Debt Sustainability and Grants

1. Consultation on the 7th replenishment of IFAD’s resources Debt Sustainability and Grants

2. Context: imperatives in development assistance today • increase levels of ODA to reach MDGs • contain the debt burden of poor countries at sustainable levels • harmonize development assistance in substance and form

3. Poorest country debt reduction: role of MDBs • large percentage of poorest country debt is held by multilateral institutions • limited applicability of Paris Club procedures • comprehensive debt relief necessitates participation of MDBs • Multilateral engagement in poorest country debt relief - HIPCDI (1996) and enhanced HIPCDI (1999)

4. Scope and extent of HIPCDI • 38 countries potentially eligible • 27 have reached Decision Point • Total value of relief - about US$ 58 billion in 2004 NPV terms

5. IFAD in HIPCDI • IFAD Governing Council approved full participation in February 1997 • nominal value of IFAD relief – approximately USD 620 million (over 40 years)

6. Accelerating relief and debt sustainability • recognition of poor progress towards achieving MDGs in many poorest countries - especially in Africa • increased appreciation of linkages between poverty and global insecurity • push towards increased ODA flows • going beyond HIPC - from debt relief to debt avoidance

7. The dilemma of the MDBs • Irreconcilable imperatives: • increase assistance (in context of traditional emphasis upon loan instruments) to poor countries • avoid increasing debt burden of poor countries beyond sustainable levels • avoid undermining the long-term financial sustainability of the MDBs themselves

8. Opening a way forward: the “package” of three elements • major expansion of the grant element in new assistance to poor countries with debt sustainability problems: avoid expansion of indebtedness beyond sustainable levels • expansion of committable resources of MDBs (strong replenishments): increase in immediate support • replenishment commitment to compensation to MDBs for repayments forgone: maintain sustainability of MDBs

9. Two-pronged approach to debt sustainability Asian Development Fund, African Development Fund and IDA now have two dimensions of debt management support: • HIPC reduces level of payments from poor countries on existing debt • DSF avoids new assumption of debt obligations (by replacing them with grants) taking debt burden above sustainable level • HIPC and DSF will run side by side: one applies ex post; the other ex ante

10. Criteria of eligibility for grant-based assistance under DSF In African Development Fund and IDA, debt sustainability is defined in both financial and institutional terms, combining: • 3 debt finance indicators (ratio of debt to GDP and exports; ratio of debt service to exports) • Strength of policy and institutional framework (CPIA scores provide indicator) Countries classified as high, medium or low debt vulnerable on basis of these variables

11. Results of application of the DSF In IDA, for example: • 40 Highly debt vulnerable countries will receive 100% of all assistance in grants • 5 Medium debt vulnerable countries will receive 45% of assistance in grants • the remaining low debt vulnerable countries will receive no grants • grants to rise to estimated 30% of all IDA assistance • all grants to countries to be based only on debt vulnerability assessment within Debt Sustainability Framework (DSF)

12. Performance-based allocation systems and the DSF • PBAS determines volume of assistance • DSF determines what proportion of the country PBAS allocation is available in loans and in grants • “disincentive” effect of grants to poor CPIA scorers balanced by Modified Volume Approach (MVA): • high and medium debt vulnerable countries get about 90% of PBAS allocations • low debt vulnerable countries to get about 110% of PBAS allocation

13. Overcoming the impact of grants on the MDBs’ development assistance capacity • IDA will lose reflows from about 30% of assistance, involving more than half of the un-blended IDA recipients. AfDF will lose even more (>40%) • 9% of PBAS allocations of grant receiving countries will be put aside for management to compensate for service charges forgone • replenishment members commit to compensating IDA and AfDF for principal payments forgone - when forgone (pay-as-you-go formulation) An operational cost item additional to core replenishment commitments

14. Benefits and responsibilities of the 3-piece package • poor debt vulnerable countries get increased access to resources (expanded replenishment) with no debt repayment obligations (DSF) • non-debt vulnerable countries get expanded PBAS allocations (expanded replenishment) plus about 10% (DSF) • MDBs expand grant component of assistance on a no-win, no-lose basis • MDB replenishment members commit themselves to cover future cost of expanded grant programme as a separate and additional financing item

15. Building a debt sustainability system • objective is to construct a debt management system for debt vulnerable poor countries and for all their financiers • desired outcome - a uniform approach to country ODA by all financiers. Hence IDA and AfDF DSFs are virtually identical from the beginning • forthcoming IDA-IMF guidelines will very probably make access to grants conditional on containing borrowing from other sources

16. Implications of a debt sustainability system for IFAD • in 40 IDA countries, IFAD may rapidly be under pressure to provide assistance only within new common approach • inability to participate in DSF may lead to narrowing or closure of opportunities for IFAD to provide poverty reduction assistance in many of the poorest countries

17. Adoption of DSF methodology and IFAD assistance • about 30 percent of highly concessional lending shifts from loan to grant terms • assistance shifts to grant terms in: • West & C Africa 18 countries • Asia and Pacific 11 countries • East & S Africa 11 countries • Latin America & C 3 countries • Middle East and NA 3 countries • if committable resources do not expand, the volume of assistance to the most debt vulnerable countries declines (action of MVA)

18. What adoption of DSF would mean for IFAD’s finances • If the IDA and AfDF grant and compensation sub-package is adopted the financial implications for IFAD would be zero, i.e.: • setting aside of 9 per cent of PBAS allocation of grant recipients covers loss of service charge* • replenishment commitment to “pay-as-you-go” formula replaces principal payments implicitly forgone *Subject to IFAD-specific re-calculation

19. Implications without the compensation element of the IDA package • short-term impact on IFAD would be low (because highly concessional loans have 10 year grace period) • in medium-to-long term IFAD’s commitment capacity would be seriously and quite rapidly depleted – necessitating curtailment of the overall programme of work

20. Conclusions • IFAD adoption of DSF would be beneficial if whole three-element IDA package is adopted • short term financial benefits of DSF alone for vulnerable countries are negative • system only gives MDG boost when linked to higher replenishment • adoption of DSF without the compensation element of the package would lead to major reduction of IFAD commitment capacity to all countries in longer term

21. What next? • 2nd. Consultation requested information paper on DSF for discussion at 3rd Consultation • 3rd. Consultation considers information paper • September 2005 Executive Board considers policy paper on fragile states and post-conflict/disaster situations – and review of application of Grant Policy (2003) • 4th. Consultation considers role and level of grants in IFAD – and appropriate Replenishment recommendations