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The World Bank’s Role in and Use of the Low-Income Country Debt Sustainability Framework


Background and Context for Evaluation

This evaluation, requested by the Committee on Development Effectiveness of the Executive Board of the International Development Association (IDA), is intended to provide input and insight into the upcoming World Bank–International Monetary Fund (IMF) review of the Low-Income Country Debt Sustainability Framework (LIC-DSF) currently planned for fiscal year 2023. Consistent with the mandate of the Independent Evaluation Group, it will assess only the World Bank’s role in and use of the LIC-DSF. Collaboration with the IMF will be reviewed only to the extent that it informs the World Bank’s role in and use of the LIC-DSF.

The sharp rise in debt stress among low-income countries and a changing global risk landscape leading up to and after the onset of the COVID-19 pandemic have pushed concerns with debt sustainability to the top of the global policy agenda. IDA-eligible countries increased external borrowing in the wake of the 2008 global economic and financial crisis, with much of the new borrowing from non–Paris Club members and from commercial creditors, often on nonconcessional terms or in the form of complex lending arrangements under opaque terms. The number of IDA-eligible countries at high risk of or in debt distress more than doubled between 2015 and 2019, increasing further since the start of the COVID-19 pandemic. This has been exacerbated by the war on Ukraine, which has contributed to increasing energy, food, and other commodity prices; as well as broader inflation; a tightening of financial conditions and increased volatility in global financial markets; and a global growth slowdown. As a result, many IDA-eligible countries are now facing or expected to face significant debt-related challenges in the near future at the same time as they need to support recovery from COVID-19 and finance investments to support longer-term development, including adaptation to climate change.

This evaluation assesses the World Bank’s inputs into the LIC-DSF and how the World Bank uses LIC-DSF outputs to inform various corporate and country-level decisions. In doing so, the evaluation seeks to identify opportunities for the World Bank to strengthen its role in the preparation and use of the LIC-DSF in a changing global landscape and to highlight issues that may need to be addressed in the upcoming joint review, including the extent to which the LIC-DSF meets the needs of IDA-eligible countries. Although the LIC-DSF is a joint framework elaborated, updated, and implemented by both the World Bank and the IMF, consistent with the Independent Evaluation Group’s mandate, recommendations from this evaluation focus on aspects of the LIC-DSF that are more clearly within the World Bank’s areas of responsibility.

The scope of the evaluation has been calibrated to focus on inputs into the LIC-DSF that the World Bank is either solely responsible for or has the lead in providing and on how the World Bank uses the consequent outputs. The structure of the underlying LIC-DSF model—which is a joint IMF–World Bank product—and assumptions therein (thresholds, interest rates, and so on) are not assessed.

The 2017 guidelines indicate that the World Bank “takes the lead on longer-term growth prospects, and when required on assessing the investment-growth relationship” (IDA and IMF 2017a, 18). As such, World Bank work to estimate long-term growth prospects is in scope, with “longer term” defined to be beyond five years. The scope also includes assumptions about the impact of climate change on growth given their relevance for long-term growth. In addition, this evaluation assesses the rigor and consistency with which data quality and debt data coverage issues are reflected in country-specific Debt Sustainability Analyses (DSAs). It also looks at the World Bank’s use of LIC-DSF outputs in corporate decisions, with respect to the Sustainable Development Finance Policy (SDFP) and IDA grant allocation process, to inform country-specific engagement and policy advice.

Main Findings and Recommendations

The reforms to the LIC-DSF introduced in 2017, and for which the World Bank has a significant implementing role, have been implemented as planned. There has been increased use of country-specific stress tests covering market financing, contingent liabilities, natural disasters, and commodity price volatility. Application of judgment has also followed the revised guidelines. Presentation and discussion of coverage of debt data in the DSA have improved, although DSAs do not regularly discuss issues of data quality and do not consistently articulate concrete plans to address shortcomings, particularly with respect to state-owned enterprise debt data coverage.

The introduction of realism tools helped calibrate the degree of optimism in medium-term projections underpinning DSAs, but the realism of long-term projections in DSAs was not routinely assessed. Realism tools were applied almost exclusively to medium-term projections, with the exception of one tool showing 10-year debt forecasts across various DSA vintages. In recent years, there has been a minor reduction in the optimism of long-term gross domestic product growth forecasts. However, long-term forecasts of primary balances showed increased optimism compared with historical averages.

There is lack of clarity in the LIC-DSF guidelines on what is expected of World Bank staff in taking the lead on long-term growth prospects. Although the 2017 LIC-DSF guidelines assign the lead to the World Bank in producing long-term growth projections, there is significant variation from country to country in the extent and form of the World Bank’s contribution to long-term projections. Only 10 percent of World Bank economists surveyed reported leading work in this area, and another 30 percent reported having significant or shared responsibility with the IMF.

There has been an increase in attention to the implications of climate change for debt sustainability, particularly for the most vulnerable economies. About 60 percent of all DSAs discuss climate change or natural disasters. For a subset of countries that are particularly vulnerable to climate shocks—Small Island Developing States—climate change considerations were incorporated in almost three-quarters of baseline projections and in over four-fifths of tailored stress tests. Country clients have expressed a desire to see greater attention to climate change considerations in DSAs.

There is close collaboration between World Bank and IMF staff working on DSAs, although recent changes to the World Bank internal clearance processes have lengthened processing times and, according to many World Bank staff, have stressed the relationship with the IMF. A majority of World Bank economists working on DSAs rated World Bank–IMF collaboration in the preparation of DSAs as “good” or “very good.” Not surprisingly, there were some differences of opinion between World Bank and IMF staff on assumptions in DSAs. This is to be expected as part of a robust process across institutions for an inherently complex analysis, but almost all these differences of opinion were resolved at the technical or managerial level. At the same time, changes to the World Bank guidelines on DSA clearance and approval have improved internal contestability and the quality of World Bank inputs. However, they have, on occasion, created some delays and stressed the relationship with the IMF. Although the World Bank’s stronger engagement in DSA preparation is positive, it is important to ensure that clearance processes do not make the World Bank less agile in supporting DSA production.

For the most part, World Bank operational priorities are appropriately influenced by the level of debt distress determined by the LIC-DSF. This is reflected, for example, in the extent to which development policy operations for countries at higher risk of debt distress have a higher share of fiscal and debt-related prior actions. However, the share of fiscal and debt-related prior actions has decreased since 2017, despite a worsening in country risk ratings. At the same time, fiscal and debt-related prior actions and SDFP performance and policy actions often prioritize the major drivers of debt stress or debt reporting risks, but this is not always the case.

Based on the above findings, there is scope to strengthen the World Bank’s contribution to the LIC-DSF and the extent to which the results of DSAs inform World Bank corporate and operational decisions:

  1. Expectations of the World Bank in taking the lead on long-term growth prospects should be clarified. Given the World Bank’s development mandate, the current guidance is appropriate but comes with the expectation that the World Bank systematically take the lead in highlighting the country-specific factors that influence long-term growth, which is not currently the case. To do this effectively, the World Bank will need to strengthen its capacity to systematically identify country-specific determinants of long-term growth and fiscal prospects in DSAs. These should be more explicitly identified in DSAs and used to inform realism tools and stress tests, the horizon for which should be extended into the long term. Integrating long-term considerations into DSA projections will require enhanced awareness and use of tools to analyze long-term prospects.
  2. The recently increased attention to debt data coverage should be sustained and extended; greater attention is needed to assess data quality. Although DSAs routinely include a clear and up-front assessment of the coverage of the data on which DSAs are based, they do not always articulate concrete plans (if any) to address specific data shortcomings, particularly with respect to state-owned enterprises and associated contingent liabilities. The LIC-DSF guidelines do not explicitly require an assessment in the DSA of data quality, including with respect to requirements for timeliness of reporting and accuracy and identification of data sources. Strengthening these aspects of DSAs would bolster country incentives for timely, accurate, and comprehensive reporting of debt data and help channel technical assistance to entities within countries responsible for debt reporting. The World Bank’s stewardship of the Debtor Reporting System and its management of the Debt Management Performance Assessments suggest that it has the comparative advantage among development partners to lead on this issue and can draw on its convening power to work with other partners to foster stronger debt data quality and coverage.
  3. The DSA should be more directly and consistently used to inform priorities for the identification of fiscally oriented prior actions in development policy operations and SDFP performance and policy actions. Drawing on the drivers of indebtedness and sources of risk identified therein, the DSA should be considered a core diagnostic that is routinely updated and systematically used to inform the articulation of priorities for World Bank Group–supported strategies and operations (including prior actions in relevant development policy operations and performance and policy actions under the SDFP).
  4. The World Bank should continue to give increasing attention in the LIC-DSF to the long-term implications of climate change, in terms of both growth and fiscal requirements of adaptation and mitigation. The emergence of the Country Climate and Development Reports is a positive development, and efforts will be needed to ensure that the analysis they contain is adequately and systematically integrated into DSAs, with more forward-looking assessments of vulnerability to climate change for both the medium and the long term. As part of this, the World Bank should consider extending the forecast horizon for DSAs to 20 years, at least for countries most vulnerable to climate change, to enable the incorporation of both medium and longer-term impacts of climate change.

The upcoming joint World Bank–IMF review of the LIC-DSF offers several opportunities for strengthening the LIC-DSF more broadly. Among issues that could be considered in the context of the joint review, this evaluation points to the following:

  1. Although the World Bank has recently strengthened its participation in the LIC-DSF, the joint review provides an opportunity to review preparation and approval procedures to ensure that DSAs are produced on a timely basis.
  2. Given the changes to the 20th Replenishment of IDA financing arrangements, how best to incorporate financing assumptions in DSAs should be reviewed.

The review could consider how to strengthen the use of realism tools for longer-term assumptions. In particular, the upcoming review offers the opportunity to assess how climate change impacts on long-term growth and finances can be better incorporated in the LIC-DSF, including with more forward-looking assessments of vulnerability to climate change.