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Debt Relief, Grants and Free Riding: IDA’s proposed response Multilateral Development Bank Meeting on Debt Issues Wa PowerPoint Presentation
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Debt Relief, Grants and Free Riding: IDA’s proposed response Multilateral Development Bank Meeting on Debt Issues Washington, DC, June 21-22, 2006. Overview. IDA grants are linked to a country’s risk of debt distress.

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Debt Relief, Grants and Free Riding: IDA’s proposed responseMultilateral Development Bank Meeting onDebt IssuesWashington, DC, June 21-22, 2006

overview
Overview
  • IDA grants are linked to a country’s risk of debt distress.
  • MDRI debt relief and IDA grants create significant benefits for recipient countries in the form of strengthened debt sustainability prospects and resources for the MDGs.
  • However they also potentially add to the risk of “free riding”
  • This presentation will discuss the free-rider problem, and building blocks to limit the risk.
what is free riding
What is free riding?
  • the indirect cross-subsidization, through IDA grants and debt relief, of other creditors offering non-concessional terms

Higher risk of debt distress

IDA

Other creditors

Grants and debt relief

Non-concessional lending

Lower risk of debt distress

what are the risks
What are the Risks?
  • Grant-recipient countries with little access to financial markets – risk is limited.
  • Higher in resource-rich grant-recipient countries that could rely on non-concessional borrowing collateralized with future export receipts.
  • Risks of free riding may be magnified as a result of lower debt ratios resulting from the implementation of the Multilateral Debt Relief Initiative (MDRI).
the impact of the mdri
The Impact of the MDRI
  • MDRI brings debt ratios for eligible countries (at least initially) down to levels below those of many Middle-Income Countries (see slide 9).
  • But, static view leads to a risk that countries may accumulate excessive levels of debt that could threaten a return to unsustainability, and weaken IDA without the intended result.
  • However risk of debt distress post-MDRI varies by country: Forward looking DSF points out continued fragility of most countries. See diagram on slide 10.
preliminary risk ratings post mdri
Preliminary Risk Ratings post-MDRI

Ghana Senegal Tanzania Mali Uganda

Benin Mozambique Zambia Madagascar

Burkina Faso Ethiopia Guyana

Nicaragua

Rwanda Niger

key building blocks to an approach to free riding
Key building blocks to an approach to free riding
  • Agreement on a concessionality benchmark
  • Creditor coordination
  • Advanced reporting, increased monitoring.
  • Disincentives aimed at borrower level
concessionality benchmark for decisions
Concessionality benchmark for decisions
  • Concessional borrowing: multiples ways to measure it.
  • DAC ODA definition used for statistical purposes: 25% concessional using 10% discount rate.
  • Concessionality benchmark of at least 35% concessional using CIRR discount rates from IMF PRGF programs more realistic.
  • 35% is a proven benchmark in IMF programs for borrowing in LICs that does not endanger sustainability
  • 35% used by IDA in free-rider context: may be higher/lower if IMF program requires it.
2 creditor coordination
2. Creditor coordination
  • Free riding is a major issue for IDA donors
  • Need a concerted international effort to prevent a repeat of the past
  • Requires Broadening Creditor Acceptance of the DSF as useful tool – ideally to underpin an informal arrangement.
  • We have presented free-rider issue in number of fora as it has been developed – to MDBs early on in Tunis, to OECD creditors more recently at meetings in Paris.
  • Consultations will continue – including with non-OECD and commercial creditors.
access to information in dsfs
Access to Information in DSFs
  • Country-specific DSAs are already available on IMF website - by country (www.imf.org)
  • About 40 DSF-style DSAs available - 23 joint DSF-style DSAs.
  • Every month 2-3 additional DSAs are released.
  • A stand-alone site should be available in the next 6-8 weeks on World Bank debt website. (www.worldbank.org and type in debt).
  • Access to interactive DSF template also to be made more readily available.
3 reporting and monitoring
3. Reporting and Monitoring
  • Reporting and Monitoring of information flows is a weakness that may hamper a comprehensive approach to free-riding.
  • Close sharing of information and monitoring of flows will help to identify and prevent cases of unwarranted non-concessional borrowing.
  • Monitoring is difficult – IDA is strengthening adherence to reporting requirements, working with other creditors to enhance reporting.
  • IDA requiring advanced reporting of planned new non-concessional borrowing.
4 ida disincentives at country level
4. IDA disincentives at country level
  • Ultimately Borrower makes the final borrowing decisions.
  • Pragmatic approach to determining whether a non-concessional loan is a “breach” of the free-rider policy.
    • accept that some potentially high return projects may warrant special exceptions
    • Some additional flexibility for post-MDRI countries with low risk of debt distress
    • Emphasizes importance of debt management
available instruments in ida
Available instruments in IDA
  • For unwarranted breaches options available:
    • a reduction in volumes,
    • changing IDA financing terms

However, there is a tradeoff:

  • volume cuts reduce resources that could be used to reach the MDGs
  • hardening of terms may exacerbate debt sustainability problems.
disincentives
Disincentives

Grant-eligible countries:

  • Volume cuts would primarily be used in countries in which debt sustainability is a major concern
  • Initial 20% cut to grant allocations removes “subsidy”, but can be escalated for more serious or prolonged breaches.
  • lf disincentives are ineffective, a strong undertaking would be sought from borrower to abide by an agreed borrowing strategy.
  • Last resort measure: Management could consider disengaging from future support to the country.
risks to ida incentive approach
Risks to IDA incentive approach
  • Approach limited effectiveness if:
    • Countries can compensate through additional non-concessional borrowing (risk higher for post-MDRI)
    • Disincentives lead to a delay or reluctance to report, which has been particularly problematic outside of Fund arrangements.
    • Size of available non-concessional borrowing dwarfs IDA allocations (no leverage)
conclusion
Conclusion
  • No magic bullet to free rider problem
  • Requires concerted international effort by all actors.
  • Efforts to enhance creditor coordination will continue.
  • Ongoing efforts to improve debt management capacity should help.
  • Efforts to improve information on non-concessional borrowing and adherence to reporting requirements need to continue.