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The2017VersionoftheIMFandWorldBank’sLICDebtSustainabilityFramework:

“SignificantOverhaul”orObsolete?BrianPinto1

June12018

1TheauthorthanksHansWeisfeldforpromptlyclarifyingquestionsonIMF(2017a).AnearlyversionofthispaperwassharedwiththeIMFandtheWorldBank.WhilethispaperdrawsupontheworkoftheADFPolicyInnovationLab,theviewshereinarethoseoftheauthoraloneactinginhisindependentcapacityandshouldnotbeattributedtotheAfricanDevelopmentBank,itsExecutiveDirectorsoritsManagement.

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Acronyms/AbbreviationsADF:AfricanDevelopmentFundBoP:BalanceofPaymentsCAD:CurrentaccountdeficitCI:CompositeIndicatorCPIA:CountryPolicyandInstitutionalAssessmentDRM:DomesticRevenueMobilizationDS:DebtSustainabilityDSA:DebtSustainabilityAnalysisDLP:DebtLimitsPolicy(oftheIMF)[check]NCBP:Non-concessionalBorrowingPolicy(oftheWorldBank)[check]DSA:DebtSustainabilityAnalysisDSF:DebtSustainabilityFrameworkEM:EmergingMarketFDI:ForeignDirectInvestmentForexdebt:DebtdenominatedinthehardcurrenciesFX:ForeignexchangeFXRA:ForeignexchangereserveadequacyHIPC-MDRI:HeavilyIndebtedPoorCountries-MultilateralDebtReliefInitiativeMCLs:ModeratelyConcessionalLoansMDBs:MultilateralDevelopmentBanksLIC:Low-IncomeCountryLIDC:Low-IncomeDevelopingCountryNR:NaturalResourceNRX:NaturalResourceExportingODA:OfficialDevelopmentAssistancePFM:PublicFinanceManagementpp:percentagepointPPG:PublicandPubliclyGuaranteedPV:PresentvalueSDGs:SustainableDevelopmentGoalsSOE:State-ownedenterprise(publicenterprise)SSA:Sub-SaharanAfricanToT:TermsofTradeTPD:TotalPublicDebtTPDD:TotalPublicDebtDistressWB:WorldBankWP:WorkingPaperXDD:Externaldebtdistress

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Summary

Thispapercritiquesthe2017versionoftheIMFandWorldBank’sLICDSFcontainedinIMF(2017a).Itusesaccumulatedemergingmarketanddevelopingcountryexperience,especiallyfromAfrica,andeconomiclogictoshowthatthe2017DSFisobsoleteandshouldnotthereforebeimplemented.Itrecommendsanalternative,simplerapproachthatrespondstotheexigenciesoftheday:thatanewpublicdebtcrisisinADFcountries(AfricanLIDCsinIMFparlance)isunfoldingevenaspublicinvestmentneedsformeetingtheSDGsandcreatingjobsforAfrica’sburgeoningyouthremainvast.

TheframeworkcomesfromtheADFPolicyInnovationLab,whichbeganworkinlate2015onthedebtsustainabilityimplicationsoflessconcessionalODA(intermsofvolumes,termsorboth)goingforward.Itbecameclearfromthiswork(ADFLab2016,FelinoandPinto2017),whichlookedat33ADFcountries,thattheLICDSFwouldnotbesuitablebecauseofitsoverwhelmingfocusonPPGexternaldebtrisks:theattentionneededtoshifttopublicdebtanditsdynamicsasthefundamentaldriverofexternaldebtdistress.Furthermore,thetusslebetweendebtsustainabilityanddevelopmentneededattentionatatimewhenODAwasshowingsignsofbecominglessplentiful.TheworkoftheLabfedintothereportoftheHighLevelPanelonreinvigoratingAfricandevelopmentfinance(HLP2017).

Evidencehasgrown,includingfromtheIMF—seeIMF(2017b)andespeciallytheexcellentreportinIMF(2018a)—thatpublicdebtsustainabilityproblemshaveintensifiedinADFcountries,investmentneedsarevast,andODAisdwindling.Themarkethasdisplacedtheofficialsectorindefiningthemarginalborrowingcostofagrowingnumberofgovernments.Onereasonisthatofficialfundingsourcesarenotenoughforthehugepublicinvestmentsneededinhumancapitalandinfrastructure.AnotherreasonuncoveredbycountryvisitsbytheADFPolicyLabisthat,asoneofficialputit,“themarketdoesnotaskquestions”—althoughitdoespriceforriskandislessforgivingthanofficiallenders.

Indeed,amajorissueisthemisuseofpublicresourcesamongAfricanLIDCs,includingthosefromnaturalresourcewealthandmarketborrowings.Themainfactorsdrivingthedeteriorationinpublicdebtdynamicsincludehighinterestratesonmarketborrowings,growthslowdowns,exchangeratecollapsesandgrowingprimaryfiscaldeficits.Thelastfactorincorporatesatusslebetweenpooruseofpublicfunds,insufficientDRMandweakPFMsystemsontheonehandandspendingpressuresfromthevastupfrontinvestmentneedsinconnectionwithinfrastructureandSDGsontheother.

Forexample,atoneextreme,GhanaandMozambiquefaceobviouspublicdebtsustainabilityproblemsmagnifiedbyweakPFMsystems.Attheotherextreme,Ethiopia,KenyaandRwandacapturetheconstanttensionbetweenmacroeconomicsustainabilityandvastinvestmentneedsininfrastructurepresentinallADFcountries.Thistensionisreflectedinhighfiscaldeficitsthatspilloverintoburgeoningcurrentaccountdeficitsandexternaldebtdynamics.

NowassumethattheLICDSFdidnotexistandhadtobedesignedfromscratch,whichiswhatthe“significantoverhaul”claimedinIMF(2017a)implies.Itshouldataminimumdothefollowing:

1. Concentrateonpublicdebtlevelsanddynamicsbecausethisiswherethefundamentalproblemlies.Inaddition,examinevulnerabilityfromcurrentaccountdeficitsandexternaldebtaccumulationrecognizingthesearesymptomsofrisingfiscaldeficitsandthegrowingunsustainabilityinpublicdebtdynamics

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2. Recognizethatthemarketandnonconcessionalfundingsourcesincreasinglydeterminethemarginalcostofgovernmentborrowing,evenincountrieswhichhavenotissuedEurobonds,thoughnotalwaysintransparentways(recallMozambique’s“hiddendebt”uncoveredinApril2016,ataboutthesametimethatitissueditsfirstEurobondinconnectionwithrestructuringtheguaranteeddebtofthestate-ownedtunafishingcompany.ChadborrowedUSD1.45billionin2014fromGlencoreandfourbankstoberepaidwithcrudeoilshipments)

3. Acceptthat,inspiteoftheHIPC-MDRIdebtwriteoff,concessionalityhasnotpreventedthere-emergenceofpublicdebtsustainabilityproblemsorledtoasolidfoundationformeetingtheSDGs.Thereasonisthatconcessionalitycannotcompensatefortheseriousgapsinleadership,economicgovernance,fiscalandfinancialinstitutionsandtheprivateinvestmentclimate.ThiscallsforatougherpolicydialoguecoordinatedacrosstheIMF,WBandAfDBinsteadofthepresentfragmentedapproach

4. Buildinadiscussionofhowtoreconciledebtsustainabilitywithdevelopment.Themarketisunlikelytobeasuitablefinancingsourceforthevastpublicinvestmentneeds,callingformorefrontloadingofODA—buthowtoachievethisgiventhefiscalconstraintsdonorsface?TheanswermustinvolvesomeincreaseinthepricingofODAandraisingthebarforaccess,bothofwhichcanbefacilitatedbythefactthatcostlymarketborrowingsnowplayasignificantroleamongADFcountriescombinedwithheterogeneityintheirabilitytousepublicresourceswell.

Notwithstandingtheaboverequirementsdictatedbytheaforementionedexigenciesoftheday,the2017versionoftheDSF(IMF2017a)toberolledoutonJuly12018continueswiththeinheritedfocusonassessingdistressinrelationtothepresentvalueofPPGexternaldebt.ThiswasentirelyappropriatewhentheLICDSFwasoriginallyintroducedtomakeacaseforHIPC-MDRIdebtrelief:mostpublicdebtwasthenconcessionalPPGexternaldebtfromofficialsources,therebyalsojustifyingtheuseofthepresentvalueofdebt.Butthisisnolongertrue.Whilethe2017DSFincludestotalpublicdebt,itdoessoignoringmarketrealitiesandcontinuingtheantiquatedfocusonthepresentvalueofdebt.Itshouldthereforenotbeimplementedandanalternativedevelopedthataccordsprimacytopublicdebtanditsdynamics,andrecognizestheever-presenttensionbetweendebtsustainabilityanddevelopmenteveninthebest-governedADFcountries.ThefeaturesofsuchanalternativearesketchedoutandillustratedwiththerecentLICDSFexperienceofEthiopia.

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I.INTRODUCTION

The2017IMF-WBReviewoftheLICDSFwaslaunchedinearly2016tooverhaultheDSF.AconsultationseminarwasheldonApril12,2016,duringthe2016SpringMeetingsatIMFHQinWashingtonDCtodiscussthescopeandkeytopicstobeincludedinthereview.2Theseincluded:

• Allowingforachangedfinancinglandscapewithmoremarketdebtfromdomesticandexternalsourcesandashiftawayfromofficialfinancingsources

• Strengtheningtheanalysisofpublicdebtbyincorporatingdomesticdebt(whichistypicallycontractedatcommercialterms)

• Reflectingmarketrisksbetter(debtrollovers,yieldspreadsrelativetobenchmarks,foreignexchangereserveadequacy)

• Needforbetteranticipationofrisksandmorerobustriskratings.

Insum:theDSFneededtogetinclosertouchwiththenewfinancingrealitiesinLICs,callingforgreateremphasisonpublicdebt,thegrowingroleofmarket-basedfinancingandforeignexchangereserveadequacy(FXRA).Thereview,whichtookmorethanoneyearandinvolvedajointIMF-WorldBankteam,culminatedinanIMFStaffReportdatedAugust222017(IMF2017a).ItwasapprovedbytheIMF’sBoardinSeptember2017andisduetoberolledoutonJuly12018bytheWorldBankandIMF.

ThispapercritiquestheIMF-WB2017reviewoftheLICDSF(“2017DSF”)fromtheperspectiveoftheclientcountriesoftheADF,namely,theSub-SaharanAfricancountriesincludedinthelistof“Low-IncomeDevelopingCountries”(LIDCs)containedinAnnexTable1ofIMF(2018a).Itsmainconclusionisthatthe2017DSFfallsshortofthe“significantoverhaul”itclaimstobeandisobsolete.Hence,implementingitwouldbecounterproductive.Themainreasonsarethefollowing:

1. ContinuedobsoletefocusonPPGexternaldebt.ThisfocuswasentirelyappropriatewhentheLICDSFwasintroducedin2004tomakeacaseforHIPC-MDRIdebtrelief.Atthattime,officialexternalborrowingspredominatedinpublicdebt,makingPPGexternaldebtanobviousvariabletofocuson.Butoncedebtreliefwasprovided,AfricanLIDCgovernmentsstartedborrowingfromthemarkets,domesticandinternational.Thiswouldnecessitateashifttorisksfromtotalpublicdebt,includingitsdomesticcomponent,andawayfromPPGexternaldebt.

2. Unsatisfactoryincorporationoftotalpublicdebt.The2017DSFallowsforrisksassociatedwithtotalpublicdebtbysimplygraftingdomesticdebtontothePVofexternalpublicdebt,whichcontinuestodefinetheframeworkforriskassessment.Thiscausestwoproblems.First,forAfricanLIDCsaswithmostEMsbeforethem,thecausalflowisfromunsustainablepublicfinancestoexternaldebt:largefiscaldeficitsandadversepublicdebtdynamicsspilloverintocurrentaccountdeficitsandexternaldebtdynamics.Tocontinuetofocusonexternaldebtisthereforetoconfusethesymptomwiththemalady.Second,theinsistenceonretainingthePVofexternaldebt(computedusinga5%discountrate)asthevariableofinterestisoutdatedintworespects:(i)itobscurestheinsightsthatcanbeaffordedbysimplylookingatthenominaldebt-to-GDPratio,inwhichcaseitbecomeseasytointerpretthedynamicsbasedonprimaryfiscalbalancesandr-g,theinterestrate-growthrate

2Theauthorwaspresentduringthisconsultationseminar.

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differential;and(ii)itisinconsistentinthatmarketdebtisincludedatfacevalue,notatitspresentvaluediscountedat5%becausethiswouldgiveanumberlargerthanthenominaldebtvalue(sincetheinterestrateonsuchdebtistypicallyabove5%).Butifonebelievedthat5%wasanappropriatediscountrateforassessingthe“true”burdenofdebt,thenitshouldbeappliedacrosstheboard.ThesearepowerfulreasonsforabandoningthePVofdebtconceptandshiftingtonominaldebt.Besides,eventhepoorestandmostfragileAfricanLIDCsnowborrownonconcesionallyatthemargin,bringingustothenextpoint.

3. Failuretoincorporatemarketsignals.ForasignificantsetofADFcountries,themarketnowdeterminesthemarginalcostofgovernmentborrowing.3ThoseissuingEurobondshavesovereignratingsfromthemajorcreditratingagencies.Likewise,domesticdebtistypicallyissuedoncommercialterms—EthiopiaisanotableexceptionandKenyaintroducedinterestrateceilingsinlate2016—andmostADFcountrieshaveahighdegreeofopencapitalaccountopenness.The2017DSFignoresthisinformation,stickingtothePVofdebtandassessingriskbasedonthresholdslinkedtotheCPIAandnowanewCompositeIndicatorbasedonpast,narrowlydefinedinstancesofdebtdistress(linkedtosuchvariablesasarrearstotheIMF).Instead,moreattentionneedstobepaidtomarketsignalsondevaluationanddefaultrisks.

4. Unsuitabilityforreconcilingdebtsustainabilityanddevelopment.IMF(2017a)notes:“CSOshaveshownincreasedinterestintheLICDSFandhaveadvocateditsuseasatooltohelpdeterminehowtofinancethelargedevelopmentneedsofLICsinthecontextoftheeffortstoachievetheSustainableDevelopmentGoals(SDGs).”Thisclaimnotwithstanding,theestimatedfinancingneedsfortheSDGsaresovastthattheyarelikelytoblowpublicdebtandCADsustainabilityoutofthewaterevenforthebest-managedADFcountries,suchasRwanda,KenyaandEthiopia.Considerablemodificationisneeded,notjustintheDSF,butthewholearchitectureofODA,forabetterreconciliationofdevelopmentanddebtsustainability.

Further,theLICDSFeveninits2017versiontendstotreatdebtsustainabilityasanendinitself,notasaplatformfordevelopment,aswillbecomeclearfromthecountryexamplesinthenextsection.Moreover,theinsistenceonconcessionalityisoutofsyncwiththefactthatthemarketnowdeterminesthemarginalcostofborrowingforagrowingnumberofcountries.Indeed,ADFcountries,withtheexceptionofthemostfragile,shouldeasilybeabletocopewithlessconcessionalODAiftherootcausesofunsustainabledebtareaddressed:inabilitytodeliveronprimaryfiscaldeficittargets,poorexpenditurecompositionandmisuseofpublicresourcesandnaturalresourcewealth,weakgrowthpolicyandexchangeratecollapsesrelatedtopoliticalandmacropolicyrisksthatmagnifytheburdenofforexdebt.ThesefindingsinFelinoandPinto(2017)areechoedintheIMF’sownexcellentMarch2018LIDCdebtpaper(IMF2018a),whichalsonotesthatgrantsandremittancesaredeclining.ThesefactorscallforaseachangeinthepricingandallocationofODAandthenatureofpolicydialogueinordertoincreasethechancesforbetterdevelopmentoutcomesinSub-SaharanAfrica.

ThispaperpresentsanalternativeDSAapproachforAfricanLIDCsbasedontheanalysisoftheADFPolicyLabdescribedintwoworkingpapers:ADFLab(2016)andFelinoandPinto(2017).ThesepapersuseexactlythesamedataasintheIMF-WBDSAsbutemployasimplerapproachwhichislikelytobemorerobustgiventhevariousdataissuesnotedinIMF(2018a).Ultimately,DSAframeworkscanonlyprovidehypothesesthatthenrequiretestingviacountryvisitsanddiscussionswithvariousstakeholders.Suchanapproachhasbecomeurgentgiventhe

3Weusetheterms“AfricanLIDCs”and“ADFcountries”interchangeably.

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deteriorationinpublicdebtsustainabilitynotedinFelinoandPinto(2017—henceforth,FP2017)andconfirmedinIMF(2018a).AnewdebtcrisisisunfoldinginAfricaandadifferentDSAapproachisneededthathelpsreconciledebtsustainabilityanddevelopmentwhileallowingforcountyheterogeneity.

ThenextsectionprovidesthreecountryexamplestoillustratetheshortcomingsoftheLICDSF,whichareunlikelytobeaddressedbyits2017version.SectionIIIdescribesthemainreformsproposedinthe2017DSFfollowedbyacritiqueinsectionIV.SectionVproposesanalternativeapproachillustratedbytheEthiopianexperienceinsectionVI,whilesectionVIIconcludes.

II.THREECOUNTRYEXAMPLES

ThissectiondiscussesrecentDSAsforGhana,RwandaandEthiopiatoillustratechallengesassociatedwiththeLICDSFthatareunlikelytoberemediedbythe2017DSF.TheADFPolicyLabvisitedtwoofthesecountriesduringitswork:GhanaandRwanda.

Twopointscanbedistilledfromthecountryexamples:

First,theLICDSFdoesnotgivesufficientprominencetopublicdebtanditsdynamics.ToanticipatethecritiqueinsectionIV,the2017DSFretainstheobsoletefocusonPPGexternaldebt.AddingondomesticdebtinthemannerproposedinIMF(2017a)toanalyzerisksfromtotalpublicdebtdoesnotalterthisconclusion.TheDSFneedstobecomemoremarketorientedandincorporatehard-wonlessonsfromEMsinitsprescriptions.

Second,theLICDSFtendstotreatdebtsustainabilityasanendinitself.Thisisobviousfromallthreecountryexamples,withimportantquestionsbeingleftoffthetable.Amoresuitableapproachwouldtreatdebtsustainabilityasaplatformfordevelopment,notasanendinitself.ElementsofanalternativeapproachwillbespeltoutinsectionV.

Athirdpointisworthmaking.AgrowingbodyofevidenceindicatesthatpublicdebtsustainabilityproblemsarenowentrenchedinseveralAfricanLIDCsandthatanewdebtcrisisissprouting.Forexample,IMF(2018a,pp42-3)lists8ADFcountriesasbeingindebtdistressasofend2017basedontheLICDSF:Chad,Eritrea,Somalia,SouthSudan,Sudan,andZimbabwe.Inaddition,MozambiqueandRepublicofCongowereindefaultandthereforeclassifiedasindebtdistress.Afurther7ADFcountrieswereathighriskofdebtdistressasofend2017:Cameroon,CentralAfricanRepublic,Ethiopia,Ghana,Mauritania,TheGambiaandZambia.Moreover,“Onlyintwowerelargerfiscaldeficitslinkedtohigherpublicinvestment,eitherinfull(Cameroon)orinpart(Zambia).”Ethiopiatoofallsintothiscategory,asisapparentfromIMF(2018b).ThisprecarioussituationimpartsameasureofurgencytodesigningaDSFthatcanbelinkedtodevelopmentfinancingneedsandcanbecontinuouslyupdatedinsteadofwaitingforthenormalArticleIVconsultationcycle,whichcouldresultinneedlessdelaysindiagnosisandpolicyprescription.

Ghana

GhanawasheldupastheposterchildfortheHIPC-MDRIdebtwrite-offin2007,whenitissuedthefirstofitsfive[check]Eurobondswiththegoalofusingitsnewlydiscoveredfiscalspacetopromotegrowthanddevelopment.StevenRadeletgaveanupbeataccountof17“emergingcountries”inhis2010bookonEmergingAfrica,openingwithaglowingsummaryofGhana’sachievementsovertheprevious15years.

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InJanuary2017,withGhanaalreadydeeplymiredinmacroeconomicdifficulty,a“fiscalhole”of4%ofGDPwasdiscoveredfollowingtheinstallationofanewgovernment.Publicdebthadreached74%ofGDPatend-2016comparedtoaprojected70.4%intheIMF-WorldBankOctober2016debtsustainabilityanalysis.

Thenegativedebtoutcomeshouldnothavecomeasabigsurprisegivenobviouslyadversepublicdebtdynamicsinearlieryearsandaweaktrackrecordonusingpublicresourceswell—infact,electionissuesincludedcorruption,electricityshortagesandinsufficientattentiontopublicvalueformoney,resultingintheincumbentgovernmentbeingvotedout.Inotherwords,largefiscaldeficitswerenotassociatedwithinvestmentsthatwouldspurfuturegrowthandtaxes.

MoresurprisingisthefailuretocomeupwithadecisiveplantoaddressGhana’spersistentfiscalimbalanceinspiteofitstrackrecord.Forexample,theDSAinIMFcountryreport16/16(January2016)recommendedastrategytolowergovernmentinterestpaymentsbysubstitutingEurobondsforlocalcurrencydebtaspartof“debtmanagement”,anapproachthathassubsequentlycontinued,asindicatedintheDSAinIMFcountryreport16/321(October2016).Thisignoredthestrongsignalsfromthemarketondefaultrisk—forexample,thesecondarymarketyieldonGhana’s2020Eurobondwas15%inearly2016.ItalsoignoredacostlylessonfromEMsonavoidingthebuildupofcurrencymismatchesonthegovernment’sbalancesheet.Preferencehasbeengiventoshort-termfinancialengineeringploysthatincreasefiscalriskoverrecognizingandaddressingthecountry’sfundamentalfiscalproblem.

Indeed,theADFLab’svisittoGhanainFebruary2017indicatedrelyingheavilyonrevenuesfromnewoilfieldsaswellasissuingEurobonds(toavoidsoaringinterestcostsinthedomesticmarket)asastrategyforloweringthepublicdebt-to-GDPratio,reflectingtheanalysisintheOctober2016DSA.Newoilproductionwouldraisegrowthrates,primarysurplusesandforeignexchangereserves,whileputtingdownwardpressureonthecedi/USDrate.ShiftingtoEurobondswouldlowerinterestratepaymentsreportedinthefiscaldeficit(domesticborrowingcostswereoftheorderof25%)butatthecostofincreasingcurrencymismatchesandenhancingcurrencyrisksonthegovernment’sbalancesheet.NowhereintheOctober2016DSAisthewasteofpublicresourcesorthemisuseofnaturalresourcewealthmentioned.Debtsustainabilityistreatedmyopicallyasanendinitself.

OnlyinFebruary2017wereweaknessesinfiscalgovernancehighlightedbyattributingthe“fiscalhole”to“significantpublicspendingcommitmentsthatbypassedPFMsystems”.4Improvingmatterswouldrequireimplementing“thenewgovernment’sintentionstoreducetaxexemptions,improvetaxcomplianceandreviewthewidespreadearmarkingofrevenues”;inshort,ensuringtheintegrityofPFMsystemsandselectingandexecutingpublicinvestmentscarefully.

ItisatleastmildlyshockingthatastarofthepostHIPC-MDRIerahasnotbeenabletoimplementbasicPFMsystemsinspiteof10yearshavinggoneby.Italsounderlinestheimportanceofshiftingtheonusonre-attainingpublicdebtsustainabilitytotheGhanaianleadersthemselvesandawayfromexternalbodiesliketheIMF,whichcandolittlewithoutcommitmentandleadershipfromtheverytopinGhanaitself.Indeed,the4%ofGDPfiscalholeoccurredundertheverynoseoftheIMF,withGhanahavingbeenanExtendedCreditFacility(ECF)IMFprogramcountrysinceApril2015.

4QuotesfromIMF’sFebruary102017PressRelease17/43.

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Rwanda5

RwandaisthehighestratedADFcountrybasedontheCPIAandranked56thoutof190countriesinthe2017WorldBank’sDoingBusinesssurvey,secondinAfricaafterMauritius.IthasbeenselectedfortheG20CompactwithAfrica,thegoalofwhichistofosterforeigndirectinvestmentfromadvancedcountriesbyaddressingimpedimentsinboththehostandhomecountries.

AspartofitsVision2020strategyaimedatattainingmiddle-incomestatusby2020,significantpublicinvestmenthasbeendirectedto“programstoimprovesocialoutcomes,increaseagriculturalproductivityandtransformtheeconomytohighervalueaddedactivities,improvegenderequality,andfosterfinancialinclusion,amongotherthings”.

TheIMF2017ArticleIVreportnotes:"Growth-enhancinginfrastructureinvestmenthascontinued,withprojectscarefullychosentomaintainRwanda’slowdebtriskrating,whiledomesticrevenuesandexternalfinancinghaveincreasedanddomesticfinancingwaslimited.Supervisoryframeworkshavebeenstrengthened,andexchangerateflexibilityhasbeenthecenterpieceofadjustmentpoliciestoaddressexternalimbalances."

Nevertheless,currentaccountdeficits(CAD)areunsustainablyhigh,at14.4%ofGDPin2016withprojectionsof10.1%for2017and11.3%for2018.TheIMFreportstwoCADnumbers:thestandardoneandonewithoutbigprojects.Eventhelatterisexceptionallylarge,closetodoubledigitsasapercentageofGDP.Infact,S&PdowngradedRwandafromB+fromBinSeptember2016onaccountofitsswellingCAD,althoughtheIMFDSFcontinuestoratethecountryatlowriskofdebtdistress.

Rwanda’sexperiencecapturesthetensionbetweenvastupfrontpublicinvestmentneedsfordevelopmentandpublicdebtsustainabilityeveninthebest-governedADFcountries.Inspiteofitsbeingratedatlowriskofdebtdistress,thedatapresentedintheIMF2017ArticleIVreportposeapuzzleinthattheactualincreaseinexternaldebttoGDPbasedontheDSA(Table4,baselinescenario)overthethreeyears2014-16isalmost15percentagepointsofGDPlessthantheamountonewouldexpectbasedonthefundamentaldriversofexternaldebt,namely,thenon-interestCAD(NICAD),netFDIchangeandendogenousdebtdynamics(whichcapturetheeffectsofinterestrates,exchangeratesandgrowthrates).

Inotherwords,hadwestartedwiththeexternaldebt-to-GDPratioof26%attheendof2013andaddedthe“Identifiednetdebt-creatingflows”overthenextthreeyearsshowninTable4oftheDSA,wewouldhaveendedupwithanexternaldebt-to-GDPratioof53.4%attheendof2016insteadofthemoresoothing39%showninthetable.Thislargediscrepancyrequiresanexplanation:eithertheNICADandothervariablesdeterminingthepathofexternaldebtarebeingoverstatedordebtisbeingaccumulatedoff-balancesheet.6Yetthissignificantdiscrepancy,whichshowsupasaseriesoflargenegativenumbersinthe“Residual”lineofTable4doesnotmeritanymentionintheDSAapartfromagenericfootnotetoTable4.Thisexampleillustratestheriskthatpopulatingtemplatesoftenbecomesamechanicalexercise.Onemustask:wouldEthiopia’sriskratinghavebeenloweredhaditsexternaldebtratiobeen53%in2016insteadof39%?

Ethiopia

5QuotesfromJuly2017ArtIVReport(IMFCountryReport17/217).6Notethatiftheactualincreaseinexternaldebtisgreaterthantheamountidentifiedbytheprecedingfactorsthatcouldinprinciplebeexplainedbyfront-loadedborrowing;buttheconverseispuzzling.

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InJanuary2018,EthiopiawasdowngradedtohighriskofdebtdistressbasedontheLICDSF.Theverynextmonth,Moody’saffirmeditsB1(B+equivalent)ratingwithastableoutlook.ThisissimilartotheratingsforKenyaandRwanda,bothofwhichareratedatlowriskofdebtdistressbytheLICDSF.7

TheproximatereasonforEthiopia’sdowngradebytheIMFandWBisthattheratioofPPGexternaldebtservicetoexports(DSE)wentaboveitsthresholdinthemostrecentbaselineprojectionscenariocontainedinIMFCountryReport18/18releasedinJanuary2018(IMF2018b).ThereasonfortheDSEbreachisonaccountofmaturingprincipalonnon-concessionalloans,withthematurityreductionofoneparticularbilateraldepositatthecentralbankfrom8to6yearsbeingpivotal.8Inaddition,foreignexchangereservesfellandtherewere"widespreadforeignexchangeshortages",inotherwords,internationalliquidityisanissue.

NowconsiderwhathappenswhendatafromTable2(selectedindicators)andTable5b(balanceofpayments)inIMF(2018b)arecombined.Forexample,in2016/17,thetradedeficitwas16.1%ofGDPofwhich13.1pporover80%wasonaccountofthepublicsectordeficit(differencebetweeninvestmentandsaving)whileonly3.1ppwereonaccountoftheprivatesector.Moreover,netprivatetransferswere6.9%ofGDPwhileofficialtransferswerejust1.8%,meaningthatthe"public"componentofthecurrentaccountbalancewas-11.3%ofGDPpartiallyoffsetbytheprivatecomponentof+3.8%ofGDP,resultinginanoverallbalanceof-8.1%ofGDP(thatis,aCADof8.1%ofGDP,includingadeficitof0.6%ofGDPonnetincomefromabroad,seeTable5b).Thus,thepublicsectordeficit,itselfdrivenbylargeinfrastructureinvestments,drivestheCADandexternaldebt.Therefore,ifEthiopiaisathighriskofexternaldebtdistress,thefundamentalcausemustlieinthepublicfinances.Thismeansthatpublicdebtanditsdynamicsneedtobegivenacentralpositioninanyassessmentofdebtdistress.

ButtheDSAinIMF(2018b)hasnothingtosayaboutpublicdebtexceptthatitstaysbelowitsthresholdanddoesnot"flagadditionalrisks".Indeed,twocrucialquestionsforEthiopia,butunlikelytobeaddressedevenbythe2017DSF,arethefollowing:

1. Whatwouldpublicdebtdynamicslooklikeintheabsenceoffinancialrepression(issuingdomesticdebtatnegativerealinterestratescombinedwithcapitalcontrols)andrealexchangerateovervaluation?Boththesecouldmaskunsustainablepublicdebtdynamicsbykeepinginterestratesartificiallylowandunderstatingtheburdenofforeigncurrencydebt.

2. Willthebigpublicinvestmentspayoffbywillboostingfuturegrowthandtaxesandtherebyensuringsolvencyviaadequatefutureprimaryfiscalsurpluses?

BothquestionsarevitalbutunlikelytobepickedupwithoutanewframeworkforDSAasdiscussedinsectionsVandVI,wheretheEthiopiancaseisexploredfurther.

III.REFORMSEMBEDDEDINTHE2017DSF

TheLICDSFwasintroducedin2005andhasbeenreviewedthricepriortothe2017Review,mostrecentlyin2012,whencountry-specificinformationanddomesticdebtvulnerabilities

7Theratingagenciesarenotwithouttheirowncredibilityproblems.Butthediscrepancyisnoteworthy.8Seefootnote7intheDSAinIMF(2018).

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werehighlighted.The2017Review(thefourth)ismotivatedbythefollowingbroadconsiderations:9

1. Needtopaymoreattentiontomarket-basedfinancingrisksfromdomesticandforeign(Eurobond)sources(mentionedthroughoutIMF2017a)

2. Recognitionthatdebtprojectionshavetendedtounderestimatedebtburdensforbothexternalandtotalpublicdebtwithunexpectedchangesindebtratiosdrivenprimarilyby“fiscaldeviationsandbalanceofpayments(BoP)shocks”(IMF2017ap.9)

3. Inlikevein,andcontinuingtoemphasizetheprimacyoffiscalandpublicfinanceshocks,IMF(2017ap.11)notesthatshocksfromtheprimaryfiscaldeficittendtobeunderestimated.

4. TheDSFhasnotperformedwellinidentifyingXDDepisodesoutofsample.IMF(2017ap.18)notesthatperformancedeterioratessharplywhen7extrayearsofdataareincluded.

5. Staffjudgmenthasbeenappliedinonlyabout25%oftheDSAssincetheinceptionoftheDSFaccordingtoIMF(2017ap15).Moreover,thenewfeatureinthe2012reviewtoallowforadeeperassessmentoftotalpublicdebtanditsimpactontheoverallriskratinghasbeen“onlysporadicallyused”.Theseneedtochangetoallowfordeeper“attemptstodisentanglerisks”.

Mainreforms

Themain2017reformscanbegaugedfromacomparisonofFigure6onpage21withthefigureinAppendix1ofIMF(2017a).Theseinclude:

1. Classifyingcountriesasweak,mediumorstrongbasedonanewcompositeindicatorCIinsteadofexclusivelyontheCPIA

2. Eliminatingthe“probabilityapproach”tosettingdebtthresholds(theprobabilityapproachreferstousingcountryspecificinformationwhencountriesareontheedgeofbreachingadebtburdenthresholdtobetterinformtheriskrating)

3. Eliminatingremittance-augmentedthresholds104. Introducing“realismtools”tocrosschecktherobustnessofmacroeconomicprojections

andbaselinestresstests.

Anotherchangeistoshortentheprojectionhorizonfrom20yearsto10yearsforthemechanicaldeterminationofriskratings,asmostriskthresholdbreachestypicallyhappeninthefirstfiveyears(seep.31ofIMF2017a).

ImplementationofrevisedDSF

DrawingmainlyuponAnnexIIItoIMF(2017a),themainstepsinimplementingthe2017DSFareasfollows:

Step1:IdentifyaseriesofXDDepisodesovertheperiod1970-2015.98episodeswereidentifiedbasedonthenewmethodologyshownininFigureAIII.1(versus76undertheoldmethodology).AstrikingfeatureofthemethodologyisitsIMF-centricnature.

9Theinterpretationandassessmentofthe2017ReviewcontainedinthispaperareinformedbytheADFLab’sownexplorationofDSoverthe18-monthperiodNovember2015toJune2017.10ThischangeiswelcomeonconceptualgroundsbecauseremittancesmayincreaseFXreservesbuttheydonotaugmentthegovernment’scapacitytoserviceitsdebtunlessremittanceflowscanbetaxed.Wereturntothispointlater.

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Step2:Runaprobitmodelforeachof4debtburdenindicators.TheseindicatorsallpertaintoPPGXDandincludePVofXDtoGDPorexportsanddebtservice(interestplusmaturingprincipalonPPGXD)torevenueorexports.Theprobitmodel(whichestimatestheprobabilityofXDDforaparticularcountryinaparticularyear)usesthefollowingcontrolorexplanatoryvariables:

1. Debtburdenindicator2. CPIA3. Countrygrowthrate4. Reserves(scaledbyimports)5. Reservessquared6. Remittances(scaledbynominalGDP)7. Worldgrowth(proxyforexternalshocks)

Adisappointingfeatureistheabsenceofdiscussionofalternativesthatmighthavebeenpursued,forexample,variablespertainingtounsustainablepublicdebtdynamicsthatfeedintoXDD.Also,therationaleforusingremittancesisnotclear.IMF(2017a)claimsthisenhancesrepaymentcapacity.Remittancesenhanceinternationalliquidity,butunlesstheycanbetaxedtheydonotincreasethegovernment’srepaymentcapacity.Likewise,thereisnodiscussionofendogeneity.IstheCPIAhighbecauseXDDhasbeenavoidedorhasXDDbeenavoidedbecausetheCPIAishigh?Similarly,theinclusionofworldgrowthisnotclearlyjustified.Whynottermsoftradeshocks?

Step3:Classifycountriesasweak,strongormediumbasednotsimplyontheCPIA(asearlier)butonacompositeindicatorCIbasedonvariables2to7inthelistinStep2andusingthecoefficientforeachvariableaveragedoverthefourprobitregressions(oneforeachofthefourdebtburdenindicators).TheclassificationisbasedonevenlyspacedpercentilesfortheCI.Notethatitisnotclearwhyacountrywithhigherremittancesshouldbeclassifiedas“strong”ifremittancesresultfromadiasporathathasleftthecountrybecauseoflackofopportunitiesthere.ThevirtueoftheCPIAisthatitspolicyandinstitutionalimplicationsareeasytograsp.Thisisapuzzling“reform”.

Step4:Obtainathresholdforeachdebtburdenindicatorbyfirstchoosingacutoffprobabilityofdebtdistress.ThiscutoffprobabilityischosentostrikeadesiredbalancebetweenType1(missedcrises)andType2(falsealarms)errors.TheninverttheestimatedprobitregressionequationtoobtainthedebtburdenthresholdcorrespondingtothecutoffprobabilityasafunctionoftheCI(asshownonp26ofAnnexIII)andvaluethesethresholdsatthesamepercentilesfortheCIwhichdefinethecountryclassificationsoastoobtainanumericaldebtthresholdforeachcountryclassification.

Step5:DefineapredictionruleforpredictingXDDbasedonabreachofthedebtburdenthresholds(the2017DSFwouldsignalhighriskofXDDifanyofthethresholdsisbreached).

Step6:ThissteppertainstosettingbenchmarksforthePVoftotalpublicdebt(TPD=PVofPPGexternaldebtplusdomesticpublicdebt.Inpractice,“publicdebt”forADFcountriesusuallyincludesjustthedebtofthecentralgovernment;thedebtofSOEstendstobeexcluded.)Aruleisdefinedfordomesticdebtdefaultepisodes,explicit(rare)orimplicit(forexample,basedonhighinflationorfinancialrepression,morecommon).TheresultsareshownTableAIII.7,butitisnotclearwhichofthe18definitionsofdebtdistressiseventuallyused.SufficeittosaythatthresholdsforTPDaregraftedontothoseforthefourXDthresholdstoensureconsistencyand

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obtainbenchmarksforTPDforeachofthethreecountryclassifications;theapproachisdescribedinsectionDofAnnexIII.

Tosumup:The2017Reviewcouldhavetakenabolderapproachinsteadofcontinuingtobeconstrainedbyexternaldebtdistress(XDD),inparticular,byengaginginadeeperdiscussionoftheunderlyingcausesofsuchdistress,whicharelikelytoemanatefromfiscalimbalancesandTPD.Inthiscase,emphasizingpublicdebtasbothafundamentalcauseofmacroeconomicdistressandthefocusofcorrectivepolicybecomeslogical.

IV.CRITIQUEOFTHE2017DSF

Partofthecritiquehasbeenintegratedintothedescriptionofthe2017DSFinsectionIII.ItisIMF-centricinitsdeterminationofexternaldebtdistressepisodesatatimewhenmarketdebthasbecomeimportantandremainsanchoredintheoriginalframeworkofXDD.Tweakingthe2012DSFtoobtainanupdatedversionthatfitsadditionalhistoricaldatabetterdoesnottellushowthe2017DSFwillperformoutofsample.Forthis,wewillneedtowaitanother10years.

Acripplingdrawbackofthe2017DSFisthatitdoesnotaccordsufficientimportancetopublicdebtasthefundamentaldriverofCADsandexternaldebtdynamics.Thisalonewouldmaketheimplementationofthe2017DSFcounterproductive.Further,theadditionalsophisticationintroducedcoulddilutetheincentivesfortheuseofstaffjudgmentanddiscretion,whicharevitallyimportantgiventhedeterioratingdebtsituationamongAfricanLIDCs.

WhilethestatementinIMF(2018a)thattheLICDSF“hasbeenthecornerstoneofassessmentsofriskstodebtsustainabilityinLICs”mayhavebeentrueofthepast,theclaimthatthe2017DSFisa“significantoverhaul…bringingsignificantadvantagestoallstakeholders”fallsshort.

Thefirstproblemisthatthe2017DSFworkswithintheconfinesoftheinheritedDSF,whichbyitsnatureprecludesasignificantoverhaul.The2017ReviewneededtorevisitthehistorybehindtheintroductionoftheLICDSFin2004-5andaskwhethertheoriginalreasonsstillapplied,alongthelinesofazero-basedbudgetingapproach.ItneededtoaskwhatthefundamentalcausesofXDDepisodesare.TheseareunlikelytobelowremittancesorFXreservesorworldgrowth,variablesincludedintheprobitregressionsdiscussedabove.Thefollowinghypothesiswouldhavebeenworthinvestigating:thevastmajorityofXDDepisodesamongAfricanLIDCsaredrivenbyunsustainablepublicfinances.

ThereisnomoreeloquenttestimonysupportingthishypothesisthantheexecutivesummaryoftheIMF’sownOctober2017RegionalEconomicOutlookreportonSub-SaharanAfrica(IMF2017b):“Thenumberoflow-incomecountriesindebtdistressorfacinghighriskofdebtdistressincreasedfrom7in2013to12in2016,andalloftheregion’sfrontiermarketsorothercountrieswithcreditratings,exceptNamibia,havebeendowngradedbelowinvestmentgrade.Thedebtincreasehasbeendrivenbyawideninginfiscaldeficits,slowgrowth,theslumpincommodityprices,andexchangeratedepreciationsinsomecountries.Whilecurrentaccountshaveimprovedandexchangemarketpressureseasedsomewhat,internationalreservesarebelowadequacylevelsinmanycountries.”

TheideathatXDDistypicallydrivenbyfiscalimbalancesandunsustainablepublicdebtissupportedbyEMexperience,wheremostofthesovereigndebtcriseshavebeencausedeitherbyunsustainablepublicdebttrajectoriesleadingtoeventualdefaultsonexternaldebt(andpossiblyevenondomesticdebt)orbybailoutsoftheprivatesector(seeforexample,Pinto2014

14

chapter8).ItisalsosupportedbythecountrycasestudiesinAnnexIIofIMF(2017a).InthethreeexamplesgivenofmissedcrisesinGhana,MalawiandMozambique,primaryfiscaldeficits,publicdebt,terms-of-tradeshocks(tobaccopricesforMalawi)andoptimisticgrowthforecastsallplaymajorroles.

Similarly,correctivepolicyisalmostalwayslikelytohingeonthepublicfinancesandbettergrowthpolicy.ThisislikelytobethecaseevenwhentheimmediatecauseoftheXDDepisodeispurelyexogenous,suchasaToTshock.Ontheotherhand,apartfromgrowthandtheCPIA,thepolicyimplicationsoftheothercontrolvariablesintheprobitmodelinsectionIIIarehardtofathom.

Second,IMF(2017a)couldhavebenefitedfromamoresystematiccost-benefitanalysisofimplementingtheDSF.Onegetstheimpressionthatperformancewasnotgreat;butthiscouldhavebeenbetterdocumented.Besides,onewouldhavelikedtoknowwhattheaveragecostofproducingaDSAisintermsofstaffweeksandcosts.Hasitbeenworththeeffort?ThesequestionsareimportantbecausetheLICDSFhasbeenonacoursetowardsobsolescenceeversincethecompletionoftheHIPC-MDRIprocesssome10yearsagoforthreereasons:(i)thecontinuedemphasisonPPGXDtotheneglectoftotalpublicdebt;(ii)theslowrecognitionthat,afterHIPC-MDRIdebtrelief,governmentshavebeenrelyingonheavilyonmarketfinance(notjustEurobondsbutalsodomesticdebt,thelatterpossiblyapplyingtothefragilecountriesaswell);and(iii)thecontinuedrelianceonCPIA-linkeddebtburdenthresholdswithoutpayingattentiontomarketsignalsondefaultanddevaluationrisk.

Third,the2017DSFfailstoaddresstheshortcomingsidentifiedinsectionIandconveystheimpressionthattheDSFisanendinitself.Thiscanbedemonstratedintwoways.

• ThedisconnectbetweentheriskratingsforXDDandmarketassessmentsofrisk.Forexample,Rwanda,atopperformerbasedontheCPIAandwhichcarriesalowriskofXDD,hasonlyaBsovereigncreditratingfromS&P,5levelsbelowinvestmentgradeonaccountofitsgrowingCADnecessitatedbyimportsformeetinginfrastructureandotherdevelopmentneeds.

• Analmostexclusiveemphasisoncrisisavoidance,asillustratedbythediscussiononpage17ofIMF(2017a)andespeciallyfootnote10onthedistresssignalsused,whichareevidentlygearedtotheinterestsofexternalofficialcreditors.

Fourth,theorientationoftheDSFshouldberadicallyalteredtomakeitmoredevelopment-relevant.

• Thefirstchangeshouldbetomakepublicdebtanditsdynamicsthecentralfocus.ThereasonisthatmostoftheXDDriskprobablyemanatesfromthepublicsector(governmentplusSOEs)forADFcountries.Therecouldbeamuchshorterhorizon,say5years,fordiscussingpublicdebtdynamicssupplementedwithadiscussionofCADsandFXRA.Atthesametime,risksfromtheprivatesector’sbalancesheetshouldbemanagedandmonitoredbyrestrictingexternalprivateborrowingaswellascurrencymismatchesonbanks’balancesheets.ThisneedstobedoneproactivelybasedonEMexperience:preventionofdebtcrisesisfarlesscostlythanthecure.11

• ThesecondchangeshouldenhancetheDSFasaninputintoapolicydialoguefordevelopment,asopposedtomerecrisisavoidanceoraninputintotheDLPoftheIMFandNCBPoftheWorldBank.Adistinctionneedstobemadebetweennaturalresource

11AizenmanandPinto(2013).

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exporting(NRX)countriesandtherestowingtotheexistenceoftheNRcurseinSSA,asarguedinFP2017.ThisisamajortopicgiventheprevalenceofhydrocarbonsaswellasotherexhaustibleNRsuchascopperandironoreinSSA,buthastendedtobesoft-pedaledinrecentyears.NRXcountriesshouldfaceamuchhigherbarforaccesstodevelopmentfinancetocreateanincentiveforthemtousetheirownwealthwell.Indeed,asshowninFP2017,countriesrichinNRtendtoheadlinegroupsthataremarkedeitherbyunsustainablepublicdebtdynamics(suchasGhana,MozambiqueandZambia)orpovertyandfragility(ofthe9ADFcountriesintheLabstudywithapercapitalessthan$500,FP2017notesthat5areNR-richandall9havepublicdebtsustainabilityproblems).

Onthepositiveside,theemphasisonjudgmentaspartofthe2017DSFreformsiswelcome.Asapracticalmatter,exercisingjudgmentrestsontwopremises:thoroughfamiliaritywiththenuts-and-boltsoftheunderlyingalgebraicequationsofthemodelandtheabilitytomodifyflexiblytohighlightcountry-specificaspects;andexperience,includingathoroughunderstandingofhowaparticularcountry’seconomyworks.Thediscussionatthebottomofpage15ofIMF(2017a)showsthatdiscretionisrarelyused.Unfortunately,templatesliketheDSFtendtobecomesubstitutesforthinkingandthisriskincreasesthemoresophisticatedthetemplateis.

V.ANALTERNATIVEFRAMEWORKFORAFRICANLIDCDEBTSUSTAINABILITY

ThealternativetoDSF2017proposedhereshouldbeseennotasafixedtemplatebutanapproachallowingforcountryspecificitythatrespondsnimblytochangingcircumstances.Inthisspirit,thealternativeapproachrestsonafewprincipleswhicharemotivatedbymacroeconomicbasicsandlessonsfromEMs,andtheparticularcircumstancesdefiningthedebtsituationinAfricatoday:

Principle1:Basedondevelopmenttheory/empiricsandmacroeconomicaccounting101,onecansetoutthefollowing"causalhierarchy":

Weakleadershipandgovernance(lowtransparency,highcorruption)plusweakinstitutions(especiallyfiscalandfinancial)=>unsustainablepublicfinances=>unsustainablespilloversintocurrentaccountdeficitsandexternaldebtdynamics.

Conclusion:TheattentioninDSAsmustshiftfromdebtdistressassociatedwithPPGexternaldebttodistresslinkedtopublicdebtanditsdynamics,correspondingtoashiftfromsymptomtomalady.

Principle2.EvidencefromFP2017andIMF(2018a)indicatesdeep-seatedpublicdebtsustainabilityproblemsamongAfricanLIDCs.Theunderlyingfactorsincludeslowinggrowth,aweakprivateinvestmentclimate,largeprimarydeficitswithbadexpenditurecompositionandexchangeratecollapseslinkedtoweakmacromanagementandpoliticalinstability.ThesefactorsarenotgoingtobealleviatedbyaninsistenceonconcessionalityinODA,whichhasfailedtopreventthere-emergenceofunsustainablepublicdebtinthepostHIPC-MDRIeraortocontributetoastrongfoundationforlong-rungrowth.Moreover,mostAfricancountriesarenatural-resourcerichbuthaveaweaktrackrecordinusingthiswealthtosupportdevelopment.

Conclusion:ConcessionalityisoverratedinthesensethatitwillnotcompensateforthefundamentalproblemsAfricanLIDCsfaceandcoulddilutetheincentivesfordifficultreform.

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TheAfricanLIDC-donorrelationshipneedstoberevisitedwithamorefocusedandtougherpolicydialoguewiththeonusshiftingtoAfricanleaders.

Principle3.Debtsustainabilityisnotanendinitselfbutaplatformforthesustainabilityoflong-rungrowthanddevelopment.Eventhebest-governedAfricanLIDCisgoingtofaceconsiderabletensionbetweenpublicdebtandCADsustainabilityontheonehandandthevastinvestmentsneededininfrastructureandhumancapitaltomeettheSDGsontheother.Atthesametime,ODAisdwindlingwiththemarketnowdefiningthemarginalcostofborrowingforasignificantsetofAfricanLIDCs.

Conclusion:ThebiggestchallengeforAfricanLIDCstodayisreconcilingdebtsustainabilityanddevelopment.Thiswouldrequireacombinationof:(i)re-pricingODAtoreflectthenewmarketrealities,(ii)findingmechanismstofrontloadODAwithoutincreasingthefiscalburdenondonors,and(iii)launchinganEnhancedPolicyDialogueconductedcollaborativelyacrosstheAfDB,IMFandWBtomaximizetheimpactofanalyticalandpolicywork.12

SimplifyingthePublicDSA13

Inlinewithprinciples1and2,theDSAshouldconcentrateonthevariablesdrivingpublicdebtdynamicsinamannerthatistransparent.Thismeanshighlightingthethreevariablesdrivingdynamics:theprimaryfiscaldeficit(totalrevenueminusnon-interestspending),theinterestrateonpublicdebtandtheGDPgrowthrate.ThesevariablesdeterminethetrajectoryofthepublicdebttoGDPratio(the“debtratio”).Forexample,ifthegovernmentisrunningaprimarydeficitandinterestratesexceedgrowthrates,thedebtratiowillgrowwithoutlimitintheabsenceofcorrectivefiscalpolicy,eventuallyresultinginacrisis.Similarly,ariseintheratiooftheprimarydeficittoGDP,oranincreaseininterestratesoracollapseingrowthratesorsomecombinationoftheseoutcomeswillworsendebtdynamicsandcouldprecipitateacrisis.

Inaddition,theexchangerateisakeyvariableimpactingpublicdebtdynamicsinADFcountries:theaverageshareofpublicdebtdenominatedinforeigncurrency(“forexdebt”)iscloseto70%.Largecurrencydepreciationssuchaswehavewitnessedoverthepastfewyearsquicklyincreasetheburdenofforexdebtandthedebtratio.Therefore,theframeworkshouldincorporatecalculationsthatenabletheimpactofcurrencyvolatilityonforexdebttobecapturedbyseparatinginterestratesonlocalcurrencyandforexdebt.14

Similarly,debtratioscanbeadverselyaffectedbycontingentliabilitiesfromstate-ownedenterprisesandcommercialbanks.Ifthestate-ownedenergycompany,orafailingbank,needsabailout,thiswilladdtothepublicdebtburden.MoresystematicinformationisneededonSOEdebtsandrelatedsolvencyissues,asemphasizedinIMF(2018a).

Makingdebtdynamicstransparentmeansthefollowing:

ShiftattentiontoNominalPublicDebt:The2017DSFlikeitspredecessorssetsriskthresholdsfortheratioofthePVofpublicdebttoGDP(seeforexampleTableAIII.8inAnnexIIIofIMF2017a).ThePVofpublicdebt(definedbytheIMFasthePVofPPGexternaldebtplusnominaldomesticdebt)isappealingwhenmostdebtisfromofficialsourcesandisconcessional,thatis,contractedatbelow-marketinterestrates.UsingadiscountratehigherthantheofficialinterestratethenenablesagrantelementtobecalculatedasthedifferencebetweenthenominalvalueofthedebtanditsPV.However,forEurobondsorcommerciallocalcurrencydebt,sucha12TherationalefortheserecommendationsisspeltoutindetailinHLP(2017)anddiscussedlaterinthissection.13TheapproachhereisbasedonADFLab(2016)andFP2017.14ThenumericalexamplefromEthiopiabelowwillshowexactlywhatthismeans.

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calculationwouldyieldanegativegrantelement(becausetheinterestrateonsuchdebtwouldtypicallybehigherthanthediscountrate).Forthisreason,theIMFincludessuchdebtatitsnominallevel.15Butthiscreatesaninconsistencybecauseitunderstatesthetrueburdenofmarketdebtassumingthat5%isindeedtheappropriatediscountrateandnotarbitrary.Usingnominaldebtavoidsthisproblemandenablesustoeasilyinterpret(r-g),theinterestrate-growthratedifferential.

Levelsversusdynamics:Thelevelofpublicdebtanditsdynamicsbothneedexamination.ThiswouldenableearlywarningbygettingawayfromthebinaryclassificationinherentintheLICDSF(somedegreeofdebtdistressversusnodistressbasedonsomethresholdbeingbreached)basedondebtlevels:onceadebtdistressepisodetakesplace,itisalreadytoolate.Ontheotherhand,lookingatpublicdebtdynamicsoverahistoricalperiodandhowthesearelikelytoevolveoverashortprojectionperiod,say5years,providesampleopportunityfordiscussingcorrectivepolicy.ThisnodoubthappensinthecaseofIMF-supportedprograms.Butitdoesnotflowfromthecore2017DSF.

Concentrateonhistorywithashortprojectionperiod:Thereasonforconcentratingonhistoryisahighdegreeofpathdependence:thenextfewyearsarelikelytobesimilartothepastfew.BasedonEMexperience,weknowthatgrowingoutofadebtproblemisextremelyrare.Instead,countriesusuallyhavetomakeharddecisionstoreduceprimaryfiscaldeficitsandlowercountry(macroeconomicandpolitical)risk.Longlagsmaybeinvolvedbeforereformsareseenascredibleandgrowthresumes.Moreover,seriousdebtdatagapsargueinfavorofsimplerapproachesandshorterprojectionperiods.

ShifttheonusforreformtoAfricancountrygovernments:InsteadofbuildinginoptimisticfiscalconsolidationandgrowthscenariosintoDSAprojectionsthatseldommaterialize—seetheexcellentaccountinMooneyanddeStoyres(2017)—theapproachshouldshifttotakingahardlookathistoryand,whereapplicable,askingcountrygovernmentshowtheyintendtorestoresustainabledebttrajectories.Thisisextremelyimportantincasesofpoortrackrecordsonusingpublicresourceswellandwheretheprobabilityofdifficultreformsbeingimplementedislow.Insuchcases,asimplifiedDSAfollowedbycountryvisitstoascertainthegovernment’sownstrategyislikelytobemoreeffectivethancontinuingtoinsistonconcessionalborrowingthatcoulddiluteincentivesfordifficultreform.AtougherdialogueandhigherbarforaccesstoODAareneeded.

DevelopmentandDebtSustainability

Inspiteofafallinthepercentageofthepopulationlivinginpoverty,50millionmorepeoplewereaddedtothepoorinAfricaduring2000-15owingtorapidpopulationgrowth.In2015,420millionAfricanswerelivinginabsolutepovertybasedontheWorldBank’s2011yardstick,morethanhalftheworld’spoor.Peopleundertheageof25makeup60%ofthecontinent’spopulation.With500millionmorepeopleexpectedby2030andanother250milliongoingintotheworkforce,therestorationoffastgrowthisessentialtoavoidasocio-economicdisaster.Evenifgrowthweretoaverage6%duringthe2020s,thiswouldstillleave400millionpoorpeoplein2030;ifgrowthweretostagnateinthe3-4%range,thenumbersofthepoorwouldswellto500million,puttingthefirstSDGto“eradicateextremepovertyforallpeopleeverywhereby2030”outofreach(HLP2017).

Twoobservationsareparamountinthisconnection.

15SeeforexampleAnnexIIinIMF(2015).

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First,ADFcountriesneedlargeamountsoffrontloadeddevelopmentfinancetoplugtheinfrastructuredeficitiftheyaretogrowfastenoughtomeettheSDGs,continuetoalleviatepovertyandcreatejobsforAfrica’sburgeoningyouthpopulaton.UNCTAD(2016)estimatesthattheSDGscouldrequireinvestmentsofbetween$600billionand$1.2trillionperyear.RecentworkbytheAfricanDevelopmentBankindicatesthatinfrastructurealonerequire$130-170billionperyear,leavingafinancinggapofasmuchas$108billion(AfricanEconomicOutlook2018).Theseneedsexistatbothatthenationalandregionallevelstointegrateseveralsmalleconomiestogethergiventhearbitrarycarvingupofthecontinent.Themarketisclearlynotaviablesourceforsuchfinancingonvolume,costandmaturitygrounds,makingthefrontloadingofODAtheonlyremainingalternative.

Box1:Africa’sDevelopmentandDebtSustainabilityChallenges

LessonsfromEMsandtheTransitionCountriesofCentralandEasternEurope:Fast-growingcountriestendtoself-financetheircapitalaccumulationwithhighsavingsratesandrelativelylowcurrentaccountdeficitsandevensurpluses.Inadditiontostrongfiscalandfinancialsectorinstitutions,countrieshaveespousedhardbudgetconstraintsforthepublicandprivatesector,competitionincludingfromimports,andcompetitiverealexchangerates.FollowingthespateofEMcrisesinthelate1990sandearly2000s,thesecountrieshaveself-insuredbystrengtheningpublicsectorbalancesheets,increasingFXreservesandbetterregulationofcapitalflowsandexternalborrowingbytheprivatesector.

ADFcountriesarenotinapositiontoself-financetheirgrowthbecauseoftheirrelativelylowincomesandmassivedevelopmentfinancingneeds.Theirspecialdevelopmentchallengesaresetoutbelowinthreemodules:growth;debtsustainability;anddevelopmentfinance.

Growth:Thisrequiresacombinationofcapitaldeepening(increaseincapital-laborratios)andafastrateoftotalfactorproductivity(TFP)growthtosupporteconomicgrowthandoverallwelfare.Inprinciple,Africashouldbenefitfromahighrateofreturntocapitalgivenitsscarcitythereanditsdistancefromtheglobaltechnologicalfrontier.Herearethespecialchallengesitfaces:

1. Loweringcountryriskthroughbettergovernanceandinstitutions,improvedvolatilitymanagement(especiallyfromdomesticcorruptionandpoliticalshocks)andensuringsustainablepublicfinancestoraiserisk-adjustedreturns

2. Engineeringabigpushoninfrastructureandskills3. Promotingregionalintegrationofinfrastructureandtradegivensmallaveragecountrysizeand

fragmentationoftheinternalmarket.

Debtsustainability:AconstanttensionexistsonthecontinentbetweenpublicdebtandCADsustainabilityandfinancinginfrastructure(nationallyandregionally)andtheSDGs,evenforthebetterperformingcountries.Themarketisunlikelytobeanappropriatefinancingsourceonvolume,costandmaturitygrounds.AstrongcaseexistsforfrontloadingODA,evenonmoderatelyconcessionalterms,whichwillremainfarsuperiortothemarketalternativesnowbeingpursued.Butcountriesmustdemonstratetheirwillingnessandabilitytostrengthenfiscalinstitutionsandpublicfinancemanagementandshowthatresourcescanbeusedwell,includingthosefromNRwealth.

Developmentfinance:ADFcountriesneedlargeamountsoffrontloadeddevelopmentfinancetoplugtheinfrastructuredeficitandmeettheSDGs.Thisisbothatthenationalandregionallevel.DonorscanhelpwithoutincreasingtheirfiscalburdenbyadoptingthetriplepackageofsecuritizingpartoftheannualflowofgrantsviaaBigBond,moderatelyconcessionalloansandanenhancedpolicydialogue(seetextfordetails).SomecountrieswillstillneedaccesstohighlyconcessionalODA,callingforatwo-tierapproachasoutlinedinHLP(2017)andFP2017.ThebiggestchallengeistoachievegreatercollaborationacrossMDBsandbilateraldonors.

Source:HLP(2017),Pinto(2014).

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Second,eventhebest-governedcountryhasvastpublicinvestmentneedswithoutwhichitwillbehardifnotimpossibletocreateafoundationforlong-rungrowthanddevelopment.Butborrowingtofinancetheseinvestments,especiallyfromthemarketswiththeirrelativelyhighinterestratesandshortmaturitiesrelativetothelongpaybackperiodsforinfrastructureinvestments,willfurtherexacerbatethealreadyworseningpublicdebtsustainabilityinAfrica.Box1abovesummarizesthenexusofdebtsustainabilityanddevelopmentchallengesinAfrica.

ReconcilingdebtsustainabilityanddevelopmentwithODAdwindlingcallsforharddecisions.First,ODAneedstobepricedandallocatedbetterandthereisclearscopeforthisgiventhefactthatthemarketdefinesthemarginalcostofborrowingforagrowingnumberofADFcountriesandheterogeneityamongcountriesinusingpublicresourceswell.Second,amechanismhastobedesignedtofrontloadODAwithoutincreasingtheburdenondonors.HLP(2017)recommendsthisbedonebyconvertingaportionofthegrantsnowgoingtoAfricaintoa“BigBond”.Forexample,ifapproximately$5billionofthe$45intheannualgrantstoAfricaissetaside,thiscouldsupporttheissuanceofa30-year$100billionbondbydonors:thepresentvalueofanannualstreamof$5billionforthenext30yearsis$100billionwhendiscountedat3%,whichisapproximatelyequaltotheprevailingyieldontheUS30-yearbond.TheproceedsofthisBigBondcouldbedisbursedthroughmoderatelyconcessional40-yearloansat3-4%(MCLs),whichwouldbesuperiortomarketborrowingoncostandmaturityconsiderations.Third,suchfrontloadingwouldneedtobeaccompaniedbyanenhancedpolicydialoguetoensurethatpublicresourcesareusedwell,withaccesstofrontloadedfinancesprovidingthecarrot.Fourth,thefocusoftheexistingsystemonhighlyconcessionalfinanceshouldshifttothemorevulnerableandfragileADFcountries.

Apragmaticwayofproceedingwouldbetoclassifycountriesaccordingtotwocriteria:whetherthemarginalcostofborrowingdeterminedbynon-concessionalborrowing(includingthemarket)orofficialcreditors;andwhetherpublicdebtsustainabilityproblemsmorelikelytobelinkedtopoorresourceuseandweakPFMsystemsormassivepublicinvestmentsininfrastructure,asshowninthematrixbelow.

UnsustainableDebtDynamicsdrivenprimarilyby:

Marginalcostofborrowingdeterminedby:

PoorresourceuseandweakPFM

Largepublicinvestmentsininfrastructure

Market

A

B

Officialcreditors

D

C

GhanaandMozambiqueareexamplesofcountrieswhichwouldbeinquadrantA.ThesecountrieswouldneedtomeetstringentcriteriainordertoqualifyforaccesstoanykindofODA,giventhegrowingscarcityofthelatterandtheinabilityofthesecountriestousepublicresources,includingfromtheirNRwealth,well.CountriesclassifiedasfallingintoquadrantBin

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thematrixwouldbeidealcandidatesforfrontloadedODAthroughMCLs:theywouldbenefitfromMCLsrelativetothecostsofmarketfinanceandprovidesomeassurancepublicresourceswillbeusedwell,therebypotentiallyignitingaracetothetopthroughsignalingeffects.AnillustrativelistofcountriesforQuadrantBisEthiopia,Kenya,Rwanda,Senegal,Cameroon,Côted’IvoireandTanzania.Similarly,countriesinquadrantCcouldbecandidatesforsuchfinance:theymaynothaveissuedEurobonds,buttheirmarginalcostofborrowingcouldbedeterminedbydomesticborrowingsorloansfromcommercialbanks.

QuadrantDwouldprobablyincludemostofthefragilecountries.Whileitmayseemlogicaltorestricthighlyconcessionalfinancetothesecountries,theincentiveeffectsmayposeadilemma.TheresultsinFP2017indicatethatthesecountriestypicallyhavethelowestCPIAscoresandareoftenNRrich,suggestingthefragilitycouldbeself-inflicted.NorisitobviousthatthemarginalborrowingcostofcountriesinquadrantDisdeterminedbyofficialcreditors:Chad,whichisclassifiedasADF-onlyandasa“fragileandconflict-affectedstate”,borrowedUSD1.45billionin2014fromGlencoreandfourbankstoberepaidwithcrudeoilshipments.Thisloanhadtoberestructuredin2015whenoilpricesfellasrepaymentswereabsorbingagrowingfractionoffiscalrevenues,asreportedinthisReutersarticle.

Thediscussioninthecontextofthematrixstressestheneedtomoveawayfromaone-size-fits-allDSAtemplateandtothinkofhardeningaccesscriteriafordwindlingODA.TheADFLab’svisitsto5countriesinthecontextofitsdebtsustainabilityworkindicatethatsuch“hardeningofbudgetconstraints”wouldnotcomeasashocktoAfricanLIDCs.ThesentimentwasoftenexpressedthatODAisnotlastforeverandthatwhatisparamountishowpublicresourcesused,notwhetherloansarehighlyormoderatelyconcessional.

ForeachADFcountry,thefollowinginformationwouldneedtobegathered:

1.UnderstandtheSDGanddevelopmentfinanceneedsofthecountrywell:whataretheprioritypublicinvestmentstoreduce(ifnotclose)theinfrastructuregapinpowerandtransport?Istherearosterofproperlyvettedavailableflagshippublicinvestmentprojects?Whataretheneedsforinvestinginhumandevelopmentandskills?Anunsettlingdisconnectistheshortageofbankableinfrastructureprojectsinacontinentwheretheinfrastructuredeficitismassive.

2.Attempttodefinethemarginalcostofgovernmentborrowings,notjustfromEurobondsandthroughdomesticT-bills,butalsousinginformationonbridgeloansfromcommercialbanksandloansfromChina,thetermsofwhichareoftennottransparent.

3.UnderstandcontingentliabilitiesbetteraswellastheroleofSOEsintheprovisionofinfrastructureservices.

4.PreparearosterofkeyregionalinfrastructureprojectsthatcanbefundedbypartoftheproceedsfromtheBigBond,asnotedinHLP(2017).SuchprojectscouldchangethenarrativeaboutAfricabysignalingitisopenforbusinessandattractingtheinterestofinfrastructurecompaniesworldwide.Togetanideaoftheimpact:arecentstoryinIndia’sEconomicTimesnoted“nearly15globalplayers,includingSamsungConstructionandChinaConstruction”arecompetingwithdomesticcompaniestosecureacontractforanINR26,000croreinternational

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conventionandexpocenter.16INR26,000croretranslatesto$4billion.Thinkofwhatevena$20billionBigBondcouldachieveforAfrica.

VI.ETHIOPIA:ACONCRETEILLUSTRATIONOFTHEALTERNATIVEAPPROACH

TheEthiopianvignetteinsectionIIdemonstratesconclusivelythathighpublicsectordeficits,linkedtolargepublicinvestmentsininfrastructure,havespilledoverintocurrentaccountdeficitsandexternaldebtdynamics.ThiscallsforadeeperexaminationofEthiopia’spublicdebtdynamics,whichwereexaminedinFP2017usingdatafromtheOctober2016IMFCountryReport16/322,theoneimmediatelyprecedingtheJanuary2018report(IMF2018b)thatdowngradedEthiopiatohighriskofdebtdistress.TheassessmentinFP2017madethreepoints:

1. Publicdebtdynamicsweremaskedbyfinancialrepression(issuingbirrdebtathighlynegativerealinterestrates)andrealovervaluation.Bothimprovetheappearanceofpublicdebtdynamicsbutthesustainabilityofsuchpoliciesisquestionableandinvolvesseriousdistortions(includingmisallocationofinvestment)whilepotentiallyhurtingcompetitivenessandgrowth.

2. Ethiopiaepitomizestheconstanttensionbetweentheneedforlarge,upfrontpublicinfrastructureinvestmentsinADFcountriesandpublicdebtsustainability.Theimmediateeffectoftheinvestmentsistoraisepublicindebtedness(albeitartificiallyloweredinEthiopia’scasethroughfinancialrepressionandrealovervaluationofthebirr)andcurrentaccountdeficits:Ethiopia'sCADin2016/17was8.2%ofGDPinspiteofsignificantremittances.However,thepublicinvestmentswillpayoffonlyoverthelongrun.

3. Thecrucialquestioniswhetherthepublicinvestmentswillindeedpayoff:havetheybeencarefullyselectedanddotheyhavesufficientlyhigheconomicratesofreturntoboostfuturegrowthandtaxestherebyensuringsolvencyviaadequateprimaryfiscalsurplusesinthefuture?Thisvitalquestionneedsananswer.

ThebigquestionthereforeiswhethertheEthiopianpublicsectorisfacingaliquidityorasolvencyproblem.Whileitdoesnotexplicitlyaddressthisquestion,IMF(2018b)appearstothinktheproblemisliquidity,notsolvency.Thiscanbeinferredfromthereasonforthedowngrade:thematurityreductionofoneparticularbilateraldepositatthecentralbankfrom8to6yearstippedtheratioofdebtserviceonPPGexternaldebttoexports(DSE)overitsthreshold,triggeringthedowngrade(seefootnote7intheDSAinIMF2018b).AlsomentionedarefallingFXreservesand"widespreadforeignexchangeshortages".

TheIMFreportisalsosanguineaboutprospectivereturnsonthelargepublicinvestmentsmade.Box1intheDSAnotes:"ThecommencementoftheAddis-Djiboutirailwaylinewillimprovetradelogisticsandreducethetransportationcostofmovinggoodsinandoutofthecountry.Itwilltakeonly10hoursforthenewrailwaytotakegoodsbetweenEthiopiaandDjibouti,asignificantimprovementoverthe3-4daysbytruckcurrently.Further,theHawassaIndustrialParkandsecondphaseoftheBole-LemiIndustrialParkhavestartedoperationsandaresetto

16TheEconomicTimesNovember29,2017.“GlobalfirmslineupforIndia’slargestconventioncentre;Rs26,000-crprojectmaycreate5Ljobs”.

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increasemanufacturingexportsandcontributetothediversificationofexports.Investmentsinhydro-power,industrialparks,exportprocessingzones,andpublicpoliciestoencourageFDIandprivateinvestmentinlightmanufacturingindustriesareexpectedtosupportexportgrowthanddiversification."Whileencouraging,thisassessmentcomesacrosslikeabest-casescenario.

Twostepsareinvolvedinthesolvencyversusliquiditydetermination.Thefirstisadeeperdiveintopublicdebtdynamics.Thesecondistoestablishthatthebigpublicinvestmentsthathavebeenmadearelikelytopayoff.

Ethiopia’spublicdebtdynamicsrecast

TobeconfidentthatEthiopiadoesnotfaceasolvencyproblem,onewouldneedtoexaminepublicdebtdynamics.AllthatIMF(2018b)saysaboutthisinthecontextofthedowngradeisthatpublicdebtstaysbelowitsthresholdanddoesnot"flagadditionalrisks".However,therealquestioniswhatpublicdebtdynamicswouldhavelookedlikeintheabsenceoffinancialrepressionandrealovervaluation.ThisquestioncanbeansweredbetterbyfollowingthesimplifiedalternativeDSAapproachreferredtoearlierinthissection.Table[xx]usesexactlythesameinformationasinIMF(2018b)torecastthepublicDSAinawaythatmakesthedynamicsmoreevident.17

Table[xx]:Ethiopia’sPublicDebtDynamics2015-17BasedonIMF(2018b)

Ethiopia

2014/2015 2015/2016 2016/2017

PublicDebt/GDP% 61.20 59.60 53.80 Forexshare% 51.31 54.53 54.65

Primarydeficit/GDP% 9.50 5.90 5.20 NominalGDPgrowth% 22.32 22.32 37.70 CompositeNominalInterestrate% 5.60 5.13 9.51 ofwhich:localcurrency% 4.58 3.49 3.53 ofwhich:Forex% - 6.70 14.50

RealGDPgrowth% 10.30 10.40 8.00 CompositeRealinterestrate% -4.78 -5.11 -14.11

Externaldebt/GDP% 35.10 35.60 31.60 ofwhich:publicshare% 89.46 91.29 93.04

Non-interestcurrentaccountdeficit/GDP% 11.40 9.60 7.70 Source:ComputationsbyauthorbasedondatafromTable3oftheDSAinIMF(2018b). TheformulasfortheimpliedcompositeinterestratesshowninTable[xx],whichincludetheimpactofexchangeratemovementsonthestockofforexdebt,arederivedinAppendix1.Take2016/17asanexample.Thenominalinterestrateonlocalcurrencydebtwas3.5%whilethatonforexdebtwas14.5%,givingacompositenominalinterestrateof9.5%.ThiswasfarlowerthannominalGDPgrowthof37.7%!Thesameappliestothetwoearlieryears,resultinginrealgrowthratesfaraboverealinterestratesforallthreeyears.Asaresultofthismassive

17Appendix2setsoutafewquestionsneedingclarificationwithregardtotheDSAinIMF(2018b).

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differential,thepublicdebt-to-GDPratiofellfrom61%in2014/15to54%in2016/17inspitelargeprimaryfiscaldeficits.Debtdynamicsarethereforebeingdrivenbyrapidgrowthconnectedtomassivepublicinfrastructureinvestmentscombinedwithexceptionallylowinterestratesonaccountofcurrencyovervaluationandfinancialrepression.

Asitturnsout,thebirrwasdevaluedby15%inOctober2017(theexchangeratewentfrom23.4177to26.9215birrperUSD,ariseofabout15%,onOct102017accordingtoReuters).Furthermore,accordingtoIMF2018b,thegovernmenthasbeentakingstepssinceOctober2016tocurbborrowingbythegovernmentandSOEs.ThisindicatesconcernsaboutcompetitivenessandtheCADaswellasrestrictionsonfiscalspacegivenalltheborrowingandinvestmentthathavealreadybeenundertaken.Ontheimpactofthedevaluation,Table3oftheDSAinIMF(2018b)showsa11.3%realdepreciationin2017/18comparedtoacumulativerealappreciationofsome17%overthepreviousthreeyears.Thiswilladd3.1percentagepointstothepublicdebt-to-GDPratioin2017/18(incontrasttoareductionof3.1ppin2016/17,aswingofover6ppofGDP).

Onfinancialrepression,thecentralbank,NBE,requiresbankstopurchaseNBEbillsequalto27%oftheirloanissuance(IMF2018bparagraph20)carrying3%interest(inflationisprojectedat12%in2017/18)inordertofundtheDevelopmentbankofEthiopia.TheIMFisarguingforamorecompetitivebankingsystemandamovetowardsmarket-determinedinterestrates,whichareclearstepsintherightdirection(accordingtoReuters,theinterestrateondepositswasraisedfrom5%to7%inOctober2017alongwiththedevaluation).Similarly,amovetowardsaflexible,marketdeterminedexchangeratewouldbeastepintherightdirection,asnotedinIMF(2018b)(accordingtointernetreports,theblackmarketratewas31.80-33birrversustheofficialrateof27.22perUSDinearly2018).

Thismovetowardsmarket-determinedinterestandexchangerates,whichwouldprobablybeneededtoimprovetheinvestmentclimateespeciallyforFDI,couldhaveasignificantimpactonthedebttrajectory.Forexample,supposethecompositerealinterestratewere3%foreachoftheyears2015/16and2016/17--areasonablelevelforaLIC--insteadofthe-5.1%and-14.1%respectivelyshowninTable[xx].ThengiventheactualrealgrowthratesandprimarydeficitsfortheseyearsshowninTable[xx]above,thedebt-to-GDPratiowouldhavebeen65.3%ofGDPattheendof2016/17insteadofthe53.8%showninthetable.Thisisalargedifference.

Microfoundationsforgrowth

Thesecondstepinthesolvencyversusliquiditydeterminationcallsformoreinsightintotheprospectivereturnsonthepublicinvestmentsininfrastructureandthemicrofoundationsforgrowth.Doingsowouldrequireattemptinganswerstothefollowingtypesofquestions:

1. WhatareEthiopia’sremainingprioritypublicinvestmentsininfrastructureandhumancapital?

2. WhatspecificallyaretheFDIandprivatesectorinvestmentsthatareanticipated?Theprivateinvestmentrateisshownasover20%ofGDPinIMF(2018b),whichisrelativelyhigh.Inwhatsectorsisitinvesting?Alsonotethat(Ethiopiaisrankedat161among190countriesontheDoingBusinessIndex).WhatlessonscanEthiopialearnfromothercountriesonthesuccessfactorsforIndustrialParksandEPZs?

3. Whatistheplanformovingtomarketinterestratesandexchangeratesandwhatwilltheimpactbeonpublicdebtanditsdynamics?

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4. Isthebirracrediblestoreofvalue(notethatthereisablackmarketfortheUSDandadeeperunderstandingisrequiredofwhethercurrencysubstitutionexistsandwhetherpeopleprefertoholdtheirsavingsoutsidethebankingsystemonaccountofnegativerealinterestrates)?

5. Whatarethekeystructuralreformspending(includinginincreasingcompetition,privatization,pricingofpowerandotherinfrastructureservices)?

6. Isthereastrongframeworkformanagingvolatilityfromexogenoussources(includingdrought)anddomesticsources(includingsocialinstabilityandcorruption)?Inthiscontext,encouragingmoveshavestartedinpursuitofnationalreconciliationaftertheinstallationofanewPrimeMinisterinApril2018.

ThesequestionscouldbepursuedjointlybytheIMF,WBandAfDBinthecontextofanenhancedpolicydialoguewiththeEthiopiangovernment.IfsuchadialogueestablishesthatEthiopiaindeedfacesonlyaliquidityproblem,thenitwouldbeasolidcandidateforthe40-yearmoderatelyconcessionalloansinthecontextoffrontloadingODAthroughtheBigBonddiscussedinsectionV.

VII.CONCLUSIONS

Eventhoughthe2017LICDSFhasbeenapprovedbytheIMF’sBoardwithimplementationsetforthesecondhalfof2018,theargumentsadvancedhereindicateitisobsoleteforthefollowingreasons:

1. AcontinuedfocusonPPGexternaldebtinspiteofgrowingmarketborrowings,domesticallyandexternally,withthemarketnowdefiningthemarginalborrowingcostforagrowingnumberofADFcountrygovernments

2. AtreatmentoftotalpublicdebtthatdoesnotrecognizethecausalflowfromunsustainablepublicfinancestoexternaldebtdistressandsimplytagsondomesticpublicdebttoPPGexternaldebt.Besides,retainingtheconceptofthepresentvalueofdebtisunhelpfulbecauseofthearbitrarydiscountrateof5%,theinconsistentapplicationwithmarketdebtbeingincludedatfacevalueandtheobscuringofdebtdynamics,inparticular,theimpactof(r-g),theinterestrate-growthratedifferential

3. InsufficientprominencegiventomarketsignalsondefaultanddevaluationriskandignoringlessonsfromEMsintheDSF’sprescriptions,forexample,focusingonfinancialengineeringinsteadoffiscalfundamentalsasinthecaseofGhanaandgenerallybeingexcessivelyoptimisticaboutprospectsforfiscalconsolidationandgrowthgoingforward

4. ThetendencytotreatdebtsustainabilityasanendinitselfandtheunsuitabilityoftheLICDSFforreconcilingdebtsustainabilityanddevelopmentatatimewhenpublicdebtproblemshavere-emergedandinvestmentneedsfortheSDGsremainvast.

ThepaperprovidesevidencefromrecentDSAsonGhana,EthiopiaandRwandainsupportoftheprecedingclaims.Itthenrecommendsanalternative,simplerframeworkthatusesthesamedataasintheLICDSFbutstartswithadetailedexaminationofpublicdebtdynamicsthatisbasedonnominaldebtandpermitsaneasyinterpretationofthekeyvariablesdrivingdebtdynamics.Thiscouldandshouldbecomplementedbyananalysisofcurrentdeficits,externaldebtandforeignexchangereserveadequacy.Thefocuswouldbepredominantlyonhistorywithashortprojectionperiodandthegoalofidentifyingkeyreformstobediscussedwiththegovernment.Thiscouldbedoneinthecontextofanenhancedpolicydialogue,recognizingthat

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theonusforpositivechangerestswiththegovernmentandcannotbedictatedbythedonors,withahigherbarbeingsetforaccesstodwindlingODA.

ThisalternativeapproachisillustratedwithEthiopia’srecentdowngradetohighriskofexternaldebtdistressinJanuary2018andthelogicalquestionsthatthisraiseswithpublicdebtconsideredasnotposinganyriskaccordingtoIMF(2018b).Thealternativeapproachwouldtakeahardlookatpublicdebtanditsdynamicsasthedriverofexternaldebtdistress,therebyshiftingattentionfromsymptomtomalady.Thisapproachwillalsobehelpfulinattemptingtoreconciledebtsustainabilityanddevelopment.

InconsideringthealternativeapproachtoDSA,itbecomesabundantlyclearthatthewholeframeworkforODAtoAfricanLIDCsmayhavetoberevisited.Inparticular,reconcilingdebtsustainabilityanddevelopmentinanenvironmentofgrowingdebtvulnerabilityanddeceleratinggrowthwithODAdwindlingcallsforharddecisions.First,ODAneedstobepricedandallocatedbetterandthereisclearscopeforthiswiththemarketdefiningthemarginalcostofborrowingforagrowingnumberofADFcountriesandheterogeneityamongcountriesinusingpublicresourceswell.Second,amechanismisneededforfrontloadingODAwithoutincreasingtheburdenondonors.HLP(2017)recommendsthisbedonebyusingaportionoftheannualgrantsnowgoingtoAfricatosupporttheissuanceofa“BigBond”,asdiscussedinsectionV.Third,frontloadingODAwouldneedtobeaccompaniedbyanenhancedpolicydialoguetoensurethatpublicresourcesareusedwell,withaccesstofrontloadedfinancesprovidingthecarrot.Fourth,highlyconcessionalfinanceshouldbestrictlyrestrictedtothemostvulnerableandfragileADFcountries.

Tosumup,fortheLICDSFtoserveasagenuine“cornerstone”fordebtsustainabilityassessments,anurgentshiftinemphasistowardspublicdebtanditsdynamicsisneeded.Thisisrequiredbothforeconomicreasons(unsustainablepublicfinancesarelikelytobethemainfactorbehindexternaldebtdistressepisodes)anddevelopmentreasons(economicgovernance,whichiscrucialforlong-termdevelopment,isliabletofinditsmostimmediateexpressioninthemanagementofthepublicfinances,includingequitablerevenuemobilizationandtransparentlyvettedpublicinvestments).Besides,massivepublicinvestmentsareneededtomeettheSDGs.Bothreasonsmakeacompellingcasefortheshifttowardspublicdebt.

Inparallel,HLP(2017)hasrecommendationsonattemptingtobetterreconciledebtsustainabilityanddevelopmentwithfront-loadedODAbasedonsecuritizingaportionofannualgrants,moderatelyconcessionalloansandanenhancedpolicydialogue.Therecouldalsobeafocusonfundingpotentialsuccessstoriestoignitearacetothetop,asdiscussedinthecontextofthematrixinsectionV.Thesearesimpleandlogicalideas.ThebigchallengeishowtogetacceptancefortheseideasgiventhecurrentODAarchitecture.AsKeynesnotedintheprefacetohisGeneralTheory,“Thedifficultylies,notinthenewideas,butinescapingfromtheoldones.”

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ReferencesADFLab.2016.“DebtsustainabilityimplicationsofhardenedMDBlendingtermsforAfricancountries.”WorkingPaperSeriesNo.1.ADFLabWP1,March.

AfricanDevelopmentBank,OECDandUNDP.2017.AfricanEconomicOutlook2017.

AfricanDevelopmentBank.2018.AfricanEconomicOutlook2018.

Aizenman,JoshuaandBrianPinto.2013.“ManagingFinancialIntegrationandCapitalMobility—PolicyLessonsfromthePastTwoDecades.”ReviewofInternationalEconomics.21(4),636-653.

IMF.2015.StaffGuidanceNoteontheImplementationofPublicDebtLimitsinFund-SupportedPrograms.

IMF.2016.Ghana:ThirdReviewUndertheExtendedCreditFacilityReview.IMFCountryReportNo.16/321.October.

IMF.2017a.ReviewoftheDebtSustainabilityFrameworkforLowIncomeCountries:ProposedReforms.PublishedOctober2,2017.

IMF.2017b.RegionalEconomicOutlook.Sub-SaharanAfrica:FiscalAdjustmentandEconomicDiversification.October.

IMF.2018a.“MacroeconomicDevelopmentsandProspectsinLow-IncomeDevelopingCountries—2018.”IMFPolicyPaper.March.

IMF.2018b.“TheFederalDemocraticRepublicofEthiopia:StaffReportforthe2017ArticleIVConsultation--PressRelease;StaffReport;andStatementbytheExecutiveDirectorforTheFederalDemocraticRepublicofEthiopia.”IMFCountryReportNo.18/18.

Felino,LuisaTeixeiraandBrianPinto.2017.DebtSustainabilityandDevelopmentImplicationsofModeratelyConcessionalLendingTermsforADFCountries.ADFLabWP3,June.

HighLevelPanel.2017.ReinvigoratingAfricanConcessionalFinance.ReportoftheHighLevelPanelonTransformingTrustintheAfDBGroupIntoInfluence.

Mooney,HenryandConstancedeStoyres.2017.“DebtSustainabilityAnalysesforLow-IncomeCountries:AnAssessmentofProjectionPerformance.”IMFWorkingPaperWP/17/220.

Okonjo-Iweala,Ngozi.2012.ReformingtheUnreformable:LessonsfromNigeria.CambridgeMA,andLondon:TheMITPress.

Pinto,Brian.2014.HowDoesMyCountryGrow?EconomicAdviceThroughStory-Telling.OxfordUniversityPress.

UNCTAD.2016.EconomicDevelopmentinAfricaReport2016.DebtDynamicsandDevelopmentFinanceinAfrica.

WorldBank.2017.CPIAAfrica.AssessingAfrica’sPoliciesandInstitutions.July.

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Appendix1:ComputationofInterestRatesonPublicDebtThisannexcontainsthederivationsforthethreenominalinterestratesincludedinthedebtsustainabilitycomponentofthecountrytablesinFelinoandPinto(2017).Theseare(i)thecompositenominalinterestrate,(ii)theinterestrateondomestic(localcurrency)debtand(iii)theinterestrateonforex(foreigncurrency)debt.Asthenamesuggests,thecompositenominalinterestrateonpublicdebtisaweightedaverageoftheothertworates,afterconvertingtheinterestrateonforexdebtintoalocalcurrency-equivalentusingexpostinterestparity,thatis,bytakingintoaccounttheimpactofnominalexchangeratemovements.Adepreciationmeansacapitallossonforexdebt,increasingitsburdeninlocalcurrencyterms,whileanappreciationmeansacapitalgain,loweringtheburdenofforexdebtinlocalcurrencyterms.Theweightsusedarethesharesofdomesticandforexdebtattheendofthepreviousyear.18

Theprecedingdescriptionsuggeststhattheinterestratesondomesticandthelocalcurrency-equivalentinterestrateonforexdebtneedtobecomputedbeforethecompositerate.Todoso,onewouldneedtheprecisecurrencycompositionofforexdebt:howmuchinUSD,howmuchinEUR,JPYetcetera.Thiscurrencybreakdownistypicallynotavailable.Theproceduredevelopedforthisreportsidestepsthisproblembyreversingtheorder:itfirstcalculatesthecompositeinterestrateonpublicdebtandthenobtainsthelocalcurrency-equivalentrateonforexdebtusingtheinformationprovidedontheinterestrateondomesticdebtandtheweightsofforexandlocalcurrencydebtintotalpublicdebt.AllthedatacomefromthejointIMF-WorldBankDSAforeachcountry.

CompositeNominalInterestRateonPublicDebt

TheIMF-WorldBankPublicDebtSustainabilityAnalysistablehas,foreachyear,the"identifieddebt-creatingflows"duringthatyear.Thishastwocomponents:theprimarydeficit;andtheso-called"AutomaticDebtDynamics"orADD.Together,theprimarydeficitplusADDcapturetheimpactofthefiscaldeficit(primarydeficitplusinterestpaymentsondebt),GDPgrowthandtheimpactofexchangeratemovementsontheforexcomponentofthepublicdebt.

Byitself,ADDcapturestheimpactofinterestrates,exchangeratesandgrowthratesondebtdynamics.IntheIMF’spublicdebttable,ADDisgivenbytheequation:

ADD=Contributionfrominterestrate/growthratedifferential+Contributionfromrealexchangeratedepreciation.

Inturn,thefirsttermontherighthandsideoftheaboveequationisgivenby:

Contributionfrominterestrate/growthratedifferential=contributionfromaveragerealinterestrate+contributionfromrealGDPgrowth.19

Indiscretetime,thedecomposition,intovariouscomponents,oftheincreasesinthedebt-to-GDPratiofromyeartoyearisgivenbytheequation:

(1) 𝑑! − 𝑑!!! = 𝑝𝑑! +(!!!!!)(!!!!)

𝑑!!!,where:

ddenotesthepublicdebt-to-GDPratio,pdistheratiooftheprimaryfiscaldeficittoGDP,risthecompositerealinterestondomesticandforexdebt,includingtheimpactofrealexchangeratechanges,gistherealgrowthrateandtdenotestheyear.20Intermsofthediscussionabove,thesecondtermontherighthandsideofequation(1)equalsADD.

18Forthetechnicallyinclined:thederivationsfollowfromthediscrete-timedifferenceequationforpublicdebtexpressedasaratioofGDP.Thechangeinthedebt-to-GDPratiorelativetothepreviousyearisdeterminedbytheprimarydeficit,theGDPgrowthrate,interestratesandexchangeratemovementsduringtheyearinquestion.Theinterestratecalculationimplicitlyassumesone-yeardebtasasimplification.19NotethatcontributionfromrealGDPgrowthisgivenby−[𝑔/(1 + 𝑔)]𝑑!!!,wheregisrealGDPgrowthinyeartanddt-1isthepublicdebt-to-GDPratioattheendofyear(t-1).20Foracompletederivation,seeAnnex2inPinto(2014).

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Nowtherealgrowthrate,g,aswellasinflationmeasuredbytheGDPdeflator,𝜋,aregiveninthe“Keymacroeconomicandfiscalassumptions”atthebottomoftheIMF-WB’sDSAtableforpublicdebt.Thiscanbeusedtocomputethenominalgrowthrate,G,givenbytheequation: 1 + 𝐺 = 1 + 𝑔 1 + 𝜋 .

Thenextstepistousethefactthatthesecondtermontherighthandside(whichequalsADD)canalsobewrittenas:

(2) (!!!!!)(!!!!)

𝑑!!! = 𝐴𝐷𝐷.

Inequation(2),𝑖!isthecompositenominalinterestrateondomesticandforexdebtandalso,byconstruction,capturestheimpactofexchangeratemovementsontheforexcomponentofpublicdebt.Theformulausedforthevariouscountrytablesinthisreporttocomputethecompositenominalinterestrateisobtainedbyrearrangingequation(2):

(3) 𝑖! = 𝐺! +!""!!!!

(1 + 𝐺!).

NominalInterestRatesonLocalCurrencyandForexDebt

The“Keymacroeconomicandfiscalassumptions”atthebottomoftheIMF-WB’sDSAtableforpublicdebtalsoincludetherealinterestrateondomesticdebt.Letusdenotethisas𝑟!.Thenitsnominalequivalentisgivenbytheequation:

(4) 𝑖! = 1 + 𝑟! 1 + 𝜋 − 1,where𝜋isinflationonceagainmeasuredbytheGDPdeflator.21

Thefinalstepistocalculatethelocalcurrency-equivalentoftheinterestrateonforexdebt,whichwedenote𝑖!.Thisisgivenimplicitlybytheformula:

(5) 𝑖 = 𝑤𝑖! + 1 − 𝑤 𝑖!.

In(5),𝑖isthecompositenominalinterestrateonpublicdebtcomputedinaccordancewith(3)andwistheweightoflocalcurrency(domestic)debtintotalpublicdebtattheendofthepreviousyear.Theonlyunknownis𝑖!,anditcanbesolvedforusing(5).22

CompositeRealInterestRateonPublicDebt

Thecompositerealinterestrate,r,isgivenimplicitlybytheequation:

(6) 1 + 𝑟 = (1 + 𝑖)/(1 + 𝜋),where:

𝑖isthecompositenominalinterestrategivenbyequation(3)and𝜋isinflationmeasuredbytheGDPdeflator.

21ThereasonforusingtheGDPdeflatortoobtainthenominalinterestrateisthatwearelookingattheratioofdebt-to-GDPandthesamepricethatisusedtoconvertrealgrowthintonominalgrowthshouldbeusedtoobtainthenominalinterestrate.22Notethat𝑖!isthelocalcurrency-equivalentinterestrateonforexdebt.Togiveanexample:supposeallforexdebtisinUSDandcarriesa(dollar)interestrateof2%.Inotherwords,𝑖$ = 0.02.Nowsupposethenominalexchangerate,expressedasthelocalcurrencypriceoftheUSD,goesupby10%duringtheyear.Then𝑖!wouldbe12%takingintoaccountthecurrencydepreciation(itwouldactuallybeslightlyhighergiventhediscretetimesettinginwhichtheformulasinthisannexhavebeenpresented).

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Appendix2:AfewquestionsontheEthiopianDSAinIMF(2018b)BeforeproceedingtothequestionsontheDSAinIMF(2018b)below,theseriousdiscrepanciesindebtdatarelativetothepreviouscountryreportforEthiopia,IMFCountryReport16/322,areworthnoting.Forexample,thepublicdebt-to-GDPratiofor2014/15isshownas61.2%inIMF(2018b)whereasitwas50.7%ininthepreviouscountryreport.ThisillustratesthedatachallengesonpublicdebtinADFcountries.

(i)MoreclarityisneededonthenumbersinTable3oftheDSAforpublicdebtinIMF(2018b):

(a)Table3showspublicdebt-to-GDPat53.8%in2016/17butparagraph1oftheDSAputsthenumberat57%.

(b)Table3showstheprimarydeficitat5.2%ofGDPfor2016/17.Texttable1showsthefiscaldeficitat3%ofGDPfor2016/17whileTable3bonpage22showsinterestpaymentsat0.5%ofGDP.Thismeansaprimarydeficitof2.5%forthegeneralgovernment.Whatdoesthebalanceof2.7%ofGDPrepresent?AretheselossesofSOEs?HowaretheSOEsperforming(apartfromEthiopianAirlines)?HoweffectivehavethestepstocurbSOEborrowingbeen?

(c)Howshouldoneinterprettheresidualof7.5%ofGDPfor2014/15inTable3?

(d)Doestherealdepreciationof11.3%for2017/18inTable3(under"Keymacroeconomicandfiscalassumptions")incorporatetheeffectoftheOctober201715%devaluation?

(ii)WhatexactlyisthebilateraldepositatNBEreferredtoinparagraph12andfootnote7oftheDSA?Whatisthesizeandwhataretheterms?

(iii)ThenumbersinTextTable1oftheDSAdon'tseemtomesh.Forexample,iftheratioofexportstoGDPgoesupfrom8.3%in2017/18to9.1%in2018/19andGDPgrowsat8.5%in2018/19,thiswouldrequireexportstogrowatover18%;butthenumbershownforexportgrowthis13.4%.Perhapsdifferentdeflatorsarebeingused?