Annex 1. How Have DSAs Taken Account of the Investment-Growth Nexus
An important criticism of the DSF is that it does not fully take into account the impact of investments on growth and, as a result, constrains borrowing to finance productive investments. The cases discussed below suggest that, despite the inherent difficulties in assessing the growth effect of public investments, recent country DSAs have attempted to take into account such effects.
Annex 2. The Efficiency of Public Investment, Economic Growth, and Debt Sustainability
Adam, C. and D. Bevan, 2006, “Aid and the Supply Side: Public Investment, Export Performance, and Dutch Disease in Low-Income Countries,” World Bank Economic Review, 20(2), pp. 261–90.
Agénor, P. and D. Yilmaz, 2008, “Aid Allocation, Growth and Welfare with Productive Public Goods,” Centre for Growth and Business Cycle Research Discussion Paper Series 95, Economics, The University of Manchester.
Arellano, C., A. Bulír, T. Lane, and L. Lipschitz, 2009, “The dynamic implications of foreign aid and its variability,” Journal of Development Economics, Elsevier, Vol. 88(1), pp. 87–102.
Berg, A., T. Mirzoev, R. Portillo, and L.F. Zanna, 2009, “The Short-Run Macroeconomics of Aid Inflows: An Analytical Framework,” IMF Working Paper, Forthcoming.
Blackburn, K., N. Bose, and E. Haque, 2005, “Public Expenditures, Bureaucratic Corruption and Economic Development,” Centre for Growth and Business Cycle Research Discussion Paper Series 53.
Bose, N., M. E. Haque, and D. R. Osborn, 2007, “Public Expenditure and Economic Growth: A Disaggregated Analysis for Developing Countries,” Manchester School, 75, 533.56.
Briceño-Garmendia, C., D. Doemeland, A. Farah, and J. Herderschee, 2009, “Macroeconomic Impact of Large-scale Chinese Financed Infrastructure in the Democratic Republic of Congo,” Manuscript, IMF and World Bank.
Cerra, V., S. Tekin, and S. Turnovsky, 2008, “Foreign Aid and Real Exchange Rate Adjustments in a Financially Constrained Dependent Economy,” IMF Working Paper, WP/08/204
Chami, R., A. Barajas, T. Cosimano, C. Fullenkamp, M. Gapen and P. Montiel, 2008, “Macroeconomic Consequences of Remittances,” International Monetary Fund Occasional Paper, 259.
Chatterjee, S., G. Sakoulis, and S. Turnovsky, 2003, “Unilateral capital transfers, public investment, and economic growth,” European Economic Review, Elsevier, Vol. 47(6), pp. 1077–1103.
Chatterjee, S. and S. Turnovsky, 2007, “Foreign aid and economic growth: The role of flexible labor supply,” Journal of Development Economics, Elsevier, Vol. 84(1), pp. 507–533.
Commission on Growth and Development, 2008, “The Growth Report: Strategies for Sustained Growth and Inclusive Development.” The World Bank.
Collier, P., 2007, “The Bottom Billion: Why the Poorest Countries are Failing and What Can Be Done About It,” Oxford University Press, New York.
Collier, P., F. Van der Ploeg, and A. Venables, 2008, “Managing Resource Revenues in Developing Economies,” Manuscript, University of Oxford.
Cubbin, J. and J. Stern (2006), “The impact of regulatory governance and privatization on electricity industry generation capacity in developing countries,” World Bank Economic Review, 20(1), pp. 115–41.
Dal Bo, E. and M. Rossi, 2007, “Corruption and Inefficiency: Theory and Evidence from Electric Utilities,” Journal of Public Economics, Vol. 91, pp. 939–962.
Easterly, W., T. Irwin, and L. Servén, 2008. “Walking up the Down Escalator: Public Investment and Fiscal Stability,” The World Bank Research Observer, Oxford University Press, Vol. 23(1), pp. 37–56.
Esfahani, H., and M. Ramirez, 2003, “Institutions, Infrastructure, and Economic Growth,” Journal of Development Economics, Vol. 70, pp. 443–477.
Estache, A., 2006, “Africa’s Infrastructure: Challenges and Opportunities”, Paper presented at IMF Institute and Joint Africa Institute Seminar on Realizing the Potential for Profitable Investment in Africa in Tunis, Tunisia on February 28, 2006.
Flyvberg, B., 2007, “Policy and Planning for Large-Infrastructure Projects: Problems, Causes, Cures,” Environment and Planning B: Planning and Design, Vol. 34, 2007, pp. 578–597.
Guasch J, J. Laffont, and S. Straub, 2007, “Concessions of infrastructure in Latin America: Government-led renegotiation, “ Journal of Applied Econometrics, John Wiley & Sons, Ltd., Vol. 22(7), pp. 1267–1294.
Gupta, S., G. Schwartz, S. Tareq, R. Allen, I. Adenauer, K. Fletcher, and D. Last, 2008, “Fiscal Management of Scaled-up Aid,” International Monetary Fund, Washington, DC.
Haque, M. and R. Kneller, 2008, “Public Investment and Growth: The Role of Corruption,” Centre for Growth and Business Cycle Research Discussion Paper Series 98, Economics, The University of Manchester.
Henisz, W. and B. Zelner, 2006, “Interest Groups, Veto Points, and Electricity Infrastructure Deployment,” International Organization, Cambridge University Press, Vol. 60(01), pp. 263–286.
Hulten, C., 1996, “Infrastructure Capital and Economic Growth: How Well You Use it May Be More Important than How Much You Have,” NBER Working Paper 5847, (Cambridge, Massachusetts: National Bureau of Economic Research).
International Monetary Fund and International Development Association, 2004a, “Debt-Sustainability in Low-Income Countries—Proposal for an Operational Framework and Policy Implications,” www.imf.org/external/pp/longres.aspx?id=41.
International Monetary Fund and International Development Association, 2004c, “Debt-Sustainability in Low-Income Countries—Further Considerations on an Operational Framework and Policy Implications,” www.imf.org/external/pp/longres.aspx?id=440.
International Monetary Fund and International Development Association, 2005, “Operational Framework for Debt-Sustainability Assessments in Low-Income Countries—Further Considerations,” www.imf.org/external/pp/longres.aspx?id=412
International Monetary Fund and International Development Association, 2006a, “Review of Low-Income Countrys Debt-Sustainability Framework and Implications of the Multilateral Debt Relief Initiative (MDRI),” www.imf.org/external/pp/longres.aspx?id=557.
International Monetary Fund and International Development Association, 2006b, “Applying the Debt Sustainability Framework for Low-Income Countries Post Debt Relief,” http://www.imf.org/external/np/pp/eng/2006/110606.pdf.
International Monetary Fund, 2008a, “The Macroeconomics of Scaling Up Aid: the Cases of Benin, Niger and Togo,” http://www.imf.org/external/np/pp/eng/2008/091908a.pdf.
International Monetary Fund and International Development Association, 2008b, “Staff Guidance Note on the Application of the Joint Fund-Bank Debt Sustainability Framework for Low-Income Countries,” http://www.imf.org/external/np/pp/eng/2008/070308.pdf.
International Monetary Fund, 2009a, “Changing Patterns in Low-Income Country Financing and Implications for Fund Policies on External Financing and Debt,” http://www.imf.org/external/np/pp/eng/2009/022509a.pdf.
Keefer, P., and S. Knack, 2007, “Boondoggles, Rent-seeking, and Political Checks and Balances: Public Investment under Unaccountable Governments,” Review of Economics and Statistics, MIT press, Vol. 89(3), pp. 566–572.
Pritchett, L., 2000, “The Tyranny of Concepts: CUDIE (Cumulated, Depreciated, Investment Effort) Is Not Capital,” Journal of Economic Growth, Vol. 5(4), pp. 361–84.
Romp, W., and J. de Haan, 2007, “Public Capital and Economic growth: A Critical Survey,” Perspektiven der Wirtschaftspolitik, Blackwell Publishing, Vol. 8(s1), pp. 6–52, 04.
Sarte, Pierre-Daniel G., 2001, “Rent-seeking bureaucracies and oversight in a simple growth model,” Journal of Economic Dynamics and Control, 25(9), pp. 1345–1365.
Semmler, W., A., Greiner, B. Diallo, A., Rezai, A., and A. Rajaram, 2007, “Fiscal policy, public expenditure composition, and growth theory and empirics,” Policy Research Working Paper Series 4405, The World Bank.
Straub, S., 2008a, “Infrastructure and Growth in Developing Countries: Recent Advances and Research Challenges,” World Bank Policy Research Working Paper No. 4460.
Straub, S., 2008b, “Infrastructure and Development: A Critical Appraisal of the Macro Level Literature,” World Bank Policy Research Working Paper No. 4590.
This paper was produced by a team consisting of Boris Gamarra, Naoko Kojo and Mona Prasad (all World Bank), Era Dabla-Norris, François Painchaud, Claire Gicquel, Douglas Hostland, Marie-Hélène Le Manchec, Shannon Mockler, Perry Perone and Felipe Zanna (all IMF), and supervised by Leonardo Hernandez (World Bank) and Bhaswar Mukhopadhyay (IMF). Carlos Braga (World Bank), Dominique Desruelle and Hervé Joly (both IMF) provided overall guidance.
These include the International Development Association (IDA), the Inter-American Development Bank (IaDB), the African Development Bank (AfDB), the Asian Development Bank (AsDB), the European Bank for Reconstruction and Development (EBRD), European Investment Bank (EIB), and the International Fund for Agricultural Development (IFAD).
See for instance the “Nouakchott Declaration on the Financing for Development in Africa: The role of nontraditional donors”, August 1, 2008, Nouakchott, Mauritania.
Examples include the DSAs for Niger (2008) and Nigeria (2008) which consider the impact of lower oil prices, and the DSA for Mongolia (2009) which assesses the possible effect of lower copper prices.
However, in cases where there is a major change in a country’s economic outlook that has not been reflected in the last DSA, IDA’s grant-loan allocation decisions is not based on the joint Bank-Fund DSA, but on an update.
This policy does not apply to IDA-blend or gap countries even if they are grant-eligible or MDRI recipients.
The standard practice has generally been to not allow nonconcessional external borrowing while not restricting concessional borrowing. The standard concessionality requirement in programs has been a grant element of at least 35 percent.
Country-specific factors include overall borrowing plans of the country, the impact of the additional borrowing on the macroeconomic framework, the effect on the risk of debt distress, and the strength of the country policies and institutions. Loan-specific factors include the development content of the loan, expected rates of return, the equity stake of the lender, whether there are additional costs, and the concessionality of the financing package as a whole. Other considerations include the magnitude of the breach, the size of the nonconcessional loan relative to the country’s IDA allocation, the incidence of previous violations, and whether the information on non-concessional borrowing was provided by the country ex-ante or discovered ex-post. In practice, IDA has responded to breaches of the minimum concessionality requirement using a case-by-case approach.
This critique has generally been applied to excessive reliance on short-term deficits and gross debt indicators when assessing fiscal and macroeconomic stability.
It should be noted that some critics also argue that growth projections are on average too optimistic.
Applying the Debt Sustainability Framework for Low-Income Countries Post Debt Relief, IMF and IDA (2006b)
These included: (i) caution about projecting prolonged growth accelerations that make debt-led scaling up appear feasible; (ii) focus on the overall return to aggregate public investment in assessing debt sustainability; (iii) emphasis on reforms to improve the quality of policies and institutions; (iv) caution about economic volatility and shocks; and (v) an analysis of the nature of aid inflows, especially their volatility.
Roache (2007) finds that public investment flows may have had a negative effect on growth in the Eastern Caribbean Currency Union. Also, in a recent survey, Straub (2008a) reviews 140 different specifications from 64 studies undertaken between 1989 and 2007, which include some measure of infrastructure as an independent variable and a measure of development performance (output level, growth, productivity and others) as the dependent variable. Overall, less than half of the empirical studies using measures of public capital stocks or infrastructure spending flows find significant positive effects. In contrast, over three fourths of the studies using physical indicators (e.g. electricity generation capacity, mileage of roads, number of telephone lines, etc.) find a significant positive contribution of infrastructure. There is also some evidence to suggest that there are robust measurable impacts on growth of investing in education (see Bose et. al. (2007)).
The channels noted here are not an exhaustive list of the factors affecting growth. As indicated in Box 4, the composition of spending may also influence both the level of growth rates and the time frame over which it materializes. Moreover, the public expenditure process must also be well managed and run, with adequate provisions for maintenance and other recurrent expenditures.
IMF (2009b) Debt Limits in Fund Supported Programs: Proposed New Guidelines contains a detailed discussion of indicators that could be used to measure capacity.
It should be noted that in view of weaknesses in national accounts, fiscal and other data in LICs, a considerable degree of judgment would always be required to assess investment-growth linkages.
Some examples of these studies in the context of endogenous growth models include Chatterjee, Sakoulis and Turnovsky (2003), Chatterjee and Turnovsky (2007), and Agenor and Yilmaz (2008) who develop models that are calibrated for “typical” low-income countries to study the implications for growth and welfare of both permanent and temporary, tied and untied, increases in aid. Semmler et al. (2007) use a general equilibrium model that features a government with different types of public expenditures (education, health, infrastructure, public administration, transfers and public consumption facilities) to explore the effects of fiscal policy, including the composition of public expenditure, on economic growth.
In this context, the study of scaling-up scenarios associated with megaprojects may be particularly important, as they could pose large risks to debt sustainability if they do not deliver the expected returns. Indeed, Bank-Fund staff are already pursuing detailed analysis of megaprojects (Annex 1). The guidelines too already call for special scrutiny of high projected growth dividends associated with ambitious borrowing plans. Specifically, the staffs are required to prepare an alternative “high investment-low growth” scenario in such circumstances.
At the Fund, Arellano et al. (2009) have constructed a dynamic stochastic general equilibrium (DSGE) model, calibrated using data for aid-dependent countries in Africa, to examine the effects of aid and its volatility on consumption, investment, and the structure of production. Berg et al. (2009) develop a New-Keynesian DSGE model for Uganda and examine how different fiscal and monetary policies can affect the “spending” and “absorption” of aid, implying different responses for inflation, real exchange rate, output, consumption, private investment and other macroeconomic variables. A recent project by the Fund and the United Nations utilized this model to compute the macroeconomic implications of scaling up aid, as promised by the G-8 at Gleneagles, in some African economies (see IMF (2008a)). Adam and Bevan (2006) and Cerra, Tekin and Turnovsky (2008) also formally investigate the macroeconomic effects of aid.
IMF and IDA (2004a) indicated that in the event that only one debt burden indicator exceeds its thresholds: “A careful interpretation of the results would also need to take account of other factors that influence a country’s effective repayment capacity, such as high workers’ remittances or significant re-exports (with a large import component) which would tend to ease or tighten a country’s foreign-exchange constraint, respectively.”
It is, however, important to bear in mind that remittances may also sometimes be procyclical. Evidence suggests that this may indeed be the case in the current global crisis, with some countries in Europe and Latin America especially hard hit.
If one were to proceed in this manner, three of the five DSF debt burden indicators would be affected.
However, preliminary indications suggest that remittances, like exports and FDI, have been severely affected by the current global crisis.
The current DSF thresholds are based on empirical analysis (See IMF and IDA (2004 a) and Kraay and Nehru (2004)). The analysis relates a country’s probability of debt distress to its: (i) debt burden; (ii) quality of institutions; and (iii) shocks affecting the economy. Formally including remittances in the DSF would require re-estimating the probability of debt distress using debt burden measures that take into consideration remittances. Since the empirical analysis was based on historical data from 1970–2002 covering 132 countries (Kraay and Nehru (2004)), remittances data of similar scope would be needed to re-estimate the framework.
In the literature, remittances conceptually consist of three components: (i) workers’ remittances; (ii) employee compensation; and (iii) migrants’ transfers. Workers’ remittances is the most appropriate concept of remittances to be used within the context of DSAs, as it represents a periodic transfer of resources from a nonresident to a resident. In contrast, employee compensation represents earned income of a resident in a foreign country (which can be spent in the host country), rather than a formal transfer. Migrants’ transfers are associated with a onetime repatriation of assets (migrants returning home with savings) or a reclassification of assets (residents vs. non-residents) arising from individuals’ change of residency. The latter would not necessarily involve any real financial flows.
Based on the average CPIA scores for 2006–08, five PRGF-eligible countries will change their performance category compared to the one using the average for 2005–07. Of these, three are IDA-only countries. In addition, fifteen PRGF-eligible countries have their average CPIA scores within 0.05 of the applicable CPIA boundary (3.25 or 3.75). Of these, nine are IDA-only countries.
As indicated in Box 9, the benchmarks where the implied probabilities of debt distress are measured are the two cutoff points 3.25 and 3.75, and the mid-point of the medium performance category, 3.5. With the modifications proposed under Option 2, there would be two new benchmarks, corresponding to the mid-points of the two new performance categories.
For instance, country A, whose 3-year average CPIA score may have increased from 3.74 to 3.76 in the last year would face an indicative debt threshold of 150 percent of PV of debt-exports. On the other hand, Country B whose score has moved in the other direction, from 3.76 to 3.74, in the last year, would face a threshold of 200 percent.
The CIRR is used as a proxy for market interest rates in a number of contexts, including the Highly Indebted Poor Country (HIPC) Initiative and for calculating concessionality. The base rate for the long-term dollar CIRR is the interest rate on the 7-year US Treasury Note.
As indicated by the small average change and the low standard deviation in Table 2 below, the range of increases is clustered near the lower bound.
For an additional 5 members, where debt ratios exceeded their thresholds even under a 5 percent discount rate, but were nonetheless rated as being at moderate risk of debt distress, the size of the breach increases slightly.
Some countries who do not see an increase in their thresholds continue to experience small and temporary breaches under Option 2.
These issues were discussed by the Bank and Fund Boards in 2004 (IMF and IDA (2004a, c)) and 2005 (IMF and IDA (2005)). The 2005 paper noted that the rule was to be reviewed periodically to ensure that it is the most appropriate way to calculate PVs of debt stocks.
IMF and IDA (2004a) state that, “ … to the extent that world interest rates embody information on expected future world inflation (consistent with the Fisher equation), lower (higher) interest rates would signal weaker (stronger) export earnings of borrowing countries in the future. In this wider interpretation of the NPV (that also embodies repayment-capacity considerations, but is hard to prove empirically) lower world interest rates are indicative of higher debt service-to-exports ratios, and thus, a higher risk of debt servicing difficulties, in the future.”
The same argument has been used in the HIPC Initiative to consider as an exogenous negative shock a decrease in discount rates in the context of discussions on the need for additional HIPC relief (“topping up”) at the completion point.
While a 50 percent ownership stake in a public enterprise would ensure government control, in some instances the government may have control of such enterprises even with a smaller ownership stake.
The following specific considerations could also be used to guide decisions: (i) managerial independence, including pricing policy and employment policy; (ii) relations with the government, including existence of subsidies and transfers, quasi-fiscal activities, and the nature of the regulatory and tax regime;(iii) governance structure, including periodic outside audits, publication of comprehensive annual reports, and shareholders’ rights; (iv) financial conditions and sustainability, including market access, less than full leveraging (debt-to-asset ratio comparable to the industry average), profitability, and record of past investment; and (v) other risk factors, including vulnerabilities stemming from contingent liabilities, and the importance of the public enterprise.
See IMF (2009a) for a discussion of this issue.
In such cases, a Technical Memorandum of Understanding would typically identify the appropriate coverage of SOEs for the purpose of the nonconcessional debt limits policy.
It is possible to show that there is an isomorphism between this specification and the approaches followed by these Dabla-Norris (2009) and Sarte (2001).
The parameterization corresponds to ρ = 0.04 σ = 1.5, α = 0.65, τ = 0.25 , A = 1.4, and δ = 0.05