THE LIC-DSF: WHERE NEXT ?

1. THE LIC-DSF: WHERE NEXT ? Matthew Martin Director, Development Finance International Presentation to BWI African Caucus Meeting Kinshasa, 1 August 2012

2. 1) PERSPECTIVE/BACKGROUND • It is a great honour to be asked to speak here and also a pleasure to be again among so many friends with whom I have worked for over 20 years on debt management in Africa • As most of you know, Debt Relief International (DRI) worked with virtually all Africa’s HIPCs to get debt relief, and we are still working with the last few HIPCs – such as Chad, Guinea and Sudan. We also worked with you on enhancing your capacity to manage debt prudently, until in 2009 we decentralised this function to your own regional organisations. We continue to work closely on debt issues in partnership with the World Bank and IMF in the Debt Management Facility • But as Development Finance International (DFI), we are now also working more broadly helping countries to mobilise better development financing – and therefore very conscious of massive needs Africa has for financing its development • I hope this presentation reflects both perspectives – of prudent debt managers (as expressed recently in the World Bank debt management conference in Accra) and of the ambitious development planners whose programmes need funds

3. 2.1: OUTCOME OF DSF REVIEW • The recent review is to be welcomed as being much more fundamental than its predecessor: • First, reestimating external public debt thresholds: • 15 years ago DRI with your help analysed that debt crisis occurred at around 15% debt service/revenue; • this was also subsequently used by UEMOA countries as an additional criterion to assess their debt burdens; • therefore I welcome the downward threshold revision • However, I think the PV/revenue threshold is still too high. We estimated it at about 180% PV/revenue compared to the 250% current mid-threshold. This should also be reduced – it wont reduce country borrowing space because, like DS/revenue, it is not the binding constraint on countries, but it will give a more prudent signal to borrowers and lenders

4. 2.2: OUTCOME OF DSF REVIEW • Second, introducing public debt thresholds (incl.domestic debt) • Domestic debt is a key source of finance: if well-managed, it has a major positive impact on financial sector development and availability of domestic finance; but if badly managed, it can wreck the domestic financial system • It is also often the first recourse of governments to fund budget deficits - in response to the 2008-09 crisis, 2/3 of countries relied on domestic rather than external borrowing – and others have often done so if the IMF or donors temporarily suspend disbursements • Your governments in ministerial meetings organised by DRI (more recently by OIF) have therefore insisted since 1999 that we put domestic debt at the centre of analysis. To do this, we compiled data on 35 LICs and estimated indicative thresholds 12 years ago

5. 2.2: OUTCOME OF DSF REVIEW • Domestic debt thresholds (continued): • It is therefore excellent that the IMF has now compiled figures, noted the rapid rise of domestic debt in some LICs, and set benchmarks on public debt. This is especially true because until now, the lack of benchmarks on domestic debt (combined with clear external debt thresholds) were in some cases “pushing” countries to borrow domestically even if this was not a good option in terms of cost or risk. • However, deducting the external from the total public thresholds, it looks like most countries may be encouraged to borrow 25-33% domestic debt and 67-75% external. We estimated that 50-50 was sustainable and potentially desirable to promote financial sector development. It would be useful to know whether the IMF has analysed the impact of these limits on financial sector development. • In addition, given that budget revenue is more directly linked with debt service, it seems essential to define public debt thresholds in terms of revenue, rather than GDP

6. 2.3. PUBLIC INVESTMENT/GROWTH NEXUS • There was previously no tool to show the positive impact on growth of infrastructure investment. Now that it exists, its analysis should be applied to all African countries • The key questions it should answer in IMF Board papers are: • how much infrastructure can be funded while keeping debt sustainable ? How does this compare to needs, and will it transform growth prospects fundamentally? • what difference do the terms of the financing make ? Surely official MDB/bilateral or bond finance would allow much more to be done while keeping debt sustainable – scenario tests should argue this case • “soft infrastructure” (human capital etc) is also essential to growth. It is therefore vital that the model should be able to show the impacts of spending on the MDGs, social protection, vocational/tertiary education or financial inclusion on growth and development • Each IMF Board paper should contain systematic scenarios which include all these aspects and show there is a realistic path to sustainable and equitable growth, and the MDGs without compromising debt sustainability – but that this is possible only with more concessional finance

7. 3.1: WHAT THE REVIEW HAS NOT DONE • However, there are still some important shortcomings in the review which leave the framework weaker than necessary in assessing Africa’s debt vulnerabilities and which merit urgent future work: • First, all thresholds are based on and linked to the CPIA assessment. African Governors have already expressed their strong disagreement with the content and methodology of this system and asked for it to be reviewed fundamentally for the next IDA period – so I will not go into detail • Second, on a related issue, African countries’ vulnerability to exogenous shocks varies dramatically, and African governors have long requested that the DSF and allocation formula for IDA resources take account of this. Indeed the original DSF calculations found that the most important factor determining country debt sustainability was vulnerability to shocks. However, though the review encourages countries and BWI country teams to examine country-specific shocks, in judging debt sustainability it will still use the same shocks for all countries

8. 3.2: WHAT THE REVIEW HAS NOT DONE • Third, the review has not dealt adequately with debts owed by the private sector (PSD): • The scale of private sector debt in LICs is majorly underestimated. DFI worked with 25 African governments during 2000-2010 to improve data on private debt and other capital flows through private sector surveys, and found that almost all countries were excluding offshore, intra-company, and short-term debt. When these are included, debt stocks are 2-3 x higher than current data. • In many countries this meant that by 2010 private sector debt accounted for 40-50% of national external debt, and 15-25% of GDP, and it was still growing rapidly so levels must be even higher now. • Analysis by DFI and African governments also found high volatility of these flows. During the past decade, excessive debts contracted by individual companies, or collapses in trade finance due to commodity price falls, have caused massive problems in foreign exchange markets, and eaten up LIC reserves – and the frequency of this is rising as so as LICs become more integrated into global financial markets • It will be vital to improve data collection further, deepen analysis and include realistic forecasts for PSD growth, as well as helping governments to design measures to help the private sector to reduce its borrowing costs

9. 3.3: WHAT THE REVIEW HAS NOT DONE • Fourth, the review has not dealt with contingent liabilities: • Many LICs are increasingly being attracted by PFI/PPP financing for infrastructure. As in OECD countries, this reflects two main factors • The laudable wish to benefit from private sector project expertise; • The much less laudable wish to move liabilities off budget and keep debt burdens sustainable (encouraged by LIC-DSF borrowing limits) • However, they have also been encouraged by irresponsible “selling” of PPPs/PFIs by private sector (and even some public sector/multilateral) institutions of benefits - and often silence on costs and risks.

10. 3.4: WHAT THE REVIEW HAS NOT DONE • Fortunately, there are now many analyses (eg IMF, OECD and UK government) which reveal that • private sector expertise can help build infrastructure, but • Even successful PPPs result in large budget revenue losses (in order to supply returns of 20-25% pa which are demanded by investors). This means that the projects are much more expensive than when funded by borrowing, and the infrastructure loses its direct revenue-increasing effect • There are very high risks associated with PPPs. Even in OECD economies there are many examples of poor delivery, cost overruns, or default by private sector – all of which can dump major costs or liabilities on public sector. • These risks are even higher in less advanced economies, and therefore governments need to ensure careful project/contract design, and have high capacity to negotiate with contractors/monitor delivery, to reduce these risks • Other key risks arise from financial sector contingent liabilities and guarantees of parastatal/private debt

11. 3.5: WHAT THE REVIEW HAS NOT DONE • It is vital that countries own the LIC-DSF and infrastructure tools and are able to use them for themselves to assess the best ways to finance their development • So far, there has been little capacity-building assistance available from Fund or Bank to assist countries – most of the detailed training and hands on in-country assistance has been organised by regional organisations and DRI • The review has agreed that the BWIs willreduce the frequency of their DSF assessments but countries should continue to conduct themselves – but most countries do not have capacity • The IMF has recently proposed a donor-funded Trust Fund for its TA work on LIC-DSF and Medium-Term Debt Strategies. However, as African francophone ministers have said: • The IMF has potentially large amounts of funds available from its excess gold sales profits and should not divert scarce donor grants • Any Trust Fund should be for capacity-building (not missions which design strategies for countries) and ensure implementation jointly by the Fund and other partners to maximise coordination • Given that the World Bank already has a debt management Trust Fund, why not merge the two to reduce overhead costs ?

12. CONCLUSION • Key possible next steps for Ministers to consider are: • Reducing external debt/revenue thresholds • Checking domestic debt thresholds are compatible with financial development, and calculating PV/revenue thresholds • Using the investment/growth tool in all countries and to show impact of “soft infrastructure” as well as need for concessional/official finance • Reviewing the CPIA methodology • Varying DSF thresholds to include vulnerability to shocks • Monitoring/analysing private debt closely, to reduce borrowing costs • Including scenarios showing the loss of revenue from contingent liabilities, and the impact if they become explicit public debt • providing capacity-building assistance (preferably via a joint Trust Fund with World Bank and other organisations) so all countries can use LIC-DSF and infrastructure tools.