When asked how he went bankrupt, a character in one of Ernest Hemingway’s novels offered the now famous explanation: “Gradually, and then all of a sudden.” It could be said that the rise of debt stress in low-income countries has followed a similar pattern. For countries eligible for IDA, the World Bank’s fund for the poorest countries, the number deemed at high risk of, or in, debt distress more than doubled (from 19 to 40) over the past decade. One third of these countries experienced a two-level deterioration (either from low to high risk, or moderate to in debt distress) in less than three years. On July 1, 2020, as part of its efforts to help change the trajectory on debt distress in IDA-eligible countries, the World Bank launched the Sustainable Development Finance Policy (SDFP.)

Sustainable public borrowing has an important role to play in low-income countries, including to finance investments for economic growth and poverty alleviation. It is also critical for countercyclical public spending during economic downturns, such as the current downturn caused by the pandemic. Servicing growing levels of debt, however, can crowd out spending on core public services like education, health, and basic infrastructure, and choke off access to affordable finance. The SDFP aims to create incentives for both IDA borrowers and their creditors to manage debt accumulation in a sustainable and transparent manner.

In view of the importance of effective debt management both to the recovery from the pandemic and to keep development agendas on track, the World Bank Board's Committee on Development Effectiveness asked the Independent Evaluation Group (IEG) to conduct an "early stage" assessment of the SDFP to identify opportunities to strengthen the policy's effectiveness.

What was learned from the first year's implementation?

In many ways, the SDFP is an improvement over the Non-Concessional Borrowing Policy (NCBP) that it replaced. Crucially, it takes a broader view of the types of countries at risk of debt distress, and the potential sources of debt.

The NCBP applied to IDA-only countries, not IDA "blend" or "gap" countries (countries which meet some conditions for non-concessional IBRD borrowing but also some for IDA), despite the fact that a third of the IDA-eligible countries at high risk of or in debt distress by 2020 were blend or gap countries. The SDFP expands coverage to include all IDA-eligible countries.

The SDFP also broadens the coverage of public debt to include domestic borrowing, which played a significant role in the rapid rise in debt stress over the past decade. Beyond broadening scope, the SDFP provides a new mechanism for dealing with the drivers of debt stress. As part of one of the policy's pillars --the Debt Sustainability Enhancement Program (DSEP) -- at risk IDA-eligible countries are required to implement performance and policy actions, known as PPAs, to correct factors contributing to debt distress risks.  

In one critical aspect, however, the policy has not heeded the warning from Hemmingway’s famous character of how quickly things can go from bad to worse. The screening process the SDFP uses for excluding countries from undertaking PPAs – based on being assessed at "low risk" according to the World Bank–IMF Debt Sustainability Framework, or DSF – potentially excludes countries with significant underlying vulnerabilities. With evidence that the transition to debt stress occurs more sudden than gradual, a review of the criteria for excluding countries from PPAs is warranted.

As they are at the core of the policy, for the SDFP to be successful, it is also essential that the PPAs are actually relevant – that they address the underlying country-specific drivers of debt stress. IEG undertook case studies to assess PPA relevance over the first year, and from those found that about two thirds of PPAs responded to the main sources of debt stress in their respective country. The remaining third did not. For example, non-concessional borrowing ceilings were included as PPAs across the board for high-risk countries, even where ceilings already existed or where non-concessional borrowing did not contribute to the country's rising risk of debt distress.

Much like the old policy, the new one also focuses on creditors as well as debtors. The Program of Creditor Outreach (PCO), the second pillar of the SDFP, aims to use the World Bank's role as convener to promote information sharing and collective action at the creditor level, including with nontraditional creditors, to reduce debt related risks to IDA-eligible countries.

While the PCO represents a well-intentioned effort to engage the broader community of creditors, a review of the NCBP found that previous efforts at creditor coordination by the World Bank have had a positive but limited impact on lending decisions, and little was achieved with respect to coordination with non–Paris Club and private creditors.

It is too early to assess whether the PCO will incentivize creditor coordination, but a fundamental question from past experience is whether the World Bank is best placed, on its own, to convene non-Paris Club and private creditors, both of which are key to tackling mounting debt stress. 

The debt build-up over the decade highlighted clear deficiencies in the previous policy meant to ensure debt sustainability among IDA-eligible countries. The SDFP is a positive step toward shifting the trajectory of debt distress risks downwards. At the same time, IEG’s early-stage evaluation finds there is scope for improvement and provides a number of recommendations for increasing the effectiveness of the new policy.

Read: IDA's Sustainable Development Finance Policy - An Early-Stage Evaluation

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Submitted by Romain Guéléo NDOUBA on Tue, 11/23/2021 - 14:28

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The debt build-up over the decade highlighted clear deficiencies in the previous policy meant to ensure debt sustainability among IDA-eligible countries. The SDFP is a positive step toward shifting the trajectory of debt distress risks downwards. At the same time, IEG’s early-stage evaluation finds there is scope for improvement and provides a number of recommendations for increasing the effectiveness of the new policy.

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