MACROECONOMICS, TRADE AND INVESTMENT MACROECONOMICS, TRADE AND INVESTMENT EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT An Overview of the Potential Im- pact of the COVID-19 Crisis on the Accumulation of Government Ex- penditure Arrears Robert Utz Massimo Mastruzzi Francisco Vasquez Ahued Ehab Tawfik ABSTRACT The COVID-19 pandemic introduced tremendous fiscal pressures for many countries, requiring additional spending to mitigate the health, economic, and social impacts of the pandemic while government revenues are falling. Governments are addressing these fiscal pressures through a range of measures, including additional borrowing and expenditure adjustments. In environments where fiscal space is tight and public expenditure management is weak, the accumulation of government expenditure arrears is likely. This note presents some early data on the impact of these fiscal pressures on government arrears in low income countries. © 2020 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved. This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. 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The risk of claims resulting from such infringement rests solely with you. If you wish to reuse a component of the work, it is your responsibility to determine whether permission is needed for that reuse and to obtain permission from the copyright owner. Examples of components can include, but are not limited to, tables, figures, or images. All queries on rights and licenses should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; e-mail: pubrights@ worldbank.org. AN OVERVIEW OF THE POTENTIAL IMPACT OF THE COVID-19 CRISIS ON THE 4 >>> ACCUMULATION OF GOVERNMENT EXPENDITURE ARREARS >>> Contents 1. Introduction 7 2. Definition and Measurement 7 3. Drivers of Arrears Accumulation 10 4. Consequences of Arrears Accumulation 10 5. The Impact of COVID-19 on Arrears Accumulation and 11 Settlement: Early Data 6. Conclusions and Recommendations 14 7. References 15 8. Annex 1 - Country Information 16 9. Annex 2 - Responses from Country Economists 26 10. Annex 3 - Caveats to Data & Analysis 27 >>> Acknowledgements This note was prepared under the supervision and guidance of Chiara Bronchi and Marcello Estevao and benefitted from valuable inputs and feedback by Zoubida Allaoua, Doerte Doeme- land, Ranjeet Gosh, Sandra Hlivnjak, Sandeep Mahajan, Nadir Mohammed, and Lalita Moorty. The team expresses its gratitude to all the regional EFI/MTI country teams who provided infor- mation on public expenditure arrears in their countries of responsibility. AN OVERVIEW OF THE POTENTIAL IMPACT OF THE COVID-19 CRISIS ON THE ACCUMULATION OF GOVERNMENT EXPENDITURE ARREARS <<< 5 3. MTI INSIGHT >>> An Overview of the Potential Impact of the COVID-19 Crisis on the Accumulation of Government Expenditure Arrears >> INTRODUCTION The COVID-19 pandemic introduced tremendous fiscal pressures for many countries, requiring additional spending to mitigate the health, economic, and social impacts of the pandemic while government revenues are falling. Governments are addressing these fiscal pressures through a range of measures, including additional borrowing and expenditure adjustments. In environments where fiscal space is tight and public expenditure management is weak, the accumulation of government expenditure arrears is likely. This note presents some early data on the impact of these fiscal pressures on government arrears in low income countries. Before presenting the data, we discuss briefly definition and measurement of arrears as well as the main drivers and economic consequences of arrears accumulation. We conclude with some options for preventing and managing arrears accumulation. >> DEFINITION AND MEASUREMENT Government expenditure arrears are financial obligations that have been incurred by any level of the public sector for which payments have not been made by the due date (Flynn and Pessoa, 2014). Contractually agreed interest and penalties on overdue payments also form part of arrears. Arrears can be classified by the underlying type of expenditure and whether they are within the public sector - including payments for goods and services provided by public utilities and other SOEs as well as transfers and subsidies to subnational governments, SOEs, statutory funds and other government entities - and arrears with individuals and entities outside government - including wages and salaries, payments to commercial contractors and suppliers, interest and principal on government debt and other liabilities, and transfers and subsidies to households, and businesses. There is wide variation across countries and types of payment obligations as to when these turn into arrears and whether and when they are registered and reported. Weaknesses in governments’ PFM systems hinder the adequate capture and timely reporting of domestic arrears, a problem likely compounded by work-from-home policies enacted since the outbreak of the COVID-19 pandemic. The lack of standardized national definitions and coverage further AN OVERVIEW OF THE POTENTIAL IMPACT OF THE COVID-19 CRISIS ON THE ACCUMULATION OF GOVERNMENT EXPENDITURE ARREARS <<< 7 complicates the problem of quantifying arrears across coun- The way arrears are reflected in a country’s public financial tries (IMF 2019). Figures on arrears, where they exist, are accounts differs depending on whether cash or accrual often incomplete due to “unrecognized” arrears, i.e., arrears accounting is being used. With cash accounting, only actual that have not yet been recorded or audited, often including payments received and made are reflected in the accounts. arrears to utilities and social security funds. Due payments to Consequently, the accumulation of arrears during a fiscal suppliers may not turn as quickly and as visibly into arrears as year would make that year’s fiscal deficit appear smaller as obligations for debt service, wages and salaries, potentially re- payment is delayed to another fiscal year. Therefore, under maining unrecognized for some time. Terms of payment often cash accounting, arrears can affect the size of the fiscal include long and sometimes flexible payment deadlines, in- deficit and authorities at times use arrears to achieve fiscal voices may not be recorded on a timely basis in governments’ targets. Under accrual accounting, on the other hand, revenue PFM systems, and payment terms are often re-negotiated is recorded when earned and expenditures when incurred with suppliers. and the size of the fiscal deficit would not be affected by the accrual of arrears. “Arrears” to SOEs and transfers to subnational governments are often not recorded as arrears and used extensively in Public Expenditure and Financial Accountability moving around fund flows in the interest of reaching a fiscal Assessments (PEFAs) for 76 countries suggest that arrears deficit target. For the SOEs, public institutions do not pay for are widespread and monitoring of arrears often weak (Figure the services delivered; SOEs do not pay their taxes, or submit 1). Countries in the South Asia and Africa regions have the dividends, and often governments are “bailing them out” on highest levels of arrears and the weakest monitoring systems, a regular basis. While cross arrears are frequent for “within while countries in ECA have relatively strong monitoring public sector arrears,” they also occur with respect to entities systems and low levels of arrears. outside government, especially in the form of tax arrears and generate complex financial management and transparency issues for all parties involved. > > > > > > F I G U R E 1 - PEFA Arrears Indicators by Region F I G U R E 2 - Arrears-related DPO Prior Actions by Region, FY20004-20 AN OVERVIEW OF THE POTENTIAL IMPACT OF THE COVID-19 CRISIS ON THE 8 >>> ACCUMULATION OF GOVERNMENT EXPENDITURE ARREARS > > > > > > F I G U R E 3 - Arrears-related DPO Prior Action by F I G U R E 4 - Arrears-related DPO Prior Actions by Approval Year, FY2004-20 (#) Theme, FY2015-20 (#) Note: With respect to the stock of arrears, PEFA ratings of 2/3/4 (corresponding to the original rating of C/B/A) indicate that the stock of expenditure arrears is no more than 10%/6/%/2% of total expenditure in at least two of the last three completed fiscal years. With respect to expenditure arrears monitoring, PEFA ratings of 2/3/4 indicate that data on the stock and composition of expenditure arrears is generated: annually at the end of each fiscal year / quarterly within eight weeks of the end of each quarter / quarterly within four weeks of the end of each quarter. For both sub-indicators, a rating of 1 (D) indicates that performance is less than required for a score of 2. Widespread problems with arrears are also reflected in the A recent IMF study (2019) on domestic expenditure World Bank’s Development Policy Operations, which often arrears in Sub-Saharan Africa1 showed that they significantly support countries in reducing arrears and strengthening PFM increased since the global financial crisis, especially in systems to prevent and manage arrears. In the past five commodity exporting countries, in parallel with the increase years, 30 prior actions in the World Bank’s development policy in public and private debt. As a result, arrears were already operations supported programs to address arrears problems. large and pervasive vis-à-vis historical trends before the onset About half of these actions targeted directly arrears clearance. of the COVID-19 pandemic, adding to existing vulnerabilities Payment of arrears to energy companies, collection of arrears of limited fiscal space. The 2019 IMF report also showed that to government, and strengthening arrears reporting are also at least 70 percent of countries in Sub-Saharan Africa had supported in several DPOs (Figure 4). Looking at arrears- domestic expenditure arrears in 2018 amounting on average related prior actions in DPOs over the past 15 years (Figure to about 3% of GDP with arrears to private sector suppliers 3) shows an increase in their frequency in the years following accounting for the largest share, followed by arrears to SOEs; the global financial crisis, hinting at the impact of the crisis on government employees; statutory funds; and subnational arrears. Over that period, arrears related prior actions where governments. most frequent in the Africa region (60 prior actions), but DPOs in ECA and LAC also addressed arrears issues frequently (20 prior actions in each region) (Figure 2). 1. Sub-Saharan Africa Regional Economic Outlook: Navigating Uncertainty, IMF, October 2019. AN OVERVIEW OF THE POTENTIAL IMPACT OF THE COVID-19 CRISIS ON THE ACCUMULATION OF GOVERNMENT EXPENDITURE ARREARS <<< 9 >> D R I V E R S O F A R R E A R S A C C U M U L AT I O N Government arrears are in the first instance the consequence Fiscal shocks such as unforeseen expenditure requirements of weaknesses in public expenditure systems that fail to and drops in government revenue as in the case of natural align and constrain expenditures to available resources. disasters or pandemic outbreaks can create extraordinary These include the adoption of policy initiatives without proper fiscal pressures leading to arrears even in environments where costing and identification of funding sources, government public expenditure management is solid enough to prevent the budgets that are based on unrealistic revenue estimates and accumulation of persistent and large arrears in normal times. underestimate expenditure; weak commitment control and Indeed, large fiscal shocks are historically a leading indicator cash management at the budget execution stage; and often of substantial arrears accumulation, especially where PFM also simple weaknesses in the management and processing systems are weak. The IMF (2019) estimated that for Sub- of payables, compounded in some cases by illegal and corrupt Saharan African economies, a one-standard deviation decline practices such as illegitimate or inflated invoices and corrupt in GDP growth and in commodity terms of trade would result processes for the settlement of invoices. All these factors in a 0.9 and 0.6 percentage point increase in the domestic result in a situation where accounts payable are not settled on expenditure arrears-to-GDP ratio, respectively. Naturally, these time. “Within public sector” arrears are also used to achieve effects would generally be larger in countries with weak fiscal fiscal deficit targets. institutions and PFM systems as well as other macroeconomic and structural factors such as fixed exchange rates regimes, limited fiscal space, and countries in fragile situations. >> C O N S E Q U E N C E S O F A R R E A R S A C C U M U L AT I O N Government arrears have a corrosive effect on public particular consequence, as it may result in reduced access to finances and economies. Delayed, or non-payment of credit and reduced tax morale and compliance. obligations, has direct effects on those due to receive payment, with potential spill-over effects reverberating Arrears can also create complex governance issues, as they throughout the economy. Such impacts are particularly severe introduce a significant degree of administrative discretion into in an environment of economic crisis and recession, where public financial management both at the time when they are private sector revenue streams are also under stress and created and when they are settled. In an environment where where expected incomes and payments from government are there is not enough money available to settle all payments often critical to avoiding hardship for households and avoiding before their due dates, public finance managers decide liquidity and solvency problems for businesses, SOEs, and which obligations to settle before their due date and which other government entities. These, in turn, may affect entire not. Similarly, once the authorities embark on settling arrears, value chains, as those suffering delayed or non-payment from there are typically again decisions to be made on which arrears the government may not be able to fulfill their commitments to to give priority. This creates opportunities for corruption, their employees, to their suppliers, to their creditors, to their where illegal payments can influence the prioritization of the owners and even to the same government. settlement of particular invoices and arrears. In addition, once governments start to accumulate arrears, there are additional To the extent that government arrears are a recurring governance risks in terms of illegitimate invoices and high problem, they will also affect the cost and quality of penalties for payment delays that are added to the arrears government procurement. Suppliers will factor in the likelihood stock for settlement. of government payment difficulties into the pricing of goods and services and their decisions to enter into contracts with governments. High quality suppliers may decide to refrain from government engagements. In general, delayed or non-payment of arrears will undermine the credibility of government with not only the entities with whom it transacts, but also with the financial sector and citizens more widely. Loss of credibility with the public and the financial sector is of AN OVERVIEW OF THE POTENTIAL IMPACT OF THE COVID-19 CRISIS ON THE 10 >>> ACCUMULATION OF GOVERNMENT EXPENDITURE ARREARS > > T H E I M PA C T O F C O V I D - 1 9 O N A R R E A R S A C C U M U L AT I O N A N D S E T T L E M E N T - E A R LY D ATA As the COVID-19 pandemic triggered sharp drops in GDP, arrears in other categories. This may signal that governments government revenues, and commodity prices around the globe, are leaning on domestic financial institutions to absorb government arrears are likely to increase in many countries. governments’ liquidity pressures, creating space to remain The Global Economic Prospects (June 2020) projects real current or reduce obligations on other categories of accounts GDP growth in EMDEs to drop by 6 percentage points to a -2.5 payable. percent in 2020. Using the estimated relationship between a shock to GDP and the increase in arrears for Sub-Saharan With respect to supplier arrears, they have not recorded Africa, this would imply that domestic expenditure arrears significant increases in the countries for which data are would be expected to increase by more than 2 percent of GDP available. In some countries this reflects a deliberate policy on average, though countries with weak fiscal institutions and to keep small- and medium-size suppliers afloat and prevent PFM systems – as well as commodity exporters - are at risk of further strain on businesses, unemployment, economic significantly higher accumulation of arrears.2 activity, and business confidence7. However, as mentioned above, due payments to suppliers may not turn as quickly, Data and commentary received from WB country economists and as visibly into arrears as obligations for debt service and revealed some important emerging trends with respect to wages and salaries, with the potential to remain unrecognized arrears accumulation and arrears stocks in the early months for some time. Therefore, further investigation will be needed of the COVID-19 pandemic.3 All country economists were to corroborate these trends and assess with precision the canvassed to obtain information on the evolution of arrears exact size of arrears. following the outbreak of the Covid-19 pandemic.4 In all, 74 country responses were received, of which 25 included recent Outside of the general government, there is some evidence data on arrears, 14 only included basic narrative of recent that arrears to and by SOEs may have increased as a result of trends and 35 provided insufficient data and information for the liquidity crunch, although further investigation is warranted. inclusion in analysis. Of the 25 countries for which data on The halt in economic activity has strained the balance sheets arrears was received, about a third registered an increase and income statements of SOEs, particularly utility and in arrears since March 2020 (Figure 5). These were mostly energy corporations. Exacerbating these constraints, some concentrated in Sub-Saharan Africa5 and within domestic debt governments that are accustomed to providing direct support service arrears. Four countries in Sub-Saharan Africa6 also to their SOEs now find themselves with limited fiscal capacity presented arrears disaggregated by economic category; within to do so. As an example, consolidated comments from the this group, most governments reported to have kept current, ECA Region reveal that arrears are concentrated in SOEs, or even reduced, their arrears in salaries, social contributions, especially in the energy, transport, and communications pensions and transfers. sectors. The drop in oil prices is likely to have reduced financial pressures on the energy utility corporations and oil importing Data also indicate financial sector dynamics that could countries in general, but postponement of utility payments increase macro-financial vulnerabilities. For instance, some as well as lockdowns and slowdown in economic activity are countries have securitized arrears while others have allowed likely to have had a severe negative impact on the financial debt service arrears to increase while simultaneously reducing situation of SOEs. 2. The median of the standard deviation of real GDP growth for all countries over the period 2001-2017 was about 2.7 percent. 3. Data quality considerations might affect the validity of these findings - see Annex 3- Caveats to Data & Analysis. 4. The standard definition of domestic expenditure arrears excludes overdue debt service. However, available data at times do not make this distinction and therefore the data in this note also includes domestic debt service arrears. 5. See Annex 1 for a discussion on a country by country basis. 6. SSA countries that have provided disaggregated arrears by category are: Cameroon, Central African Republic, The Democratic Republic of Congo, and Sierra Leone. 7. This was the case for instance in Cameroon, Democratic Republic of Congo, Sierra Leone, Haiti, and Costa Rica where supplier arrears have, in fact, decreased. AN OVERVIEW OF THE POTENTIAL IMPACT OF THE COVID-19 CRISIS ON THE ACCUMULATION OF GOVERNMENT EXPENDITURE ARREARS <<< 11 > > > F I G U R E 5 - Change in Arrears Following the COVID-19 Outbreak /1 Dates for pre and post COVID vary (June-20/Mar-20, June-20/Dec-19, May-20/Mar-20) Note: Change in arrears data returned for only 25 countries. Countries with zero change on chart reported no change in arrears position. GG refers to General Government. 2019 fiscal data are used to estimate relative size of arrears for each country and therefore how problematic arrears are. *Arrears reported only for salaries. BDI numbers are estimates. Sources: WB BOOST Staff Calculations based on WB Country Economist data/emails and IMF WEO AN OVERVIEW OF THE POTENTIAL IMPACT OF THE COVID-19 CRISIS ON THE 12 >>> ACCUMULATION OF GOVERNMENT EXPENDITURE ARREARS > > > F I G U R E 6 - Stock of Arrears /1 Latest dates for stock vary (Jun-20, Mar-20, Jan-20, Dec-19) Note: Stock of arrears data returned for only 19 countries. GG refers to General Government. 2019 fiscal data are used to estimate relative size of arrears for each country and therefore how problematic arrears are. Net debt data not available for most countries. Gross debt is used instead. BDI numbers are estimates. Sources: WB BOOST Staff Calculations based on WB Country Economist data/emails and IMF WEO October 2019 vintage. AN OVERVIEW OF THE POTENTIAL IMPACT OF THE COVID-19 CRISIS ON THE ACCUMULATION OF GOVERNMENT EXPENDITURE ARREARS <<< 13 >> C O N C L U S I O N S A N D R E C O M M E N D AT I O N S The analysis and data collected indicate that the fiscal sector performance. In addition, fiscal multipliers for different pressures created by the COVID-19 pandemic are already sub-categories of current and capital spending can be an resulting in an increase in arrears in some countries. As important tool to guide government prioritization of payment discussed in this note, delayed payments may manifest decisions, helping identify the most consequential categories themselves as arrears in governments’ financial monitoring of payment with the highest fiscal multipliers. Staying current systems and reporting only after some period of time. As the on these high impact categories will ameliorate shocks to crisis persists and fiscal buffers are further depleted, there is short-term and medium-term growth. a significant risk that governments’ liquidity problems and the accumulation of arrears will become more widespread. In the To avoid the accumulation of arrears, governments may also following we summarize key actions to prevent and manage seek to renegotiate payment periods and related conditions, the accumulation of arrears due to COVID-19 related fiscal especially when liquidity constraints are temporary. pressures. Strengthening monitoring of arrears. If arrears are Avoiding arrears accumulation. Dealing with the structural unavoidable, it will be important to establish systems to keep weaknesses in countries’ public expenditure management track of payments in arrears. A detailed inventory of arrears systems that facilitate the occurrence of arrears requires should be maintained by the Ministry of Finance. Of particular systemic reforms which require significant time, resources, importance is the monitoring of newly accumulated arrears and political commitment.8 Nonetheless, in environments by subnational government entities, SOEs, and government where fiscal space is limited and public expenditure systems agencies, which create significant fiscal risks for the central are weak, short term measures to avoid the uncontrolled government. accumulation of arrears during the COVID-19 crisis need to be put in place. These include continuous updating of revenue Settling of arrears. Good practice for settling arrears projections to capture the impact of the COVID-19 pandemic, requires that it is done on in a systematic way grounded in costing of COVID-19 related policy measures, and assessment an arrear clearance strategy. Characteristics of sound arrears of available fiscal space including the creation of additional clearance strategies include comprehensiveness, i.e. they fiscal space through adjustments of non-COVID-19 related include all public sector arrears; verification of arrears to ensure expenditures and additional borrowing and mobilization of that they represent valid claims; transparency, i.e., it sets out aid resources. This would feed into budget revision and cash a clear timetable and prioritization criteria for the clearance flow management. Given the unpredictability of the health and of arrears; and realism and credibility, i.e., credible measures economic impacts of COVID-19, revenue and expenditure have been adopted to prevent further arrears accumulation performance will need to be regularly monitored through cash and to ensure that resources will indeed be available to settle flow management committees with continuous adjustments of arrears according to the timetable. expenditure and resource mobilization measures. Using the settlement of arrears to insert liquidity into the Prioritization of payments and cash management. To economy should follow good practice for arrears clearance to reduce governance risks related to arrears, appropriate cash reduce the risk of abuse. Arrears clearance is also likely to management processes need to be in place to prioritize have very poor targeting for vulnerable entities. payments when cash resources are not sufficient to settle all payments before the due date. Cash management committees are important institutions to manage and prioritize payments. Criteria for prioritization should be spelt out clearly. Key considerations that feed into the prioritization of payments typically include the socio-economic impact to avoid harm to vulnerable households and businesses, the cost associated with delayed payments in terms of interest and penalty charges, and the risk of legal and the risk of disrupting or increasing the cost of essential inputs to public 8. See Flynn and Pessoa for a summary of reforms to prevent and manage arrears. AN OVERVIEW OF THE POTENTIAL IMPACT OF THE COVID-19 CRISIS ON THE 14 >>> ACCUMULATION OF GOVERNMENT EXPENDITURE ARREARS Securitization of arrears. Arrears represent unilateral borrowing of government from other economic actors, generating implicit claims on government (Ramos 1998). Securitization of arrears provides creditor with market- negotiable titles to their claims on government. As such, it provides claimants some reassurance about the value and time of settlement of their claims. It also allows them to trade these claims in secondary markets, thus being able to obtain funds (possibly with a discount) earlier. Securitization is typically only a credible policy action as part of a credible arrears clearance plan when the accumulation of new arrears has been stopped. However, in the case of a large external shock such as the COVID-19 pandemic, securitization may be considered by governments that have a credible track record for meeting their obligations. >> REFERENCES Flynn, N. and M. Pessoa. 2014. Prevention and Management of Government Arrears. Technical Notes and Manuals 14/01. Fiscal Affairs Department. IMF. May 2014 IMF. 2019. Regional Economic Outlook: Sub-Saharan Africa – Navigating Uncertainty. Background Paper: Online Annexes and Statistical Data. October 2019. Ramos, A. 1998. Government Expenditure Arrears: Securitization and Other Solutions. IMF Working Paper WP/98/70. May 1998. World Bank. 1998. Public Expenditure Management Handbook. AN OVERVIEW OF THE POTENTIAL IMPACT OF THE COVID-19 CRISIS ON THE ACCUMULATION OF GOVERNMENT EXPENDITURE ARREARS <<< 15 >> A N N E X 1 - C O U N T RY I N F O R M AT I O N >>> SUB-SAHARAN AFRICA Cameroon has kept its headline arrears constant as a share of GDP but altered their composition. Growth in total Sub-saharan Africa is the region for which the team has arrears amounted to 5.5 percent between March and April of received data and commentary for the largest number of 2020. While government arrears to suppliers were reduced, countries. Reports on arrears paint a diverse picture ranging arrears to an unidentified category called “Other” increased from sharp increases in arrears stocks to countries that have markedly. However, there were no reported increases to other managed to keep stocks unaffected by the liquidity constraints. categories of arrears such as salaries, pensions, transfers, or domestic debt, suggesting relatively successful management In Angola, preliminary reports from the country team suggest of liquidity. that the government continues to reinforce its commitment to regularize arrears, albeit at a slower pace. As such, country > > > F I G U R E 8 - Cameroon: Arrear Breakdown economists believe that headline arrears accumulation is not a risk for Angola. In partnership with the IMF, Benin has committed to reduce arrears in 2020. As of March 2020, there was no arrears accumulation registered and, as of June 2020, the Government of Benin has indicated no difficulties in maintaining its objective of reducing arrears. In Burundi, while comprehensive information is not yet available, domestic arrears are estimated to have increased. Starting from the budget law of 2018/2019, the Government opted for securitizing arrears into government debt through financial instruments that were purchased by > > > banks. Notwithstanding, pre-covid and post-covid estimates F I G U R E 9 - Cameroon: Contributions to Growth in of arrears for the country show an estimated increase by 1 Arrears percent of GDP. > > > F I G U R E 7 - Burundi: Arrears as % of GDP Sources: WB Boost Staff calculations based on data provided by WB Country Economists AN OVERVIEW OF THE POTENTIAL IMPACT OF THE COVID-19 CRISIS ON THE 16 >>> ACCUMULATION OF GOVERNMENT EXPENDITURE ARREARS In the Central African Republic total arrears increased remained constant in recent years because of commitments to from 12.1 % GDP to 12.6% GDP between March and June zero arrears accumulation under World Bank and IMF reform of 2020. This is also equivalent to a 5.5 percent growth in programs. In 2020, the amount of domestic arrears is expected total arrears with the principal driver being salary arrears, to decline as authorities settle part of the accumulated arrears. contributing 3.6 percentage points of the total growth of 5.5 No arrears have been registered thus far in 2020. percent. Structurally, domestic debt arrears are the biggest component of total arrears pre-and post-covid at around 70 % In the Democratic Republic of Congo, arrears have increased of total arrears. It remains unclear who is holding this debt and but still remain at manageable levels. After an aggressive what repercussions this may have on broader macro-financial reduction in arrears in 2020Q1, arrears have risen in Q2. stability. Coupled with the sharp increase in salary arrears, this The government reduced arrears to suppliers aggressively in is likely to have negative repercussions for economic activity both quarters but the increase in Q2 is due to a sharp rise in as consumer demand and confidence dwindle further. transfers arrears. Nonetheless, total arrears do not appear to be a significant problem at 0.27 percent of GDP. > > > F I G U R E 1 0 - Central African Republic: Arrear > > > Breakdown F I G U R E 1 2 - DRC: Arrear Breakdown > > > F I G U R E 1 1 - Central African Republic: Contributions > > > to Growth in Arrears F I G U R E 1 3 - DRC: Contributions to Growth in Arrears In Chad, the authorities made considerable progress in clearing external arrears and auditing domestic arrears. The restructuring agreement with international commercial creditors in 2018 significantly improved Chad’s liquidity position and restored debt sustainability. Domestic arrears AN OVERVIEW OF THE POTENTIAL IMPACT OF THE COVID-19 CRISIS ON THE ACCUMULATION OF GOVERNMENT EXPENDITURE ARREARS <<< 17 In Cote d’Ivoire, arrears have remained stable and possibly believe that Niger would have accumulated arrears in 2020Q2 reduced. The government has a zero-ceiling policy on the because it enjoys access to international capital markets accumulation of new external and domestic arrears, including (Niger has recently raised US$47.4 million in early July 2020) those to suppliers and debt service, with close monitoring and donors have continued to fulfill funding pledges. and control systems in place. In the context of COVID-19, the government accelerated payments of debt to private sector In Senegal, no change in arrears has been recorded so far. suppliers, but the exact numbers have not yet been reported. Moreover, faster payment and arrears repayment schedules The government has confirmed that it remains current on all have been proposed as part of the governments Covid-19 payments for salaries, pensions, and debt service. response. Guinea continues to adhere to its strategy of clearing Sierra Leone has kept the growth in arrears in check longstanding domestic arrears that it adopted in 2017. In by significantly altering the composition of arrears. The addition, authorities continue to make good faith efforts to government has kept its salaries arrears at zero and has reach a collaborative agreement on external arrears owed to managed to bring down its total arrears between 2020-Q1 private creditors. and 2020-Q2 by 2 percentage points. It has done this by aggressively reducing arrears to suppliers by 60 percent at the Kenya announced a policy to reduce arrears across expense of debt holders, whose arrears increased by 10 %, the entire public sector as an explicit part of its COVID-19 a substantial spike given the fact that historically, debt arrears crisis-fighting response. While no data are yet available on have represented the largest component of total arrears (70 how successful this drive has been in the midst of cashflow percent of total arrears and 16-17 percent of GDP). and payments pressures, especially for some vulnerable > > > SOEs such as Kenyan Airways and the national power utility F I G U R E 1 4 - Sierra Leone - Arrear Breakdown company, the clearance of outstanding bills is a key national priority and arrears are expected to be reduced. The total outstanding stock of arrears stands at 3.7 % of GDP. In Mali, the government is committed to zero accumulation of arrears on domestic and external payments as one of its top priorities in the “Quality Performance Criteria” program. This commitment has thus far been observed under the IMF Extended Credit Facility arrangement that commenced in August 2019. In September 2019, 0.4 percent of GDP in domestic arrears were accumulated but were quickly cleared by end 2019, reinforcing the government’s commitment to this policy. Moreover, 2020Q1 fiscal data shows zero arrears accumulation, with CFAF 107.3 billion (1 percent GDP) > > > as scheduled payments (“fonds en route”, less than three F I G U R E 1 5 - Sierra Leone - Contributions to months). 2020Q2 data are not yet available and Mali rarely Growth in Arrears discloses quarterly fiscal reports. It will take some time to ascertain whether certain scheduled payments have become arrears in 2020Q2 as a result of the liquidity pressures from COVID-19. Similarly, Niger has hard restrictions on its arrears accumulation and cannot structurally run arrears. Niger successfully eliminated all domestic payment arrears at the end of 2019 as called for under its IMF Extended Credit Facility arrangement. Data through end-April 2020 show that no new arrears have materialized. In addition, there is no reason to AN OVERVIEW OF THE POTENTIAL IMPACT OF THE COVID-19 CRISIS ON THE 18 >>> ACCUMULATION OF GOVERNMENT EXPENDITURE ARREARS >>> EAST ASIA & PACIFIC as possible. This is due primarily to reduction of central government arrears and to the repayment of arrears owed In East Asia and Pacific region, data were only reported by the national health insurance fund in late 2019 and 2020. for a few countries with Papua New Guinea as the only The state social security fund arrears were due primarily to country where COVID-19 may impact arrears. In Kiribati, hospitals and the accumulation of such arrears to hospitals COVID-19 has not introduced any liquidity constraints as the is nothing new. They are usually resolved through a transfer country has large cash reserves and its fisheries revenues from the central government. Municipalities’ arrears have seem unaffected by the pandemic. Similarly, Philippines and also marginally declined in 2020Q2. Arrears by municipalities Thailand reported no liquidity constraints. While information is account for slightly more than one-third of all general not available for Myanmar, given strict rules and regulations, government arrears, and include arrears to suppliers of the size of arrears has historically been very small accounting construction works, waste management services and utilities, for less than 0.001% of GDP. In Papua New Guinea, as of amongst others. end-2019, the government estimated arrears to be close > > > to USD 583 million (2.6 percent of GDP). The government F I G U R E 1 6 - Bulgaria: Contributions to Growth in was planning to clear half of these arrears in 2020 but the General Government Arrears COVID-19 crisis is expected to lead to a substantial revenue shortfall. Government estimates a shortfall of USD 640 million and extra spending on health and economic relief measures (USD 175 million package approved by the government). Most likely, these will alter government’s plans for clearing arrears. This will be confirmed by the government in its mid- year reporting, expected by end of July 2020. >>> EUROPE & CENTRAL ASIA In ECA, initial reports from country teams suggest that most of arrears are expected to come mainly from SOEs. This is typically an area of the public sector for which there is usually less timely data, and when available, is highly fragmented. Arrears accumulation is likely to affect SOEs in the communications sector, the transport sector, and the energy sector. However, in the energy sector, the low price of oil is an ameliorating factor for SOEs in oil importing countries. Further data mining will be needed in order to better understand arrears dynamics in SOEs across the region. Anecdotally, in Serbia, the national airline and telecommunications corporations are in a dire financial situation. Utility payments have been postponed, and it is not clear yet if local governments are budgeting for these revenue shortfalls. Liabilities could be mounting in sectors for which a paucity of oversight is provided in the short run, even during ordinary times. In Tajikistan, only salary arrears were reported and although they jumped by 50 percent from pre to post- covid, they only represent 0.02 percent of GDP. In Bulgaria, although at a diminished rate, the government is following through on its commitment to clear as much arrears AN OVERVIEW OF THE POTENTIAL IMPACT OF THE COVID-19 CRISIS ON THE ACCUMULATION OF GOVERNMENT EXPENDITURE ARREARS <<< 19 Finally, in North Macedonia total arrears have inched > > > up by 2.1 percent at the end of 2020Q2. While there has F I G U R E 1 8 - North Macedonia: Contributions to been a marked reduction in SOE arrears under the central Growth in Arrears by Category government, arrears in SOEs under local governments and public health provider and other arrears were the main drivers. The bulk of the increase in arrears from 2020Q1 to 2020Q2 were in payments for materials and small inventory, utilities, and other services. Nonetheless, this increase in total arrears represents only around 0.05 percent of GDP. > > > F I G U R E 1 7 - North Macedonia: Contributions to Growth in Arrears by Entity AN OVERVIEW OF THE POTENTIAL IMPACT OF THE COVID-19 CRISIS ON THE 20 >>> ACCUMULATION OF GOVERNMENT EXPENDITURE ARREARS > > > L AT I N A M E R I C A & T H E In Costa Rica, arrears jumped by 78 percent, pulled in CARIBBEAN opposite directions by arrears in pensions and arrears to suppliers of goods and services. Pension arrears were non- In Latin America and The Caribbean, country economists existent prior to the COVID-19 outbreak, but now represent 80 reported little accumulation of arrears, reflecting historical percent of total arrears. Coupled with current transfers, these fiscal discipline in mitigating accumulation of arrears, which arrears account for 92 percent of total arrears, suggesting was exhibited and reinforced during the global financial crisis that the most vulnerable might not be receiving the kind of of 2007-08 and the commodity price crash of 2014. However, assistance they require, or are accustomed to, and that the there are a few notable exceptions: principally Argentina, Haiti, government of Costa Rica is running into cash constraints. Costa Rica, and Guatemala. These countries might warrant Costa Rica also simultaneously reduced arrears to suppliers further monitoring. aggressively, perhaps because of the collapse in demand for government goods and services not related to combating In Argentina, arrears increased significantly by 32 percent COVID-19. Total arrears at end of 2020-Q2, however, between January 2020 and May 2020. Arrears were reduced represented only 0.12 percent of GDP, are small relative to the in the categories of salaries and transfers but maintained at the country’s fiscal position and do not appear to be problematic same level in the category of suppliers of goods and services. for the time being. Debt arrears, however, skyrocketed, contributing more than > > > 30 percent of the growth in total arrears. Notwithstanding this F I G U R E 2 0 - Costa Rica: Growth in Arrears large jump in nominal arrears, relative to GDP total arrears Decomposition registered a marginal increase of 0.2 percent of GDP. > > > F I G U R E 1 9 - Argentina: Contributions to Growth in Arrears > > > F I G U R E 2 1 - Costa Rica: Arrears Decomposition AN OVERVIEW OF THE POTENTIAL IMPACT OF THE COVID-19 CRISIS ON THE ACCUMULATION OF GOVERNMENT EXPENDITURE ARREARS <<< 21 Haiti’s total arrears also shot up by 32 percent between for Honduras as recent credit operations have yielded June 2020 and December 2019. Haiti reduced its arrears to substantial resources. It remains unclear if the government employees, suppliers, and “other” category but simultaneously will experience a need for running arrears as the crisis increased its debt arrears position. In fact, all the growth in total unravels. In addition to the central government, SOEs might arrears came from increases in debt arrears, suggesting that be at risk of running into trouble. The state electricity company Haiti might be running into liquidity constraints and passing (ENEE) has been in financial distress for several years and along the buck to creditors in order to remain current on its has been experiencing a new buildup of arrears to generators other obligations. For Haiti, this is particularly troubling since (estimated at US$100 million by end-June 2020) that cannot its stock of arrears is larger than that for its regional peers, be eliminated in the short-run. The authorities are expected hovering in the 5-7 percent of GDP range. to clear these new arrears by end-2020 by using the funds from a recent placement of a sovereign bond. According to the > > > IMF program targets, ceiling on the accumulation of domestic F I G U R E 2 2 - Haiti: Contributions to Growth in arrears (and new external arrears) by ENEE is set at zero. As Arrears of April 2020, this hard ceiling has not been breached. Prior to COVID-19, and at the inception of the new IMF program (July 2019), ENEE accumulated arrears to private generators of around 1.5% GDP. Similarly, Guatemala has also seen its arrears rise as a result of COVID-19. The WB team reports that while public arrears were never flagged as a salient issue in Guatemala beforehand, the COVID-19 crisis has conspicuously impacted the government’s ability to honor obligations. Historically, arrears have been at 0.5% of spending in 2018 and 2019 but jumped up to a high of 2.5 percent of GDP in May 2020 before dropping back to the higher year-to-date 2020 average of 1.2 percent of expenditure by June 2020. Government expenditure in Guatemala does not seem to have collapsed In the Caribbean, Dominica has stayed current on its since cumulative spending for the first half of 2020 appears to obligations by maneuvering on the income side. It has be in line with the trajectory of spending in the previous two been diverting revenue earmarked for other non-essential years. It is unlikely that government demand for goods and construction projects to finance arrears clearance and services completely collapsed as nominal growth in 2020 over extraordinary covid-related spending. In addition, Dominica 2019 spending is at trajectory of -3.4 %. continues to be current on its debt servicing, salary payments > > > and pension contributions. Arrears to suppliers are declining, F I G U R E 2 3 - Guatemala: Bugetary Arrears albeit at slower rate than anticipated pre-covid. While COVID-19 has had an impact on the fiscal position, the stock of arrears continues to decline, though at a rate slower than expected pre-covid. Arrears as of July 2020 totaled 2.7% of GDP and are principally amounts owed to suppliers who helped with the reconstruction efforts after successive hurricanes caused damages estimated at 220 percent of GDP. In Honduras, the fiscal responsibility law establishes a ceiling on the accumulation of arrears by the central government. This law has not been suspended, despite recent calls to utilize its escape clauses. There is a hard and legally binding upper bound of 0.5 percent of GDP on total arrears of the central government. In addition, liquidity is unlikely to be problematic AN OVERVIEW OF THE POTENTIAL IMPACT OF THE COVID-19 CRISIS ON THE 22 >>> ACCUMULATION OF GOVERNMENT EXPENDITURE ARREARS In the case of Peru, the COVID-19 crisis has not led to of subsidized goods and services such as energy, transport, the occurrence of any payment arrears. The government and construction. continues to have ample savings and liquidity available to meet its payment obligations. While there are some payment In Iran, structurally higher stocks of arrears that predate arrears at the subnational level, these are the legacy of the COVID-19 are exacerbating the shock and forcing the past failures of the local authorities to pay social security government to resort to extraordinary measures to generate contributions for its employees many years ago and are not and recognize revenue to meet its spending obligations. affected by the ongoing crisis. While recent data on public sector arrears are not published by the authorities, as of 2017 total arrears stood at 30 percent In other southern cone economies, data are not yet of GDP, almost exclusively as arrears to domestic creditors available, or arrears do not appear to be problematic yet. In (0.5 percent of GDP are owed to external creditors). These Brazil, expenditure arrears are classified as arrears only if domestic arrears are primarily owed to social security they are not paid by the end of the calendar year, masking a institutions, private contractors, and domestic banks. These potentially large arrears accumulation caused by COVID-19. high stocks of arrears and the severity of the economic shock to In Colombia, and by legal decree, no entity of the government fiscal balances from COVID-19 have caused the government can accrue expenditure if it does not have funds to make to resort to extra-ordinary measures to keep arrears in check payments. This would imply that there cannot be arrears as in order to meet its financial obligations. The government has such. In Uruguay, there is no evidence of an uptick in arrears resorted to four main strategies: 1-securitizing its arrears and attributable to the pandemic. Moreover, there are no debt selling these instruments to domestic banks, 2-netting out arrears to date. In Paraguay, no arrears data is published but taxes from payments due to the government by counterparties, WB colleagues report that Ministry of Finance is unaware of 3- selling financial assets and shares in SOEs, and 4- making any arrear accumulation. withdrawals from the national development banks. Media reporting suggests that a substantial share of arrears is in >>> MIDDLE EAST & NORTH AFRICA salary arrears, other labor compensation to the public sector, including pension funds, Social Security Organization (SSO), In MENA, arrears accumulation is a structural issue municipalities, SOEs and the banking sector. Coupled with independent of COVID-19 but has certainly been exacerbated the collapse in oil prices and oil revenues, all of these extra- by the sharp drop in revenues brought about by COVID-19. ordinary behaviors suggest that Iran is likely to be in a very Arrears accumulation was prevalent in the region, including uncomfortable fiscal position. in high income countries such as Saudi Arabia, and has been > > > a backburner issue for many years, becoming particularly F I G U R E 2 4 - Iran: Arrears by Counterparty prominent in periods of oil price declines. Furthermore, arrears in the MENA region are particularly concentrated for suppliers, vendors and contractors with governments generally keeping current on other categories such as wages. In addition, it is expected that payments for SOEs and public utilities have been delayed. In Algeria, it is expected that fiscal risk will soon materialize due to government financial support to SOEs. Given the severe shock to fiscal revenues, exacerbated by the economic toll of containment measures on SOEs, and the high costs of fiscal policies to support firms and households, the government is likely to incur large domestic payment arrears, especially to public utilities, with repercussions to banking liquidity and the real economy. Some sectors, however, might experience a more moderate buildup in arrears as a result of the lockdown measures because of the decrease in government consumption of goods and services and in total consumption AN OVERVIEW OF THE POTENTIAL IMPACT OF THE COVID-19 CRISIS ON THE ACCUMULATION OF GOVERNMENT EXPENDITURE ARREARS <<< 23 In Iraq, the COVID-19 shock has been so severe that it In Jordan, the government is rapidly adding to its known has resulted in the suspension of transfers from the central stocks of arrears due to SOEs. The principal component of government to the Government of Erbil (42 percent of Erbil’s these arrears is for the energy sector through the national fiscal revenues). Pre-covid arrears on external and domestic petroleum refinery company. By June 2020, WB staff estimate debt are estimated at 0.5 percent of GDP. At its worst oil price that the stock of arrears increased to USD 1.5 billion, an almost shock and simultaneous ISIS conflict in 2015, the government 50% increase in arrears attributable to just the electricity and accumulated arrears in the order of magnitude of 5 percent of water sectors. GDP. WB team estimates suggest that oil prices would need to surpass a minimum threshold of USD 58 per barrel for Iraq to meet its wage and pension obligations alone. Average oil prices for the first half of 2020 did not exceed US$35 and rigid expenditure categories such as wages continue to rise. As such, it is very likely that Iraq will run large arrears if the price of oil does not recover. > > > F I G U R E 2 5 - Jordan: Stock of Arrears by Debtor In Morocco, WB staff believes there is no risk of arrears from banks, including for working capital. Finally, the central accumulation as additional expenditures and liquidity bank has increased its refinancing of banks and allowed for needs will be financed by a COVID-19 fund.9 Additional extended maturities, with eligibility granted for working capital mitigating factors on fiscal pressure and the accumulation loans. of arrears include the withdrawal of energy subsidies and the rationalization measures planned for a revised budget law, aimed at capping wages and instating hiring freezes. In addition, in April 2020, Morocco accessed USD 3 billion through its IMF Precautionary and Liquidity Line (PLL), further reducing the risk of running into liquidity crunches that would otherwise result in accumulation of arrears. Since then Morocco has also launched (i) a guarantee fund (7% of GDP) also available to SOEs; (ii) a strategic investment fund (4% of GDP), also available to SOEs. The combination of these factors allows commercial SOEs to increase their borrowing 9. SOEs: Morocco has an observatory of payment delays, with data for each SOE (commercial and not commercial) going back a couple years. AN OVERVIEW OF THE POTENTIAL IMPACT OF THE COVID-19 CRISIS ON THE 24 >>> ACCUMULATION OF GOVERNMENT EXPENDITURE ARREARS >>> SOUTH ASIA In addition, it is worth monitoring developments in SOEs. Stressed public sector enterprises such as Air India, the While no recent data is available for SAR, the sources leading national carrier, could see an increase in arrears due to the to a build-up in arrears in SAR typically include few prominent impact of COVID-19 on their operations. Some public sector categories. These include government arrears to the state- undertakings (PSUs) could see an increase in arrears payable owned electricity utility and, with the advent of COVID-19, to the central government due to an ongoing court hearing on other infrastructure service-providers (Afghanistan); payments license fees for mobile spectrum which is still being decided. At for goods/services/public works and expenses related to staff the subnational level, arrears in payments to power generation salary/ allowances (Nepal); payments to local contractors and companies by state-owned power distributions companies are suppliers (especially on infrastructure projects) and inter-SOE rising but the central government has taken steps to refinance payments (Sri Lanka); central government arrears stemming these companies. This will lead to a reduction in arrears from deferment of certain subsidy payments, subnational going forward. However, reduced electricity demand is putting transfers, increases in salary/allowances (post-COVID-19) as renewed stress on utility finances. well as SOE arrears (India). In India, and in contrast to normal times, the central government and several state governments are deferring pay increases and payment of allowances to employees. However, clearances of past arrears in the rural employment guarantee program and to small firms are being expedited as a part of COVID-19 support measures. For now, deferment of debt service payments in India is not expected, however, faced with an unprecedented fiscal crunch, the government may postpone recognition of payments arising from COVID-19 related shocks, which might lead to a large build-up of arrears in the coming. This phenomenon might be exacerbated through off-budget financing of some payments in order to keep ‘official’ fiscal deficits under control. These trends were already evident in India, in the years prior to the advent of COVID-19, when arrears on the payment of food and fertilizer subsidies were deferred and public agencies were encouraged to borrow from public sector banks and small savings fund to finance their operations. Moreover, in the past, the central government has delayed transfers to subnational governments when faced with a tight fiscal situation. Given the fiscal stress caused by COVID-19, the government might decide to opt for similar maneuvers, although for the time being arrears on this account seem to have been reduced so far. AN OVERVIEW OF THE POTENTIAL IMPACT OF THE COVID-19 CRISIS ON THE ACCUMULATION OF GOVERNMENT EXPENDITURE ARREARS <<< 25 >> A N N E X 2 - R E S P O N S E S F RO M C O U N T RY EC O N O M I S T S QUANTITATIVE/ QUALITATIVE DATA NO DATA/SUFFICIENT INFORMATION Algeria Afghanistan Angola Antigua Argentina Bangladesh Benin Barbuda Brazil Belize Bulgaria Bhutan Burundi Burkina Faso Cameroon Cabo Verde Central African Republic Congo (Rep. of) Chad Equatorial Guinea Colombia Federated States of Micronesia Congo (DRC) Fiji Costa Rica Ghana Cote D’Ivoire Guinea-Bissau Dominica India Gabon Liberia Gambia, The Maldives Guatemala Marshall Islands Guinea Mauritania Haiti Nauru Honduras Nepal Iran Nicaragua Iraq Nigeria Jordan Pakistan Kenya Palau Kiribati Samoa Mali Solomon Islands Morocco Sri Lanka Niger Timor-Leste North Macedonia Togo Papua New Guinea Tonga Paraguay Trinidad & Tobago Peru Tuvalu Philippines Vanuatu Senegal Sierra Leone Tajikistan Thailand Uruguay AN OVERVIEW OF THE POTENTIAL IMPACT OF THE COVID-19 CRISIS ON THE 26 >>> ACCUMULATION OF GOVERNMENT EXPENDITURE ARREARS >> A N N E X 3 - C A V E AT S T O D ATA A N D A N A LY S I S 1 There are little up-to-date data for Q2, Q1 2020 for some countries. For some countries, high-frequency data do not exist, aren’t published by authorities, 2 or aren’t collected by teams 3 There are different definitions of what “arrears” are among countries There are different time frames for arrears triggers among countries (30 days, 90 4 days, 120 days, or only at end of fiscal year trigger) There is little clarification if arrears data provided are stock vs. flow and reporting is 5 possibly inconsistent among countries The definition of government is not clear in some countries and possibly inconsistent 6 among countries (central vs. local vs. entire public sector) 7 Disaggregation of arrears by economic sub-category is not available in most countries Period over period definition for calculations and comparison changes from country 8 to country because latest data point available varies from country to country AN OVERVIEW OF THE POTENTIAL IMPACT OF THE COVID-19 CRISIS ON THE ACCUMULATION OF GOVERNMENT EXPENDITURE ARREARS <<< 27