Debt Relief and HIPC

Gumisai Mutume

The Need for Debt Relief

There is growing consensus around the world that debt is a major obstacle to the sustainable development of poor countries. Some countries spend more than 75% of their budgets on debt payments, leaving them with little money for developing their economy/ies, or for social expenditures, like education and health. The cost of debt payments, or servicing the debt, can also suck up much of the foreign currency a country earns with its exports, leaving little foreign currency to buy vital imports.

When the burden of external debt, or the money owed outside the country, becomes too much, countries generally try to renegotiate the terms of the loan. Over the years, more than 70 developing countries have at one time or another renegotiated the terms of their external debt. Generally, in the past, richer countries that loaned money to poorer countries have agreed to delay the payments, cut interest rates, or extend the period over which the debt was paid off. These traditional mechanisms of debt relief provided an estimated $6.5 billion in relief to more than 50 developing countries since the late 1970s. But that is a drop in the bucket compared to the total external debt of developing countries estimated at anywhere between $2 trillion and $2.7 trillion. (Such figures cannot be precise because of differences in definitions: the term “emerging markets”, sometimes includes, for instance, South Korea and Taiwan; other figures are for more narrowly defined “developing” countries; still others differentiate between “developing” and “transitional” economies. A further statistical complication arises because of growing disparities in figures for the various component countries: for instance, conditions for some countries with formerly very large foreign debts, such as Nigeria, Mexico and Thailand, have changed for the better, while a larger number of much lower-income countries have slipped deeper into debt. As a result, the aggregate figures no longer reflect the reality of external debt in the way they once did. We are here concerned primarily with the poorer countries with rising debt levels.)

Responding to mounting criticism that richer countries were condemning poor countries to poverty by not easing the pressure of their debt burdens, the World Bank and International Monetary Fund (IMF) in 1996 announced a new debt relief programme known as the Heavily Indebted Poor Countries (HIPC) initiative.

But the debt of poor countries has continued to grow and so has pressure for further debt relief, including forgiving some debt altogether. Jubilee 2000, an international movement of civil society groups and religious organisations in both developing and developed countries, has been one major proponent of debt relief. Based on biblical teachings, Jubilee 2000 proposed a one-off cancellation of the backlog of the unpayable debt of the poorest nations, as a gesture of goodwill to mark the new millennium.

History of Debt Crises

How do countries get themselves into a situation where debt relief is necessary? For the very poorest countries, which are the subject of discussion here, there have been several sources of the problem:

  • During the early 1970s, overspending by the US government led to more printing of dollars resulting in a sharp decline in the value of the dollar. In turn, the price of oil, denominated in dollars, soared and developing countries were forced to borrow more to pay for it. In the late 1970s and early 1980s, interest rates soared, to unprecedented levels. With those increases in interest rates, what were serviceable debt levels, suddenly became unsustainable. In the late 1990s, interest rates to emerging markets soared again. Even when countries do not have short term debt, there is a constant need to roll over debt, and when it is rolled over, they face higher interest rates.
  • Most debt is denominated in dollars or other hard currencies, and accordingly, what is a manageable debt level becomes unmanageable when poor countries’ currencies are devalued or depreciate in relation to hard currencies.
  • Many developing countries are dependent on exporting commodities such as agricultural products, minerals or metals, to earn money to pay off their debts. When export prices collapse, the debt burden becomes unsustainable.
  • Many of the very poor countries borrowed extensively throughout the 1980s, hoping their economies would start to grow by more than enough to repay the debt. But for one reason or another, the growth did not materialize.

History of Debt Relief

Long before HIPC, there had been a process by which countries that could not pay their debts could have them rescheduled. Often, in doing so, there was a write-down, or reduction, of the total amount of debt, at least in present value terms. To renegotiate official debts, debtor countries had to deal with the so-called Paris Club, a group of rich creditor nations. To renegotiate commercial debt, or money owed to private creditors, such as banks, countries had to deal with a group known as the London Club.

By 1996 it was widely recognized that more substantial debt relief was required. By the late 1990s, 41 heavily indebted countries owed about $205 billion in external debt, a figure that accounted for more than 130 percent of their combined gross national product. HIPC was introduced in an attempt to do something more for countries locked in a cycle of rescheduling debt with the Paris or London Clubs. For the first time, debt relief would cover multilateral debt, or loans made by the World Bank and IMF, as well as bilateral debt, where one country owes another, and commercial debt.

But, in fact, by 1999, critics pointed out, very little debt relief had been provided. Bolivia and Uganda had debt cancelled in 1998, but within a year found debt had returned to unsustainable levels, forcing them to seek further relief. Mozambique received relief, but found itself paying nearly the same amounts in debt service after HIPC. In 1999, conceding that original HIPC had not delivered, the Group of 7 industrialised nations launched Enhanced HIPC and promised to streamline the programme in order to provide “faster and deeper debt relief”. But even that did not seem to work well. Even before being fully implemented, there were growing concerns over the likely effectiveness of Enhanced HIPC, given problems of under-funding, restrictions over eligibility, inadequate debt relief, excessive conditionality and cumbersome procedures. By May 2000, only five countries had begun to receive some form of debt relief under enhanced HIPC: Bolivia, Mauritania, Mozambique, Tanzania and Uganda. Under pressure from the Jubilee 2000 movement, debt forgiveness was finally extended more broadly. For the 22 countries that became eligible by December 2000, a commitment of $33.6 billion in debt relief was made. It was expected that debt servicing in some of these countries would be reduced by one third during the next few years following HIPC treatment, combined with traditional debt rescheduling and bilateral debt relief. However, even by the end of the 2000, only Uganda had reached the final stage of HIPC, when full debt relief is given.

In an assessment of HIPC issued in September 2004, the UN Conference on Trade and Development (UNCTAD) said it was increasingly doubtful that HIPC beneficiaries would attain sustainable debt levels after completion point and maintain them in the long term. One of the major reasons for this was a drastic fall in commodity prices from the late 1990s to 2002 (export revenues are used in the calculation of debt sustainability). In some cases countries were forced to borrow again to finance current development programmes, creating a vicious cycle. Rising commodities prices over the past few years improved the outlook for some: Nigeria, for instance, which at its peak owed $35bn, cleared its debt to the Paris Club in 2006., and Argentina, which defaulted in 2001 when it owed $100bn, paid off its debt to the International Monetary Fund also in 2006.

In June 2005 the Multilateral Debt Relief Initiative (MDRI) was proposed by the Group of 8 (G-8) major industrial countries and was implemented in 2006 by the IMF, World Bank and the African Development Fund (AfDF). Under the MDRI, debt relief is provided in respect of 100 per cent of these institutions’ eligible debt claims on countries that reach the completion point under HIPC. The objective was to provide additional debt relief to free up resources to help HIPC countries reach the Millennium Development Goals. In 2007, the Inter-American Development Bank (IaDB) offered similar debt relief to the five HIPCs in the Western Hemisphere.

The Process

Only low-income, debt-distressed countries that borrow from the World Bank’s International Development Association (IDA) qualify for HIPC. The IDA provides loans at highly discounted rates only to countries with annual per capita incomes of less than a certain threshold – set at $1,095 in fiscal year 2009. These countries must go through a two-stage process.

Stage One:
This is a three-year period during which a country carries out economic reforms prescribed by the World Bank and IMF. Countries are expected to make changes in their economic policy in line with the IMF’s Poverty Reduction and Growth Facility. And they must establish a track record of carrying out poverty reduction programmes. To do this, HIPC countries must prepare Poverty Reduction Strategy Papers (PRSPs) with support from the IMF and World Bank. PRSPs outline a country’s macro-economic and structural reform policies and its concrete poverty reduction goals. The Bank and IMF require that PRSPs be prepared through consultation with civil society, key donors and regional development banks, such as the Inter-American Development Bank in the case of Latin America.

These reforms often require deregulation and privatisation of state enterprises, reform of the taxation system and changes in the way the public sector operates to improve efficiency. At the end of this period a country reaches its decision point. The two institutions then decide whether the country’s debt – after the full application of all forms of traditional debt relief – remains unsustainable. If it does, they offer the country a relief package. But debt relief at this stage would only be partial, cancelling a small part of the debt.

Stage Two:
During the second three-year phase of HIPC, the country has to undertake further reforms. Only after fulfilling these requirements will it reach completion point and receive the full package of debt relief. Responding to complaints over the slow pace of a process that makes countries wait six years before receiving relief, donor nations have agreed to reduce the total time required to qualify and complete the process.

By mid-2008 some 33 countries had reached the stage where they were receiving some debt relief. Of those, 23 reached the so-called completion point, qualifying for irrevocable debt relief. However, another group of about 8 countries remained unable to reach the decision point – in other words they were yet to be considered for assistance. Many of them are affected by conflict while others are in large arrears to various creditors that must first be settled before they can become eligible. It is this group of countries that may prove the most problematic for the HIPC program as many of them are unable to carry out the basic prerequisites of the programme, such as implementing policy reforms. Some of the countries that find themselves in this situation are Burundi, the Democratic Republic of Congo, Myanmar and Sudan.

Criticism of the IMF and the World Bank
Some of the harshest criticism of the debt relief process has been aimed at the multilateral institutions. The Bank and IMF are reluctant to write off the debts that developing countries owe them, saying this could create a “moral hazard”, that is, promote risky behaviour by giving borrowers the feeling they will be bailed out even if they don’t pursue “good policies” and that the debt would be forgiven again if it reaches similar levels. Advocates of debt forgiveness contend that these official institutions, with their greater sophistication, should be able to perform a full risk analysis better than the borrowing countries, and should be able to refuse to lend to countries that are overstretched.

But officials at the Bank talk ominously of the damage debt write-offs would cause to its AAA credit rating. Debt write-offs would imply an acknowledgment that the Bank had made mistakes in lending. Therefore, to avoid jeopardizing their financial standing and ensure repayment of their loans, a HIPC Trust Fund was created. It finances debt relief on money owed to the multilateral institutions. The Trust Fund either purchases and cancels the debt, or services it when repayment is due. The Trust Fund is in turn financed by creditor nations, but by the Bank’s own admission, it remains under-funded. In addition, special Poverty Reduction and Growth Facility grants from creditor nations are used to cover debt relief provided by the IMF. This practice has been criticised as showing a lack of commitment by the institutions as they are avoid taking losses for their lending mistakes in the past. Activists charge that the Bank and the IMF are passing their losses onto their shareholders, in order to maintain their high credit ratings.

Things to watch for when reporting on debt relief

Pace of debt relief

By mid-2001, only two of the 41 HIPC countries (Bolivia and Uganda) had reached completion point, while 23 had reached decision point, and four were deemed not eligible for debt forgiveness. After that the pace of debt relief slackened even further, with only five HIPCs reaching decision point between January 2001 and January 2004. It had also been expected that those countries reaching decision point would get to completion point within three years. The World Bank acknowledged that there were slippages in some countries owing to political tensions, fiscal policy setbacks and problems of governance and 8 of those that had reached decision point had still failed to reach completion point by mid-2008. Another 8 countries were eligible but had not applied for HIPC initiative status.

Staying on track with economic reforms during the interim period leading to completion has been difficult for many countries. One of the major challenges confronting many is the preparation of PRSPs, a task that requires full participation of various sectors of society, collection and analysis of data and detailing priorities on how to spend money saved through HIPC. Many HIPC countries lack sufficient human and institutional resources to perform these tasks.

It is important to report on why countries are failing to meet the requirements for full debt relief. What is delaying debt relief for your country? What standards are being used, and how does the country’s performance and circumstances compare with others that have received debt relief?

Poverty Reduction Strategy Papers
Examine the PRSP process in your country. Is it supporting or hindering poverty reduction efforts? Is it delaying debt relief? How? Increasingly, civil society organisations are charging that the process is too complicated, requiring institutional and administrative capacity that many HIPCs do not possess. Many are complaining that they are not really consulted; in the end, the papers are little different from what they would have been without a consultation process.

Try to get access to your country’s PRSP document as it provides excellent information on the spending priorities of your government. What are the concrete proposals to tackle poverty that your government outlines in its PRSP? How will money saved from debt servicing be spent? Is debt relief beginning to make a difference?

It is also necessary to assess how transparent and open the PRSP process is in your country. Many governments are reluctant to make World Bank and IMF documents accessible to their citizens. That makes it all the more important to ask: is it really engaging civil society? Is there any debate around PRSPs and on how to improve fiscal systems so that resources released by debt relief reach the poor?

Government expenditure
Debt relief opens up the budgeting process to greater involvement of civil society and the public. This brings many issues into public scrutiny – e.g. how reasonable is government expenditure in areas such as defence? How does it compare with spending in the social sector? Is government spending in non-essential areas undermining planned poverty reduction? Governments may claim to be prioritising poverty reduction in their commitments for debt relief. Is this reality reflected in their budgets?

To make the HIPC process accountable, Uganda set up a Poverty Action Fund where money released through HIPC is deposited. This fund in turn finances poverty alleviation programmes, such as building rural schools. Uganda, the first country to receive full debt relief under Enhanced HIPC, is largely considered a success story. It is reportedly spending HIPC savings on poverty reduction. The IMF expected Uganda to save 0.7 percent of Gross Domestic Product (GDP) during the first three years of debt relief under Enhanced HIPC. This amounts to about 10 percent of currently projected social expenditure. Among other things, the money has been targeted towards agricultural expansion, primary education and healthcare programs.

More recently, Honduras proposed to set up a fund for the distribution of HIPC savings along the lines of Uganda’s model.

Are there similar efforts in your country? Once set up, how transparent is the management and auditing of such a fund?

There may also be trade-offs between poverty reduction and other policy targets. Report on the inconsistencies that may exist between poverty reduction under HIPC and other broader economic objectives.

Is debt relief working?
Non governmental organisations active in the area charge that HIPC does not live up to its promise of bringing down the debts of poor countries to sustainable levels. Analyses by Jubilee 2000 UK show that the debts of many of these countries will become unsustainable again after full HIPC treatment. This is partly because the World Bank and IMF base the amount of debt cancelled on the performance of HIPC economies over the next two decades – i.e. on projected levels of revenue, exports and GDP. Jubilee 2000 UK says because the institutions use “wildly optimistic” growth projections and project higher revenues than historical trends reveal, less relief is being provided. Subsequently, countries will find that export earnings in future will not be able to meet debt repayments, Jubilee argues.

The institutions base their calculation of debt sustainability on the ratio of a country’s debt in relation to exports. It is deemed sustainable if it falls below 150 per cent. Using this criterion (which debt activists say is too narrow because it does not take into account a country’s debt in relation to social spending) several of the countries that have qualified for HIPC will still not achieve debt sustainability at completion point. The Jubilee 2000 UK study, utilizing World Bank data, noted that Malawi has to wait until 2013 and Niger until 2014 to attain sustainable debt. Bolivia’s debt will not be sustainable in the next 20 years, the report noted.

What is the situation in your country? Monitor levels of debt servicing compared to revenue and social spending in your country following HIPC. How do other factors, such as the vulnerability of HIPC economies to shocks, affect debt servicing? Hurricanes and earthquakes in Latin America, floods in Mozambique and the growing burden of HIV/AIDS in sub-Saharan Africa affect economic growth and budget revenues in these countries, yet observers say HIPC does not adequately take into account such factors. Most HIPCs depend on primary products for most of their export revenue. How did falls in commodity prices affect revenues and debt servicing and was there any relief from this during the years of rising commodity prices? And now that the gloomy outlook for the world economy points to declining prices again, what might that mean?

Growth rates
When estimating the amounts of debt relief to provide to 23 HIPC countries, the World Bank and IMF projected average GDP growth rates of 5.5 per cent for 2000-2010. However, from 1990 to 1999, the countries averaged 3 percent GDP growth. If the Bank and IMF overestimated growth in HIPC countries, they also overestimated future revenue. That may mean these countries will have to continue allocating relatively large shares of government budgets to debt servicing, instead of other vital areas, such as health and education. The Bank acknowledges that some of the projections used had been unrealistic. You should recalculate debt servicing obligations as a fraction of government revenue or export earnings, using more reasonable estimates of growth. How far will HIPC go to resolve the country’s problems? Will yet another debt rescheduling be required? More sophisticated analyses would look at, for instance, fluctuations in commodity prices. How large a fall in the price of the principal export commodity would be required to make the debt unsustainable? Based on historical variability, what is the likelihood of such a drop? Try to find an economist or institution that may have done studies including these calculations to help with your reporting.

Under HIPC, most of the debt relief is given at completion point, with the expectation that the amount given is sufficient to return a country’s debt to sustainable levels. However, critics charge that this formula does not factor in the accumulation of new debt. In order to run their economies, many HIPCs will continue borrowing after debt relief, a situation aggravated by the decline in official development assistance to poor countries. The General Accounting Office (GAO) of the US government reports that due to shortfalls in revenue and lower GDP growth than predicted, some HIPCs will require increased donor assistance. It notes that the debt levels of 7 countries studied will resume rising after receiving relief because, in order to have the funds necessary for poverty reduction, they must continue borrowing at the same rate as during the years prior to qualifying for HIPC. The GAO presents a scenario where Tanzania will not be able to repay its debt unless donor flows (loans and grants) increase by more than 30 per cent. Yet, new loans would only add to the endless debt cycle.

The case for non-HIPC countries:
There are a number of countries with huge debt burdens that still do not qualify for debt relief because of their classification at the Bank and IMF. Some countries are considered severely indebted, but because they do not borrow from the IDA but from a fund at the Bank that provides loans to middle-income countries they do not qualify for HIPC. Others are classified upper middle-income countries and therefore are also not eligible, even though they might also be severely indebted. Still others are low-income countries but are considered moderately indebted and therefore not qualified.

Because of the pressing nature of indebtedness among poor countries there has been increasing pressure for total debt write-offs. The sense of urgency has grown since the adoption of the Millennium Development Goals by the international community in 2000 at the UN Millennium Summit in New York. These goals include ambitious targets such as cutting global poverty by half by 2015. It is now generally accepted that many indebted countries will not meet these targets unless massive amounts of financing are poured into them. Critics argue that debt servicing further compounds the problem because it entails transferring to wealthy countries scarce financial resources from countries that can least afford it. Now, with the onset of a severe world financial and economic crisis, there have been calls for policy-makers not to forget the poor countries just because the rich ones are themselves in trouble.

To prevent the HIPC Initiative from becoming a permanent facility, a sunset clause was proposed in 1996. It stipulated that HIPC would be open to countries that carry out programmes supported by the Bank and IMF and that within a two-year period the initiative would be reviewed and a decision made on whether it should continue. In 2006, the IMF and the Bank endorsed and “ringfenced” the list of countries eligible or potentially eligible at that time but clarified that it could be amended to include other countries using end-2004 data. Afghanistan was later found to be eligible for HIPC Initiative assistance and reached the decision point in July 2007. Questions remain on how debt relief will be extended to those countries that failed to reach the decision point by the cut-off date or do not have the same strategic geo-political importance as Afghanistan. Also, when HIPC comes to an end, it is almost certain that a significant number of countries will be saddled with unsustainable debt levels. So even after HIPC, the debt problem does not seem to be going away.

List of Countries That Have Qualified for, are Eligible or Potentially Eligible and May Wish to Receive HIPC Initiative Assistance (as end-September 2008) -- IMF

Post-Completion-Point Countries (23)
Benin, Bolivia, Burkina Faso, Cameroon, Ethiopia, The Gambia, Ghana, Guyana, Honduras, Madagascar, Malawi, Mali, Mauritania, Mozambique, Nicaragua, Niger, Rwanda, São Tomé & Príncipe, Senegal, Sierra Leone, Tanzania, Uganda, Zambia

Interim Countries (Between Decision and Completion Point) (10)
Afghanistan, Burundi, Central African Republic, Chad, Republic of Congo, Democratic Republic of Congo, Guinea, Guinea Bissau, Haiti, Liberia

Pre-Decision-Point Countries (8)
Comoros, Côte d'Ivoire, Eritrea, Kyrgyz Republic, Nepal, Somalia, Sudan, Togo

Important Terms

Term Definition
Official Debt

Money owed by the government of your country. There are three broad categories of official debt.

Commercial debt

money owed to private sector lenders. Governments often borrow from commercial banks etc. to meet budget deficits. Commercial debt should not be confused with private debt, which is borrowing done by companies in your country.

Bilateral debt

Country–to-country debt. Often, industrial countries give loans to poorer nations for development programmes or to purchase manufactured goods, such as arms, vehicles and industrial equipment.

Multilateral debt

Debt owed to a multilateral institution such as the World Bank, International Monetary Fund, African Development Bank, or Asian Development Bank. Many governments are “shareholders” in these institutions, which is why they are called multilateral. The level of a country’s contributions determines what amount of the institution a country can control; rich nations control majority shares in the institutions.

Sustainable debt

To qualify for debt relief under HIPC, a country’s debt must be deemed unsustainable. The Bank, IMF and the debtor country determine this through a debt sustainability analysis. The most common criteria used assess the ratio of a country’s debt to its exports.

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