The impact of the COVID-19 pandemic on debt sustainability, particularly in lower income countries, is getting considerable attention but the resurgence of debt stress among this group predates COVID. Drawing on recent evaluation work from the World Bank’s Independent Evaluation Group, this article discusses how inadequate attention to public financial and investment management, coupled with enthusiasm for fostering “growth enhancing” public investment in the wake of the Global Financial Crisis, contributed to the sharp rise in debt stress, including among many countries in Africa.
Key messages
- Many lower income countries experienced disappointing returns on public investment made in the wake of the global financial crisis including that undertaken with borrowed funds. At least some of this can be attributed to shortcomings in the quality of public investment management.
- For many of the most vulnerable countries, the World Bank has paid insufficient attention to the importance of improving public investment management, despite widely recognized synergies between borrowing, fiscal transparency, and the quality of public spending and investment,
- In the wake of COVID, public resources will continue to be dwarfed by development needs. It is therefore increasingly important that support for strengthening systems that foster the most efficient and impactful use of resources be better leveraged by the World Bank. Development partners can help support these efforts by more deliberately prioritizing and integrating improvements in public financial and debt management into their activities.
The impact of the COVID-19 pandemic on debt burdens and debt sustainability, particularly in lower-income countries, is getting considerable attention these days, as it should. Compounded by the fallout on food, fuel, and fertilizer prices from Russia’s war with Ukraine, developing economies are facing rising costs and depressed economic activity, forcing many to borrow heavily to meet basic needs. As a result, the impact on debt stress is palpable. But as my World Bank colleagues Marcello Estevão and Sebastian Essl argue in a recent blog, “global debt has surged in recent years…the seeds were sown long before COVID-19.” (When the debt crisis hit, don’t simply blame the pandemic, 2022).
Indeed, between 2013 and 2019, the number of countries eligible for concessional financing from the World Bank which was at high risk of, or in, debt distress, rose from 13 to 33, and the average debt-to-GDP ratio increased from about 40 percent to 60 percent. This occurred alongside significant support from the international community (and the World Bank in particular) to improve the debt management capacity of low-income countries. Despite this, and against a backdrop of persistently low global interest rates, median interest payments from low-income countries (LICs) rose 128% between 2013 and 2018 (see Here we go again: Debt sustainability in low-income countries, 2021).
Where does all this debt come from?
Clearly, there was a lot going on over this period that impacted debt burdens in lower-income countries, much (but not all) of which was difficult to anticipate. The positive effect of historically low global interest rates and large-scale support to improve debt management capacity were more than offset by persistently low global commodity prices and the realization of significant contingent liabilities, including those associated with often opaque state-owned enterprises.
Estevão and Essl attribute much of the rise in debt to governments that ran up primary deficits “not to make productive long-term investments but simply to pay current bills.” This debt rise, they argue, did nothing to strengthen the ability of governments to repay the debt. They are correct in pointing this out, but there is a third driver of pre-COVID debt stress that played a significant – and potentially avoidable – role in many countries, including Africa.
Governments have three – not two – options for using scarce public resources: (i) they can pay current bills (although it is important to distinguish between efficient and inefficient spending and spending that supports longer-term growth and that which does not), (ii) they can make productive long term investments or (iii) they can make unproductive long term investments (for example, unnecessary, poorly designed or inefficiently implemented infrastructure). Regrettably, much of the spending that led to the rise in debt stress resulted from the last of these, with the numerator of the debt-to-GDP ratio rising but little impact on the denominator.
When and how did the nature of borrowing change?
It is worth recalling that in the period following the Global Financial Crisis, there was a drying up of long-term project financing as European banks (many of which had specialized expertise in this market segment) repositioned themselves to meet regulatory requirements (see, for example, Investment Financing in the Wake of the Crisis: The Role of Multilateral Development Banks (Chelsky et al., 2013). Faced with credit constraints and difficult access to long-term financing (including capital constraints in institutions like the World Bank), governments in many emerging markets and developing economies seeking to finance growth-enhancing long-term investments--including in infrastructure--turned to less concessional sources of financing or collateralized loans with future revenue from natural resources.
Around the same time, there was significant high-level support in the international community to increase “growth-enhancing” public spending and investment to close infrastructure “gaps” and meet the Millennium Development Goals and, subsequently, the Sustainable Development Goals. World Bank analyses at the time noted that investments that promoted growth might also enhance domestic resource mobilization, supporting increases in “pro-poor” spending.6 The G20 was also at the forefront of calls to ramp up infrastructure spending, with the 2014 Leaders Communique from the Brisbane Summit under the Australian Presidency stating that:
Tackling global investment and infrastructure shortfalls is crucial to lifting growth, job creation, and productivity… Our growth strategies contain major investment initiatives, including actions to strengthen public investment and improve our domestic investment and financing climate, which is essential to attract new private sector finance for investment. We have agreed on a set of leading voluntary practices to promote and prioritize quality investment, particularly in infrastructure…We are working to facilitate long-term financing from institutional investors and to encourage market sources of finance, including transparent securitization, particularly for small and medium-sized enterprises. We will continue to work with multilateral development banks, and encourage national development banks, to optimize the use of their balance sheets to provide additional lending and ensure our work on infrastructure benefits low-income countries.
So What Went Wrong?
Well, it turned out that many of the investments made were not as “growth-enhancing” as had been hoped for. Indeed, many LICs experienced disappointing returns on public investment, including that undertaken with borrowed funds. Should this have been a surprise? According to the IMF, public investment in LICs is estimated to be, on average, 40 percent less efficient than in the best-performing countries (IMF 2015). This should itself have pointed to the need for the kind of emphasis and support from the international community to improve public investment management in LICs that we had seen for debt management capacity building in the wake of the Heavily Indebted Poor Countries (HIPC) Initiative through multi-donor trust funds like the Debt Management Facility.
This is not just a lesson learned from hindsight. In the context of the 19th Replenishment of the World Bank’s International Development Association (IDA) there was an explicit recognition of the complementarity among the pillars of public financial and debt management (PFDM). This was unambiguous in the February 2020 statement of IDA Deputies, who stated that “the first challenge is to assist IDA countries to ensure that the benefits [of borrowed resources] exceed the costs of servicing their debt. IDA and other partners can help by supporting initiatives that enhance capacity in areas such as public finance management, public investment management … and debt management”.
What did the World Bank Do?
At this point, a relevant question is to what extent did the World Bank provide effective support on public investment management to client countries in Africa? Part of the answer can be found in IEG’s 2020 evaluation of World Bank Support for Public Financial and Debt Management in IDA-eligible Countries (FY08 to FY17). The evaluation looked at World Bank support in this space in the decade following the global financial crisis. It found that, for many of the most vulnerable countries, debt management support was not systematically accompanied by, or coordinated with, efforts to improve public financial management, despite widely recognized synergies between borrowing, fiscal transparency, and the quality of public spending and investment. This proved problematic, as noted above, as many LICs were borrowing extensively from private markets and bilateral donors to finance investment projects, and thus could have potentially benefited from improvements in institutional structures and systems to improve the quality and efficiency of public spending.
Another noteworthy finding of this evaluation was that diagnostics of the quality of country-level public investment management were undertaken by the Bank for less than half of IDA-eligible countries, with demand concentrated among higher-income LICs. Of the 32 IDA-eligible countries at high risk of, or in, debt distress in FY18, only eight had received relevant analytical and advisory services (ASA) from the World Bank over the previous decade (compared with 36 ASA activities for the 37 IDA-eligible countries that were in low or moderate risk of debt distress). Interestingly, the leading diagnostic of the quality of public investment management (the Public Investment Management Assessment or PIMA) is an IMF instrument which may have something to do with its limited use by the World Bank.
At the same time, available data suggest that, over the evaluation period, lending from the World Bank to IDA-eligible countries to improve public investment management (PIM) was modest, was not focused on longer-term capacity building, and did not reach many “at-risk” countries. The World Bank supported 46 lending operations with a PIM focus during the evaluation period in IDA-eligible countries, almost equally divided between those that were HIPC at one time and those that were not. This support includes 44 budget support operations (DPOs), 30 of which were part of eight programmatic series with 59 prior actions related to PIM. In effect, countries that ended the decade at high levels of debt distress were less likely to have benefited from World Bank support for PIM than those that did not end the decade at high levels of debt distress. This does not necessarily imply that PIM support alone would have prevented the deterioration in the risk of debt distress in all these countries, or that it would have been welcome had it been offered. But raising the profile of shortcomings in PIM over the last decade and a half in analysis, policy dialogue, operations, and conditionality would have sent a valuable signal to potential lenders. Given the implications for all creditors (including MDBs) of debt sustainability, good quality PIM should be seen as a precondition for countries borrowing heavily to finance public investment; it is not just one among many development priorities.
Few budget support operations from the World Bank to IDA-eligible countries in Africa currently at risk of, or in, debt distress had PIM-related prior actions to support the set of reforms targeted by the operations. Indeed a disproportionate share of PIM-related actions were concentrated in budget support operations in East Asia and Pacific and in Europe and Central Asia; relatively few were in IDA-eligible countries currently at risk of or in debt distress. For example, of the 32 IDA-eligible countries either at high risk of or in debt distress at the 2017 year-end, only four countries in sub-Saharan Africa had budget support operations with PIM-related prior actions: Cape Verde, Ghana, Mauritania, and Mozambique.
Very little of the World Bank’s PIM support to IDA-eligible countries was delivered through investment projects. In fact, investment project financing (IPF) to support improvements in PIM was limited to two projects (only one of which was in Africa (Benin)). This is again telling, given the conventional wisdom that PIM requires capacity building at an institutional level, which takes time to establish, and for which investment projects are particularly well suited.
The lack of sufficient attention to public investment management was also found in the more recent 2021 IEG Early Stage Evaluation of IDA’s Sustainable Development Finance Policy (SDFP). This evaluation of the SDFP, which was adopted early in 2020, contained several case studies assessing the extent to which the Performance and Policy Actions (PPAs) articulated to help IDA-eligible countries achieve and maintain debt sustainability address the country-specific drivers of debt stress. In several of these cases, the intensification of debt stress was routed in large-scale borrowing for inefficient public investment. The report concluded that there was scope to improve the extent to which the World Bank uses the SDFP to target the main drivers of debt stress, including through greater attention to improving PIM.
What Have We (Hopefully) Learned?
While there has been considerable (and legitimate) attention over the last couple of years to improving debt transparency, there is also an important but perhaps under-emphasized link between the quality of PIM and debt sustainability. For example, weak PIM can increase the cost and associated borrowing incurred to pay for projects while reducing their impact on growth, thereby increasing the ratio of debt to GDP. Conversely, carefully and strategically selected and executed public investments can achieve economic benefits (including growth and revenue mobilization) that justify their (often significant) costs.
In the wake of the economic shock associated with the pandemic and the increased scarcity of resources, improving public financial management, more generally, and public investment management, more specifically, should be rising closer to the top of the development agenda. This should be integral to efforts to promote and protect debt sustainability in low-income countries, including through greater transparency and rigor in identifying and implementing debt-financed public investment.
With this in mind, the recommendations of IEG’s evaluation on Public Financial and Debt Management (PFDM) are worth noting. First, IEG calls for “a more deliberate and coordinated approach to PFDM capacity building” if the World Bank is to help client countries ensure that debt burdens do not overwhelm their ability to reduce poverty or provide essential government functions. The evaluation recommends that World Bank staff maintain a clear and up-to-date picture of PFDM strengths and weaknesses for each IDA-eligible country, drawing on existing assessments of the main dimensions of PFDM (including not just PIM, and PDM but also procurement and other components critical to the efficient use of scarce resources). To a significant extent, this has already been addressed within pillars of PFDM, but synergies across pillars (including initiatives and mechanisms to reduce debt stress) remain underexploited. Moreover, the financing of diagnostics for public financial management can be unpredictable and, unlike the trust fund financed support for debt management, may not always receive the priority warranted in Bank-supported work programs at the country level.
Using this information, IEG recommends that the World Bank more systematically support PFDM in IDA-eligible countries with better sequenced and complementary lending and nonlending support. It noted that implementation of the new Sustainable Development Finance Policy and the associated identification of performance and policy actions, as well as prior action in budget support operations and provide an early and straightforward opportunity to take a more holistic view of PFDM at the country level.
Work to implement these recommendations is underway within the World Bank, particularly in bringing together various diagnostics and making them easier to access, but there is more to be done. Obtaining agreement across development partners on a set of core PFDM diagnostics and the frequency with which they should be updated would help provide a useful framework for more efficient use of development assistance. There is also considerable work needed to ensure that weaknesses and priorities identified in diagnostics are more systematically used to inform decisions on program, project, and operational design and the allocation of resources to capacity-building efforts at the country level. Achieving this will require overcoming silos that have developed within development institutions like the Bank, wherein debt management, procurement, public investment management, and other aspects of PFDM are the responsibility of different parts of the institution.
Bringing this back to Africa where the pandemic and international events have further compounded the pre-COVID resurgence of debt, how do the findings of this evaluation and related work help build a stronger and more resilient continent? Public resources -- whether domestically generated, obtained through borrowing, or from development partners – will continue to be dwarfed by development needs to promote economic growth and resilience. Therefore, governments must strengthen systems that foster the most efficient and impactful use of resources. Development partners can help support these efforts by more deliberately prioritizing and integrating improvements in public financial and debt management in their activities.
This prioritization, it should be noted, does not come at the expense of other development priorities like, for example, climate change adaptation. Rather, it is wholly complementary in that public spending and investment are critical components of many, if not most development efforts. Development partners, for their part, need to ensure that institutional structures, financing mechanisms, and incentives are aligned with these objectives. If this is done, and alongside other support, we will be more effective in helping heavily debt stressed countries to grow toward more sustainable debt burdens.
August 3, 2022
References
Chelsky, J., (2021), “Here we go again: Debt sustainability in low-income countries”, Available at https://ieg.worldbankgroup.org/blog/here-we-go-again-debt-sustainability-low-income-countries (Accessed 26 August 2022)
Chelsky, J., Morel, C. and Kabir, M. (2013) “Investment Financing in the Wake of the Crisis: The Role of Multilateral Development Banks”, Economic Premise, Number 121, June 2013, World Bank, Available at http://hdl.handle.net/10986/22619
Estevão, M. and Essl, S. (2022), “When the debt crisis hit, don’t simply blame the pandemic”, Available at https://blogs.worldbank.org/voices/when-debt-crises-hit-dont-simply-blame-pandemic (Accessed 26 August 2022)
Group of Twenty, (2014), G20 Leaders’ Communique Brisbane Summit, Available at http://www.g20.utoronto.ca/2014/2014-1116-communique.html
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