Outline
1. Defining debt? The complexity of the concepts related to debt
3. A key theoretical debate: the relationship between debt and growth
4. Another key theoretical debate: the relationships between debt and aid
5. Assessing the relevant causalities: commodity dependence and the limits of debt relief in SSA
5. Important issues in SSA: capital flight and the concept of odious debt
7. The debt relief initiatives; the notion of debt sustainability
8. The mixed results of the HIPC debt relief initiative
9. The Multilateral Debt Relief Initiative (MDRI)
1. Defining debt? The Complexity of the concepts related to debt
· Debt coexists with many other forms of external finance.
In addition, public debt has to be distinguished from external debt
For middle-income countries, clearer difference between external debt (=private and public sector debt) and public debt (=public sector external and domestic debt).
Less clear in low-income countries: private sector external debt and domestic public debt are often smaller.
Fiscal deficits can be financed either in selling assets (privatisation) or domestic or foreign borrowing.
Easier access to foreign borrowing in SSA, with terms more favourable than for domestic borrowing (concessional, long maturities, grant terms, from international agencies).
So foreign debt is a more attractive way of financing fiscal deficits, even if there are significant currency (devaluation) risks: see Beaugrand, Loko and Mlachila 2002 The Choice Between External and Domestic Debt in Financing Budget Deficits.
· In low-income countries/LICs, the relevant concept: public and publicly guaranteed external debt.
This concept was used for the HIPC Initiative.
But several LICs with mineral or natural resource sectors have large private sector external debts, not all of which are government guaranteed
+some governments have domestic debt liabilities in either foreign or domestic currency (e.g., Ghana).
Other LICs (e.g. CFA franc zone) use intra-regional (domestic-currency denominated) government securities to finance their fiscal deficits.
The definition of the public sector varies across countries: central government vs. more comprehensive concept (local governments and/or state-owned enterprises/SOEs)
+contingent liabilities (balance-sheet exposures of often publicly-owned banks): into the public debt analysis
There are important forms of finance not guaranteed by or mediated through the public sector: e.g., FDI, project lending, portfolio investment, equity funds, private non-guaranteed debt, licensing, joint ventures, etc.
· A key concept: the concept of debt sustainability: it assesses both external and public debt sustainability.
Distinct from other concepts: e.g. vulnerability, e.g. consequences of domestic policy shocks, or real external shocks (e.g. decline in the terms of trade, conflicts, natural disasters, protectionism from rich countries, etc). See IMF website, Assessing sustainability, mimeo 2002. See below.
· Complexity of the facts referred to as 'debt'.
See before the IMF-OECD-BIS-WB joint statistics on external debt, now the Joint External Debt Hub (JEDH) developed by the Bank for International Settlements, the IMF, the OECD) and the WB: http://www.jedh.org/
Stocks=the amounts outstanding at the end of each period
Vs. Flows= disbursements net of repayments during the period
Just to give an idea of the complexity of the notions: the OECD/IMF/BIS/WB was providing data series on:
1. (All maturities): Bank loans (source: BIS): Loans from banks resident in 38 countries.
+Debt securities issued abroad (BIS): Money market instruments, bonds and notes issued in international markets by both public and private sector borrowers.
+Brady bonds (World Bank): Bonds issued to restructure commercial bank debt under the 1989 Brady Plan.
+Non-bank trade credits (OECD): Official and officially guaranteed non-bank export credits from 26 OECD countries.
+Multilateral claims (AfDB, ADB, IDB, IMF, WB): Loans from the AfDB, ADB and IADB, use of IMF credit, and IBRD loans and IDA credits from the World Bank.
+Official bilateral loans (DAC creditors, OECD): concessional (aid) and other loans provided mainly for developmental purposes by the 21 member countries of the OECD DAC and Korea as of 2000.
2. (Debt due within a year):Liabilities to banks (BIS): Liabilities to banks which are nationals of (i.e. headquartered in) 30 countries and which report their claims on a worldwide consolidated basis.
+Debt securities issued abroad (BIS)= Money market instruments, bonds and notes issued in international markets by both public and private sector borrowers.
+Non-bank trade credits (OECD): Official and officially guaranteed non-bank export credits from 26 OECD countries.
3. (Memorandum items):Total liabilities to banks (locational) (BIS): Liabilities to banks resident in 38 countries.
+Total liabilities to banks (consolidated) (BIS): Liabilities to banks which are nationals of (i.e. headquartered in) 30 countries and which report their claims on a worldwide consolidated basis, both short term and long term liabilities.
+Total trade credits (OECD) Official and officially guaranteed export credits from 26 OECD countries.
+Total claims on banks (locational) (BIS): Claims on banks resident in 38 countries.
+International reserve assets (excluding gold) (IMF): Monetary authorities' holdings of SDRs, reserve position in the IMF and foreign exchange assets.
2. Debt in SSA: Facts
· High levels of indebtness characterise the Least Developed countries/LDCs : see UNCTAD LDC report 2002: 34 of the 50 LDCs are in SSA.
End-2000, the LDCs debt stocks fell, due to debt forgiveness grants and changes due to cross-currency valuation: this counterbalanced a small increase in debt owing to new loans.
New debt in the LDCs: official loans, particularly multilateral loans.
Excluding IMF credit, multilateral loans were equivalent to 115% of net official debt flows in 2000. Net bilateral debt flows were negative in 2000. Level of debt service payments= $4.7 billion in 1999, $4.6 billion in 2000+ as ratio of exports of goods and services, debt service payments =9.6% in 2000, 11.8% in 1999.
Behind aggregate statistics, mixed situation. Between 1999 and 2000, for 42 LDCs, the ratio debt stocks/GDP declined in 18. Total arrears on long-term debt declined in only 8 LDCs. 29 LDCs had unsustainable external debt in 2000, i.e. a ratio of NPV debt stocks/exports of 150.
· Most of the debt is in SSA owed to official creditors (multilateral debt)àthis is why the Enhanced HIPC initiative of debt relief has been important.
In 2000 for 20 HIPC-LDCs which have reached decision point or completion point: debt service exceeded 20% of government revenue in 8 of them.
+it exceeded 20% of social expenditure in 7. In 14 countries, debt service payments in 2000=40% or more of government social expenditure.
32 LDCs = HIPCs countries.
On average, the ratio of debt service to government revenue declined from 17.4 % in 1999 to 10.4 % in the 7 HIPC-LDCs that had reached completion point. In the LDCs that have reached decision point this ratio declined from 19.9 % to 15.3 % (see UNCTAD LDC report 2004).
· The characteristics of debt in SSA
In particular, an increase in debt vis-à-vis multilateral creditors
See Loser 2004 External Debt Sustainability: Guidelines For Low- and Middle-Income Countries: in billion dollars: 0.9 (1970); 7.6 (1980); 38.2 (1990); 54.7 (1996); 53.6 (1997); 57.1 (1998); 56.1 (1999); 54.7 (2000); 54.5 (2001); 60.4 (2002).
· Due to the debt relief initiatives (HIPC, MDRI), a decrease in public debt in SSA after the mid-2000s
See IMF Regional Economic Outlook SSA, 2008, April
Box 1.3. The Changing Nature of Public Debt in Sub-Saharan Africa
The size and composition of public debt in Africa have changed significantly in recent years. Debt relief under the HIPC and the MDR Initiatives and fiscal adjustment have significantly reduced external public debt over the past four years, creating room for fiscal spending and borrowing. At the same time, domestic public debt and debt held by private external creditors have become increasingly important, reflecting (i) increased banking sector liquidity; (ii) regional financial integration, which has allowed currency union members to tap larger pools of liquidity because private banks in the CFA franc zone are increasingly operating at the regional level, and the BCEAO is supporting development of a regional bond market; and (iii) higher capital inflows, reflecting improved macroeconomic conditions, a global search for yield, and greater interest in Africa by new official creditors.
The enhanced relevance of private domestic and external debt presents analytical and policy challenges as countries try to prevent a reemergence of debt vulnerabilities. The first is the lack of comparable cross-country data, with domestic debt data not being compiled systematically in many countries, and methodological differences in such areas as the definition of the public sector, treatment of contingent liabilities, and conventions for decomposing public debt. Another challenge is to go beyond the traditional focus on external public debt and integrate domestic public debt into debt sustainability analysis, recognizing that a domestic debt overhang can contribute to future debt and balance of payments crises. The fiscal template of the IMF/World Bank Debt Sustainability Analysis for Low-Income Countries provides a starting point for analyzing long-term total public debt dynamics. In addition, it will be increasingly important to assess near-term vulnerabilities (such as rollover, currency, or interest rate risks), especially in countries with a high share of domestic debt, which has generally shorter maturities, higher and more variable interest rates, and debt rollover dependent on an underdeveloped local banking sector or potentially volatile foreign portfolio flows.
A central policy question is the appropriate speed of new borrowing in post HIPC/MDRI countries, where the low level of debt and the benign borrowing environment may be seen as an opportunity for a rapid expansion of debt-financed public investment. The policy choice will depend on the cost and risk of new debt, especially in countries that have received HIPC and MDRI relief, the expected rate of return (and risk) of additional public investment, and the desired overall fiscal policy stance in a cyclical context. Another policy challenge is to better manage public debts, which can help governments control debt service and guard against exchange rate, interest rate, and rollover risks. In an environment with many new borrowing options, this will require careful cost-risk analysis to inform choices about debt composition. In many countries, it will take time and resources to improve public debt databases, strengthen debt management offices, and develop customized software tools. In addition, development of local financial markets will be important for reducing the cost and risks of domestic borrowing.
SSA data profile: see WB website, countries, SSA region: no data for 2006 and 2007.
1999 | 2000 | 2002 | 2003 | 2004 | 2005 | |
FDI, net inflows, bn | 9.3 | 6.3 | 7.8 | 10.1 | 11.3 | 16.6 |
Long-term debt (curr. US$), bn | - | 172.4 | - | - | 196.6 | 176.7 |
Total debt service (% exp. goods, services) | 13.5 | 11.4 | 10.5 | 8.5 | 8.7 | 8.8 |
Short term debt outstand., bn | 41.0 | 33.1 | 29.1 | 31.1 | 28.8 | - |
WB WDI database, Aug 2004, 2005, 2007, WB Debt website, current US $
A relevant annual WB report: WB Global Development Finance.
See WB GDF 2006: The rise in ODA reflects debt relief and other special-purpose grants. The shift from concessional loans to grants continues. Impact of debt relief: The HIPC Initiative has eased the debt-service burden of a small group of poor countries, most of which are in SSA. The 28 countries that reached the "decision point" for debt relief prior to 2006 received $2.3 billion per year in debt relief from 2001 to 2005, equal to 2.2 % of their GDP and 9.2 % of their exports. The HIPC Initiative has provided debt relief equal to about half of the debt service due from the group.
See GDF 2007: The pace of foreign exchange reserve accumulation is picking up in SSA, with reserves rising by $33 billion in 2006, following increases of over $20 billion in 2004–05, with about half of the accumulation in 3 countries: Nigeria ($5.9 billion), Angola ($5.4 billion), and South Africa ($4.5 billion).
See GDF 2008: in 2007, expansion of an African sovereign issuer base. Ghana became the first heavily indebted poor country (HIPC) to issue an external bond, with a $750 million Eurobond issue in September 2007. The bond issue was oversubscribed several times, despite being launched in the midst of the turmoil in international financial markets. Gabon issued its inaugural sovereign bond in December 2007 when it launched a $1 billion 10-year Eurobond with a yield of 8.25% that was used to prepay its Paris Club creditors.
From WB GDF 2008
Though a bit old, see UNCTAD 2004, Debt sustainability: oasis or mirage?
See UNCTAD 2004, Debt sustainability: oasis or mirage: private commercial bank lending accounts for much of the external debt of middle-income developing countries, but most low-income SSA countries have borrowed more from multilateral financial institutions and official bilateral creditors.
Such loans=directly contracted from other governments or their export credit agencies (ECAs), and private loans were insured for payment by ECAs.
=debt relief mechanisms launched in the late 1980s (Latin American debt crisis) addressed the commercial bank debt of middle-income developing countries.
In 1980, 56 % of SSA total public and publicly guaranteed debt was official.
In 1995 =77%. Corresponding ratios for multilateral debts were 14% (1980) and 27 % (1995).
Between 2000 and 2002, more than 80% of SSA public and publicly guaranteed debt = official, and about 1/3rd of it was multilateral debt.
Debt owed to multilateral financial institutions was considered immutable because of the preferred creditor status of these institutions. SSA external debt crisis = an 'official' rather than a 'commercial bank debt' crisis.
SSA external debt burden increased significantly between 1970 and 1999 = just over $11 billion in 1970, then SSA had accumulated over $120 billion of external debt in the midst of the external shocks of the early 1980s.
Total external debt then worsened significantly during SAPs in the 1980s and early 1990s =$340 billion in 1995.
SSA external debt = $39 billion during the 1970s, $317 billion in the late 1990s. Over this period, total debt service increased from $3.5 billion to $26 billion.
+2 oil price shocks of 1973–1974 and 1979–1980 àadverse impact on the trade balance of oil-importing countries + fiscal crises+ second shock coincided with sharp rises in real interest rates and the global recession of 1981–1982. (UNCTAD 2004, debt sustainability)
See Rwegasira and Mwega 2003, in UNCTAD 2003 Management of capital flows: comparative experiences) on the evolution and characteristics of SSA debt, and its links with fiscal deficits and macroeconomic policies.
· See UNCTAD reports, see UNCTAD, SSA performance (2001): decline explained by debt write-offs, i.e. the HIPC and Paris Club initiatives
+ movements of the dollar: 50% of SSA's external debt denominated in currencies other than USD
Despite the decline in the absolute nominal level of SSA debt, the conventional debt indicators (debt/export and debt/GNP ratios) are unfavourable in comparison with other developing countries.
SSA had a lower debt-export ratio in 1990 than South Asia and Latin America, but the highest ratio at the end of the 1990s.
Ratio of debt/GNP fell or remained relatively stable in other regions, but increased in SSA during the 1990s. SSA external debt is high/GNP and export earnings, but debt service ratio=low because of the concessional nature of a large proportion of this debt.
Debt service ratio (principal and interest payments)=major problem +deteriorated in the 1990s, above the ratios of East Asia and the Middle East.
From UNCTAD 2004, debt sustainability
· The problem of arrears: particularly acute during the 1990s.
SSA external debt crisisàincreasing levels of arrears: an indicator of the inability to service debt obligations.
In 1995, accumulated arrears on principal repayments =$41 billion, SSA) owing almost all of this + arrears = 1/5th of the total debt stock of SSA (see UNCTAD 2004 debt)
At the beginning of the 1990s, the share of arrears in total debt of SSA=15% (above the Latin American ratio, 11%), but 27.7% in 1998.
Conversion of arrears on interest liabilities into debt= substantial portion of the increase in the debt stock of SSA since the 1980s.
A substantial portion of debt-generating flows from donors=addition of arrears to existing debt stock rather than fresh money. (see UNCTAD SSA performance 2001)
· In SSA, domestic debt markets are small, highly short-term, high interest rates, narrow investor base.
But although much smaller than foreign debt, domestic debt is a significant burden to public budgets
+ it crowds out lending to the private sector: see Christensen 2004 Domestic Debt Markets in SSA.
· Evolution of debt for LDCs: interesting as many SSA countries are LDCs
See UNCTAD. 2008. The Least Developed Countries Report 2008: Growth, Poverty and the Terms of Development Partnership: for the LDCs:
F. Trends in external debt
(…) Country data show that the debt stock fell in 17 out of 46 LDCs, including 16 of the 33 African LDCs for which data are available. African LDCs still accounted for 65% of the total debt stock of the LDCs in 2006, but this was down from a high of 77% in 1998. Both multilateral and bilateral debt fell between 2004 and 2006, but the former declined at a faster rate. Multilateral debt constituted 58 % of total LDC debt stock in 2004, but fell to 53 % in 2006.
In contrast to other developing countries, most of the debt of LDCs is owed to official creditors. In 2006, for example, debt arising from concessional loans constituted 73% of the total debt stock in LDCs, as against 22% in other developing countries. As a consequence, trends in debt stock are strongly influenced by official debt relief initiatives.
The recent debt stock trends in LDCs reflect, in particular, the continued implementation of the Enhanced Heavily Indebted Poor Countries (HIPC) Initiative and also the adoption of the MDRI in 2006. The latter Initiative goes further than the former by providing additional resources for the cancellation of multilateral debt contracted with the World Bank, International Monetary Fund (IMF) and African Development Bank for countries which have passed the completion point of the HIPC Initiative (see box 3). As a result of the MDRI, grants for ODA principal forgiveness increased from $1.5 billion in 2005 to $28.2 billion in 2006. In effect, such debt forgiveness retrospectively converted earlier concessional loans into grants (see subsection E.2 above). Of this sum ($26.9 billion), 97% was related to the MDRI.
Table 19 shows the status of LDCs within the HIPC Initiative as of October 2007. 16 LDCs had reached completion point and were receiving irrevocable debt relief under the terms of the initiative. Of these countries, 4 LDCs — Malawi, Rwanda, Sierra Leone and Zambia — reached the HIPC completion point in 2005 or 2006 and Sao Tome and Principe in 2007. All of these 16 LDCs
have also benefited from MDRI debt cancellation. This has radically changed their debt burden and opens a window of opportunity.
3. A key Theoretical debate: the relationship between debt and growth
· Determinants of indebtness?
=debt and its snowball effects as a market imperfection
For those interested, see Cohen, Daniel and Richard Portes. 2004. Towards a Lender of First Resort, London, CEPR discussion paper 4615: if interest rates (country spreads) rise, debt snowball effectàthen self-fulfilling with regard to the fundamentals
=market imperfection=the unaided market may not choose the "good equilibrium" over the 'bad equilibrium'= fundamental flaw in market discipline;
3 types of origin of crises =crisis of confidence (spreads and currency crisis), a crisis of fundamentals (real growth rate), and a crisis of economic policy (primary deficit).
· For some studies: SSA lack of growth is explained by macroeconomic mismanagement and low investment: see Cohen 1997. Growth and External Debt.
· No clear relation between growth and external finance
See Aizenman, Pinto and Radziwill 2004 Sources for Financing Domestic Capital: no evidence of any 'growth bonus' associated with increasing the financing share of foreign savings.
Rather the opposite= in the 1990s, countries with higher self-financing ratios grew faster than countries with low self-financing ratios, even after controlling growth for the quality of institutions.
· Link between financing and growth in low-income countries? Now more pessimism vis-à-vis the models of financing gaps (savings/investment) and capital scarcity. See IMF 2003, Debt sustainability in low-income countries/LICs, May, IMF website.
Same doubts on aid effectiveness, i.e. more aid=higher growth in the presence of good policies and good institutions.
In the context of borrowed resources, failure to generate growth=more problematicà the resulting debt burden may in itself be a factor undermining growth.
· Concept of 'debt overhang': so much debt that the entire surplus of any new investment goes to the existing debt holders.
Foreign financing has a positive impact on investment and growth, but the associated debt service works in the opposite direction, with the latter effect becoming stronger as debt grows=the 'debt Laffer curve'.
Increasingly adverse effect of debt service on investment and growth explained by the anticipation of more distortionary taxes needed to repay the debt, which dampen investors' (after-tax) returns.
At a high level of debt, the adverse effect dominates=the initially positive relationship between borrowing and investment is reversed.
Resulting debt-servicing difficulties=expectations debt will have to be forgiven, thereby discouraging private foreign investors and new financing + reducing borrowing governments' incentives to pursue sound policies that strengthen their capacity to repay.
· Concept of 'defensive lending': official lenders do not recognise losses, fear arrears
àperpetuate problems by engaging in defensive lending, i.e. providing new loans only to ensure repayment without sufficient regard to the policy framework.
See the concept of fungibility: using new inflows to service debts
· See Arslanalp and Henry 2003, The world's poorest countries: debt relief or aid?: the problem facing the HIPCs is not debt overhang, but poor social infrastructure, poor institutions
+lack of physical infrastructure that lower private rates of return and reduce incentives to invest (property rights, roads, schools, hospitals, water). HIPC resources for debt relief more efficiently employed as direct foreign aid.
· Concept of 'debt distress' (not only for LICs): for the IMF: policies matter
=periods in which countries resort to exceptional finance=significant arrears on external debt, or Paris Club rescheduling, or nonconcessional IMF lending. Factors of debt distress= debt burden, quality of policies and institutions, shocks. (see Kraay and Nehru 2004 When Is External Debt Sustainable)
· Concept of 'debt intolerance' (more relevant in emerging markets)= inability of emerging markets to manage levels of external debt that are manageable for advanced countries.
'Safe' external debt-to-GNP thresholds for debt intolerant countries may be very low=e.g. 15%.
The problem=volatility of emerging financial markets and their difficulty in servicing and repaying their debts.
But different possible causalities: debt intolerance=institutional weaknesses of the countries, weak and unreliable policies:
See the well-known distinction made by Eichengreen, Hausmann and Panizza 2003 Currency Mismatches, Debt Intolerance and Original Sin:
Between 1) debt intolerance
And 2) the 'original sin', i.e. inability of a country to borrow abroad in its own currency=causality assigned to the international financial markets and the structure of global portfolio
Thresholds depend on a country's default and inflation history=serial default that has plagued many countries over the past two centuries=essential for assessing debt sustainability, debt restructuring, capital market integration, international lending (see Reinhart, Rogoff and Savastano 2003 Debt Intolerance).
· Existence of thresholds, at which the debt stock has a negative impact on growth
But in practice, very difficult to identify=disentangling the impact of the debt overhang from other factors+ threshold depends on several economic and political factors. Thus HIPC thresholds of 150 % of exports and 250% of revenues: not unequivocal in the separation of sustainable and unsustainable debt ratios.
· Non linearities of the impact of external debt on growth:
See Pattillo, Poirson and Ricci 2004, What Are the Channels Through Which External Debt Affects Growth.
Various channels of the impact of debt on growth: factor accumulation or total factor productivity growth: debt affects growth via a negative affect on physical capital accumulation and TFP growth.
Presence of nonlinearities in the effects of debt on the different sources of growth.
Panel data set (61 developing countries), over 1969-98
The negative impact of high debt on growth operates both through a strong negative effect on physical capital accumulation and on total factor productivity growth.
On average, for high-debt countries, doubling debt will reduce output growth by about 1 percentage point and reduce both per capita physical capital and total factor productivity growth by somewhat less than that. In terms of the contributions to growth, approximately one-third of the effect of debt on growth occurs via physical capital accumulation and two-thirds via total factor productivity growth.
The average impact of debt becomes negative at 160-170% of exports or 35-40% of GDP. The marginal impact of debt starts being negative at about half of these values
· Specificity of low-income countries/LICs? The IMF acknowledges that LICs exhibit specific problems
See the IMF website: in LICs, very little private capital and FDI, no commercial loans, official grants and concessional loans, insulation/volatility of private capital flows+concessional financing= returns on new investments exceed their (subsidised) costs and so sustainable debt dynamics+but aid dependence complicates debt-sustainability: flows are not under government's control and are intrinsically uncertain+aid allocation=disincentives to implement debt reducing policies as aid flows reduced in response to improvements in debt indicators.
Investment and debt dynamics in low-income countries: use of funds: poor governance, mismanagement. But even if positive payoffs, returns highly uncertain. +payoffs accrue only over the long term, diffuse benefits (e.g. security and health care).
In contrast, debt service (at least interest) starts falling due immediately, potentially crowding out other spending, as governments have limited ability to increase revenues. +narrow and highly volatile production and export bases, vulnerability to exogenous shocks that alter debt dynamics
àhigh investment returns in low-income countries, general lack of confidence, fear of debt repudiation by potential investors. Hence scarce private capital flows, contrary to neoclassical theory.
For the IMF= 5 types of constraints on the ability to generate the resources necessary to service debts
=1) Foreign-exchange constraints=limited degree to which domestic factors of production can be transformed into the foreign exchange required for debt service and financing of imports
2) Fiscal constraints= government's limited capacity to tax in order to meet debt service
3) limited fungibility of resources (earmarking of revenues for sub-national governments and agencies, restrictions on the use of foreign aid for debt service (e.g., tied aid/projects, thus reducing the government's ability to shift resources toward debt service)
4) rollover constraints=difficult refinancing debt-service humps
5) political considerations=resources allocated to debt service/social expenditure.
· Important impact of external debt on income and poverty
External debt may have a negative impact on public investment and income growth,
And a high debt service's crowds out government social spending: see Loko et al 2003 on the impact of external indebtness on poverty.
· The key role of growth in debt crises
See Easterly 2001. Growth Implosions, Debt Explosions: debt crises due to low growth, itself due to poor policies.
Worldwide growth slowdown after 1975 has been a major negative fiscal shock: it lowers growth, lowers the present value of tax revenues and primary surpluses +makes a given level of debt more burdensomeàpublic debt/GDP ratios exploded.
Growth slowdown had an important role in the debt crisis of the middle income countries in the 1980s, the crisis of the HIPCs countries in the 1980s and 1990s, and the increased public debt burden of industrial countries in the 1980s and 1990s+HIPCs' debt problems worse because of slow growth after 1975.
· Other theoretical approaches of debt dynamics:
E.g., the theory of contracts, and in the case of the analysis of debt, the limited enforceability of contracts.
Conditional aid as a set of implicit contracts=e.g. between altruistic donors concerned by the poor and recipient government representing the interest of the well-off, infinite horizons, punishment threats: see Cordella et al 2003 on conditional aid, sovereign debt and debt relief, IMF workshop Oct 2003.
Debt as a component of the intertemporal maximisation of a borrower in a competitive loan market facing an intertemporal budget constraint.
Recent models of endogenous growth and the relationship between debt and growth, sovereign risk, incentives to repay.
4. Another key theoretical debate: the relationships between Debt and aid
· The relationship between debt relief and official development assistance/ODA: the debate on the additionality of aid flows and debt relief.
See Ndikumana 2002. Additionality of Debt Relief and Debt Forgiveness: from the recipient side, countries that received debt relief also received more aid compared to those that did not qualify for debt relief.
From the donor side, decline in aid disbursement since the early 1990s+no econometric evidence for any direct causal relationship between the decline in aid and debt relief/forgiveness. Decline in aid=serious concerns: external resources cannot be met by debt relief alone.
For the IMF, debt relief to LIC does not lead to extra resources from the donors, nor crowd out other aid flows: see Powell 2003 Debt Relief, Additionality, and Aid Allocation in Low Income Countries.
See Gunter,Rahman and Wodon. 2008. Robbing Peter to Pay Paul? Understanding Who Pays for Debt Relief: on the distributional impacts of recent debt relief initiatives among 4 groups of countries: the heavily indebted poor countries (HIPCs), the other IDA-eligible countries, the non-IDA developing countries, and the industrialized countries.
The distributional impacts are subject to two questions: (a) is debt relief additional to donors' traditional aid budgets?
and (b) will donors make reallocations of their traditional aid budgets to HIPCs due to debt relief provided to them?
The recent debt relief initiatives are positive but under certain circumstances, they may have some negative implications on future aid allocations for HIPCs or non-HIPCs. The degree to which these countries are affected depends critically on 2 factors: (1) the degree of additionality of debt relief to traditional aid flows and (2) the degree to which aid donors make reallocations in their existing aid allocation due to the provision of debt relief. The higher the degree of additionality, the higher are the costs of the creditors. The higher the reallocation of the HIPCs' traditional aid, the lower are the benefits to the HIPCs.
See UNCTAD. 2008. Trade and Development Report 2008: Commodity Prices, Capital Flows and the Financing of Investment. Debt relief: the need for additionality: Debt relief has played an important role in ODA, particularly since 2003. However, there is no clear evidence that it has been additional to other forms of aid, as called for in the Monterrey Consensus. Such additionality is indispensable because the reduction of the debt stock has a very limited effect on the capacity of governments to increase their expenditure in the period in which it is granted. Full additionality would not only improve the chances of beneficiary countries to meet their growth and social objectives, including those set by the MDGs, but it would also increase their ability to do so without encountering an unsustainable debt situation in the future.
Past debt relief efforts have largely by-passed the considerable development needs of low-income countries that have relatively low debt levels either as a result of prudent external financing strategies or because they have not undertaken essential public sector investments. In order not to discriminate against such countries, it would be appropriate to allow other poor countries to benefit from the Multilateral Debt Relief Initiative, including those that have sustainable levels of indebtedness. Moreover, it may also be necessary to consider providing debt relief to developing countries that have an unsustainable level of debt but are not eligible under the Heavily Indebted Poor Countries debt initiative.
· See UNCTAD LDC report 2002: Unsustainable external debt also undermines aid effectiveness:external debt has influenced donor behaviour.
Official donors, e.g. the major creditors, have been supplying aid to ensure that official debts can be serviced=throughout the 1990s gross aid disbursements: strongly correlated with debt service payments.
· Debt dynamics may be analysed as a game between governments and donors involving aid and debt.
Debt servicing imperfectly offset by debt postponements, arrears, new loans and grants from donor governments=creditor governments take away with one hand what they give with the other.
Debt game=cycle of economic stagnation, slow export growth, external debt, low impact of aid=subtracts aid resources for development + for the donors, it curtails the focus of resources on countries with high levels of poverty.
'Defensive lending'=disbursements by official creditors to ensure that debtor countries can continue to service past credits;
+'forced lending'=desire to avoid arrears.
Changing the rules of the 'debt game? Growing debt in SSA=affects the provision of new resources by donors. If debt levels are reduced, donors can shift from current non-selectivity and defensive lending to a low debt regime.
For the CGD and the IIE; Birdsall and Williamson 2002 Delivering on Debt Relief:: econometric analysis, compare the relation net transfers/GDP per capita (proxy for poverty), during 1978-1998.
Findings: donors are more responsive to the quality of domestic policy and the level of GDP per capita in the low-debt regimes than in the high-debt regimes. In high-debt regimes, responsiveness disappeared over 1988–1998. In high multilateral debt regimes, any increase in debt service is offset by an equivalent increase in aid disbursements. Domestic policies mattered little.
Donors (bilateral donors) made greater transfers to countries with high debt owed to multilateral creditors and 'bad' policies=debt relief has the potential to restore selectivity in support of good policies?
See Birdsall, Claessens and Diwan. 2002. HIPC and the debt game.
· Aid is in fact used for repayments of debt
In SSA, on 18 SSA countries, over 1971-95, the sum of 31 cents of every additional dollar of grants and concessional loans used to finance principal repayments of foreign loans+ 50 cents of every additional dollar of grants used for the same purpose: for those interested, from Devarajan, Shantayanan, A. S. Rajkumar and V. Swaroop. 1999. What Does Aid to Africa Finance?, Washington D. C., the World Bank, policy research working paper 2092.
See McGillivray and Ouattara. 2005. Aid, Debt Burden and Government Fiscal Behaviour in Côte d'Ivoire: impact of aid on public sector fiscal behaviour in Côte d'Ivoire + relationship between aid, debt servicing and debt.
The model using 1975–99 time series data (period of adjustment starts in 1980) shows: the majority of aid inflows are allocated to expenditure on debt servicing + these inflows are associated with increases in the level of public debt.
· Debt game: debtor countries are more aid-dependent
Higher levels of gross aid disbursements necessary to ensure positive level of net transfers.
SSA: high transfers, large increases in gross disbursements (grants), and debt service payments. Little room for ownership, capital formation processes have become dominated by creditor-donors.
· The relationship aid and debt in the specific case of post-conflict countries: see Alvarez-Plata and Brück 2007 External Debt in Post-Conflict Countries: no systematic study of external borrowing in post-conflict countries.
Example of 3 SSA countries (Mozambique, Uganda, DR Congo): many war-affected countries face rising debt arrears and deteriorating relations with creditors. Rebuilding trust between lenders and borrowers is hence a crucial but often slow process. Furthermore, donors to war-affected African countries have been slow to grant exceptional debt relief based on odious debt or on financial requirements.
· An important debate: what is the best between loans and grants?
See Cohen, Jacquet and Reisen. 2006. After Gleneagles: What Role for Loans in ODA? Cancelling debt does not imply that grants are the best forms of aid. Switching from concessional loans to grants may create incentives for governments to loosen their fiscal discipline: aid via loans may be better if it maintains debt sustainability. Proposal of soft loans with higher interest rates and provision of cancellation in the case of negative shock.
For those interested, see the point of view (somewhat official, i.e. authors being at OECD or at the French development agency) of Cohen, Daniel, Pierre Jacquet and Helmut Reisen. 2007. Loans or Grants?, Helsinki, UNU-WIDER Discussion Paper No. 2007/06 November: cancelling the debt of the poorest countries should not imply that the debt instrument should be foregone. Debt and debt cancellations are indeed two complementary instruments which, if properly managed, perform better than either loans or grants taken in isolation: the poorest countries are also the most volatile, so that contingent facilities, explicitly incorporating debt cancellation mechanisms, are a valuable instrument.
· The additional inflows of aid to SSA promised by the donor community will create new problems
See the lecture on aid. See Gupta, Powell, and Yang. 2005. The Macroeconomic Challenges of Scaling Up Aid to Africa:
Very important flows: The 2005 G-8 Gleneagles declaration calls for raising annual aid flows to Africa by $25 billion by 2010, while the UN Millenium Task Force has argued for $70 billion of annual additional resources to achieve the MDGs in Africa. Most studies which attempt to "cost" the achievement of the MDGs in Africa focus only on direct costs of providing services in particular sectors (e.g., health and education) and ignore the need for investments in complementary growth-oriented sectors, such as infrastructure. World Bank and IMF (2005) has argued that a conservative estimate of the additional ODA that Africa could use effectively in both infrastructure and human development ranges from $14–18 billion per year during 2006-2008, rising to $24–28 billion by 2015. ODA (including debt relief) to SSA averaged about $17 billion per year during 2000–2003.
All scaling-up scenarios must be consistent with maintaining public and external debt sustainability. Increased aid can have a significant impact on macroeconomic developments that are fundamental to debt dynamics and will affect its GDP growth, fiscal position, interest rates, and balance of payments. Even if all the additional financing included in the scaling-up scenario is assumed to be in the form of external grants, the results of a debt sustainability analysis will not necessarily show improved debt burden indicators over time.
See Ouattara (2006), Aid, debt and fiscal policies in Senegal; see the review of Ouattara in IDS id21 Research Highlight: 24 January 2007. Debt relief a better option than aid (loans) for Senegal. Senegal, which has also built up a large country debt, receives a significant proportion of its government revenues from aid. But is aid the best way to support economic growth in countries with large debts, or could debt relief be a better policy? A report from the University of Swansea investigates the economic and financial effects of aid given to Senegal between 1970 and 2000, and the relationship between aid and debt =different approach to aid effectiveness, which has usually dealt with aid's impact on savings, investment and growth: here, influence of aid on the choices of the Senegalese government in managing its finances, as a way to understand aid's wider effects.
Before the 1980s aid to Senegal was just over 2% of its Gross Domestic Product (GDP). During most of this period the country achieved positive economic results, mainly driven by agriculture and exports. However, for the whole period 1970-2000, except for 1997 and 1998, public expenditure exceeded government revenues. And from the late 1970s, when Senegal started to face various economic problems, borrowing fell while aid increased. Between 1980 and 1989 the government turned to the IMF and the World Bank, and aid increased to just over 10% of GDP. The government also undertook a series of economic reforms in an attempt to halt the decline. Government revenue fell, and increases in paying the country's debt appear to be associated with declining government spending.
The Senegalese government uses around 20% of its resources for paying its debt. But it also spends more than 60% of its resources on development-oriented activities such as health, education and public investment. Paying the debt has a significant negative impact on domestic expenditure—increasing debt repayments by 1% of GDP reduces domestic expenditure by 0.13%. Foreign aid does not appear to have any significant impact on public spending. But foreign aid has a significant negative impact on government revenue – a 1% increase in aid leads to a 0.68% reduction in government revenue. Domestic expenditure includes health and education: high debt makes it difficult for Senegal to achieve its Millennium Development Goals (MDGs) targets in these areas. The amount of aid it receives is almost equal to what it pays for its debt, making aid appear worthless.
Reducing the debt of Senegal would then be more effective than additional aid, as it would have a positive affect on pro-poor economic growth by increasing the quality and quantity of domestic and foreign investment; provide resources, currently used to finance the debt, to meet development targets; offer a more effective policy tool for increasing spending on health, education and public investment
5. Assessing the relevant causalities: commodity dependence and the limits of debt relief in SSA
· Relationships between external trade and finance in most commodity-exporting countries:
High dependence on a narrow range of unproductive and low-value-added commodity exports
+unsustainable external debt burden
+enmeshment within the aid/debt service system
=SSA countries: commodity-dependent, debt-relief-dependent and aid-dependent.
Each element of these external trade and finance relationships reinforces the other+ reinforced by generalised poverty.
· Common to most LDCs: the debt/commodity dependence trap
See UNCTAD 2002, LDC report, see UNCTAD. 2000. Debt relief
The commodity dependence-unsustainable debt-poverty trap=low productivity of investment, slow export growth and large terms-of-trade shocks, weak state capacities=causes unsustainable external debt.
For the commodity exporting LDCs there is a remarkable correlation between export structure and external debt. 85% of LDCs dependent on non-oil primary commodities have an unsustainable external debt. Close association between an export structure focused on non-oil primary commodities and unsustainable external debtàthe debt problem of the non-oil commodity exporting LDCs is not national, but a systemic issue
+domestic mismanagement reinforced by poor donor policies, particularly export credit granted at the end of the 1970s and 1980s, and poor forecasts.
· Debt problems of commodity-exporting countries are rooted in the low level of domestic resource mobilisation, low rates of return on investment, vulnerability to external shocks, slow export growth.
One major condition for debt sustainability= the rate of growth of exports must be greater than the rate of interest on outstanding debt. Commodity exporters have much slower export growth rates, a strong propensity to develop debt problems and also to fall back into debt after debt relief.
The commodity price recession (early 1980s), ToT shocks + movements in primary commodity prices: the root cause of unsustainable indebtedness. Once a country has an unsustainable external debt => poverty trap.
· A very large proportion of the debt is owed by governments rather than by the private sector, debt servicing reduces resources available for public investment in physical and human capital.
The debt overhang: a deterrent to private investment, because of uncertainty.
Domestic interest rates may be very high. Debt service payments tighten the foreign exchange constraint. No virtuous investment–export nexus, but export–debt repayment nexus, no external viability, as the preconditions, i.e. increased productive capacity and efficiency, never fulfilled. Unsustainable external debt affects the volume, composition and effectiveness of external finance.
High levels of external debt deter private capital inflows→general perception of risk, discourages lenders and investors.
Highly indebted countries receive FDI, but marginalised from international capital markets. Difficult access to short-term loans in order to moderate the effects of external and climatic shocks. See UNCTAD 2002, LDC report, see UNCTAD. 2000. Debt Relief)
· Close association between falling and volatile commodity prices and unsustainable external debt
See UNCTAD 2004 Commodity in SSA: ToT losses have contributed to the debt overhang in SSA. IMF="almost all countries hit hardest by falling commodity prices are also among the world's poorest. All but two (Brazil and Chile) are classified as low-income countries+16 are HIPCs countries.
The IMF is aware of it: see the 2002 IMF/World Bank HIPC status of implementation: substantial drop in the prices of export commodities explains the deterioration in the net present value (NPV) of debt-to-export ratios relative to ratios projected at decision point for 2001 of 15 HIPCs (13 in SSA)
+the export price index of these countries fell by 4.8% /decline of 1.1 % in other HIPCs where debt indicators did not worsen+ exports concentrated in cotton, coffee, cashews, fish and copper, i.e. commodities that experienced large price reductions in 2001.
ToT declined by 1.5% for HIPCs with the worse debt ratios. In 2001 the price of coffee -main export in 5 HIPCs-, fell by 35 %. Large price drops for other commodities=cotton fell by 19 % (Benin, Burkina Faso, Chad, Mali), cashews by 69 % (Mozambique, Tanzania), fish by 21% (Senegal) and copper by 13 % (Zambia).
à10 SSA countries affected by export price declines projected to have the NPV of debt-to-export ratios above the sustainability threshold at their completion point under HIPC Initiative.
E.g., Uganda, at completion point, but in unsustainable debt because of decline in the price of coffee +completion point debt relief for Burkina Faso had to be topped up by $129 million because of the decline in the price of cotton.
HIPCs with deteriorating debt indicators have higher export commodity dependence+much greater exports volatility relative to other HIPCs. (see UNCTAD 2004 on SSA commodity dependence)
àA key issue= the inclusion of external shocks and commodity prices volatility in debt relief initiative, e.g. in the HIPC initiative= otherwise difficult to break the international poverty trap.
A solution: state-contingent debt repayment contracts, which link debt service payments to the external environment=to world commodity prices: see Nissanke and Ferrarini, 2001, on Debt dynamics and contingency financing/HIPC.
· Debt relief initiatives alone for external financing are insufficient
= need to double the existing level of official financing in order to sustain a growth rate of 6%=raising net official capital inflows by 7% of the combined GDP in SSA. Principal repayments and interest payments on official debt by SSA amounted to 3% of its combined GDP in the past 5 years
=if countries in SSA were all under HIPC and granted full and immediate relief on their official debt, the amount thus released would be less than half of the external financing requirement for achieving the rate of growth needed: see UNCTAD SSA 2001.
From UNCTAD, LDC Report 2002, Poverty Trap
See UNCTAD. 2008. Trade and Development Report 2008: Commodity Prices, Capital Flows and the Financing of Investment
Debt sustainability: borrowing for the right purpose
It is often during periods of economic boom that borrowing and lending decisions are taken on the basis of overoptimistic expectations. This consideration is particularly important at the current juncture, as a large number of developing countries have strengthened their current-account positions and lowered their external debt ratios. They have been able to achieve this partly through better macroeconomic policies and debt management, but mainly as a result of a favourable external environment, characterized by high commodity prices and low interest rates, a scenario that may not last forever. The challenge is therefore to build on recent improvements in debt indicators, and economic indicators more generally, and accelerate the process of investment, growth and structural change while maintaining a sustainable debt situation. The first step towards achieving debt sustainability is to borrow for the right reasons and not borrow too much during "good times". Debt should be used only to finance projects that generate returns that are higher than the interest cost of the loan. And foreign-currency-denominated borrowing should, in principle, be limited to projects that can either directly or indirectly generate the foreign currency necessary to service the debt. To the largest extent possible, and especially when the projects do not depend on imports, developing countries should seek to finance them from domestic sources. Therefore external debt strategies should be closely related to renewed efforts to strengthen domestic financial systems and to macroeconomic and exchange-rate policies that aim to prevent unsustainable current-account deficits.
External indebtedness: dealing with vulnerability to external shocks
A major constraint on countries that have access to international financial markets is their vulnerability to the effects of the high volatility of these markets. Shocks that may lead to a liquidity crisis in the developing world often depend on external factors that may originate from policy decisions of developed countries.
The use of innovative debt instruments that reduce the vulnerability of developing countries to shocks or unfavourable developments in the international economic and financial environment could help maintain debt sustainability. Such instruments could include issuance of external debt in domestic currency, which would reduce the foreign exchange risk, and of GDP-indexed bonds that allow lower debt service payments when capacity to pay is low. The creation and dissemination of these instruments could be facilitated by support from the international community for developing uniform standards and achieving the required market size.
Implementing national policies to reduce the risk of a debt crisis is especially difficult for low-income countries. These countries often depend on external resources to finance not only projects in the productive sectors of their economies and large infrastructure projects, but also the development of their health and education sectors. Although these social sectors may yield high returns in the long run, they are unlikely to generate the cash flows necessary to service the debt in the short and medium term. This suggests that, since low-income countries cannot sustain high levels of debt, most of their external support should take the form of grants.
Finally, it must be accepted that, even with improved debt management and better and safer debt instruments, debt crises are bound to occur. Thus the international community should not abandon the idea of creating a mechanism aimed at speedy resolutions of debt crises and fair burden-sharing among creditors and debtors. The latter would also help to improve risk assessment of creditors. Because of their particular vulnerability to external shocks originating in international financial and commodity markets, developing countries should also evince a particular interest in reform of the international monetary and financial system. Such reform should aim at minimizing destabilizing speculative financial flows and at strengthening institutions and mechanisms in support of macroeconomic policy coordination.
5. Important issues in SSA: capital flight and the concept of odious debt
· The relationship between external debt and capital flight
See Ndikumana and Boyce. 2002. Public debts and private assets
Determinants of capital flight from 30 SSA countries, period 1970-1996: external borrowing is positively related to capital flight
Capital flight is debt-fueled: for every dollar of external borrowing, 80 cents flowed back as capital flight in the same year.
Capital flight shows a high degree of persistence: past capital flight is correlated with current and future capital flight. The growth rate differential between the SSA country and its OECD trading partners negatively related to capital flight.
Effects of several other factors: inflation, fiscal policy, interest rate differential, exchange rate appreciation, financial development, political environment and governance.
See Ndikumana 2003 in UNCTAD, Management of capital flows: some SSA countries have very high levels: Angola, Cameroon, Côte d'Ivoire, DRC, Nigeria (Nigeria=87 billion over 1970-1996).
See Boyce and Ndikumana 2001 Is Africa a Net Creditor?: SSA is a net creditor: capital flight from 25 LIC over 1970-1996. Capital flight=$193 billion (in 1996 $); with interest earnings, accumulated stock of flight capital=$285 billion. Combined external debt of these countries= $178 billion in 1996.
Taking capital flight as a measure of private external assets, and calculating net external assets as private external assets minus public external debts, SSA appears to be a net creditor vis-à-vis the rest of the world.
See Ndikumana and Boyce. 2008. New Estimates of Capital Flight from SSA Countries: Linkages with External Borrowing and Policy Options. SSA countries became increasingly indebted from 1970 to 2004, but they experienced large-scale capital flight.
Some of this was legitimately acquired capital fleeing economic and political uncertainties; some was illegitimately acquired wealth spirited to safer havens abroad.
New estimates of the magnitude and timing of capital flight from 40 SSA countries and its determinants, including linkages to external borrowing.
SSA is a net creditor to the rest of the world: SSA private external assets exceed its public external liabilities: total capital flight amounted to $420 billion (in 2004 dollars), compared to the external debt of $227 billion.
For country i in year t, capital flight is computed as follows (Boyce and Ndikumana 2001):
KF it = ΔDEBTADJit + DFI it − (CA it + ΔRESit ) + MISINV it
where ΔDEBTADJ is the change in the country's stock of external debt (adjusted for cross-currency exchange rate fluctuations, so as to take into account the fact that debt is denominated in various currencies and then aggregated in US dollars); DFI is net direct foreign investment; CA is the current account deficit; ΔRES is the change in the stock of international reserves; and MISINV is net trade misinvoicing.
Econometric analysis indicates that for every dollar in external loans to Africa in this period, roughly 60 cents flowed back out as capital flight in the same year, a finding that suggests debt-fuelled capital flight.
+ debt-overhang effect, as increases in the debt stock spur additional capital flight in later years.
Policies for recovery of looted wealth and repatriation of externally held assets? Differentiate between legitimate and odious debts.
Democratic Republic of Congo Lost $15.5 Billion in Capital Flight since 1980, According to Global Financial Integrity Report. July 24, 2008, Washington, D.C. The Democratic Republic of Congo (DRC) lost an estimated $15.5 billion due to capital flight from 1980 to 2006, according to a new report from Global Financial Integrity (GFI), a program of the Center for International Policy. The report was prepared using data from the International Monetary Fund and World Bank and represents the most up-to-date figures for illicit capital outflow from the DRC. According to the report, "pervasive corruption," and trade mispricing in goods and services led to a per annum loss of nearly $600 million dollars from the DRC economy. Notes the report's author, lead economist Dev Kar, "With that money, the DRC could have paid off its entire external debt, which is $11.2 billion."
The developing world loses $500 to $800 billion per year due to illicit financial outflows," said GFI director Raymond Baker. "Recognizing and curtailing this massive capital loss is critical to combating poverty and fostering economic prosperity in poor and developing nations." "The DRC is a textbook example of what international development experts call the 'paradox of plenty,'" said Baker. "Although the DRC is a resource-rich nation, possessing 80% of the world's coltan and 10% of its copper, as well as diamonds, gold, and oil, 80% of the Congolese population live in abject poverty. GFI director Raymond Baker met with 50 high-level finance and academic representatives in Kinshasa this week to present the report's findings and discuss strategies for curtailing capital flight out the DRC. "This study illustrates a reality facing many poor countries and the international development community: capital flight undermines economic development and poverty alleviation efforts and makes poor countries more poor," said Baker. "With rising commodity prices giving rise to fears of a global poverty crisis it is critical we take steps to address this problem and implement measures to curtail illicit financial outflows from these countries."
· The IMF is aware of the link debt-capital flight
See Cerra, Rishi, and Saxena. 2005. Robbing the Riches: Capital Flight, Institutions, and Instability:. Sample of developing countries, including SSA. Capital flight undermines growth and the effectiveness of debt relief and foreign aid:
='revolving door' hypothesis that links debt accumulation and capital flight=strong evidence of the revolving door relationship between borrowing and flight, and "debt-fueled capital flight.
· Capital flight and resource-rich countries: in particular oil exporters
For those interested, for the group of low-income countries, see Thomas Dorsey, Helaway Tadesse, Sukhwinder Singh, and Zuzana Brixiova. 2008. The Landscape of Capital Flows to Low-Income Countries, IMF Working Paper WP/08/51.
Box 4. Capital Flight In Low-Income Countries
Much of what literature is available on capital flows to low-income countries focuses on capital flight. Particularly among those studies focusing on Africa, estimates of capital flight are often very large, to the point where some estimates indicate that Africa is a net creditor region due to capital flight in excess of external lending (Boyce and Ndikumana, 2001).
There is not an agreed definition of capital flight in the literature; indeed much of the literature distinguishes itself from earlier studies by devising new measures of the concept. What most measures of capital flight have in common is an approach of taking some elements of the balance of payments at face value, and explicitly or implicitly defines the rest as flight capital.
For example, one common approach defines capital flight as the change in debt stock, plus FDI, less the current account deficit and the change in official reserves (World Bank, 1985). Thus by implication, portfolio equity liabilities, non-reserve financial account assets, the entire capital account as defined by BPM5, and errors and omissions are all part of capital flight. Other estimates use c.i.f./f.o.b. differentials from trade data to impute an additional element of estimated capital flight, adjust changes in debt stocks for exchange rate changes, compound imputed cumulative flows by using a proxy rate of return on the estimated stock of flight capital (Boyce and Ndikumana, 2001 and 2002), or deduct foreign assets of domestic commercial banks (Hermes, 2002)
Most of these approaches share two problems: (i) they use a residual approach to measuring capital flight in a data environment in which there are many other sources of errors and mis-measurement, such as smuggling or poor data compilation; and (ii) they tend to mix data from different sources (e.g., IMF data for flows, World Bank data for debt stocks, and LIC and partner country trade data for c.i.f./f.o.b. differentials), adding an additional element of noise to calculations (see Annex for details on the inconsistency between some of these data sources). Approaches that take an internally consistent set of data (e.g., Bosworth, et al., 1999) are the exceptions to the rule.
A. Regional Patterns: Is India Driving These Results? Does this Apply to Africa?
Capital flows across the three larger regions all exhibit rising private inflows and relatively steady official inflows Private flows have surged in Africa, India, and other South and East Asian LICs in broadly similar proportions. Official flows started at very different levels in the three regions and have grown roughly in line with GDP.
Inflows from official sources are consistently higher in African LICs than in South and East Asian LICs, and official capital inflows to India are much lower than either of the other groups. Inflows from official sources have been volatile, but they have averaged about 4 % of GDP in African LICs, and about 2% of GDP in South and East Asian LICs other than India, and have never exceeded 1.0 percent of GDP in India, except at the time of India's 1991 financial crisis.
The composition of official flows has also varied across regions and over time. Inflows to African LICs have been dominated by grants rather than loans from the early 1990s, even after netting out the impact of debt forgiveness on official loans (Table 5 and 6). In South and East Asia, official loans have exceeded grants from the early 1980s to the present, and debt forgiveness has been unimportant. In India, the modest amount of official-source inflows has consistently taken the form of loans.
Private source inflows into LICs reveal much more similarity across regions, with a pronounced and accelerating trend in all three. Private inflows as a share of GDP are similar across regions over time and in terms of their rates of increase. However, the
composition differs markedly across regions. FDI is the most important source of inflows to the African LICs, running at roughly twice the share of GDP as private transfers and at roughly two thirds of total private inflows. The pattern is reversed in South and East Asian including India with private transfers running at roughly three times the level of FDI since the early 1990s. Notwithstanding the differences in the relative importance of private transfers and FDI, both components are increasing strongly in all three regions.
Asset outflows and errors and omissions in hydrocarbon-rich and mineral-rich LICs show both reserve accumulation and some patterns that are often attributed to capital flight. In both groups of countries, non-reserve financial assets and net errors and omissions have been consistent outflows. These groups have also been accumulating reserve assets, but non-reserve outflows have exceeded reserve accumulation in most years since the mid-1990s. There have also been outflows of "other" other financial account liabilities (e.g., net reduction in liabilities such as trade credits or bank deposits). These non-reserve outflows do not necessarily represent capital flight, but they include some of the core components of most capital flight estimates in the literature and may merit further investigation. Alternatively, this might reflect different investment strategies (in the case of non-reserve assets) or other factors.
Non-mineral LICs have also had consistent asset outflows in recent years, but these are dominated by reserve accumulation. Non-reserve financial assets accumulation and net errors and omissions have been small and frequently switch signs. Non-mineral LICs also have very small net flows of "other" other financial account liabilities, with a positive sign (i.e., an inflow) more often than not.
· The concept of 'odious debt'
Successor governments may repudiate debts accumulated by dictators. E.g. Mobutu accumulated a debt of $14 billion. In 1990, real capital flight was $12 billion, and with interests earnings, an accumulated stock flight capital of $18billion: see Ndikumana and Boyce. 1998. Congo's odious debt.
Should civil societies pay for the irresponsible behaviour of their governments -dictatorial governments?
SSA + outside SSA: e.g. Haïti, one of the poorest countries, debt of $1,1billion: 45 % borrowed under Duvalier's dictatorship having siphoned $900 million when they escaped (1986).
See Jayachandran and Kremer. 2006. Odious Debt: sovereign debt incurred without the consent of the people and not for their benefit, e.g. apartheid South Africa. It should be considered odious and not transferable to successor governments: successor governments should not suffer reputational loss from failure to repay odious debt
Equilibria with odious lending could be eliminated by amending creditor country laws to prevent seizure of assets for failure to repay odious debt and restricting foreign assistance to countries not repaying odious debt.
Shutting down the borrowing capacity of illegitimate regimes=economic sanction. 2 advantages= it helps rather than hurts the population+ it does not create incentives for evasion by third parties.
However, an institution empowered to assess regimes might falsely term debt odious if it favored debtors. If creditors anticipate this, they would not make loans to legitimate governments.
Trade sanctions are often viewed as ineffective because they create incentives for evasion or as harmful to the target country's population. Loan sanctions, in contrast, could be self-enforcing and could protect the population from being saddled with "odious debt" run up by looting or repressive dictators.
Governments could impose loan sanctions by instituting legal changes that prevent seizure of countries' assets for nonrepayment of debt incurred after sanctions were imposed. This would reduce creditors' incentives to lend to sanctioned regimes. Restricting sanctions to cover only loans made after the sanction was imposed would help avoid time-consistency problems.
· The World Bank remains cautious regarding the concept of 'odious debt'
See Nehru and Thomas. 2008. The Concept of Odious Debt: Some Considerations: little agreement on a workable definition of "odious" debts
There are but few examples where the concept has been invoked in law to justify non-payment of sovereign debts. Most often, these have been cases when a successor state or government has refused to honor certain debts contracted by its predecessor state or government.
Repudiating sovereign debts on broader grounds - such as that money may have been misused by the borrower or that results were not as hoped for at the outset of lending - would create real risks not only of reduced financial flows to poorer countries as a result of the danger of ex post challenges to lenders' claims, but also of moral hazard and lack of project ownership.
=> discussion of the legal and financial environment facing developing country sovereign borrowers: focusing attention on codes of conduct along the lines of the Equator Principles and on refining forward-looking attempts to increase aid effectiveness and recover stolen assets.
7. The debt relief initiatives; the notion of debt sustainability
The HIPC initiative,
which was followed by the MDRI (multilateral debt relief initiative)
· Context of the HIPC initiative
Many large projects built in the 1970s, petrodollars, post-independence governments eager to build infrastructure and prestigious projects. Many projects=overpricing, low profitability.
In the mid-1990s, increasing perception of corruption and responsibility of the rich countries in the failure of projects and non profitability ('white elephants'). Good governance, poverty reductionàlink HIPC-PRSPs.
Pressure from campaigning groups=money not used for productive purposes, but Swiss bank accounts of kleptocrats. Debt relief=releasing poor countries from misused official loans in return for reforms.
Donor side= increased consensus=SSA growth rates too low to reduce poverty and significant official financing needed+ policies. Additional resources to be allocated to investment in infrastructure; accompanied by increases in domestic savings in order to reduce dependence on external financing. (see UNCTAD, SSA, 2001)
Also, importance of multilateral institutions: see above, UNCTAD 2004 on debt: in 2000-2002, more than 80% of SSA public and publicly guaranteed debt = official+1/3rd of it= multilateral debt.
Unsustainable external debt=cycle of economic stagnationàbasis of international agreement on a comprehensive debt relief
àthe HIPC Initiative (1996)
+the enhanced HIPC (1999)+ the Enhanced Structural Adjustment Facility/ESAF becoming the PRGF (IMF).
HIPC means to restructure debt to manageable levels, and reward for countries that introduce economic reforms by lifting the debt burden.
· The Heavily Indebted Poor Countries/HIPCs Initiative
See IMF HIPC factsheets: 41 countries (enhanced HIPC). Initially, countries with a 1993 GNP per capita of $695 or less and 1993 present value of debt to exports higher than 220% or present value of debt to GNP higher than 80% +countries that have received concessional rescheduling from Paris Club creditors.
Finally include all countries eligible for the ESAF and eligible only for concessional financing/loans from the World Bank (IDA-only) and the Enhanced Structural Adjustment Facility (ESAF) that face unsustainable debt after traditional debt-relief mechanisms + also undertake adjustment programs.
· Later, the Enhanced HIPC initiative: 3 years after its launch, the initial HIPC initiative appeared insufficient, hence the Enhanced HIPC initiative.
=lower external debt sustainability thresholds, and stronger link between debt relief and PRSPs.
Debt sustainability under the enhanced HIPC: a single net present value/NPV of debt-to-export target of 150%
+fiscal target lowered to 250% of NPV of debt/revenue ratio
+lower eligibility thresholds for the openness of an economy: 30% for the export/GDP ratio; and for the revenue effort: 15% for revenue/GDP ratio.
Targets calculated at the decision point (rather than the completion point)
+ 'sunset clause' included in the HIPC Initiative to prevent it from becoming a permanent facility= extended several times.
- the decision point: point at which a HIPC completes its first (3 year) track record of good performance under adjustment programs + country's eligibility for HIPC Initiative is determined.
- the completion point: point at which the country concerned receives the bulk of its assistance under the HIPC, without further policy conditions.
The Enhanced HIPC: the idea of floating completion points= the timing of completion points is tied to implementation of pre-agreed key structural reforms including the PRSP.
An enhancement is the 'frontloading' of debt relief=provision of a proportion of debt relief to eligible countries at the decision point in order to maximise support for poverty reduction programmes
At the decision point: interim period and immediately interim debt relief (see UNCTAD 2004)
From the WB website, topic, then debt, then HIPC.
See the IMF website: series of HIPC Status of Implementation Reports (Sept. 2002, 2003, 2004, Aug. 2005, Aug 2006); see HIPC Progress in implementation reports, various years; see the HIPC statistical updates, various years.
See Boote and Thugge. 1997; see Andrews, Boote, Rizavi, and Singh. 2000.
See IMF Website. October 2008. A Factsheet - Debt Relief Under the Heavily Indebted Poor Countries (HIPC) Initiative
The HIPC Initiative is a comprehensive approach to debt reduction for heavily indebted poor countries pursuing IMF- and World Bank-supported adjustment and reform programs. To date, debt reduction packages have been approved for 33 countries, 27 of them in Africa, providing US$51 billion (in end-2007 net present value terms) in debt-service relief over time. Eight additional countries are potentially eligible for HIPC Initiative assistance and may wish to avail themselves of this debt relief.
What is the Heavily Indebted Poor Countries (HIPC) Initiative?
The HIPC Initiative was first launched in 1996 by the IMF and World Bank, with the aim of ensuring that no poor country faces a debt burden it cannot manage. The Initiative entails coordinated action by the international financial community, including multilateral organizations and governments, to reduce to sustainable levels the external debt burdens of the most heavily indebted poor countries. Following a comprehensive review in 1999, a number of modifications were approved to provide faster, deeper, and broader debt relief and to strengthen the links between debt relief, poverty reduction, and social policies. In 2005, to help accelerate progress toward the United Nations Millennium Development Goals (MDGs), the HIPC Initiative was supplemented by the Multilateral Debt Relief Initiative (MDRI). The MDRI allows for 100 percent relief on eligible debts by three multilateral institutions—the IMF, the International Development Association (IDA) of the World Bank, and the African Development Fund (AfDF—for countries completing the HIPC Initiative process. In 2007, the Inter-American Development Bank (IaDB) also decided to provide additional ("beyond HIPC") debt relief to the five HIPCs in the Western Hemisphere.
How the HIPC Initiative works
To be considered for HIPC Initiative assistance, a country must:
(1) be IDA-only and PRGF-eligible;
(2) face an unsustainable debt burden, beyond traditionally available debt-relief mechanisms;
(3) establish a track record of reform and sound policies through IMF- and IDA-supported programs; and
(4) have developed a Poverty Reduction Strategy Paper (PRSP) through a broad-based participatory process. Once a country has met or made sufficient progress in meeting these criteria, the Executive Boards of the IMF and IDA formally decide on its eligibility for debt relief, and the international community commits to reducing debt to the agreed sustainability threshold. This is called the decision point.
Once a country reaches its decision point, it may immediately begin receiving interim relief on its debt service falling due. In order to receive the full and irrevocable reduction in debt available under the HIPC Initiative, however, the country must: (i) establish a further track record of good performance under IMF- and IDA-supported programs; (ii) implement satisfactorily key reforms agreed at the decision point, and (iii) adopt and implement the PRSP for at least one year.
Once a country has met these criteria, it can reach its completion point, at which time lenders are expected to provide the full debt relief committed at decision point.
Who receives HIPC Initiative assistance
41 countries have been found to be eligible or potentially eligible for HIPC Initiative assistance. 23 countries have already reached their completion points and have received or are receiving irrevocable debt relief from the IMF and other creditors. Ten countries have reached their decision points and some of them are receiving interim HIPC Initiative debt relief. Eight countries, which have been identified as potentially eligible for HIPC Initiative assistance, have not yet reached their decision points.
(…)How countries have benefited from the HIPC Initiative
For the 33 countries for which packages have already been approved, debt service paid, on average, has declined by about 2½ percent of GDP between 1999 and 2007. Their debt burden is expected to be reduced by about 90% after the full delivery of debt relief (including under the MDRI). Yet for debt reduction to have a tangible impact on poverty, the additional resources need to be targeted at the poor. Before the HIPC Initiative, eligible countries were, on average, spending slightly more on debt service than on health and education combined. Now, they have increased markedly their expenditures on health, education and other social services and, on average, such spending is about six times the amount of debt-service payments.
Debt relief, while welcome, addresses only a relatively small part of HIPCs' financing needs and cannot ensure debt sustainability permanently. Debt relief savings accrue through time and generally constitute only a fraction of net aid inflows to HIPCs. Addressing HIPCs', and more generally LICs', development needs therefore requires higher new aid flows in addition to debt relief. These new flows need to be on appropriate terms to make sure that debt sustainability is maintained in the future.
Debt relief has markedly improved the debt position of post-completion-point countries, bringing their debt indicators down below those of other HIPCs or non-HIPCs. However, their medium-term debt sustainability is still not assured. They remain vulnerable to shocks, particularly those affecting exports, and their payment capacity is highly sensitive to the terms of new financing. To reduce their debt vulnerabilities decisively, these countries need to pursue cautious borrowing policies and strengthen their public debt management capacities.
Remaining challenges
Many of the 18 pre-completion-point HIPCs face common challenges, including preserving peace and stability, and improving governance and the delivery of basic services. Addressing these challenges will require continued efforts from these countries to strengthen their policies and institutions and support from the international community.
Another challenge is to ensure that HIPCs get full debt relief from all their creditors. Although the largest creditors (the World Bank, the African Development Bank, the IMF, the Inter-American Development Bank, and all Paris Club creditors) provide debt relief in line with their commitments under the HIPC Initiative, and even beyond, other are lagging behind. Smaller multilateral institutions, non-Paris Club official bilateral creditors, and commercial creditors, which together account for about 25 percent of total HIPC Initiative costs, have only delivered a small share of their expected relief so far. Non-Paris Club bilateral creditors as a whole have delivered about 40% of their share of HIPC Initiative debt relief, but close to half of these creditors have not delivered any relief at all. The delivery of HIPC Initiative relief by commercial creditors, although still low at an estimated 33 percent, has increased markedly in recent years through a few large operations. A number of commercial creditors have initiated litigations against HIPCs, raising significant legal challenges to burden sharing in the context of the Initiative.
Given the voluntary nature of creditor participation in the HIPC Initiative, the IMF and the World Bank will continue to use moral suasion to encourage creditors to participate in the Initiative and to deliver fully their share of HIPC Initiative debt relief. The IMF and World Bank will also continue to gather more information to assess and monitor better the delivery of HIPC Initiative debt relief. The IMF will continue to address issues related to the participation in the HIPC Initiative during its regular consultations and other missions to creditor countries.
List of Countries That Have Qualified for, are Eligible or Potentially Eligible and May Wish to Receive HIPC Initiative Assistance (as end-September 2008)
List of Countries That Have Qualified for, are Eligible or Potentially Eligible and May Wish to Receive HIPC Initiative Assistance | ||
Post-Completion-Point Countries (23) | ||
Benin | Honduras | Rwanda |
Bolivia | Madagascar | São Tomé & Príncipe |
Burkina Faso | Malawi | Senegal |
Cameroon | Mali | Sierra Leone |
Ethiopia | Mauritania | Tanzania |
The Gambia | Mozambique | Uganda |
Ghana | Nicaragua | Zambia |
Guyana | Niger | |
Interim Countries (Between Decision and Completion Point) (10) | ||
Ahghanistan | Republic of congo | Haiti |
Burundi | Democratic Republic of Congo | Liberia |
Central African Republic | Guinea | |
Chad | Guinea Bissau | |
Pre-Decision-Point Countries (8) | ||
Comoros | Kyrgyz Republic | Sudan |
Côte d'Ivoire | Nepal | Togo |
Eritrea | Somalia | |
1This estimate is based on data published in the annual report on the implementation of the HIPC initiative and the MDRI, and updated with revised data as of end-August, 2007.
An example of the HIPC mechanisms: WB Press release. March 2006: Republic of Congo Qualifies for Debt Relief: The Bank's International Development Association and the IMF determined that the Republic of Congo qualified for debt relief by reaching the decision point under the enhanced HIPC. These decisions were based on the country having established external arrears clearance operations, remained on track with an IMF-supported program and developed an interim poverty reduction strategy. =29th country to reach its decision point under the Initiative. The government will begin receiving interim debt relief from certain creditors, but must address serious concerns about governance and financial transparency in order to qualify for irrevocable debt relief at the completion point.
Specifics of the Debt Relief Operation: Congo's external debt as of end-2004 was estimated at US$9.2 billion in nominal terms, equivalent to US$9.0 billion in 2004 net present value (NPV) terms, which makes it one of the world's most indebted developing countries on a per capita basis. Debt service in 2006 is estimated to represent 43 % of fiscal revenues (before HIPC relief). In total, debt relief to Congo under the enhanced HIPC Initiative will be approximately US$1.7 billion in 2004 NPV terms, equivalent to a 32.4 % NPV reduction of Congo's debt after traditional debt relief. Over time, this will lower the Republic of Congo's debt service payments by about US$2.9 billion in nominal terms. IDA's share of enhanced HIPC assistance to the Republic of Congo amounts to US$49 million in NPV terms (equivalent to US$71 million in nominal terms), which will be delivered through a 37.0 % reduction in debt service on IDA creditors in 2006, a 50.5 % reduction from 2007-20, and 15.5 % in 2021. The IMF will provide assistance of US$8 million in NPV terms. Under the enhanced HIPC Initiative's burden sharing approach, other creditors of the Republic of Congo will provide the remainder, and indeed the bulk, of the Initiative's debt relief.
· A key concept of debt relief initiatives: the debt sustainability assessments (or analyses)/DSA.
Also the concept of debt sustainability framework/DSF
A key indicator of external debt sustainability: the ratio of the net present value (NPV) of debt/exports.
The target NPV of debt/export used country-specific 'vulnerability factors'=the concentration and variability of export earnings, the fiscal burden of external debt service, external debt/GDP, the resource gap, the level of international reserves, and the burden of private sector debt.
Countries with very open economies (defined as having an export/GDP ratio of at least 40%) and making efforts to generate revenue (=fiscal revenues of at least 20% of GDP) considered eligible if the NPV of their debt exceeded 280% of government revenues.
See IMF website: The Challenge of Maintaining Long-Term External Debt Sustainability, April 2001
The Net present value (NPV) of debt is the value in today's terms of debt service (principal and interest) due in the future, where each payment is discounted back to the present.
The concept of NPV has been used in the HIPC Initiative as it captures the concessionality of debt to enable comparisons with other creditors and countries.
It differs from the nominal debt concept, as it involves both principal and interest. As long as the interest rate applicable to the debt is below the discount rate, the NPV of debt remains lower than the nominal debt.
The difference between the nominal value and NPV of debt is referred to as grant element. The grant element of debt erodes over time, with the speed of erosion depending on (i) the difference between the interest rate and the discount rate, and (ii) the repayment profile of the debt including the length of the grace period.
First, where there is a grace period specified in a new loan, the NPV of the loan will increase until the grace period has been completely exhausted. Therefore, in a few HIPCs (e.g., Rwanda) the NPV of debt rises following the decision point primarily due to the fact that the grace period on loans/credits contracted in the past is growing shorter.
Second, the NPV, measured over time, is expressed in terms of value at specific points in time. As there are changes in the discount rates over the life of a loan, the NPVs will vary inversely with the discount rates.
Net Present Value=the face value of the external debt stock is not a good measure of debt if a significant part of the external debt is concessional with an interest rate below the prevailing market rate.
The NPV of debt takes into account the degree of concessionality=the sum of all future debt-service obligations (interest and principal) on existing debt, discounted at the market interest rate.
When the interest rate charged for a loan is lower than the market interest rate, the resulting NPV of debt is smaller than its face value (difference=grant element).
NPV=assessment of the total debt burden. The debt-service ratio captures only the immediate cash flow impact of external debt and is influenced by the maturity structure of the underlying debts.
See the several definitions on the WB and IMF websites.
E.g., The Net Present Value (NPV) of debt is the discounted sum of all future debt service obligations (interest and principal).
It is a measure that takes into account the borrowing terms of a country's debt stock. Whenever the interest rate on a loan is lower than the prevailing market rate, the resulting NPV of debt is smaller than its face value, with the difference reflecting the grant element. Nominal terms means the actual dollar value of debt service forgiven over a period of time.
On the definitions and equations of debt dynamics and debt sustainability, for those interested, see Christina Daseking and Bikas Joshi IMF 2005. Debt and New Financing in Low-Income Countries.
Debt sustainability is a basic debt dynamics equation, derived from the balance of payments identity.
For definitions, and an UNCTAD G-24 perspective, see Loser. 2004. External Debt Sustainability: Guidelines For Low- And Middle-Income Countries
External debt sustainability entails the need to pursue a time-consistent path that will allow that the debt-servicing burden over time, as a minimum, does not hamper economic growth, and in more general circumstances enhances growth.
The simplest test of sustainability is that over the medium term the rate of return on investment exceeds the opportunity cost of the funds, with the real interest rate as the most relevant proxy. While such principle is valid at the micro level, and it would hold if all external resources were to be invested on that basis, the actual experience of debtor countries is more complex.
In practice, the public sector borrowing and part of the private sector borrowing do not follow these principles and tends to be oriented to expenditure with no market-related rate of return. It thus entails the need for limits in expenditure or increases in revenue, associated with higher growth in the future. Debt sustainability exercises focus mainly on the public finances, where the level of indebtedness has to be seen at an aggregate level, fundamentally, through the medium term debt service ratio to revenues of the public sector, and the behaviour of the external public debt to GDP ratio.
There are three typical scenarios, with an increasing, a stabilizing, or a declining ratio of debt to GDP. The simplest policy proposition is that the debt/GDP ratio should either stabilize or decline, although there are no set rules as to what is an adequate level of debt. The ratio of debt to GDP will depend on the behaviour of debt, the behaviour of real GDP and the movements in the real exchange rate. To the extent that GDP grows faster than debt, or the real exchange rate appreciates, the ratio will tend to decline, and vice versa.
However, this principle does not help in terms of policy making, but only alerts to the behaviour of the variables. It is thus crucial to understand the behaviour of the underlying variables, namely the components of debt dynamics.
Those components are the payment of interest and the net resource transfer; the resources that are effectively available for actual use after interest payments; and the impact of these resources on growth.
To the extent that the interest rate exceeds the rate of growth of the economy, the debt to GDP ratio will increase.
Thus, a transfer of real resources abroad will be required to attain the stabilization of the debt ratio. Accordingly efforts will be required to obtain the resources internally.
In circumstances of a crisis either of internal or external origin, it could also result in the need for a reduction in the face value of debt as a mechanism to restore viability.
· With experience, for the IMF: concept of long-term external debt sustainability
It considers not only a single key measure like NPV but aims at a more comprehensive view that include policies, institutions, exogenous factors, debt management over time.
+more flexibility
Further operational considerations for the debt sustainability framework in low-income countries/LICs=indicative thresholds for debt burden indicators informed by the quality of policies and institutions
à empirical thresholds informing decisions on debt sustainability, and the financing mix for LICs= indicative guideposts, rather than as rigid ceilings, allowing room for judgment based on country circumstances.
Debt sustainability is also an assessment of domestic debt, given its growing importance in LICs.
See World Bank and International Monetary Fund, Applying the Debt Sustainability Framework for Low-Income Countries Post Debt Relief, November 6, 2006
Many papers on the WB and IMF website on the DSAs: see WB, How to Do a Debt Sustainability Analysis for Low-Income Countries, October 2006 (WB website)
In Spring 2005, the WB and the IMF implemented a new Debt Sustainability Framework in Low-Income Countries.
= There is a HIPC DSA, using uniform thresholds, and a LIC DSA, using flexible benchmarks.
See World Bank-Independent Evaluation Group. 2006. Debt Relief for the Poorest: An Evaluation Update of the HIPC Initiative.
See World Bank-IMF, Review of Low-Income Country Debt Sustainability Framework and Implications of the MDRI, March 27, 2006: In April 2005, the WB and the IMF endorsed a joint framework for debt sustainability assessments (DSAs) in LICs. Since then, IDA, IMF, and the African Development Fund (AfDF) have decided to provide debt relief under the Multilateral Debt Relief Initiative (MDRI). Debt relief under MDRI will significantly reduce debt ratios in qualifying HIPCs.
But problems posed for the DSF by the substantial space to borrow that the MDRI will provide for many countries. See below.
For the WB, the adoption of the DSF has resulted in a fundamental change in IDA's grant allocation criteria: they now focus exclusively on risks of debt distress.
See World Bank-IMF, Review of Low-Income Country Debt Sustainability Framework and Implications of the MDRI, 27 March 2006:
The Characteristics of a DSA
1. The objective of a joint Bank-Fund low-income country DSA is to monitor the evolution of a country's debt burden indicators and to guide financing strategies. The DSA consists of:
• standardized, forward-looking analyses of external and public debt and debt-service indicators under a baseline scenario based on realistic assumptions and standardized shocks;
• an assessment of external debt sustainability in relation to indicative country-specific debt burden thresholds that depend on the quality of policies and institutions;
• a risk of debt distress classification that takes into consideration this threshold assessment, as well as other country-specific factors.
2. The low-income country framework uses two separate templates for external debt and for public sector debt. Both templates generate output tables that display debt and debt-service dynamics under the baseline scenario and summarize the results of standardized alternative scenarios and stress tests. Templates are, however, flexible enough to be adapted to country-specific circumstances.
3. The assessment of external debt-burden indicators in relation to policy-dependent thresholds reflects the key empirical finding that a low-income country with better policies and institution can sustain a higher level of external debt. The LIC DSA framework, therefore, classifies countries into one of three policy performance categories (strong, medium, and poor) using the World Bank's Country Policy and Institutional Assessment (CPIA) index. Corresponding to these categories, the framework establishes three indicative thresholds for each debt burden indicator. Thresholds corresponding to strong policy performers are highest.
4. To facilitate consistency in the treatment of low-income countries and cross-country comparability of debt sustainability assessments, and to meet IDA needs in determining a country's eligibility for grants, a joint Fund-Bank DSA includes an assessment of the risk of external debt distress based on the following classification:
• Low risk. All debt indicators are well below relevant country-specific debt-burden thresholds. Stress testing does not result in indicators significantly breaching thresholds.
• Moderate risk. While the baseline scenario does not indicate a breach of thresholds, stress testing shows a significant rise in debt-service ratios over the projection period and/or a breach of debt thresholds.
• High risk. The baseline scenario indicates a breach of debt and/or debt-service thresholds over the projection period. This is exacerbated by stress testing.
• In debt distress. Current debt and debt-service ratios are in significant and/or sustained breach of thresholds.
The descriptions of the risk classes do not fully capture the complexity of the assessment. For example, in cases where the various indicators give different signals, there is still need for careful interpretation and judgment. Furthermore, vulnerabilities related to domestic public debt should also be taken into account. The past record in meeting debt-service obligations may also be a factor in determining the classification, especially for countries at high or moderate risk of debt distress.
Key concepts of the Debt Sustainability Framework/DSF: 'forward-looking'; debt distress
WB website: Background on the Concept of Debt Sustainability Framework: The debt sustainability framework is a "forward looking" approach that aims to guide borrowing and lending decisions for low-income countries on terms that allow borrowing countries to devote resources toward achieving the MDGs, while also staying within their means to repay loans. By accounting each country's specific circumstances, the framework tries to help borrowing countries balance their need for funds with their current and prospective ability to repay their debts. Linking a country's borrowing potential to its current and prospective ability to service debt should help countries avoid accumulating excessive debts.
This approach puts responsibilities on both, borrowers and creditors. The low-income countries that seek new loans are responsible for maintaining debt sustainability. They must develop and strengthen policies and institutions that enhance their capacity to manage debt and reduce their vulnerability to exogenous shocks ranging from international trading conditions to natural disasters. Among other things, they will need to: keep new borrowing in step with their capacity to repay loans, diversify exports, and build up foreign exchange reserves.
Creditors and donors, for their part, need to comprehensively review long-term debt projections, which incorporate forward-looking analysis and account for possible shocks. Potential creditors and donors should also consider giving additional resources in the form of grants and/or highly concessional loans for low-income countries with high levels of debt distress to reduce the possibility that these are countries who experience debt distress. Creditors and donors also need to explore options that can help limit the potential impacts of adverse exogenous shocks or help low-income countries cope with them.
See IMF Factsheet - May 2007. The Joint World Bank–IMF Debt Sustainability Framework for Low-Income Countries.
Low-income countries (LICs) have often struggled with large external debts. Now debt burdens have been reduced, thanks in large part to international debt relief initiatives. As part of the Monterrey Consensus to meet the Millennium Development goals (MDGs), the IMF and the World Bank have developed a framework to help guide countries and donors in mobilizing the financing of low-income countries' development needs, while reducing the chances of an excessive build-up of debt in the future. The joint World Bank–International Monetary Fund (IMF) Debt Sustainability Framework (DSF) was introduced in April 2005 to address this challenge.
The main objectives of the DSF
- Guide the borrowing decisions of LICs in a way that matches their financing needs with their current and prospective repayment ability, taking into account each country's circumstances;
- Provide guidance for creditors' lending and grant-allocation decisions to ensure that resources are provided to LICs on terms that are consistent with both progress towards their development goals and long-term debt sustainability;
- Improve World Bank and IMF assessments and policy advice in these areas; and
- Help detect potential crises early so that preventive action can be taken.
Under the DSF, debt sustainability analyses (DSAs) are conducted regularly. They consist of:
- an analysis of a country's projected debt burden over the next 20 years and its vulnerability to external and policy shocks—baseline and shock scenarios are calculated;
- an assessment of the risk of debt distress in that time, based on indicative debt burden thresholds that depend on the quality of the country's policies and institutions; and
- recommendations for a borrowing (and lending) strategy that limits the risk of debt distress.
How does the DSF work?
The DSF analyzes both external and public sector debt. Given that loans to LICs vary considerably in their interest rates and length of repayment, the framework focuses on the net present value (NPV) of debt obligations. This ensures comparability over time and across countries.
To assess debt sustainability, debt burden indicators are compared to indicative thresholds over a 20-year projection period. A debt-burden indicator that exceeds its indicative threshold suggests a risk of experiencing some form of debt distress. There are four ratings for the risk of external debt distress:
- low risk, when all the debt burden indicators are well below the thresholds;
- moderate risk, when debt burden indicators are below the thresholds in the baseline scenario, but stress testing indicate that the thresholds could be breached if there are external shocks or abrupt changes in macroeconomic policies;
- high risk, when one or more debt burden indicators breach the thresholds under the baseline scenario; or
- in debt distress, when the country is already having repayment difficulties.
LICs with weaker policies and institutions tend to face repayment problems at lower levels of debt than countries with stronger policies and institutions. The DSF, therefore, classifies countries into one of three policy performance categories (strong, medium, and poor) using the World Bank's Country Policy and Institutional Assessment (CPIA) index, and uses different indicative thresholds for debt burdens depending on the performance category. Thresholds corresponding to strong policy performers are highest—indicating that in countries with good policies debt accumulation is less risky.
Debt Burden Thresholds under the DSF | |||||
| NPV of debt in percent of | Debt service in percent of | |||
Exports | GDP | Revenue | Exports | Revenue | |
Weak Policy | 100 | 30 | 200 | 15 | 25 |
Medium Policy | 150 | 40 | 250 | 20 | 30 |
Strong Policy | 200 | 50 | 300 | 25 | 35 |
How does the IMF and the Bank use the DSF?
The DSF has enabled the IMF and the Bank to integrate debt issues more effectively in their analysis and policy advice, through improved frequency and quality of the analysis. It has also allowed comparability across countries. The DSF is important for the IMF's assessment of macroeconomic stability, the long-term sustainability of fiscal policy, and overall debt sustainability. Furthermore, debt sustainability assessments are taken into account to determine access to IMF financing. IDA uses the assessment of the risk of external debt distress from the DSF to determine the share of grants and loans in its assistance to each low-income country.
The effectiveness of the DSF in preventing excessive debt accumulation hinges on its broader use by borrowers and creditors. The IMF and the Bank encourage LICs to use the DSF or a similar framework as a first step toward developing medium-term debt strategies. Creditors are encouraged to take into account the results of debt sustainability assessments in their lending decisions. In this way, the framework should help LICs raise the finance they need to meet the MDGs, including through grants when the ability to service debt is limited.
More Information about the DSF: http://imf.org/dsa; http://www.worldbank.org/debt
Update in 2008: see IMF-WB, October 2008, Staff Guidance Note on the Application of the Joint Bank-Fund Debt Sustainability Framework for Low-Income Countries
Box 1. Enhancing the DSF: Main Changes from Previous Practice
• Historical scenarios should be used actively and large differences between the baseline and historical scenarios will need to be carefully justified in the text (Section III A).
• Scrutinizing past projections against outcomes is critical to improve the quality of future projections (Section III A).
• High projected growth dividends associated with large upfront borrowing (5 percent of GDP or more in PV terms) trigger the inclusion of an alternative "high-investment, low-growth" scenario and a detailed and explicit justification of projected growth dividends (Section III A).
• Financing assumptions require an explicit justification when the scenario assumes a significant improvement in the terms, such that, absent this improvement, the evolution of debt indicators would be significantly worse (Section III A).
• Public DSAs should be included in all DSAs. The write up should explicitly flag situations where the inclusion of domestic debt in overall debt and debt-service prospects would lead to a different interpretation of debt sustainability from consideration of external debt and debt service alone (Section III B).
• Additional analysis is needed in cases where increased private external capital flows into sovereign debt instruments may give rise to new vulnerabilities (Section III C).
• A three-year moving average CPIA score should be used to reduce the volatility of the thresholds and, as a result, the potential unwarranted fluctuations in the IDA grant share for a given country (Section II B).
• Building capacity and ownership. Staff should actively discuss the DSA assumptions and outcomes with the authorities and encourage them to use the instrument (Section VI).
• DSAs should be published as supplements to Fund staff reports, self contained (in both Bank and Fund documents), and easily accessible to enhance the effectiveness of the DSF as a coordinating tool for creditors and borrowers (Section IV A).
• Review process. To provide teams with early constructive feedback, a preliminary DSA needs to be included in IMF briefing papers; Bank-Fund collaboration needs to take place prior to the preparation of briefs for the DSA to be joint (Section IV A, B, D and Box 3). In cases where the DSA is needed for a Bank document, a similar timeline should be adhered to.
· Critique of the DSA:
See Machiko Nissanke studies
The Nissanke and Ferrarini 2001 paper is deepened in a critique of the CPIA indices in Nissanke and Ferrarini. 2006. Assessing the Aid Allocation and Debt Sustainability Framework: Working towards Incentive Compatible Aid Contracts.
Now published as Nissanke and Ferrarini (2007), Assessing the Aid Allocation and Debt Sustainability Framework: Working Towards Incentive Compatible Aid Contracts critique of the IDA aid allocation and debt sustainability framework on the grounds of their over-reliance on the country policy and institutional assessment (CPIA) as the guiding criterion.
CPIA-centred allocation of aid fails to introduce an incentives structure supportive of a genuine donor-recipient partnership. CPIA-dependent debt thresholds—central to the new debt sustainability framework—effectively submit sustainability concerns to the policy performance prerogatives of the aid allocation system.
Such approach fails to take due account of low-income countries' vulnerability to exogenous shocks, as a key determinant of debt distress.
An alternative to the current CPIA-based scheme = a state-contingent mechanism, guiding both aid allocation and debt sustainability analysis.
8. the mixed results of the HIPC debt relief initiative
· For the IFIs, the HIPC framework has been effective
BUT: many criticisms
There have been several problems during the implementation process
Enhanced HIPC: the present value of the stream of future debt service payments has been reduced. But in absolute terms, debt service relief is less impressive, for UNCTAD LDC reports.
Some HIPC countries have been off track: acknowledged by the IMF and the WB
Weak global economic environment +low commodity prices on which most HIPCs depend→difficult to reach the targets. + conflicts.
Interim debt relief halted because of failure to meet the IMF's targets
· A recurrent criticism against the HIPC: too little, too late?
Failure of initiatives of debt relief? See Easterly 1999, Highly Indebted Poor Countries: HIPCs countries became highly indebted after 2 decades of debt relief. Theory predicts that countries or governments with unchanged long-run savings preferences will respond to debt relief with a mixture of asset decumulation and new borrowing+high discount rate government will choose poor policies and lower growth.
Review of HIPC countries/other LDCs=evidence of asset decumulation and new borrowing associated with debt relief. The net present value of debt to exports rose strongly over 1979-97 despite the debt relief efforts. Average policies in HIPCs 1980-97 were generally worse than other LDCs, controlling for income.
For Easterly, no different trend of ToT in HIPCs than in non-HIPC LDCs.
Important shift over time in financing HIPCs away from private and bilateral non-concessional sources to IDA and other multilateral concessional financing; this implicit form of debt relief failed to reduce debt in net present value terms.
· Little response from capital markets to the HIPC initiative: see Arslanalp and Henry 2003: what do the markets think?
Thus recommendations of expanding the HIPC to all low-income countries, increasing the resources for debt relief.
· Debt relief is only a first step: what is needed are reforms of aid architecture
=making debt more predictably sustainable: see Birdsall, Williamson, and Deese. 2002 Delivering on Debt Relief: From IMF Gold to a New Aid Architecture.
· Hesitant generosity from rich countries
The HIPC initiative is a trust fund (administered by IDA) where the rich countries committed financial support. 23 multilateral creditors committed to HIPC relief=US$24.3 billion (2003 NPV terms)=over 99% of the total debt relief required.
Multilateral creditors (MDBs) (IDA, IMF, AfDB, etc) provide relief to most HIPCs in the interim period. Support is provided to several MDBs through the HIPC Trust Fund.
Critics, e.g. Oxfam= goals fell short of what was needed.
See Cohen 2000: HIPC false promises: contrary to the Brady deal, HIPC: no perspective on the 'market value' of the debt= the value that takes account of the risk of non-payment: arrears, rescheduling and 'constrained' refinancing. HIPC=10 times less generous than face value accounting would suggest.
· The impact of conditionalities attached to the HIPC initiative and PRSPs
The enhanced HIPC initiative debt relief program differs from previous ones by its conditionality: freed resources must be used for poverty reduction.
This severely limits the extent to which the initiative provides significant debt relief.
For those interested, see Craig Burnside and Domenico Fanizza. 2005. Hiccups for HIPCs? Implications of Debt Relief for Fiscal Sustainability and Monetary Policy, B.E. Contributions to Macroeconomics. Vol. 5, n°1, art. 4, pp. 1133-1133 (also NBER working paper 10903.
For Burnside and Fanizza: long-run fiscal sustainability in the HIPCs are fiscal reforms. In Debt Relief and Fiscal Sustainability for HIPCs, Craig Burnside and Domenico Fanizza, mimeo, December 2004, they argue that the conditionality that freed resources must be used for poverty reduction, implies no net improvement in the sustainability of the government's finances.
The constraints and conditionalities linked to the HIPC initiative: key issue: link of debt relief-HIPC disbursements to compliance to PRSPs conditionalities: e.g., tight monetary policies, liberalisation, privatisation.
E.g.: (BBC 10/12/02). Uganda: the country's foreign debt 'unsustainable' 5 years after applying the HIPC. Uganda's foreign debt=has grown from $3.4 billion in 1998 to $3.83bn June 2002, though it has received $1bn in debt relief. But for the IMF: see the IMF documents on debt sustainability, September. 2004: Uganda =first country to qualify for debt relief under the HIPC Initiative=completion point in April 1998 under the original HIPC framework, and in May 2000 under the enhanced HIPC framework, receiving total debt relief equivalent to US$656 million in NPV termsàthe ratio of the NPV of external debt to exports reduced to 150 % at end-June 1999, but has subsequently deteriorated to 260 % of exports (30 % of GDP) at end 2003 (sharp decrease in the international price of robusta coffee).
· The uncertain relationships between debt relief and growth
See Depetris Chauvin and Kraay 2005, What Has 100 Billion Dollars Worth of Debt Relief Done for Low-Income Countries? Between 1989 and 2003, low-income countries received $100 billion in debt relief, to reduce debt overhang and to free up recipient government resources for development spending that would otherwise have been used for debt service.
Sample of 62 low income countries: little evidence that debt relief has affected the level and composition of public spending in recipient countries. No evidence that debt relief has raised growth, investment rates or the quality of policies and institutions.
For those interested, see Nicolas Depetris Chauvin and Aart Kraay (2006), Who Gets Debt Relief?, Washington D. C.? the World Bank, policy research working paper 4000. allocation of debt relief across a sample of 62 low-income countries.
Aid allocation is higher in poor countries: But surprisingly, conditional on per capita incomes and policy, more indebted countries are not much more likely to receive debt relief. However, countries that are large debtors vis-a-vis multilateral creditors are more likely to receive debt relief.
Debt relief does not seem to respond to shocks to GDP growth. Debt relief is driven by slowly-changing country characteristics, indicating that it may be difficult for countries to "exit" from cycles of repeated debt relief.
· Similarly, complex and uncertain effects of debt relief on fiscal variables
See Cassimon and Van Campenhout. 2007. Aid Effectiveness, Debt Relief and Public Finance Response: Evidence from a Panel of HIPCs:
Substantial amounts of debt relief have been granted to a set of low-income countries: it is an alternative modality of aid.
Is it effective? Which linkages between debt relief and other fiscal variables such as current expenditure, government investment, taxation and domestic borrowing, in comparison to grants and concessional loans?
Findings: the fiscal impact of HIPC debt relief follows complex dynamics: e.g., debt relief initially reduces government investment, but the effect becomes positive after two years, well outperforming other modes of aid delivery.
The fiscal impact of debt relief may be analysed via the fiscal response models – see the lecture on aid.
For those interested, see Cassimon and Van Campenhout. 2007. Aid Effectiveness, Debt Relief and Public Finance Response: Evidence from a Panel of HIPCs, WIDER Research Paper 2007/59, September.
Efforts of donors to scale up aid to SSA => substantial debt relief has been granted in recent years through the HIPC Initiative and its successor, the Multilateral Debt Relief Initiative (MDRI).
For a sample of 24 African countries that have at least reached decision point status in the HIPC Initiative, to what extent this debt relief has created fiscal space in recipient country budgets, and what, on average, the actual fiscal response effects have been, relative to other types of aid.
In line with the fiscal response literature, model of public finance behaviour.
Findings: no evidence that substantiates the worries that debt relief might provoke no or even perverse fiscal responses.
Debt relief affects public finance behaviour in a desired way, with effects being most similar to those of its most direct substitute, program grants.
· Do HIPC suffer from debt overhang? The non linear relationship between growth and debt?
For an IMF view, see Cordella, Ricci, and Ruiz-Arranz. 2005. Debt Overhang or Debt Irrelevance? Revisiting the Debt-Growth Link: HIPCs: the debt-growth relationship varies with indebtedness levels and other country characteristics:
= negative marginal relationship between debt and growth at intermediate levels of debt, but not at very low debt levels, below the 'debt overhang' threshold, or at very high levels, above the 'debt irrelevance' threshold.
Countries with good policies and institutions face overhang when debt rises above 15-30% of GDP, but the marginal effect of debt on growth becomes irrelevant above 70-80%. In countries with bad policies and institutions, overhang and irrelevance thresholds seem to be lower.
See Cordella, Ricci and Ruiz-Arranz. 2005. Deconstructing HIPCs' Debt Overhang: is there evidence that HIPCs suffer from a debt overhang, and that more debt relief is needed? How indebtedness has affected growth, resource flows, and investment in a panel of developing countries.
Findings =highly non-linear relation between debt and growth: positive at low levels of debt, negative at intermediate levels, nil at high levels. Donors' behaviour may partially explain why HIPCs have not shown symptoms of debt overhang in the past.
Such symptoms may appear in the future. After graduation from the debt relief initiative, most HIPCs' debt levels will probably fall in that intermediate region where debt negatively affects growth. Therefore, case for additional debt relief.
· The HIPC initiative is inefficient as it relies on a wrong diagnosis; the debate on debt overhang
=HIPC will not stimulate investment and growth as HIPC countries do not suffer from debt overhangàobstacle to investment and growth= lack of basic economic institutions that provide the foundation for profitable economic activity. If the goal is to help poor countries build institutions, then resources devoted to the HIPC initiative could be more effectively employed as direct foreign aid (see Arslanalp and Henry 2004, Helping the poor to help themselves).
· UNCTAD views: series of problems of implementation: see UNCTAD 2004, debt.
= pace of implementation; long-term debt sustainability; problem of remaining on track after the decision point; problematic level of interim relief provided by the donors; problems of financing the total costs of the HIPC initiative; creditor participation and their 'burden sharing';
+the problem of 'additionality', i.e. each dollar of debt relief should be additional to existing aid.
But, see the first WB OED Report (2003), additionality is close to zero –though it is difficult to assess because of counterfactual issues;
+ problems of disruptions of pre-decision point and post-conflict countries (e.g., Burundi, Ivory Coast, Central African Republic, Liberia, Sierra Leone, Congo RDC, etc).
· The problems of the criteria of eligibility and debt sustainability
See UNCTAD 2004 on debt: which objectivity of the HIPC eligibility criteria? E.g., the poverty criterion = IDA-PRGF, which may be narrow
+ the debt sustainability criteria (2 main debt indicators=the NPV debt-to-exports ratio and NPV debt to- revenue ratio)
= questionable objectivity and theoretical justifications
+ Post-HIPC sustainability?
E.g., problem of the fiscal sustainability in HIPCs countries dependent on non renewable resources, e.g. oil = fiscal fragile positions: see on the case of Gabon, Ntamatungiro, 2004, Fiscal Sustainability in Heavily Indebted Countries Dependent on Nonrenewable Resources: the Case of Gabon.
· A crucial issue: does the HIPC initiative represent a durable exit from the debt problem?
For UNCTAD, over-optimistic forecasts underlying the expectation that current debt relief is sufficient for a durable exit from debt: over-optimism that the debt relief agreed at HIPC decision and completion points lead to a durable exit from the debt problem.
IMF/WB estimates on the projections of external debt indicators in HIPC-LDCs that had reached decision point: expectations that current levels of debt relief will lead to future debt sustainability: based on the assumption of a higher economic growth and export growth through HIPC in 2000–2010 than in 1990–1999, with less external finance (grants plus new borrowing) as a ratio of GDP and a higher grant element in loans.
For UNCTAD, the debt of some LDCs would not become sustainable, according to the criterion of a NPV debt/export ratio of 150. E.g.: Burkina Faso and Zambia: the NPV debt-to-export ratio will reach 257% in 2010 if export volume growth follows the trend in the 1990s and cotton prices do not recover from their levels in 2001. Zambia: the NPV debt-to-export ratio will reach 270% if the last decade's trends in the volume and price of copper exports persist. Future debt sustainability is sensitive to the concessionality of new financing: NPV debt-to-export ratio can be 40 percentage points higher over the projection period 2000–2020 if financing terms deteriorated (IFIs analyses)
Enhanced HIPC=optimistic projections based on 'sound macroeconomic policies'. 'Sound' policies will not achieve durable exit from the debt problem if unsustainable external debt. Durable exit if policies strengthen growth. But the debt problem undermines the ability of the policies to have this effect.
HIPC countries, and creditor countries, locked into a repetitive pattern of perpetual economic adjustment.
· Small magnitude of resources released compared with aid inflows.
E.g., annual debt service relief in 2003–2005 for the 20 HIPC-LDCs that have reached decision point=only 5.5% of net ODA disbursements in 2000.
HIPC contribute to poverty reduction less through the resources released by debt relief than through enabling a durable exit from the debt problem:
· Effectiveness of HIPC debt relief? The issue of the real costsà case by case analysis
E.g. Mozambique in 1999: On paper, looks generous=creditors wipe off $1.44bn (in net present value terms) from the debt stock, down to $1.1bn, but conditions attached. BWIs accepted Mozambique as eligible for HIPC treatment in April 1998, the "decision point". The actual granting of debt relief, "completion point": 15 months in the future. During that time=SAP. Among the targets and conditions=increase in health service user charges, introduction of VAT, despite protests from private businesses. IMF's position: "No VAT, no HIPC".
$1.44bn is a more meaningful figure=the servicing of debt. Over 1996-1998 debt servicing=$110.8m a year. After HIPC, down only to $100m a year. HIPC ends the debt overhang, removes unpayable debts that had been forever rescheduled, but still leaves a substantial annual debt servicing for the state budget after HIPC.
· Criticisms of the HIPC initiative from inside the WB, i.e. from the WB Evaluation Department/OED
See WB OED review of HIPC 2003.
The robustness of debt sustainability analysis is not convincing.
2 components= 1) current levels of debt using a new methodology calculating the amount of debt relief for each country;
2) projections of future debt indicators to assess each country's likelihood of achieving debt sustainability.
Economic models + methodological basis underlying debt projections are not transparent.
This evaluation of the HIPC has been updated. The OED became the IEG. See World Bank-Independent Evaluation Group. 2006. Debt Relief for the Poorest: An Evaluation Update of the HIPC Initiative. A major issue is new borrowing: after reaching the completions point, debt ratios in a majority of HIPC countries have risen above HIPC thresholds.
Improved repayment capacity has been offset by increases in debt levels owing to new borrowings: not the case in Mali and Senegal, but it is the case in Uganda.
For the IEG, aid has been additional for HIPC countries. There has been an increase in the percentage of global transfers to HIPC countries compared to non-HIPC countries.
Debt ratios showed a decline in debt following HIPC initiatives, but a subsequent rise due to new borrowing, exacerbated by volatile exchange rates.
· The IMF itself acknowledged that assumptions regarding growth were not realistic.
See the IMF World Economic Outlook April 2004: it recognises that IMF WEOs have systematically overestimated growth in SSA because of natural disasters, political instability, 'unexpected shocks'.
Similarly, see World Bank-IEG 2006. Debt Relief for the Poorest: current GDP and export growth forecasts for post-completion-point countries still very optimistic.
· The IMF itself acknowledges that debt levels will remain unsustainable even after HIPC initiative on the basis of current fiscal policies
=dilemma between the requirements of increasing poverty-reducing expenditure and possible weaker fiscal primary balance and worse debt-sustainability.
Consequence=ensuring debt-sustainability conditioned on increased non-debt-creating grants→ so no debt sustainability in HIPC countries in the long-term: see Fedelino and Kudina 2003 Fiscal Sustainability in African HIPC Countries.
The IMF is aware of the limits of debt relief: E.g. Rodrigo De Rato (March 2006) (WB press review): recent large-scale debt relief for SSA are not enough. SSA governments receiving debt relief must maximise their savings on foreign debt servicing and channel the resources to improving health, education and infrastructure.
Crucial risks: SSA countries sliding back into indebtedness
Also, issue of corruption, "clear impediment" to economic development in SSA.
IMF aware that debt relief creates new problems= how to deal with a surge in aid=governments should aim for policies that strengthen the impact of aid on growth, i.e. the problem of scaling up assistance.
Aid to SSA expected to double over the next few years, so for the IMF, governments should think about how to spend it effectively to boost growth (see the lecture on aid).
The IMF acknowledges that cross-country evidence demonstrates the higher vulnerability of PRGF countries to external shocks. The year-on-year volatility of the terms of trade and export volumes and of real GDP growth is relatively large in PRGF countries, and in low-income countries more generally, in comparison with advanced and transition economies. (see IMF Monetary and Fiscal Policy Design Issues in Low-Income Countries, PDR and Fiscal Affairs Department, August 8, 2005).
· Problem of institutions also acknowledged by the IMF:
For those interested, see Yan Sun, 2004, External Debt Sustainability in HIPC Completion Point Countries, IMF WP/04/160: in countries that have reached the completion point, the problem=policy and institutional frameworks still weak, and poor debt management practices.
+their export base remains narrow + poor fiscal revenue mobilisation, even compared with many other low-income countries.
· For the IMF, debt has a negative impact on growth: but investment is a key channel, with positive impacts.
See Clements, Bhattacharya and Nguyen. 2005. Can Debt Relief Boost Growth in Poor Countries?
Although high levels of debt can depress economic growth in low-income countries, external debt slows growth only after its face value reaches a threshold level estimated to be about 50% of GDP (or, in net present value terms, 20–25% of GDP). These findings imply that the substantial reduction in external debt projected for the countries participating in the HIPC Initiative would directly add 0.8–1.1 percent to their per capita GDP growth rates. Indeed, the positive effects of debt relief may already be reflected in some of the healthier growth rates achieved by these countries in the past few years relative to their poor performance in the 1990s. (Annual GDP growth averaged 1.2 percent in 2000–02, compared with 0.2 percent during the 1990s.)
External debt also affects growth indirectly through its effect on public investment. Although the stock of public debt does not appear to depress public investment, the cost of servicing the debt does. The relationship is nonlinear, with the crowding-out effect intensifying as the ratio of debt service to GDP rises. On average, every percentage point increase in debt service as a share of GDP reduces public investment by about 0.2 percentage point, implying that reducing debt service by about 6 percentage points of GDP would raise public investment by 0.75–1.0 percentage point of GDP, which, in turn, would result in a modest increase of about 0.2 percentage point in growth. But if a greater share of this debt relief— say, about half—could be channeled into public investment, growth could increase by 0.5 percentage point a year.
While each low-income country participating in the HIPC Initiative determines its use of debt relief in the context of its own poverty reduction strategy, the findings here suggest that one way for country authorities to raise growth and combat poverty would be to allocate a substantial share of debt relief to public investment. The full benefits of higher public investment will be reaped only if greater public spending on capital outlays is not associated with increasing budget deficits.
These findings have important implications for the design of adjustment programs in countries receiving debt relief. Reducing the stock of debt alone—rather than immediately reducing debt service— is unlikely to induce governments to increase their spending on public investment. And, although cutting debt-service obligations can provide countries with the breathing space they need to increase public investment, debt relief by itself is likely to raise public investment only modestly.
9. The Multilateral Debt Relief Initiative (MDRI)
· Series of initiatives of the international financial institutions.
Policy changes regarding development finance in 2005:
The international Finance Facility/IFF of the UK in 2004-2005: developed countries governments issuing bonds for financing aid; poorest countries debt cancellation.
See the WB Global Development Finance/GDF 2006: Chap 3 Supporting Development through Aid and Debt Relief
The High-Level Forum on Aid Effectiveness held in Paris in March 2005 set out to change how aid is delivered and managed. The Commission for Africa issued a report in March urging donors to scale up aid for Africa significantly = expectations for a big push in aid with a strong focus on SSA
Then the G-8 Summit in Gleneagles, in July 2005, with 'Africa and Development' as one of two main themes. The United Nations World Summit followed in New York in September to assess progress toward the Millennium Development Goals (MDGs)
Multilateral trade liberalisation also played a central role in the development agenda. In December 2005, World Trade Organization (WTO) Ministerial Meeting in Hong Kong: 'aid for trade' as a major policy initiative.
In July 2005, the G8-Gleneagles summit, Annual Meetings of the WB and IMF agreed to implement the G8 proposals to cancel debt: the multilateral debt relief initiative/MDRI
=Proposal by the G-8 to provide further multilateral debt relief to the countries that have been part of the Enhanced HIPC Initiative.
IMF=$4.8billion debt relief plan to cancel the debts of 20 of the world's poorest countries. The leaders of the G8, the WB and the IMF set a target of writing off $55bn of debts of poorest countries. Around 70% of the debt is owed to the World Bank, while the rest is owed to the IMF and African Development Bank. The World Bank: expected $38bn debt relief package.
Part of PRSPs and reducing corruption:
In some cases, very substantial debt relief: e.g., see DRC Congo, Nigeria (see the lecture on aid)
· The Multilateral Debt Relief Initiative/MDRI
See WB website: The Multilateral Debt Relief Initiative: IDA to cancel all debt outstanding and disbursed owed by HIPCs to IDA as of end-2003 when these countries reached the HIPC completion point.
The MDRI provides HIPCs that have reached the completion point irrevocable, up-front cancellation of debt owed to IDA, the African Development Fund, and the IMF. Debt cancellation under the MDRI is in addition to debt relief already committed under the HIPC Initiative.
The MDRI applies to Highly Indebted Poor Countries (HIPC) that have reached completion point, as eligible for 100% debt cancellation.
The MDRI takes effect on July 1, 2006. Under the MDRI, IDA is expected to provide some US$37 bn in debt relief over 40 years.
Many WB-IMF documents on their website: for those interested, see International Monetary Fund and International Development Association, Heavily Indebted Poor Countries (HIPC) Initiative—Statistical Update, March 21, 2006
International Development Association and International Monetary Fund, Heavily Indebted Poor Countries (HIPC) Initiative and Multilateral Debt Relief Initiative (MDRI)—Status of Implementation, August 21, 2006
See IMF Website: A Factsheet – September 2008. The Multilateral Debt Relief Initiative (MDRI).
The Multilateral Debt Relief Initiative (MDRI) provides for 100% relief on eligible debt from three multilateral institutions to a group of low-income countries. The initiative is intended to help them advance toward the United Nations' Millennium Development Goals (MDGs), which are focused on halving poverty by 2015
What is the Multilateral Debt Relief Initiative (MDRI)?
In June 2005, the Group of 8 (G-8) major industrial countries proposed that three multilateral institutions—the IMF, the International Development Association (IDA) of the World Bank, and the African Development Fund (AfDF)—cancel 100 percent of their debt claims on countries that have reached, or will eventually reach, the completion point under the joint IMF-World Bank enhanced Initiative for Heavily Indebted Poor Countries (HIPC Initiative). The HIPC Initiative entailed coordinated action by multilateral organizations and governments to reduce to sustainable levels the external debt burdens of the most heavily indebted poor countries. The MDRI goes further by providing full debt relief so as to free up additional resources to help these countries reach the MDGs. Unlike the HIPC Initiative, the MDRI does not propose any parallel debt relief on the part of official bilateral or private creditors, or of multilateral institutions beyond the IMF, IDA, and the AfDF. However, in early 2007, the Inter-American Development Bank also decided to provide similar debt relief to the five HIPCs in the Western Hemisphere.
How is the IMF implementing the MDRI?
Although the MDRI is an initiative common to several international financial institutions, the decision to grant debt relief is ultimately the separate responsibility of each institution, and the approach to coverage and implementation may vary. In deciding to implement the MDRI, the IMF Executive Board modified the original G-8 proposal to fit the requirement, specific to the IMF, that the use of the IMF's resources be consistent with the principle of uniformity of treatment. Thus, it was agreed that all countries with per-capita income of US$380 a year or less (whether HIPCs or not) will receive MDRI debt relief financed by the IMF's own resources through the MDRI-I Trust. HIPCs with per capita income above that threshold will receive MDRI relief from bilateral contributions administered by the IMF through the MDRI-II Trust.
MDRI relief covers the full stock of debt owed to the IMF at end-2004 that remains outstanding at the time the country qualifies for such relief. There is no provision for relief of debt disbursed after January 1, 2005.
Which countries are eligible for the MDRI? Which have already qualified?
All countries that reach the completion point under the enhanced Initiative for Heavily Indebted Poor Countries (HIPC Initiative), and those with per capita income below US$380 and outstanding debt to the Fund at end-2004, are eligible for the MDRI. The list of eligible countries is detailed in Table 1.
In December 2005, IMF staff assessed whether the group of 20 countries that were already eligible according to the criteria explained above effectively qualified for MDRI relief. To qualify, the IMF Executive Board required that these countries be current on their obligations to the IMF and demonstrate satisfactory performance in (1) macroeconomic policies; (2) implementation of a poverty reduction strategy; and (3) public expenditure management. The Board determined that 19 countries qualified for immediate MDRI relief. They included 17 HIPCs that had reached the completion point, and two non-HIPC countries whose per capita income was below the established threshold. These countries benefited from MDRI relief in January 2006. Following the implementation of corrective actions, Mauritania qualified for and received MDRI relief in June 2006.
Countries that have not yet reached the completion point under the HIPC Initiative will qualify for MDRI relief upon reaching the completion point. That was the case of Cameroon (April 2006), Malawi (September 2006), Sierra Leone (December 2006), São Tomé and Príncipe (March 2007), and The Gambia (December 2007). In all, 25 countries have qualified for, and received MDRI relief from the Fund.
How much debt relief will be provided by the Fund?
The estimated total cost to the IMF of MDRI debt relief, excluding remaining HIPC Initiative assistance not yet delivered, is around US$4 billion in nominal terms at end-September 2008. Of this amount, US$3.3 billion has been delivered by end-September 2008. In addition, the cost of the IMF's debt relief to Liberia—both HIPC and beyond-HIPC—was estimated at its decision point at SDR 530 million (US$867 million) and would be covered by bilateral contributions.
The G-8 has committed to ensure that proposed debt forgiveness does not undermine the ability of the three multilateral institutions to continue to provide financial support to low-income countries, nor the institutions' overall financial integrity. In this context, the G-8 has provided SDR 100 million (in end-2005 NPV terms) to the IMF as additional subsidy resources for PRGF-ESF lending in the wake of the MDRI. Additional contributions will be needed to cover the cost of HIPC Initiative and MDRI debt relief to newly identified HIPCs and to countries with protracted arrears to the IMF. In this context, the G-8 committed that donors will provide the extra resources necessary for full debt relief for these countries.
Follow-up and monitoring
The IMF and the World Bank are cooperating closely in the implementation and monitoring of the MDRI, particularly as regards assessing qualification for MDRI relief and monitoring MDG-related spending after provision of debt relief. The first progress report on the IMF's implementation of the MDRI was presented to the IMF Board in April 2006. The subsequent reports have been prepared with the Bank and folded into the regular joint Bank-Fund HIPC Initiative status of implementation report. The fourth report was published in September 2008.
See UNCTAD. 2008. The Least Developed Countries Report 2008: Growth, Poverty and the Terms of Development Partnership:
Box 3. The Multilateral Debt Relief Initiative
In 2005, the G-8 countries, during the summit in Gleneagles, proposed to cancel the entirety of the debt of the eligible heavily indebted poor countries (HIPCs) contracted with the International Development Association (IDA) — the concessional facility agency of the World Bank — before 1 January 2004, and with the IMF and the African Development Fund before 1 January 2005. The Inter-American Development Bank joined in 2007. Such an initiative led to the creation of the MDRI, whose objective is "to provide additional support to HIPCs to reach the MDGs while ensuring that the financing capacity of the IFIs is preserved" (World Bank, 2006b: 2). The MDRI became effective on 1 January 2006 for the IMF and the African Development Fund, and 1 July for the IDA.
Analysts have shown that, to preserve the IFI financing capacity, the MDRI applies the criterion of additionality in aid, which implies that debt cancellation will involve additional financing by the international community. The MDRI is particularly important for LDCs because multilateral debt accounts for such a high level of their overall debt stock. LDCs which have received debt cancellation under MRDI have experienced major reductions in indicators of their debt burden. But the additionality of the debt relief is not as great as it might be because of how it works. The way in which the World Bank debt cancellation works is that if a country paid IDA debt service of $10 million, this would be cut by $10 million, but at the same time the country would receive an equivalent cut of $10 million in new finance from IDA. Donors would then compensate IDA for this $10 million write-off and this money would be distributed amongst all IDA-only countries according to their score on the Country Policy and Institutional Assessment index. For example, the country getting the debt relief might get $5 million back from this process. Analysis suggests that this considerably reduces the additionality of the MRDI (Hurley, 2007).
Countries become eligible for debt relief under the MDRI once they reach the HIPC completion point. This requires that they meet all of the following conditions:
(a) Satisfactory macroeconomic performance under an IMF poverty reduction and growth facility programme;
(b) Satisfactory progress in implementing a poverty reduction strategy; and
(c) An adequate public expenditure management system that meets minimum standards for governance and transparency in the use of public resources (World Bank, 2006a; World Bank, 2006b).
Furthermore, all post-HIPC completion point countries "will be required to maintain reasonable governance standards" (World Bank, 2006b: 6), as well as high standards for transparency and public expenditure management. MDRI recipient countries are subject to a three- to five-year assessment of their public financial management.
Source: Djoufelkit-Cottenet (2007), World Bank (2006a) and World Bank (2006b).
From the WB website, Debt, HIPC, Annual Meetings, October 2008
· For the IMF and the WB, the outcomes of the MDRI are a success
A key concept for the IMF: the concept of 'fiscal space', and a criterion may be how policies maintain this fiscal space
From the WB website, Debt, HIPC, Annual Meetings, October 2008
See IMF Survey magazine, Debt sustainability issues. Africa's Improved Debt Outlook Sparks Investor Interest, February 25, 2008. Sharp decline in debt: the external debt of low-income countries in Africa has declined significantly as a result of debt relief from the enhanced HIPC Initiative, the MDRI, and the Paris Club agreement with Nigeria: their debt sustainability outlook has improved substantially, with 21 out of 34 countries classified on the basis of the DSF at a low or moderate risk of debt distress at end-2007.
Debt relief under the HIPC initiative and MDRI is projected to reduce the debt stocks of the 26 African countries by more than 90 % when all the eligible countries reach the HIPC Initiative completion point. Debt service paid by these countries has declined by about 3 percentage points of GDP between 1999 and 2006, while poverty-reducing expenditures have increased by about the same magnitude.
Before the HIPC Initiative, eligible African countries were, on average, spending slightly more on debt service than on health and education combined. Now, they have increased their spending on health, education and other social services and, on average, such spending is more than 5 times the amount of debt-service payments.
33 African countries are eligible for debt relief of about $80 billion (in end-2006 net present value terms) under the 2 initiatives.
See the example of Niger: see IMF Survey Magazine, Debt Relief Yields Results in Niger, January 25, 2008. In Niger, lower debt service, significant budgetary aid and higher domestic revenue mobilisation, have an impact on spending in education, health, and the rural sector, where budgetary allocations increased by 4 % of GDP between 2002 and 2007. The debt stock was reduced through the HIPC Initiative and the MDRI from 76 % of GDP at end-2002 to 14 % at end-2006, or by the equivalent of $1.3 billion, with all multilateral and bilateral creditors participating in the cancellation. Debt cancellation yielded a drop in debt service of about 2% of GDP between 2003 and 2006.
· But there are criticisms of the MDRI
See Arslanalp and Blair Henry, 2006, Debt Relief: two reasons why MDRI is unlikely to help poor countries.
1) the amount of money at stake is trivial. The roughly $2 billion of annual debt payments to be relieved under MDRI amounts to roughly 0.01 percent of the GDP of the OECD countries—a mere one-seventieth (1/70) of the quantity of official development assistance agreed to by world leaders on at least three separate occasions (1970, 1992, 2002).
2) the existence of debt overhang is a necessary condition for debt relief to generate economic gains. Since the world's poorest countries do not suffer from debt overhang, debt relief is unlikely to stimulate their investment and growth.
The principal obstacle to investment and growth in the poorest countries is the inadequacy of the basic economic institutions= the real problems of the poor countries are unaddressed.
See Moss 2006, Will Debt Relief Make a Difference? Impact and Expectations of the Multilateral Debt Relief Initiative: The actual gains may be modest: limited short-term financial impact of the MDRI because the debt service obligations being relieved were themselves relatively insignificant. For example, in 2004 the average African country in the program paid $19 million in debt service to the WB, but received 10 times that amount in new Bank credit and more than 50 times as much in total aid.
+ finances are rarely the binding constraint on poverty
The impact may be considerable over the long-term, especially on the ability of creditors to be more selective in the future: most of the impact of the MDRI will be long-term: hence expectations of the effect on indebted countries and development indicators should be kept modest.
As for the HIPC, many criticisms of the MDRI underscore its over-optimism.
See Nwachukwu, Jacinta. 2008. The Prospects for Foreign Debt Sustainability in Post-Completion-Point Countries: Implications of the HIPC-MDRI Framework: The Enhanced HIPC Initiative was launched to reduce the Net Present Value (NPV) of foreign debt of the world's poorest countries to a sustainable threshold of 150% of their exports.
A growth-with-debt model to 16 post-completion-point HIPCs to assess whether this goal will be met by 2015
Optimistic base-case projections suggest that participation in the current Enhanced HIPC-MDRI initiative will only reduce the NPV of their total external debt to 176% of exports by this date.
+ risks of accumulating again unsustainable debt levels.
See UNCTAD. 2008. The Least Developed Countries Report 2008: Growth, Poverty and the Terms of Development Partnership: Progress in debt relief remains slow for the other LDCs eligible for HIPC. Various conditions have to be met, both to reach the HIPC decision point and to proceed to completion point. The time between decision point and completion point has been increasing since the early batch of countries reached decision point before end–2003. For the five LDCs which reached completion point in 2005 and 2006, the time between completion point and decision point was 4.3 years for Zambia and Rwanda, 4.7 years for Sierra Leone, 5.7 years for Malawi and 6.2 years for Sao Tome et Principe (IMF and World Bank, 2007: figure 1). Of the nine LDCs that have passed the decision point, but not reached completion point, four reached decision point in 2001 and one in 2003. These countries —Chad, Gambia, Guinea, Guinea-Bissau and Democratic Republic of the Congo— have all experienced interruptions in their IMF-supported programmes and have faced difficulties in meeting completion-point triggers. But Burundi, Chad, Democratic Republic of the Congo, Gambia, Guinea-Bissau and Guinea adopted a full Poverty Reduction Strategy Paper (PRSP) by the end of 2007, a condition for reaching the completion point.
Of the seven LDCs which have been judged eligible for HIPC according to their debt sustainability criteria, but have not reached decision-point, four — Liberia, Somalia, Sudan and Togo — have large arrears to multilateral institutions and have not been able to engage in IMF- and IDA-supported programmes, three years' participation in which is a condition for reaching the decision point.10 Moreover, other LDCs which are not judged eligible for the HIPC Initiative remain outside the debt forgiveness process.
The effect of these initiatives on the debt burden for the LDCs as a group and for individual LDCs is shown in table 20. For the LDCs as a group, there has been a major reduction in the overall debt burden since 2000–2002. LDCs' debt stocks fell from 86 per cent of GNI during 2000–2002 to 58 per cent in 2005, and then dropped further to 42 per cent in 2006. But within the overall trend, some countries are doing much better than others.
From the table, it is apparent that there has been a major improvement in the debt situation in those LDCs which have received debt cancellation under the MDRI. The debt stock in these countries was cut from $54.7 billion in 2005 to $25.7 billion in 2006. In almost all of these countries, the total debt stock as a share of GNI was halved between 2005 and 2006. Nevertheless, the debt service payments of these countries actually increased, from $1.1 billion in 2005 to $1.3 billion in 2006. As a ratio of exports of goods, services and workers' remittances, debt service payment for this group of countries fell marginally, from an average of 6.8 per cent in 2005 to 5.7 per cent in 2006.
At the other end of the spectrum, it is clear that the debt burden remains very high in most of those LDCs which are eligible for HIPC debt relief, but have not reached the decision point or the completion point. The debt stock as a share of GNI is increasing in nine LDCs, including five LDCs which have reached the HIPC decision point — Burundi, Chad, Guinea, Guinea-Bissau and Haiti. Moreover, of the 45 LDCs for which data are available, the debt stock in 2006 was higher than the GNI in nine LDCs and over 50 per cent of GNI in a further 13 countries.
Despite overall improvement in the debt situation, the debt burden for the LDCs as a group remains much higher than in other developing countries — on average 42 per cent of GNI in 2006 in the LDCs, compared with 26% in other developing countries. Moreover, although the debt relief provides important breathing space for those countries which have reached HIPC completion point and have received debt cancellation under the MDRI, the long-term sustainability of debt remains a problem.
This point was clearly made by the evaluation update of the HIPC Initiative, which was undertaken before the MDRI. It pointed out the limits of debt relief as a means of assuring debt sustainability and showed that "debt ratios have deteriorated significantly since completion point in the majority of countries, with the increase in debt ratios correlated quite closely to the length of time since completion point" (IEG, 2006: 21). Before the MDRI, Burkina Faso, Ethiopia, Rwanda and Uganda were all expected to be unable to maintain debt sustainability above the HIPC thresholds in the nine years following completion point. Moreover, the evaluation found that the forecasts underlying predictions of future debt sustainability for these countries, and also those which were expected to remain below the sustainability threshold, continued to be based on forecasts of GDP and export growth which were far higher than historical trends.
The MDRI has improved this situation. However, according to the latest IMF World Bank assessment of debt sustainability, debt distress is low in only seven post completion point LDCs. It is moderate in Benin, Burkina Faso, Ethiopia, Malawi, Mauritania, Niger, Sao Tome and Principe and Sierra Leone, and remains high for Rwanda (IMF and World Bank, 2007). A simulation of the first 16 post-completion point HIPCs to participate in the MDRI also finds that, in the absence of MDRI, the net present value of the external debt stock of these countries is expected to rise from 74 per cent of exports in 2004 to 236 % by the end of 2015. With the MDRI, it is expected to rise much less, but — at 176 per cent of exports — still be unsustainable according to HIPC thresholds in 2015 (Nwachukwu, 2008).
These results reflect the assumption of the simulation. They depend on estimates of the grant component of new disbursements, as well as forecasts of domestic savings and foreign exchange receipts. However, the model also clarifies the key conditions for growth with external debt. These are that: (a) the projected marginal savings rate exceeds the fixed investment ratio required to achieve the target rate of growth; (b) the anticipated rate of growth of imports should not exceed the growth of exports; (c) the estimated growth of external debt and interest payments should not continuously exceed the real growth rate of exports; and (d) the marginal product of foreign capital should be greater than the cost of international borrowing.
The key to ensuring debt sustainability is to develop productive capacities. The problem with the current situation and the focus on social sectors is that this is not being done. On the contrary, the MDGs build up fiscal obligations for Governments without generating at the same time a sound fiscal base to raise these revenues. Similarly, they increase import requirements without building up export receipts to pay for these imports. Unless there is a shift in emphasis to building up the productive base of poor economies and promote structural change to reduce vulnerability to commodity price shocks, they will inevitably become unsustainably indebted again.
· Even the IMF acknowledges that the MDRI does not solve the problem that SSA countries depend on commodities
and hence the root cause of their fiscal problems and debt remain unaddressed….
See the example of Cameroon: IMF Survey, June 18, 2007: Cameroon: What next after debt relief? A year ago, Cameroon received debt relief under two major international initiatives, clearing the way for a write-down of its external debt from about 40% of GDP in 2005 to 5 % of GDP in 2006. Cameroon is now poised to make faster progress toward improving living conditions and reducing poverty. But how is this resource-rich West African country making use of the breathing space created by debt relief, and can it get onto a higher growth trajectory that would edge it closer to achieving the Millennium Development Goals (MDGs)?
Since 1994, Cameroon's economic growth has picked up, although it remains lower than required to make a significant dent in poverty. The devaluation of the CFA franc in 1994 and the accompanying macroeconomic and structural reforms since then contributed to a reversal of Cameroon's declining output. Oil revenues have helped, but the country's crude reserves are dwindling, and economic activity is hampered by weak infrastructure, limited financial intermediation, uneven implementation of structural reforms, and, more generally, an unfavourable business environment. As a result, per capita real GDP has not kept pace with that in comparator countries, and progress in improving social indicators has been mixed. Cameroon's debt declined under the enhanced HIPC Initiative and the Multilateral Debt Relief Initiative (MDRI). HIPC debt relief cut Cameroon's debt by about $1.3 billion in net present value terms, reducing future debt service payments by about $4.9 billion. Debt relief under the MDRI amounts to a further $1.1 billion in nominal terms. The IMF provided 100 % debt cancellation on all debt incurred before January 1, 2005, resulting in the cancellation of $255 million of its claims on Cameroon. Debt relief has opened up new opportunities. Cameroon is using the freed-up resources to increase priority spending, including on health, education, agriculture, infrastructure development, and institution building. But expectations for a debt relief "dividend" in the form of higher current spending could undermine fiscal sustainability if not managed prudently. To build on the opportunities presented by debt relief, Cameroon will need to achieve progress in• preserving long-term fiscal sustainability while expanding priority spending,• broadening and deepening the financial sector, • liberalizing trade, and • improving the business environment by stepping up structural reforms.
Managing the "fiscal space." Although Cameroon's overall budgetary position has strengthened over the past two years, the underlying fiscal situation is less favorable. Aided by large oil revenue inflows and improved budget management, the overall fiscal balance has been in surplus. But the non-oil primary balance has deteriorated over the past decade because domestically financed primary spending has expanded faster than non-oil revenues, partly reflecting an increase in debt relief–financed priority outlays. The fiscal space provided through debt relief should therefore be used prudently.
How can Cameroon achieve that? First, it needs to mobilize additional non-oil revenues over the medium term, which will be critical for preserving fiscal sustainability, given the expected decline in oil reserves and prospects for trade liberalization. But, with tax rates already high, additional revenues would need to come from a broadening of the tax base through policy and administrative measures. Second, Cameroon should devote a larger part of public expenditures to priority outlays, taking into account its absorptive capacity. Its efforts would need to be accompanied by reforms in public expenditure management to ensure that the resources are used effectively. Measures that reduce subsidies to public enterprises—a heavy burden on the budget—and redirect those resources toward education, health, and infrastructure would also help boost the quality of spending. Finally, to preserve its hard-won debt reduction, Cameroon needs to strengthen debt management. It should rely primarily on grants and concessional loans for the next few years to cover its financing requirements and avoid a rapid accumulation of new debt. It will need to monitor debt sustainability indicators closely to avoid a recurrence of past debt problems.
· Since the mid-2000s, increase on growth rates in SSA due to commodity prices.
Hence after years of marginalisation of SSA, renewed interest of international capital markets vis-à-vis SSA.
But for the IMF: new vulnerabilities: new borrowing entails risks.
See IMF Survey magazine, Debt sustainability issues. Africa's Improved Debt Outlook Sparks Investor Interest, February 25, 2008: the new financial landscape raises new policy challenges: a high share of commercially-based inflows (compared to concessional resources) would increase the volatility and cost of external finance. Lending modalities are also often more complex and may involve explicit or implicit contingent liabilities, complicating the resolution of servicing difficulties should they emerge. The resulting increase in financial vulnerabilities, particularly in countries that remain exposed to large and frequent external shocks, needs to be mitigated to avoid a new buildup of unsustainable debt.
For the IMF, concessional external resources remain the most appropriate source of financing for low-income SSA countries: their needs = education, health, or other investments that do not generate the cash flows necessary to service commercial debt. Nonconcessional finance is better fitted for specific high-return projects, especially when no or limited concessional resources are available and debt sustainability is not at risk.
Public debt has been important in SSA because of the low level of private financial flows. But the situation had improved since the mid-2000. However, uncertainties created by the 2008 financial crisis.
See Masood Ahmed, 2008, The Next Frontier, Finance and Development, vol. 45, n°3, September. Creating a good business climate. The third big challenge is to develop a business climate that will support a vibrant and competitive private sector, which will create jobs and sustain broad-based growth. Part of the solution to this challenge is to develop liquid and well-functioning domestic capital markets that can support private sector growth.
Stronger integration with global financial markets represents an important opportunity for low-income countries to raise foreign capital and channel it to finance growth-enhancing development. In SSA, private capital flows have grown almost fivefold in the past seven years: from $11 billion in 2000 to $53 billion in 2007. Such flows have increased rapidly since 2004 to low-income countries as a group, although they have decreased to resource-intensive low-income countries (see chart). And between 2001 and 2007, foreign direct investment (FDI) has remained stable at $15-$21 billion (IMF, 2008c).
A number of countries in sub-Saharan Africa in fact are achieving a "frontier emerging market" status as their financial markets mature sufficiently to permit portfolio investment by international investors. Consider Ghana. It entered the global capital market in September 2007 with a $750 million bond issue that was more than four times oversubscribed. With terms similar to those for Ghana, Gabon issued $1 billion in bonds to repay its Paris Club debt.
Several African countries that have made significant progress toward macroeconomic stability and debt sustainability have also succeeded in selling treasury bills in their own currency to foreign investors. At the end of June 2007, foreigners held more than 14 % of domestic currency government debt in Zambia, 11% in Ghana, and a significant share of such debt in Tanzania and Uganda (Wakeman-Linn and Nagy, 2008).
But although some African countries are doing well, progress is uneven. Indeed, data show that although the share of private capital flows to sub-Saharan Africa is growing, such flows are neither evenly spread across countries nor large or diversified, particularly if FDI is excluded (Ratha, Mohapatra, and Plaza, 2008). After all, between 2000 and 2007, South Africa and Nigeria accounted for nearly half of the FDI, and South Africa accounted for more than 85 percent of the portfolio inflows (IMF, 2008c). And for many low-income countries, official aid flows and inward official sector FDI by state-owned entities of other governments still account for the bulk of external capital flows.
To attract more investment and outside capital, countries need to liberalize their economies. Creating the right policy framework and developing a sequenced liberalization strategy are critical to successfully integrating with the global economy. But opening up the economy to outside capital flows has its risks—and here low-income countries can learn from the experience of today's emerging market economies.
Instituting well-designed capital account policies and financial liberalization strategies is a multistep process. In the short term, it involves reviewing capital account regulations to enhance transparency, consistency, and efficiency. In the medium term, a well-sequenced and well-timed liberalization strategy is needed—longer-term and more stable flows should be liberalized first, leaving enough time for implementing robust regulatory and supervisory frameworks for private sector financial institutions to take root. In addition, countries should have in place the ability to monitor capital inflows. Only then would a full lifting of existing controls be appropriate.
Low-income countries need to strengthen all aspects of local debt and equity market development—from the legal and the regulatory to the infrastructural. By developing the appropriate currency borrowing (and creditor) mix, countries can play a key role in enhancing the depth and liquidity of these markets, and in creating healthy conditions for corporate borrowers to access markets.
See David C. L. Nellor. 2008. The Rise of Africa's "Frontier" Markets, Finance and Development, September, vol. 45, n°3. A number of sub-Saharan countries are beginning to attract investors to their financial markets
Investing in financial markets Only recently have Africa's financial markets attracted significant interest from institutional investors. Just as first-generation emerging markets welcomed institutional investors to their equity markets, African countries are doing so now. African equity market capitalization was about 20 percent of GDP in 2005, comparable to the level reached by ASEAN in the late 1980s. By 2007, Africa's equity market capitalization had surged to over 60 percent of GDP. Africa's domestic bond markets are attracting interest in a way not seen in first-generation emerging markets. Trading of domestic and foreign debt in the international markets has accelerated rapidly. Emerging Markets Traders Association data show that trading in Africa's debt markets (excluding South Africa) more than tripled in 2007, reaching about $12 billion (see Chart 3).
Nigeria, as the largest country in this group, dominates the trade. During 2005–06, Nigeria received Paris Club debt relief and bought back much of the remainder of its external debt. Since then, trade in Nigerian debt has been mainly in domestic issues. Nigerian debt trading ranked 21st globally at the end of 2007; this is equal to or exceeds many first-generation emerging markets. Using a variety of investment vehicles, Nigeria's banks raised about $12 billion in capital over 2006–07, much of it from offshore investors.
The criteria for an emerging market set out here—growth, private sector–led growth, and investible markets—can be identified in eight sub-Saharan African countries: Botswana, Ghana, Kenya, Mozambique, Nigeria, Tanzania, Uganda, and Zambia. Together these countries account for about 40 percent of the region's population outside South Africa and almost one-half of its GDP.
The new frontier and the old This group of African countries compares favorably with the ASEAN countries of 1980 (see table). ASEAN was already experiencing strong economic growth in 1980 but, in many other areas, the ASEAN countries looked quite different than they do today—and the African candidates perhaps have lower vulnerability and greater economic stability than the ASEAN countries had in 1980. Growth in sub-Saharan Africa is strong, as it was in Asia. Unlike the high ASEAN inflation in the 1980s, inflation in Africa is single digit. High international reserves and low debt-to-GDP ratios—the result, among other things, of debt relief—characterize the African countries relative to the ASEAN countries of 1980. Government, however, comprises a larger share of the African countries than it did in the ASEAN countries.
It is critical that new borrowing does not undermine debt sustainability: see IMF Survey Magazine: private capital flows: more investors turn to SSA, January 3, 2008.
See IMF Survey Magazine, vol. 37, n°2, February 2008. Investors Eyeing SSA
Two African countries successfully tapped international capital markets in the second half of 2007, demonstrating global investors' rising confidence in sub-Saharan Africa's economic performance and prospects. (…) Ghana entered the international capital market in September 2007 with a $750 million bond issue. It was more than four times oversubscribed; total bids exceeded $3.2 billion. Despite increased volatility in international capital markets, Gabon followed in December with a $1 billion bond issue to repay Paris Club debt, with terms similar to those for Ghana. These bond sales are the logical outcome of the growing interest of international investors in Africa and in emerging and developing countries worldwide. The economic situation of SSA countries has improved markedly; collectively, they are experiencing the highest growth and lowest inflation in 30 years.
Countries in the subcontinent have substantially improved their economic policies, they have received significant debt relief through the Heavily Indebted Poor Countries Initiative and the Multilateral Debt Relief Initiative, and the external environment is favorable. That is why investors are looking at SSA countries in their search for yield, diversification, and potential, despite recent outbreaks of violence in Chad and Kenya.
Foreign holdings
Besides raising funds on international capital markets, several African "mature stabilizers"—countries that have made significant progress toward macroeconomic stability and debt sustainability— have succeeded in selling treasury bills in their own currency to foreign investors.
At the end of June 2007, foreigners held about 11% of Ghana's domestic currency government debt valued at more than $400 million. In Zambia, foreigners reportedly hold more than 14% of local currency government debt, and they hold a significant share in Tanzania and Uganda.
This heightened international investor interest presents SSA countries with significant opportunities but also with significant challenges. The opportunities are obvious. With international donors not yet delivering on their Gleneagles promise to double aid to help low-income countries meet the Millennium Development Goals, funds from private investors offer SSA governments an alternative and readily available source of financing for major projects, including urgent infrastructure needs.
But unless these new sources of debt financing are carefully managed, SSA countries could once again find themselves in debt distress. It will therefore be critical for those countries to ensure that new borrowing does not undermine their newly earned debt sustainability. Sound management of external and total debt and of public finances to ensure that debt proceeds are used effectively will be vital.
Debt sustainability
SSA countries will need to make debt sustainability central to their economic planning. The focus needs to be on total debt because the line between external and domestic debt is becoming increasingly blurred. SSA countries need comprehensive debt management systems that allow them to choose between different financing options in a way that is consistent with their economic policy objectives.
Strengthening public financial management is essential, so that the spending financed by loans is efficient. SSA countries also need to broaden the domestic investor base for local currency debt so that sudden capital inflows or outflows do not destabilize the market.(…)
Development finance
Despite the increasing importance of nonconcessional financing, concessional financing should remain the main source of development finance for the foreseeable future. The challenge here is for donors rather than recipient countries: It is important that they not only increase their support, in line with international commitments, but also make it more predictable and more timely.
Another factor SSA countries must take into account is the increased role of emerging creditors, such as China; the main challenges here are transparency and integration with the country's debt sustainability and macroeconomic frameworks.
But, ultimately, financing of the private sector, including non-debt-creating foreign direct investment, will be the key to financing sustainable growth in SSA.(..). John Wakeman-Linn and Piroska Nagy, IMF African Department
· A new issue: the impact of China?
See Helmut Reisen. 2007. Is China Actually Helping Improve Debt Sustainability in Africa? G-24 Policy Brief No. 9
Accusations that China is 'free-riding' are misplaced. China has a positive impact on debt tolerance in SSA through stimulating exports, infrastructure investment and GNP.
Even Angola and Sudan, the two African countries where the presence of China is most strongly felt (and which have not benefited from debt relief), show big improvements in their debt indicators. Both countries have built official foreign-exchange reserves at rapid pace recently, so that their net debt exposure is even lower.
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