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INTERNATIONAL MONETARY FUND AND

THE WORLD BANK

Review of Low-Income Country Debt Sustainability Framework and Implications of the MDRI

Prepared by the Staff of the IMF and the World Bank Approved by Mark Allen and Danny Leipziger

March 24, 2006

Executive Summary

Purpose: This paper reviews the experience with the joint IMF-World Bank Debt Sustainability Framework (DSF) for low-income countries, including cooperation between the staffs, and highlights the implications of the Multilateral Debt Relief Initiative (MDRI).

Review of experience: Experience with the DSF has so far been encouraging. The depth and quality of debt sustainability analyses have varied, but there have been improvements over time. The DSF has strengthened Fund surveillance and is beginning to help with program design. On the Bank side, the DSF has fundamentally changed the IDA grant allocation criteria, which now focus exclusively on risk of debt distress. Bank and Fund staffs have generally cooperated well, and, while the resource costs for the preparation of the DSAs have generally been substantial, the additional resource implications of the enhanced collaboration have been small in most cases. One important challenge is to take domestic debt more systematically into account in the framework; despite data difficulties, the paper recommends that future work on the framework focus on the development of a more integrated approach.

Implications of MDRI: The MDRI provides post-HIPCs considerable new breathing space to strengthen their financial position and support their efforts to reach the Millennium Development Goals (MDGs). It is important, however, to avoid a new round of over-indebtedness. Toward this end, we discuss three questions:

  • Should the DSF debt thresholds be lowered? One option is to lower the indicative thresholds that guide the level of new borrowing a country can undertake. The paper finds that, on balance, it may be better to maintain the current debt thresholds embodied in the DSF. These thresholds reflect a balance between risk of debt distress, opportunities for productive investment, and a realistic assessment of grant resources. Lowering them would reopen questions related to HIPC eligibility and, if applied selectively, would raise issues related to uniformity of treatment.

  • How should debt accumulation be managed in countries that are well below the DSF thresholds? The paper considers the merits of two polar frameworks: simple across-the-board rules for new borrowing (such as a restriction on changes in the NPV of debt), and a case-by-case examination of the unique situation and needs of each country. On balance, a case-by-case approach appears preferable.

  • What is the role of nonconcessional debt, and how can the "free-rider" problem be dealt with in the DSF? No fully effective solution to these difficult questions emerges. A common, coordinated approach towards concessionality by all creditors would be ideal. The paper suggests that countries that continue to face debt distress should avoid nonconcessional borrowing completely, while for others, high return projects that can significantly improve creditworthiness could be financed on nonconcessional terms.

Issues for discussion: We seek the Boards' guidance on: (i) refinements to the DSF; (ii) implications of MDRI, especially their views on rules-based or case-by-case approaches to debt reaccumulation; and (iii) ways to deal with the "free-rider" problem.

Contents

  • I. Introduction

  • II. Review of Low-Income Country Debt Sustainability Framework

  • A. Experience with the New Joint DSA Framework

  • B. Application of the DSF

  • C. Usefulness to Other Donors and Creditors

  • D. Bank-Fund Collaboration

  • III. The Debt Sustainability Framework in Light of MDRI

  • A. Indicative Debt Thresholds in Light of the MDRI

  • B. Debt Accumulation Below the Thresholds

  • C. The DSF and the "Free Rider" Problem

  • IV. Conclusions and Issues for Discussion

  • A. Refinements to the DSF on the Basis of Experience

  • B. Issues to Consider in the Context of MDRI

  • Appendix

  • Post-MDRI Debt Scenarios

  • Tables

  • Table 1. Risk Ratings in Joint DSAs Before MDRI Debt Relief

  • Table 2. Alternative Joint DSA Scenarios and Stress Tests in 2005 and Early 2006

  • Figures

  • Figure 1. Risk Ratings in Joint DSAs—Before MDRI Debt Relief

  • Figure 2. NPV of Debt-to-IExports Ratio in MDRI Recipients

  • Figure 3. NPV of Debt-to-Exports Ratio in African MDRI Recipients

  • Boxes

  • Box 1: The Characteristics of a DSA

  • Box 2: Good Practices for DSA Design and Presentation

  • Box 3: The 2005 Vietnam DSA

  • Box 4: Will MDRI Relief Lead to an Increase in IDA Lending?

  • Box 5: External Debt Sustainability in the CIS-5

  • Box 6: Composition of Financing Flows to Low-Income Countries

  • Box 7: Nonconcessional Borrowing in the Context of Fund-supported Programs

  • References

Abbreviations and Acronyms

AfDF

African Development Fund

AfDF-10

Tenth Replenishment of African Development Fund

AsDB

Asian Development Bank

CAFOD

Catholic Agency for Overseas Development

CIS

Commonwealth of Independent States

CPIA

Country Policy and Institutional Assessment

DSA

Debt Sustainability Analysis

DSF

Debt Sustainability Framework

EFF

Extended Fund Facility

GDP

Gross Domestic Product

HIPC

Heavily Indebted Poor Countries

IDA

International Development Association (World Bank)

IDA-14

Fourteenth Replenishment of IDA

LIC

Low-Income Countries

MDB

Multilateral Development Banks

MDG

Millenium Development Goals

MDRI

Multilateral Debt Relief Initiative

NPV

Net Present Value

PRGF

Poverty Reduction and Growth Facility

PSI

Policy Support Instrument

SMP

Staff-Monitored Program

TFP

Total Factor Productivity

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Review of Low-Income Country Debt Sustainability Framework and Implications of the Multilateral Debt Relief Initiative (MDRI)
Author:
International Monetary Fund