Keeping debt sustainable in low-income countries

• Pages: 102-104

Page 102

Although low-income countries are a diverse group, most rely mainly on official financing. Nevertheless, excessive debt in low-income countries poses serious problems. A debt overhang may undermine urgently needed progress on policy reforms and discourage private investment. And lenders may be forced to allocate scarce concessional resources to keep high debtor countries afloat, often at the expense of other deserving countries.

Donors and creditors can help low-income countries achieve debt sustainability, but the primary responsibility lies with the countries themselves. As they strive to reach the MDGs, low-income countries will need to preserve debt sustainability by keeping new borrowing in step with their ability to repay, adopting better policies and institutions that help accelerate growth, and gradually increasing resilience to exogenous shocks.

What the IMF-World Bank paper proposes is a framework that aims to guide the borrowing decisions of low-income countries in a way that matches their need for funds with their current and prospective ability to service debt. At the same time, the framework also provides guidance for the lending and grant-allocation decisions of official creditors and donors. It is designed to serve as a forward-looking analytical tool beyond the Heavily Indebted Poor Countries (HIPC) Initiative and will have no bearing on the implementation of the initiative itself.

Main elements of proposed framework

The proposed debt sustainability framework is based on two pillars: an analysis and careful interpretation of actual and projected debt-burden indicators in a Page 103 baseline scenario and in the face of plausible shocks, and indicative country-specific external debt-burden thresholds related to the quality of the country's policies and institutions. These two pillars, in combination with other relevant country-specific considerations, provide an informed basis for the design of an appropriate borrowing strategy.

The proposed framework also suggests important policy implications for donors and creditors. First, creditors and donors would need to review current financing policies to ensure that they appropriately reflect countries' risk of debt distress. An increase in the overall concessionality of financing to low-income countries, including a larger volume of grants, is almost certainly required. Second, since...