House of Commons - International Development

Select Committee on International Development Minutes of Evidence

APPENDIX 7

Memorandum from Debt Relief International

This memorandum suggests to Committee members several measures through which the UK government could strengthen the HIPC Initiative and improve the process of negotiating debt relief. The most important are:

(1) To ask the Bretton Woods Institutions to "close the gaps" in the HIPC Initiative, namely by:

— reducing sustainability ratios to levels which are objectively sustainable;

— analysing the historically sustainable levels of debt burdens on the budget;

— combining adjustment, debt relief and new aid to allow macroeconomic and social sustainability for HIPCs;

— providing relief to severely-indebted-low-income countries (e.g., Ghana, Malawi) which will not receive relief under HIPC.

(2) To ensure all creditors provide relief on the basis of HIPC country need, by:

— unilaterally relieving debts owed to the UK Government by all HIPCs.

— pressing (and if necessary funding) other creditor governments (especially HIPCs) to provide relief;

— pushing commercial creditors to play their full part in the Initiative;

— contributing to the World Bank and African Development Bank Trust Funds;

— making financial contributions to HIPC-run Multilateral Debt Funds.

(3) To ensure that more countries can potentially receive relief by extending the deadline for entering the Initiative to 2000.

(4) To accelerate relief and avoid delay by:

— shortening the period to decision point for countries which have recently started programmes but have a good economic record, or are emerging from war;

— shortening the period to completion point for countries which have a good medium-term record but have experienced temporary adjustment problems;

— expanding UK interim assistance through country-run Multilateral Debt Funds;

— if delay causes loss of relief, providing post-completion point budget support.

(5) Creating a "stronger debtor voice in negotiations" by:

— insisting that all HIPCS have the right to present their case to donors through national Debt Strategy Reports presented at Consultative Group or Round Table meetings;

— encouraging all HIPCs to establish their own Multilateral Debt Funds to channel interim assistance, enhance ownership and build their debt management capacity;

— funding support to HIPCs to build their capacity in debt analysis and strategy, so that they receive the maximum relief and avoid renewed debt problems in the next century.

II. INTRODUCTION

2.1 In its press notice of 10 December 1997, the House of Commons Committee on International Development requested memoranda on three aspects of Debt Relief:

"1. The terms and conditions of the Heavily Indebted Poor Countries (HIPC) Debt Initiative and its progress to date.

2. The policy of the United Kingdom on bilateral (official sector and commercial bank) and multilateral debt relief, including the Mauritian mandate.

3. The process of debt negotiation and the question of conditionality in debt relief."

2.2 All are inter-related, because UK policy will ideally be oriented to ensure the most desirable terms and conditions and rapid progress of the HIPC Initiative, through the most efficient process of debt negotiation. The rest of this memorandum therefore presents the progress and problems in the HIPC Initiative (Section II) and the process of debt negotiation (Section III), before making suggestions for how UK policy could overcome the problems identified (Section IV).

III. THE HIPC INITIATIVE: PROGRESS AND PROBLEMS[48]

3.1 Progress

The Heavily Indebted Poor Countries' (HIPC) Initiative, agreed by the international community in October 1996, marked a major step forward in debt relief to poor countries in three ways:

Relief was to be based on the debtor's long-term needs

— Relief would be provided by all creditors, with multilateral creditors such as the IMF and World Bank abandoning their refusal to provide debt relief—known as a "preferred" creditor status, and other creditors being co-ordinated so that the international community would press all (even the most reluctant) to provide relief.

— Calculations of relief needs and negotiations on conditionality were to be a tripartite process, with the IMF, the World Bank and the debtor having an equal say.

In addition, relief was to be subject to "strengthened adjustment programmes" monitored by the IMF and World Bank, extending beyond existing programmes. Advocates of conditionality saw this as progress, but those doubtful of its benefits saw a potential risk that tougher and longer adjustment would delay relief.

3.2 Problems

In practice, each of the four issues discussed above has proven complicated. The first two and the last are discussed here; the issue of tripartite process is analysed in Section 4.

3.2.1 Defining a Debtor's Needs

Debt needs are defined by the eligibility criteria for the HIPC Initiative. Thanks to flexibility by Fund and Bank management and Boards, these have been broadened slightly since 1996. There are now three criteria:

— a debt service to export ratio above 20-25 per cent;

— a present value to budget revenue ratio above 280 per cent (provided that the HIPC has exports over 40 per cent of GDP and revenue over 20 per cent of GDP—only five HIPCs meet these criteria).

Countries will be able to choose whether they wish to receive relief on the basis of the export ratios or the fiscal ratio, so that they can receive the higher amount of relief.

However, several problems remain with these criteria:

The target levels have been found to be historically impossible for HIPCs to pay

— There are inconsistencies in the design of different ratios. The fiscal threshold is much higher than the present value/export (XGS) threshold; it is a flat percentage, while the export threshold is a range; there is no ratio to measure the liquidity burden of debt service on the budget (e.g., debt service to budget revenue); and, to receive relief on a fiscal basis, a country has extra barriers to cross: if these applied to the export ratios, only five countries would receive relief under the Initiative. These inconsistencies stem from the fact that, as the Bretton Woods Institutions have stated, they "are not aware of a firm analytical basis which would provide specific guidance" for the fiscal ratios, which are therefore "based on pragmatic considerations of assuring eligibility for the most deserving cases but also containing additional costs for the Initiative" (IMF/World Bank 1997a). This means fiscal debt sustainability may be being undermined by ill-founded worries about lack of funds.

Export thresholds continue to use "ranges", with precise criteria for each country set using vulnerability indicators. These indicators have several major faults, notably:

— they fail to take into account overall macroeconomic sustainability. "Debt sustainability" can be achieved only when the combination of debt relief, aid and economic reform allow HIPCs to reach domestically and externally "sustainable" levels of indicators such as foreign exchange reserves, current account and budget deficits and GDP growth by the completion point. This is the only way to ensure that HIPCs are on a sustainable economic path which will avoid renewed debt problems after 2000.

— In calculating the amount of debt relief needed, they omit social indicators and poverty measures such as those used in the UNDP Human Development Report, or objectives such as the International Development Targets. Given the large body of evidence that low human development undermines long-term growth and development, HIPCs cannot be sustainable unless debt relief explicitly aims at "social sustainability", allowing debt relief to share the burden of sustainable human development with new aid and HIPC government policy.

they exclude key debts

— Domestic debt is excluded from the budget ratios, ignoring major problems for the budget and the domestic financial system if countries are switching borrowing from external to domestic sources.

The basis for the ratios should be consistent—they should measure the whole economy's external capacity to pay debt (including private sector export and debt) and the government's capacity to pay (through the budget, including domestic debt).[49]

There are two other important respects in which relief is not being tailored to debtor needs:

Such countries are absorbing huge budget burdens with little prospect of relief.

— The relief provided will be delayed for periods varying between one and six years, while countries need it now (for more detail see 3.2.3 below).

Finally, and most crucial, the Initiative was originally based on the principle that debt relief targets for individual HIPCs would be based only on their needs to reach sustainability, with multilateral creditors footing any residual bill. Nevertheless, in mid-1997, IMF and World Bank Boards agreed that targets should reflect also equal burdensharing of relief by multilateral and non-multilateral creditors (IMF/World Bank 1997b). This could potentially have threatened the principle of debtor sustainability.

3.2.2 Relief by All Creditors

The threat to debtor sustainability came from failure by creditors to agree on how to share the burden of debt relief. According to the definition agreed by the international community last July, calculating "burdensharing" based only on relief additional to existing commitments, the Paris Club of creditor governments needed to pay more.

Paris Club Burdensharing

To share the burden and make debtors sustainable, the Club will need to go beyond 80 per cent reduction for six HIPCs (Guinea-Bissau, Madagascar, Mozambique, Nicaragua, Rwanda and Sao Tome). In spite of flexibility by many Governments (including Canada, Denmark, the Netherlands, Norway, Sweden, Switzerland, the UK and the US), a few governments have refused to go beyond 80 per cent—or to take other measures such as moving the "cutoff date" or cancelling ODA debt which would have a similar effect. Recently, the Club has found a solution which will allow Club members to provide extra relief without requiring a public announcement that the Club as a whole has gone beyond 80 per cent. However, there is another danger posed by archaic Paris Club rules. So far, the Club has provided only 50 per cent reduction to some HIPCs (e.g., Guinea), imposing its own extra criteria (PV/XGS before relief above 350 per cent or per capita GDP below US$500), regardless of whether 50 per cent is enough to make them sustainable. This inconsistency must be resolved, with the Paris Club adopting a minimum of 67 per cent and if necessary 80 per cent for all HIPCs.

Burdensharing by the Multilaterals

In line with increased relief from the Paris Club, the multilaterals appear likely to have to increase their contributions for some countries. The World Bank appears willing (and has sufficient net income) to fund such a definition. Most other multilateral institutions appear to have resolved their funding problems, by drawing on their own resources or those of donors. Even the less wealthy of these institutions (e.g., the African Development Bank) will be contributing substantially to HIPC. The main argument remains whether the IMF is short of funds. Evidence for this is fast disappearing as delay in ESAF implementation in many countries reduces the money needed for ESAF disbursements and frees it for HIPC relief, and as delay in HIPC relief reduces the amounts needed.[51]

Burdensharing by Other Creditors

The final burdensharing issue is with other groups of creditors, especially:

Non-OECD governments.

— Commercial Creditors. Most HIPCs owe small amounts of commercial debt—in many cases, to hardline creditors which have refused to let their debt be bought back at a high discount. Funds and pressure will be needed to clear such debts.

3.2.3 Delay and Conditionality

The initial design of the Initiative said all HIPCs needed six additional years of adjustment before receiving relief. After an international outcry that this penalised HIPCs with long track records of adjustment, the Development Committee in October 1996 said HIPCs with long records should receive "maximum flexibility". Many interpreted this as meaning that they would receive full credit for past adjustment—so Bolivia and Uganda would get relief immediately. They were encouraged by IMF and World Bank press statements that Uganda would get relief in 1997.

Instead, "flexibility" has been marginal—resulting in only partial shortening of the period of three years between the "decision point" (at which the amount of relief is decided) and the "completion point" (at which it is provided). For example, Bolivia will receive its relief only after 12 years of adjustment, and Uganda after 10.5 years. It has also been made clear by the Fund and Bank that the vast majority of HIPCs, with shorter track records, will receive no flexibility.

Why should we worry about the delay?

— it will delay relief, and therefore reduce its positive effects on growth and development. Countries will not receive the HIPC relief until their completion point but, at the same time, will be required to spend more money on social sectors under their enhanced adjustment programmes, potentially creating major budget liquidity problems. In Uganda, this contributed to underfunding of the Universal (free) Primary Education and Poverty Eradication Programmes, forcing donors to fill gaps with grants. In addition, as Bolivia found, delay in lifting the debt overhang, caused caution about new investment; for both of these reasons, it undermines the credibility of the Initiative.

What are the causes of delay?

Problems with ESAF compliance for many countries.

— Failure to take into account an additional need for flexibility for HIPCs which have either not needed ESAF programmes until recently because of good economic management, or had major temporary disruptions through civil wars or unrest, and are therefore finding it difficult even to begin the first stage of the HIPC process (see also Stewart 1997).

IV. THE PROCESS OF DEBT NEGOTIATION

4.1 Finally, the principle that the process of debt negotiation would become tripartite has proved hard to implement. From the beginning, it was made clear that it would be only "partly tripartite": once the basic projections of debt sustainability ratios were completed, it would be up to the management and Boards of the Bretton Woods Institutions to decide when relief was provided and what precise targets should be aimed at for each country, though government views are reported to the Boards (see also Kitabire 1997).

4.2 Nevertheless, the main problem is not will by the Bretton Woods Institutions but capacity within HIPC governments. The Initiative requires the typical HIPC massively to increase its capacity for debt analysis,in order to lead the process of analysing its debt needs from the Initiative, and to ensure that it does not fall back into debt problems in the 21st century. To this end, HIPC governments need to design their own national debt strategies, in order to participate equally with the IMF and World Bank in the "Debt Sustainability Analysis" which determines relief under the Initiative, and to ensure that their strategy ensures a sustainable "exit" from debt problems.

4.3 Most HIPC countries have not previously designed debt strategies based on computerised simulations of the macroeconomic sustainability of their debts, and a result, many initial candidates for the Initiative have not been able to play their tripartite role. Debt Relief International's assessment of 22 countries indicates that they are hampered by many factors:

— Lack of training in concepts of the HIPC Initiative and debt sustainability. Notable exceptions to this have been regional Debt Strategy Workshops for Eastern and Southern African HIPCs in November 1995 (and national workshops for Tanzania and Uganda in 1997) funded by the Macro-Economic and Financial Management Institute (MEFMI) of Eastern and Southern Africa and designed by Debt Relief International; and the Debt Sustainability Workshop in June 1997 funded by the Commonwealth Secretariat (with technical documentation designed by Debt Relief International).

— Lack of documentation on the details of implementing the HIPC Initiative from a debtor country point of view. The only detailed documents describing the techniques for implementing HIPC are those prepared for the above workshops. In particular, for the Francophone, Lusophone and Hispanophone HIPCs, there has been no translation of detailed documents into any language other than English.

— Lack of fully reconciled debt data. Though much recent progress has been made in improving debt recording by HIPCs, the IMF and World Bank have needed for the Initiative a degree of accuracy surpassing previous levels, in order to be sure that they are not providing any more or less relief than needed. The resulting data reconciliation exercises have forced excruciating workloads on debtor and BWI staff.

— Institutional problems within government, especially lacking: co-ordination among government agencies responsible for debt and macro-economic policy, interest by senior policymakers; and staff, equipment and access to global information on variables such as interest and exchange rates, and commodity prices. In many countries, there has never before been sufficient motivation for these problems. The new HIPC Initiative principle that relief will be based on debtors expressing their own needs provides a unique motivation and opportunity to sensitise senior policymakers and resolve these problems.

4.4 For this reason, many institutions are making efforts to accelerate assistance to HIPCs. In particular, four donor governments (Austria, Denmark, Sweden and Switzerland) have launched a programme which is led by the HIPC governments themselves, to build their capacity to design debt strategies. This programme, co-ordinated by Debt Relief International, has been endorsed by (and is being implemented in full co-operation with) all major international institutions such as the IMF, World Bank, UNCTAD, Commonwealth Secretariat and UNDP. It operates strictly on the basis of demand from HIPC governments for independent (i.e., non-creditor) and co-ordinated capacity-building, training in the latest techniques for computer simulation of debt strategies, and other assistance, to help them play their full role in debt sustainability analysis and design a sustainable longer-term debt strategy. To ensure full long-term HIPC ownership, it will be a temporary mechanism, handing over all functions to competent regional organisations run by the HIPCs (such as MEFMI) at the earliest opportunity. Its primary aim is to create a pool of expertise in HIPC countries themselves, through which they will assist one another to develop sustainable debt strategies. The programme is already operating in 20 HIPCs.

4.5 Finally, to motivate them to improve their capacity, HIPCs need to believe that the international community will listen and allow them to lead discussions. This has happened for several countries (Bolivia, Mozambique, Tanzania, Uganda) when they were encouraged to:

establish country-run Multilateral Debt Funds

— present their national debt strategies and plans for building their debt management capacity to international donors meetings such as Consultative Group or Round Table conferences of donors, in order to mobilise pledges of debt relief and capacity-building, and demonstrate their commitment to ensuring the long-term sustainability of their debt through responsible new borrowing policies.

Such procedures need to be standardised for all HIPCs in order to give all of them an equal chance to show their commitment to resolving their debt problems, and to prove that the international community is committed to a genuinely tripartite process of debt relief.

(V) WHAT CAN THE UK GOVERNMENT DO?

5.1 Existing UK Policy

The UK Government has for several years been at the forefront of the campaign for increasing debt relief to developing countries. Most recently, John Major and Kenneth Clarke advocated the "London Terms" (50 per cent cancellation by the Paris Club) and the "Naples Terms" (67 per cent cancellation—originally known as Trinidad Terms) and the sale of gold by the IMF; and were at the forefront of moves to improve the eligibility criteria and timing of HIPC relief.

Under the "Mauritius Mandate" announced in September 1997, the new Labour Government has taken several important additional steps as a "new impetus to debt relief for the poorest countries". Above all, the new Government has taken very welcome measures to "put more money where its mouth is", relieving Uganda's debt to the African Development Bank, and providing budget support to several HIPCs, and debt relief support to Mozambique. It has also been a strong advocate of greater flexibility by the Paris Club, committing itself to going beyond the 80 per cent cancellation limit and including post-cutoff date debt.

5.2 The HIPC Initiative

Paragraph 23 of the Mauritius Mandate suggested that the World Bank should continue to analyse whether there were "gaps in existing mechanisms" under the Initiative. The above analysis indicates that the UK Government needs to advocate "closing" the following gaps:

5.2.1 Fulfilling Genuine Debtor Needs

If relief under the Initiative is to fulfil genuine debtor needs and ensure long-term sustainability for HIPCs, MPs may wish to suggest that the IMF and World Bank should:

— reduce sustainability ratios to levels which have been objectively found sustainable;

— analyse the historically sustainable levels of PV and debt service compared to budget revenue, so that the IMF and World Bank Boards can set objectively-founded fiscal thresholds including a ratio measuring the liquidity burden on the budget, and drop the additional barriers to fiscal relief;

— design adjustment programmes and debt relief thresholds for genuine sustainability so that debt relief, combined with aid and economic policy reforms, will ensure overall macroeconomic and social sustainability for the HIPC countries;

— include private sector and domestic debt in sustainability analysis (though not in relief).

In addition, they might suggest that the UK Government could:

— Provide more budget or debt relief aid, and debt cancellation, to low-income countries which are suffering a heavy debt burden but are not seeking HIPC Initiative relief (e.g., Ghana) or classified as HIPCs (e.g., Malawi).

5.2.2 Ensuring Relief by All Creditors

In order to ensure that all creditors provide adequate relief for HIPC needs, MPs need to insist on the core principle of the Initiative—that relief is determined by country need and that all creditors must share this burden. To this end, the UK Government could:

— unilaterally relieve debts owed to the UK Government by cancelling all remaining ODA and export credit debts (including post-cutoff date).

— press other creditor governments (especially HIPCs) to provide relief in line with the Initiative and, if appropriate, fund trilateral debt reduction agreements.

— push commercial creditors (especially those which have refused to participate in past buybacks) to play their part in the Initiative;

— contribute to the World Bank and African Development Bank Trust Funds for debt relief in order to ensure they are adequately funded and that the UK is even more listened to when it advocates relief by others.

— make financial contributions to HIPC—run Multilateral Debt Funds in order to share the burden of interim relief with other like-minded donors.

5.2.3 Accelerating Relief

The target dates set by Gordon Brown in Mauritius are now under threat. He suggested that:

extending the deadline for qualifying for the first phase of the Initiative to 2000,

— three-quarters of HIPCs should have reached decisions on their eligibility, to ensure that 300 million people would have been promised firm amounts for debt relief by the year 2000. It now looks as though only 23 countries will reach their decision points by then, and only 15 countries with less than 250 million people will have been promised relief. Most important, only four countries (or 50 million people) will actually receive their full relief by 2000. MPs could urge the Government to accelerate relief for HIPCs by suggesting that the BWIs:

— avoid proliferating and tightening ESAF conditions which delay progress;

— shorten the period to decision point for countries which have recently started programmes but have a good economic record, or are emerging from war;;

— shorten the period to completion point for countries which have a good medium-term record but have experienced temporary problems (e.g., Ethiopia).

Financially, especially if more flexibility is not agreed, the UK Government could:

expand its provision of interim assistance

— if delay causes loss of relief, build on its Ugandan precedent of providing post-completion point budget support—especially for social and anti-poverty programmes.

4.2 The Process of Negotiations: Building Debtor Capacity

The Mauritius Mandate speech referred to the need for a "stronger debtor voice in negotiations" (paragraph 22). What can the UK government do to ensure that the process is genuinely tripartite?

stronger debtor role in the decisions taken by the Executive Boards of the IMF and World Bank.

— Insist that all HIPCs have the right to present their case to donors—for interim assistance, HIPC eligibility and targets, post-completion point assistance and long-term borrowing strategies—through national Debt Strategy Reports presented as successive Consultative Group or Round Table meetings.

— Encourage all HIPCs to establish their own Multilateral Debt Funds for channelling interim assistance, in order to enhance their ownership, build their debt management capacity and allow full discussion of debt-related issues in the HIPC country itself.

— Fund support to HIPCs to build their capacity in debt analysis and strategy. Such support needs to be:

— Genuinely capacity-building, rather than short-term technical assistance.

— Provided not through ad hoc general courses on debt management, but through programmes tailored to the individual country's needs and identified by the country itself.

— Independent of creditor institutions, encouraging HIPC countries to help one another, and orientated to the transfer of responsibility in the shortest period to regional institutions run by the HIPCs themselves.

— Fully co-ordinated with (preferably confinancing) existing in-country debt strategy capacity-building programmes such as those by MEFMI and DRI, to avoid any duplication.

The measures to strengthen the debtor voice in negotiations are perhaps the most important: it is only by building their own capacity that the HIPCs will ensure that they receive the maximum possible relief under the Initiative, and avoid falling back into debt problems in the next century.

REFERENCES

Bhinda, Nils and Joyner, Karen (1997) Assessing Sustainability and Vulnerability in Determining Needs for Debt Relief: Possible New Approaches for the HIPC Initiative, paper for EURODAD Annual Conference, Vienna, Austria, 25-28 November.

Bolivia, Government of (1996) Bolivia's Enhanced Debt Strategy and Proposal for Multilateral Debt Relief, Consultative Group Document, September.

Brown, The Rt Hon Gordon (MP) (1997) Statement to Commonwealth Finance Ministers Meeting in Mauritius, 16 September 1997.

Debt Relief International

Highly Indebted Poor Countries: Debt Strategy and Analysis Capacity Building Programme

Highly Indebted Poor Countries: Debt Strategy and Analysis Capacity Building Programme: Summary

International Monetary Fund and the World Bank

HIPC Initiative—Guidelines for Implementation

HIPC Initiative—Estimated Costs and Burden Sharing Approaches

Killick, Tony (1995) Solving the Multilateral Debt Problem: Reconciling Relief with Acceptability, Report to Commonwealth Secretariat, September.

Kitibire, Damoni (1997) The HIPC Debt Relief Initiative and Its Implementation in Uganda, paper to Commonwealth Secretariat Debt Sustainability Workshop, 18-20 June, London.

Martin, Matthew

Key Issues on Multilateral Debt: an Update

A Multilateral Debt Facility: Global and National

Multilateral Debt: Key Issues for Ministers

Implementing the HIPC Initiative: Key Issues for HIPC Governments

— Johnson, Alison, and Bhinda, Nils (1996) Reducing Sub-Saharan Africa's Debt to Non-OECD Creditors: Sharing the Burden. UNCTAD Document GID/MISC.42, 13 September.

Mozambique, Government of (1997) Debt Strategy for Mozambique, Note to Consultative Group Meeting, May.

Stewart, Frances, and Fitzgerald, Valpy (1997) The IMF and the Global Economy: Implications for Developing Countries, memorandum in Treasury Committee Fourth Report: IMF, Session 1996-97, House of Commons, 4 November.

Uganda, Government of

Uganda and the HIPC Debt Initiative

A Strategy for Reducing the External Debt of Uganda

Matthew Martin

Director

Juan-Carlos Aguilar

Co-ordinator

Debt Relief International

February 1998

48 This section draws substantially on Bhinda and Joyner 1998, Martin 1996 and 1997, and Martin and Johnson 1997. Back

49 Including these debts in analysis does not mean that relief is required on them. Back

50 In addition, some countries are being denied HIPC relief because of old Paris Club rules (see 3.2.2). Back