1. Concessional Debt and Debt Rescheduling

2. 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.

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

4. 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

5. 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

6. 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?  

7. 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

8. 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

9. 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

10. 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

11. 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

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

13. 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)

14. 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

15. 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?