How Congress Should Relieve Poor-Country Debt

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How Congress Should Relieve Poor-Country Debt

June 29, 1999 24 min read

Authors: Brett Schaefer and Denise Froning

Over the past several years, policymakers have come to realize that many of the world's poorest countries cannot finance the debt that they owe to other countries, multilateral lending institutions such as the World Bank and the International Monetary Fund (IMF), and private creditors. For many of these countries, this external debt is over two times their gross domestic product (GDP), and servicing the debt eats up a growing share of scarce foreign exchange and government revenue. To meet this escalating burden, countries are forced to allocate increasing portions of their budgets to debt service. The result: Taxes or borrowings increase, other government expenditures are cut, or there are arrears or default on debt or interest.

In 1996, the IMF and the World Bank asked their member states to support and fund a proposal known as the Heavily Indebted Poor Country (HIPC) Initiative. The HIPC initiative outlines a plan to relieve the excessive debt levels in 40 extremely poor countries.1

The Clinton Administration and many in Congress have embraced the HIPC initiative eagerly. However, close examination reveals that the initiative will not reduce the debt burdens in extremely poor countries to levels at which these countries can be self-sufficient and meet their debt obligations without depending on foreign assistance.

Rather than supporting the flawed HIPC program, Congress should alter it to better achieve debt reduction in poor countries. Most proposals to "fix" the HIPC initiative agree that at least some portion of debt must be forgiven; differences center around the amount to be forgiven and the timetable for relief. However, most of these proposals--including the recent proposal put forth by the Group of Seven (G-7) industrialized nations in Cologne, Germany--overlook the fact that a key component of any solution to the problem of excessive debt is preventing a return to unsustainable debt levels.

The debt cycle can be stopped only through debt forgiveness along with reductions in and eventual elimination of bilateral and multilateral development assistance, which is the primary source feeding the debt problem. Forgiveness of HIPC debt should be made contingent upon agreement by the recipient country not to seek or accept any future loan from the IMF, the World Bank, or other multilateral lending institutions.

The HIPC Program

Begun in September 1996, the HIPC initiative seeks to alleviate the debt burden of countries for which the usual round of debt relief and economic aid has proved insufficient. The IMF and the World Bank, which jointly oversee the HIPC initiative, evaluate the ability of low-income countries to service their debt after they have exhausted other debt relief measures through the Paris Club2 and multilateral lending institutions.

Criteria for Assistance. The IMF and the World Bank established three criteria for HIPC assistance:

  1. The country must be eligible for concessional assistance, the primary requirement being a per capita gross national product (GNP) equal to or less than $695;

  2. The country's debt burden must be "unsustainable" even after the country has exhausted all other debt-relief options; and

  3. The country must have established a track record of adherence to IMF and World Bank conditionality.

After evaluation, 41 countries were deemed eligible for HIPC assistance. Thirty-two had a GNP per capita of $695 or less and a debt-to-exports ratio greater than 220 percent or a debt-to-GNP ratio of more than 80 percent in 1993 (present value terms). The remaining nine did not meet these criteria, but were eligible for Paris Club concessional debt rescheduling.

Before receiving HIPC debt relief, these countries must follow an economic reform program sanctioned by the IMF and World Bank for three years and then establish a further three-year track record of "good policy performance."3 The HIPC program has granted exceptions to this six-year evaluation period on a country-by-country basis. The length of the evaluation period came under review during a recent assessment of the program after member countries expressed their belief that debt relief should be hastened.

How Creditors Share Debt Relief.
The HIPC initiative is funded by contributions from multilateral institutions and individual countries.4 The program allocates the burden of debt relief among bilateral and multilateral creditors on the basis of the amount of debt each is owed after the heavily indebted countries have exhausted traditional debt-relief measures. The creditors themselves decide how to extend their share of the debt relief: through outright forgiveness, rescheduling, or reduction of debt; by making the debt service payments themselves; or by offering new loans to cover the payment of old loans.

The IMF and the World Bank have chosen not to forgive debt outright. Instead, they have set up special accounts to make debt payments for countries deemed eligible for HIPC assistance.
Specifically:

  • The World Bank manages its share of debt relief through a specially established HIPC Trust Fund. The World Bank transfers income from the International Bank for Reconstruction and Development (IBRD)--an internal organization that lends to middle-income countries at profitable interest rates--to the Trust Fund, which then repurchases or repays debt that countries owe to the International Development Association (IDA) branch of the World Bank.5 The World Bank had transferred $850 million to the HIPC Trust Fund as of February 1999 to cover its share of the program's costs. As of that date, the Trust Fund had received an additional $450 million through pledges and donations from 19 countries to finance the HIPC program.6

  • The IMF has established an escrow account for special grants to finance its share of the HIPC initiative and has financed this account through donations from member countries and through the transfer of funds from the Enhanced Structural Adjustment Facility Trust Reserve Account. (The ESAF is a concessionary lending mechanism.) Member states also have proposed supplementing this effort by selling IMF gold reserves. The money from the escrow account will be used to cover service payments on debt owed to the IMF. As of February 1999, the IMF had allocated $520 million to this fund.

Current Status.
As of February 1999, 12 countries had been evaluated under the HIPC initiative; of these, seven received promises of HIPC assistance.7 On May 14, 1999, the IMF and World Bank announced that the latest HIPC debt relief package, worth $410 million, will go to Guyana.8

Shortcomings of HIPC

The IMF and World Bank are correct: The debt burden of many countries is unsustainable for reasons that include lack of structural reforms, poor debt management, and deterioration of trade conditions in many HIPC countries. But the problem is exacerbated by imprudent credit policies of bilateral and multilateral lending institutions.

The debt burden on HIPC countries has increased despite numerous efforts to address that burden through traditional means, such as rescheduling debt and exchanging market-interest debt for concessionary debt. According to the U.S. General Accounting Office (GAO), HIPC countries have nearly doubled their average external debt from $122 billion between 1983 and 1985 to $221 billion between 1993 and 1995.9 In most cases, this rise in indebtedness has outstripped economic and export growth, making debt service increasingly difficult and forcing many of these countries into arrears or into default on debt or interest.

However, the HIPC initiative is not the answer to the debt problem in low-income countries. The initiative falls short in several ways:

  1. HIPC does not significantly reduce debt in low-income countries.
    Even if the HIPC initiative received full support from member states, was fully funded, and was used for all 40 eligible countries, it would not solve the debt crisis in low-income countries. As the IMF notes, "assistance under the HIPC Initiative is estimated to reduce debt service due in the period following the completion point by 18 percent (within a wide range)." However, results so far have shown that "in comparison to the debt service paid prior to HIPC debt relief, the reduction is about 2 percent on average, within a wide range, and some countries are expected to experience an increase in debt service due even after HIPC assistance."10 The bottom line is that the HIPC initiative does not solve the debt problem in low-income countries: At best, it offers only token relief; at worst, it increases the debt service burden on the very countries it purports to help.

The international development committee of the British House of Commons charged that the HIPC initiative was at risk of being a "rearrangement of accounts,"11 and correctly observed that the initiative failed to provide a permanent solution to the HIPC debt problem. Unfortunately, this is consistent with past IMF and World Bank lending practice. Multilateral lending agencies like the World Bank and IMF have been rearranging accounts for years to disguise their ineffective lending. Countries unable to service existing debt burdens are given new loans. The World Bank and IMF are spared the embarrassment of explaining a technical default, but the countries have defaulted nonetheless. For private lenders, such practices would mean serious trouble with regulators.12 For multilateral lenders, they are business as usual.

  1. HIPC will not make low-income countries self-sufficient in debt management.
    The stated purpose of the HIPC program is to make the debt burdens of eligible countries "sustainable." An IMF pamphlet defines sustainable debt as meeting "current and future external debt-service obligations in full, without recourse to debt relief, rescheduling of debts, or the accumulation of arrears, and without unduly compromising growth."13 Noticeably absent is any reference to foreign assistance.

The HIPC program is designed in a way that leaves beneficiaries highly dependent on foreign assistance to meet payments on the debt they still owe after receiving relief. In fact, the level of debt relief offered through the HIPC initiative is based on the assumption that foreign assistance will continue indefinitely. Under the initiative, countries cannot achieve self-sufficiency because HIPC debt relief is "sustainable" only as long as those countries continue to receive new flows of foreign assistance.

However, even assertions of "sustainability" are doubtful. Estimates of the sustainability of post-HIPC debt are based on an assumption that exports in eligible countries will grow at a steady, high rate. The historical record indicates otherwise: These countries often have had poor export growth and large fluctuations in the rate from year to year.14

For example, for the six countries that had been approved for aid through the HIPC program as of August 1998, estimates of future growth in exports averaged 75 percent greater than the actual average over the most recent ten-year period for which records are available. Specifically, annual export growth averaged 4.5 percent in those countries between 1985 and 1995, while the HIPC program assumes that an average annual export growth of 7.8 percent is needed for the debt of those countries to be sustainable.15 Every country but one is projected to have export growth at least 39 percent greater than its previous ten-year average. For Uganda, the estimate exceeds the historical average by 2,800 percent. Clearly, the export growth estimates that form the basis of the HIPC program are overly optimistic and probably unattainable for most countries.

  1. HIPC glosses over IMF and World Bank debt even though both organizations are primary creditors of low-income countries.
    The IMF and the World Bank are less than forthright about their role in creating the unsustainable debt problem. The evidence shows that, for most HIPC-eligible countries, IMF and World Bank assistance is a key component of their massive debt burdens. For 29 of the 40 HIPC countries, IMF and World Bank assistance totals more than one-fifth of total government debt. Of these countries, six owed a majority of their government debt to the IMF and World Bank. (See Table 1.)

Instead of alleviating the debt burden of these countries by stimulating economic growth or providing financial relief, multilateral assistance has aggravated the problem by increasing an already unsustainable development burden. Indeed, HIPC countries are becoming ever more indebted to these organizations. For example, IMF and World Bank debt owed by the HIPC countries increased from $43.95 billion in 1996, when the HIPC initiative was originally proposed, to $48.6 billion at the end of February 1999--a jump of 10.6 percent.16

According to the GAO, these organizations will not forgive debt outright because of a "belief that forgiving or reducing debt would diminish assurances of repayment on new lending and, in some cases, hurt their credit ratings."17 In other words, the IMF and the World Bank are unwilling to accept responsibility for past errors by forgiving loans and reforming lending practices that are in large part responsible for "unsustainable" debt burdens in HIPC countries because doing so might harm their ability to pursue those activities in the future.

Instead of working to solve the debt crisis in many low-income countries by acknowledging their role in low-income debt problems, forgiving debt, and restricting future assistance, the IMF, the World Bank, and other multilateral lending institutions argue that additional assistance is the solution.

This is incorrect. The bottom line is that the HIPC proposal is not a solution to poor-country debt problems. It is an empty proposal that orchestrates a token reduction in debt, ensuring that countries will remain dependent on foreign assistance for the foreseeable future.

HOW CONGRESS CAN MAKE THE PROGRAM WORK

Congress and the Clinton Administration are right to be concerned over the debt in extremely poor countries. In many cases, the debt burden of low-income countries exceeds their ability to service it. However, the HIPC initiative as designed by the IMF and World Bank, and as championed in Congress and by the Administration, will not address the problem adequately.

To its credit, the Clinton Administration has identified some of the shortcomings of the HIPC initiative. It recommends increasing debt relief in the early stages of the program, forgiving and reducing bilateral loans, and providing "at least 90 percent of new development assistance on a grant basis to countries eligible for debt reduction."18 The G-7 countries also have reiterated their support for greater relief on an accelerated timetable, and have urged that the funds saved from reduced debt service by poor-country governments be allocated to education and wealth programs and to poverty reduction.19

Unfortunately, however, even though the Administration correctly identifies the role of international development assistance in causing poor-country debt problems, its remedy is to create an international welfare system of grants. This would largely prevent an accumulation of debt from international assistance, but it would do so at the cost of all free-market incentives to reform. Countries would be assured of a costless and unending source of funds regardless of what economic policies they pursued. Under such a system, few economic reforms would be implemented, and the poorest countries would be relegated to perpetual poverty.20Likewise, the G-7 countries would have HIPC countries channel savings from reduced debt service into government health, education, and poverty reduction programs rather than lower the tax burden on their citizens--which likely would have more real impact.

Congress should increase the amount and speed of debt relief. However, it should correct the flaw in proposals advanced by the President and others that overlook the counterproductive role of bilateral and multilateral lending in fueling the debt crisis in many countries. To put a permanent end to the debt crisis in the HIPC countries, Congress should:

  1. Forgive bilateral debt owed to the United States by the HIPC countries and encourage other members of the Organization for Economic Cooperation and Development (OECD) to do the same.21
    The HIPC initiative tacitly admits that many very poor countries cannot repay the debt they have accumulated and simultaneously achieve the economic growth necessary to escape perpetual poverty. Although the HIPC initiative would address part of this debt burden--albeit only a portion and within a time frame that undermines the benefits of the relief--the debt remaining is still very high in relation to the economic wealth of the countries under consideration. The U.S. and other members of the OECD, as the primary sources of bilateral foreign assistance, can aid the relief effort by forgiving all bilateral debt owed by these countries. Congress should supplement this debt forgiveness by significantly reducing and eventually eliminating bilateral development assistance to avoid future repetition of debt accumulation.

Concerns have been raised about the cost of total bilateral debt forgiveness, but these fears are overblown. Total debt owed to the United States by the HIPC countries is $6.8 billion--an amount roughly equivalent to annual U.S. expenditures on economic assistance. However, the actual cost of this debt forgiveness to American taxpayers would be minimal, as the repayment of most of this debt is unlikely22 and the balance would be offset through reduction in bilateral development assistance.

  1. Advocate cancellation of all debt owed by a HIPC-eligible country to the IMF, the World Bank, or any other multilateral lending institution if that country agrees not to seek or accept future assistance from the IMF or any other multilateral lending institution.
    Subsidized loans from the IMF and other multilateral lending institutions form a substantial portion--and sometimes a majority--of low-income country debt. Any credible effort to alleviate that debt must include a means of forgiving it. The best way for Congress to support low-income debt relief is by expressing this policy in legislation and requiring that the U.S. representatives at the IMF and other multilateral lending agencies

    • Present public, written notification of this position to their respective institutions;

    • Demand a recorded vote in these institutions on the policy of full debt forgiveness in return for forfeiture of future assistance; and

    • Report the results of this vote to Congress.

    • Ensure the cooperation of the IMF, the World Bank, and other multilateral lending institutions in forgiving poor-country debt.
      Congress should create incentives for the IMF and other multilateral lending institutions to eliminate unsustainable debt burdens in poor countries by restricting the disbursement of funds currently authorized for the IMF and any multilateral lending institution until

      • Those institutions publicly issue a written statement of their support for and adoption of a policy to cancel the debts of HIPC countries that agree not to seek or accept any future assistance, and

      • Congress is convinced that those institutions have cancelled outstanding debt for every HIPC country, and also has received a letter signed by the debt relief recipient and the lending institution stating that all debt has been forgiven, completely and irrevocably, and that the country has agreed not to seek or accept any future loan from the IMF or other multilateral lending institutions.23

      • Authorize the U.S. Treasury to purchase and cancel the external debts of HIPC-eligible countries that agree not to seek or accept future loans from the IMF or any other multilateral lending institution.
        If the IMF or other multilateral lending institutions have not forgiven the debts of HIPC-eligible countries within one year of the adoption of this policy, Congress should direct the Treasury to purchase and cancel the debt owed by HIPC countries to those institutions. This action, which should be financed through reductions in callable capital authorized for the IMF or the multilateral lending institutions, would allow the U.S. to support debt relief even if those institutions were reluctant to forgive existing debt or opposed the cessation of future assistance.

      If implemented by the United States, OECD member states, and the multilateral lending institutions, this policy not only would provide substantial debt relief to the countries in the HIPC program, but also would prevent them from accumulating unsustainable debt through foreign assistance in the future. The restriction on official credit would provide a strong incentive for low-income countries to adopt the economic reforms necessary to secure private-sector credit and investment.

      This policy would lessen the possibility that these countries will assume unsustainable debt in the future. Private creditors and investors have a greater incentive to ensure that the borrowing countries can meet their debt obligations than do the multilateral or bilateral lending agencies or institutions, because the viability of their investments or loan portfolios depends on reliable returns and repayment. 24 In addition to increasing the likelihood that the level of debt will not exceed a country's ability to service it, this strategy provides ancillary benefits to poor countries. For example, private investment generally yields greater economic benefits than official (bilateral or multilateral) investment, and economic policies that attract private-sector creditors also create the best environment for long-term, sustainable economic growth.25

      CONCLUSION

      The HIPC initiative is flawed and will not eliminate poor-country debt problems; it will not even make poor countries self-sufficient in handling their debt burdens. In reality, the HIPC initiative is a mirage that offers poor countries token relief while perpetuating their dependence on bilateral and multilateral assistance.

      The poor-country debt crisis is real, however, and Congress should take action to solve the problem. A long-term solution requires total forgiveness of existing bilateral and multilateral debt, which is unlikely to be repaid in any event, but it also must end the debt cycle by eliminating bilateral and multilateral assistance. Congress should take steps to implement the policies that are necessary to solve poor-country debt problems and encourage the economic policies that attract private-sector credit and investment and have proven the best means of achieving long-term, sustainable economic growth.

      Brett D. Schaefer is Jay Kingham Fellow in International Regulatory Affairs and Denise H. Froning is a former Research Assistant in the Kathryn and Shelby Cullom Davis International Studies Center at The Heritage Foundation.


      1. The 40 countries eligible for HIPC debt relief are Angola, Benin, Bolivia, Burkina Faso, Burundi, Cameroon, Central African Republic, Chad, Congo, Côte d'Ivoire, Democratic Republic of the Congo, Equatorial Guinea, Ethiopia, Ghana, Guinea, Guinea-Bissau, Guyana, Honduras, Kenya, Lao PDR, Liberia, Madagascar, Mali, Mauritania, Mozambique, Myanmar, Nicaragua, Niger, Rwanda, São Tomé and Principe, Senegal, Sierra Leone, Somalia, Sudan, Tanzania, Togo, Uganda, Vietnam, Yemen, and Zambia. Nigeria had been classified as a HIPC but was removed from the list in 1998.

      2. The Paris Club is an informal group of developed nations that meet regularly to coordinate a common approach to restructuring the debt service on official loans owed to them. Paris Club members include Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Ireland, Italy, Japan, Norway, The Netherlands, Spain, Sweden, Switzerland, the United Kingdom, and the United States. A few additional countries are members ad hoc.

      3. "The Heavily Indebted Poor Countries Debt Initiative," prepared by the staff of the World Bank's HIPC Unit and the World Bank's External Affairs Department, April 1999. Available on the Internet at http://www.worldbank.org/html/extdr/hipc/pb-hipc.htm

      4. Contributions from multilateral creditors constitute 54 percent of HIPC funding. Among these multilateral organizations are the World Bank, which provides 25 percent of HIPC funding, and the IMF, which supplies 9 percent. Contributions from bilateral creditors come mainly from Paris Club countries and constitute 46 percent of HIPC funding. In addition, private creditors are expected to complement bilateral and multilateral efforts to relieve debt. Axel van Trotsenburg and Alan MacArthur, "The HIPC Initiative: Delivering Debt Relief to Poor Countries," February 1999, at /static/reportimages/7F2C4E0A7BD0D9D4474BE229FADE3DF5.pdf.  The authors are manager of the HIPC Unit at the World Bank and deputy division chief of the Policy Development and Review Department at the IMF, respectively.

      5. U.S. General Accounting Office, Developing Countries: Status of the Heavily Indebted Poor Countries Debt Relief Initiative, GAO/NSIAD-98-229, September 1998, p. 8.

      6. Van Trotsenburg and MacArthur, "The HIPC Initiative: Delivering Debt Relief to Poor Countries."

      7. These countries are, in the order in which they received HIPC assistance, Uganda, Bolivia, Burkina Faso, Guyana, Côte d'Ivoire, Mozambique, and Mali. See http://www.imf.org/external/np/hipc/hipc.htm

      8. "Guyana to Receive Over US$400 in Debt Relief," IMF Press Release No. 99/17, May 14, 1999, at http://www.imf.org/external/np/sec/pr/1999/PR9917.HTM.   

      9. GAO, Developing Countries: Status of the Heavily Indebted Poor Countries Debt Relief Initiative, p. 21.

      10. "Heavily Indebted Poor Countries (HIPC) Initiative: Perspectives on the Current Framework and Options for Change--Supplement on Costing," prepared by the Staffs of the World Bank and International Monetary Fund, April 13, 1999, at http://www.imf.org/external/np/hipc/cost2/index.htm#17.   

      11. Frances Williams and Robert Choate, "UN Seeks Final Elimination of Debt Overhang," Financial Times, June 12/13, 1999, p. 4.

      12. See Gerald P. O'Driscoll, Jr., and Brett D. Schaefer, "The IMF Promotes Poor Banking Practices," Heritage Foundation Executive Memorandum No. 592, April 26, 1999.

      13. Anthony R. Boote and Kamau Thugge, "Debt Relief for Low-Income Countries: The HIPC Initiative," International Monetary Fund, Washington, D.C., 1999, p. 10.

      14. Low-income countries experience dramatic fluctuations in exports because their exports generally are primary products, such as agricultural goods and natural resources, which historically are more vulnerable to the effects of price fluctuations and natural disasters than are most manufactured items.

      15. GAO, Developing Countries: Status of the Heavily Indebted Poor Countries Debt Relief Initiative, p. 53.

      16. "Heavily Indebted Poor Countries (HIPC) Initiative: Perspectives on the Current Framework and Options for Change--Supplement on Costing."

      17. GAO, Developing Countries: Status of the Heavily Indebted Poor Countries Debt Relief Initiative, p. 4.

      18. President Bill Clinton, "Conference on U.S.-Africa Partnership for the 21st Century," Office of Press Secretary, The White House, Washington, D.C., March 16, 1999, at http://www.state.gov/www/regions/africa/990316_clinton.html

      19. Susan McInerney, "G-7 Unveils $70 Billion Debt Relief Plan, Seeks Sale of 10 Million Ounces of Gold," Bureau of National Affairs Daily Report for Executives, June 21, 1999, p. A24.

      20. For a detailed discussion of the beneficial impact of economic freedom on economic development, see William W. Beach and Gareth G. Davis, "The Institutional Setting of Economic Growth," in Bryan T. Johnson, Kim R. Holmes, and Melanie Kirkpatrick, eds., 1999 Index of Economic Freedom (Washington, D.C.: The Heritage Foundation and Dow Jones and Company, Inc., 1999), pp. 1-15.

      21. The 29 OECD member countries produce nearly two-thirds of the world's goods and services and extend nearly all of bilateral development assistance. Member countries are Australia, Austria, Belgium, Canada, the Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Korea, Luxembourg, Mexico, The Netherlands, New Zealand, Norway, Poland, Portugal, Spain, Sweden, Switzerland, Turkey, the United Kingdom, and the United States.

      22. Most experts acknowledge that HIPC debt is overvalued because most of it is unrecoverable. For example, Jeffery Sachs, director of the Harvard Institute for International Development, estimates that this debt is worth only about one-tenth of its face value (about $600 million). Michael M. Weinstein, "Economic Scene," The New York Times, June 17, 1999, p. C2.

      23. This agreement would effectively reduce the number of nations borrowing from the IMF and World Bank by approximately one-fourth. The resulting reduced demand for IMF and World Bank resources should eliminate the need for future replenishments. Indeed, as the HIPC countries flourish without this assistance, the Congress should consider whether these organizations are needed at all.

      24. This assumes that international financial institutions do not imply, through policy or practice, that unwise private investments and loans will be repaid through international assistance packages in the event of financial crisis or a country's inability to honor its debt. Such an implication creates a "moral hazard" that undermines the essential discipline and self-evaluation by banks, businesses, and investors that are necessary for markets to operate efficiently. For a detailed analysis of this problem, see Edwin J. Feulner, "The IMF Needs Real Reforms, Not More Money," Heritage Foundation Backgrounder No. 1175, May 5, 1998, pp. 4-5.

      25. Such policies include financial transparency, strong and fair judicial systems, and non-punitive tax and investment regimes, among others. See Beach and Davis, "The Institutional Setting of Economic Growth," in Johnson, Holmes, and Kirkpatrick, eds., 1999 Index of Economic Freedom.

      Authors

      Schaefer
      Brett Schaefer

      Jay Kingham Senior Research Fellow, Margaret Thatcher Center

      Denise Froning

      Senior Fellow and Director of Government Finance Programs