House of Commons - International Development

Select Committee on International Development Third Report

DEBT RELIEF

Conditionality Attached to Debt Relief

46. It is broadly accepted that some conditions should be attached to debt relief in order to ensure that both the potential economic and human development benefits are realised. Clare Short told us: "we have got to have the conditionality in order that debt relief is about poverty eradication, not just about debt relief for its own sake"[98]. We strongly agree with this, and recommend that any conditionality require the inclusion of targets in the health and education sectors.

47. In order to receive debt reduction under Paris Club Naples Terms and under the HIPC Initiative, a track record of structural adjustment and reform must be established. For low-income countries, this usually involves the IMF's Enhanced Structural Adjustment Facility. The precise contents of structural adjustment programmes for particular countries are not published. However, there are broad guidelines issued by the IMF Board of Directors:

(a) Encourage members to adopt corrective measures at an early stage;

(b) Stress that the IMF pay due regard to members' domestic, social and political objectives, as well as economic priorities and circumstances;

(d) Emphasise that IMF arrangements are decisions of the IMF that set out - in consultation with members - the conditions for its financial assistance[99].

48. Structural adjustment programmes are designed and agreed on a case-by-case basis. Structural adjustment can involve public and private sector reforms, in addition to fiscal measures such as devaluation. The programmes aim to encourage economic stability, which will in turn improve the likelihood that the debtor country will be able to sustain its remaining debts. There are several criticisms of structural adjustment programmes in terms of their economic achievements, but more importantly there are issues concerning their appropriateness to the economies of heavily indebted poor countries, their success in contributing to the achievement of poverty eradication, and their effectiveness in inducing genuine policy reform.

49. The success of structural adjustment programmes in promoting economic stability is controversial. For example, in his submission to the inquiry of the Treasury Committee on the International Monetary Fund[100], Tony Killick, research fellow at the Overseas Development Institute, suggested that there is no significant impact of structural adjustment on growth[101]. In 1994, the IMF Board of Directors reviewed the experience of structural adjustment programmes in 36 member countries. The report found that "economic growth and investment were frequently slow to respond to the programmes, however it concluded that structural reform remained the best way forward in terms of economic achievements[102]. A recent report published by the World Bank[103] states that "even in the best performing countries the improvements have not been large enough to make substantial progress towards the objective of reduced poverty: only five of the ten good compliers have been able to prevent an increase in the number of poor in the most recent four years"[104]. The achievements of structural adjustment in pure economic terms remain unproven, and we are therefore concerned that these programmes are being imposed on the most vulnerable economies in the world. The lack of publication makes proper scrutiny of these programmes and objective evaluation of their achievements impossible, as has previously been argued by the Treasury Select Committee[105]. The publication of details of structural adjustment programmes is also necessary in order to enable taxpayers to be informed of what UK contributions to the IMF ESAF are being spent on. We urge the Government to insist that the IMF publish its Policy Framework Papers, and the annual programmes related to them, and that the World Bank publish its Country Assistance Strategies, in order that structural adjustment programmes can be properly evaluated.

50. The appropriateness of structural adjustment as a development strategy for HIPC economies remains unproven. For example, the World Development Movement argue that "the imposition of inappropriate and sometimes damaging macro-economic conditions attached to debt relief is, in our view, at least as problematic as the actual drain of resources due to debt repayments ... they are based on an outdated model which damages the poorest without achieving substantial economic growth"[106]. Jubilee 2000 Coalition point out in their memorandum that "very few countries are both at the economic equivalent of death's door, while maintaining the equivalent financial fitness of an athlete"[107].

51. The impact of structural adjustment on poverty eradication has been seriously questioned. A recent World Bank Report[108] states that "even in the best performing countries the improvements have not been large enough to make substantial progress towards the objective of reduced poverty: only five of the ten good compliers have been able to prevent an increase in the number of poor in the most recent four years"[109]. CAFOD cite their own research in their submission to this inquiry, claiming that "the costs of structural adjustment are felt most acutely by the poor. The introduction of user fees and cost recovery measures in health and education have contributed directly to falling rates of enrolment at primary school level, rising infant mortality rates, falling adult life expectancy and falling per capita incomes"[110]. Dr Joseph Hanlon, Research Fellow at the Open University, argues in his submission to this inquiry that structural adjustment programmes "can actually increase poverty in poor countries"[111]. He cites Jobs For Africa, which states that "structural adjustment is purchased at the price of economic contraction, high unemployment, and massive poverty[112], illustrating this argument with the example of Mozambique, which has become poorer since the introduction of structural adjustment in 1990 (The World Development Indicators 1997 show that GNP per capita fell from $90 in 1990 to $80 in 1995). Jubilee 2000 Coalition claim that structural adjustment can involve the imposition of spending caps on health, and education[113]. Since one of the major problems associated with unsustainable debt is a reduction in social investment spending, it seems perverse that the conditions attached to debt relief should contribute to the exacerbation rather than the solution of this problem.

52. Oxfam suggest that instead of being linked to ESAF programmes, debt relief should be integrated into broader development strategies. This would have two advantages. First, the linking of debt relief to internationally agreed development targets, such as the OECD's Development Assistance Committee targets, would provide an impetus for renewed political will. Secondly, it would refocus the objectives of debt relief on human development rather than simply on economics[114]. Dr Joseph Hanlon suggests that debt relief should be linked specifically to the achievement of the six measurable goals agreed by the OECD Development Assistance Committee at its meeting in 1996:

(a) Reducing the proportion of people living in extreme poverty;

(b) Progress towards universal primary education

(d) Reducing maternal and under 5 mortality

(e) Increasing access to reproductive health services

(f) Reducing loss of environmental resources[115].

53. These targets have already been endorsed by the Government[116]. Whilst we agree that the ultimate aim of debt relief must be poverty eradication, and that the achievement of the above targets is central to this goal, there are potential problems with social conditionality, as advocated by Oxfam, Dr Joseph Hanlon, and others. As with economic reform programmes, there is no guarantee that the policies will be adopted once the period of conditionality is complete, as pointed out by CAFOD. CAFOD raise a further issue, that a defining human development goals could lead to a decrease in productive expenditure, such as investment in agriculture, as a result of over-emphasis on human development over economic recovery, which would have a negative economic impact, and adversely affect the poorest people[117]. The Bretton Woods Project and Christian Aid point out that social conditionality is difficult to monitor, and that the relationship between expenditure and achievements in the social sector is "notoriously inexact". Furthermore, compliance is an issue with all types of conditionality, including social conditionality[118].

54. Even if the focus of structural adjustment programmes shifted dramatically towards poverty reduction measures, some witnesses argue that conditionality in itself is inadequate to induce genuine policy reform[119]. The key issue is not the nature of the conditions, but the degree of ownership of and commitment to the programmes by the debtor government [120]. This has recently been confirmed by a World Bank study, which led the Bank to conclude that the key factor in the success or otherwise of structural adjustment programmes in achieving stable economic growth and creating conditions in which poverty could be tackled was the degree of ownership by the debtor government[121]. A report by the Working Group to the SPA Plenary made an identical assertion: "country commitment is the most critical factor distinguishing successful from unsuccessful reform efforts"[122].

55. In principle, it was envisaged that debtor countries would participate fully in the negotiation process leading to the agreement of terms and conditions attached to debt relief. In practice this does not appear to be the case. Christian Aid attribute this failure to the "vulnerability of the process to creditor politics and financial concerns"[123]. Others argue that the main problem is not the will of creditors, but a lack of technical expertise and resources in debtor countries[124]. Oxfam mention the high "transaction costs" involved in negotiations, which contribute to the inability of debtors to participate fully in negotiations. In the Mauritius Mandate, the Chancellor pledged that the UK would do more to support debtor-debtor linking initiatives and provide technical assistance to allow debtor countries to participate fully in debt relief negotiations and the design of reform programmes attached to the relief. We welcome this pledge. We note that HMG is not involved in the programme to facilitate links between debtor governments, co-ordinated by Debt Relief International, and launched by Austria, Denmark, Sweden and Switzerland, and endorsed by IMF, World Bank, UNCTAD, Commonwealth Secretariat and UNDP[125]. We recommend that in its response to this report, the Government tell the Committee what technical assistance it has so far provided to heavily indebted poor countries to enable them to become fully involved in the negotiation process, and that this information be provided on an annual basis as part of British Aid Statistics. We also recommend that the Government tell the Committee what involvement it has had in south-south linking initiatives, and why it is not involved in the programme of assistance co-ordinated by Debt Relief International.

Rwanda

56. Rwanda is one of the three poorest countries in the world, with 45.7 per cent of the population living below US$1 a day[126], and a GNP per capita of only US$180, compared to US$18,700 in the UK[127]. Rwanda owes external debt equivalent to 84 per cent of its GDP: about US$1billion, including US$99 million arrears. 84 per cent of this debt is owed to multilateral creditors, comprising 55 per cent owed to the World Bank, 25 per cent to the African Development Bank, and 4 per cent to other multilateral creditors. The remaining 16 per cent of Rwanda's external debt is owed to bilateral creditors, 8 per cent being owed to France. Rwanda's net present value of debt to exports ratio is 550 per cent, and it is expected that by 2000 this will have escalated to 732 per cent, with a debt service to exports ratio of 54 per cent[128]. This is clearly a situation which requires urgent and deep relief. We are concerned that debt relief for Rwanda must be provided as rapidly as possible, in order to make a real contribution to Rwanda's economic recovery. This is vital if the projected NPV/exports ratio of 732 per cent is not to become a reality. We urge the Government to insist that multilateral debt relief for Rwanda be implemented as rapidly as possible. We further recommend that the Government urge all bilateral creditors, in particular France, to cancel debt incurred by the previous regime.

57. The IMF and World Bank have been working on programmes in Rwanda since 1994, and have been involved in agricultural, social, and public and private sector reform measures. IMF officials in Rwanda told us that there was a possibility that these measures would be taken into account in discussions concerning the time frame of relief for Rwanda. We urge the Government to insist that the reforms already undertaken by Rwanda since 1994 be taken into account in decisions concerning the time frame of debt relief.

58. The Chancellor told us in evidence that the agreement of a structural reform programme was imminent in Rwanda. If Rwanda adheres to this programme for an initial period of three years, it will be eligible for relief under the HIPC Initiative. During this time, the World Bank estimate that Rwanda will owe US$60 million in debt service payments. The World Bank in Rwanda told us that there will be a meeting in June of creditors to arrange funding for the payment of these obligations, in order to help Rwanda get through the process. We urge the Government to take part in discussions concerning Rwanda's debt relief package, and in the light of its exceptional circumstances, to contribute to the US$60 million needed to service Rwanda's debts during the first stage of the HIPC process.

59. The issue of moral hazard in the case of Rwanda has been raised. IMF officials in Rwanda explained that conflict should not be "rewarded". We accept that there is a basis for this argument in some cases, however Rwanda is now governed by a completely different regime from that which was responsible for the genocide. Secondly, Jubilee 2000 Coalition pointed out to us in evidence that "pre-conflict, Rwanda had really quite a good economic record ... she was liberalising her economy, and the World Bank and the Fund were pleased with her track record; post-conflict, she is being penalised for her own civil conflict, and we think that is very unfair"[129]. Furthermore, greater than the moral hazard is the human hazard that if the government of Rwanda cannot afford to fund its judicial system, if it cannot fund its National Reconciliation Programme, and if it is unable to achieve economic stability, in part due to its massive external debt burden, there is a real danger of further conflict. The international community failed to act when the genocide took place in Rwanda in 1994. It now has a responsibility to act to do everything possible to prevent such events recurring. Obviously debt relief is not the only condition necessary for recovery from genocide, but it is clear that debt relief can make a significant contribution.

The Cost of Debt Relief

60. The World Bank estimate that the total cost of the HIPC Initiative will be in the region of US$5.5 billion to US$8.4 billion in 1996 net present value terms[130]. These figures are tentative, because the amount of relief is not determined until the completion point is confirmed. The World Bank will finance its contribution by setting up a Trust Fund, which will be furnished with World Bank International Bank for Reconstruction and Development (IBRD) surplus, and donations from other creditors. The IMF has also set up a trust fund, but its contribution is controversial. The Fund will finance its Trust Fund through ESAF loans and grants to be paid into an escrow account and used only to cover debt service payments to the IMF. The use of ESAF resources to finance the HIPC Initiative will mean that rather than new resources being made available to development, resources which would have been used for structural adjustment loans will instead be used for debt relief. This is a contentious point. Some argue that the IMF should sell a portion of its gold reserves in order to acuire income earning assets which in turn could finance its contribution to the HIPC Initiative, including the Government. The Chancellor made clear in the Mauritius Mandate that the Government will support the sale of IMF gold in order to finance the contribution of the IMF to the Initiative[131].

61. It is imperative that debt relief involves an increases in the total resources available to developing countries. If the IMF and Word Bank do not finance their own contributions, then additional funding will be required from bilateral donations, which could divert aid money from other necessary development projects. The Government has made a number of important bilateral donations in support of the contribution of other creditors to HIPC debt relief packages. The Government made a contribution to the African Development Bank of US$10.5 million, to finance their contribution to Uganda's debt package. The UK also contributes £20 million per year to the IMF to fund its contribution, and an additional £34 million was contributed in 1997-98 to the ESAF Fund. The UK owns a 5 per cent share in the International Development Association (the equivalent to £100 million is attributable to the UK), and in 1997-98 made additional contributions of £180 million to IDA, to help fund debt relief[132]. Ann Pettifor, Director of the Jubilee 2000 Coalition said that they "very much welcome the British Government's role in helping to replenish the African Development Bank Fund"[133]. Others, however, point out that this is money which would otherwise have been used for other programmes within the UK aid budget. For example, Shriti Vadera, Executive Director, SBC Warburg Dillon Read, told the Committee that "if there is a real commitment to increasing the level of relief, finding the financing should not be a serious issue, and that can be done without eroding the bilateral aid that is essential for other expenditure"[134]. She argued that International Financial Institutions should finance their own contributions to the HIPC Initiative, and that bilateral aid should be reserved for developmental projects. Clare Short told us that "the great bulk of the funding is coming from creditors themselves, from the World Bank, the IMF, the Paris Club, and relief under the HIPC is therefore truly additional to the countries concerned and is not merely a reallocation of existing aid funds" [135]. Creditors must fund all of their own contributions, not merely most of them. If bilateral creditors continue to use their aid budget to finance the contributions of multilateral creditors, there will be no incentive for those multilateral creditors to find ways of financing their own contributions. As we argued earlier, we believe that unilateral action is valid only in circumstances where further relief from other creditors is unlocked. As a general policy, the Government must continue to press for the sale of IMF gold to finance the contribution of the IMF to the HIPC Initiative. International financial institutions must finance their own contributions to the HIPC Initiative, providing additional resources, in order to ensure that debt relief does not merely represent the same amount of aid delivered in a different manner.

62. The cost to the UK of the Initiative, in reductions of bilateral debt arising from Paris Club contributions to the Initiative, will be a maximum of £600 million, if the twenty countries currently thought to be eligible for HIPC relief all receive an 80 per cent reduction in bilateral debt. Clare Short pointed out to us that "a lot of this debt is unpayable so payments are not being received, and ... there is a premium charged on all credits to cover bad debt. It may be that the cost to the Exchequer is really quite limited."[136]. Nevertheless, Clare Short also acknowledged that debt relief is not a cost-free exercise[137]. We look forward to the Government establishing a timetable within which it will achieve the UN 0.7 per cent of GNP spending target to which it is committed[138], thus providing adequate resources to finance the UK's contribution to the HIPC Initiative.

63. The case of Mozambique, though now resolved, has highlighted problems in the sharing of the burden of debt relief between multilateral and bilateral creditors. The contributions of the World Bank and IMF are based on calculations of debt sustainability, and the amount of their claim is reduced accordingly. On the other hand, the Paris Club has imposed an 80 per cent limit on the reduction of debt treated under the HIPC Initiative, representing the domination of the amount creditors are prepared to give over the needs of the debtor country. In the case of Mozambique, this was not sufficient to achieve even the already optimistic sustainability level. An agreement was eventually reached for Mozambique, after some delay, which involved additional contributions which increased the contribution of the Paris Club to an equivalent of 85 per cent, and further donations from some creditors to finance the gap of US$115 million which remained after the multilateral institutions and Paris Club members had provided relief. We congratulate the Government for taking the lead in this case by donating an additional US$10 million. Although ultimately a solution was reached for Mozambique, there was an unacceptable period of delay in providing HIPC relief. For as long as the Paris Club imposes an arbitrary limit on its contribution to HIPC Initiative debt relief, while the IMF and World Bank base their contributions on the needs of the debtor (albeit based on optimistic assumptions about debt sustainability), these problems will persist. Debt Relief International identify five countries in addition to Mozambique which will require Paris Club relief beyond 80 per cent if their exit ratios are to be achieved (Guinea-Bissau, Madagascar, Nicaragua, Rwanda, and Sao Tome). It is vital that rules governing contributions to relief, encompassing all creditors, are agreed before these countries have to suffer unnecessary delays. The Paris Club must change its rules in line with the emphasis on sustainability, rather than the willingness of creditors to contribute in the HIPC Initiative. In our view, international creditors should pay more attention to ensuring that the indebted countries receive the appropriate level of finance instead of wasting valuable time in squabbling over individual contributions. In the context of the wealth of industrialised countries and the overall benefits that can be provided to developing countries, the sums involved are comparatively slight. The United Kingdom has taken a lead in some cases in arguing for flexibility, going beyond the 80 per cent reduction in bilateral debt stock. We welcome this. We recommend, however, that the Government should argue explicitly for a revision of Paris Club rules to allow bilateral debt to be reduced to a level sustainable for debtor countries, on a case by case basis, rather than to a fixed percentage of debt stock. Clear rules encompassing all creditors are likely to be essential to the success of the Initiative in the future.

Conclusion

64. The development of debt relief initiatives since the onset of the debt crisis in the 1980s has been reactive, and has proceeded at the pace of the most reluctant creditor. Robin Fellgett, HM Treasury, told us that "Even if the case for some change is clear, to go back to the drawing board and renegotiate will result in the process stopping for a period" [139]. We believe that if the HIPC Initiative is to be successful in achieving the targets of the Mauritius Mandate and beyond, there are some key changes which must be made:

(a) The sustainability ratios must be lowered

(b) The time frame for the implementation of the initiative must be reduced

(d) Conditions attached to debt relief must be published, and must show emphasis on social measures in addition to economic measures.

65. Debt relief should be financed by the relevant creditors, in recognition of their responsibility in the creation of the crisis. As a general policy, bilateral aid should not be used to finance the contributions of multilateral or other bilateral creditors, but should instead be used to fund projects which support human development measures in support of economic reform.

66. The achievement of these changes is a question of political will. The challenge facing the Government, and the international community as a whole, is to ensure that sufficient political will is generated to implement these changes. We agree with Oxfam and others that the best way to achieve this is to discuss debt relief in terms of its role in the achievement of international development targets, since several creditors are already committed to these as OECD members. In two days time, debt relief will be discussed at the meeting of the G7 in Birmingham. This opportunity must be grasped. It is vital that the issues we have raised in this report are discussed and resolved if the HIPC Initiative is to be successful in resolving the debt problems facing the poorest countries in the world once and for all.

98 Q.260. Back

99 IMF Survey on the Fund, September 1997. Back

100 Fourth Report from the Treasury Committee, The International Monetary Fund, Session 1996-97, HC 68. Back

101 Ibid. p.15. Back

102 IMF Supplement on the Fund, September 1997. Back

103 "Adjustment Lending in Sub-Saharan Africa: An Update" Report No. 16594, May 1997. Back

104 Ibid. Paragraph 6. Back

105 Fourth Report from the Treasury Committee, The International Monetary Fund, Session 1996-97, HC 68. Back

106 Evidence p.99. Back

107 Evidence p.27. Back

108 World Bank Report no. 16594, "Adjustment Lending in Sub-Saharan Africa: An Update" May 1997. Back

109 Ibid. paragraph 6. Back