The Executive Board of the International Monetary Fund (IMF), on December 5, 2014, discussed a staff paper on “Reform of the Policy on Public Debt Limits in Fund-Supported Programs”. The paper built on the Board’s discussion, in March 2013, of a paper on “Review of the Policy on Debt Limits in Fund-supported Programs” and on ensuing informal consultations.

The last review of the Fund’s policy on the use of conditionality on public external debt in Fund-supported programs (the “debt limits policy”) took place in 2009. That review had focused on the use of debt conditionality in Fund-supported programs with low-income countries (LICs): given changes in the patterns of financing available to LICs at that time, the review proposed the adoption of a menu of options for accommodating non-concessional borrowing in Fund-supported programs. As discussed in the March 2013 paper, experience with the implementation of the 2009 reform was mixed, creating important implementation challenges. In addition, the maintenance of a sharp dichotomy in the treatment of concessional versus non-concessional loans became less tenable in light of the conjunction of large infrastructure financing needs in LICs with limited supply of concessional financing for such purposes and the increasing availability of alternative sources of financing.

The reforms proposed in the staff paper are based on a robust set of principles guiding the use of public debt conditionality in all Fund-supported arrangements across the membership. Key components include: a) tight linkage of the use of debt conditionality to the presence of significant debt vulnerabilities, as identified by debt sustainability assessments; b) a unified treatment of public debt, encompassing both concessional and non-concessional borrowing; and c) the determination of debt limits as one component of a fiscal framework, appropriately adjusted to country conditions. The unified treatment of debt provides LICs with more flexibility to manage their financing needs, within a fiscal framework that supports growth and investment while maintaining prudent debt levels.

Executive Board Assessment¹

Directors welcomed the opportunity to revisit the role of debt conditionality in Fund-supported programs. They noted that the proposed reforms have been informed by extensive consultations, which have contributed to significant refinements of the reform package.

Directors observed that the experience with the 2009 reform of the debt limits policy has been uneven. They noted that the sharp dichotomy between concessional and semi-concessional loans is difficult to justify on economic grounds. They emphasized that reforms to the policy should balance debt sustainability and borrowing requirements for investment and growth. They agreed that the coverage of debt limits should be unified and comprehensive, covering both concessional and nonconcessional debt. Moreover, there should be incentives for creditors to provide, and for borrowers to seek, financing on concessional terms.

Directors agreed that the use of debt conditionality in Fund-supported programs is warranted when a member faces significant debt vulnerabilities. Debt sustainability analysis should continue to play the key role in identifying debt vulnerabilities. There would be cases where the quality and coverage of fiscal statistics would warrant the use of conditionality on debt accumulation instead of, or as a complement to, conditionality on “above-the-line” fiscal measures (such as the fiscal deficit), taking care to avoid duplication of conditionality.

Directors emphasized that the broad principles that will guide the new debt limits policy should be applied in a transparent and even-handed manner. The particular form of debt conditionality adopted should reflect country-specific circumstances and program goals. Some Directors pointed to the importance of a clear description of remedial actions in case a breach of debt limits threatens to set a program off-track.

Directors supported the principle that debt conditionality policy should cover all public debt. Conditionality could take the form of a limit on total public debt accumulation, separate limits on external public debt accumulation and on domestic public debt accumulation, or targeted limits on some sub-component of aggregate public debt. A number of Directors considered that setting conditionality on the contracting rather than the disbursement of debt would tend to overstate the debt burden.

Directors noted that the appropriate definition of the public sector for purposes of specifying debt conditionality would depend on the institutional arrangements in the member country, but would normally entail wide coverage of nonfinancial public sector entities, unless specific exclusions are justified.

Directors agreed that, for members that do not normally rely on concessional external financing, limits on debt accumulation would be specified in nominal terms.

Directors concurred that, for members that normally rely on concessional external financing, conditionality on the accumulation of public and publicly guaranteed external debt would be warranted in cases where the member has been assessed as being at moderate or high risk of debt distress, or already in debt distress. Where the member is assessed as being at low risk of debt distress, Directors agreed that program conditionality need not include limits on the accumulation of public external debt. Some Directors considered that the use of debt conditionality would be warranted in low risk countries where debt levels are rapidly rising. A number of other Directors pointed out that treating all countries at moderate risk of debt distress as having significant debt vulnerabilities is not warranted, and some considered that countries with relatively low levels of debt within the moderate risk group do not merit debt conditionality in the form of performance criteria.

Directors concurred that for members that normally rely on concessional external financing, debt limits should be specified in terms of the present value of debt. Exceptions to this principle could be justified under circumstances described below.

For countries assessed as being at high risk of debt distress (or in debt distress), Directors agreed that the current use of debt conditionality would not change significantly: nonconcessional borrowing would be allowed only under exceptional circumstances; program conditionality would include a performance criterion setting a limit on the nominal value of nonconcessional borrowing; and a performance criterion or indicative limit would be set on the level of concessional borrowing. A few Directors felt that it would be appropriate to specify these limits in present value terms.

Directors noted that in cases where the member’s capacity to monitor the contracting of debt is weak, the use of a unified debt limit covering both concessional and nonconcessional borrowing may not be practical. In such cases, if the use of debt conditionality is warranted, it should take the form of a performance criterion on the nominal value of accumulation of nonconcessional external debt—as is currently the case—coupled with an agreed target on the accumulation of concessional debt. Some Directors considered that stronger conditionality on the limit on concessional borrowing would be appropriate for members in this category that are at a high risk of debt distress. Directors underscored the importance of speedily building debt monitoring capacity. They noted that this should be an explicit objective of the Fund-supported program, with sufficient external technical assistance, including from the Fund, being mobilized to aid the authorities in building capacity in a timely manner. They supported the general approach proposed by staff to assess a country’s capacity to manage and monitor debt for the purpose of implementing the new guidelines.

Directors agreed that program documentation should include a description of the key features of the authorities’ borrowing plans, noting that the key features of the borrowing strategy would depend on country circumstances. Many Directors cautioned that reporting requirements should not be unduly intrusive or onerous and should avoid undermining the member’s negotiating flexibility.

Directors noted the importance of consistency between the Fund’s new debt limits policy (DLP) and IDA’s Non-Concessional Borrowing Policy. They agreed that the DLP should take effect at end-June 2015 to provide adequate time for staff to work with country authorities on developing the necessary monitoring and reporting frameworks. A review of the experience with implementation of the new policy would take place by end-June 2018 or earlier as warranted.

¹ An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.