World Bank warns about “debt distress”

Samoa’s public external debt is “high-risk” with the Government set to breach policy limits they had previously agreed to over the next nine years.

This could see the country suffer “debt distress” as public loans exceed 56 per cent of economic activity each year, known as GDP, Gross Domestic Product.

Part of the response to growing debt could see increased pressure on government to cut public service wages, increase tax collection and push for more profitability from state owned enterprises.

So warns a report from the World Bank titled “International Development Association Program Document for a Proposed Grant in the Amount of SDR 10.1 Million (US$15 million) Including SDR 6.7 Million (US $10 Million Equivalent) In Crisis Response Window Resources to the Independent State of Samoa for A Samoa Development Policy Operation.”

Dated 21 June 2013, the World Bank refers a debt sustainability analysis (DSA), which was updated in the aftermath of Tropical Cyclone Evan.

The World Bank report also warns against spending on large “non-essential” projects.

A country’s public debt burden is assessed by comparing external debt with limits set by agreements between governments and other stakeholders, according to Public Sector Debt Statistics: Guide for Compilers and Users by the International Monetary Fund (IMF).

Those limits are referred to as thresholds, in this case referring to LIC’s or Low Income Countries, such as Samoa.

“The thresholds reflect the empirical findings that the external debt levels that LIC’s can sustain are influenced by the quality of their policies and institutions which are measured by CPIA (Country Policy and Institutional Assessment) Index, compiled annually by the World Bank,” the report reads.

PROACTIVE

The World Bank website says the CPIA measures the extent to which a country’s policy and institutional frameworks support sustainable growth and poverty reduction, and how those frameworks assist the effective use of development assistance.

According to the IMF website a country is “high-risk” when the baseline scenario and stress tests indicate a protracted breach of debt or debt-service thresholds, even if the country does not currently face any repayment difficulties.

In the above mentioned report, the Bank says despite “proactive” debt management and a clear fiscal strategy, the small size of the economy relative to the recent shocks has meant that debt-related risk has progressively increased.

“Since 2009, debt has risen rapidly as a result of increased government borrowing to finance development and capital projects, as well as to counter a series of exogenous shocks,” the report reads.

LOW TO MODERATE

The DSA - Debt Sustainability Assessment – was conducted in 2012 for Samoa.

“In the 2012 joint IMF-World Bank DSA, the risk of debt distress was raised from a low to moderate level, showing that the country was particularly exposed to exchange rate depreciation due to its growing foreign currency-denominated external debt stock.

“In response to the TCE (Tropical Cyclone Even), a new DSA was carried out in April 2013.

“The analysis indicates that sustainability of public external debt is a major risk, as evidenced by the shift from moderate to high risk of debt distress.

That DSA analysis “showed that, at end FY2012, the value of public and publicly guaranteed external debt had reached 56 per cent of GDP, 45 per cent in net present value terms.

HIGH RISK

“Given the increased fiscal commitments presented by the post-cyclone recovery, the DSA found that Samoa has shifted from a moderate to a high risk of debt distress with vulnerability to external shocks, particularly exchange rate depreciation.”

According to the report, the DSA adopts a long-run real growth rate assumption of 2.5 percent for Samoa.

“It assumes that GoS (Government of Samoa) contains expenditure following the recovery and is able to bring the overall deficit down to 2 percent by FY2018, with financing from highly concessional sources,” the report reads.

“Despite this consolidation, the present value of external debt as a ratio to GDPbreaches the policy-dependent debt burden threshold for a period of nine years. “Moreover, Samoa's debt is highly vulnerable to exogenous shocks.

“The most extreme stress test scenarioof a 30 per cent exchange rate depreciation leads to the 50 percent threshold being breachedfor the whole period of the DSA forecast.”

One loan

The Bank states that careful monitoring and constant vigilance are therefore required since, in asmall country such as Samoa, even one loan can be enough to push debt levels intounmanageable territory.

“The Bank is responding to the government's request for help inpreparing a Debt Management Reform Plan, and working with PFTAC (Pacific Financial Technical Assistance Centre) to prepare customizeddebt sustainability analysis tools that are appropriate and well-aligned to Samoa's existing macro-fiscal modeling,” says the report.

“The debt management reform plan includes short and longer term measures to improve institutional arrangements, debt policy, cash management, operational risk management.

“Because of the increased risk of debt distress, this operationincludes a prior action in the area of debt management and transparency in Samoa's debt data.”

Major risk

The report notes the Government recognises the increasingly large debt burden is a major risk factorthat will need to be managed carefully in the next few years.

“The authorities have reactedrobustly to this risk, implementing a new medium-term debt strategy and recently preparing adebt management reform plan,” the report reads.

“The government has also been proactive in seeking debtfinancing only when grants are not available, and only on highly concessional terms.

“The authorities have committed to a medium-term fiscal framework that restrains non-essentialexpenditure and establishes a path to stabilizing and then reducing debt levels.”

The Bank reports the Government updates its Fiscal Strategy Statement each year, and the FY (Financial Year) 2014 Statement sets out a clearcommitment to achieve medium-term targets to lower fiscal deficits in order to stabilise andbegin to reduce debt levels.

“The medium-term projections are ambitious, with the aim of bringing expenditure down sharply following the recovery and reconstruction period,” the report reads.

‘Less sharp’

“Whilst this shows strong commitment to bring the deficit under control and regularize debt levels, themedium-term fiscal consolidation path projected under the current operation is less sharp, with a higher level of access to grants. “Public external debt is projected to rise in FY2014 andFY2015, stabilize and begin falling in FY2017.

“In addition, the government has committed torestricting new borrowing in the post-cyclone period to identified loans from the ADB (Asian Development Bank).”

According to the report Samoa’s macroeconomic policy framework is appropriate, but will need to be closelymonitored.

Large projects

“The latest IMF Staff Report notes that policies are broadly in-line with staff recommendations,” the Bank’s report reads.

“It will be important to ensure that policies remain geared towards accommodating the essential costs of recovery in the short term.

“As soon as those costs have been shouldered, it will be critical to move towards consolidating the fiscal position in the medium term.

“An important risk to fiscal adjustment arises from non-essential spending inlarge capital projects not directly related to the recovery.

Wages

The report says since fiscal adjustment needs to be a priority in the medium run, the World Bank is working with the Government on a fiscal review (FR).

“The FR analyzes trends in macro-fiscal aggregates, government expenditures across economic and sector classifications and keyout puts and development outcomes,” the report reads.

“The FR also aims to analyze the evolution of the wagebill, government revenues and the performance of state-owned enterprises.

“It is expected that this FR can be used by the GoS next fiscal year as it considers policy options to deliver on the fiscal policy path included in the FY2013-2014 budget strategy.”