Management of the World Bank thanks the Independent Evaluation Group for the opportunity to comment on the report, The World Bank’s Role in and Use of the Low-Income Country Debt Sustainability Framework. In an increasingly turbulent world with heightened debt risks, management considers this evaluation timely and relevant to improving the understanding of the role of the Low-Income Country Debt Sustainability Framework (LIC-DSF) in the World Bank’s support to low-income countries (LICs) as they navigate multiple crises while addressing long-term development goals. Management thanks the Independent Evaluation Group for the constructive engagement throughout the process.

World Bank Management Comments

Overall

Management welcomes the report’s recognition of the World Bank’s progress in implementing the 2017 reforms of the LIC-DSF. The report finds that “there has been an increased use of country-specific stress tests covering market financing, natural disasters, commodity price volatility, and contingent liabilities. Application of judgment has followed agreed guidelines. The introduction of realism tools helped moderate the degree of optimism in medium-term growth projections underpinning DSAs [Debt Sustainability Analyses]” (70). The report also recognizes that debt data coverage in DSAs has improved, including the treatment of state-owned enterprises (SOEs) and contingent liabilities. Management appreciates the report’s acknowledgment of increased attention to the implications of climate change for debt sustainability, stating that “about 60 percent of all DSAs discuss climate change or natural disasters, particularly for the most vulnerable economies” (70), with climate change considerations incorporated in three-quarters of baseline projections and over four-fifths of tailored stress tests in DSAs for Small Island Developing States. Management also welcomes the report’s appreciation of the close collaboration between World Bank and the International Monetary Fund (IMF) staff working in DSAs and the recognition that “DSAs regularly informed DPO [development policy operation] reforms and the large majority of [Sustainable Development Finance Policy] PPAs [Performance and Policy Actions]” (72). Management appreciates the report’s suggestion that the World Bank has the comparative advantage among development partners and is best placed to take the lead in assessing debt data quality and coverage because of its stewardship of the Debtor Reporting System (DRS) and its management of the Debt Management Performance Assessments (DeMPA), while clarifying that the World Bank alone cannot be expected to tackle all possible data quality issues identified in DSAs.

Fiscal and Debt-Related Prior Actions

Management acknowledges the report’s findings that the World Bank’s operational priorities are, for the most part, appropriately influenced by the level of debt distress as determined by the LIC-DSF and emphasizes that it has maintained this focus over time. Management welcomes the finding that attention to debt vulnerabilities in World Bank Country Partnership Frameworks has increased for countries assessed at higher levels of debt stress. As the report mentions, this attention is also reflected in the fact that development policy operations for countries at high risk of debt distress have a larger share of fiscal and debt-related prior actions. Management is sobered by the observation that the share of fiscal and debt-related prior actions has decreased since 2017, given that the World Bank continues to pay strong attention to debt and fiscal stability in development policy financing, given the worsening in country risk ratings. The World Bank Development Policy Financing Retrospective 2021 shows that during fiscal years 2016–21, DPOs with at least three fiscal and debt-related prior actions represented, on average, about 52 percent of DPOs in LICs at high risk of external debt distress (World Bank 2021c). That share increases to about 82 percent in countries at high risk of debt distress when considering DPOs with at least one prior action focusing on fiscal or debt sustainability. During the same period, about 21 countries affected by fragility, conflict, and violence had programs supporting fiscal and debt reforms, which accounted for about two-thirds of all DPOs in these countries—about twice the share average for all other countries. Although management has maintained a strong use of fiscal and debt-related prior actions, it has also increasingly incorporated more climate-related and gender taggable prior actions to meet the corporate targets and priorities, which may explain the slight decline mentioned in the report. Moreover, the effectiveness of fiscal and debt-related prior actions cannot be adequately assessed only by their number but rather by their quality and complementarity with other policies and instruments. The risk of debt distress is also a key consideration in the International Development Association (IDA) performance–based allocation framework and for participation in the Debt Sustainability Enhancement Program of the Sustainable Development Finance Policy (SDFP).

Growth Projections and Debt Data

Management appreciates the report’s recognition that the World Bank is well-positioned to inform long-term growth projections and believes that the World Bank’s contributions in this realm are not adequately described in the report. In mentioning that staff often rely on extending historical trends when making long-term growth forecasts, the report understates the role played by the World Bank’s growth analytics (for example, Country Economic Memorandums [CEMs], Country Climate and Development Reports [CCDRs], and Systematic Country Diagnostics), which articulate future growth trajectories that often deviate from historical trends. Such projections are based on key long-term growth drivers and growth scenario analysis. The report also notes the increasing need for long-term projections to account for climate change risks. It recommends extending the long-term growth projections to a 20-year horizon “at least for countries most vulnerable to climate change” (73). CCDRs already extend the time horizons of growth scenarios to 2050 to illustrate the paths to net zero carbon emissions and the long-term impact of climate change. Management also stresses that long-term growth projections are more challenging than medium-term growth forecasts.

Management agrees with the report’s findings that there are gaps in data quality and coverage, and the World Bank will continue implementing plans to address shortcomings. As acknowledged in the evaluation, the IDA debt reporting heat map has been effective in directing more attention to this area. Management notes that the challenge of SOE debt reporting is linked to difficulties with domestic debt data; DSAs acknowledge that the external obligations of SOEs are relatively well measured, but loans from domestic banks may not be. In addition, a sizeable portion of SOE debt includes arrears to suppliers or other government entities (for example, utilities) that are difficult to monitor. Besides conventional SOEs, ongoing analytical work by the Equitable Growth, Finance, and Institutions Practice Group is finding a significant role for other types of “businesses of the state,” including cases of state ownership below 50 percent, indirect holdings in private companies via other SOEs, and companies owned by subnational layers of government. There is a broader agenda to pin down the financing and balance sheet aspects of these roles of the state that will take time to resolve. Management believes that careful calibration of contingent liability tests and continued efforts on debt reporting (as supported by Debt Management Facility [DMF]) can mitigate risks in this area. Management also agrees with the report finding that the World Bank needs to articulate concrete plans to improve debt data quality and notes that the World Bank has taken important steps to articulate such plans through other channels, including by issuing the debt transparency heat map, including a specific debt transparency pillar under the SDFP, and scaling up technical assistance to support the design and implementation of such plans under the DMF.

DSA Processing

While recognizing opportunities for continuous improvement, management highlights the progress made in DSA processing since the Accountability and Decision-Making (ADM) changes were first introduced. The reported delays in the DSA clearance processes are based on a small sample of DSAs at the early stages of the implementation of the ADM changes. The business standards for the various steps agreed in April 2021 are by now generally being adhered to, and delays arise when substantive issues in the review process warrant further discussion and are not resulting in a longer clearance time (or actions) than the parallel process followed in the IMF. Management is of the view that the changes to the DSA clearance process have resulted in a more structured World Bank review process and in improved internal contestability and quality of the World Bank’s inputs. Management remains committed to further improving the processing of DSAs based on experience and feedback.

Recommendations

Management will continue strengthening the World Bank’s leading role in long-term growth prospects, as mentioned in the first recommendation. One of the evaluation’s findings is that the World Bank’s leading role in providing long-term growth projections is uneven in practice. The report bases this finding on a survey of 67 World Bank country economists, 10 percent of which reported that they were leading long-term projections. Management would like to clarify that about 78 percent of survey respondents also reported that they contributed significantly to long-term growth projections, given the joint nature of this work with the IMF. Moving forward, management will ensure a more consistent role played by country economists in this process across countries. Management will also continue enhancing growth analytics, such as CEMs, to make this leading role even more effective. Staffing adjustments in the global team are being made to support regional teams preparing the improved CEM. Also, in the context of the upcoming LIC-DSF reform, management plans to introduce additional realism tools on long-term growth projections to ensure that growth and other key macro assumptions are robust.

Management agrees with the second recommendation on debt data quality and coverage to ensure that DSAs are based on comprehensive data. Management appreciates the report’s finding that the 2021 adjustments to the ADM contributed to strengthening data quality and coverage. Regarding the debt data coverage, management is pleased to note that according to the 19th Replenishment of IDA results measurement framework, the share of IDA countries that make debt data available in line with best practices has increased by 20 percentage points during 2019–20. This will remain a priority under the 20th Replenishment of IDA, with regular reporting on progress. Further efforts were undertaken to improve debt data quality and coverage through reconciling data from creditors and DRSs under Japan’s G7 Presidency in collaboration with the data group at the World Bank. These build on existing Paris Club calls to compare loan-by-loan creditor data with DRS. There would be continued efforts to improve data coverage and quality by providing DMF-funded technical assistance to LICs on debt reporting to improve debt transparency and tracking standards with the debt transparency heat map. Besides the global efforts on debt reporting, the DMF finances country-specific debt reporting assessments; these can be conducted on a modular basis as needed and do not have to be part of a DeMPA or DSA.

Management agrees with the third recommendation about the benefits of more closely linking debt vulnerabilities identified in DSAs with DPOs and PPAs. Management notes that several actions have already been taken, and plans are underway to strengthen the link between the debt vulnerabilities of DSAs to DPOs and PPAs. This would be part of assessing the adequacy of the macroeconomic framework for DPOs and the SDFP review process for PPAs. The constraints on a more direct link from debt vulnerabilities to prior actions or PPAs or both often relate to institutional capacity, the social and distributional impacts of associated reforms, and government ownership of the needed reforms. Beyond DPOs, PPAs of countries with high debt vulnerabilities include debt and borrowing ceilings that directly address or prevent the build-up of additional debt vulnerabilities and, importantly, contribute to the adequacy of the macroeconomic framework.

Management agrees with the fourth recommendation on the need to strengthen the climate analytical content of DSAs. Management would like to stress the complementary role of CCDRs and CEM 2.0 in providing analytical content on the nexus between growth, climate, and debt vulnerabilities in DSAs. As noted, plans are underway to enhance CEM-based long-term growth analytics, including climate analytical components. In addition, the LIC-DSF guides the user to “carefully consider the social and political feasibility of fiscal adjustment plans in the context of a country’s development priorities, poverty reduction plans, and/or need to comply with standards of human rights or social protection” (IMF 2018, 22–23). Management believes this gives the flexibility to incorporate climate issues identified in CCDR and CEM 2.0 diagnostics. The report also notes that extending the forecast horizon to 20 years is helpful to appropriately assess the long-term effect of climate change on the risk of debt distress. Management would like to clarify that, since 2005, the forecast scenario of all LIC-DSAs is 20 years, and management is pleased to note that this has been incorporated in the assessment for 10 countries, of which 5 were classified as Small Island Developing States by the United Nations, and 5 were classified as Small States by the World Bank, out of 67 countries with a LIC-DSA.

Management acknowledges the proposed areas for consideration in the context of the joint World Bank-IMF review of LIC-DSF. While it might still be early to review the joint approval processes, as the new ADM systems have been operational for only two years, the review will provide a stocktaking opportunity. In addition, management concurs that incorporating IDA financing assumptions in DSAs is an important issue, and technical work is already underway. The exercise will also be a good opportunity for the two institutions to review the long-term growth projections framework underpinning the LIC-DSF.