International Development CommitteeWritten evidence submitted by the Jubilee Debt Campaign

(1) Introduction

1. This submission focuses on the question of the inquiry as to “Whether DFID should offer concessional loans, and the balance between these and traditional grant aid.” A substantial amount of UK development aid is already given as loans through contributions to multilateral institutions. Jubilee Debt Campaign calculated that in 2010, $1.26 billion of UK aid money was given to multilateral institutions to then be used as loans. This was the second highest amount of any OECD country, after Japan ($2.23 billion).1

2. This submission argues that the UK should not increase aid lending further by giving bilateral loans again, because:

There is already a boom in lending to developing countries

3. Foreign lending to sub-Saharan African governments has more than doubled between 2006 and 2011, and is due to increase even more in 2013. This increase in lending is also seen in very high current account deficits across the continent. Of the 29 countries with DfID bilateral aid programmes, half are already in default on their debts, or the IMF and World Bank judge that there is a high or moderate risk they could be. The other half include countries with rapidly increasing debt burdens, including Ethiopia, Mozambique and Tanzania.

4. A representative of Agence Française de Développement told a meeting of European NGOs in June 2013 that there is currently a glut of cheap loans that the agency is hard pressed to find projects to fund as they are effectively competing with the Germans and the European Investment Bank to find viable projects.

There is no mechanism for resolving a debt crisis when it arises

5. Despite a succession of debt crises on all continents over the last thirty years, there is still no international mechanism for resolving sovereign debt crises. It would be reckless for the UK government to increase lending when there is no effective way to deal with debt problems when they arise. The UK government has consistently opposed the creation of any such mechanism. The UK government should ensure fair, independent and transparent means of resolving debt crises exist before even contemplating increasing debt burdens through more loans.

The IMF and World Bank Debt Sustainability Framework does not prevent debt crises from arising

6. The weakness of the IMF and World Bank Framework include that it pays no attention to the impact of debt burdens on poverty and inequality, it is biased because the Fund and Bank are major lenders and creditors, it fails to take sufficient account of the impact of economic shocks, it pays too little attention to debts owed by the private sector, and it does not assess what lending is used for.

The UK government ignores the Debt Sustainability Framework anyway

7. The current and past UK governments have ignored the Debt Sustainability Framework in their lending decisions. This includes climate loans to Grenada, despite the island being at high risk of debt distress, and non-concessional loans to the Gambia, despite the West African country being at moderate risk of debt distress.

“We will continue, as far as possible, to give aid as grants not loans, and will encourage other donors such as the World Bank to give aid for social objectives, whenever possible, as grants.”

A Conservative Agenda for International Development, 2009

“And to avoid another debt crisis hard on the heels of the first, poor countries need to be given more grants, rather than seeing their debt burden piled even higher with yet more loans.”

Make Poverty History Manifesto, 2005

(2) The Theoretical Rational for Loans and what could go Wrong

8. Debt is supposedly good when resources are borrowed now to be invested in something useful which increases how much can be produced. Theoretically this useful investment produces revenue, a part of which can be used to repay the debt, with more left over.

9. However, this theory does not work in practise if:

The loan resources are not invested in productive enough activities.

The country borrowing the money is hit by economic shocks.

The scale of overall lending and borrowing is too great, or some loans are unproductive, creating too large a debt burden across the whole economy.

Increased revenues do not get passed on to the government through the collection of taxes.

10. Research by Léonce Ndikumana and James K. Boyce from the University of Massachusetts finds that, between 1970 and 2008, for every $1 in foreign loans to sub-Saharan Africa, 60 cents left straight away in illicit capital flight.2 The money was not invested in the country it had been lent to, but the obligation to repay the loan remained.

11. Even if lending is invested in genuinely useful activities, problems can still be created if the project goes wrong, or the country is hit by a sudden change in circumstances. In the early 1980s many governments suddenly had large debts because interest rates increased at the same time as prices for their country’s commodities collapsed. A recent IMF and World Bank report states that in one-quarter of cases of what it defines as “negative economic shocks” in low income countries, foreign owed debt has increased by 20 percentage points of GDP or more.3

12. The large level of loans in the 1970s and 1980s, including aid loans, created a debt crisis which affected most of Latin America and Africa through the 1980s, 1990s and into the 2000s, and continues to affect countries such as Jamaica, El Salvador and Pakistan to this day. Between 1980 and 1990 the number of people living in poverty in Latin America increased from 144 million to 211 million.4 In Africa, the number of people living in extreme poverty (on less than $1.25 a day) increased from 205 million in 1981 to 330 million by 1993.5 But, the debt was not reduced. Across Latin America and Africa, government foreign owed debt increased from 17% of GDP in 1980 to 33% in 1990.6, 1

13. Foreign loans are different from domestic lending and investment because ultimately they can only be used to pay for imports, and the revenue for their repayment has to come from exports. So there are further reasons why external loans can lead to high debt burdens which increase poverty. For foreign loans to be sustainable:

Loan resources have to be spent on productive imports which do not crowd out local investment.

The increased production from the loan has to increase exports and/or reduce the need for imports.

14. One problem seen across the world is the “Dutch disease”; first noted for the Netherlands’ experience in the 1960s and 1970s. In the late 1950s a large Dutch gas field was discovered. The increased export revenues were spent on imports, pushing up the exchange rate, making manufacturing less competitive, and causing it to decline.

15. The Dutch Disease does not just arise from extractive industries, though this is a very important issue in developing countries. It can also come from official foreign aid and loans, and more generally capital movements. Foreign money, whether loans, equity or grants, can only ultimately be used to buy imports. There is potentially a tension therefore between large amounts of foreign finance undermining the domestic economy. Large inflows, whether loans, equity or grants, can push up the exchange rate, cause more imports to be bought, crowding out domestic production. Just as with natural resources, large foreign capital inflows can undermine a domestic economy. A crisis can be brought on if the money stops being granted or loaned, and/or the finance is rapidly taken out of the country.

16. Whilst grants can contribute to this problem as well, loans are more dangerous because they involve more money—more imports—and so a greater danger of crowding out. And there is a reverse in the resource flow when the loan comes to be repaid, which can help precipitate a balance of payments crisis, especially if local production has been undermined.

(3) There is already a Boom in Lending to Developing Countries

17. Lending to developing countries has been booming in recent years, through a combination of large capital flows out of rich countries during the global financial crisis, increased “aid” loans from multilateral institutions such as the World Bank and lending from governments as “aid” or export credits, including traditional actors such as Japan, Germany and France, and new lenders such as China.

18. A representative of Agence Française de Développement told a meeting of European NGOs in June 2013 that there is currently a glut of cheap loans that the agency is hard pressed to find projects to fund as they are effectively competing with the Germans and the European Investment Bank to find viable projects.

19. According to the World Bank, total lending to sub-Saharan Africa governments (excluding South Africa) has increased from $8 billion in 2006 to $20 billion in 2011 (see Graph below).7 Of this lending:

41% is from multilateral institutions, including 25% from the IMF and World Bank.

32% is from foreign governments.

27% is from private lenders.

20. Furthermore, this boom is set to continue increasing. Just eight sub-Saharan African countries are planning to borrow over $7 billion from foreign private lenders through issuing bonds this year. Governments which plan to borrow through international sovereign bonds in 2013 include Nigeria ($1.5 billion), Kenya ($1 billion), Tanzania ($500 million), Angola ($2 billion), Uganda ($500 million), Mozambique ($500 million), Ghana ($1 billion) and Rwanda ($400 million).8 In 2011, total private foreign lending to sub-Saharan Africa (excluding South Africa) was $5.5 billion.

21. Another way of measuring the scale of lending and capital inflows is through the current account deficit. This measures all financial transactions by a country which do not create future obligations. If there is a deficit, this can only be met through loans or equity capital inflows. According to the IMF, over the last five years, of 45 sub-Saharan Africa countries:

13 have had an average deficit of more than 10% of GDP.

15 have had an average deficit of more than 5% of GDP.

Nine have had an average deficit between 0 and 5% of GDP.

Eight have had an average surplus.

22. Moreover, these deficits are set to stay high, and possibly increase further. IMF predictions for the next five years are that:

16 will have an average deficit of more than 10% of GDP.

12 will have an average deficit of more than 5% of GDP.

11 will have an average deficit between 0 and 5% of GDP.

Six will have a surplus.9

23. In comparison, in the five years leading up to 2008, the UK had a current account deficit averaging 2% of GDP. Greece’s was 9%.10

Debt situations in DfID priority countries

24. Of the 29 countries in which DfID has a bilateral aid programme:

Five are in default on their debt payments already, so DfID would presumably not want to lend more money.11

Four are judged by the IMF and World Bank to be at high risk of not being able to pay their debts.12 It would be extremely reckless for any money to be lent to these countries from DfID’s bilateral programme.

Six are judged by the IMF and World Bank to be at moderate risk of not being able to pay their debts.13 It would be reckless for more money to be lent to these countries, increasing their debts further.

Ten are judged by the IMF and World Bank to be at low risk of not being able to pay their debts.14 This does not mean these countries have low debts, just that the IMF and World Bank judge that at the moment they will keep being paid. For example, the ten countries include:

Bangladesh

25. In 2013 the Bangladesh government’s foreign debt payments will be a huge 18% of government revenue,15 $2.4 billion, the same as the government’s spending on health and 60% more than spending on education. The debt is only payable because the IMF is lending Bangladesh bailout money to be used to repay lenders, with the debt coming to be owed to the IMF.

Ethiopia

26. Ethiopia qualified for some debt cancellation in 2004. Its debt payments fell from averaging 10% of government revenue a year from 1998–2000 to 4% a year from 2007–09. Combined spending on public health and education increased from 22% of government revenue in 2000–01 to 32% by 2006–07.16

27. Since the global financial crisis began the government’s foreign owed debt has shot-up from $3 billion to $8 billion, and is predicted to reach $18 billion by 2017.17 In 2012 the IMF predicted that by 2017 the country would be back to spending 10% of government revenue a year on debt payments. This assumes Ethiopia’s economy grows by 6.5% a year, and exports by 10–30% a year.18

Mozambique

28. Mozambique qualified for debt cancellation in 2001 and 2005. The government’s foreign debt fell from 110% of national income at the turn of the millennium, to 60% in 2001, then 30% in 2005. Payments fell from 12% of government revenue in 1998 to a low of 2% in 2007. Public expenditure on health and education increased from 30% of government revenue in 1998–99 to 36% by 2005–06.19

29. The government’s foreign owed debt has now increased to 40% of national income, despite strong economic growth; $6.4 billion. The IMF and World Bank predict based on current lending and borrowing the debt will increase to $12 billion by 2017, by when debt payments will be 9% of government revenue a year. This assumes economic growth of 8% a year and exports of 10% a year.

Tanzania

30. Tanzania qualified for some debt cancellation in 2001 and again in 2005. Government foreign debt payments fell from 9% of government revenue in 2000 to 1% between 2007 and 2011. Government foreign debt fell to 17% of national income by 2007. Despite fast economic growth, it has increased again to 39% of GDP in 2013.

31. Based on current lending, the total foreign owed debt is project to increase from $2.5 billion in 2006 to $12.6 billion in 2013 and $18.4 billion by 2017. Debt payments are predicted to reach 9% of government revenue by 2017, assuming economic growth of 7% a year and export growth of 10% a year.

Other countries

32. The IMF and World Bank only issue debt sustainability assessments for countries eligible to borrow from the IMF’s Poverty Reduction and Growth Trust. Therefore, no such assessments exist for the remaining four DfID priority countries: India, Occupied Palestinian Territories, Pakistan and South Africa. Of these, Pakistan is currently in a debt crisis, with government foreign debt payments projected to be over 20% of government revenue this year and next year.20

Conclusion

33. Many of the countries at high and medium risk of debt distress are judged in that way not because their debts are especially large, but because their economic weakness means that they are very vulnerable to just one economic shock, which could make it difficult to repay debts. It is too reckless for such countries to be lent more money; they need grants to assist in economic transformations to make themselves less vulnerable to, for example, changes in international commodity prices.

34. Those countries judged at low risk of debt distress, such as Ethiopia, Mozambique and Tanzania, are assessed in this way because their economies are booming. However, their debts are also increasing, even more rapidly than the size of their economies. This helps shows how foreign lending is still very pro-cyclical, accentuating booms, and possible busts. The UK government should not be adding to this pro-cyclical wave of money.

(4) There is no Mechanism for Resolving a Debt Crisis when it Arises

35. Despite a succession of debt crises across the world for the last 30 years, there is no international mechanism for resolving sovereign debt crises. In the absence of such a mechanism, it would be reckless of the UK to contribute to higher debt burdens.

36. This was recently acknowledged in a paper on sovereign debt restructuring by the IMF. The paper argues that from the recent history of debt crises, such as in Argentina, the Caribbean and Greece, “debt restructurings have been too little and too late”. Unsustainable debts get paid for too long, facilitated by IMF loans which bailout the private creditors. When negotiations between the debtor and creditor on reducing the debt finally take place, the amount of debt reduced is too small, continuing the debt crisis. The paper says that this means IMF money is sometimes used “to simply bail out private creditors”.21

37. Through campaigns such as Jubilee 2000 and Make Poverty History, civil society has advocated for the creation of a fair and independent arbitration system for resolving sovereign debt crises. Government’s in debt crisis could join an independent arbitration process. Crucially, the assessments of debt sustainablility would be undertaken independent of creditors and debtors, removing the bias in current bodies which have power to restructure some, but a limited number of debts, such as the Paris Club. And assessments and debt reductions should cover all lenders, not take place in separate negotiations with different groups.

38. However, the UK government has consistently opposed the creation of any such mechanism. The UK government should ensure fair, independent and transparent means of resolving debt crises exist before even contemplating increasing debt burdens through more loans.

(5) The IMF and World Bank Debt Sustainability Framework does not Prevent Debt Crises from Arising

39. One mechanism which has been proposed to be used to guide lending decisions is the IMF and World Bank Debt Sustainability Framework. However, this has a number of flaws which mean it can miss the build-up of various debt problems, thereby encouraging reckless lending:

Debt Sustainability Assessments (DSAs) only consider whether or not a debt will become unpayable. The assessments do not take into account the impact of lending and debt levels on poverty and inequality. Furthermore, as other IMF research notes, debts tend to keep being paid for too long (see above).

DSA’s are conducted by the IMF and World Bank, who are themselves major lenders and creditors. This makes the assessments inherently biased. The IMF and World Bank are responsible for 45% of loans to low income countries over the last five years.22

DSAs use “stress tests” to see what would happen to debt burdens if an economy was hit by one economic shock (over a period of 20–30 years). The IMF and World Bank’s own review23 found that in 12% of cases there have been shocks greater than the most extreme stress test.

The IMF and World Bank have acknowledged that the DSA’s do not take enough account of foreign debts owed by the private sector;24 the kind of debts which have resulted in financial crisis in countries such as Iceland, Ireland, Spain and the UK in recent years, and did so in East Asia in the 1990s.

DSA’s makes little or no analysis of the source of lending and what the lending is being used for.

(6) The UK Government Ignores the Debt Sustainability Framework Anyway

40. Since the Debt Sustainability Framework was introduced in the mid-2000s, the UK government has already ignored assessments and lent to already heavily indebted countries.

41. In 2008, the UK government was instrumental in creating the Climate Investment Funds of the World Bank, including the Pilot Programme for Climate Resilience (PPCR). The UK government decided to make a capital contribution of £202 million to the PPCR, so that the expenditure would have less impact on the UK’s net public borrowing figures.25 This decision was taken by the Labour government between 2007 and 2009, and implemented by the Conservative and Liberal Democrat government in 2010 and 2011. Because the contribution was given as a capital grant, it had to be disbursed by the World Bank as loans. Other countries’ contributions to the PPCR were given as grants and so used by the World Bank as grants.

42. Recipients of PPCR loans include a $12 million loan to Grenada, which is assessed by the IMF and World Bank as at high risk of debt distress when its loan was agreed, and in March 2013 went into partial default. The UK government has refused to acknowledged that these loans for Grenada clearly breached the debt sustainability framework.

43. Another Caribbean island with an extremely high debt burden is Jamaica, where government foreign debt payments are over 30% of revenue, and the recently signed IMF programme acknowledges that the debt is unsustainable and the country is in need of debt relief.26 However, as well as not supporting debt relief for Jamaica, the UK government through the PPCR is lending Jamaica money for climate change adaptation. There is no Debt Sustainability Analysis for Jamaica, because it is a middle income country.

44. The UK government also creates debts through UK Export Finance guaranteeing loans for foreign governments and companies to buy partly British made exports. The 2013 annual report reveals that UK Export Finance has guaranteed a non-concessional loan to the Gambian government of £280,000, without any referral to DfID or reference to Gambia’s Debt Sustainability Assessment.27 Since May 2013 The Gambia has been judged by the IMF and World Bank to be at moderate risk of debt distress (before that it was high risk) and that non-concessional loans should only be agreed in exceptional circumstances.28

References

1 Jones, T (2012). The state of debt: Putting an end to 30 years of crisis. Jubilee Debt Campaign. May 2012

2 Ndikumana, L and Boyce, J K (2011). Africa’s odious debts: How foreign loans and capital flight bled a continent. Zed Books. London and New York.

3 IMF and World Bank (2011). Managing volatility in low-income countries: The role and potential for contingent financial instruments. 31/10/11.

4 The percentage increase was from 40.5% of the population to 48.3%. Bertola, L and Ocampo, J A (2012). Learning from Latin America: Debt crises, debt rescues and when and why they work. Institute for the study of the Americas. 20/02/12.

5 The percentage increase was from 51.5% of the population to 59.4%. World Bank. Global Development Finance database.

6 Calculated from World Bank. Global Development Finance database.

7 Calculated from World Bank. Global Development Finance database.

8 http://www.iol.co.za/business/business-news/africa-cashes-in-on-foreign-bond-demand-at-lower-rates-1.1511960#.UcBXbefTOSp

9 Calculated from IMF. World Economic Outlook Database.

10 Calculated from IMF. World Economic Outlook Database.

11 Burma, Somalia, Sudan, South Sudan and Zimbabwe

12 Afghanistan, Democratic Republic of Congo, Tajikistan, Yemen

13 Ghana, Kyrgyzstan. Malawi, Nepal, Rwanda, Sierra Leone

14 Bangladesh, Ethiopia, Kenya, Liberia, Mozambique, Nigeria, Tanzania, Uganda, Vietnam, Zambia

15 http://www.imf.org/external/pubs/ft/dsa/pdf/2013/dsacr13157.pdf

16 Calculated from World Bank. Global Development Finance database.

17 http://www.imf.org/external/pubs/ft/dsa/pdf/2012/dsacr12287.pdf

18 IMF (2010). Joint IMF/World Bank Debt Sustainability Analysis 2010. IMF and IDA. Washington DC. 26/05/10. http://www.imf.org/external/pubs/ft/dsa/pdf/dsacr10175.pdf

19 Calculated from World Bank. Global development finance database.

20 For more information see Islamic Relief Worldwide and Jubilee Debt Campaign (2013). Unlocking the chains of debt: A call for debt relief for Pakistan. May 2013.

21 IMF (2013). Sovereign debt restructuring—recent developments and implications for the fund’s legal and policy framework. IMF. May 2013.

22 Calculated from World Bank. Global development finance database. See Jones, T (2012). The state of debt: Putting an end to 30 years of crisis. Jubilee Debt Campaign. May 2012

23 IMF and World Bank (2012). Revisiting the Debt Sustainability Framework for Low-Income countries. IMF and World Bank. 12/01/12.

24 IMF and World Bank (2012). Revisiting the Debt Sustainability Framework for Low-Income countries. IMF and World Bank. 12/01/12.

25 Email from HM Treasury to Jubilee Debt Campaign. 16/06/11.

26 IMF (2013). Jamaica: Request for an extended arrangement under the Extended Fund Facility. IMF Country Report No. 13/126. May 2013.

27 UK Export Finance (2013). Export Credits Guarantee Department Annual Report and Accounts 2012–13.

28 http://www.imf.org/external/pubs/ft/dsa/pdf/2013/dsacr13139.pdf

June 2013

1 For further information see Jones, T (2012). The state of debt: Putting an end to 30 years of crisis. Jubilee Debt Campaign. May 2012.

Prepared 11th February 2014