varied by currency, and was based on the OECD’s CIRRs (commercial interest reference rates).<sup>5</sup> In 2004, a six-month moving average of the US dollar CIRR was used to calculate the PV of debt while grant elements were determined by using currency-specific CIRRs plus a mark-up. But with interest rates in advanced economies falling to historically low levels after the Great Recession, the PV of debt tended to be inflated, compressing borrowing space. The LIC DSF discount rate (DR) dropped to 3%, pushing up the PV of debt and restricting new borrowing. Large discrepancies arose between the DR for calculating the PV of debt and grant element calculations because of the variation in CIRRs across currencies.

These developments prompted a change in the discount rate in 2013. A 10-year average of the 10-year USD CIRR was adopted both for calculating the PV of debt and its grant element. The then-average CIRR plus a margin of 1.15% implied a rate of 5.26%, which was rounded down to 5%. This would be used for all debt related calculations irrespective of currency. This rate has stayed in force ever since and is, coincidentally, the DR used at the inception of the LIC DSF in 2004.

<mark>Summing up, in the pre- and immediate post-HIPC-MDRI era, the LIC DSF was fit for purpose because external debt was both concessional—because it was predominantly from official sources—and virtually synonymous with total public debt. Focusing on the PV of external debt made sense, even though the choice of an appropriate DR presented difficult conceptual and computational problems (to which we return below). But the debt configuration changed rapidly after HIPC-MDRI.</mark>

# **<mark>3. The Obsolescence of the 2005 LIC DSF</mark>**

<mark>In 2007 Ghana became the first beneficiary of HIPC-MDRI to issue a Eurobond, marking the start of the obsolescence of the LIC DSF. HIPC-MDRI cut G</mark> hana’s government debt from 78 percent of GDP in 2005 to 42 percent in 2006. In September 2007, the government issued a 10-year $750 million Eurobond— about 5 percent of Ghana’s GDP—at an interest rate of 8.5 percent.

The Eurobond issue seemed logical. The IMF’s April 2008 Regional Outlook for Africa applauded Ghana for a “...gradual, well sequenced opening” of the capital account following “...considerable debt reduction from HIPC and MDRI debt relief” (IMF 2008). Ghana's IDA Resource Allocation Index of 4.0 for 2007 was well above the average of 3.3 for all IDA borrowers for that year (the IDA Resource Allocation <u>Index runs from a low of 1 to a high of 6 and is an important input into how much money LICs receive</u> from IDA). It had also discovered oil, with revenues expected to start in 2011. The Eurobond could have been seen as borrowing against these revenues in line with the Permanent Income Hypothesis, which posits that consumption should be determined not by current income but by the present value of lifetime income. In the Ghanaian government’s case, the latter would be increased by the oil discovery.

But then things went wrong. First, political realities reared their head. The 2008 elections contributed to the fiscal deficit ballooning to 14.5 percent of GDP in 2008 from 9 percent the previous year, while the current account deficit shot up to 19 percent of GDP from 12 percent. Second, it was not clear how the proceeds from the 2007 Eurobond and from the privatization of Ghana Telecom, a total of over 10 percent of GDP, had been spent. Third, the debt reduction via HIPC-MDRI was rapidly reversed and the situation became even worse when arrears and contingent liabilities from state-owned enterprises were included. A June 2010 IMF report expected public debt to peak at 65 percent of GDP at end-2010, an increase of 20 percentage points of GDP in four years. Not included in the calculations were “domestic

> 5 The CIRRs are linked to secondary market yields on advanced economy (AE) government bonds and constitute the minimum interest rates to be charged on fixed-interest rate export credits; floating rates have different rules.

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