• No results found

Debt Management Strategy

N/A
N/A
Protected

Academic year: 2021

Share "Debt Management Strategy"

Copied!
59
0
0

Loading.... (view fulltext now)

Full text

(1)

Debt Management Strategy

Debt Management Unit Ministry of Finance & Treasury March 2012

(2)

ii EXECUTIVE SUMMARY

This debt management strategy is the first to be developed by the Solomon Island Government (SIG). In the past, SIG did not have a strategy and debt was not managed effectively. Borrowing decisions were made on an ad hoc basis. Full use was not made of borrowed funds to contribute to SIG’s wealth and public debt reached unsustainable levels. Poor financial management and lack of controls surrounding borrowing by State Owned Enterprises (SOEs) and Provincial Governments contributed to the central Government’s debt problems. The Honiara Club Agreement (HCA), signed in 2005 after SIG went into debt arrears (following a period of instability caused by ethnic tensions) set a policy of no new borrowing. This provided the discipline to reduce debt levels. Now that SIG has reached ‘medium risk of debt distress’, government and donors are ready for SIG to resume prudent borrowing. This strategy, by providing a strong framework, is proposed as an alternative to the HCA.

Borrowing can increase the wellbeing of Solomon Islands by being used for projects that provide revenue or key infrastructure but, to do this, debt must be managed effectively. A debt strategy provides clear objectives for debt management as well as a framework for achieving these objectives.

There are two key objectives. The first is to ensure that the servicing and management of SIG’s financing requirements and payment obligations are met on a timely basis, and at the lowest possible cost over the medium to long run, consistent with a prudent degree of risk. The second objective is to support the development of the domestic securities market. In practical terms, SIG must not go into arrears when it resumes borrowing, decisions must not be made on an ad hoc basis, debt levels must be sustainable and affordable, and borrowed funds must be used to increase the wellbeing of Solomon Islands.

This document lays out plans for SIG’s debt management for the next five years. It targets three different ways to help SIG achieve its objectives. Firstly, it sets out the analysis required for a debt strategy and to determine annual borrowing limits, secondly it puts in place a borrowing framework that is intended to be incorporated into Fiscal Responsibility Legislation and lastly, clarifies the responsibilities of the Debt Management Unit (DMU) of the Ministry of Finance and Treasury.

The main debt strategy is to limit borrowing to concessional terms and prudent levels. The domestic securities market will be built up by extending the terms of Treasury Bills on issue. At present the market is limited to 182 days and Treasury Bills are mainly used for cash

(3)

iii management. Issuing longer term Treasury Bonds is not recommended due to high interest cost and refinancing risk.

To develop the debt strategy DMU assessed the past and present debt situation, examined available alternatives and decided on the best plan for action to achieve the objectives. The next step was to do a Debt Sustainability Analysis (DSA). The World Bank / IMF DSA framework provides thresholds for sustainable and affordable debt levels for Lower Income Countries (LIC) like Solomon Islands. This document sets out the information used in the DSA, including a description of the composition of the debt portfolio, costs and risks of the portfolio and associated economic indicators such as revenue and GDP, and assumptions on how the economy will perform under stress.

Prudent levels of borrowing that are below the thresholds will be calculated each year, as part of the budget process, to establish an annual borrowing limit and borrowing plan. Controlling and centralizing the approval process for all borrowing proposals (including borrowing by SOEs, issuing guarantees and on-lending) will ensure that the Government knows what its total liabilities are and that debt remains at affordable and sustainable levels. A Debt Management Advisory Committee (DMAC) will assess borrowing proposals to make sure that projects increase government revenue and GDP, or fund essential infrastructure that can benefit all citizens. Borrowing must be from an allowable source and with acceptable terms and conditions. Assessment of borrowing proposals will be part of the budget process to make sure that projects can be compared and only the best projects are funded. Borrowing also needs to be consistent with the Medium Term Fiscal Strategy, Central Bank policy and macroeconomic conditions. The DMAC will make recommendations to the Minister for Finance in relation to borrowing proposals. Based on recommendations from the DMAC, the Minister for Finance will have sole authority for approving loans and guarantees.

This Strategy document was prepared by DMU, in the Ministry of Finance and Treasury, which is responsible for SIG’s Sovereign debt management, including debt repayments, debt recording and reporting, formulating the debt strategy and annual borrowing plan, loan negotiations and debt sustainability analysis.

(4)

iv

Table of Contents

EXECUTIVE SUMMARY ...ii

1. OBJECTIVES FOR PUBLIC DEBT MANAGEMENT AND SCOPE OF THE DEBT MANAGEMENT STRATEGY ... 1

1.1 Introduction... 1

1.2 Overall Objectives for Public Debt Management ... 1

1.3 Definition of Debt ... 1

1.4 Definition of a Medium-Term Debt Management Strategy ... 2

1.5 Scope ... 2

2. BACKGROUND ... 3

2.1 Current debt situation and de facto debt management strategy ... 3

2.2 Need to review the Honiara Club Agreement ... 6

2.3 Background on domestic debt market:... 7

3. THE CURRENT STATUS OF THE DEBT PORTFOLIO * ... 9

3.1 Profile of existing debt ... 9

3.2 Cost of existing debt ... 10

3.3 Affordability and Sustainability of existing debt levels ... 12

3.4 Domestic security market ... 12

3.5 Risk of existing debt ... 14

1. REPAYMENT (DEBT SERVICE COST) RISK ... 14

2. FOREIGN EXCHANGE RATE RISK ... 16

3. INTEREST RATE RISK ... 16

4. ROLLOVER RISK ... 17

5. CREDITOR CONCENTRATION RISK ... 17

6. INFLATION RISK ... 18

7. RISKS IN MANAGING THE PORTFOLIO ... 18

4. DEBT SUSTAINABILITY ANALYSIS ... 21

4.1 What is a Debt Sustainability Analysis and why is it important? ... 21

(5)

v

1. GDP ... 22

2. FISCAL ... 23

3. MONETARY ... 23

4.3 Economic baseline, projections and assumptions ... 23

1. GDP ... 23

2. FISCAL ... 24

3. MONETARY POLICY ... 25

4.4 Economic indicators, risks and thresholds ... 25

4.5 Stress testing ... 26 1. FALL IN REVENUES ... 27 2. DECREASE IN GDP ... 28 3. DECREASE IN EXPORTS ... 28 4. DEPRECIATION OF CURRENCY... 28 5. FUTURE GROWTH ... 29

4.6 Results of the IMF Debt Sustainability Analysis ... 29

5. DEBT MANAGEMENT STRATEGY ... 31

5.1. Maintain debt at sustainable and affordable levels ... 31

5.2 Ensure that any new borrowing follows legal and fiscal responsibility guidelines ... 32

1. ENSURE THAT ANY NEW BORROWING IS FOR A FIT PURPOSE ... 33

2. ENSURE THAT ANY NEW BORROWING IS FROM AN ACCEPTABLE SOURCE ... 33

3. ENSURE THAT TERMS AND CONDITIONS ARE ACCEPTABLE ... 36

5.3 Develop the domestic debt market ... 37

1. STRENGTHEN CURRENT MARKET ... 38

2. EXTEND CURRENT CAPABILITIES ... 38

5.4 Introduce and consolidate fiscal, legal, institutional and operational measures that ensure that the above three objectives are met ... 39

1. FISCAL MEASURES ... 39

2. LEGAL MEASURES ... 39

3. INSTITUTIONAL FRAMEWORK ... 40

(6)

vi LIST OF TABLES

TABLE 1 Debt situation 2003 – 2005 (SI$million)* 5

TABLE 2 Debt sustainability indicators 2005 – 2011 (per cent) 6 TABLE 3 Outstanding debt as at 31 December 2011 (SI$million) 9

TABLE 4 Debt servicing payments (SI$million) 2005 TO 2011 11

TABLE 5 Projected debt affordability and sustainability 2010 TO 2016 (per cent) 12 TABLE 6 Volume of Treasury Bills as at 31 December 2011 (SI$million) 12

TABLE 7 Thresholds for a weak policy country 26

TABLE 8 Effect of a 30 per cent depreciation on debt stock and servicing costs (SI$million)

29

TABLE 9 Examples of multilateral loan terms 35

LIST OF CHARTS

CHART 1 Debt balances outstanding 1998 – 2020 (SI$billion) 10

CHART 2 Foreign currency proportion of external debt 11

CHART 3 Weighted average yields for Treasury Bills (per cent) 13 CHART 4 Ratio of bids received to allocation for Treasury Bills 14 CHART 5 Projected debt servicing cost 2012 – 2016 (SI$million) 15

CHART 6 Monthly pattern of debt repayments (SI$million) 15

CHART 7 Volume of debt outstanding by currency (SI$billion) 16

CHART 8 Volume of debt by creditor (SI$million) 18

CHART 9 Export earnings (SI$billion, f.o.b.) 21

CHART 10 Contribution to GDP 2010 22

CHART 11 Historic and projected GDP growth 24

CHART 12 Historic and projected revenue and expenditure growth SI$billion) 24

Annexure I IMF definition of debt

Annexure II Solomon Islands total debt attributed by creditors as at 29 February 2004 Annexure III Joint World Bank–IMF Debt Sustainability Framework for Low-Income

Countries

Annexure IV Extract from Technical Memorandum of Understanding between Solomon Islands Government and IMF November, 2011

Annexure V Debt Status as at 31 December 2011 Annexure VI DSA using IMF template charts

(7)

1

1.

OBJECTIVES FOR PUBLIC DEBT MANAGEMENT AND SCOPE OF THE

DEBT MANAGEMENT STRATEGY

1.1 Introduction

Sovereign governments need to prepare a strategy for managing their debt – this fact is

recognised around the world and contained in guidelines prepared by the World Bank, the IMF and the United Nations, for example.1 One of the key recommendations that came out of the Debt Management Performance Assessment conducted in 2009 by a team led by the World Bank2 was that Solomon Islands develop a Debt Management Strategy. Worldwide, developing sound debt management strategies has been identified as an important factor in avoiding debt and financial crises, and the hardship that such crises bring to all citizens.

1.2 Overall Objectives for Public Debt Management

Public debt management is more than making debt payments. There are two overall objectives for Solomon Islands:

1. Ensure that the servicing and management of the Solomon Islands government’s financing requirements and payment obligations are met on a timely basis, and at the lowest possible cost over the medium to long run, consistent with a prudent degree of risk; and

2. Support the development of a domestic debt market.

1.3 Definition of Debt

Government debt, or borrowing, includes the contracting or guaranteeing of domestic and external (foreign) debt through loans, financial leasing, on-lending and any other type of borrowing, including concessional and non-concessional borrowing, whatever the source. Borrowing and debt of SOEs and other public corporations are included in the definition of total government debt. Even if this debt is not guaranteed by the government, experience around the world and in Solomon Islands has shown that when SOEs get into debt service difficulties governments are obliged to pay. This definition of debt is broader than the IMF definition of debt (see Annexure IV for the IMF definition of public sector debt).

1 For example in the World Bank/IMF (2003) ‘Guidelines for Public Debt Management’ and United Nations Institute

of Training and Research (UNITAR) course notes for ’Effective Public Debt Management’.

2

Solomon Islands Debt Management and Performance Assessment was published on the WB website at http://go.worldbank.org/GZ4857VJ91

(8)

2

1.4 Definition of a Medium-Term Debt Management Strategy

This Medium-Term Debt Management Strategy (Debt Strategy) is a framework that the government intends to use over the medium-term (five years) to ensure that debt levels stay affordable and sustainable, that any new borrowing is for a good purpose and that the costs and risks of borrowing are minimized.

1.5 Scope

This Debt Strategy covers (domestic and external) both central government and SOE debt, including the portfolio of government guarantees and contingent liabilities. External debt is defined as debt denominated in currencies other than Solomon Island dollars. Domestic debt is defined as debt denominated in Solomon Island dollars, even when the creditor is a foreign entity.

Although the focus of the Debt Strategy is on actual direct liabilities of the Government, contingent liabilities (whether explicit or implicit) may have an important bearing on the sustainability of debt and robustness of the Debt Strategy. Consequently, it is prudent to consider, when preparing a Debt Strategy, the potential risk that contingent exposures could materialize under specific scenarios. For example the Solomon Islands Government may be obliged to assume liabilities from SOEs3.

Note that the scope of a Debt Strategy does not prescribe borrowing amounts. These are typically determined in a government’s Fiscal Strategy and prescribed in an annual Borrowing Plan. For Solomon Islands, where borrowing is not to fund recurrent expenditure, but only for development expenditure, the Debt Strategy will be aligned to the Medium Term Fiscal Strategy (MTFS)4 as well as to the National Development Strategy. The key elements of the Debt Strategy will be incorporated into the MTFS, and updated every year as part of the budget process. In the proposed amendments to the Public Finance Act this will be a requirement.

3

This requires the Debt Management Unit (DMU) to have good information on the nature of these liabilities.

4

(9)

3

2.

BACKGROUND

2.1 Current debt situation and de facto debt management strategy This is the first true debt management strategy for Solomon Islands. Knowing about the historical context helps understand the need for and the form of this Debt Strategy.

After Independence and in the period 1978 to 1998, there were no systems in place to guide borrowing decisions. Multilateral and bilateral loans with what appeared to be generous terms and long grace periods were agreed to on an ad hoc basis without any consideration of debt sustainability, risks and future impact on budgets or, in some cases, what was best for development in Solomon Islands. At Independence in 1978, SIG had loans with Asian

Development Bank (ADB) of around US $2 million and in the period to 1995, SIG took out loans with the ADB, the European Commission (EC), the World Bank (International Development Assistance (IDA)), the European Investment Bank (EIB) and the International Fund for Agricultural Development (IFAD). These loans were to fund education, agriculture,

infrastructure projects, and for the Development Bank Solomon Islands (DBSI). Debt servicing payments were made regularly.

The finances of SIG gradually deteriorated from around 1995 to 1998, as evidenced by late or delayed payments and loan rescheduling. In 1995, SIG borrowed around SI$60 million from Kuwait and OPEC at higher interest rates (3.5 to 4 per cent) to fund main road upgrades. To help mitigate payment difficulties, SIG set up a debt servicing account in 1998 for the purpose of paying debt servicing expenses and committed 15 per cent of consolidated revenues to the Debt Servicing Account (this was reduced to 10 per cent in 2009).

In the period of ethnic tension from 1998 to 2003, and as economic activity declined and public service systems were threatened, government revenue collection became increasingly difficult. This, together with uncontrolled expenditure and a currency devaluation of 30 per cent,

precipitated a financial crisis. Loan repayments were made late or not at all because it was difficult for public servants to perform their duties and because there were insufficient funds. By 2001 SIG had defaulted on all its external loans. Continued non-servicing of World Bank and ADB loans caused both these institutions to suspend new lending and technical assistance programs to Solomon Islands. The government was unable to redeem its domestic securities, which amounted to around SI$29 million in Treasury Bills and SI$269 million in Treasury Bonds. In this period SIG again borrowed at an interest rate of 3.5 per cent from EXIM Republic of China and the International Cooperation and Development Fund (ICDF) for ‘general commercial use’ and to prop up the DBSI. Advances of SI$209 million were also obtained from the Central Bank Solomon Islands (CBSI), at levels well above the legal limit. Failure of Provincial

Governments and SOEs to repay their debts, and large trade creditors arrears that were accumulated by the central government compounded the debt crisis. As can be seen in

(10)

4 Annexure II, a significant proportion of SIG debt post 2003 was ‘informal’, comprising

government guarantees and contingent liabilities, particularly with State-Owned Enterprises (SOEs), the national superannuation provider (NPF) and provincial debt. In addition, the large number, complexity and political sensitivity of trade creditor arrears added to the difficulties of normalising SIG’s debts.

In 2003, and with assistance from the Regional Assistance Mission Solomon Islands (RAMSI), the process of putting debt management on a sound footing began. This is described in the

Comprehensive Debt Management Plan for Solomon Islands, 2004. As a result of this plan, the Debt Management Unit (DMU) was established. The focus of this plan was debt restructuring and developing a repayment plan for trade creditors.

The first step was to verify and determine the correct amounts for all debt obligations (see the chart in Annexure II), and then establish an equitable way of prioritizing arrears payments, including trade creditors arrears. In August 2003, the Australian Government settled SIG’s World Bank and ADB arrears and continued servicing these loans until mid-2004.

There was a one-off restructure of domestic debt in 2004. Domestic debt, including Treasury Bonds in default, large trade creditor arrears and advances from CBSI, were securitised and restructured as bonds, with a monthly coupon and amortising principal and with maturity dates from 2011 to 2018. For restructured Treasury Bonds, the interest rate was set at 2 per cent (2.5 per cent for the longest tranche) with a contingent bonus interest component of 1 per cent set annually and paid when SIG revenue grew in excess of 15 per cent per annum.

TABLE 1: DEBT SITUATION 2003 – 2005 (SI$million)*

Stock 2003 2004 2005

External 1,158 1,201 1,123

Domestic 503 527 519

Total 1,661 1,728 1,642

Debt Service Cost

External 34 37 56

Domestic 8 34 24

Total 42 71 80

Debt Sustainability Indicators

Debt to GDP (per cent) 67 62 53

Debt to Solomon Islands Government revenue (per cent)

303 243 210

* This is an underestimate, because it does not include contingent liabilities and trade creditors’ arrears, which were approximately SI$450 million in 2004, for example.

(11)

5 Servicing the high levels of debt arrears made it difficult to make scheduled debt servicing payments. In 2004, the volume of domestic arrears was SI$400 million, with external debt arrears of SI$100 million and SI$300 million of informal debts such as trade creditor arrears. As shown in Table 1, debt payments were a significant (and unaffordable) proportion of the Solomon Islands government revenue. However, although debt levels for SIG were

unsustainable and unaffordable, Solomon Islands did not qualify under the joint IMF/World Bank Heavily Indebted Poor Countries (HIPC) Assistance Initiative for debt relief, for example through a Paris Club agreement5. The decision was made for Solomon Islands to have its own ‘Honiara Club’6 meeting with external creditors. The agreement signed at this meeting, held in October 2005, has become known as the ‘Honiara Club Agreement’. Since then, Solomon Islands debt management has been determined by the conditions of the Honiara Club Agreement (paragraph 13 of the Minute) which states:

(1) No further borrowing or sovereign guarantees until the Government of Solomon Islands reaches ‘green light status’ under the Joint World Bank/IMF Debt Sustainability Framework for Low-Income Countries Debt Distress Rating system7

(2) Maintaining a fully funded recurrent budget excluding the use of borrowing to fund recurrent expenditure for the duration of any loans held at this time by creditors who are party to the [Honiara Club Agreement], subject to five yearly reviews; and

(3) Debt servicing funds are only to be used for meeting debt servicing costs.8

The immediate outcome of the Honiara Club Agreement and the associated Action Reform Plan was that external creditors agreed to a moratorium on debt repayments for two years. The Australian Export Finance and Insurance Corporation (EFIC) forgave around 70 per cent of Solomon Islands debt. Other debt write-offs have been from Maruha and EIB. In 2010 Maruha Nichiro Seafood wrote off SI$123 million in long-term debt owed by the Investment

Corporation of Solomon Islands). In 2011 EIB wrote off SI$14.6 million of long-term debt owed by DBSI.

5

The Paris Club is the first stage to gaining HIPC relief. Solomon Islands Government only had one external loan with a permanent member of the Paris Club (Australia). Following a possible Paris Club settlement, Solomon Islands Government would still have been required to convince, through negotiation, all its other external creditors.

6

Signatories were a representative from Australia (with Export Finance and InsuranceCorporation as the creditor), European Investment Bank and International Fund for Agricultural Development with representatives of the World Bank, Asian Development Bank and Taiwan (all creditors) and IMF as observers.

7

See Annexure III for details.

8

(12)

6 Since the Honiara Club Agreement, the implicit Debt Strategy for Solomon Islands has been built around crisis recovery – reducing the cost of debt and improving debt sustainability. Debt Management Plans produced in 2004 and 2009 focussed on normalisation of the debt position and of relations with SIG’s creditors.

The Honiara Club Agreement, in imposing a regime of no new borrowing, has been very successful. It, together with an environment of increased fiscal responsibility, has meant that debt has been reduced to sustainable and affordable levels. In 2010, following the IMF 2009 Article IV consultation, Solomon Islands was moved from red to yellow light status in the Joint World Bank/IMF Debt Sustainability Framework for Low-Income Countries (see Annexure III). As shown in Table 2, official debt levels fell from 53 to 24 per cent of GDP from 2005 to 2010. By the end of May 2011, the Solomon Islands Government no longer had any debt arrears9.

TABLE 2: DEBT SUSTAINABILITY INDICATORS 2005 – 2011 (Per cent)

Per cent 2005 2006 2007 2008 2009 2010 2011

Debt*/GDP 53 47 38 30 28 24 19

Debt*/Government revenue 210 168 128 101 97 69 50

Debt*/Exports 176 122 102 118 84 40

Debt Servicing/Government revenue 9 11 10 6 5 4

Debt Servicing/Exports 10 11 11 8 6 5

* Note this figure does not include unofficial debt such as Trade Creditors’ arrears and contingent liabilities which were around SI$360 million in 2006, SI$100 million in 2008 and 2009, SI$70 million in 2010 and SI$100 million in 2011.

However, poor management and accountability of SOEs continues to be a source of risk to the Government. For example, the Solomon Island Water Authority (SIWA) still owes the Solomon Islands Electricity Authority (SIEA) around $38 million, although in 2008 the Government paid $10 million of SIWA’s debts to SIEA. The Solomon Islands Postal Service and the Solomon Islands College of Higher Education are also experiencing financial difficulties.

2.2 Need to review the Honiara Club Agreement

There are three reasons why SIG now needs to review the Honiara Club Agreement. Firstly, it was part of the original agreement, signed in October 2005, that it would be reviewed after five years. The second reason is that moving to yellow light status means that the Solomon Islands Government is no longer eligible for 100 per cent grant funding from the World Bank or ADB. If SIG wants to fund future development projects that will increase GDP or help the country reach its Millennium Development Goals, then it may no longer be able to rely entirely on grants to provide the funding to do this. Lastly, it is unlikely that the conditions for borrowing (reaching

9

On 23 May 2011, and in response to Solomon Islands remitting the proceeds from the sale of DBSI properties, EIB wrote off the remaining SI$14.6m of the loans to DBSI.

(13)

7 ‘green light’ status) will be met in the foreseeable future10. Even if all debt were repaid in early 2012, Solomon Islands would not reach green light status until 2022 at the earliest.

SIG therefore needs to make provisions to allow for prudent borrowing again, but must replace the Honiara Club Agreement with a strong fiscal, legal and operational framework. This

framework must be in place before borrowing resumes to allow for fiscally responsible borrowing for a fit purpose. SIG must ensure that borrowing is for good quality development projects and that Solomon Islands does not return to situation of poor borrowing decisions leading to high debt levels, expensive debt and borrowed funds not contributing to the welfare of its people.

An additional consideration is that borrowing is also limited by the conditions of a

Memorandum of Understanding (MOU) that was signed in November 2011 between Solomon Islands and IMF11. This MOU provides for the use the IMF’s Standby Credit Facility (SDR125.2 million for 12 months) on the condition that the Government continues with its fiscal reform agenda. A number of items in the agreed reform program relate to debt management. For example, the MOU requires no new debt or government guarantees, with the exception of concessional borrowing (see Annexure IV). If this or a similar arrangement is renewed, the conditions on borrowing are likely to continue.

The Honiara Club Agreement needs to be reframed, amended or replaced to take account of borrowing opportunities in the short to medium term and to ensure that if any

borrowing occurs, it is guided and restricted by a strong framework.

2.3 Background on domestic debt market:

The Solomon Islands domestic debt market consists of Treasury Bills and Treasury Bonds. Treasury Bills are short-term debt securities (up to one year) that carry an annual rate of fixed interest over the life of the security, payable on maturity. The Solomon Islands’ Treasury Bill market has been operating since 1985. Treasury Bonds are longer-term debt securities. The issue of Treasury Bills and Bonds is governed by the Government Loans and Securities Act1996. During the period of ethnic tension, and as investor confidence decreased, interest rates for Treasury Bills increased, and at their peak were 16 per cent for 91 day Bills. The Treasury Bill market collapsed in August 1995. SIG was unable to redeem around SI$29 million of Treasury Bills. In April 1999 Treasury Bills that were in default were restructured and the Treasury Bill

10

This is because the mathematical methodology on which the Debt Sustainability Framework is based uses standard deviations. A standard deviation is a measure of variability. Countries, such as Solomon Islands, which have a narrow economic base, are subject to greater variability and therefore the shocks the analysis applies to these countries are relatively larger.

11

http://www.imf.org/External/NP/LOI/2011/SLB/110411.pdf

12

SDR is a monetary unit of international reserve assets defined and maintained by the IMF. It is defined as a weighted sum of contributions of four major currencies, the euro, the US dollar, the British pound, and the Japanese yen, and is re-evaluated and adjusted every five years

(14)

8 market was reinstated. The Treasury Bill market was essentially there to maintain a SIG

presence and yields were capped at 4 per cent. Since July 2010, the Treasury Bill market has been reinvigorated, with the operational cap extended to SI$40 million, the publication of a monthly issuance calendar, and the extension of the terms offered to 182 days.

SIG also defaulted on around SI$270 million of Treasury Bonds (see Annexure II) in 2001. In 2004, Treasury Bonds in default were restructured as amortizing bonds. There has been no resumption of Treasury Bond issuance. The current status of the domestic securities market is discussed in section 3.4.

(15)

9

3.

THE CURRENT STATUS OF THE DEBT PORTFOLIO *

* (as at 31 December 2011)

3.1 Profile of existing debt

The total volume of outstanding debt and as shown in Table 3, is SI$1,191 million, with an additional SI$100 million of contingent liabilities. (See Annexure V for the Government’s Debt Statistical Bulletin for 31 December 2011.) The existing portfolio is composed of 27 per cent domestic debt and 73 per cent external debt (by definition debt not denominated in SBD). The majority (85 per cent) of external debt comes from multilateral creditors, dominated by the (ADB (SI$387 million) and the World Bank (SI$298 million). Domestic debt is predominantly held by commercial banks, the superannuation provider (NPF) and the Central Bank (CBSI).

TABLE 3: OUTSTANDING DEBT AS AT 31 DECEMBER 2011 (SI$million)

Domestic Debt

Treasury Bills 37.6

Government Bonds 271.6

Advances from Central Bank 15.1

324.3 External Debt

Multilateral Creditors 734.2

Bilateral Creditors 132.2

866.4

Explicit Informal Debts and Contingent Liabilities

Loan Guarantees 50.0

Other 49.9

99.9

Grand Total 1,290.6

All bonds and external debt are in the form of amortizing bonds. Therefore, the maturity profile (shown in Chart 1) of all debt is fixed. All domestic debt is amortized on a reducing balance basis (with regular constant payments and a reducing principal component). External debt is amortized with a fixed principal repayment.

(16)

10

CHART 1: DEBT BALANCES OUTSTANDING 1998 – 2020 (SI$billion)

In addition to ‘official debt’, the debt portfolio includes SI$100 million of contingent liabilities. Of this, SI$50 million is a government guarantee to Soltai that the government assumed when NPF refinanced Soltai’s debt with ANZ. The guarantee has a sunset clause and expires on 24 August 2015. SIG also has a contingent liability with Solomon Telekom Ltd which, as at 31 December 2011, was SI$35.2 million. SIG signed an agreement with Telekom for a total settlement amount of SI$86.31 million, for compensation for the termination of Solomon Telekom’s exclusive licence. Under the Telecommunications Act 2009, license fees will be collected by the Telecommunications Commission, and then SIG will facilitate the payment of these fees from a special compensation fund to Telekom. If after 15 October 2015, license fee collection has been insufficient to pay this settlement amount, then the Solomon Islands Government is liable to pay the remainder. In practice, this would be undertaken by reducing the amount of sales tax due from Telekom. The Government needs to have a better understanding of the extent of implicit contingent liabilities associated with SOEs.

3.2 Cost of existing debt

Table 4 below shows actual debt servicing payments (of both interest and principal) from 2005 to 2011. 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

External Debt Arrears External Debt Principal Domestic Debt Arrears Domestic Debt Principal $billion

(17)

11

TABLE 4: DEBT SERVICING PAYMENTS (SI$million) 2005 TO 2011

2005 2006 2007 2008 2009 2010 2011 Domestic Debts 23.7 57.4 42.5 46.1 33.0 31.3 46.0 Principal 30.1 35.0 22.6 23.0 36.6 Interest 12.4 11.1 10.4 8.4 9.4 External Debts 56.4 31.1 95.9 117.1 67.6 79.3 59.3 Principal 43.1 21.7 70.8 83.2 52.7 65.4 46.7 Interest 13.3 9.4 25.0 33.9 15.0 13.9 12.6 Total 80.1 88.5 138.4 163.2 100.6 110.6 105.3

As shown in Chart 2, the largest portion of SIG’s external debt is denominated in United States Dollars (USD) (47 per cent,) followed by Euros (EUR) with 22 per cent, Japanese Yen (JPY) 17 per cent, and British Pounds (GBP) and Australian Dollars (AUD) both 5 per cent. The ‘other’

category includes Kuwaiti Dinars (KWD), New Zealand Dollars (NZD), Swedish Kronor (SEK), Canadian Dollars (CAD), Norwegian Krone (NOK) and Korean Won (KRW).

CHART 2: FOREIGN CURRENCY PROPORTION OF EXTERNAL DEBT

USD

JPY

EUR

AUD OTHER GBP

(18)

12 3.3 Affordability and Sustainability of existing debt levels

The debt to GDP ratio is currently 19 per cent and with no new borrowing is projected to fall to 15 per cent by the end of 2012 (see Table 5 below). Other parameters are also below the Joint World Bank/IMF Debt Sustainability Framework thresholds for low-Income countries, with debt servicing cost to revenue ratio currently being at 4 per cent.

TABLE 5: PROJECTED DEBT AFFORDABILITY AND SUSTAINABILITY 2010 TO 2016 (Per cent)

(Assuming no new borrowing)

Measure Threshold 2012 2013 2014 2015 2016

Debt to GDP 30 15 12 10 8 7

Debt to Solomon Islands Government revenue

200 40 34 26 21 17

Debt to exports 100 34 34 30 27 25

Debt service to Solomon Islands Government revenue

25 4 3 3 2 2

Debt service to exports 15 3 3 3 3 3

3.4 Domestic security market

The primary domestic securities market is currently made up of Treasury Bills issued by the government – most of the take up has been by domestic financial institutions. Treasury Bills are discount instruments with a term of up to one year. Currently issuance is limited to terms of 56, 91 and 182 days. Table 6 shows the volume on issue for each term. Issuance is authorised for up to SI$100 million, and capped operationally by the Minister of Finance at SI$40 million. Since early March 2011, CBSI has auctioned SI$60 million of its own Bokolo Bills with a term of 28 days and a yield of 1 per cent. Treasury Bill auctions are held weekly with a settlement period of trade + 1 day. The prospectus is published on the CBSI website, and monthly calendars are published in advance. The calendar is devised so that issuance is on a rolling basis, with maturing Treasury Bills being funded out of the proceeds raised from new issuance.

TABLE 6: VOLUME OF TREASURY BILLS AS AT 31 DECEMBER 2011 (SI$million)

Tenor Volume ($mIllion)

56 days 3.770

91 days 9.230

182 days 25.000

(19)

13 Since July 2010, SIG has used Treasury Bills as a short-term cash management tool. Up to 50 per cent of the volume of Treasury Bills on issue can be used for cash management purposes (to smooth fluctuations in the cash balance) according to strict guidelines.

Improved investor confidence following the revitalisation of the Treasury Bill market in mid 2010 is evidenced by declining weighted average yields and increasing bid ratios (Charts 3 and 4). The period of reduced appetite from March 2011 shown in Chart 4 resulted from CBSI commencing issuance of large volumes of Bokolo Bills. Currently, the primary market for

Treasury Bills is narrow, with a small domestic investor base and lack of foreign investors. There is no secondary market (interbank trading) in Treasury Bills at present. Many of the commercial investors have limits on the volume of SIG securities that they can hold, and the lack of a Sovereign Credit Rating precludes increasing this cap.

There is no primary market of Treasury Bonds at present. Restructured Treasury Bonds issued to commercial banks and the NPF in the past are tradeable. The maturity dates of these bonds are in 2014, 2017 and 2018 or 2019.

CHART 3: WEIGHTED AVERAGE YIELDS FOR TREASURY BILLS (Per cent)

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 2 4 /0 8 /2 0 1 0 2 4 /0 9 /2 0 1 0 2 4 /1 0 /2 0 1 0 2 4 /1 1 /2 0 1 0 2 4 /1 2 /2 0 1 0 2 4 /0 1 /2 0 1 1 2 4 /0 2 /2 0 1 1 2 4 /0 3 /2 0 1 1 2 4 /0 4 /2 0 1 1 2 4 /0 5 /2 0 1 1 2 4 /0 6 /2 0 1 1 2 4 /0 7 /2 0 1 1 2 4 /0 8 /2 0 1 1 2 4 /0 9 /2 0 1 1 2 4 /1 0 /2 0 1 1 2 4 /1 1 /2 0 1 1 2 4 /1 2 /2 0 1 1

56 Days 91 Days 182 Days

(20)

14

CHART 4: RATIO OF BIDS RECEIVED TO ALLOCATION FOR TREASURY BILLS

3.5 Risk of existing debt

The extent of the risk will depend on risk factors and risk exposure. The main risk factors, together with the extent of SIG exposure, are discussed below.

1. REPAYMENT (DEBT SERVICE COST) RISK

Servicing debt is the primary concern for debt management. The Government must make sure that total expenditure including debt service costs do not exceed revenue collected. The main risk for the debt portfolio for the Solomon Islands Government is the government’s inability to make repayments or ‘repayment risk’. This risk can be expressed as the cost of debt

repayments compared with funds available. This risk is currently mitigated by setting aside ten per cent of domestically sourced revenue to service debt. The risk is that revenue could

decrease so much that ten per cent is less than the debt servicing cost. If this happens, there will be insufficient funds available to make debt payments.

The dollar value of the projected debt servicing cost, assuming no new borrowing, is given in Chart 5. Debt servicing costs increase in 2012 and 2013 because grace periods for current loans are ending. 0.0 2.0 4.0 6.0 8.0 10.0 12.0 0.0 2.0 4.0 6.0 8.0 10.0 12.0 2 4 /0 8 /2 0 1 0 2 4 /0 9 /2 0 1 0 2 4 /1 0 /2 0 1 0 2 4 /1 1 /2 0 1 0 2 4 /1 2 /2 0 1 0 2 4 /0 1 /2 0 1 1 2 4 /0 2 /2 0 1 1 2 4 /0 3 /2 0 1 1 2 4 /0 4 /2 0 1 1 2 4 /0 5 /2 0 1 1 2 4 /0 6 /2 0 1 1 2 4 /0 7 /2 0 1 1 2 4 /0 8 /2 0 1 1 2 4 /0 9 /2 0 1 1 2 4 /1 0 /2 0 1 1 2 4 /1 1 /2 0 1 1 2 4 /1 2 /2 0 1 1

56 Days 91 Days 182 Days

(21)

15

CHART 5: PROJECTED DEBT SERVICING COST 2012 – 2016 (SI$million)

(Assuming no new borrowing)

As shown in Chart 6, the repayment profile exhibits periodicity, with peak repayment volumes in June and December. There is a risk that in a period of falling revenues, there will be

insufficient funds set aside to make debt repayments during these months

CHART 6: MONTHLY PATTERN OF DEBT REPAYMENTS (SI$million)

Note: does not include additional, one-off, principal payments -20 40 60 80 100 120 2012 2013 2014 2015 2016 2017 2018 2019 2020 $million -2 4 6 8 10 12 14 16 18 20

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2009 2010 2011

(22)

16

2. FOREIGN EXCHANGE RATE RISK

Foreign exchange rate risk relates to vulnerability of the debt portfolio, and therefore the government’s debt servicing cost, to a depreciation or devaluation in the external value of the domestic currency. Of the debt portfolio, SI$866 million (73 per cent) is denominated in

currencies other than the Solomon Islands Dollar (SBD) and therefore exposed to exchange rate changes. Therefore, foreign exchange rate risk dominates the portfolio.

Debt servicing costs fluctuate from month to month according to exchange rate changes. Foreign exchange movements will also change the value of debt outstanding and therefore the ratio of debt to GDP. SBD has generally moved in line with the USD. Chart 7 shows that the about half of external debt is denominated in USD.

CHART 7: VOLUME OF DEBT OUTSTANDING BY CURRENCY (SI$billion)

3. INTEREST RATE RISK

The weighted average interest rate of external debt is 1.14 per cent and 2.87 per cent for domestic debt. Interest rate risk is the risk associated with interest rate changes. All external debt is at a fixed interest rate, and about half of the domestic debt portfolio is subject to interest rate changes. The total volume exposure to interest rate changes is around SI$162 million. Of this, for SI$114 million, the possible interest rate change is limited to a 1 per cent bonus interest that is payable in the event that SIG domestically sourced revenue increases

-200 400 600 800 1,000 1,200 1,400 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038 2039 2040

KRW NOK CAD SEK NZD KWD GBP AUD YEN EUR USD SBD $million

(23)

17 from year to year by 15 per cent or more. The interest rate increases to 3 per cent for the shorter two tranches and to 3.5 per cent for the longest tranche (with a maturity of 2018 or 2019). The remaining SI$10 million is subject to annual resets of the interest rate based on the 91-day Treasury Bill weighted average yield plus 1.5 per cent. The interest rate on Treasury Bills changes according to market forces (as indicated in Chart 3).

4. ROLLOVER RISK

Rollover risk is the risk that maturing debt cannot be replaced or refinanced, or that the replacement debt will be more expensive. With the exception of Treasury Bills, SIG debt is legacy debt (maturing debt is for projects that have been completed) with an amortizing principal. Rollover risk is limited to Treasury Bills, which are currently capped at SI$40 million. Treasury Bills are essentially funded on a rolling system, with new issuance funding maturities. Therefore, rollover risk is the risk that auctions will be undersubscribed or that new issuance will be at higher yields than for maturing Bills. SIG has put in place a mechanism to mitigate this risk by allowing the use of Debt Servicing Account at the CBSI to pay off maturing Treasury Bills in the event that funding from new issuance is insufficient. As Table 6 indicates, there is a greater proportion of longer tenor dated Treasury Bills, which have a lower rollover risk.

5. CREDITOR CONCENTRATION RISK

Creditor concentration risk refers to risks associated with most of the debt portfolio being held by one or two creditors. Creditors who hold a large proportion of debt could have a vested interest in the course of a country’s affairs. Large creditors could potentially have an undue influence in government policy development. In the case of Solomon Islands (see Chart 8), the ADB and the World Bank dominate the external debt portfolio.

(24)

18

CHART 8: VOLUME OF DEBT BY CREDITOR (SI$million)

External Domestic

6. INFLATION RISK

SIG does not hold any inflation-linked debt, therefore the portfolio is not directly exposed to inflation risk. The impact of inflation on debt affordability and sustainability can be mediated through currency valuation, GDP and government revenues and is difficult to predict. Inflation could actually have the effect of decreasing the debt burden, as has been the case in Solomon Islands during 2011.

7. RISKS IN MANAGING THE PORTFOLIO

Operational risk:

Operational risk is defined by the Bank of International Settlements as the risk of losses resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk, but excludes strategic and reputational risk.

The operational risks facing debt management in Solomon Islands stem from the very small size of the DMU and its vulnerability to staff movements. For example, as at 30 June 2011 only two of its four positions were filled. The DMU therefore cannot take advantage of the controls that come with separations between front, back and middle office, as is the case with larger

ADB $387 EU $32 EXIM $121 IDA $298 Other $28

Other: Kuwait, IFAD & ICDF

ANZ $19 BSP $50 CBSI $88 NPF $89 Other $25

(25)

19 Sovereign Debt Management offices. The difficulty in developing and retaining skilled staff is a risk for Ministry of Finance and Treasury in general.

Legal risk:

Legal risk is the risk that the DMU and, by extension, SIG do not execute their legal obligations as stated in the deed documents, loan agreement contracts or in the legislation dealing with debt. Possible examples are failure to make payments on time or for the correct amount. The loss of senior staff members makes the DMU vulnerable because corporate knowledge about legal requirements can be lost The DMU is also exposed to payment demands that do not have a sound legal basis.

Reputational risk:

The failure of past SIG to make payments on time and the accumulation of debt arrears has damaged the country’s reputation, making debt more expensive or institutions unwilling to lend.

The use of borrowed funds for inappropriate or wasteful expenditure gives investors and donors a very strong negative signal. Evidence of an ill-disciplined approach to debt

management will undermine donor and creditor confidence in the Government, which will in turn complicate future access to debt financing. In a similar vein, a policy stance that leaves open the possibility of using debt to delay or to avoid having to make difficult budgetary decisions must also be avoided.

Strategic risk:

Strategic risk is the risk that decisions made about the management of the debt portfolio have a high opportunity cost. For example, if SIG decides not to borrow, then it could miss out on grant funding (if grant funding for these projects is not available from other sources). If SIG decides to borrow for particular projects that do not match expectations, then this money could have been better spent elsewhere on other, more beneficial projects. Money spent on servicing debt might be better spent on providing essential services, for example. Alternatively, it is better to pay down debt (which saves the Government future interest payments and increases

borrowing opportunities in the future) rather than spending funds unwisely. Financial risk:

Financial risk is the risk that the government’s portfolio management is a source of instability for the private sector. The risk for Solomon Islands is that a poorly managed debt portfolio will mean that less money is available for servicing the country’s basic needs. A burgeoning debt portfolio or a build-up of debt arrears will cause a collapse in investor confidence, which will also impact the private sector, leading to a withdrawal of investment in the country, a decline in

(26)

20 GDP growth and a further increase in debt to GDP ratios. Donors will also withdraw funding and technical assistance if SIG goes into debt arrears.

(27)

21

4.

DEBT SUSTAINABILITY ANALYSIS

4.1 What is a Debt Sustainability Analysis and why is it important? A debt sustainability analysis is an evaluation of the ability of a country to continue to be able to afford to repay its debts, even when faced with financial and economic difficulties. It involves an assessment of the current economic situation and projections based on past patterns,

current developments and likely trends, and an analysis of a country’s projected debt burden over the long term and its vulnerability to external and policy shocks.

4.2 The Solomon Islands economy

Solomon Islands has a small, open economy based on primary commodities, principally logs, fish, agricultural production (cocoa, copra and palm oil), and from April 2011, mining. Chart 9 shows that logging is currently the largest contributor to export earnings. The main trading partners are China (with close to 50 per cent of export earnings) followed, after a significant margin, by the Philippines and Spain.

CHART 9: EXPORT EARNING (SI$billion, f.o.b.) 2010

(Source: CBSI Annual Report 2010)

The economy is small, vulnerable to external demand shocks and terms of trade vulnerability. The economy is based on a few key commodities and therefore is susceptible to changes in

1.01 0.26 0.20 0.14 0.10 0.05 0.03 0.03 Logs

Palm Oil & Kernels Fish

Cocoa

Copra & Coconut Timber

Other Exports Minerals

(28)

22 commodity prices and to weather conditions affecting agricultural production, forestry and fisheries. Solomon Islands is remote and dispersed consisting of almost one thousand islands. It is heavily reliant on imported fuel (and therefore vulnerable to changes in the oil price), and manufactured items, machinery and other general merchandised goods. Fuel and food make up 40 per cent of imports. Solomon Islands is heavily reliant on foreign aid.

The vulnerability of the Solomon Islands economy was evident during the 2008-2009 global financial crisis. A decrease in demand for logs resulted in a 5 per cent contraction in GDP. Falls in revenue led to cash flow difficulties and an accumulation of domestic arrears. In 2010 the Solomon Islands economy rebounded strongly from the negative growth experienced in 2009 as a consequence of the global financial crisis.

1. GDP

GDP, as a measure of the total goods and services produced in a country, indicates the capacity of a country to generate income in the future that can be used for repaying debt. A low debt to GDP ratio suggests that a country can withstand economic shocks and, if needed, borrow to stimulate the economy without defaulting on debt repayments.

For Solomon Islands, GDP comprises the primary (agriculture, forestry and fisheries), industry (including mining) and services sectors. The current contribution of each sector to GDP is shown in Chart 10. GDP growth in 2010 was 7 per cent and is estimated to be around 10 ¾ per cent in 2011, rebounding from a contraction of 5 per cent in 2009. These relatively high rates of real GDP growth were driven primarily by unsustainable logging.

CHART 10: CONTRIBUTION TO GDP 2010

Forestry, Logging, Sawmilling Transport & Communications Electricity & Water

Finance Other Services Agriculture

Retail & Wholesale Trade Manufacturing

Fishing Construction Mining & Exploration Source: CBSI Annual report 2010

(29)

23

2. FISCAL

Revenue collection during 2010 and 2011 was strong, recovering from weak growth during 2009. The Government continues to operate a fully funded consolidated budget, and has budgeted for a small surplus in 2012.

3. MONETARY

The annual inflation rate to December 2011 (calculated on a 3 months moving average basis) was 10 per cent. Inflation pressures came from rising fuel and food import prices. Inflation pressures have been relieved by appreciation of the currency from SBD:USD 1:8.0645 to 1:7.3584 over 2011. Excess liquidity has been partly sterilized by CBSI recommencing market operations. Since March 2011, around $200 million of 28 day Bokolo Bills have been issued each month.

During 2011, the trade balance shifted from deficit to surplus for the first time since 2004. This was driven by exceptionally strong logging and gold exports and as a result, the balance of payment position improved, supported by large Foreign Direct Investment (FDI) and aid flows. Gross international reserves increased to US$355 million (6 months imports cover) in June 2011 from less than US$100 million in mid-2009. Three months imports cover is considered to be a minimum reserve buffer.

4.3 Economic baseline, projections and assumptions

Economic data is collected by the Ministry of Finance and Treasury and CBSI. Historical and current information is used to form a ‘baseline’ or an expectation of how the economy will perform provided that everything goes well and there are no ‘shocks’. Economic modelling is carried out by the Economic Reform Unit (ERU) within the Ministry of Finance to project (predict) values for key economic variables such as GDP, inflation, revenue in future years.

1. GDP

Baseline projections assume annual growth in real GDP of about 4 ½ per cent in the projection period 2012 to 2016. The IMF expects GDP growth to be 6 per cent in 2012, with gold mining being the driver of growth. The Gold Ridge Mine is expected to have a life of ten years and from 2013 onwards but will add very little to real GDP growth. Logging volumes are forecast to fall from 2011 levels (1.8 million cubic metres) but remain at historically strong levels over the next decade due to unsustainable secondary forest logging (in the absence of significant primary forest supply). The anticipated slowing in logging will have a negative effect on GDP growth. These changes can be seen in Chart 11 which shows past and projected future GDP growth and the lower levels of average GDP growth from 2013.

Annual GDP growth over the medium to long term is expected to be around 4 per cent. GDP deflator growth is assumed to be equal to CPI increases. GDP growth in the medium to long

(30)

24 term is expected to come from expansion in other sectors of the economy. Fish production is anticipated to expand following additional investment in the Soltai tuna cannery’s productive capacity from 2010. The production and demand for other major export commodities is expected to expand as the world’s economic recovery leads to increased prices and demand.

CHART 11: HISTORIC AND PROJECTED GDP GROWTH

(Source: IMF) 2. FISCAL

Over the next five years, annual growth in domestically-sourced revenue is expected to be around 12 per cent with, at the same time, an increase in government spending (refer to Chart 12). The IMF forecasts real revenue growth over the medium term projected to be 3 per cent per annum.

CHART 12: HISTORIC AND PROJECTED REVENUE AND EXPENDITURE GROWTH (SI$billion)

-20 -15 -10 -5 0 5 10 15 2000 2002 2004 2006 2008 2010 2012 2014 2016 Per cent 0 1 2 3 4 5 6 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 $Billion

(31)

25 Lower revenue from logging is expected to be replaced from mining, particularly from 2014 when it is expected that the Gold Ridge mine will start generating profits and therefore commence paying company tax.

3. MONETARY POLICY

CSBI is operating monetary policy with a view to controlling inflation. The IMF projects inflation to be 5.25 per cent for 2012. Inflation is expected to be around 6 per cent per annum over the medium term with a CPI of around 6 per over the period 2012-2016 due to expected increasing costs of fuel and food.

4.4 Economic indicators, risks and thresholds

The IMF and World Bank use a standard framework, the Joint World Bank/IMF Debt

Sustainability Framework (see Annexure III) to carry out debt sustainability analysis. The World Bank uses the assessment of the risk of external debt distress from this analysis to determine the share of grants and loans in its assistance program.

The key economic indicators used in the Joint World Bank/IMF Debt Sustainability Framework for Low-Income Countries are summarised in Table 7. The volume of debt, expressed as a proportion of GDP, is used as a measure of debt sustainability.

Debt affordability is usually expressed as the debt servicing cost in relation to domestically-sourced revenue. Debt sustainability is a longer-term measure than debt affordability. If a government cannot afford to make debt repayments, it will go into arrears and even default on payments, which will cause a loss of investment in the country and a failure of the financial systems. So, irrespective of the debt to GDP ratios, it is critical that debt is affordable.

Exports indicate the ability of a country to generate foreign income. Solomon Islands, with an economy based on commodities, is very exposed to external factors that influence export earnings, such as global demand and prices.

The IMF and World Bank express debt in terms of the Present Value (PV) (or Net Present Value, NPV) of debt. This allows the thresholds to be applied irrespective of the term structure, grace periods or concessionality of the debt and also allows comparisons to be made between countries and time periods. The PV of debt is the stream of future debt service payments discounted by a rate13 which represents the alternative cost of borrowing.

13

(32)

26

TABLE 7: THRESHOLDS FOR A WEAK POLICY COUNTRY14

PV of External Debt in per cent of External Debt Service in per cent of

GDP Revenue Exports Revenue Exports

30 200 100 25 15

4.5 Stress testing

The baseline is a reference point for looking at the effect of shocks, or risk scenarios on the state of the economy in the future. Economic modelling is not concerned with upside risks – the likelihood that conditions will be better than expected, but only with downside risks. For

example, what would happen if there were a global financial shock similar to the one in 2009? Stress testing involves deciding on realistic problems (downside risks) that the country might face, and looking at how they are likely to affect the country’s future economy. Stress testing is an important part of a debt sustainability analysis, where the effect of downside risks on the ability of a country to continue to make debt repayments is examined.

As the SIG’s Medium Term Fiscal Strategy highlights15, the medium term risks to economic growth and prosperity in Solomon Islands remain extremely high. It is therefore important that stress testing captures the likely risks to debt sustainability and affordability so that even if there is another global economic crisis or if forest resources are exhausted sooner than anticipated, for example, debts can continue to be repaid. Stress testing helps decide on prudent levels of debt over the medium term.

Although the focus of a debt strategy is the medium term (around five years), concessional loans typically have a grace period of ten years, when no principal payments are made, and maturities of up to 40 years. SIG needs to ensure that the government is able to make loan repayments at the end of the grace period, but it is very difficult to make predictions about the state of the economy such a long way into the future. Modelling by ERU extends to five years only.

The approach taken in a debt management strategy must be conservative and assume that the future will not be any better than the past. Financial models use conservative estimates by assuming that present conditions will continue (for example, current interest rates and exchange rates will continue) and by using the least favourable value when there is a choice.

14

Solomon Islands has been assessed as a weak policy country by the World Bank’s ‘Country Policy and Institutional Assessment’ by looking at the country’s structural policies, public sector management, policies for social inclusion and economic management.

15

(33)

27 This is a way of making sure that there will be funds available to make statutory debt

repayments.

Economic modelling and sustainability analysis should be able to be performed by local staff without reliance on data collection or manipulation from outside sources. The stress tests must be simple to perform and robust.

Stress tests involving a decrease in revenue, GDP and export earnings, and depreciation in the SBD will be examined by DMU each year as part of the budget process to assess SIG’s ability to maintain debt levels at sustainable and affordable levels over the borrowing horizon, and to determine an annual borrowing limit. Note that these are not ‘worst case scenarios’ but events similar to those that have occurred historically, and which are reasonable. What follows are examples of factors that will be considered in conducting the debt sustainability analysis for 2012, and in determining the borrowing limit for the 2013 budget.

1. FALL IN REVENUES

The Government needs to make sure that debt is affordable, even if revenue is less than expected. Donor funding cannot be assumed. In recent years, ten per cent of domestically sourced revenues has been set aside for debt servicing. This has made sufficient funds available for debt repayments. Forecast debt payments must therefore be maintained at a level that is less than that set aside for debt servicing. This must be based on a conservative projection of revenue, for example, by allowing for a decline in forest reserves, a decrease in logging

revenues caused by a decrease in demand and allowing for times when revenue collection may fall for various other reasons. Examples include shocks such as a global financial crisis (as occurred in 2009). The following scenarios were examined:

1. Assuming a sustainable logging regime16;

2. No revenue from logs;

3. Revenue declines by one standard deviation17 (for the period 2006-2010) in year 2014;

4. A revenue shock (decrease in revenue) similar to that during the Global Financial Crisis of

2009.

The lifespan of logging operations is unclear, but these resources are expected to be

substantially reduced by around 2017. In its revenue modelling, ERU identifies revenue from logs, so estimated data for this stress test is available.

16

SKM (2012). Solomon Islands National Forest Resources Assessment – 2011 Update. Report to RAMSI Economic Governance Pillar.

17

(34)

28

2. DECREASE IN GDP

The ratio of debt to GDP measures the ability of a country to generate income to make debt payments over the long term. Factors that cause the growth in the economy to slow or even reverse (such as the global financial crisis) have flow-on effects that make debt unaffordable. Historical evidence suggests that a Debt to GDP ratio of below 30 per cent, even under stress, is required for debt distress to be prevented for a country like Solomon Islands.

The following scenarios were examined:

1. No contribution from logs;

2. Sustainable logging, plus no contribution from mining;

3. GDP declines by one standard deviation (for period 2007-2010) in 2014;

The most conservative scenario is one where there is no contribution from logging or mining. It is unclear when forest resources will be exhausted, but logging is expected to decline in around 2017. A more realistic stress test is logging at sustainable levels with no contribution from mining. Mining operations could be interrupted by, for example, issues surrounding

landownership. Both the IMF and ERU separate out the contribution by logging and mining to GDP growth, so data for these stress tests is available.

3. DECREASE IN EXPORTS

Exports determine the capacity of the country to generate foreign exchange receipts. The following scenarios were examined:

(i) Assuming a sustainable logging regime

(ii) No revenue from logs;

(iii)Exports decline by one standard deviation for period 2006-2010) in 2014;

4. DEPRECIATION OF CURRENCY

A 30 per cent depreciation (1SBD=USD10.4) is the most commonly used shock to currency exchange rates in scenario analyses and equates to the shock experienced by the SBD at the end of the tensions period.

A future depreciation of the currency would lead to an increase in the foreign debt to GDP ratio (see Table 8) and increase the cost of servicing debt (because it increases the value of foreign currency denominated liabilities of Solomon Islands). Similarly, a negative terms of trade shock (a fall in the relative price of the exports) would also lead to an increase in the debt to GDP ratio (as it reduces the real income) and would thus require a larger trade surplus adjustment to avoid an unsustainable increase in the debt to GDP ratio. At the same time, a depreciation of the SBD would also increase revenues (through taxes on fuel). The overall effect is, however, to reduce debt sustainability and affordability.

(35)

29 A 30 per cent depreciation of the SBD would be roughly equivalent to a 3.5 per cent increase in interest rates on the debt stock. Thus the advantages of low interest rates with concessional loans are easily overwhelmed by foreign exchange movements.

TABLE 8: EFFECT OF A 30 PER CENT DEPRECIATION ON DEBT STOCK AND SERVICING COSTS (SI$million) (Assuming no new borrowing)

2012 2013 2014 2015 2016

Debt stock 1,154 1,069 985 905 829

Debt Servicing cost 103 103 102 91 89

Debt stock after 30 per cent depreciation 1,414 1,315 1,216 1,121 1031 Debt Servicing cost after 30 per cent depreciation 121 121 120 108 106

5. FUTURE GROWTH

It is difficult to make projections about growth, since future sources of growth are unclear at present (except for Gold Ridge mine, which has a limited life span) and income from logs is forecast to be lost over coming years as forests are depleted. The simplest and most conservative approach is not to assume any growth.

In their 2011 Article IV report, the IMF considered the key near-term risk of current financial turmoil in Europe and the United States causing the global recovery or Asian growth to falter. This would lead to a sharp contraction in investment and demand for commodities from Asia, and a deterioration of the terms of trade. The IMF suggest that a 20 per cent decline in gold and log prices in 2012–13 compared to the baseline, a sharp drop in logging exports, and delays in gold production would lower GDP growth by around 4 per cent to 2 per cent and double the size of the current account deficit in 2012. Political instability within Solomon Islands could possibly have a similar effect.

4.6 Results of the IMF Debt Sustainability Analysis

“Solomon Islands is at moderate risk of external debt distress according to this World Bank-IMF Low-Income Country (LIC) Debt Sustainability Analysis (DSA). The debt profile is sensitive to shocks to non-debt creating flows, export growth, and financing terms. Containing the risk of debt distress will require continued efforts to rebuild fiscal buffers, establish a multi-year budget framework to provide fiscal discipline, and implement structural reforms that are essential to promote broad-based growth.”

The Joint World Bank/IMF Debt Sustainability Analysis, using the Joint World Bank/IMF Debt Sustainability Framework for Low-Income Countries, and conducted in 2011 as part of the IMF

(36)

30 Article IV deliberations18 placed Solomon Islands as being at moderate risk of debt distress (Annexure VI). All external debt indicators remain below the threshold levels summarized in Table 7. The risk of debt distress was assessed by subjecting the baseline data to many standard stress tests or ‘shocks’. Under all scenarios, debt servicing costs remain below the thresholds shown in Table 7. However, debt sustainability is vulnerable to shocks, in particular to:

1. A temporary growth shock (real growth at historical average minus one standard deviation over one year); and

2. Net non-debt creating flows7 at the historical average minus one standard deviation for one year.

As shown in the charts in Annexure VI, the thresholds are broken for these shocks.

The Joint World Bank/IMF Debt Sustainability Framework for Low-Income Countries applies relatively large shocks to the Solomon Islands economy. This is because historical averages and standard deviations are calculated over ten years, thus including the period of civil unrest. Therefore, the recovery from low levels of economic activity and government finances after the end of the ethnic tensions means that the shock applied in the analysis is relatively large

because the standard deviation (the measure of variability) is large and the average is relatively low. The second issue in the methodology is that net non-debt creating flows19 are negative (inflows) not only because logging exports are projected to decline, but also because large foreign investment is anticipated.

18

http://www.imf.org/external/pubs/cat/longres.aspx?sk=25444.0

References

Related documents

Electrostatic Precipitators are not only used in Power Plant applications but also other industries (for other exhaust gas particles) such as Cement (dust),

molekul senyawa 119.38 g/mol. Kedua senyawa tersebut memiliki berat senyawa yang berbeda jauh. Hal ini juga dipengaruhi oleh ukuran molekul senyawa tersebut. Seperti

Input and feedback on the following elements of the Terms are being sought: eligibility criteria; minimum bidding requirements; maximum bidding limits; the price range for

On the basis of these results, we can accept our hypothesis H2a: Posts with Single picture are the strongest motivator for engagement index for Kerala and H2b: Posts with

To look up a specified account string and print a report of detailed information in the Actuals Ledger access the LBC GL Expense Detail Report from either the Budget Reports tile

There are three ways to update the time on devices, which are at the device itself (locally), through an SNMP (Simple Network Management Protocol) command, or via Xerox

The age component that contributed most to the decline in the infant mortality rate was the early neonatal, followed by the post-neonatal period.. The late neonatal

We hypothesized that serological evidence of acute herpesvirus infection (VZV, HSV1, HSV2, EBV, CMV) would be associated with risk of AIS among children ages 29 days to 18 years