By Stan Nkhata
July 2009
The main feature of the external debt management environment in the MEFMI post HIPCs is that the foreign debt indicators are currently significantly lower following the external debt cancellations under the Enhanced Heavily Indebted Poor Countries (HIPC) and Multilateral Debt Relief Initiatives (MDRI). For example, Malawi’s external debt stock was reduced from US$2.97 billion as of end-2005 before debt relief to US$0.49 billion as of December 2006 and was estimated at US$0.68 billion as of end-2008. As a proportion of Gross Domestic Product (GDP), the external debt stock was reduced from 104% before debt relief to 14.2% in 2006 after debt relief.

Uganda’s external debt stock was also reduced significantly due to MDRI from US$7.0 billion (or 20.7% of GDP) at end the 2005/06 financial year (FY) to US$5.0 billion (or 12.5% of GDP) at end of 2006/07FY. Similarly, the external debt cancellations under MDRI and HIPC have had a significant impact on Tanzania’s debt indicators. The external debt stock was reduced from 37% of GDP before debt relief in 2005/2006FY to 16.6% of GDP after debt relief in the 2007/08 financial year.

The significant reduction in the external debt indicators in the above MEFMI member countries have led to highly sustainable external debt situations thereby increasing the space for additional public external borrowing. The main risk arising from this scenario is that the Governments may be tempted to acquire new external financing that is not sufficiently concessional thereby leading to future external repayment problems. In addition, future external debt sustainability may be compromised by several risk factors, including the possibility of low GDP and exports growth which are some of the main binding constraints to debt sustainability in low income countries. An additional problem for Malawi is that the overall fiscal sustainability of public debt is still fragile despite the significant reductions in the external debt stock.

In view of the above, this paper seeks to assess the impact of the main risks to public external and domestic debt sustainability after the HIPC and MDRI debt cancellations in the Malawi. Specifically, a Debt Sustainability Analysis (DSA) will be conducted as a basis for assessing the impact of adverse developments in the main variables that affect Malawi’s external debt sustainability, including low GDP and export growth and contraction of external loans on non-concessional terms. In addition, this paper reviews the recent public debt sustainability reports of Tanzania and Uganda in order to have a broad view of the main risks to public external and domestic debt sustainability in the post HIPC period in these countries

Using the Debt Sustainability Framework (DSF), this paper has confirmed that Malawi’s external is projected to remain highly sustainable in the period 2009-2029 under the baseline macroeconomic scenario. The ratio of the present value (PV) of external debt to exports is estimated at 56% in 2009 and is projected to remain below the sustainability threshold of 150% in the period 2009-2009. The ratios of the present value of external debt to GDP and domestic budget revenue are projected to remain below the sustainability thresholds of 40% and 250%, respectively, through to 2029.

The case studies of Tanzania and Uganda also show that external debts were projected to remain highly sustainable from 2008 through to 2029 (Tanzania and Uganda DSA reports, 2008). The debt sustainability analysis conducted by the Government of Tanzania found that all debt indicators fall below the sustainability thresholds of these strong performers under DSF. The ratio of the present value of Tanzania’s external debt to GDP was estimated at 15.1% in 2009 and was projected to remain below 10% for most of the projection period 2009-2029, which is significantly below the sustainable threshold of 50% for strong performers. In Uganda, the ratio of the present value of external debt to GDP was projected at 14.9% in 2008, which is also highly sustainable and was expected to remain below the PV/GDP threshold of 50% throughout the projection period 2009-2029.

However, this paper suggests that Malawi’s external debt is subject to the risk of low GDP and export growth which may lead to the breach of the relevant sustainability thresholds in the period under review. The results show that lower GDP growth leads to a steady increase in the ratio of PV of debt to exports from 56% in 2009 and breaches the sustainability threshold of PV/XGS of 150% by 2014 and remain unsustainable thereafter. On the other hand, lower exports growth leads to an increase the ratio of PV of external debt to exports from 54% in 2009 and exceeds the sustainable threshold by 2010 and remains unsustainable thereafter through to 2029. This analysis has also found that Malawi’s total public debt (including domestic and external debt) is vulnerable to the risks of low GDP and export growth and increased primary deficit. It is observed that adverse movements in GDP and exports lead to significant increases in almost all the debt ratios during the projection period compared to the baseline, indicating public debt may not be sustainable from the fiscal point of view.

The case study of Tanzania shows total public debt (external and domestic debt) is marginally sensitive to low GDP growth and worsening primary balance since all the debt ratios do not significantly increase over the baseline projections. The case of Uganda shows that external debt is vulnerable to the risks of both low GDP and exports growth since the relevant debt ratios tend to worsen significantly during the projection period under the pessimistic macroeconomic scenario compared to the baseline scenario.

The vulnerability of external debts in these countries to increased lending rates suggests that Governments should analyse all new external borrowing proposals so that new debts are sufficiently concessional in a way that promotes future debt sustainability. Non concessional financing may only be considered for activities that are strategic, have high economic value and generate the future repayment capacity. It is further recommended that the international donor community should consider providing more grants financing in order to improve the future prospects of external debt sustainability in Low Income Countries (LICs) prospects while meeting their financing requirements.

The sensitivity of public debt sustainability to lower GDP growth and exports, and higher primary deficits confirms that good economic management is crucial to improving the sustainability of public domestic and external debt. It is recommended that the Government authorities should remain committed to implementing sound macroeconomic policies in order to support their debt sustainability prospects.

It is also recommended that countries in the MEFMI region should prepare robust national debt strategies to guide their debt management operations. The key elements of these strategies should include specifying the linkages between public debt and macroeconomic frameworks in order to monitor the developments either way. In addition, the strategies should include country specific reference benchmarks for domestic debt and total public debt which do not have internationally agreed benchmarks for assessing the changes in these variables.