Debt Relief, Grants and Free Riding: IDA’s proposed response Multilateral Development Bank Meeting on Debt Issues Wash

1. Debt Relief, Grants and Free Riding: IDA’s proposed responseMultilateral Development Bank Meeting onDebt IssuesWashington, DC, June 21-22, 2006

2. Overview • IDA grants are linked to a country’s risk of debt distress. • MDRI debt relief and IDA grants create significant benefits for recipient countries in the form of strengthened debt sustainability prospects and resources for the MDGs. • However they also potentially add to the risk of “free riding” • This presentation will discuss the free-rider problem, and building blocks to limit the risk.

3. What is free riding? • the indirect cross-subsidization, through IDA grants and debt relief, of other creditors offering non-concessional terms Higher risk of debt distress IDA Other creditors Grants and debt relief Non-concessional lending Lower risk of debt distress

4. What are the Risks? • Grant-recipient countries with little access to financial markets – risk is limited. • Higher in resource-rich grant-recipient countries that could rely on non-concessional borrowing collateralized with future export receipts. • Risks of free riding may be magnified as a result of lower debt ratios resulting from the implementation of the Multilateral Debt Relief Initiative (MDRI).

5. The Impact of the MDRI • MDRI brings debt ratios for eligible countries (at least initially) down to levels below those of many Middle-Income Countries (see slide 9). • But, static view leads to a risk that countries may accumulate excessive levels of debt that could threaten a return to unsustainability, and weaken IDA without the intended result. • However risk of debt distress post-MDRI varies by country: Forward looking DSF points out continued fragility of most countries. See diagram on slide 10.

6. Debt Burden Indicators-Post MDRI

7. Preliminary Risk Ratings post-MDRI Ghana Senegal Tanzania Mali Uganda Benin Mozambique Zambia Madagascar Burkina Faso Ethiopia Guyana Nicaragua Rwanda Niger

8. Impact of Non-concessional borrowing

9. Key building blocks to an approach to free riding • Agreement on a concessionality benchmark • Creditor coordination • Advanced reporting, increased monitoring. • Disincentives aimed at borrower level

10. Concessionality benchmark for decisions • Concessional borrowing: multiples ways to measure it. • DAC ODA definition used for statistical purposes: 25% concessional using 10% discount rate. • Concessionality benchmark of at least 35% concessional using CIRR discount rates from IMF PRGF programs more realistic. • 35% is a proven benchmark in IMF programs for borrowing in LICs that does not endanger sustainability • 35% used by IDA in free-rider context: may be higher/lower if IMF program requires it.

11. Source: IMF presentation ECA Meeting May 2006

12. 2. Creditor coordination • Free riding is a major issue for IDA donors • Need a concerted international effort to prevent a repeat of the past • Requires Broadening Creditor Acceptance of the DSF as useful tool – ideally to underpin an informal arrangement. • We have presented free-rider issue in number of fora as it has been developed – to MDBs early on in Tunis, to OECD creditors more recently at meetings in Paris. • Consultations will continue – including with non-OECD and commercial creditors.

13. Access to Information in DSFs • Country-specific DSAs are already available on IMF website - by country (www.imf.org) • About 40 DSF-style DSAs available - 23 joint DSF-style DSAs. • Every month 2-3 additional DSAs are released. • A stand-alone site should be available in the next 6-8 weeks on World Bank debt website. (www.worldbank.org and type in debt). • Access to interactive DSF template also to be made more readily available.

14. Countries subject to IDA free-riding policy

15. 3. Reporting and Monitoring • Reporting and Monitoring of information flows is a weakness that may hamper a comprehensive approach to free-riding. • Close sharing of information and monitoring of flows will help to identify and prevent cases of unwarranted non-concessional borrowing. • Monitoring is difficult – IDA is strengthening adherence to reporting requirements, working with other creditors to enhance reporting. • IDA requiring advanced reporting of planned new non-concessional borrowing.

16. 4. IDA disincentives at country level • Ultimately Borrower makes the final borrowing decisions. • Pragmatic approach to determining whether a non-concessional loan is a “breach” of the free-rider policy. • accept that some potentially high return projects may warrant special exceptions • Some additional flexibility for post-MDRI countries with low risk of debt distress • Emphasizes importance of debt management

17. Available instruments in IDA • For unwarranted breaches options available: • a reduction in volumes, • changing IDA financing terms However, there is a tradeoff: • volume cuts reduce resources that could be used to reach the MDGs • hardening of terms may exacerbate debt sustainability problems.

18. Disincentives Grant-eligible countries: • Volume cuts would primarily be used in countries in which debt sustainability is a major concern • Initial 20% cut to grant allocations removes “subsidy”, but can be escalated for more serious or prolonged breaches. • lf disincentives are ineffective, a strong undertaking would be sought from borrower to abide by an agreed borrowing strategy. • Last resort measure: Management could consider disengaging from future support to the country.

19. Risks to IDA incentive approach • Approach limited effectiveness if: • Countries can compensate through additional non-concessional borrowing (risk higher for post-MDRI) • Disincentives lead to a delay or reluctance to report, which has been particularly problematic outside of Fund arrangements. • Size of available non-concessional borrowing dwarfs IDA allocations (no leverage)

20. Conclusion • No magic bullet to free rider problem • Requires concerted international effort by all actors. • Efforts to enhance creditor coordination will continue. • Ongoing efforts to improve debt management capacity should help. • Efforts to improve information on non-concessional borrowing and adherence to reporting requirements need to continue.

21. End