Debt Sustainability Analysis and Grants

ADB revised its ADF grant framework in September 2007. The revised ADF grant framework is substantially aligned with that of IDA.

During its IDA14 replenishment, IDA revised its framework with a goal of helping low-income countries restore or maintain external debt sustainability. The revised framework is grounded in the debt-sustainability framework (DSF) of the International Monetary Fund (IMF) and the World Bank, wherein a country’s eligibility for grants is based solely on debt-sustainability criteria. The DSF seeks to minimize the possibility that low-income countries will incur unsustainable debts in view of the large financing needs implied by the Millennium Development Goals. An evaluation of prospective debt dynamics and judgments about the risk of debt distress are at the core of the new framework.

Under the revised ADF grant framework, eligibility for ADF grants is limited to ADF-only countries. The risk of debt distress will determine the proportion of grants in the country allocation. The debt distress classification is based on debt sustainability analyses (DSAs) using the joint IMF-World Bank DSF for low-income countries (or the debt data available at that time in the absence of a DSA).

The IMF and the World Bank conduct joint DSAs for low-income countries. ADB collaborates with the IMF and the World Bank on DSAs.

The analytical basis for the DSA rests on three pillars: (i) policy-dependent external debt thresholds, (ii) DSAs and associated stress tests, and (iii) an appropriate borrowing (and lending) strategy that contains the risk of debt distress.

The ratings from ADB’s country performance assessment are used to classify countries as having strong, medium, or weak policy performance.

ADF resources under the revised framework are distributed according to the current performance-based allocation (PBA) formula. The proportion of grant assistance is then set based on the debt-distress classification. For countries eligible for grant assistance, the proportion of grants in the country program follows the same debt-distress classification used by IDA:

  • No grants for low risk of debt distress,
  • 50% grant for moderate risk of debt distress, and
  • 100% grant for high risk of debt distress.

A 20% volume discount is applied to the grant portion of the PBA. Thus, for moderate-risk countries, which have access to 50% of their PBA as grants, the discount is equivalent to 10% of the PBA. The grant allocations of post-conflict countries are not subject to the volume discount.
Directly linking the ADF grant allocation scheme to countries' debt sustainability analyses has had significant operational and financial implications for ADF countries and ADB itself.

ADB's annual review of country debt distress classifications coincides with the country performance assessment exercise. Within a biennial allocation period, ADB takes a conservative approach in the reclassification of countries. If it finds improvement in a country's debt distress classification after the first year of the biennial period, ADB maintains the higher proportion of grants to the end of the period (e.g., if a high-risk country becomes moderate-risk after the first year of a biennial allocation, the allocation will continue to be on a 100% grant basis). In contrast, if the country's debt distress situation deteriorates, the higher grant proportion will be applied to the remainder of the PBA in the second year of the biennial period.