Concessional Debt and Debt Rescheduling

The story so far: Current treatment: “... other transactions may take place at implied prices that include some element of grant or concession so that those prices are not market prices. Examples of such transactions could include ... government loans bearing lower interest rates than those consistent with grace and repayment periods or other terms for purely commercial loans.” (BPM5 para 104) Consistent with general valuation principles. No follow-through with advice on how to implement. Seems not widely implemented.

Possible treatments: Option 1 - Ignore concessionality. Omits transfer element of arrangement Violates general valuation principles Very easy to implement

Possible treatments: Option 2 – Current transfer Recognizes transfer element of arrangement Transfer is ongoing throughout life of loan Neutral effect on current account deficit Preferred by BOPTEG, subject to some concerns expressed later

Possible treatments: Option 3 – Capital transfer Recognizes transfer element of arrangement Transfer occurs entirely at initiation Neutral effect on current account deficit Consistent with present value (PV) of loan, not consistent with nominal valuation of loans Consistent with subsequent sale but inconsistent with subsequent forgiveness

Possible treatments: Example of impact of capital transfer Year 1 Present value basis for loans Nominal value basis for loans Funds advanced 1000 Interest accrued 34 Transfer 442 Outstanding debt at Dec 31 592 Adds up?  

Concessionality and Debt Rescheduling Debt rescheduling by reducing contractual interest rate may generate economic transfers if new rate below prevailing market rate Measurement of transfers in lending has gained importance as benchmark used in quantifying amount of HIPC debt relief Creditors can choose between extended maturities and low interest rates, debt cancellation, grant financing in providing debt relief

Possible Treatments—Case 1: Interest on on-Going basis Record transfers on an on-going basis using the difference between historical interest rate and new concessional interest rate (same as option 2) The weakness with this approach is that it uses historical rate of a contract that is already extinguished and does not reflect current economic reality

Case 2: NPV of interest charges NPV of two streams of future payments related to interest charges recorded as capital transfer upfront If loan extinguished before maturity, value of transfers not yet received would be recorded, thus reversing initial transfer Advantages: loan will continue to be valued at nominal value does not use historical rate

Case 3: NPV as Memorandum Item Calculate capital transfers arising from concessional loan as the difference between the nominal value and the present value of the loan Record transfers upfront as memorandum item If loan subsequently rescheduled, capital transfers would need to be recalculated to adjust the original transfer As in case 2 except that it takes into account maturity of loan in computing concessionality

Concerns from BOPTEG Must be intention to convey benefit by offering concessional interest rate Should not see below-average rate as proof that it is intended to be concessional. Government or non-profit institution usually involved, does not often arise in commercial arrangements. Encourage bilateral cooperation between compilers in lending and borrowing countries

Other concerns from BOPTEG Effect of subsequent changes in debtor’s creditworthiness Loan could become more or less concessional in practice

Other concerns from BOPTEG Effect of subsequent changes in market interest rate. Proposal: If concessional rate for a fixed term, then imputed interest should be based on the market rate for the same term (i.e., not influenced by subsequent changes in market rate) Some BOPTEG members thought it should be current short-term market rate (i.e., would change with subsequent changes in market rates)

Outcome of BOPCOM Differing views were expressed on possible treatment of transfers arising from interest rate concessionality on debt. The Committee decided that there was not sufficient consensus to include transfers in core accounts but agreed to include a supplementary item IMF to consider whether supplementary item should be on current or capital transfer

Questions for WPFS/WPNA 1. How should concessional interest be treated: a) not at all? b) as current transfer, on ongoing basis during life of loan? c) as capital transfer, as NPV of difference between PVs of future payments related to accrual interest payments two loans? 2. If a), then (i) what should current transfer be based on, difference with market price at inception, or during life? (ii) How is “market rate” determined? 3. If b), are implications for nominal valuation and potential reversing of capital transfer in event of rescheduling acceptable?