Debt strategy and policy

The HIPC and multilateral debt relief initiatives provided vital relief to overburdened economies. But low income countries are continuing to borrow and now have access to a wider range of potential sources of finance. To minimise the cost and risk associated with these debts, both low and middle income countries must adopt a more strategic approach to credit. The question is what should a debt strategy look like?

The primary objective of debt management is to meet the government’s financing needs at the lowest possible cost consistent with a prudent level of risk. Implicit in that is a balancing act, choosing between different sources of finance to manage the trade-off between the cost and risk of borrowing. By getting the balance right, countries can use debt to finance critical infrastructure investment, support vital social programmes and contribute to the management of the economy.

The starting point for a balanced debt strategy is necessarily an understanding of a country’s existing commitments through a portfolio review. Over recent years, there has been significant progress in improving debt recording and reporting. Progress has also been achieved in examining sustainability and tools such as the IMF-World Bank Debt Sustainability Framework are increasingly used to help assess a country’s debt exposure under different economic scenarios.

However, a debt strategy needs to look more broadly than pure sustainability. It is about determining the optimal blend of different types of debt to meet the government’s financing needs. This borrowing requirement is an outcome of the budget process. The size of the deficit is often a matter for considerable discussion internally, and provides an obvious link between debt management and wider budget planning.

Having decided how much borrowing is required, it’s then time to look at potential sources, from multilateral development banks to domestic instruments, such as treasury bills or bonds. With this shortlist of potential sources, the analysis can begin to determine the optimal blend of debt to achieve the government objective, minimising costs consistent with the right level of risk. The government may also have secondary objectives to consider, such as capital market development.

OPM adopts a wide range of tools to support this analysis. The IMF and World Bank have recently developed a Medium Term Debt Strategy (MTDS) tool. Other techniques can also be used such as Cost at Risk (CaR) and Value at Risk (VaR) modelling. A debt strategy should be tailored to a country’s circumstances, but is likely to include a mix of foreign and local currency debt, variable and fixed interest rate debt, and a range of different maturities. By diversifying borrowing in this way, governments can mitigate their risk against economic shocks and ensure a smooth debt service profile in the future.

Of course, such a perfect outcome is rare – and in reality many low income governments may have limited borrowing options available. It’s here that OPM’s pragmatism is vital: with a wealth of experience in planning and supporting reform in low and medium income countries we know how to match solutions to the circumstances on the ground – for example, in supporting the development of a debt strategy in Lesotho.

Managing cashflow

Alongside the high-level debt strategy, it’s vital that governments also have the tools at their disposal to manage cash effectively – so they don’t run the risk of expensive short-term borrowing. Our working paper on cash management explains how effective cash management can be achieved in developing countries. 

For more on our debt management capacity, see our brochure below.

Downloads: