Introduction: Debt reduction

Research

Relevant links

Introduction: Debt reduction

During the 1970s, against a background of rising oil prices, high interest rates and an economic slowdown, developing countries built up a high external debt. As oil prices rised further, and the prices for commodities exported by developing countries decreased, current account deficits continued to increase. This further increased the external debt of developing countries. Some countries had to borrow more money only to service their debts. At the same time, however, the maturity of loans to developing countries got shorter. These developments made the debt situation of these countries unsustainable. In 1982, Mexico was the first country to announce that it could no longer service it debt. This also happened to other countries in the years that followed. Financial crises in the 1990s and the new millennium have increased the number of countries with high debts.

Starting with the debt crisis of the 1980s, debt restructuring and debt relief have become an important theme in development co-operation as it is recognised that excessive debt burdens divert resources from key productive investments and discourage policy reforms, which could promote growth.

Debt relief - Paris Club initiatives

In the first years of the debt service problems of developing countries, debt relief took the form of payment rescheduling, sometimes on concessional terms, sometimes coupled with new packages of loans. This rescheduling of debt was generally agreed at the Paris Club, an informal group of creditor countries (for more information see the Paris Club website. After some time it was recognised, however, that more was needed to overcome the debt service problems, especially for the low-income countries. In 1988 at the G7 Summit in Toronto leaders decided to implement for the first time a reduction of part of the debt of poor countries. This reduction was part of a package of measures known as the “Toronto terms”. In the following years, increasingly concessional mechanisms were adopted for poor countries for more sustainable debt relief through the London terms (1991) and Naples terms (1994). The level of debt forgiveness has been raised progressively from 33 percent in 1988 to 50 percent in 1991, and 67 percent in 1994.

The role of the multilateral financial agencies in these Paris Club initiatives has been to assist countries with high debt burdens to design stabilisation and economic policy, and structural reform programmes with concessional lending from the IMF and the World Bank. As a result, the multilateral debt stock of these countries increased. Although this lending was on concessional terms, these institutions have historically assumed the status of preferred creditors and have not rescheduled their loans.

The HIPC Initiative

In 1996, the international financial community recognised that the external debt situation for a number of low-income countries, mostly in Africa, had become extremely difficult. For these countries it seemed that even full use of the Naples terms, together with continued provision of concessional financing and pursuit of sound economic policies, might not be sufficient to attain sustainable external debt levels within a reasonable period of time and without additional external support. In October 1996, the IMF and the World Bank therefore jointly announced the Heavily Indebted Poor Countries (HIPC) Initiative. Under this Initiative, all types of creditors (bilateral, multilateral and commercial) participate, and through a mix of sound policies, further debt relief and new aid inflows, the Initiative aims to make the debt service burdens of countries manageable and thereby sustainable.

Only the countries the per capita income is low enough to qualify for concessional lending from the IMF and the World Bank and that face an unsustainable debt burden after traditional debt relief are eligible for the HIPC initiative. As of January 2003, 42 countries are classified as HIPCs.

Initial results of the HIPC Initiative were disappointing. In 1999, the “enhanced HIPC Initiative” was therefore introduced, which allowed faster, deeper and broader debt relief and a strengthened link between debt relief and poverty reduction.

In the first phase of the enhanced HIPC Initiative, countries must adopt adjustment and reform programmes supported by the World Bank and the IMF and must have a satisfactory performance in carrying out these programmes. At the end of the first phase, a debt sustainability analysis is carried out, which will determine a country’s eligibility for support. The eligibility is determined at the “decision point”. If a country is eligible, it receives interim debt relief. In the second phase, a country must further prove its performance under the IMF/World Bank-supported programmes. The performance of country determines the length of this phase. At the end of this phase, referred to as the “completion point”, remaining assistance will be provided to the country under consideration. One important requirement for countries participating in the HIPC Initiative is that they adopt and implement a Poverty Reduction Strategy Paper (PRSP).

As of January 2003, of the 42 countries that have been classified as HIPCs since 1996, only 26 have reached decision point, i.e. the stage at which they start to receive interim debt relief, and only six of those have reached the completion point.

Research

The research on HIPC addresses the questions of additionality of HIPC debt relief, the sustainability of the debt relief and the link with poverty reduction. A selection of papers contributing to the ongoing research on debt reduction and its effectiveness is presented below. 

Additionality of debt relief and debt forgiveness, and implications for future volumes of official assistance, Ndikumana, L., UNU/WIDER Discussion paper No. 2002/97, October 2002

This paper looks at the issue of additionality of debt relief by examining whether and to what extent debt relief has been accompanied by a decrease in the flow of development aid, grants, and other forms of concessional external financing, using econometric tests. The results show that the supply of ODA has declined in 1998-2000, but this decline had started prior to the start of the HIPC initiative. No direct causal relationship can be established between the downward ODA trend and debt forgiveness The results also show that countries that received debt relief were granted more ODA compared to countries that did not qualify for debt relief. The author argues that although debt relief does not seem to crowd out other forms of external assistance, it is important to increase this external assistance, because the gains from debt relief alone will not be enough to meet the financing needs of low-income countries.

For the full text of this document, click here.

Debt issues in Africa, Thinking beyond the HIPC Initiative to solving structural problems, Geda, A. UNU/WIDER Discussion Paper 2002/35, March 2002

This paper tries to explain the historical origin of the African debt crisis, going beyond what happened in the 1970s. The author argues that a weak and vulnerable structure was created in Africa as a result of the continent’s specialisation in primary commodity exports. This structure paved the way for indebtedness by creating the necessity for borrowing and by making debt servicing difficult. The author shows that the situation has changed very little over the last three decades. Four reasons are identified: 1) the pattern of trade and finance between Africa and the Rest of the World has not changed fundamentally; 2) lack of financial resources for investing in diversification; 3) the existence in power of African leaders is informed by maximisation of short-run gains subject to the constraint of inherited trade and financial structure; 4) since the mid-1980s the African economy was (mis)managed by the World Bank and the IMF.

The full text of this document is available here.

Making debt relief conditionality pro-poor, Morrissey, O., UNU/WIDER Discussion paper No. 2002/04, January 2002

This paper addresses the link between debt relief through the HIPC Initiative and poverty reduction. The author notes that it is only the funds that are associated with debt relief can have a poverty reducing effect, provided that these funds are allocated to pro-poor expenditures. He therefore criticises the current conditions attached to debt relief, because they are linked to policies, rather than to expenditures of funds, which are only released after the conditions have been met. He argues that pro-poor expenditures should be disbursed independently of, and if necessary prior to, full compliance with policy conditions. The paper examines in what ways debt relief can influence policy reform.

The full text of this document is available here.

Debt reduction through the HIPC Initiative – “Jubilee 2000 Germany” takes inventory, J. Kaiser, 2001, Jubilee 2000

The paper provides an overview of the background of the HIPC Initiative, status of and commitment to debt relief, and outlines a number of weaknesses of the HIPC Initiative. According to the author, the HIPC Initiative will not solve the debt crisis in the South due to conceptual weaknesses in the HIPC Initiative on one hand, and due to structural and economic problems involved in the implementation of the initiative on the other. Points of criticism raised in the paper include:

• the calculated debt sustainability levels of debt (related to export earnings) for HIPC relief which are argued to be to high;
• the optimistic assumptions of the economies’ growth rates used for calculating sustainable debt relief; 
• debt relief replaces other forms of official overseas development aid;
• the HIPC Initiative is only available to a limited number of countries.

For the document click here.

Debt relief: still failing the poor, Oxfam, Oxfam International Briefing Paper, April 2001 

This paper shows that although debt relief seems substantial that many countries will still be spending more on debt than on basic education or health after receiving HIPC debt relief. Oxfam believes that a country should not be spending more than 10 percent of government revenue on debt service, but recognises that even this level would not be enough to meet the Millennium Goals. It urges the World Bank and IMF to 1) agree to a new HIPC initiative, which would link future debt sustainability to the financing requirements of the 2015 goals in indebted countries; 2) widen the HIPC initiative to more countries; and 3) agree to 100 percent cancellation of IMF and World Bank debt to HIPC countries that have illustrated that the resources will be spent on poverty reduction and where the ceiling  of 10 percent debt service to government revenue is insufficient to release enough resources.

The full text of this document is available here.

Debt relief under the HIPC Initiative: context and outlook for debt sustainability and resource flows, Abrego, L. and Ross, D.C., IMF Working Paper WP/01/144, 2001, IMF

This paper argues that the HIPC Initiative can substantially reduce debt burdens and therefore provides a solid basis for debt sustainability and increased social spending. On the relation between the HIPC Initiative and poverty reduction, the authors note that the contribution of the HIPC Initiative is important for countries to support their poverty reduction strategies, but much broader international aid is needed. Experience has shown that external support can only be effective if it reinforces sound policies implemented by HIPCs themselves and leads to more resources being allocated to social development and poverty reduction. The authors conclude therefore that debt relief should not be viewed in isolation.

For the full text of this document, click here.

Does the HIPC Initiative achieve its goal of debt sustainability? Gunter, B.G., paper presented at the WIDER/UNU conference on debt relief, 17-18 August 2001, Helsinki, Finland

The author notes that the evidence is growing that the HIPC Initiative does not provide long-term debt sustainability, mainly because its growth assumptions are considered too optimistic; its debt sustainability analysis inappropriate and its country selection too narrow. The author identifies a number of other problems in the HIPC Initiative, both regarding the HIPC framework and the debt relief provided under HIPC. The paper tries to examine the likelihood of the HIPC Iniative to provide debt sustainability by comparing various capital flows before and after the adoption of the HIPC Initiative; by assessing how realistic the growth assumptions are; and by examining the appropriateness of debt sustainability indicators under HIPC. On the basis of this analysis, the author concludes that the HIPC Initiative is unlikely to provide a solid exit from future debt rescheduling for many of the poorest countries.

The full text of this document is available here.

Globalisation, Growth and Poverty: Building an inclusive world economy, D. Dollar, and P. Collier, World Bank, 2001

The report deals with the large subject of growing integration of the economies and societies around the world. In the policy research report the authors dedicate a small section on debt relief in which they stress that debt relief is particularly powerful when combined with policy reform (improvements in the investment climate and social services). Debt relief should make a significant difference for countries that have reasonably sound policy environments for poverty reduction, as in the HIPC initiative. Furthermore the authors find it important to put debt relief in the larger context of the overall foreign aid for marginalized countries. Moreover, debt relief should be additional and should not come out of the existing envelope for aid.

For the document click here.

HIPC: Good news for the poor? Ranis, G. and Stewart, F. paper presented at the WIDER/UNU conference on debt relief, 17-18 August 2001, Helsinki, Finland

This paper aims to investigate whether HIPC is an over simple solution, advocated by NGOs with good intentions, but which in a way does not respond to the real problems of the economies in difficulties. The authors argue that HIPC appears to be a false promise for the poor: it provides limited and highly conditional resources, most of which are not likely to be additional; the resources are not distributed according to need; and the policy packages accompanying HIPC are unlikely to do much for the major development problems constraining these countries’ development efforts. In addition, the initiative diverts attention from the needs of the great majority of the world’s poor who do not live in HIPC countries.

The full text of this document is available here.

Putting Poverty Reduction First, Eurodad, 2001

The paper states that the current HIPC Initiative will not go far enough in changing the poverty situation of HIPCs because it does not take into consideration the resources these countries need for poverty-reducing expenditures and for spurring growth. The paper sets out why a new approach is needed and makes new calculations of what levels of external debt service are ‘affordable’ for HIPCs.

The authors propose to replace the debts-to-export measure for debt sustainability with one that measures what debt servicing is affordable as a percentage of government resources. Taking the pro-poor debt servicing methodology as a starting point the paper finds that seven countries selected for the HIPC initiative have no capacity at all to service external debt, and that at least nine require significant extra debt reduction.

For the document click here.

An appraisal of debt relief for poor countries, Mochrie, R., CERT discussion paper No. 2000/05, July 2000, Centre for Economics Reform and Transformation

This paper analyses the capacity of the multilateral financial institutions (MFIs) to manage the HIPC Initiative and concludes that the Initiative is unlikely to achieve the purposes for which it has been established. Criticism is based upon the MFIs’ own policy advice as well as that of public campaigners, and also other economists’ appraisals of MFI performance. The conclusion is drawn that there are a number of reasons for wishing to restrict the role of the MFIs in this process and that there should be movement towards a simplified framework for debt cancellation with a greater role for private institutions and market-oriented payments disciplines. This would imply less policy prescriptions for the countries that receive debt cancellation.

The full text of this document is available here.

The HIPC Initiative, True and False Promises, Cohen D. Technical paper no. 166, 2000, OECD-DAC, Paris

The author argues that the amount of debt relief provided by the HIPC Debt Initiative is much less significant if you look at market values of debt and debt relief instead of nominal values. The market value of debts takes into account the risk of non-payment, and is therefore lower than the nominal value. Based on market value calculations, the author argues that debt relief is 10 times less generous than nominal value accounting would suggest. The author therefore warns against scaling down aid flows on the grounds of debt relief provided under the HIPC Initiative. Donors should split the Initiative in two components: one is a reported loss (written-off net present value of the debt) and one is the amount of new ODA involved (the market value of written-off debt).

For the document click here. 

Implementing Debt Relief for the HIPCs, Sachs, J., Kwezi, B., Maciej, C., Sievers, S., 1999, Harvard University, Centre for International Development

The paper provides an overview of the issues with which both the Cologne Initiative and the HIPC Initiative of 1996 have not been able to deal with. The debt relief is in general not enough for HIPC governments to meet basic social needs of the population, and bilateral grants do not offset the heavy burden of debt servicing. In addition, the process of offsetting heavy debt payments with grants and new loans is highly unstable and erratic. The authors argue that an effective process of HIPC debt relief should be grounded on the following principles: the unmet social needs of most HIPC countries require significant net resource inflows; to achieve these increased inflows, it will be necessary to cancel most or all old debts; to the extent possible, new inflows should be highly concessional; debt relief should be guided by a process that helps to insure that the increased resource transfers will be channeled into areas of urgent human need, especially in public health and primary education.

For the document click here.

Relevant links

More information on debt relief can be obtained at:

Jubilee Research

Successor of Jubilee 2000, providing research, analyses, news and data on international debt and finance.

Eurodad

The European Network on Debt and Development is a network of 48 development non-governmental organisations from 15 European countries. These NGOs are working for national economic and international financing policies that achieve poverty eradication and the empowerment of the poor. The website contains research, policy and news on various themes related to debt and development.

ELDIS - debt relief resource guide

Provides many linkages to publications on this topic. It is also possible to subscribe to the ELDIS electronic newsletter on this topic. 

World Bank - section on the HIPC-initiative

Provides general information of the HIPC initiative (background, review, partners, papers) and contains up-to-date information on progress and country cases.

The Centre for International Development (Harvard University)- section on the HIPC Debt Relief

Contains a HIPC database, links to conferences and other relevant sites, and a number of articles.

IMF - section on debt relief

This section contains a HIPC fact sheet, and contains links to other IMF papers on debt relief, to documents specifically on HIPC and to country studies.

Website of the WIDER/UNU conference on debt relief

Website with a large number of papers that were presented during a conference on debt relief on 17 and 18 August 2001, Helsinki, Finland.

As a recently launched site, we still have some way to go towards providing a comprehensive information resource. You can help by submitting your own contributions (academic papers, position papers, analysis or comments etc.). To do this, go to Contact us.