Debt Relief, Grants and Free Riding: IDA’s proposed response Multilateral

Bank Meeting on Debt Issues Washington, DC, June 21-22, 2006

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.

debt relief, of other creditors offering non-concessional terms

Higher risk of

debt distress

Lower risk of debt distress

IDA

Grants and debt relief

Non-concessional lending

Other creditors

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).

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.

Guyana
Nicaragua
Ghana Senegal Tanzania Mali Uganda
Benin

Mozambique Zambia Madagascar

a concessionality benchmark
Creditor coordination
Advanced reporting, increased monitoring.
Disincentives aimed at borrower

level

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.

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.

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.

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.

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

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.

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.

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)

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.