Author : World Bang Group
Site of publication : World Bank Group
Type of publication : Report
Date of publication : August 2022
Sierra Leone’s risk of external and overall debt distress remains high, but debt is sustainable. Fiscal slippages and external factors have increased the risks around the baseline, as a larger and more frontloaded fiscal adjustment is now required to achieve the program objectives. Although Sierra Leone’s debt carrying capacity has been upgraded to medium compared to the previous Debt Settlement Arrangement (DSA) report, one external debt burden indicator and the PV of public debt-to-GDP ratio exhibit sustained breaches of their respective sustainability thresholds. A heavy reliance on short-term domestic financing (T-Bills) creates potential rollover risks, as reflected in persistently elevated debt service ratios and gross financing needs over the medium- and long-term. Domestic rollover risks are mitigated by limited alternative investment options for domestic banks and the authorities’ commitment to limit future domestic borrowing. That said, a lengthening of the maturity structure of domestic debt (via active liability management operations) is critical to reduce refinancing risks. Sierra Leone’s debt is sustainable as all the debt indicators remain on a declining trend over the medium- to longterm. This assessment is predicated on the authorities’ ambitious fiscal adjustment and continued reliance on concessional financing and grants, and moderately high growth rates. Maintaining debt sustainability requires sustained fiscal adjustment underpinned by strengthened public financial management, effective expenditure prioritization, redoubling structural and revenue mobilization reforms.
Public debt coverage
1. The Government is working, with the support of development partners, to improve its financial and debt management systems, and to enhance the accounting and timely reporting of public debt, including those of state-owned enterprises (SOEs) and selfaccounting-bodies.
BACKGROUND ON DEBT
2. The COVID-19 shock seriously strained Sierra Leone’s public finances, and total public debt increased in 2021. The large shock to growth and revenues and measures to counter the impact of the pandemic, increased the fiscal deficit in 2020 and 2021. Total public debt at end-2021 is estimated to be around 76.8 percent of GDP, slightly increased from the level of end-2020. Public debt would slightly increase further in 2022-2023 and steadily decrease over the medium term.
Sierra Leone’s debt is sustainable as all the debt indicators remain on a declining trend over the medium- to longterm. This assessment is predicated on the authorities’ ambitious fiscal adjustment and continued reliance on concessional financing and grants, and moderately high growth rates
3. Public and publicly guaranteed (PPG) external debt was around 50 percent of GDP in 2021, almost the same level as at end-2020. It is expected to increase further in 2022. About 79 percent of Sierra Leone’s PPG external debt at end-2021 comprised non-restructurable obligations to multilateral creditors.
4. Sierra Leone domestic public debt increased from 26.6 percent of GDP at end-2020 to 27.6 percent at end-2021. Around 59 percent of domestic debt is owed to commercial banks mainly in the form of 364-day T-Bills, while the rest are distributed between the BSL, the non-bank, and legacy domestic arrears owed to suppliers (Text Figure 2). The pre-April 2018 legacy arrears have been progressively paid down from about 9.8 percent of GDP in 2019 to about 5.6 percent of GDP in 2021, largely at face value.
The large shock to growth and revenues and measures to counter the impact of the pandemic, increased the fiscal deficit in 2020 and 2021. Total public debt at end-2021 is estimated to be around 76.8 percent of GDP, slightly increased from the level of end-2020. Public debt would slightly increase further in 2022-2023 and steadily decrease over the medium term
KEY ASSUMPTIONS UNDER THE BASELINE SCENARIO
5. The assumptions are consistent with the macroeconomic framework in the staff report.
Growth. Real GDP growth is estimated to have rebounded to about 3.2 percent in 2021 following the COVID shock in 2020, and to increase to 3.6 percent in 2022. Growth in 2022 has been downgraded from 5.9 percent in the previous DSA, due to lower forecasts for iron ore production, greater uncertainty around the global trajectory of the COVID-19 pandemic, and the likely shock to terms-of-trade4 and global growth as a result of the ongoing war in Ukraine. Nearly three-fourths of the country is assessed to be food insecure and recent rise in food prices and supply disruptions, precipitated by the war in Ukraine, has intensified this concern and poses risks to economic activity. Growth is projected to converge to its long-run potential and historical average of around 4½ percent over the medium term, supported by the recent resumption of production at both the Tonkolili and Marampa iron ore mines (for the first time since Ebola), good prospects for new developments in the diamond mining sector, and continued policy support for the agricultural sector. Around 17¼ percent of the population have received two vaccination doses as of mid-May. Vaccine hesitancy and logistical challenges persist.
Sierra Leone domestic public debt increased from 26.6 percent of GDP at end-2020 to 27.6 percent at end-2021. Around 59 percent of domestic debt is owed to commercial banks mainly in the form of 364-day T-Bills, while the rest are distributed between the BSL, the non-bank, and legacy domestic arrears owed to suppliers
Inflation. Inflation, as measured by the GDP deflator, is estimated to be broadly in line with average consumer price inflation in 2021 at 11.1 percent and increases to 15.8 percent in 2022.5 Inflation projections for 2022 and beyond have been revised up relative to the previous DSA due to recent trends in global food and fuel price inflation, and the outturn through March 2022, which was higher than expected. Inflation is projected to decline gradually after 2022, and to reach single digits by 2027 measured by the GDP deflator, as fiscal financing pressures recede, and the monetary policy framework improves.
Fiscal. Successive shocks and emerging spending pressures have rendered an extremely tight budget situation. Notwithstanding revenues being on target, the overall fiscal deficit widened by about 3.5 percentage points higher than the target of 3.8 percent of non-iron ore GDP in 2021. These overruns reflected expenditure pressures (containing a third wave of COVID-19, wages and salaries, goods and services due to inflationary pressures, accelerated domestic capital projects following COVID delays) and more than anticipated energy subsidies. A supplementary 2022 budget covers emerging spending pressures, while ensuring that the fiscal targets under the program remain on course. Pressures on social transfers, wage bills and pre-election spending will continue to pose risks to planned fiscal consolidation. Under the baseline scenario, the domestic primary balance shifts into surplus in 2023 and to 1.7 percent of non-iron ore GDP by 2024, as domestic revenues improve.
External. Due to the ongoing Russia-Ukraine war and the resulting fuel price increases, the current account deficit is projected to remain high in 2022. The deficit will be partly offset by strong exports due to the commodity (iron ore) price increase. The current account will gradually improve towards the medium-term, supported by mining production.
6. The three-year average of fiscal adjustment over 2022-25 reflects a structural break recovery from a sharp deterioration in the primary balance in 2020 and 2021 due to the COVID-19 shock and its impact on revenues, higher energy subsidies, and wage pressures from key sectors (education, security and health). To maintain the fiscal path under the program, Sierra Leone authorities will have to frontload a steeper fiscal adjustment than anticipated in the previous DSA. Regarding domestic revenue, it is projected to increase from about 13.8 percent of GDP in 2020 to about 16.0 percent in 2025, lower relative to previous DSA due to lower than anticipated efficiency yields from the automation program.
Country classification and determination scenario stress test
7. Sierra Leone is assessed to be at high risk of external debt distress, and PPG external debt is assessed to be sustainable. This is predicated on the strong fiscal adjustment and continued reliance on concessional financing and grants, and moderately high growth rates.
8. The debt service to revenue ratio and gross financing needs in Sierra Leone are persistently high and their reduction is contingent on very strong fiscal policies and greater grant and/or concessional borrowing. The need to rollover T-Bills issued in the previous year accounts for around 70 percent of gross financing needs and the debt service-to-revenue ratio. However, considering the characteristics of Sierra Leone’s domestic financial market—where commercial banks’ business model has relied heavily on T-Bills, there is no secondary market, and foreign participation is absent—liquidity risks from this rollover appear manageable.
9. While Sierra Leone is assessed to be at high risk of external and overall public debt distress, its debt is assessed to be sustainable. While the COVID-19 shock worsened the public debt situation by weakening growth, revenue, and exports, the medium- to long-term trajectories of debt ratios remain largely unchanged from the pre-pandemic projection. However, the increasing public debt service-to-revenue ratio over the medium term suggests high liquidity-related vulnerabilities.
10. It should also be mentioned that the baseline outlook is subject to downside risks mainly due to the Russia-Ukraine war and emergence of new COVID-19 variants. Further increases in fuel, food and fertilizer prices or health shocks could exacerbate the severe burden on the population, deteriorate budget and external balances, increase costs for businesses, prolong fuel subsidies, provoke social discontent, and put debt sustainability at risk. Given these vulnerabilities to exogenous shocks and potential fiscal pressure stemming from upcoming elections, reducing debt and maintaining debt sustainability requires, first and foremost, sustained fiscal adjustment, underpinned by strengthened public financial management, effective expenditure prioritization, and redoubling structural and revenue mobilization reform efforts.
11. Development of a deeper domestic debt market will be critical in mitigating potential rollover risks. While these risks remain manageable so far given the characteristics of Sierra Leone’s market, greater exposure of commercial banks to the sovereign risks that unanticipated future shocks could impact financial stability. This risk is mitigated by the authorities’ commitment to limit future domestic borrowing and continued technical assistance in debt management and development of a domestic market, including drawing on recent IMF technical assistance on debt recording and joint World Bank/IMF technical assistance on a medium-term debt strategy.