WORKSHOP ON DEBT, FINANCE AND EMERGING ISSUES IN FINANCIAL INTEGRATION LONDON, 6-7 MARCH 2007

1. WORKSHOP ON DEBT, FINANCE AND EMERGING ISSUES IN FINANCIAL INTEGRATIONLONDON, 6-7 MARCH 2007 DOMESTIC DEBT AND ACHIEVING MDGS IN LICS Presentation by Dinesh Dodhia Rappidd Consultancy Ltd

2. Introduction • MDGs major challenge for LICs: Sub-Saharan Africa far from achieving by 2015. • Key requirement: Govt. & donor resources targeted at MDGs. • Debt servicing: claim on Govt resources: external debt (ED) reduction to HIPCs • Govt need to service domestic debt (DD), which if freed, could be utilised for MDGs

3. Domestic Debt in LICs: Some Stylised Facts • 66 LICS (1995-2004) av. DD/GDP ratio & DD//TD= about 20%. • Non-CFA African HIPCs (1980s/90s) DD/GDP=6-9%, but DD/TD fell 22% to 6%: End-2005 DD/GDP significant in Guinea-Bissau, Ethiopia, Sierra Leone, Burundi, Zambia & Guinea. • DD taken hold in CFA HIPCs • LA HIPCs sharp increases in 2000-03, but reduced.

4. Domestic Debt in LICs: Some Stylised Facts • Other African LICs, Kenya & Nigeria significant reliance: Kenya up Nigeria down • Asian LICs, Sri Lanka DD/GDP=47% TD/GDP=100% • DD/GDP underestimated • LG & SOE debt excluded • arrears & other un-securitised debt not clear • CLs can be very large. • DD/TD expected to increase with ED reduction

5. Fiscal/Budgetary Impact of Domestic Debt Burden • Non-CFA Af. HIPCs (1980-2000): despite DD/TD decline DISP/TISP>40% • AIDIR=21% AIFIR=1% • 66 LICs (1995-2004) DISP/TISP> 40% RDIR= 3%. • Govts resorted to domestic borrowing • to reduce external vulnerability • cap on non-concessional external borrowing in IMF programs. • Recently RDIR fallen, but in CP HIPCs Ethiopia, Zambia & Tanzania DISP>FISP • Sri Lanka DISP/GDP=6%, EISP/GDP=0.7%

6. Fiscal/Budgetary Impact of Domestic Debt Burden • Short maturity structure • Shallowness of financial sectors • Concentration of the investor base

7. Debt Sustainability & Domestic Debt in LICs • HIPC Initiative established ED thresholds & relief given to bring ratios below thresholds • Did not preclude IMF considering DD burden, when serious macroeconomic concern (2003 programmes of Bolivia, Ghana and Nicaragua)

8. Debt Sustainability & Domestic Debt in LICs • IMF/WB DSF: forward looking DSAs assessed in relation to indicative thresholds to establish risks of debt distress • Advising the strategies of lending institutions, especially IDA in determining grant/credit mix. • IMF/WB against DD in DSF due to difficulties of determining empirical thresholds: • lack of historical data series, • different characteristics of DD & ED • purpose of DSF to guide official lending decisions.

9. Debt Sustainability & Domestic Debt in LICs • CHMF: Need to work out prudential ratios for DD through more research & analysis. • DD/GDP=10% typical African HIPC, situation varying according financial depth, with TPD/GDP= 40-60% depending on policies and institutions. • MDRI: bringing down NPV ED ratios well below DSF indicative thresholds • perverse effect • giving non-participating HIPC creditors less incentive to provide debt relief • increasing complacency of governments on tackling DD shortcomings

10. Rationale for Debt Relief, MDGs & Domestic Debt • HIPC Initiative predated MDGs, although underpinnings with poverty alleviation. • MDRI more explicit link • Should DD holders provide debt relief • internal borrowing: transfer of purchasing power within country. • Debt cancellation by DD holders: a tax. • Positive: if resources released used by Govt for MDGs

11. Rationale for Debt Relief, MDGs & Domestic Debt • Negative: • if resources transferred affected private sector activity, growth & poverty reduction. • reneging trade contractual payments affected willingness of private sector to provide future credit to Govt • securitised debt holders deterred from holding future government debt, adversely impacting on dev of financial markets. • action that serves to reduce the high DD servicing burden, through debt restructuring: benefit to MDGs

12. Rationale for Debt Relief, MDGs& Domestic Debt • Should donors reduce DD stock • If existing aid diverted to reduce DD • Negative: resources taken away from MDGs, unless further rebalancing of public expenditure, • Positive: • would support private sector credit & investment, hence long term growth, poverty alleviation & MDGs. • Government’s credit standing improved resulting in lower future debt servicing cost • Constraint on reducing DD eased if additional external resources utilised for DD reduction

13. Dealing with DD Burden: What can LIC Governments Do? • Improve DD database • set up of machinery to verify arrears claims, including agreement on disputed claims, with recording on central register. • promote centralised data on CLs • Make norms • Total public DSA • MDG scenario

14. Dealing with DD Burden: What can LIC Governments Do? • DS dependent on macroeconomic variables, having bearing on MDGs • Need to focus on • Measures to enhance growth, • Maintaining strong anti-inflationary policies to ensure low interest rates • Maintaining fiscal discipline, while enhancing MDG related expenditures • Reforms to reduce quasi fiscal costs associated with SOEs

15. Dealing with DD Burden: What can LIC Governments Do? • Domestic Debt Restructuring • use opportunity of low inflationary & interest rate environment to refinance expensive debt instruments • explore prospects for lengthening maturity structure of DD instruments by test issues without significant increases in yields. • Develop policies to broaden investor base

16. Dealing with DD Burden: What can LIC Governments Do? • Securitize arrears to ensure orderly settlement • Offer incentives to settle upfront a certain proportion of arrears or all credits up to a certain limit • seek debt reduction along the model of Brady bonds

17. Domestic Debt Reduction& Donors • Donors’ role in providing grants, other concessional aid & exceptional financing through debt relief • DD candidate most suited for providing future donor debt relief • Assist LICs to clear verified arrears, fully or partially with the remainder securitised.

18. Domestic Debt Reduction& Donors • Assist LICs to reduce high DD ratios: options • below a uniform threshold, (10%): added benefit of retiring short term debt & improving DD maturity profile • Negative: does not distinguish between different LIC circumstances • Reduce DD according to LIC circumstances • but depends on IMF diagnosis & willingness of donors to provide additional resources.

19. Domestic Debt Reduction & Donors • Insert degree of automaticity based on individual LIC circumstances • DD/GDP relief not > 10%, with eligibility for HIPCs with DD/GDP>20% or TPD/GDP 40-60% depending on the quality of policies & institutions. • Assist LICs to extend DD maturities by guaranteeing interest payments on the later portions of maturity • Provide TA for development of long term institutional investors

20. Domestic Debt Reduction& Donors • Provide TA for debt management • WB proposal: global debt management partnership providing TA on a standardised diagnostic tool & work with select group of LICs demonstrating commitment to sound debt management. • Related idea: donor funded partnership for capacity building, dissemination of international best practices & knowledge transfer on domestic debt management