concessional (Text Table 2). Multilateral institutions, notably the World Bank and the African Development Bank are the main creditors; and Portugal is the main bilateral creditor. Average maturity is about 30.5 years, and average interest is below 1 percent.3 More than two third of the external debt portfolio is euro-denominated, and therefore, exchange risk is low given that the Cabo Verdean escudo (CVE) is pegged to the euro.

Text Table 2.

Cabo Verde: External Debt Profile by Type of Creditors, 2018

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Source: Cabo Verdean authorities and IMF staff estimates.

5. Domestic debt consists mostly of medium and long-term Treasury securities. At end-2018, it accounted for 33 percent of total public debt (Text Table 3), comprising mainly Treasury bonds (97 percent); with average maturity and interest rate of about 7 years, and 5 percent respectively. Securities holders are: the banking sector (62 percent), the national social security fund (36 percent) and households (2 percent).

Text Table 3.

Cabo Verde: Publicly-Guaranteed Debt, 2016–18

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Source: Cabo Verdean authorities and IMF staff calculations.

6. Publicly-guaranteed debt stood at CVE 13.8 billion (7.4 percent of GDP) at end-2018 (Text Table 3). The State guarantee is mainly issued for SOEs’ domestic debt. For 2018, the stock of publicly-guaranteed external debt covers TACV debt contracted with a consortium of foreign banks, while guaranteed domestic debt consists primarily of liabilities of ELECTRA, ENAPOR, IFH, TACV and CERMI to the domestic banking system and stock exchange; and borrowing by a few municipalities.4 The issuance and management of State guarantee is regulated by Decree-Law 42 of June 29, 2018 which clarified the entities that could benefit from guarantees and under which conditions. It also cut red tape by empowering the Ministry of Finance and Planning in authorizing up to CVE 50 million of guarantees per project. Additionally, the recently approved public debt law includes an article requiring parliamentary approval for the issuance of loan guarantees.

7. Historical series of private external debt derived from international investment position (IIP) data indicate a relatively low stock of about 10 percent of GDP at end-2018. Private debt includes both bank and non-bank external debt. The central bank (BCV) compiles and publishes non-financial corporations’ private debt stock statistics, and a recent external sector statistics (ESS) technical assistance (TA) mission welcomed the significant progress achieved by the BCV in ESS compilation since 2012, including the migration of BOP and IIP statistics to BPM6 and the reporting of quarterly IIP.

B. Outlook and Key Macroeconomic Assumptions

8. The baseline scenario is predicated on a strong medium-term outlook. Medium and long-term real GDP growth is expected to be higher relative to the 2018 Article IV Consultation DSA. GDP growth reached 5.5 percent in 2018 and is projected to stabilize at 5 percent from 2019 onward (Text Table 4). The momentum in economic activity is expected to be supported by strong performance in the tourism, fishery, and industry sectors. Structural reforms aimed at enhancing the business environment, including through improved inter-island connectivity and strengthened linkages between tourism and non-tourism sectors, as well as the implementation of projects under the authorities’ Strategic Plan for Sustainable Development (PEDS) 2017–21, should also support growth going forward. Inflation is expected to remain below 2 percent in the medium term, lower than the level projected under the previous DSA.

Text Table 4.

Cabo Verde: Assumptions for Key Economic Indicators, 2017–24

(Percent of GDP)

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Sources: Cabo Verdean authorities; and IMF staff estimates and projections.Note: Averages for 2018 Article IV DSA are from 2030–37. Overall financing needs refer to the overall balance adjusted for below-the-line net liabilities capturing government support to SOEs through onlending and capitalization.

9. The current framework assumes a more ambitious and steadfast fiscal consolidation path (Text Table 4), with the fiscal deficit projected to fall from 2.8 percent of GDP in 2018 to 0.8 percent of GDP in 2024, before turning into a surplus in the long term. Fiscal efforts are assumed to be underpinned by strengthened domestic revenue mobilization and expenditure restraint. The projected improvement in the primary balance, combined with a steady reduction in government financial support to SOEs would bring total financing needs down to 1 percent of GDP by 2024 (3.8 percent of GDP in 2018). Compared with the previous DSA, the external current account deficit is projected to be lower and to further narrow in the medium term owing to robust export performance and increased remittances. Together with higher FDI inflows, it should contribute to a gradual accumulation of reserves.

10. The DSA assumes that financing needs would be covered by identified external sources and by domestic borrowing up to the authorities’ annual ceiling of 3 percent of GDP. Multilateral sources comprise budget support from the World Bank and the African Development amounting to US$240 million during 2019–24. While projecting continued foreign support in the short and medium term, the DSA assumes in the long term a gradual shift of external financing from concessional loans toward less concessional financing, and toward commercial borrowing from 2025 onward, consistent with Cabo Verde’s middle-income status. In line with the profile of domestic debt portfolio at end-2018, bonds with maturities of at least 4 years are assumed to account for 97 percent of the stock in the medium term. The average interest rate is set to 1 percent for T-bills, and 4 and 5 percent for short-term and medium to longer-term bonds respectively.

11. Tools for assessing the realism of the baseline scenario do not flag significant and systematic deviations from historical experience.

  • Drivers of debt dynamics (Figure 3). The contributions of past and projected debt-creating flows for PPG external debt remain broadly unchanged, although prices and exchange rates are expected to negatively contribute to PPG external debt accumulation relative to historical experience. For total public debt, the projected contribution of real GDP growth to public debt reduction is higher than what the past five years would suggest, owing to an upward revision of medium- and long-run growth. Although significant support to loss-making public enterprises in recent years is expected to increase public debt more than in the past as captured by “other debt creating flows”,5 continued fiscal consolidation efforts and restructuring of SOEs should significantly limit the contribution of the primary deficit to public debt accumulation relative to what the past five years would suggest. Unexpected changes in prices and exchange rates were the main drivers of past forecast errors of debt dynamics.

  • Realism of planned fiscal adjustment (Figure 4). The projected three-year fiscal adjustment in the primary balance stands at 1.5 percentage points of GDP between 2018 and 2021 and lies beneath the top quartile of the distribution of past adjustments of the primary fiscal deficit derived from the sample of LICs.

  • Consistency between fiscal adjustment and growth (Figure 4). The projected growth path for 2019 and 2020 is in line with the multiplier-based projections. The realism of the expected adjustment is predicated on the authorities’ commitment to further fiscal consolidation and restructuring of SOEs. It is also underpinned by robust real GDP growth at 5 percent on the back of strong activity in the industry, tourism and transportation sectors and positive contribution from expected reforms aimed at transforming Cabo Verde into an air and maritime transportation hub in the medium term, under the PEDS.

  • Consistency between public investment and growth (Figure 4). The realism tool shows that like historical figures, the contribution of public investment to real GDP growth remains marginal across the previous and current DSA, mainly reflecting low multiplier for public investment, consistent with the high import content of capital spending. While public investment is expected to hover around 4 percent of GDP in the medium term as in the previous DSA, private investment should remain at 34 percent of GDP on average over 2020–24

Figure 1.
Figure 1.

Cabo Verde: Indicators of Public and Publicly Guaranteed External Debt Under Alternatives Scenarios, 2019–2029

Citation: IMF Staff Country Reports 2019, 255; 10.5089/9781513509402.002.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.

Cabo Verde: Indicators of Public Debt Under Alternative Scenarios, 2019–2029

Citation: IMF Staff Country Reports 2019, 255; 10.5089/9781513509402.002.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. 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.

Cabo Verde: Drivers of Debt Dynamics – Baseline Scenario

Citation: IMF Staff Country Reports 2019, 255; 10.5089/9781513509402.002.A003

Sources: Country authorities; and staff estimates and projections.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.

Cabo Verde: Realism tools

Citation: IMF Staff Country Reports 2019, 255; 10.5089/9781513509402.002.A003

Sources: Country authorities; and staff estimates and projections.

C. Country Classification and Determination of Stress Test Scenarios

12. Cabo Verde’s debt-carrying capacity is assessed as “strong” as in the 2018 Article IV DSA (Text Table 5). In the previous framework, the debt-carrying capacity was solely informed by the World Bank Country Policy and Institutional Assessment (CPIA) score. The new methodology relies on a composite indicator (CI) combining the CPIA score, external conditions captured by world economic growth and country-specific factors. Based on data from the April 2019 World Economic Outlook (WEO) vintage and the 2017 CPIA, the CI score for Cabo Verde stands at 3.28, which is above the threshold of 3.05 applicable for a “strong” rating. The CI score reflects positive contributions from the CPIA (44 percent), international reserves (31 percent), world growth (15 percent), remittances (6 percent) and country real growth rate (3 percent). Debt burden thresholds implied by the strong debt-carrying capacity under the previous and new frameworks are summarized in Text Table 6.

Text Table 5.

Cabo Verde: CI Score Summary Table

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Source: IMF staff calculations. The CI cutoff for strong debt-carrying capacity is CI > 3.05.
Text Table 6.

Cabo Verde: Debt Thresholds under Strong Debt-Carrying Capacity

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Source: IMF staff calculations.

13. The debt sustainability analysis relies on the six standardized stress tests and the contingent liability stress test. While the former uses the default settings, the latter is customized to address potential vulnerabilities stemming from the incomplete coverage of public sector debt as explained in paragraph 2. None of the tailored stress tests is triggered for Cabo Verde.

Debt Sustainability Analysis

D. External Public Debt

14. Under the baseline scenario, the PV of PPG external debt-to-GDP ratio breaches its applicable threshold in 2019–22, thereby signaling a high risk of external debt distress (Figure 1, Tables 1 and 3). However, the other debt burden indicators remain comfortably below their prescribed thresholds throughout the DSA horizon. The PV of PPG external debt ratios to GDP and exports are expected to steadily decrease over time. Both debt service-to-exports and debt service-to-revenue ratios display similar patterns, declining through 2020 with the full amortization of TACV’s publicly-guaranteed external debt, picking up in 2021 when Cabo Verde starts repaying the principal on loans from the Portuguese bank Caixa Geral de Depósitos (CGD), and decreasing gradually from 2022 onward.

Table 1.

Cabo Verde: External Debt Sustainability Framework, Baseline Scenario, 2016–2039

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.1/ Includes both public and private sector external debt.2/ Derived as [r – g – ρ(1+g) + εα (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, ε = nominal appreciation of the local currency, and α= share of local currency-denominated external debt in total external debt.3/ 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.4/ Current-year interest payments divided by previous period debt stock.5/ Defined as grants, concessional loans, and debt relief.6/ 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).7/ Assumes that PV of private sector debt is equivalent to its face value.8/ 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.

Cabo Verde: Public Sector Debt Sustainability Framework, Baseline Scenario, 2016–2039

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.1/ Coverage of debt: The central government plus extra budgetary funds, central bank, government-guaranteed debt. Definition of external debt is Residency-based.2/ 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.3/ Debt service is defined as the sum of interest and amortization of medium and long-term, and short-term debt.4/ 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.5/ 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.6/ 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.

Cabo Verde: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2019–2029

(Percent)

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Sources: Country authorities; and staff estimates and projections.

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.

15. The PV of PPG external debt-to-GDP ratio also breaches its threshold protractedly under the stress test scenarios (Figure 1, Tables 1 and 3). Under the most extreme shock which is a one-time 30 percent nominal depreciation, it rises to 88.2 percent in 2020 before gradually decreasing and receding below the threshold of 55 percent of GDP from 2028 only. The threshold is also breached under the remaining five standardized bound tests, albeit to different extents, and under the tailored combined contingent liabilities test over 2019–28. While the PV of PPG external debt-to-exports ratio exhibits a similar trend, it remains below its applicable threshold throughout the projection period, despite being close to its limit in 2021. Likewise, none of Cabo Verde’s debt service-related indicators breaches their respective thresholds under the stress test scenario. However, the projected trajectories of PPG external debt burden indicators appear vulnerable to export growth shocks and to a one-time depreciation shock, thus highlighting the country’s exposure to adverse shocks due to the lack of diversification.

E. Total Public Debt

16. The PV of total public debt-to-GDP ratio exceeds the 70 percent benchmark through 2025 under the baseline scenario (Figure 2, Tables 2 and 4). The prescribed benchmark is also breached throughout the projection period under the six standardized bound tests and the tailored combined contingent liabilities test, with the one-time depreciation being the most severe shock. Furthermore, the debt outlook, as shown by the other public DSA indicators, is particularly vulnerable to depreciation shocks and to contingent liabilities associated with SOEs’ debt which emerge as the most extreme shock.

Table 4.

Cabo Verde: Sensitivity Analysis for Key Indicators of Public Debt, 2019–2029

(Percent)

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Sources: Country authorities; and staff estimates and projections.

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

Includes official and private transfers and FDI.

F. Debt Distress Ratings

17. Cabo Verde’s DSA finds a “high” risk of external and overall debt distress, with risks tilted to the downside. The PV of PPG external debt-to-GDP ratio breaches its threshold over the medium-term projection period under the baseline scenario, thereby signaling a high risk of external debt distress, and is particularly sensitive to export and growth shocks. However, it is projected to gradually decline as the forecast horizon advances, falling below the 55 percent threshold from 2023 onward. Similarly, the PV of PPG external debt-to-exports ratio exhibits a continuous downward trend over the projection period. In addition, debt service indicators are projected to remain comfortably below their respective thresholds throughout the DSA projection horizon. The “high” risk of overall debt distress is the outcome of the breach of the PV of PPG external debt-to-GDP ratio (which also resulted in a “high” risk of external debt distress), combined with the breach by the PV of total public debt-to-GDP ratio. However, although the latter ratio stays above the 70 percent benchmark, it is expected to gradually decline, with the breach ending in 2026. Based on these dynamics, external and public debt are deemed sustainable going forward.

18. Cabo Verde could graduate to “moderate” external and overall public debt distress ratings by 2023 and 2026 respectively if the assumptions built into the DSA materialize. The projected fiscal adjustment, notably under the PCI, combined with successful implementation of SOEs reforms are expected to help contain debt accumulation. Prudent borrowing policies, adhering to the zero limit on non-concessional borrowing, as well as strengthened debt management strategy remain critical to keeping public debt at sustainable levels. Ensuring debt sustainability will also require implementation of growth-enhancing structural reforms with a focus on actions needed to diversify the productive base and to address the infrastructure gap. Effective implementation of the PEDS could play an important role in this respect.

G. Authorities’ Views

19. The authorities broadly agreed with the assumptions and results of the DSA and made a few observations. While agreeing that the interest rate on the end-December 2018 stock of medium and long-term bonds averaged 5 percent, they emphasized the more favorable terms on new issuances in 2018 and 2019, with an average interest rate below 4 percent. They also ruled out any uncertainty about the repayment of TACV’s publicly-guaranteed external debt by highlighting that the largest share of the debt corresponds to a EUR 13.5 million loan to finance the workforce retrenchment cost, and that financing was already secured. On the borrowing strategy assumptions, the authorities insisted they will refrain from contracting non-concessional debt and reiterated commitment to reducing the stock of public debt, including by enhancing revenue administration and spending quality, containing expenditures, increasing private sector participation through concessions and privatizations, selling government properties, and supporting the development of domestic debt markets. They also underscored that the recently adopted pieces of legislation regulating the issuance and management of public debt and State guarantees are a welcome step in the right direction.

1

Government-guaranteed domestic borrowing of municipalities from the banking system stood at CVE 682 million (0.4 percent of GDP) at end-December 2018 (see Text Table 3 for more details).

2

The total stock of non-guaranteed domestic debt stood at CVE 79.2 billion at end-2018, of which CVE 32.1 billion represented borrowing by the following SOEs which recorded negative net income in 2018: ELECTRA, TACV, CVFF, APN, the Cabo Verdean News Agency, CABNAVE, CERMI, SCS, FIC and EHTCV.

3

Commercial loans mainly consist of debt owed to Caixa Geral de Depósitos (CGD) under favorable terms, with an average maturity of 20 years and an average interest rate of 1.55 percent.

4

These are Porto Novo, Santa Catarina, Sao Vicente and Paul. The 2018 stock also includes the domestic debt of Santiago island’s water company, owned by the island’s municipality.

5

“Other debt creating flows” capture below-the-line liabilities from the fiscal accounts, including government support to SOEs through onlending and capitalization.

Cabo Verde: Staff Report for the 2019 Article IV Consultation and Request for an Eighteen-Month Policy Coordination Instrument-Press Release; Staff Report; and Statement by the Executive Director for Cabo Verde
Author: International Monetary Fund. African Dept.
  • View in gallery

    Cabo Verde: Profile of Public Debt and Debt Service, 2002–18

  • View in gallery

    Cabo Verde: Indicators of Public and Publicly Guaranteed External Debt Under Alternatives Scenarios, 2019–2029

  • View in gallery

    Cabo Verde: Indicators of Public Debt Under Alternative Scenarios, 2019–2029

  • View in gallery

    Cabo Verde: Drivers of Debt Dynamics – Baseline Scenario

  • View in gallery

    Cabo Verde: Realism tools