The Acting Chair’s Summing Up— Operational Framework for Debt Sustainability Assessments in Low-Income Countries— Further Considerations, Executive Board Meeting 05/34, April 11, 2005

Executive Directors welcomed the opportunity to consider the outstanding issues regarding the joint Fund-World Bank operational framework for the debt sustainability assessments (DSAs) in low-income countries. They underscored the importance of such a framework for helping low-income countries avoid an unsustainable build-up of debt in their pursuit of the Millennium Development Goals. Directors reiterated their broad support for the key elements of the framework: (i) country-specific, policy-dependent external debt-burden thresholds to guide debt sustainability assessments; (ii) forward-looking simulations of debt and debt service under a baseline scenario and in the face of shocks; and (iii) prudent borrowing strategies to contain risks of debt distress. Most Directors agreed that the operational framework is now ready to be incorporated in Fund operations.

Directors endorsed the proposed country-specific thresholds for external debt-burden indicators, including the classification of countries based on policy and institutional performance. They noted that the empirical evidence indicates that a country’s ability to carry debt is correlated with the quality of its policies and institutions, and agreed that this should be reflected in the debt-burden thresholds. Directors also maintained that the need for prudence in external borrowing calls for a conservative approach in setting the thresholds. Directors felt that the staffs’ preferred option is consistent with these criteria. They also saw centering the thresholds on the operational threshold of the HIPC Initiative as essential to preserve the coherence of the international community’s approach to debt sustainability. Directors noted, moreover, that the preferred option does not require as high a share of grant financing, the availability of which is not assured, as the alternatives considered.

Directors again cautioned that the thresholds should be seen as guideposts for informing debt sustainability assessments rather than as rigid ceilings, and that individual country circumstances, including the burden of domestic public sector debt, need to be factored into the assessments. In this regard, some Directors expressed concern that the framework could be implemented rigidly, resulting in foregone development opportunities if additional grant financing or debt relief does not materialize; but some others stressed the need to avoid perceptions that the thresholds can be consistently exceeded because they are only indicative.

Directors stressed that the framework does not imply that countries with lower debt should borrow up to their thresholds. A few Directors noted the importance of adequate conditionality being attached to grants, to reduce any moral hazard implicit in the framework. Some Directors also stressed the need to avoid using over-optimistic export projections in the DSAs. Some Directors continued to express some reservations about the use of the World Bank’s Country Policy and Institutional Assessment (CPIA) to classify the quality of policies and institutions, but most Directors supported its use, subject to periodic review, and while recognizing that CPIA thresholds should not be used mechanically in country assessments.

Directors welcomed the proposed transitional arrangements for the use of the new DSA framework for HIPCs, while the HIPC Initiative is still under way. They recognized that there are fundamental differences between DSAs under the HIPC Initiative and those under the new framework, the former being a backward-looking calculation for the purpose of determining debt relief, while the latter is a forward-looking exercise to inform future borrowing and policy decisions. While these differences would need to be clarified, Directors felt that applying the new framework to HIPCs as soon as possible is important to guide HIPCs in their borrowing decisions and provide creditors and donors with a clear view of these countries’ debt sustainability outlook. Directors also stressed the importance of a well-designed communications strategy to accompany the introduction of the framework.

Directors supported the preparation of a joint DSA for each low-income country and welcomed the proposed modalities of collaboration between Fund and World Bank staffs for achieving these objectives. Most Directors felt that the proposed modalities are in line with previous Board discussions of this topic and the respective mandates of the two institutions. They noted that, in almost all cases, Fund and World Bank staffs are expected to agree on the baseline for the DSA and the assessment of the risk of debt distress; and only in highly exceptional cases would they be unable to reach agreement on the underlying DSA baseline or the assessment of debt distress risks. Directors agreed that in such cases the different views of the staffs should be reported to the country authorities at an early stage, and later to the Boards in the DSA document. They urged the staffs, however, to avoid this outcome to the extent possible, and a number of Directors were of the view that the production of a single DSA is critical for the framework’s credibility. Directors noted that minor revisions to DSAs would only be made in cases where both staffs agreed that the revision was minor, and would not in any case change the overall assessment or lead to two separate and inconsistent DSAs. Some Directors urged a clearer definition of what would be considered a minor update under the framework that would not warrant the production of a new joint DSA.

Directors noted that the framework would be an important addition to the Fund’s toolkit to assess the appropriate balance between adjustment, lending, grants, and debt restructuring/relief in low-income countries. They also underlined the importance of the Fund and Bank staff working closely with other IFIs and donors to allow a coordinated approach to concessionality decisions and to ensure that the proposed framework guides the decisions of donors and creditors, including the Fund. Directors also saw a key role for the Fund and Bank staff in integrating country-led approaches into the process and building broad country ownership of the analytical underpinnings of the framework, which would be essential to enhance its effectiveness.

Directors asked the staffs to report to them after a six- to twelve-month period on the results of the country application of the proposed framework after sufficient experience has been gained and welcomed the staffs’ intention to update the framework in light of these results. Directors provided a number of suggestions for guiding the implementation of the proposed framework and the Fund’s continuing work in this area, which the staff will take into account.

BUFF/13/2005

April 13, 2005