Djibouti: Requests for Disbursement Under the Rapid Credit Facility and Debt Relief Under the Catastrophe Containment and Relief Trust— Press Release; Staff Report; and Statement by the Executive Director for Djibouti

Requests for Disbursement Under the Rapid Credit Facility and Debt Relief Under the Catastrophe Containment and Relief Trust-Press Release; and Staff Report; and Statement by the Executive Director for Djibouti

Abstract

Requests for Disbursement Under the Rapid Credit Facility and Debt Relief Under the Catastrophe Containment and Relief Trust-Press Release; and Staff Report; and Statement by the Executive Director for Djibouti

Context

1. Djibouti’s macroeconomic performance and outlook have until recently been broadly favorable.1 As a regional trade and logistics hub, the country benefitted from a recovery in Ethiopia’s trade flows last year. Real GDP is estimated to have grown by about 7½ percent; the underlying current account balance (excluding trade flows related to re-export activities) continued to improve (Text Table 1); and international reserves increased by close to US$50 million, bringing the reserve coverage to 3.6 months of imports (excluding reexports-related imports). These trends were expected to continue in 2020. Fiscal and debt metrics have also been improving: the overall deficit declined to about ¾ percent of GDP in 2019, and total public and publicly guaranteed external debt dropped for the second year in a row (to about 66 percent of GDP). The understanding reached last year with China’s Exim bank on the restructuring of the railway loan helped ease short-term debt service constraints. Despite some progress in strengthening banks’ balance sheets in recent years and a capital adequacy ratio of 15.7 percent at end-2019, nonperforming loans (NPLs) still accounted for about 16.3 percent of bank loans, highlighting underlying vulnerabilities.

Text Table 1.

Djibouti: Selected Economic and Financial Indicators, 2015–23

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Sources: Djibouti authorities; and IMF staff estimates and projections.

Excludes exports and imports for re-exports.

Impact of COVID-19

2. The COVID-19 pandemic has significantly altered Djibouti’s near-term economic prospects and has given rise to an urgent balance of payments need. The shock is operating through the following main channels:

  • Loss of output due to demand and supply shocks. The rapid growth in trade and logistics activities in recent years, underpinned by large investments in ports and transport infrastructure, has made the country more dependent on global and regional trade developments. The global recession therefore entails a large negative external demand shock for Djibouti. In addition, virus prevention and containment measures are affecting both domestic demand and supply.2 Assuming that, in Djibouti and most other countries, these measures have the greatest impact

  • during the second quarter and activity recovers thereafter, 2020 real GDP growth is expected to fall to -1 percent, 8 percentage points below the pre-shock baseline, and 2½ percentage points below the growth rate experienced during the global financial crisis. The social consequences of the crisis are also likely to be acute given Djibouti’s high poverty rate, large informal sector, and tradition of hosting and caring for sizeable refugee and migrant populations.

  • Fiscal pressures. Additional health and other priority expenditures of about 2.4 percent of GDP will be necessary this year to address the pandemic and its economic and social consequences. The shocks are also projected to reduce government revenue in 2020, by about 0.9 percent of GDP (Text Table 2).

  • Balance of payments financing need. Lower external demand for Djibouti’s trade and logistics services and a near-cessation of travel and tourism are expected to reduce the current account balance by about 4.2 percent of GDP compared to the pre-pandemic baseline. Foreign direct investment (FDI) is also projected to drop by 40 percent (Text Table 3). The resulting balance of payments financing need consistent with maintaining an adequate international reserve coverage of 3.1 months of prospective imports (excluding re-export related flows) is assessed to be some US$ 164 million (4.8 percent of GDP).3

Text Table 2.

Djibouti: Central Government Finances, 2019–20

(In percent of GDP)

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Sources: Djibouti authorities; and IMF staff estimates and projections.

Tax revenues are the most affected (-1 percent of GDP). Non tax revenue is resilient in nominal terms (supported by foreign non tax revenues—rents from the foreign military bases—that are unaffected) and contribute positively by 0.1 percent of GDP.

Current spending, mostly rigid, increases by 0.3 percent of GDP with the shock due to a lower nominal GDP.

Text Table 3.

Djibouti: Balance of Payments Financing, 2019–20

(In millions of USD)

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Sources: Djibouti authorities; and IMF staff estimates and projections.

The large drop in net exports between 2019 and 2020 under the pre-shock scenario is mainly driven by the balance of trade for reexports. The shock is projected to have an impact on both re-exports activities and the underlying current account.

Covers all balance of payment flows with the exception of current account and FDI.

Financing needed after accounting for the Central Bank’s NFA variations and repayment of arrears.

Economic Prospects and Risks

3. Medium-term macroeconomic prospects remain encouraging. The impact of the shock is expected to be temporary. Assuming policy responses start bearing fruit across the world, Ethiopia’s trade picks up, and containment efforts in Djibouti are gradually unwound in the second half of this year, a strong recovery could be expected in 2021, with real GDP growth reaching 10 percent, while both the external and fiscal positions would improve significantly.

4. There is considerable uncertainty around the baseline scenario and the impact of the COVID-19 pandemic on the economy could be worse. A more severe pandemic, with disruptions to global activity lasting longer or more acute than currently envisaged would have negative spillovers on Djibouti, with negative implications for growth and debt sustainability. Domestically, a more acute epidemic amidst high poverty and weak health system capacity, could also entail additional economic costs, including lower growth, weaker government revenue and higher health spending needs. Given the estimated size of the balance of payments and fiscal needs, a financing shortfall would have significant impact on economic and social outcomes and could lead to a debt distress situation. Many of the risks already identified at the time of the last Article IV consultation also remain (Annex I).

Economic Policies

Discussions with the authorities focused on immediate measures to fight the pandemic, alleviate its economic and social consequences, and address the urgent balance of payments need. Once the crisis abates, the authorities are also committed to policies that will strengthen debt sustainability and reforms that foster a strong and sustainable recovery and better social outcomes.

5. The government’s response to the pandemic has been swift. To prevent the spread of the virus, the government has taken early steps to impose border restrictions, including by interrupting all passenger flights and trains and by suspending visa issuance. Social distancing measures such as closure of schools, cancelation of public gatherings, and confinement of non-essential employees were also taken. These measures have been supported by an active communication campaign to sensitize the population. The Ministry of Health and its partners have increased their preparedness by building surveillance, testing, quarantine and health worker capacity. They have coordinated closely with the World Health Organization—with the latter providing protective and medical equipment, including tests and respirators—and other partners.

6. Against the backdrop of the currency board, the balance of payments shock will mainly be accommodated through higher financing. Consistent with the analysis provided in the context of the last Article IV, staff and the authorities saw Djibouti’s exchange rate arrangement as appropriate. Given the comfortable build-up in reserves last year, part of these can be used to absorb part of the COVID-19 shock while maintaining the reserves coverage at 3.1 months of imports. The authorities are engaging with development partners to seek support to finance the residual $118 million (3.5 percent of GDP) balance of payments need. The World Bank is considering their request for emergency budget support. The authorities have also noted their intention to request a debt service suspension from bilateral creditors in the context of the G20-sponsored initiative. They are committed to using the associated fiscal space for COVID-19-related spending and disclosing fully their public sector debt situation. The government has also taken steps to re-prioritize some spending to alleviate the impact of the shock (see below). A financing shortfall may, however, require a larger drawdown in international reserves as well as undesirable deeper cuts to non-COVID-19 spending and reprioritization of government outlays away from nonessential spending.

7. Accommodating a higher fiscal deficit in 2020 is critical to fight against COVID-19. The government’s policy response has been to scale up healthcare and other emergency spending and to support families and firms affected by the outbreak (2.4 percent of GDP; see text table). Additional spending is primarily channeled through existing programs. Together with the fall in tax and non-tax revenue (0.9 percent of GDP), and notwithstanding efforts to re-prioritize spending—some 0.9 percent of GDP in capital spending have been cut compared to the initial budget—the fiscal deficit is set to reach 4.5 percent of GDP this year. This increase is critical to help mitigate economic and social consequences of the pandemic. The authorities are committed to ensure that these additional expenditures are well-targeted and cost-effective. They are using a combination of social registry data and community targeting to identify beneficiaries and are engaging with METAC technical assistance experts on designing cash transfers.

Text Table 4.

Covid-19 related expenditures

(In billions DJF and percent of GDP)

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8. The authorities are also committed to use the resources dedicated to fight the impact of the pandemic in a transparent manner and in line with best budget practices. Notably, they will clearly outline these measures in a supplementary budget expected to be submitted to Parliament in a few weeks. The authorities also committed to undertake an ex-post audit of COVID-19 expenditure and to subject them to enhanced public disclosure, including by publishing large procurement contracts and the beneficial ownership of selected firms (see attached Letter of Intent).

9. Djibouti is at high risk of debt distress, but its debt is sustainable, provided that additional financing is available to close the urgent balance of payments need and the authorities sustain their efforts to enhance returns on infrastructure projects. The updated joint IMF-World Bank Debt Sustainability Analysis (DSA; see accompanying document) shows that the present value (PV) of the external debt-to-GDP ratio breaches its threshold during 2020–26 and the debt service-to-revenue ratio increases and largely stays above its threshold from 2022 onward. This indicates a high risk of debt distress, and financial support in the form of grants would therefore be preferable. Provided additional financing is available to address the urgent balance of payments need, the authorities are expected to be able to service their debt under current terms. Debt is therefore assessed as sustainable. This assessment takes into consideration the understanding reached with Exim Bank of China in 2019 to restructure the railway loan and accumulated arrears, which is expected to be finalized soon. It also hinges upon implementation of a range of fiscal and debt management reforms to underpin debt sustainability— including efforts to address and prevent the recurrence of external arrears.

10. The authorities reaffirmed their commitment to policies aimed at strengthening debt sustainability while creating space for poverty-reducing spending. A multifaceted approach is needed to underpin debt sustainability. This includes a rapid ramp-up of operations of several key projects to generate the revenues necessary for debt service. A combination of policies that reduce the pace of borrowing—which should be facilitated by the projected rapid improvement in fiscal accounts starting in 2021—and prioritize concessional financing and foreign direct investment (FDI) for projects is needed.4 Reforms to develop a medium-term fiscal framework and strengthen public investment management, and debt management capacity are also important. Strengthening SOEs oversight is also critical in this respect. The authorities have recently created a Sovereign Wealth Fund that will manage some of the government assets, including SOEs. They are committed to do so under best international governance practices and while ringfencing budget resources. The authorities are also committed to design a strategy to increase domestic revenue mobilization and create space for poverty-reducing outlays, notably by reducing tax exemptions and streamlining special regimes. IMF and World Bank technical assistance covering many of these areas will resume as soon as possible.

11. The authorities are committed to promptly resolve their outstanding external arrears. As of end-March 2020, Djibouti had an outstanding stock of arrears to bilateral creditors of the order of 3.3 percent of GDP. Part of these have been accumulated—and will be restructured— pending finalization of the railway loan restructuring with Exim Bank of China. The authorities have indicated that the remaining arrears reflect delays in finalizing conversions and cancellation agreements and arrears of a technical nature or reflecting diplomatic disagreements. They have committed to engage with their creditors to address these expeditiously. They are also taking steps to strengthen cash management, including with the support of IMF technical assistance, to prevent recurrence of arrears. In these exceptional circumstances and given the authorities’ intention to make a request for debt service suspension under the G20-sponsored initiative, the RCF is expected to rapidly advance the normalization of relations with creditors by the time of any successor IMF arrangement. Against this backdrop, arrears to G20 and Paris Club creditors are deemed away for the purpose of the IMF’s lending into arrears policy. With this group of creditors accounting for the bulk of the arrears, the creditor grouping is deemed representative. The authorities have a credible plan to clear arrears to three organizations and intend to contact these creditors to seek financial assistance.

12. Financial sector policy discussions focused on steps that maintain the balance between preserving financial stability and sustaining economic activity. Staff welcomed the guidance issued to banks and the steps taken by the central bank of Djibouti (CBD) to ensure business continuity. In a pandemic environment, banks could face loan repayment difficulties. Staff and the authorities agreed that the CBD should go along with prudent renegotiation of loan terms for impacted borrowers without lowering loan classification and provisioning standards. Banks’ capital and liquidity buffers should be used to absorb potential credit losses and the liquidity squeeze. Some flexibility could be used on the timing of bringing capital ratios above the minimum required once these buffers are exhausted. The CBD has committed to reinforce its monitoring of banks’ liquidity risks and encourage banks to strengthen their liquidity risk controls and management practices. As the crisis abates, it will be important to strengthen banks’ balance sheets and to put in place a CBD strategic plan and associated resource mapping exercise, as recommended by the recent Financial Sector Stability Review. Such a plan would set a longer-term financial sector reform vision (including to bolster the central bank governance and supervisory capacity).

13. Although the most pressing priority is to fight the pandemic, the authorities should not lose sight of reforms aimed at fostering higher and inclusive growth. Addressing impediments to private sector investment and improving external competitiveness will be important to encourage a strong recovery once the pandemic abates. Critical reforms include further enhancing the business environment, promoting competition, and improving the governance and efficiency of public enterprises to lower factor costs, particularly in the telecommunications and electricity sectors. Enhancing the skills of Djiboutian nationals through education and training is important to raise labor productivity and reduce unemployment. Fully implementing the anti-corruption framework, including by strengthening the capacity of relevant institutions, is also important to reduce the perception of corruption and enhance private investment.

Modalities of Support

14. Staff supports the authorities’ request for assistance under the RCF in the amount of SDR 31.8 million (100 percent of quota). Djibouti faces an urgent BOP need, which, if not addressed, would result in immediate and severe economic and social disruptions. Without IMF financing (which would represent about ¼ of the estimated financing gap) and support from other donors (which could in part be catalyzed by the RCF disbursement), international reserves would fall to about 2 months of prospective imports. The emerging fiscal financing gap would prevent an adequate response to the COVID-19. Under staff’s baseline, the balance of payments’ difficulties are expected to be resolved within the next 12 months without major policy adjustments. Should the magnitude of the shocks faced by the economy be more pronounced or last longer, an upper-credit tranche arrangement may become necessary to support policies to achieve the necessary adjustment and catalyze additional donor support.

15. Staff also supports Djibouti’s request for debt relief under the CCRT’s catastrophe containment window. The country meets the income threshold with GNI per capita of US$2,180, below the small states’ threshold of US$2,350. It also faces exceptional BOP needs stemming from the impact of COVID-19 and is pursuing appropriate macroeconomic policies to address the disaster. Djibouti has debt service of SDR 1.7 million falling due in the initial period of debt service relief from April 14 to October 13, 2020 (Table 7). The debt service falling due in the 24 months from April 14, 2020 (the maximum potential period of debt service relief, subject to availability of resources and decisions of the Executive Board) amounts to SDR 6.03 million. Subject to resource availability, staff supports the authorities’ request for debt service relief for amounts falling due to the Fund for the 5-month period starting May 8, 2020 up to October 13, 2020.

Table 1.

Djibouti: Selected Economic and Financial Indicators, 2015–2025

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Sources: Djibouti authorities and IMF staff estimates and projections.

Using the SDR/USD exchange rate as of April 20, 2020.

Current account balance excluding imports and exports associated with re-export activities.

Latest available.

Table 2.

Djibouti: Central Government Operations, 2015–2025

(In millions of Djibouti francs)

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Sources: Djibouti authorities; and IMF staff estimates and projections.

Using the SDR/DJF exchange rate as of April 20, 2020.

Represents debt service of railway and water pipeline loans covered by the SoEs managing these projects.

Table 3.

Djibouti: Central Government Operations, 2015–2025

(In percent of GDP)

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Sources: Djibouti authorities; and IMF staff estimates and projections.

Using the SDR/DJFexchange rate as of April 20, 2020.

Represents debt service of railway and water pipeline loans covered by the SoEs managing these projects.

Table 4.

Djibouti: Balance of Payments, 2015–2025

(In millions of U.S. dollars, unless otherwise indicated)

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Sources: Djibouti authorities; and IMF staff estimates and projections.

Using the SDR/USD exchange rate as of April 20, 2020.

Assumes debt relief under CCRT for the next 6 months, and if resources are available up to the next 18 months.