Measuring Performance in Public Debt …

1 1 Measuring Performance in Public debt management : Key Findings from the debt management Performance assessment (DeMPA)1by Abha Prasad and Malvina Pollock This note focuses on the status of Public debt management (DM) Performance in developing countries, primarily those classified by the World Bank as low- or lower-middle-income It describes how the debt management Performance assessment (DeMPA) tool measures DM Performance in individual countries, and draws on the findings from the 44 DeMPA reports that have been finalized to date to describe the current state of DM Performance and highlight particular strengths and weaknesses.

2 Equally important, it illustrates how the DeMPA tool may be used by policymakers to manage some of the operational, institutional and technical challenges they face in meeting the requirements of modern day debt management to ensure Public debt is managed effectively. The arguments in favor of sound debt management are compelling. Empirical evidence supports the view that higher the quality of a country s policies and institutions, the better is its capacity to carry debt and withstand exogenous Throughout history poorly structured debt in terms of maturity, currency or interest rate composition, and large unfunded contingent liabilities, have been an important factor in inducing or aggravating economic crises in many countries.

3 Such crises, including the ones currently being experienced by some developed countries, underscore the need to be vigilant about borrowing levels and costs, and the DM framework within which these decisions are made and results monitored. Background The debt management Performance assessment ( DeMPA) is a tool developed by the World Bank, with inputs from regional and international technical assistance providers in debt management , including the IMF in response to a growing concern within the international community about the adverse impact of passive or inadequate debt management practices in developing countries (ref May 2007 Board paper).

4 This was further underscored by the World 1 This Note has been peer reviewed by Phillip Anderson, Tomas Magnusson, and Leonardo Hernandez. Comments and suggestions from Ian Storkey and Mike Williams are acknowledged. Inputs received from Signe Zeikate and William O Boyle on earlier drafts are gratefully acknowledged. Thanks to Ying Li for compiling the data. 2 The World Bank classifies countries by income groupings on their GNI per capita according to the Atlas methodology. For FY11 the classification is as follows: low income countries: $995 or less, lower middle income countries: $996-$3,945, upper middle income countries: $3,946-$12,195, and high income countries: $12,196 and above.

5 3 Kraay, A and Nehru, V, 2006, When is External debt Sustainable? World Bank Economic Review, Vol. 20, No. 3, pp 341-365. See also, WB-IMF (May 2007), Strengthening debt management Practices - Lessons from Country Experiences and Issues Going Forward - Background Paper (Chapter III prepared by A. Prasad and F. Rowe). 2 Bank s Independent Evaluation Group report pointing that although countries had been given debt relief under the Heavily Indebted Poor Countries (HIPC) Initiative and Multilateral debt Relief Initiative (MDRI), most of them still had weak debt management practices and functions4,5.

6 Further, the lowered debt burdens on account of the HIPC and MDRI debt relief had made several post-HIPCs attractive to non-traditional creditors that offered funds with terms and conditions with differing concessionality which could well lead to the re-accumulation of unsustainable debt burdens, if not managed prudently and effectively. While debt relief provided new borrowing space and the opportunity to diversify instruments and sources of financing to meet large scale investment needs, more options can add to the complexity, and cost, of the debt portfolio and increase operational risks. In addition debt management in these countries is often constrained by weak governance, lack of transparency, and shortage of skilled staff.

7 In most low income countries, the government debt portfolio typically comprises the largest financial portfolio; on average, Public debt accounts for over 60 percent of If not properly managed, the structure of the debt portfolio may evolve in ways that could generate substantial ris ks to government balance sheets and affect the countries financial stability (Wheeler, 20047). Further, the economies of lower-income countries are less diversified than those at higher income levels: export bases are narrower, exposure to recurrent commodity price shocks is higher, and reliance on limited and unpredictable aid flows for budget support is often heavier8.

8 All these factors make lower-income countries highly vulnerable to exogenous shocks that can significantly, and rapidly, worsen debt dynamics. Such shocks can consist of sharp slowdowns in external demand and a contraction in export growth. As was the case in the current crisis, developments in advanced economies could precipitate fall in aid flows on which many lower-income countries depend. Combined with a drying up of already limited external private sources of financing, lower-income countries can be left with large financing gaps, especially if the outlook for continued official flows remains The challenges faced by these countries highlights the need to identify and address weaknesses in debt management capacity.

9 Moreover, some lower-income countries have already raised funds in international capital markets, and others are contemplating this step as market conditions improve. However, several developing countries place a low priority on strengthening their DM systems and formulating coherent debt management strategies. Until the development of the DeMPA, 4 World Bank, 2006, Independent Evaluation Group Report on the HIPC Initiative. 5 As of June 2011,thirty-two countries have qualified for irrevocable debt relief under the HIPC and MDRI. Four countries have qualified for interim debt relief under HIPC.

10 6 See Preserving debt Sustainability in Low-Income Countries in the Wake of the Global Crisis (IMF and World Bank 2010) 7 Wheeler, Graeme (2004), Sound Practice in Government debt management , World Bank. 8 Some countries depend on donor flows for up to 30-40 percent of budget support ( , Malawi, Rwanda) 9 See Dang, Knack, and Rogers (2010) for data on the effect of banking crises on aid flows from donor countries. 3 neither borrowers nor lenders had any tool to measure debt management capacity in a systematic, comprehensive and objective manner. How debt management Performance is measured Proper DM requires the formulation and implementation of a strategy that enables a government to prudently meet its financing needs, its cost and risk objectives, and any other goals that the government may have set for itself, , developing the domestic debt market.