The World Bank says Zambia’s external debt may hit distress levels by 2019. What does this mean for the country and its people?
Distressed debt refers to the securities of a government which it has either defaulted or are under distress and moving towards that in the near future. It includes all credit instruments that are trading at a significant discount and have a spread substantially wider than the average. Distressed debt is a part of the leveraged and high-yield loan market, and is rated below investment grade debt. This is the situation Zambia is likely to get into.
Edgar Lungu and his minions have no sensible alternative but get on the International Monetary Fund programme. And the sooner they do it, the better. They will not be able to handle this debt crisis on their own. They need IMF, politically and socially painful as it may be. For all the problems associated with such assistance, the IMF programme is right now Zambia’s best option.
Trying to respond to Low-income countries (LICs) that were often struggling with large external debts, the IMF and the World Bank developed a framework to help guide countries and donors in mobilising the financing of LICs’ development needs, while reducing the chances of an excessive build-up of debt in the future. The Debt Sustainability Framework (DSF) was introduced in April 2005 and is periodically reviewed. The current framework was approved by IMF and World Bank Executive Boards in September 2017 and has been implemented since July 2018. The framework is designed to guide the borrowing decisions of LICs in a way that matches their financing needs with current and prospective repayment ability.
Under the DSF, debt sustainability analyses (DSAs) are required to be conducted regularly. These consist of: (i) an analysis of a country’s projected debt burden over the next 10 years and its vulnerability to economic and policy shocks—baseline and stress tests are calculated; and (ii) an assessment of the risk of external and overall debt distress, based on indicative debt burden thresholds and benchmark, respectively, that depend on the country’s macroeconomic framework and other country-specific information.
The DSF analyzes both external and public sector debt. The framework focuses on the present value of debt obligations for comparability, as terms extended to LICs vary considerably and still carry concessionality.
To assess debt sustainability, debt burden indicators are compared to indicative thresholds over a projection period.
There are four ratings for the risk of external public debt distress: low risk, generally when all the debt burden indicators are below the thresholds in both baseline and stress tests; moderate risk, generally when debt burden indicators are below the thresholds in the baseline scenario, but stress tests indicate that thresholds could be breached if there are external shocks or abrupt changes in macroeconomic policies;
high risk, generally when one or more thresholds are breached under the baseline scenario, but the country does not currently face any repayment difficulties; or in debt distress, when the country is already experiencing difficulties in servicing its debt, as evidenced, for example, by the existence of arrears, ongoing or impending debt restructuring, or indications of a high probability of a future debt distress event (e.g., debt and debt service indicators show large near-term breaches or significant or sustained breach of thresholds).
To flag countries with significant public domestic debt, the framework provides a signal for the overall risk of public debt distress, which is based on the joint information from the four external debt burden indicators, plus the indicator for the present value of public debt-to-GDP ratio.
Countries with different policy and institutional strengths, macroeconomic performance, and buffers to absorb shocks, have different abilities to handle debt. The DSF, therefore, classifies countries into one of three debt-carrying capacity categories (strong, medium, and weak), using a composite indicator, which draws on the country’s historical performance and outlook for real growth, reserves coverage, remittance inflows, and the state of the global environment in addition to the World Bank’s Country Policy and Institutional Assessment (CPIA) index. Different indicative thresholds for debt burdens are used depending on the country’s debt-carrying capacity.
Thresholds corresponding to strong performers are highest, indicating that countries with good macroeconomic performance and policies, can generally handle greater debt accumulation.
The DSF has enabled the IMF and the World Bank to integrate debt issues more effectively in their analysis and policy advice. It has also allowed comparability across countries.
The DSF is important for the IMF’s assessment of macroeconomic stability, the long-term sustainability of fiscal policy, and overall debt sustainability. Furthermore, debt sustainability assessments are taken into account to determine access to IMF financing, as well as for the design of debt limits in Fund-supported programmes , while the World Bank uses it to determine the share of grants and loans in its assistance to each LIC and to design non-concessional borrowing limits.
The effectiveness of the DSF in preventing excessive debt accumulation hinges on its broad use by borrowers and creditors. LICs are encouraged to use the DSF or a similar framework as a first step toward developing medium-term debt strategies. Creditors are encouraged to incorporate debt sustainability assessments into their lending decisions. In this way, the framework should help LICs raise the finance they need to meet the Sustainable Development Goals (SDGs), including through grants when the ability to service debt is limited.