Related to the third key element in the financing segment of the Monterrey Consensus are efforts to address the reverse capital flows from developing countries. In 2000, these countries spent about 6 per cent of their combined GDP on debt servicing. Among several countries, the situation is more serious. Sub-Saharan Africa countries, for instance, spend about twice as much to comply with their financial commitment vis-а-vis external creditors than to comply with their social obligation vis-а-vis their population. To spend more on external debt servicing than on basic social services - when millions of people lack access to primary education, preventive health care, adequate food and safe drinking water - is not only morally wrong, it is also poor economics.
In the early 1980s, the debt crisis was seen as a temporary liquidity problem. Hence, debt relief took the form of partial and short-term rescheduling. By the mid-1980s, it was acknowledged that the problem was more fundamental. Several debt reduction initiatives were taken by the so-called Paris Club of creditors, resulting in successive sets of 'special terms', usually named after the city in which they were adopted - Toronto, Houston, London and Naples. But they all failed to stop the debt burden from rising and arrears from accumulating. Out of this situation emerged the Heavily Indebted Poor Countries (HIPC) initiative, largely as a result of pressure exerted by the Jubilee 2000 campaign driven by non-governmental organisations.
The HIPC concept
The HIPC initiative was launched in 1996, followed by the 'enhanced' HIPC initiative in 1999. They form laudable attempts towards large-scale debt cancellation rather than palliatives such as debt rescheduling and interest rate reduction. They are focused on the cancellation of debts owed to multilateral institutions such as the World Bank, the International Monetary Fund (IMF) and the regional development banks because a large fraction of the HIPCs' debts are owed to these multilateral institutions. Bilateral and commercial creditors also provide debt relief through this scheme.
The technical design of the original HIPC initiative - as conceived by IMF and World Bank staff - made eligibility conditional on the maintenance of macro-economic stability under IMF-approved programmes for at least six years - referred to as the 'decision point' - and receipt of a permanent reduction in their official debt stocks only after another three years of a satisfactory policy environment to reach the 'completion point'. These conditions proved too stringent for most HIPCs. The eligibility criteria under the enhanced HIPC scheme included the following:
- low per capita income;
- demonstrated good reform performance;
- ratio of net present value of debt to exports exceeding 150 per cent; or
- ratio of net present value of debt to tax revenue exceeding 250 per cent for open economies (i.e. minimum 30 per cent export to GNP ratio) with substantial tax revenue (i.e. minimum 15 per cent of GNP).
The new element in the enhanced HIPC concept was not only its broader coverage and softer conditions, but also its linkage to poverty reduction. To qualify for debt relief under the enhanced HIPC, a country is required to prepare a wide-ranging PRSP that demonstrates its intention to use the freed resources for poverty-reducing purposes. Not only must the PRSP document chart the course towards poverty reduction, its preparation should also involve broad participation by civil society and other domestic stakeholders. Such an inclusive process is meant to create 'national ownership' of the strategy and provide political legitimacy among the citizenry.
Eligible countries begin receiving debt service relief once the 'decision point' is reached, i.e. once the ex ante conditions are fulfilled in terms of macro-economic track record and the approval of PRSP by the Boards of the IMF and the World Bank. The permanent debt stock reductions are delayed until the 'completion point', i.e. once the ex post conditions have been met in terms of process, performance benchmarks, and the use of HIPC resources.
It should be pointed out that the servicing of debt owed to multilateral credit institutions is particularly important because the credit market generally treats them as 'preferred creditors'. By defaulting on multilateral debt, a debtor runs the risk of a dramatic drop in its creditworthiness, including for short-term trade credits. In effect, it may mean a retreat from the international credit market altogether. For this reason, the HIPC initiative takes on added significance as a critical element in the total financing of development.
HIPC progress
Seven years after its launch, the HIPC results are mixed. Whilst it is true that the debt burden has decreased for most HIPC countries, the diagram below suggests that the HIPC initiative did not make much of a difference. Non-HIPC countries saw their debt burden fall by a similar magnitude as HIPC countries did; and the 16 HIPC members that did not reach 'decision point' saw their debt decline by a similar degree as the 7 HIPC countries that reached 'completion point'.
Diagram: debt reduction in developing countries
(debt service as a percentage of export earnings)
Source: World Development Indicators
Of the seven countries that reached 'completion point' (as of end March 2003), three saw their debt-to-export ratio deteriorate in 2001-02 as the reduction in debt stock was overtaken by a bigger fall in export earnings - mainly caused by a dramatic deterioration in their terms of trade. At least one of these 'completion point' countries (Uganda) has a net present value of external debt in 2002 that is not sustainable in terms of the HIPC initiative's own definition, i.e. 150 per cent of total exports.
The Joint Ministerial Committee of the Boards of Governors of the World Bank and the IMF reported that of 26 countries with a HIPC debt-relief programme - having passed either the 'decision' or 'completion' points - 15 found their debt to export ratio worsening in 2001 and 2002, even after obtaining debt relief. Many of the 19 countries that have reached 'decision point' cannot advance to their 'completion point' because they are unable to meet the conditions set and/or to handle the social conflicts they are facing.
Many reasons have been given for why debt relief should be denied or delayed. Typical arguments include that debt relief rewards poor performers; that resources are fungible so as to make it impossible to track the impact of the debt dividend on poverty reduction; that many governments lack political commitment and/or institutional capacity to reduce poverty; and that there is no guarantee that governments will not refrain from entering another cycle of 'odious' debt. The fact remains, however, that the Jubilee 2000 campaign had it basically right: debt is a millstone around the neck of the poorest countries. The time for debt relief is not today; it was yesterday; for hundreds of thousands of people, tomorrow will be too late.
Improving HIPC
The concept of debt sustainability must be amended. The enhanced HIPC initiative continues to define debt sustainability essentially in terms of export ratios. It does not take full account of the fiscal burden when determining a country's external debt sustainability, despite the obvious fact that it is the public purse rather than private exporters who repay external debt. But even with improvements of the debt sustainability definition, HIPC's impact is likely to remain inadequate and slow.
The last two HIPC Ministerial Meetings, held in Washington D.C. and Kigali, respectively, highlighted a number of the important issues that confront the HIPC initiative and enumerated some of its inadequacies:
- Weak linkages between HIPC and the MDGs. The HIPC Ministers are concerned that there is no systematic analysis that links the benefits of the HIPC initiative and the extra funds needed to achieve the MDGs. The analysis is also inadequate for determining the financing gap that will remain unfilled even after debt relief - if the MDGs are to be achieved. HIPC Ministers have suggested the estimation of MDG financing gaps for all countries to ensure that the concept of debt sustainability take account of MDG financing needs. The implication is that the export earnings and public finance required to achieve the MDGs should be excluded from the pool of revenues from which debt payments are to be drawn. In other words, MDG expenditure would be considered as non-discretionary in the national budget.
- Over-optimistic export and growth forecasts. The IMF and the World Bank tend to overestimate the prospects for export and economic growth, and to underestimate the effects of external shocks such as commodity price declines and world economic downturns. Since the amount of debt relief depends on the projected debt to export ratio (the higher the ratio the more the debt relief provided), over-optimistic export projections translate into less debt relief. To address this, the World Bank and IMF allow for 'topping up' of debt relief for countries reaching completion point whose debt sustainability ratios have deteriorated due to external conditions. So far, only Burkina Faso has benefited from this facility. Uganda would be a logical country to follow suit. There is also a pending plan to provide a contingent facility for HIPCs hit by exogenous shocks after achieving 'completion point'.
- Need to include more countries. At present there are 42 countries classified as HIPCs, 34 of them in Africa. Debt relief is needed for another dozen or so heavily indebted countries not covered by the HIPC initiative. These countries may require interim programmes and a softening of conditionalities. Other low-income countries have unsustainable debts too, and proposals have been made to include them in the scheme. There are at least another ten low-income countries whose human development indicators and debt sustainability ratios warrant inclusion in the HIPC initiative.
- Litigation: the establishment of a legal technical assistance facility is needed to help HIPC deal with costly litigation by some private creditors.
- Domestic debt: domestic debt in many African countries requires urgent attention because it reduces fiscal flexibility, raises domestic interest rates and crowds out private investment.
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