1. Debt Concessionality SNA Chapter 14 (external transactions)

2. Background Debt concessionality has gained increasing importance in the development arena relating to debt relief to HIPC (heavily indebted poor countries) Initiative 1993 SNA hardly discusses the issue, although it recognizes a subsidy element in concessional loans to employees (para 7.42), as does GFSM 2001 (para 6.14). BPM5 recognizes that concessional loans encompass a transfer element (para 104) falls short of providing guidance on how such transfers should be measured or recorded.

3. Background The paper sets out five possible ways of treating debt concessionality for noncommercial official lending. It concludes that the measurement of debt concessionality for these loans be recorded in a supplementary item and be in line with approach used by those measuring debt relief.

4. Why is this Issue important The demand for data has increased tremendously since the 1993 SNA. Examples include: The Millennium Development Goals incorporate debt relief and concessional lending among its indicators for monitoring debt sustainability. The HIPC debt sustainability discussions focuses on specific amounts of debt concessionality. Need to develop a consistent definition regardless of whether the debt is new or being rescheduled.

5. Discussions on this issue BOPTEG discussed this issue in December 2004, considered that more investigation was recognized given the issues that arose during the discussion. IMF staff undertook further work consulting those with a policy interest in the IMF, government finance experts, and the debt experts from the relevant international agencies on the TFFS.

6. Discussions BOPCOM considered the issue in June 2005 no consensus to include transfers arising from concessionality into the core accounts, and so preferred a supplementary item, and was divided as to whether such transfers should be current or capital. The BOPCOM paper was presented to the OECDs Working Party on Financial Accounts in October 2005 few comments were received.

7. Current Practice DAC calculates concessionality as the difference between the nominal value and the present value of the debt service as of the date of disbursement based on a discount rate applicable to the currency of the transaction and expressed as a percentage of the nominal value. At the Paris Club, debt reduction in present value terms is calculated The difference between the nominal value of the applicable debt and its present value using a market-based interest known as the OECDs Commercial Interest Reference Rate (CIRR) is the amount of debt relief derived. As noted by World Bank and others, transfers arising from concessionality are not limited to interest rate alonethe grace period, the frequency of payments and the maturity period.

8. Possible treatments Record concessional debt in nominal value (a) without accounting for the transfer element in interest rate. (b) but account for the difference between the market interest rate and the contractual interest rate on the debt as an on-going current transfer. (c ) but account for the concessional interest by recording a capital transfer at the point of loan origination equal to the present value of interest cost savings. (d) but record one-off transfers at the point of loan origination equal to the difference between the nominal value of the debt and its present value using a relevant market discount rate, as a supplementary item. (e) Record concessional debt at market-equivalent value but account for the concessionality element by recording one-off capital transfer at the point of origination.

9. Option (a) This is no change But because of the interest described above in data on debt concessionality, was never seriously considered by any group that considered the topic.

10. Option (b) Has the logic that the debtor is accruing less in interest than at the market rate. But how is the market rate to be determined ?: Should it be fixed at the time of the contract, the problem of recording transfer based on market rates no longer relevant Or should the market rate change with market conditions. After a period of time may not be concessional, could switch between concessional or not, but the two parties are locked into the same loan. Rather, if there are no conditions attached to the stream of future interest payments (BPM5 para 546) it is plausible to say that transfers arising from interest concessionality occur at the time of debt contract.

11. Option (c ) For a new loan: difference of two streams of interest paymentsone based market interest rate and the other the contractual interest ratewith the value of the transfer calculated as the present value of the difference. Such transfers could be recorded in the year they occur (i.e., when the contract becomes effective) as a memorandum item. This option is simple to implement and consistent with the concept of change of economic ownership. However, transfers do not arise from interest rate alone but are determined by many variables including the grace period, frequency of payments and maturity period.

12. Option (d) Include transfers arising from concessional loans as a supplementary item, transfer value calculated as a capital transfer the same as for DAC and the Paris Club (Table 1 in the paper) If loan is retired before maturity and replaced by a new loan, adjustment of the previously recorded transfers is required. This approach consistent with practice described above and also supported within IMF by Policy and Review Department. However, problem of appropriate discount rate: possibilities include the CIRR used in HIPC debt sustainability calculations. As a supplementary item allows these transfers to be measured and data disseminated, and compilers can develop their approaches overtime.

13. Option (e) Record the loan at market-equivalent value In the standard presentation two credit entries for the debtor would need to be recorded one under loans equal to the present value of the concessional debt, and another under capital transfers equal to the difference between the nominal value of the debt and its the present value using the market-equivalent rate as a discount factor. Interest on the loan would accrue at the market- equivalent rate as opposed to the contractual instrument rate. Such an approach is contra to the principle that loans are valued at nominal value

14. Questions for AEG Is the approach to defining these concessional loans, drawing on the work of the External Debt Guide (noncommercial, official loans) acceptable? Would option d) be an acceptable outcome? Does the AEG consider that further work should be encouraged to obtain better measures of appropriate market equivalent rates, to be used as the discount factor, but regard the CIRR as an acceptable proxy in the absence of other information?