PHA-Exchange> Commentary on the G8 Agreement on Debt Relief Beyond HIPC: Consequences for MDG-based Debt Sustainability

[claudio at hcmc.netnam.vn]

 from "Villar Montesinos, Eugenio Raul" <villare at who.int> -----

From: Jürgen Kaiser [mailto:jurgen.kaiser at undp.org]
 

Since the 2004 IMF and World Bank Annual Meetings, the British and the US
governments have promoted competing proposals for what both called "100%
debt relief for the poorest countries". The major difference between them
was that the UK wanted to refinance the current debt service of eligible
countries until 2015, while the US favoured a debt stock write-off. The UK
proposal thus implied providing fresh money, while the Bush administration
wanted to finance relief through reducing future disbursements from the same
institutions that would provide relief - the IMF, World Bank and ADB.

 

This bilateral exchange leading up to the Gleneagles summit was
intermediately disrupted by a competing joint French/German/Japanese
proposal to base enhanced relief on countries' individual needs - as
expressed in their debt sustainability analyses. Although this alternative
represented a potentially superior concept, it was poorly elaborated and
based on flawed World Bank definitions of debt sustainability. In fact, if
it had been carried out - it would have hardly resulted in any relief. As
this proposal is now off the table - it will not be further considered here.



The G8 compromise


The G8
<http://www.g8.gov.uk/servlet/Front?pagename=OpenMarket/Xcelerate/ShowPage&c
=Page&cid=1078995903270&aid=1115146455234>  compromise proposes the
cancellation of all debt owed by post-completion point HIPC countries to the
World Bank (notably IDA), the IMF and the African Development Bank (notably
its soft-loan window AfDF). The agreement will benefit 18 countries, 14
African and 4 Latin America. Preliminary figures suggest a reduction of 7.7
- 16.7 billion US-$ in present value terms over the whole repayment period.
Calculations by EURODAD suggest an annual debt service reduction of
1.047billion US-$ for all countries on average.

This looks like a substantial relief at first sight. However, it is not! The
IDA and the AfDF modalities are largely in line with the US-proposal. For
every dollar of current debt service relief, IDA and AfDF will reduce
disbursements to these countries by one dollar. Countries will therefore be
paying for their own relief. While new funding will be made available to
ensure that the Development Banks' lending volumes are maintained - the
resources will be "allocated to all IDA- and AfDF recipients based on
existing IDA- and AfDF performance-based allocation criteria." This means
that each of the 18 beneficiary countries will get, on average, about 8
million in fresh money per annum (note that his calculation is indicative
only, as there will be huge variations between countries, depending on size
and performance).

The situation looks brighter regarding the IMF. It is a minor, but not
insignificant, victory for the British to have forced the IMF into the
scheme against the will of the US. Unlike with the other two institutions,
it has been noted that there will be no dollar-to-dollar reduction in
disbursements. The IMF is to finance the relief from its own resources at
first. However, the statement notes that once countries with huge IMF
arrears are approved for tax relief (such as Sudan), bilaterals will provide
additional funds.

Therefore, the only clear winners are the three International Financial
Institutions (IFIs) which can move substantial bad loans off their books and
compensate for lost revenue by reducing disbursements. Their medium term
viability will meanwhile be guaranteed by fresh commitments from the richest
countries on Earth. Debtor countries may benefit from additional
disbursements, yet even G8 governments have voiced doubts about the
long-term commitment, particularly of the US-government (the most important
contributor in absolute terms), to providing additional resources to the
IFIs.

An additional improvement is also worth mentioning, namely the G8's
commitment to provide 300-500million US-$ in additional funds, to cover
"difficult-to-forecast-costs." What kind of expenses this may actually mean
is subject to guessing, as, unlike the HIPC, no hard-to-forecast medium-term
income or variable sustainability thresholds are involved. Eventually these
funds may be used to help facilitate the inclusion of interim period HIPCs
or bringing other multilateral creditors on board.  In any case, it seems
that the G8 has learned a lesson from the sometimes huge discrepancies
between the calculated cost for HIPC relief at their decision points and the
ultimate costs. Occasionally adjustments via the 'topping-up' of relief at
the completion point were due to wrong projections or outright errors by the
IFIs. 

 


Additional flaws


Even if the scheme had provided additional resources, rather than stealing
with one hand what the other hand has given, it would have implied
substantial conceptual flaws:

*         The most important flaw stems from the nature of fixed quotas.
Fixed quotas lead to systems where countries receive all or nothing. This is
too blunt an instrument for countries which actually require varying levels
of relief. The quota principle necessarily denies - for example - a large
group of countries the partial relief they would direly need.  It will now
be harder for these countries, as with all excluded countries, to secure
relief as creditors point to the extraordinary efforts they have already
undertaken. Surprisingly, Nigeria seems to be an exception as the Paris Club
vowed to grant them appropriate relief in their Ministers' communiqué.
Ironically a few of the HIPC success stories like Mozambique or Ghana which
will benefit from "100% cancellation" might have eventually not needed full
relief. These countries already received relief way beyond the old scheme's
thresholds. 

*         100% is actually not 100% - The proposal refers to only three
multilateral creditors, which are indeed the most important ones for African
HIPCs. However they are less important for the four Latin American HIPCs.
Latin American relief will therefore fall behind African relief for no
reason other than the British and G8 special effort for Africa. Not even
African HIPCs will be relieved of all their foreign debt as there are 19
multilateral creditors (including some who resisted cooperating in the
existing HIPC framework). As these creditors are not named by the G8, and
given the debtors' newly improved solvency, creditors are unlikely to follow
the example of debt relief. Additionally, the burden of some countries' high
domestic debt may even exceed that of external debt. 

 


Who can expect what? Some country examples


It is not yet possible to assess the effects of additional relief on a
present value (PV) basis. However, a preliminary view on the first full year
of implementation- 2006 - reveals a stark difference between the claim of
100% cancellation and the real reduction. Below is a closer look at four
randomly selected countries which are at least partly representative - as
three Africans and one Latin Americans stand for 14:4 on the eighteen
countries' list.

 


Country

Debt Service after full HIPC relief in 2006 (m US-$)

Debt Service to WB/IMF/AfDB

(million US-$)

Remaining debt service after promised reduction 

(million US-$)

% Relief

New debt service ratio

Internal debt service (US-$ equivalent)


Niger

30.9

17.4

13.5

56%

1.9%

n.a.


Zambia

86.3

32.4

53.9

38%

3.0%

70


Bolivia

344.6

101.0

243.6

29%

10.5%

515


Ethiopia

54.3

15.9

38.4

29%

8.6%

n.a.

 

First and foremost the numbers show that annual debt service relief falls
way short of a 100% cancellation. Surprisingly this is true for all African
countries. Remaining debt not covered by the proposal includes:

*         Debt to other multilaterals such as BADEA, Arab Fund, Nordic Fund,
OPEC, CAF or IDB;

*         Debt to bilateral official creditors which have not committed to
full cancellation as they have not been part of the Paris Club negotiations;

*         New debt to either of the above groups after the tentative cut-off
date (for most countries) of 20 June 2000;

*         Remaining debt to commercial creditors, occasionally already under
litigation.

For some countries it is apparent that the domestic debt burden constitutes
a considerable strain on public budgets. While domestic debt is certainly
not the responsibility of international creditors, it should be acknowledged
that states with initially low levels of domestic debt resorted to domestic
financing in order to comply with external payment obligations. In turn,
insufficient relief through HIPC (now implicitly acknowledged by this
subsequent sweeping cancellation exercise) exacerbated the
non-sustainability of their external debt.

 

Of course, countries need to be examined case-by-case:

*         Niger has the most substantial reduction of the group, but a large
amount of old debt will remain unless other multilaterals can be brought on
board.

*         In Zambia the completion point document has simply updated
expected export income from an exceptional 50% rise in copper prices.
Therefore the positive future debt service ratio is dependent on copper
prices remaining high. A more conservative calculation building on an
expected 25% reduction in copper prices in 2006, as expected by some
commodity trade experts, would bring the debt service ratio on remaining
debt closer to 4%.

*         Though certainly welcome, relief for Bolivia will only have a
limited effect, particularly considering their huge domestic debt service
obligations.

*         Ethiopia is the most surprising case, as its percentage of relief
hardly goes beyond Bolivia's and the debt service ratio must be expected to
remain high above HIPC averages, as forecasted by the World Bank.

 

Further political implications

The proposal has only been broadly outlined as of yet. The final G8 decision
will be made at the meeting in Gleneagles. But only after formal approval by
the Boards and Governors of the World Bank and the IMF at the annual meeting
next September will the proposal become operational. Many details remain to
be worked out. However, on the basis of the Finance Ministers' communiqué,
some far reaching consequences for the sovereign debt landscape can already
be identified:

*         As debtor countries are only receiving minor additional resources,
they will most likely balance their current budget and external balances
through new borrowing. With only limited new money from concessional
sources, governments are likely to take recourse to domestic as well as
non-concessional external financing at near-market conditions. The London
decision is thus laying the foundations for the next debt crisis in the same
countries.

*         HIPC, as a WB/IMF driven instrument, has received the third class
funeral it deserves. HIPC Finance Ministers will no longer make payments
based on HIPC sustainability calculations when they can look forward to the
cancellation of current obligations as well as arrears under the new scheme.
HIPC debt sustainability thresholds ceased to have relevance over night.
Obviously, creditors and important IFI shareholders have become tired of the
mission creep of HIPC-I - HIPC-II additional bilateral relief -
topping-up.etc.

*         The freshly created and formally still to be introduced Debt
<http://www.imf.org/external/np/sec/pn/2004/pn04119.htm>  Sustainability
Framework (DSF) of the IMF and IDA has equally been deemed irrelevant for an
important group of countries. Although the communiqué speaks about
"utilizing appropriate grant-financing as agreed" to avoid the piling-up of
new debt, the DSF will not be able to provide the basis for "informed
lending decision". The DSF defines grant-eligibility through potential debt
distress and poor governance performance. Even if new debt relief is not
100%, most countries are likely to fall below eligibility thresholds. It
will be interesting to see if IDA and the IMF try to redefine the
DSF-thresholds to provide countries with grants.

*         Related to this latter point, the communiqué expresses a
commitment towards using grant financing to "ensure that countries do not
immediately re-accumulate unsustainable external debts, and are eased into
new borrowing." Comparable commitments have been made before and regulations
regarding the concessionality of future external financing are routine in
IMF agreements under the Poverty Reduction Growth Facility (PRGF). However,
in a number of instances, these stipulations have not prevented countries
from covering balance-of-payment gaps with resources outside of
arrangements. If grant financing is provided in line with the DSF it will
imply a 20% overall volume reduction to compensate for the higher degree of
concessionality, for countries that are to receive grants-only and half of
that rate for "yellow-light" countries (which receive a mix of
grants/loans). This may partly be offset by new resources provided
bilaterally - however, if not, governments may feel forced to seek loans,
even at less-than-ODA conditions.

*         The special paragraph in the communiqué on Nigeria's treatment in
the Paris Club - while certainly due to President Obasanjo's scheduled
appearance in Gleneagles - does reveal the Ministers' awareness that there
is a world beyond the HIPCs. It remains to be seen, however, if this
commitment will go beyond the Nigeria case to an acknowledgment of the
broader and structural debt problem which demands more than one-off sweeping
action. 

 Jürgen Kaiser, 15 June 2005

 

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