Over the last 13 years, IDA has been a leader in supporting low-income countries’ efforts to reduce their burden of external debt—whether through debt relief, debt

sustainability analyses, or assistance in debt management.

The Heavily Indebted Poor Countries (HIPC) Initiative was jointly launched by the IMF and World Bank in 1996. It was significantly broadened in 1999, when it became linked to the development of poverty reduction strategies in beneficiary countries. Over this period a number of eligible countries undertaking economic reforms have been able to greatly reduce their external debt. Under the enhanced HIPC initiative, IDA’s share is 20 percent of the total estimated cost of debt relief.

The international community took the HIPC Initiative a step further in 2005 with the Multilateral Debt Relief Initiative (MDRI). MDRI was designed to help accelerate progress toward the Millennium Development Goals by allowing the cancellation of all eligible debts owed to IDA, the IMF, and the African Development Fund. Almost two-thirds of the total estimated MDRI cost will be borne by IDA.

These debt relief initiatives have significantly altered the economic situation in ben-eficiary countries, and this has come with both opportunities and risks. The improved macroeconomic and financial outlook of some post-completion-point HIPCs has increased their attractiveness to private and nontraditional official creditors. While welcome, this development poses new challenges for continued debt sustainability. IDA has taken steps to help countries preserve the benefits from debt relief and, at the same time, better manage their debt profile and associated financial risks. These steps include:

Developing the joint World Bank-IMF Low-Income Countries Debt Sustain-• ability Framework (DSF); Designing a grant allocation system to mitigate debt distress risks detected in • Debt Sustainability Analyses (DSAs) that are conducted using the DSF; Formulating a Non-Concessional Borrowing Policy (NCBP); • Creating the Debt Management Facility (DMF), a grant facility financed by • a multi-donor trust fund, to help strengthen debt management capacity and institutions in developing countries.1

1. This is done through the systematic application of the Debt Management Performance Assessment (DeMPA) tool and the toolkit for formulating and implementing a Medium-Term Debt Management Strategy (MTDS, jointly with the IMF). In addition, the facility finances the design and development of sequenced reform plans aimed at strengthening institutional capacities; and also the promotion of knowledge products and activities through an extensive program of training and outreach.

IDA At WOrk

Debt Issues in Low Income Countries

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IDA’S ContrIbutIon

While preserving the HIPC Initiative’s core principles, IDA has continued to apply the HIPC rules with flexibility to facilitate receipt of debt relief. Specifically, flexibility has been applied in the areas of eligibility criteria, the establishment of a track record of policy per-formance, preparation and implementation of poverty reduction strategies, delivery of interim relief, facilitation of early clearance of arrears, and fulfillment of completion point triggers. The impact of exogenous factors on debt relief recipients has also been taken into account.

Under the enhanced HIPC Initiative, IDA has provided more than 10 percent (US$6.5 billion in end-2008 NPV terms) of the total cost of HIPC debt relief to the 35 post decision point countries—the point at which it is established that a heavily indebted country has met the criteria to qualify for debt relief. IDA has also provided over 60 percent (US$15 billion in end-2008 NPV terms) of the total MDRI costs to the 26 post completion point countries.

In addition to providing its own share of HIPC debt relief, IDA helps promote the participa-tion of other creditors in the Initiative, which is important because low creditor participation can undermine the delivery of overall HIPC debt relief by official creditors. Specifically:

•In the case of multilateral creditors, an IDA-administered Debt Reduction Trust Fund allows bilateral donors to contribute financing to help cover the costs of these creditors under the HIPC Initiative.

•In the case of non-Paris Club creditors, delivery of HIPC debt relief to post-completion-point HIPCs is monitored on a scorecard published on the World Bank and

IMF websites. In addition, at the request of creditors or debtors, technical notes on methodological aspects of the Initiative have been prepared jointly with the IMF.

•In the case of commercial creditors, the key instrument for catalyzing creditor participation is the Debt Reduction Facil-ity (DRF) which is administered by IDA as trustee. The DRF helps eligible HIPCs reduce their commercial external debt through debt buybacks at a deep discount. The DRF provides grant support for both the preparation and the implementation of commercial debt reduction operations.

Debt relief alone, however, cannot guarantee debt sustainability.

Ultimately, debt sustainability can only be achieved if it is accompanied by strong eco-nomic growth, prudent external borrowing and effective debt management. Recognizing this, IDA has taken a number of measures to foster the achievement of debt sustainability in low-income countries.

A key step in this regard, as mentioned, was the development and adoption in 2005 of the DSF, which supports the efforts of countries to meet their development goals without cre-ating future debt problems. Under the DSF, the World Bank and the IMF annually assess the risk of debt distress for IDA-only countries over a 20-year horizon. This forward-looking approach helps countries balance the need for funds with their current and prospective ability to repay. It also allows creditors to tailor their financing terms in anticipation of future risks. Countries assessed under this framework are assigned risk categories—low, moderate, or high-risk, or in debt distress—based, among other things, on the quality of their policies and institutions.

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The objective of the IDA grant allocation framework adopted in FY06 is to proactively mitigate the risks of future debt distress revealed by the DSF. The sole grant eligibil-ity criterion under the framework is the country-specific risk ratings emerging from Debt Sustainability Analyses based on the DSF. IDA-eligible countries with a high risk of debt distress or already in debt distress are allo-cated 100 percent of IDA resources as grants. Countries assessed to have a moderate risk of debt distress are allocated 50 percent of IDA resources as credits and 50 percent as grants. Finally, countries assessed to have a low risk of debt distress are provided 100 percent of their IDA allocation in the form of credits.

In 2006, IDA adopted the Non-Concessional Bor-rowing Policy in order to address the risk that non-concessional borrowing, if unchecked, can lead to a rapid re-accumulation of debt and further debt problems down the road. This policy is applicable to grant-eligible and post-MDRI IDA-only countries. It is based on two pillars: creditor outreach, which aims to encourage other creditors to incorporate debt sustainability considerations into their lend-ing decisions; and IDA responses (reduction in volumes, or adjustment of IDA lending terms) affecting the borrowing countries. However, the NCBP is not a blanket restriction on non-concessional borrowing by these countries: the policy acknowledges that, under certain circumstances, non-concessional loans can be part of a financing mix that helps promote economic growth.

Disciplining IDA lending under such circum-stances, however, would have little impact on debt sustainability if other creditors do not take similar actions. Hence, IDA is undertak-ing active outreach efforts on the DSF with nearly all major multilateral and bilateral creditors to low-income countries.

Ultimately only borrowing countries can ensure that debt remains manageable over the long term.

IDA has been scaling up its efforts to improve debt management practices in low-income countries. It has organized training and capacity-building workshops on the Debt Sus-tainability Framework in partnership with the IMF and other institutions. In November 2008, the Bank launched a multi-donor trust fund, the DMF for LICs. As mentioned, the DMF is a grant facility financed by a multi-donor trust fund2 to strengthen debt management capac-ity and institutions in all low-income coun-tries and IDA-only countries. This is achieved through a comprehensive debt management toolkit composed of:

•The Debt Management Performance Assess-ment tool (DeMPA)—a methodology for identifying the strengths and weaknesses of debt management operations, using a set of 15 indicators spanning the full range of government debt management functions. The DeMPA focuses on central government public debt management and closely related functions such as issuance of loan guarantees and on-lending. It is useful in: (i) assessing debt management performance in LICs and monitoring it over time, (ii) enabling the design of actionable reform programs, and (iii) enhancing donor harmonization based on a common under-standing of debt management related priorities.

•The joint Bank-IMF work program on the medium-term debt management strategies (MTDS). Such strategies can help countries realize their debt management objectives by outlining cost-risk tradeoffs in meeting

2. To date commitments amount to US$12 million over 4 years.

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their government’s financing needs and payment obligations. An available toolkit includes a Guidance Note, a template for strategy documentation, and a quantita-tive tool for cost-risk analysis, with a User’s Guide.

• The design of debt management reform programs, and the promotion of learning and knowledge generation via an extensive program of training and outreach, includ-ing a peer-learning initiative—the Debt Management Practitioners’ Program.

Both the DeMPA and the MTDS toolkits are posted on www.worldbank.org/debt.

reSultS

Debt relief and IDA

To date, substantial progress has been made in the implementation of the HIPC Initiative, with almost 90 percent of eligible countries (35 out of 40) having passed the decision point and qualifying for HIPC Initiative assistance (Table 1). Of these, 26 countries have reached the completion point and qualified for irre-vocable debt relief under the HIPC Initiative and the MDRI. During the last fiscal year, Côte d’Ivoire and Togo reached the decision point, while Burundi, Central African Republic and Haiti reached the completion point.

table 1: Heavily Indebted Poor Countries (as of end-June 2009)

26 Post-Completion-Point Countries a/

Benin Gambia, The NigerBolivia Haiti RwandaBurkina Faso Honduras São Tomé and PríncipeBurundi Madagascar Senegal Cameroon Malawi Sierra Leone Central African Republic Mali TanzaniaEthiopia Mauritania Uganda Ghana Mozambique Zambia Guyana Nicaragua9 Interim Countries b/

Afghanistan Congo, Dem. Rep. of Guinea-BissauCôte d’Ivoire Congo, Rep. of LiberiaChad Guinea Togo5 Pre-Decision-Point Countries c/

Comoros Kyrgyz Republic d/ SudanEritrea Somalia

Notes: a. Countries that have qualified for irrevocable debt relief under the HIPC Initiative and have received MDRI relief. b. Countries that have qualified for assistance under the HIPC Initiative (i.e., reached decision point), but have not yet reached completion point. c. Countries that are potentially eligible and may wish to avail themselves of the HIPC Initiative. d. The Kyrgyz authorities indicated in early 2007 that they did not wish to avail themselves of the HIPC initiative but subsequently expressed interest for the MDRI. Based on latest available data, indebtedness indicators were estimated to be below the applicable HIPC Initiative thresholds, while income levels were estimated to be above the IMF MDRI thresholds.

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The overall assistance committed to the 35 post-decision-point HIPCs is estimated at US$124 billion (in nominal terms), including US$52 billion under the MDRI. As a result of this debt relief, as well as relief under traditional mechanisms and additional relief from some creditors, the debt stock of the 35 post-decision-point HIPCs is expected to be reduced by over 80 percent (Figure 1). This reduction has been accompanied by an increase in poverty-reducing expenditures. Poverty-reducing spending has increased by about 2 percent of GDP in HIPCs between 2001 and 2008, while debt service has decreased by about the same amount (Figure 2).

IDA’s efforts at promoting creditor participa-tion in delivering HIPC debt relief contributed to higher participation rates in all creditor categories.

•Since its inception, the Debt Relief Trust Fund has provided approximately US$2.8 billion from donor contributions to sup-port the participation of eligible creditors. These include the African Development Bank (AfDB), the West African Develop-ment Bank (BOAD), the Central American Bank for Economic Integration (CABEI), the Corporación Andina de Fomento (CAF), the Caribbean Development Bank (CDB), the CARICOM Multilateral Clearing Facil-ity (CMCF), the East African Development Bank (EADB), the Fund for the Financial Development of the River Plata Basin (FONPLATA), the Inter-American Develop-ment Bank (IaDB), the International Fund for Agricultural Development (IFAD), and the Nordic Development Fund (NDF).

•Eight non-Paris Club creditors—Egypt, Hun-gary, Jamaica, Morocco, Republic of Korea,

Sources: HIPC Initiative country documents, and IDA and IMF staff estimates.Note: Estimates based on decision point debt stocks.

Figure 1: Post-Decision Point HIPCs’ Debt Stock under Different Debt relief Stages (In billions of u.S. dollars, in end-2008 nPV terms)

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Rwanda, South Africa and Trinidad and Tobago—have provided their share of HIPC debt relief in full. Additionally, 22 creditors have delivered a portion of the expected debt relief. Recent developments include the signature of debt relief agreements between China, Kuwait, and Venezuela with a number of HIPCs and efforts by Colombia and Kuwait to lift constraints on the delivery of debt relief.

•The delivery of HIPC debt relief by com-mercial creditors increased markedly thanks to DRF-supported operations and the restructuring of a large portion of the debt owed by the Republic of Congo to its commercial creditors. Since its establish-ment, the DRF has extinguished about US$10 billion of external commercial debt (mostly in HIPCs) at a cost of about US$0.75 billion. During the last 12 months, the IDA Board approved a DRF implementation

grant for Liberia and a preparation grant for Sierra Leone. The debt buyback for Liberia extinguished about US$1.2 billion of external commercial debt with a 97% discount, the highest ever, consistent with relief required under the HIPC Initiative.

Despite all these achievements, a number of challenges remain to the HIPC initiative.

•Bringing the remaining HIPCs to comple-tion point: Many pre-decision and pre-completion-point HIPCs face challenging political and institutional situations and will require stepped-up support from the international community to be brought to the point where they can benefit from full debt relief. In addition, two pre-completion point countries have significant external debt arrears. These arrears may prevent

Sources: HIPC documents; and IMF staff estimates.Note: Prior to 2007, figures represent debt-service paid, and thereafter, debt-service figures are projected. For detailed country data refer to Appendix Table 2 of the 2009 HIPC Initiative and MDRI Progress Report.

Figure 2: Average Debt Service and Poverty reducing expenditures

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financing from traditional donors, includ-ing international financial institutions like IDA, and lead these countries to pursue other more expensive sources of financing, such as collateralized non-concessional borrowing.

•Increasing creditor participation in granting debt relief: Another challenge is to ensure that HIPCs get full debt relief from all their creditors. Despite the progress achieved in recent years, participation from non-Paris Club and commercial creditors remains low. Together, these two categories of creditors are expected to bear about 20 percent of the total HIPC Initiative cost, and therefore their participation does make a significant difference for HIPCs. In addition, their participation is essential for the credibility of the Initiative, to limit the perception of free-riding, and to maintain the goodwill of traditional donors.

• Further reducing litigations by commercial creditors: During the last year, there has been a good progress made in decreasing the outstanding litigation cases against HIPCs. The large reductions in litigation cases are mostly due to DRF operations in Nicaragua and Liberia during the last year, as well as out of court settlements by Cam-eroon, the Republic of Congo and Sierra Leone. A joint litigation by five creditors against Nicaragua was also dropped. How-ever, recent survey indicates that there are still 15 unsettled cases.

•Maintaining and improving long-term debt sustainability: Notwithstanding the decline in debt burdens, long-term debt sustain-ability remains a challenge: more than half of the post-completion-point HIPCs are classified as being at either moderate or high risk of debt distress (Figure 3). At end-2008, the net present value of the debt-

Sources: Latest joint Bank/Fund DSAs available for LICs.Note: Based on the actual/projected NPV of debt-to-exports ratio under the baseline scenario.

Figure 3: Dispersion of the nPV of Debt-to-exports ratio and risk of Debt Distress in low-Income Countries

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to-export ratio for post-completion-point HIPCs averaged 67 percent, 5 percentage points higher than in end-2007. This sug-gests that underlying vulnerabilities have remained and need to be addressed. The debt outlook for post-completion-point countries remains vulnerable, particularly for those countries dependent on exports of a few products. It is also highly sensitive to the terms of new financing received. It is very important that countries that have benefitted from debt relief, and all low income countries more generally, implement sound borrowing policies and strengthen their respective capacities in public debt management as they go for-ward.

The DSF has now graduated to a more mature phase of implementation and incremental improvement.

The Debt Sustainability Framework has become a key input to country borrowing strategies and to the lending decisions of many official creditors. The availability of successive forward-looking DSAs for most low-income countries now provides an important tool for borrowers in designing not only their debt-management strategies but also their broader macroeconomic policies. The annual DSAs also provide useful guidance to other creditors, since these DSAs are now publicly available on the World Bank and IMF websites for those countries who have provided their consent to the DSA’s disclosure.

IDA’s efforts to disseminate the DSF have resulted in an increased number of creditors using the framework to base their financing decisions. The AfDB, the IaDB, the Asian Development Bank, and IFAD now have financing rules similar to IDA’s. In addition,

the OECD export credit agencies adopted in January 2008 a set of lending principles that adhere to IDA and IMF concessionality require-ments and refer explicitly to the DSF. These principles also have been officially endorsed by European Union countries.

On the borrower side, the World Bank, in part-nership with capacity building institutions, has organized a number of training workshops on the DSF in Africa, Asia and Latin America. Country officials from all post-completion point HIPCs (and most IDA-only borrowers) have attended these workshops.

In addition, while the analytical rigor of DSAs has improved, the DSF was made more flex-ible to country specific circumstances. An important source of flexibility already present in the DSF is the need to exercise judgment in assigning the country ratings. Also, the 20-year projections under the DSF ensure that ratings are not excessively affected by short-term macroeconomic fluctuations. However, going forward, greater flexibility is expected to be applied to the framework by undertaking more in depth analysis to better capture the impact of public investments on growth, and by considering the role of remittances more systematically in DSAs. Greater flexibility is also expected to be applied while considering the extent of state owned enterprises’ debt to be included in the DSAs.

The availability of DSAs for most of the IDA-only countries has also contributed to a smooth functioning of the IDA grant allocation system.

As of end-June 2009, the World Bank’s deci-sion to allocate grants to the vast majority of IDA-only countries was based on the joint World Bank-IMF DSAs performed under the

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DSF. The share of grants during FY06-09 (the IDA14 envelope) reached 22 percent, or about US$ 7.2 billion (Figure 4 Panel A). Excluding FY08, the share of grants remained about 19 percent of total IDA commitments. In FY08, Liberia, Côte d’Ivoire and Togo received about US$1.2 billion of IDA grants, or 38 percent of total IDA grant commitments for that fiscal year. Half of that amount was used to finance the clearance of their arrears to IDA and the IBRD. Most of these grants have been allocated to African countries (Figure 4 Panel B).

The NCBP has also been applied flexibly

Seven country cases have been assessed under the NCBP in FY09, including Senegal and the Democratic Republic of Congo (DRC). The range of responses reflects the case-by-case approach within the parameters set out in the framework. Thus far, there have been

three exceptions (Mali, Rwanda and Senegal), two cases of hardening of the terms (Angola and Ghana) to reflect the countries’ increased market access, and two preliminary excep-tions (Mauritania and DRC). The importance of sufficient and early information was high-lighted in all the cases assessed to date.

Thanks to the DMF, IDA’s debt management-related work program has been scaled up.

As of end-June 2009, 32 Debt Management Performance Assessments (including five pilot assessments) had been undertaken, 14 in FY09. Similarly, the Medium Term Debt Management Strategy toolkit has been final-ized in June 2009 and applied to six countries (including five pilot assessments).

July 2009. http://www.worldbank.org/ida

Sources: The World Bank.

Figure 4: IDA Grant Allocation System

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