Memorandum from HM Treasury
Introduction
1. The purpose of this memorandum, prepared by HM Treasury
in consultation with ECGD, DFID and FCO, is to:
— explain the nature of the debt problems that
beset many poor countries;
— set out the general parameters for the terms
and conditions for providing official debt relief and the main
instruments through which such debt relief is provided;
— explain the Government's policy on providing
official debt relief to poor countries, particularly with regard
to the Heavily Indebted Poor Countries (HIPC) initiative.
2. Annex A details the debt situation in Kenya, Rwanda and
Uganda, Annex B summarises progress in implementing the HIPC initiative.
Debt and development
3. Nearly all countries need to borrow to finance investment.
Developing countries generally import capital, i.e., borrow from
abroad, as well as finance development from domestic savings.
If invested wisely, loans can play an important role in contributing
towards a country's development. But the money borrowed accumulates
as debts which need to be repaid, and what can often, with the
benefit of hindsight, be seen as lending policies which did not
take full account of the true risks of default and poor investment
on the part of the recipient, coupled with unexpected shocks such
as large fluctuations in commodity prices and interest rates,
has led to problems for many countries in servicing this debt.
4. In the most extreme cases, countries find themselves with
an unsustainable debt burden unable to raise sufficient foreign
currency from exports to pay debt service due each year. Fresh
capital is not forthcoming, as investors are put off by poor economic
prospects. Economic growth suffers and development efforts can
be severely hampered. Some of the world's poorest countries find
themselves having to allocate more money to servicing debt than
to health and education expenditure.
Official debt rescheduling in the Paris Club
5. Many of the poorest developing countries have lacked the
creditworthiness to obtain loan finance from commercial banks
and other sources of private capital. They have relied instead
on official sources of finance—
other governments (bilateral debt) and international financial
institutions such as the World Bank (multilateral debt). When
such countries face problems in meeting their debt obligations,
they are likely to approach the Paris Club to negotiate some form
of debt relief.
6. The Paris Club (so called because it meets in Paris under
French chairmanship) is an informal group of government creditors,
mostly OECD members. Since 1997 it has also included Russia. The
Club has met regularly since 1956 with debtor countries, as necessary,
to discuss common terms on which to reschedule (the value
of the debt is not reduced in net present value terms but the
country is given more time to pay) and as necessary also to reduce
official bilateral debts. Many of these are commercial credits
provided in support of exports from the lender country, whilst
others are aid-related loans. The basic aim of a rescheduling
is to give a country more time to meet its foreign debt obligations,
so that for a consolidation period (the debt falling due
in this period are the ones that are rescheduled) of anywhere
between one and three years, sufficient foreign currency remains
to pay for essential imports, rather than simply being used for
debt servicing.
7. The Paris Club negotiates with debtor countries on a case-by-case
basis. Agreement is reached by consensus and creditors adhere
to the principle of comparability of treatment. The Club has clear
rules of precedent for determining which categories of debt should
be considered and the repayment terms. Those middle-income countries
(as defined by the World Bank) whose debts the Club agrees merit
treatment are usually entitled to have their debts rescheduled.
In such cases, certain categories of debts falling due over the
consolidation period are deferred and paid over a longer period.
The resultant Paris Club agreements are termed non-concessional
as no debt has been cancelled.
8. The precise terms vary case by case, but under classical
terms, this period is usually 10 years, including up to five
years of grace when only interest payments rather than repayment
of the loan principal must be maintained. For countries at the
lower end of the middle-income spectrum, the duration of the rescheduling
can be increased to 20 years, with 10 years' grace. Short-term
debts (contracts with a credit period of no more than a year)
and debts contracted after an agreed cut-off date (aimed
at protecting new lending, this date is fixed at the first Paris
Club rescheduling, and only debts contracted prior to it are eligible
for treatment) are not treated in other than the most exceptional
cases. Even then these categories are unlikely to be accorded
the same terms as so-called eligible (pre cut-off date) debts,
even if they constitute a significant proportion of a country's
debt stock. In all non-concessional reschedulings of commercial
credits, interest is charged at a rate which reflects the creditor's
cost of funds.
9. Loans provided as part of official aid, usually known
as official development assistance (ODA) loans, at concessional
interest rates, are normally treated differently by the Paris
Club. They are generally rescheduled for longer periods, with
no increase in the interest rate. As the loan had a low interest
rate to start with, the longer repayment period provides an extra
benefit to the debtor country. The general fall in interest rates
in recent years has, however, reduced the benefit. The UK is only
rarely involved in rescheduling of ODA debt as most such loans
have been converted to grants (see paragraph 32).
10. For some countries, particularly the poorest, most severely
indebted ones, reschedulings have proved to be only a temporary
respite. Creditor countries have increasingly realised that the
problems of many low-income countries, particularly those in sub-Saharan
Africa, need exceptional treatment in the form of debt forgiveness.
Since 1988, creditors have agreed on a series of concessional
measures that have reduced the debt burdens of some of the most
severely indebted countries. Initially, the Paris Club adopted
Toronto terms, allowing a reduction equivalent to 33 per
cent in the value of the eligible debts maturing during the consolidation
period. This was followed in 1991 by the implementation of London
terms, under which certain countries would receive a 50 per
cent reduction.
11. In 1994, the Club agreed to implement Naples terms
for countries, increasing reduction on eligible debt to 67 per
cent. Moreover, for the first time it allowed for the reduction
of the stock of debt (i.e., the total amount of eligible
debt owed by the country) by two-thirds at the end of the consolidation
period in certain cases. ODA debts are only rescheduled, rather
than reduced, under Naples terms.
12. Using all these concessional and non-conessional instruments,
the Paris Club has rescheduled or reduced bilateral debts of over
$300 billion in net present value terms over the past two decades.
To date, 27 countries (including 19 in sub-Saharan Africa) have
been given Naples terms. Of these, six countries have been
given 67 per cent reductions in their debt stocks.
13. A comprehensive agreement among creditors and with the
debtor to support debt relief (either a rescheduling or a reduction)
increases not only the chances that debtors will be able to meet
their debt obligations in the future but also their willingness
to do so. Debt relief can also be seen as a means of allowing
a country to increase economic efficiency by raising real incomes,
from a starting point in which high debt service means high taxation,
discouraging investment and inducing capital flight to safer havens.
Reducing a country's stock of debts to a sustainable level can
reduce the uncertainty which inhibits investment and growth. There
is also a wider interest shared by debtors and creditors alike.
By contributing orderly solutions to financial crises, reschedulings
can help protect the international financial system, and encourage
private sector trade and investment worldwide, thus helping to
increase international economic integration.
Links to IMF programmes
14. A precondition for the process outlined above is that
the debtor secures a satisfactory economic adjustment programme
with the IMF. Economic reform programmes are negotiated on a case-by-case
basis between IMF Staff and officials of the debtor country. Resultant
programmes often involve fiscal and monetary measures, exchange
rate policy, and structural reforms in both the public and private
sector, such as labour market reforms, judicial and regulatory
reform aimed at investment generation, and financial and trade
liberalisation. In the case of a low-income country, it is likely
that a programme will be linked to drawings under the Enhanced
Structural Adjustment Facility (ESAF), designed to provide countries
facing sustained balance of payments problems with highly concessional
loans. Disbursement of loans throughout the programme period are
made conditional on the country meeting targets specified
in the programme. The programme is expected to run concurrently
with the consolidation period of the debt relief, and IMF Staff
provide information for the Paris Club about whether, and if so
how much debt relief, is, their view, necessary to support the
programme.
15. Linking debt relief to IMF programmes such as ESAF helps
to anchor the process to economic development, without which a
debtor country cannot be expected to achieve a sustainable exit
from debt problems. Debt relief in itself cannot solve a country's
developmental problems. It clears away a barrier inhibiting, and
in some cases effectively preventing, economic growth. Debtor
countries need to make full use of the opportunity created by
removing this barrier, including by adopting sound economic policies
aimed at securing sustained economic growth and thus helping to
create the right conditions for productive private and public
sector investment.
The Heavily Indebted Poor Countries initiative
16. Traditional debt relief mechanisms under the Paris Club
framework have been applied only to bilateral debts to Paris Club
creditor governments (though the impact on the overall debt burden
of a Paris Club deal is intended to be wider as debtors are required
to seek equivalent terms from other bilateral creditors, including
commercial banks). Until recently there was no mechanism through
which to reduce or restructure the debts owed to multilateral
institutions, because of the preferred creditor status enjoyed
by the IMF, the World Bank and regional development banks.
17. However, there has been growing recognition that many
countries face problems in meeting their multilateral debt obligations
and are simply unable to attain debt sustainability without some
sort of relief on these debts. At the IMF/World Bank annual meeting
in 1996, an initiative was agreed that aimed to reduce the debt
burdens of some Heavily Indebted Poor Countries (HIPCs) through
the participation of all official creditors, including the multilateral
organisations. Countries are eligible for so-called HIPC relief
if they face an unsustainable debt burden even after the full
application of standard debt relief mechanisms (up to and including
Naples terms), despite a continued track record of IMF-supported
adjustment and reforms. The World Bank and IMF have together identified
41 countries that can be classified as HIPCs. On current data,
it seems likely that up to 20 of these HIPCs will need the extra
relief offered by the initiative to reach sustainable debt positions.
For most of the remainder, Naples terms will be enough.
18. Eligibility for HIPC relief is determined over a period
of up to six years in most cases. Once a country has established
a three-year track record of reform supported by an IMF programme,
the decision point is reached. At this stage, the IMF and the
World Bank, in consultation with officials of the debtor country,
conduct a full assessment of a HIPC's ability (or otherwise) to
pay its debts at the end of a further three-year period of reform.
19. Sustainable debt levels are determined on a case-by-case
basis, taking into account any specific vulnerability factors
(for example, if a country is dependent on a single export crop).
The levels are usually defined within the range of 200-250 per
cent for the ratio of total debt stock (on a present value basis)
to annual export earnings (taken from the annual average of the
most recent three years' export earnings) and 20-25 per cent for
the ratio of annual debt service to exports. There is also a special
rule of HIPCs with open economies (in which exports account for
at least 40 per cent of GDP) which allows for examination for
the debt stock to government revenue ratio (the fiscal criterion).
If this ratio is more than 280 per cent, and on condition that
revenue is at least 20 per cent of GDP, it is regarded as unsustainable.
In this case, creditors provide the relief needed to reduce the
revenue ratio to 280 per cent.
20. The final HIPC decision does not lie with the IMF and
World Bank staff. Instead, their assessment is presented to the
Executive Boards of IMF and World Bank, including the Executive
Director for the UK, who decide on eligibility, the necessary
exit ratios and the size of the debt forgiveness.
21. At the end of the further period of IMF-supported adjustment
(the second stage) of up to three years, the HIPC completion point
is reached. At this stage, the debt relief is delivered to bring
the debt ratios down to the agreed targets. The Paris Club provides
reductions of up to 80 per cent in the country's outstanding stock
of eligible debt. The World Bank, IMF and other multilateral creditors
provide parallel reductions. The burden of debt relief is shared
proportionately between bilateral and multilateral creditors,
to maintain the same relative proportion of claims as existed
after the application of Naples terms.
22. One of the main criticisms levelled against the initiative
is the length of time needed (six years in some cases) to gain
debt relief. But in reaching firm decisions in favour of HIPC
relief for four countries, the IMF and World Bank Executive Boards
have so far shown that they are prepared to be flexible with regard
to this, as the UK has urged. The Boards have agreed that Uganda,
which has a decade-long track record of strong economic reforms,
will be the first beneficiary of the initiative, receiving a reduction
in its debt stock in April 1998. Bolivia is set to benefit from
HIPC relief in September 1998 with Burkina Faso following suit
in April 2000. It has also been agreed that Guyana will be the
first country to qualify under the fiscal criterion next December.
Final HIPC decisions are expected shortly on Cote d'Ivoire, Mali,
Mauritania and Mozambique. Benin was assessed for HIPC relief
in 1997 but it was agreed that the country has already secured
a sustainable debt burden through Naples terms (up to 67
per cent) so it did not require HIPC relief.
23. Progress in implementing the initiative is covered in
the table at Annex B.
UK policy
24. The Chancellor of the Exchequer leads on policy on official
debt relief. The Treasury works closely with other Government
Departments, notably the Foreign and Commonwealth Office, the
Department for International Development and the Export Credits
Guarantee Department.
25. The Government believes that for some countries, debt
relief is crucial if they are to emerge from severe financial
problems. When allied to sensible economic policies and necessary
aid flows, it provides a much better opportunity for the debtor
country to achieve sustained economic growth, create the conditions
in which poverty can be tackled, and contribute more to the global
economy in which the UK is a major player. Debt relief also makes
sense if it enhances our recovery prospects—a value for
money argument—which is the basis of the legislation under
which we provide relief on officials commercial credits. We participate
in the Paris Club with other significant creditors because a managed
settlement agreed between a debtor and all its major creditors
necessitates equal treatment on the part of the debtor, reducing
the risk that some creditors will be favoured over others. In
the past decade, through Paris Club agreements, the UK has cancelled
around £1.8 billion of debts owed to us.
26. The bulk of our claims on poor countries consist of debts
arising from unpaid export credits, administered by the Export
Credits Guarantee Department (ECGD). ECGD's sovereign debt portfolio
has been acquired as part of its trading activities—the
giving of guarantees and insurance against loss in respect of
export contracts in exchange for the payment of a premium by the
exporter. ECGD takes over title to the debt when it pays a claim
under its guarantee: and it seeks to recover sovereign debt through
agreements reached under the aegis of the Paris Club. Non-sovereign
debt is pursued with the individual debtor concerned. The payment
of claims under ECGD guarantees is financed by Parliamentary Vote,
and will have an impact on the PSBR (as would any recoveries of
the debt). ECGD's gross trading surplus is accounted for as government
revenue in the national accounts, rather than as public expenditure.
It is reported in ECGD's Annual Report and Accounts, which are
published to Parliament as a command paper. ECGD's sovereign debt
portfolio is shown as an asset in its balance sheet, net of provisions
against the contingency that a full recovery will not be made.
27. ECGD seeks to maximise the recovery of outstanding debt,
including sovereign debt. Under Section 3(1) of the Export and
Investment Act 1991, "arrangements"—such as debt
forgiveness—can be made only in the interests of proper
financial management of the ECGD portfolio. Debt forgiveness—the
waiving of legal title to the debt, either wholly or partly—will
be considered only if ECGD is satisfied that this is in the interests
of the proper financial management of its portfolio: for example,
that the partial forgiveness of the debt alongside similar forgiveness
by other creditors enhances the prospects for recovery overall.
28. The UK has been a firm supporter of the concessional
debt treatment which has culminated in the HIPC initiative, and
UK Ministers have been at the forefront of calling for the initiative's
rapid and flexible implementation. For instance, the Government
strongly backed moves to give Uganda and Guyana credit for their
well-established track records by reducing the length of the second
stage from three years to one year.
29. Moreover, in September 1997, at the Commonwealth Finance
Ministers Meeting in Mauritius, the Chancellor of the Exchequer
challenged the international community to work to resolve the
problem of unsustainable debt burdens faced by some poor countries
fully and finally by ensuring sufficient debt relief for heavily
indebted poor countries. He called on debtors to respond by putting
in place sound economic policies aimed at generating economic
growth—a necessary precondition for raising living standards
and reducing poverty in the future—to allow them to address
their developmental goals in the longer term. Particular emphasis
should be put on productive expenditure, such as basic health
and education, and on transparent and accountable decision-making.
30. The Chancellor sought to provide further momentum by
setting targets against which further progress could be measured.
He proposed that the international community should make a commitment
that all eligible poor countries should at least embark on the
process of securing a sustainable exit from their debt problems
by the year 2000 (by putting in place an IMF-supported economic
reform programme). Decision points should be reached on three-quarters
of the countries that need HIPC relief by the same date.
31. In his statement, known as the Mauritius Mandate, the
Chancellor also called for greater openness and flexibility—including
more debtor involvement in debt negotiations—in the Paris
Club, which he challenged to provide relief where necessary to
categories of debt not currently covered by debt reduction. This
would mean going beyond past practice, with the overriding objective
of securing debt sustainability. The UK continues to advocate
this approach, for example for Mozambique, as it is clear that
80 per cent Paris Club relief will not deliver debt sustainability.
32. In the Mauritius Mandate, the Chancellor also announced
unilateral measures to further address the debt problem. He drew
attention to the announcement by the Secretary of State for International
Development that she planned to continue the policy of cancelling
old aid loans owed to the UK. Since 1978, the UK has forgiven
unilaterally £1.2 billion of old aid loans, and plans to
cancel the remaining £132 million of aid debts owed by middle
income Commonwealth countries as quickly as possible, provided
these countries follow sensible economic policies that encourage
pro-poor economic growth. The Department for International Development
has also made available £6.5 million for a bilateral contribution
to the African Development Bank to help it to meet its share of
the costs of providing HIPC relief to Uganda. The Chancellor announced
that for the next two years, the UK would provide export credits
to HIPC countries only in support of productive expenditure, to
focus support on spending that contributes to the economic and
social development of these countries. During this period, the
Government would seek to persuade other creditors to agree that
all state-supported credits to poor countries should be focussed
in this way in future.
33. In December, the Chancellor and the Secretary of State
for International Development held a seminar, attended by leaders
of religious groups and non-government organisations based in
the UK, to consider their views on the Mauritius Mandate and to
discuss with these groups the involvement of the whole international
community in meeting the challenges set out in the Mandate. The
Chancellor also took the opportunity to announce consultation
on proposals to provide enhanced tax-relief on charitable gifts
to promote educational and anti-poverty projects in developing
countries, and he drew attention to the President of the Board
of Trade's announcement that ECGD would provide an extra £100
million of overseas investment insurance to the HIPC countries.
34. Participants of the seminar sought new momentum for the
HIPC initiative and hoped that the seminar signified a new surge
of political will and public momentum to deal with the debts of
developing countries. The Chancellor assured them that advancing
the issue is a priority. The Government will continue to work
for international agreement on the proposals made at Mauritius
in the G7, the IMF, the World Bank, the Paris Club, the OECD and
in Europe.
35. The next stage, to which the Government is committed,
is to seek further progress internationally. Progress with the
Mauritius Mandate targets are covered in Annex B.
Further information:
"Debt 2000: The Mauritius Mandate"—Statement
given by the Right Hon. Gordon Brown MP, Chancellor of the Exchequer
to the Commonwealth Finance Ministers Meeting, Mauritius, 16 September
1997.
"Debt Relief for Low-Income Countries—the HIPC
initiative", IMF Pamphlet Series, No. 51, 1997.
Global Development Finance 1997, Volume 1, World Bank, 1997.
HM Treasury web site: http//www.hm-treasury.gov.uk/pub/html/docs/debt/main.html
World Bank web site: http://www.worldbank.org
IMF web site: http://www.imf.org
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