Press Release No. 17/380

IMF Executive Board Reviews the Joint IMF-World Bank Debt Sustainability Framework for Low Income Countries

October 2, 2017

On September 27, 2017, the Executive Board of the International Monetary Fund (IMF) reviewed the joint IMF-World Bank Debt Sustainability Framework for Low-Income Countries (LIC DSF).

Since its introduction in 2005, the LIC DSF has been the cornerstone of the international community’s assessment of risks to debt sustainability in LICs, with important operational implications for stakeholders. The DSF has been playing a critical role in guiding borrowing and lending decisions; multilateral lenders including the International Development Association have linked their lending policies to the DSF results; and the risk assessment derived by the DSF has informed the IMF’s debt limits policy (DLP) and the World Bank’s non-concessional borrowing policy (NCBP).

The framework was previously reviewed in 2006, 2009, and 2012. While the 2012 review added several new features, notably incorporation of more country-specific information and greater attention to domestic debt vulnerabilities, Executive Directors saw room for further progress, including by improving the assessment of macro-linkages in stress tests and exploring more the links between investment and growth – areas which were left for future work.

In the extensive consultations surrounding the current review, stakeholders emphasized the importance of ensuring that the DSF remains balanced in its treatment of risks and borrowing opportunities, incorporates more country-specific information, and reflects the evolving financing landscape facing LICs, including risks emanating from LICs’ increased market financing and contingent liabilities.

The current review assesses the DSF’s performance in recent years and proposes a wide-ranging set of reforms that adapts the framework to the evolving circumstances facing LICs and makes it more comprehensive and transparent, and yet simpler to use. The changes will include a revised approach to the assessment of countries’ debt carrying capacity based on an expanded set of variables; adjustments to the methodology designed to improve the framework’s accuracy in predicting debt distress; new tools prepared to help shed light on

the plausibility of underlying macroeconomic projections; tailored stress tests to help better evaluate specific risks of particular relevance for some countries; and a reduction in the number of debt thresholds and standardized stress tests.

The framework is expected to become operational in the second half of 2018. This will allow for completion of the associated Guidance Note and template, followed by an extensive six-month program of training for country-level authorities.

Executive Board Assessment [1]

Executive Directors welcomed the comprehensive review of the Debt Sustainability Framework for Low-Income Countries (LIC DSF) and appreciated the extensive consultations with country authorities, the Executive Board, and external stakeholders. They noted that the LIC DSF is a vital tool for country authorities to help strengthen fiscal policy and debt management and this review has highlighted areas where the framework can be reformed. Directors agreed that the proposed reforms would make the framework more comprehensive and transparent and that the revised LIC DSF would continue to play a critical role in informing borrowing and lending decisions by more accurately flagging potential debt distress with the aim of avoiding unnecessarily constraining LICs’ ability to finance their development. They agreed that the new Guidance Note, templates, and training of officials will be necessary to ensure that the framework is fully accessible to users. Directors also underscored the importance of facilitating the use of the LIC DSF by as many actors as possible, including non-traditional bilateral and commercial creditors.

Directors welcomed that the review maintains the main features of the existing framework. They considered it appropriate that the framework continues to classify countries based on their assessed debt-carrying capacity, estimates threshold levels for a set of key debt burden indicators, evaluates baseline projections and stress test scenarios relative to these thresholds, and combines rules and staff judgment to determine ratings of the risk of entering into external debt distress.

Directors welcomed the proposed composite measure to assess a country’s debt-carrying capacity, based on both the CPIA and a set of macroeconomic variables. They observed that the inclusion of macroeconomic variables takes better account of country-specific features, and enables a fuller understanding of, and policy discussions on, how economic policies affect debt carrying capacity. This, in turn, will enhance the contribution of the DSF to policy formulation.

Directors endorsed the proposed new thresholds for debt stock and debt service indicators. They noted that, for countries whose assessment of debt-carrying capacity remains unchanged, the revised framework may imply additional borrowing space, provided countries manage debt service well. Directors observed that the quality of the framework’s outputs depend heavily on the quality of the inputs. Against this background and given deep concerns that debt levels in a number of LICS are on the rise again, Directors highlighted the need for borrowers to implement prudent debt management practices, and encouraged countries to further strengthen their Medium-Term Debt Management Strategies, including the capacity to compile needed data. They also expressed concern about “uncaptured debt” in the Fund’s work. In this light, they strongly encouraged staff, Management and country authorities to strengthen efforts to ensure full and transparent disclosure and reporting of all debt—including private, quasi-public, and official—noting that the responsibility for doing so was shared between borrowers and lenders. Promoting the Fund’s statistical and reporting standards and rules could help in this regard.

Directors agreed that the proposed new tools to assess the plausibility of macroeconomic projections will facilitate a more thorough scrutiny of baseline assumptions. They welcomed the tools’ focus on the sources of debt accumulation, the realism of fiscal adjustment, as well as the projected impact of public investment and fiscal adjustment on growth.

Directors supported the proposed streamlining of debt thresholds and standardized stress tests. They welcomed the recalibration of shocks and the introduction of interactions between key macroeconomic variables in these tests, which should enhance the insights generated by the stress-testing.

Directors agreed that adding tailored scenario stress tests will help evaluate risks of particular importance for some member countries – including those emanating from natural disasters, volatile export prices, market-financing shocks, and contingent liability exposures. They called for clear disclosure in debt sustainability analyses of the key assumptions made in calibrating these tests.

Directors welcomed the re-estimation of benchmarks for assessing total public debt levels, which should improve the quality of the analysis of risks linked to elevated levels of overall public debt. They appreciated the attention given to evaluating rollover risks related to external commercial borrowing. Directors also welcomed the additional information on debt vulnerabilities generated by the more granular assessment of the debt position of countries assessed to be at moderate risk of debt distress.

Directors considered that the prudent application of judgement as a complement to model-based mechanical results, while avoiding excess discretion, remains essential for the final determination of a country’s risk rating. They underscored the importance of even-handedness in applying judgment, and called for careful attention to providing guidance to staff in exercising this judgment in a new Guidance Note. Directors underscored that a Board discussion prior to the finalization of the Guidance Note will be helpful. Directors also agreed with the shortening of the projection horizon from 20 to 10 years, with consideration being given to identifiable and material factors that have an effect in the later years.

Directors generally saw merit in maintaining a unified discount rate of five percent for the LIC DSF, the DLP, NCBP, and the calculation of grant elements. Directors called for revisiting the determination of discount rates in future DSF reviews, or sooner if needed.

Directors welcomed staff assurances that the new framework is expected to become operational in the second half of 2018, six months after the completion of the associated Guidance Note and template. They noted that the proposed July 1, 2018 timeline for the implementation of the revised LIC DSF could be challenging. Directors called on the staff, in collaboration with the World Bank, to update guidance materials and conduct outreach and provide training opportunities to all relevant parties, including staff and LIC authorities, especially those with weak capacity, with enough lead time to ensure that the timeframe would prove feasible. Going forward, staff should continue to monitor the implementation of the framework and bring forward the next review, if warranted.