THE IMF DEBT LIMITS POLICY (DLP): WHERE NEXT ?

1. THE IMF DEBT LIMITS POLICY (DLP): WHERE NEXT ? Matthew Martin Director, Development Finance International Presentation to BWI African Caucus Meeting Kinshasa, 1 August 2012

2. 1.1: FUNCTIONING OF DLP • It is very welcome to see that the Fund is open to thinking about reviewing the content and functioning of the debt limits policy in line with changing global circumstances • Nobody has problems with the broad definition of the factors which are taken into account in applying the DLP (debt vulnerability and assessment of debt management capacity). However • The important reservations about the assessment of debt vulnerability expressed in the previous presentation obviously undermine faith in the assessment; • Equally important, the assessment of debt management capacity appears too negative. From DRI’s continuing work with many LICs, I am aware of at least 3 others (Burkina Faso, Sierra Leone, Uganda) which seem to me to have a high level of debt management capacity. The current basis for this assessment (combination of CPIA and PEFA) seems too broad, and restricts the higher degree of flexibility (ie less than loan by loan assessments) to only 3 African countries (of hich 2 LICs, Cape Verde being on its way to graduation). A narrower basis for assessment would be preferable, such as the existence of a clear approved national debt strategy, and capacity to implement it

3. 1.2: FUNCTIONING OF DLP • In addition, the policy conditionality resulting from the principles seems excessive. It is not obvious why a country with low debt vulnerability and high debt management capacity should need any debt limits whatsoever – especially in a context where the Fund is being encouraged by the Board to streamline its conditionality to those policies which are core problems for national development. • If, as understood from the IMF presentation, there might be introduction of categories of “moderate” vulnerability and debt management capacity, then the flexible overall concessionality limits would be more appropriate for countries in this group.

4. 1.3: FUNCTIONING OF DLP • It is positive to see that reasonably widespread use is being made of the “nonzero debt limits” outside the overall concessionality ceilings. However, there is a huge variation in their scale - from <1% to 11% of GDP. There needs to be a clear basis for how these are decided, linked to the scope for borrowing additionally (financing sources/terms etc) and the country needs for financing hard and soft infrastructure which will contribute to equitable and sustainable development (see previous presentation) • The information in the IMF presentation on the fact that in most cases, only small portions of the ceilings have been used, means that we are all falling short of the degree of flexibility (and investment in growth and development) which is needed by countries and agreed as sustainable by the IMF. There is therefore need for much more investigation of why this is happening. If it reflects structural problems which will persist (such as slow absorption of committed funds/project execution capacity) then ceilings might be set higher or assumptions about disbursement speeds adjusted, so as to ensure that extra flexibility is more fully used.

5. 1.3: FUNCTIONING OF DLP • The responses to the questions in the survey of authorities are very interesting and I agree with them. There appears to be some contradiction in the answers that “critical and highly profitable projects [were] not financed externally because of the new policy” in only 27% of countries, but relaxation of the 35% grant element would help obtain external financing for projects in 71% of countries. However, based on a survey we did for the AfDB two years ago, with more detailed but similar questions, the explanation for this lies mainly in the fact that authorities are sure many unfunded projects are “critical”, but are not able to say with certainty they are highly profitable. I am not sure profitable is the right word – perhaps “will have a high impact on growth” (which could also be demonstrated objectively by the Fund’s model) • In particular, I agree that there is a case for relaxing the 35% grant element to increase access to financing, and for moving in a larger number of cases from loan-by-loan to overall concessionality assessments. Let me explain why.

6. 2.1: CASE FOR A FUNDAMENTAL REVIEW • The case for a more fundamental review of the DLP rests on the changing context of financing sources in light of the impact of the global crisis • The direct impacts of the global crisis on finance have been: • Due to budget cuts, OECD concessional finance is likely to be stagnant for the next 2-5 years. It is therefore clear that LICs will not be able to finance their hard/soft infrastructure, MDG and climate change needs from these concessional sources • So far, South-South lending especially by Brazil, China, India, Arab institutions and Venezuela has continued to increase, especially for infrastructure. Though the current further exacerbation of the global crisis could cut flows from some of these sources as well, countries are making increasing use of these sources. However, some of these providers claim they could provide much more finance if terms were somewhat less concessional • In terms of global bond and loan markets, there is much discussion by banks “marketing” bonds and loans of their “cheapness”. However, in relative terms they are not cheaper – because interest earnings on government foreign exchange reserves have fallen even more rapidly than those of bonds. In addition, increased market volatility has raised the risk of higher potential interest or refinancing costs depending on the precise timing of issuance, and of greater exchange rate risk.

7. 2.2: WIDER CONTEXT: FINANCE SOURCES • The indirect impacts of the crisis on LIC financing policies have been: • During phase 1 of the crisis (in 2008-09), 2/3 of LICs turned to domestic debt markets to offset budget revenue falls, or delays in mobilising external financing. However, these were already very expensive, and have become more so (and more volatile) as foreign portfolio investors and multinational banks reduce their exposure in these markets. Many countries also used up much of their “domestic borrowing space” (in terms of market willingness to accept government paper) in phase 1, and are less able to use them in phase 2. • Due to reduction in prospects for concessional financing, and enhanced (and very over-optimistic) marketing of financing which is “off-budget” and not subject to DLP limits, countries have increasingly been turning to PPP/PFI-style financing deals, especially for infrastructure. In the presentation on the DSF I warned of the immense dangers of such deals, notably in countries with risky environments and low debt management capacity. • In a context of reduced prospects for OECD concessional funds, increased use of PPPs/PFIs, and growing financing needs (to overcome climate change/resource scarcity) a debt limits policy based largely on concessionality does not still make sense

8. 3.1: WHAT NEEDS TO BE DONE ? • Much more important than the DLP will be actions multilateral institutions take to overcome the tension between reduced concessional funding and increased LIC financing needs. • First, they should not accept that concessional funding will stagnate. Their chief executives (and at national level vice-presidents, directors and mission chiefs) should actively advocate more concessional funding. • At global level, this means both protecting ODA budgets from budget cuts (especially where budget deficits are not significant – eg in Austria, Canada, Germany); and supporting new innovative sources for concessional funding (such as financial transaction taxes and bunker fuel taxes) which could sharply increase concessional flows – in this context it is very good news that an FTT law with a proportion of the proceeds allocated to aid went through the French parliament today ! • At national level, it means advocating actively the value-added of concessionally-funded public infrastructure projects, and encouraging South-South and other sources to fund them, rather than enhancing staff incentives to promote much more expensive PPPs.

9. 3.2: WHAT NEEDS TO BE DONE ? • Second, they need to execute much more effectively (for LICs) one of their core functions – to intermediate less concessional development finance and reduce its costs: • This can begin in their own lending practices. In the recent Client Assessment I conducted for the African Development Bank, clients strongly urged that the AfDB review terms on which it can lend to LICs, notably by “blending” funds from ADF and ADB windows to lend to countries where it would not undermine debt sustainability, or for high-return projects. Other multilaterals could also blend funds (eg IBRD/IDA or IMF GRA/PRGT) – and increase funding flows to LICs by allowing them to tap broader lending pools. • But it also needs to go much further in their role as cofinanciers of projects and guardians of LIC-DSF/DLP. This would mean: • Conducting more intensive discussions with South-South funders such as Brazil, China, India and Arab institutions to see whether (as these funders suggest) they would provide more (co)-funding if it could come on slightly “less concessional” terms (a grant element of 20-35%) • Pushing equity funds and other funders of PPPs to accept lower annual returns than their current 25%, more in line with 10-15% returns accepted by other investors. This might be achieved by encouraging competition from Southern sovereign wealth funds.

10. 3.3: WHAT NEEDS TO BE DONE ? • Third, and in line with the first two, they need to review the DLP and related MDB non-concessional borrowing policies as follows: • Providing more flexibility for “non-zero limits” for “less concessional” funding, which has a grant element of 20-35% • Providing more non-zero limits for essential growth- and development-promoting projects (or possibly sectors/programmes) • Moving more frequently and rapidly to overall rather than loan-by-loan concessionality limits • Finally, it is vital to retain and indeed strengthen their functions as guardians of debt sustainability and prudent borrowing. This should imply two aspects: • Establishing limits for any PPP or similar “off-budget”/contingent liability/guarantee deals, especially if they reduce government budget revenues from projects, through NPV cost-equivalent calculations • Paying much more attention to other aspects of financing such as value for money (and where necessary untying), disbursement/execution speeds, transaction costs, and social and environmental impacts, in providing advice to governments on sources of financing and in analysing loan cost-benefits