- June 7, 2016
- Posted by: admin
- Category: Financial Sector Management
By Moris Bekezela Mpofu
1999
The Main subject of this technical paper is to present the external debt sustainability analysis for Zimbabwe and measure portfolio risk given volatilities in currency and interest rates. The study uses the World Bank’s Debt Sustainability Model Plus (DSM+) Version 2.0 to assess the external liabilities.
Although Zimbabwe does not fail into the same category as those countries classified as heavily Indebted Poor Countries (HIPIC), it is the phenomenal increase in the external debt of Non-HIPC countries which is cause for concern. Countries that have been classified as moderately or lowly indebted need to adopt pro-active debt and risk management techniques that would make them avoid falling into debt trap in the new millennium.
Zimbabwe’s current debt levels originate from the historical need to finance the rehabilitation of social infrastructure. Due to enormous financing requirements for the construction exercise, Zimbabwe had to organise ZIMCORD to mobilise and solicit for external assistance in 1981. The conference successfully raised about US$1.3 billion. The external debt overhang emerged in the 1980’s from US698 million (13% of GDP) to about US$4.5 billion (OVER 80% of GDP) as at end of 1998. In the 1990’s the creditor composition of Zimbabwe’s external debt stock switched from bilateral to multilateral has been largely due to the increase in Economic Structural Adjustment Loans from the Bretton Woods Institutions.
The currency composition of Zimbabwe’s external debt portfolio as at end of 1998 has largely been influenced by the trend pattern of government debt stock. Due to the contraction of ESAP loans there has also been an attendant shift to SDR exposure (from 4 percent in 1990 to 22% in 1998) while the USD and the Pound Sterling remained with significant shares of 40 percent to 10 percent respectively. These shares were relatively consistent with the country’s foreign exchange reserves which are largely held in US dollar and Pound Sterling. On the other hand the share of floating interest rate debt has slowly increased from 2 % in 1990 to 15% in1998, showing an increasing interest rate risk exposure.
With respect to external debt payments Zimbabwe has promptly met its servicing obligations without any rescheduling over the last 18 years. Apart from 1992 and 1993 (TDS/XGS of over 30%), when the country experienced severe drought, the external debt service ratio has remained below or around 20 percent. However due to deteriorating macroeconomic conditions experienced in the late 1990’s country faced serious liquidity problems
External debt management in Zimbabwe has been a joint responsibility of the Ministry of Finance and Reserve Bank of Zimbabwe through the External loans Coordination Committee (ELCC). The Committee is responsible for formulating the country’s external debt strategies’. Present policy ensures that external borrowings are at the lowest possible cost and also consistent with the country’s economic and financial situation. This is basically achieved through the setting of benchmarks or borrowing criteria that are adhered to by all agents intending to contract offshores loans.
In the External Debt Sustainability Analysis study , two macroeconomic scenarios ( baseline and /or pessimistic) with two borrowing strategies ( current policy and/or adopting policy of borrowing on IDA terms only) were combined to stimulate Zimbabwe’s external debt position for the period 1999-2007.The result of the simulation of these global scenarios were analysed in terms of the present value of debt to domestic product ( PV/GDP), total external debt service to export of goods and non-factor services (TDS/XGS) and total external debt service of domestic budget revenue ( TDS/DBR). The results obtained were compared to the new HIPC II benchmarks and other World Bank recommended thresholds.
For Zimbabwe ‘s public and publicly guaranteed external debt simulation results indicate that the liquidity monitoring ratios , TDS/XGS (averaging 21%) and TDS/DBR ( averaging 30%) point to a relatively unsustainable external debt position for the period 1999-2001, after incorporating new external borrowing requirement . The TDS/DBR indicator reveals that the servicing of public and publicly guaranteed external debt is quite burdening to government given a recommended threshold of 15-20%. This has implications for fiscal sustainability especially as these projections exclude domestic debt service.
With regard to the present value ratios (PV/GDP, PV/XGS and PV/DBR), indications are that these are largely relatively at sustainable levels, although these tend to significantly worsen under pessimistic macroeconomic conditions. This implies that if Zimbabwe continues to have an unsustainable liquidity position , it could possibly fall into arrears and hence, seek for rescheduling , even without having an excess overhand as measured by the PV ratios.
As fa as external debt sustainability is concerned, the important conclusion is the need to consider sustainable levels against a wider range of economic variables. Vulnerability factors such as export concentration reserve coverage budget burden, the size of the public sector domestic and private sector external debt drought effects and other external shocks can significantly contribute to worsening the country’s external debt burden and capacity to repay.
In addition, Zimbabwe like many remerging market economies has become more integrated into world financial markets. This has resulted in greater access to external sources and has led to significant exposures to interest rates and currency risks. Chapter 4 of this paper establishes the nest practices that MEFIMI member countries can employ in quantifying foreign exchange and interest rates risks in their external liability portfolios – the “Cash flow At Risk” approach
Simulations were also carried out to assess the interest and exchange rate risks of Zimbabwe external debt portfolio. The results show that there are an inherent interest rate and exchange risks.
The standard approach for Zimbabwe to deal with the imminent external debt problem is to adopt borrowing strategies, which will ensure that the cost of commercial external debt is minimized. While the thrust of new borrowings will continue to be blend (concessional and non-concessional) given Zimbabwe’s status of indebtedness , authorities should be encouraged to tap external resources for the financial of social projects only from concessional sources rather than the use of export credits . The country can optimize its portfolio of external liabilities through setting statutory external borrowing benchmarks through the External Loans Co-ordination Committee. The review of the ELCC Guide lines for the new millennium should include the following
Ensure that the contraction of commercial loans is limited to the financing of government’s income generating public sector projects, otherwise
The financing of projects of a social nature should be limited to concessional funding only with minimum grant element of 35 %
Having a quantitative limit for government’s external borrowing requirements –linking these to the public sector Investment Programme (PSIP)
Increasing the minimum grace period for loans which are not self-financing to 10 years.
Government to abstain from guaranteeing commercial loans contracted by loss making parastatals
To continue setting ceilings on maximum pricing margins on borrowings
To set the benchmark on the utilization of short-term trade finance as a proportion of projected merchandise exports for any given 90 days
To reduce the current ceiling on the external debt service ratio from 20% in the medium term to 15% and to bring the ratio down to 10% in the long term.
To allow where possible the re-financing of expensive loans in the portfolio
In order to optimize the existing external debt portfolio and mitigate it against external shocks, Zimbabwe would need to explore with caution the possibilities of engaging in pro-active portfolio risk management. The most flexible financial tools for aligning the actual sovereign portfolio with the country’s benchmarks and for hedging the portfolio from currency and interest rate risks are derivative instruments. The country’s embankment into these instruments, however would be most appropriate once the macroeconomic environment is stable and there is technical expertise and capacity to assess risk/return trade –off if the use of such techniques.
MEFMI member countries should therefore consider (I) understanding the integrated asset and liability management (ALM( approach and (ii) introduce benchmarking as a portfolio risk management tool, before (iii) venturing into the use of the more sophisticated modern financial techniques (derivatives) in managing their risks.