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

Chapter 7 | How the Low-Income Country Debt Sustainability Framework Informs World Bank Corporate and Operational Decisions

Highlights

The World Bank’s country-level operational priorities appear to be clearly influenced by the level of debt distress as determined by the Low-Income Country Debt Sustainability Framework. Risk of debt distress plays a key role in determining the grant allocation framework and participation in the Debt Sustainability Enhancement Program of the Sustainable Development Finance Policy (SDFP). Attention to debt vulnerabilities in World Bank–supported strategies (as reflected in Country Partnership Frameworks) increased for countries assessed at higher levels of debt stress.

Development policy operations (DPOs) for countries at higher risk of debt distress had a higher share of fiscal and debt-related prior actions. However, the share of fiscal and debt-related prior actions has decreased more recently, despite a worsening in countries’ debt risk ratings.

DPO–supported reforms and the majority of SDFP and performance and policy actions (PPAs) addressed debt vulnerabilities raised in Debt Sustainability Analyses (DSAs). However, some PPAs on debt transparency were included even when the DSA did not point to problems with debt coverage or reporting shortcomings. As a result, PPAs were underused to address higher priority drivers of debt stress and vulnerability identified in DSAs.

When nonconcessional borrowing was identified as a significant driver of debt stress in the DSA, there were generally subsequent PPAs requiring implementation of a nonconcessional borrowing ceiling. However, this was also sometimes the case when nonconcessional borrowing was not identified in DSAs as a significant driver of debt stress. This suggests that the identification of risks and debt drivers in DSAs was frequently not the major determinant of operational follow-up to country-level debt stress through the SDFP (and DPO prior actions).

A majority of country authorities surveyed for this evaluation believe that DSAs could better assess climate change and its impact on long-term growth in their countries.

This section assesses how the LIC-DSF informs World Bank corporate and operational decisions and priorities. LIC-DSAs influence the IDA grant allocation framework for performance-based allocations (PBAs) and affect country access to IDA special financing windows and participation in the Debt Sustainability Enhancement Program of the SDFP. At the level of country operations, DSAs are expected to inform the content and priorities of World Bank–supported country strategies (Country Partnership Frameworks; CPFs) and decisions on the composition of IDA lending and nonlending support to client countries, including for development policy financing and DMF support. The following section assesses how the LIC-DSA informs World Bank operations at these various levels.

International Development Association Grant Allocation Framework

Debt risk ratings produced by the LIC-DSF play a critical role in determining IDA resource allocations for individual countries, particularly in determining the availability of grants. The size of a country’s PBA is marginally influenced by the LIC-DSF risk rating. The rating for the risk of debt stress informs the debt policy and management score of the CPIA (which determines a country’s PBA). However, on its own, it is only a minor aspect of the PBA formula.

Of greater significance is how the risk of external debt distress assessed by the LIC-DSF determines the provision of grants to IDA-only countries. Debt distress risk ratings are translated into “traffic lights,” which in turn determine the share of IDA grants and more concessional credits for each country. In IDA19, countries at high risk of or in debt distress (red light) receive 100 percent grants, those at medium risk of debt distress (yellow light) receive 50 percent of their allocation in the form of grants and 50 percent as concessional credits, and countries at low risk of debt distress (green light) receive only concessional credits (that is, no grants).

Recent increases in the share of IDA-eligible countries at high risk of debt distress have important implications for IDA resource requirements. With the share of countries at high risk of debt stress having increased from 24 percent in 2013 to 51 percent in 2019 and 57 percent as of June 2022, this increases the share of IDA financing that is not repaid under IDA19. To contain this, under IDA20, harder financing terms were introduced starting July 2022 to enable IDA to prioritize grants to countries at the highest risk of debt distress (figure 7.1). IDA-only countries at low risk of debt distress (green light) continue to receive concessional resources mostly on regular credit terms (38-year credits with a 6-year grace period with a grant element of 53 percent), along with a small portion in shorter-maturity loans that are 12-year credits with a 6-year grace period (with a grant element of 35 percent). IDA-only countries at moderate risk of debt distress (yellow light) receive 50-year credits (with a grant element of 73 percent) and a small portion in shorter-maturity loans. IDA-only countries at high risk of debt distress (red light) continue to receive IDA allocations fully on grant terms, with a ceiling of $1 billion per fiscal year per country (IDA 2022). Shorter-maturity loans are expected to account for no more than 14 percent of IDA20 country allocations, with the share higher for IDA-only green light countries and gap and blend countries.

Access to IDA resources through IDA special windows is also affected by a country’s risk of debt distress under the LIC-DSF. Access to the Fragility, Conflict, and Violence Envelope is on the same financing terms as a country’s PBA. Financing terms for the Window for Host Communities and Refugees (WHR) are also determined by risk of debt distress. The WHR provides 100 percent grant financing for LIC-DSF countries at high risk of debt distress. Eligible IDA-only countries at moderate risk of debt distress receive 50 percent of WHR financing as grants and 50 percent as 50-year concessional credits. Those at low risk, and gap and blend countries at moderate risk, receive 50 percent of WHR financing as IDA grants and 50 percent as IDA concessional credits. Access to the IDA Scale-Up Facility is available only to countries at low or moderate risk of external debt distress.

Figure 7.1. Overview of IDA20 Financing Terms

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Infographic with an overview of changes to financing terms under 20th Replenishment of International Development Association.

Figure 7.1. Overview of IDA20 Financing Terms

 

Source: IDA 2022.

Note: a. Some of the financing terms are adjusted under IDA windows. This includes the following: (i) softer terms for most country lending groups under the Window for Host Communities and Refugees, (ii) flexibility to adjust terms in case of natural disasters under the Crisis Response Window, (iii) provisions to offer credits and grants to regional organizations under the Regional Window, (iv) credits at the International Bank for Reconstruction and Development terms and SMLs under the Scale-Up Window, and (v) the International Finance Corporation and the Multilateral Investment Guarantee Agency financing terms under the Private Sector Window. b. Except for red light small states. IDA = International Development Association; IDA20 = 20th Replenishment of IDA; SML = shorter-maturity loan.

The LIC-DSF risk rating therefore has a substantial impact on the terms of financing available to countries. For example, in their 2020 DSAs, Rwanda and Senegal both had an increase in their risk of debt stress from low to moderate. As a result, under IDA19, their financing terms changed from full credit to half grant and half credit from FY20. For Tajikistan, the risk of debt distress improved from high to low between FY14 and FY16 before rising to moderate in FY17 and high in FY19. The Completion and Learning Review for Tajikistan’s Country Partnership Strategy for FY15–18 noted that the changes “affected the [g]overnment’s borrowing decisions, which, in turn, had an impact on project delivery and implementation. Several non-revenue-generating projects were dropped or delayed as the [g]overnment was reluctant to borrow to fund these activities” (World Bank 2019, 61).

Did Debt Sustainability Analyses Inform Country Partnership Frameworks?

World Bank CPFs lay out the main development objectives that the Bank Group seeks to help a country achieve and propose a set of interventions to help achieve the objectives. CPF objectives reflect government priorities, main constraints identified through a Systematic Country Diagnostic, and the Bank Group’s comparative advantage. For countries where debt distress is increasing, CPFs would be expected to prioritize efforts to help contain the drivers of debt distress given the implications of debt stress for access to financing and the availability of budget resources to support development needs. Using the case studies, this section assesses the extent to which vulnerabilities explicitly identified in DSAs have informed CPF content and priorities (appendix F).

All but one of the nine case study countries (Nicaragua) had an objective that directly targeted reducing debt vulnerabilities explicitly discussed in DSAs (see tables F.1 and F.2).1> The Bank Group strategy of support to Dominica is embodied in the regional partnership framework, which contains an objective to improve fiscal, debt, and public financial management. All but two CPFs (Dominica and Nicaragua) sought to improve domestic resource mobilization or revenue administration. Various aspects of public financial management and debt management were often addressed in CPFs, appearing in six of nine case studies. Strengthening SOE governance and addressing contingent liabilities was a feature of at least four CPFs.

Did Debt Sustainability Analyses Inform the Content of Development Policy Financing Prior Actions and Areas for Reform?

This evaluation also assessed the extent to which the LIC-DSA influenced the prior actions in development policy operations (DPOs) for countries found to be at higher levels of debt stress.2 Across IDA-eligible countries, the share of development policy financing lending to countries at high risk of debt distress and in debt distress has been increasing gradually, reflecting in part how the overall share of IDA countries in this category has also been increasing (figure 7.2). Between 2012 and 2017, the average share of development policy financing to countries with high risk or in debt distress risk ratings was 14 percent and reached 54 percent in 2021. The share of IDA countries at high risk of or in debt distress increased from 30 percent to 58 percent between 2012 and 2021.

Figure 7.2. Share of Development Policy Financing Funding Committed to IDA-Eligible Countries by External Debt Distress Rating

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Stacked bar chart showing increase in share of development policy financing to countries at high risk of debt distress over time.

Figure 7.2. Share of Development Policy Financing Funding Committed to IDA-Eligible Countries by External Debt Distress Rating

 

Source: Independent Evaluation Group.

Note: DPF = development policy financing; IDA = International Development Association.

Countries at higher risk of debt distress had a higher share of fiscal and debt-related prior actions in their budget support operations, but this share has declined over time, particularly for countries at high risk of debt distress.3 Over time and across IDA-eligible countries, approximately 30 percent of all prior actions focused on fiscal and debt reforms. Countries at high risk of debt distress had a higher share of fiscal and debt-related prior actions (figure 7.3). Some 38 percent of prior actions in countries at high risk of debt distress were fiscal and debt reforms, whereas for those at moderate risk, the figure was 30 percent, and 18 percent for those at low risk. For the relatively few DPOs approved for countries in debt distress, the share of fiscal and debt-related prior actions was 29 percent.4 Although the number of DPOs with at least three fiscal or debt-related prior actions has increased since 2019, they have declined as a share of DPOs (figure 7.4).5 The median number of fiscal or debt-related prior actions per DPO approved each FY decreased from 2 from 2012 to 2019 (except 2014 at 3) to 1 in 2020 and 2021. The mean number of fiscal or debt-related prior actions decreased from a peak of 3.0 in 2014, before falling to 2.1 in 2015, then rising steadily to 2.5 in 2018, declining to 2.1 in 2019 and falling to 1.5 for operations approved during COVID-19.

Figure 7.3. Share of Fiscal and Debt-Related Prior Actions for LIC-DSA Countries by Risk of Debt Distress

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A line chart showing decrease in share of fiscal and debt-related prior actions for countries at higher risk of debt distress.

Figure 7.3. Share of Fiscal and Debt-Related Prior Actions for LIC-DSA Countries by Risk of Debt Distress

 

Source: Independent Evaluation Group.

Note: LIC-DSA = Low-Income Country Debt Sustainability Analysis.

Figure 7.4. Development Policy Operations with and without Fiscal or Debt-Related Prior Actions for LIC-DSA Countries

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Bar chart comparing share of development policy operations with and without fiscal or debt-related reforms over time.

Figure 7.4. Development Policy Operations with and without Fiscal or Debt-Related Prior Actions for LIC-DSA Countries

 

Source: Independent Evaluation Group.

Note: DPO = development policy operation; LIC-DSA = Low-Income Country Debt Sustainability Analysis.

Among fiscal and debt-related prior actions, expenditure management and domestic revenue administration reforms represented the largest share. From 2018 to 2021, expenditure management prior actions made up 26 percent of all prior actions, domestic revenue administration 25 percent, debt management 14 percent, and tax policy 13 percent. Across risk rating levels, countries at low risk of debt distress have fewer fiscal and debt-related prior actions. In FY21, about 25 SDFP PPAs were included in development policy financing, largely related to debt management, accounting for more than one-third of fiscal and debt-related prior actions in that year.

Six of the nine case study countries had DPOs approved during the evaluation period.6 Prior actions in these DPOs addressed the drivers of debt vulnerabilities identified in DSAs to varying degrees, although all the DPOs had at least one prior action that could be linked to a driver of debt vulnerabilities discussed in DSAs (see appendixes F and G for further details). Prior actions included fiscal and debt management, public financial management, procurement, domestic resource mobilization, debt and SOE transparency, and public investment management. Similar to the SDFP, some debt transparency prior actions did not address a problem or debt driver identified in DSAs. See appendix F for further elaboration of prior actions that addressed debt vulnerabilities.

Sustainable Development Finance Policy

A major way in which the LIC-DSF feeds into operations is through the SDFP. Amid rising debt distress among IDA-eligible countries, the deputies for IDA19 requested options for expanding and adapting IDA’s allocation and financing policies to better support countries’ development agendas while incentivizing actions that could reduce the risks of debt distress. The result was the SDFP, which replaced IDA’s Non-Concessional Borrowing Policy and was intended to create incentives for countries to implement policies and actions to enhance the transparency and sustainability of borrowing and investment practices.

IDA-eligible countries rated at moderate risk or higher for external debt distress under the LIC-DSF are required to implement PPAs each year. If countries do not successfully implement the PPAs, a portion of the country’s IDA allocation may be “set aside” until successful completion.7 The LIC-DSF debt stress rating also determines the size of the set-aside of the country’s IDA allocation. For countries at high risk of, or experiencing, external debt distress, the set-aside is 20 percent of the country’s annual country allocation, whereas it is 10 percent for countries at moderate risk of external debt distress (for countries using the Debt Sustainability Analysis for Market-Access Countries, the set-aside is 10 percent).8

With assessed debt risk levels rising among IDA countries, the number of countries undertaking PPAs has also risen. In the first year of the SDFP, 55 countries undertook PPAs, whereas in FY22, the number increased to 57. In FY21, 51 countries satisfactorily implemented PPAs, with 4 countries subject to set-asides until satisfactory completion (the Comoros, Djibouti, Maldives, and Pakistan). Over FY22, 51 countries satisfactorily implemented PPAs; 5 countries faced a set-aside of a portion of their IDA allocation.

Most SDFP PPAs in case study countries directly addressed debt vulnerabilities explicitly identified in DSAs. Countries for which PPAs addressed the main drivers of debt distress identified in DSAs included the Comoros, the Democratic Republic of Congo, Ghana, Nicaragua, Papua New Guinea, and Sierra Leone (see appendixes F and G for further details). Several PPAs for Bhutan, Dominica, and Zambia focused on issues (mostly aspects of debt transparency and nonconcessional borrowing ceilings) that had not been identified as a problem or a major driver of debt distress in DSAs. Several PPAs repeated DPO prior actions, drawing into question their value added in addressing problems or the drivers of debt distress. The 2021 early-stage evaluation of the SDFP found that about one-third of PPAs had limited additionality or value added and may have crowded out more critical reforms (World Bank 2021d).

Support through the Debt Management Facility

The DMF is a multidonor trust fund that was established in 2008 and that provides technical assistance to more than 85 countries to strengthen debt management capacity, processes, and institutions9 The DMF has been managed jointly with the IMF since 2014 and has implementing partners around the world. The DMF funds technical assistance, including training, advisory services, and peer-to-peer learning in the area of debt management. IDA-eligible countries benefit from DMF-funded support regardless of level of debt distress (figure 7.5). That said, there has recently been a significant increase in DMF support to countries at high risk of or in debt distress.

Figure 7.5. Countries Receiving Debt Management Facility–Funded Technical Assistance, by Debt Distress Risk Rating, 2018–21

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Bar chart showing increase in DMF–funded technical assistance to countries at high risk of or in debt distress over time.

Figure 7.5. Countries Receiving Debt Management Facility–Funded Technical Assistance, by Debt Distress Risk Rating, 2018–21

 

Source: Debt Management Facility annual reports.

Client Country Views on the Low-Income Country Debt Sustainability Framework

Surveys indicated that country authorities broadly agreed with projections in DSAs and DSA assessments of country risk of debt distress. Between August and September 2022, IEG carried out a survey of the debt management units of ministries of finance in all LIC-DSF countries. Nineteen countries responded—a response rate of about 25 percent (see appendix E for survey results).

Most country authorities reported being directly involved in discussions of the long-term projections of growth and fiscal variables that feed into the DSA prepared by World Bank and IMF staff. Just under two-thirds of respondents indicated that they had been involved (58 percent) or somewhat involved (11 percent) in these discussions. Of the respondents, 53 percent were in agreement with the projections and 24 percent were somewhat in agreement. For those who indicated that they were fully involved, 82 percent indicated full agreement with the projections, with the remainder indicating that they were somewhat in agreement. Surveyed country authorities found the most recent DSA prepared by IMF and World Bank staff to be reflective (76 percent) or somewhat reflective (12 percent) of the current debt risk situation in their countries.

Survey results indicated room to improve the extent to which DSAs reflected the impact of climate change on long-term growth. Over half of country authorities were not comfortable with the degree to which climate change and its impact on long-term growth in their countries were reflected in the most recent DSA.

The majority of respondents were comfortable or somewhat comfortable with the degree to which public and private investment and its impact on growth was reflected in the DSA (32 percent were fully comfortable, 53 percent were somewhat comfortable, and 16 percent were not comfortable). Most respondents were comfortable with the degree to which long-term concessional finance for their country was reflected in the DSA (58 percent were fully comfortable, 26 percent were somewhat comfortable, and 16 percent were not comfortable).

  1. Nicaragua’s fiscal year 2018–22 Country Partnership Framework included two objectives, which touched on debt vulnerability, but only indirectly, including one on improved data availability and public sector management capacity. Another objective targeted improved resilience to macroeconomic volatility, with an indicative pipeline targeting geothermal resource risk mitigation, a disaster risk management project, and potential advisory services and analytics on macroeconomic volatility and budget risks. Nonetheless, new World Bank lending to Nicaragua was restricted from 2018 after various countries placed sanctions on the government.
  2. This analysis was informed by Development Policy Financing Retrospective 2021: Facing Crisis, Fostering Recovery (World Bank 2021c).
  3. Prior actions are classified as fiscal and debt sustainability if they are associated with the following theme codes in the development policy financing prior action database: fiscal sustainability, public expenditure policy, debt policy, tax policy, subnational fiscal policies, public expenditure management, domestic revenue administration, debt management, public assets and investment management, and state-owned enterprise reform and privatization.
  4. Fifteen development policy operations (DPOs) were approved for seven countries in debt distress between 2014 and 2021: Chad, The Gambia, Grenada (seven DPOs, including one catastrophe deferred drawdown option), Mozambique, São Tomé and Príncipe (two DPOs), Somalia (two DPOs), and Sudan
  5. Although the share of fiscal prior actions has decreased, attention in development policy financing operations to other reform areas (notably, environmental and resource management, human development and gender, and urban and rural development) has increased.
  6. No DPOs were approved for Ghana, Nicaragua, or Zambia during the evaluation period.
  7. The country can recover the set-aside if it satisfactorily implements the missed performance and policy action(s) the following fiscal year; if not, the set-aside will become a discount.
  8. The influence of the Sustainable Development Finance Policy has also been leveraged by other multilateral development banks adopting similar policies. Both the African Development Bank and the Asian Development Bank have adopted a form of the Sustainable Development Finance Policy
  9. See https://www.dmfacility.org.