7 Debt Relief for Low-Income Countries and the HIPC Debt Initiative
- Zubair Iqbal, and S. Kanbur
- Published Date:
- September 1997
Since the onset in the early 1980s of the debt crisis, which affected both middle- and low-income countries, the debt situation of middle-income debtor countries has improved significantly. Many of these countries have benefited from concerted support by the international financial community in the form of Paris Club flow reschedulings, Brady Plan stock-of-debt deals, and adjustment programs supported by the multilateral financial institutions. These instruments have proved to be effective mechanisms for allowing countries to normalize relations with external creditors and to resume sustainable growth. Recent years have witnessed a reentry to international capital markets by many middle-income countries that had been most severely affected by the debt crisis.
However, heavily indebted poor countries, most of which are in sub-Saharan Africa, have continued to experience difficulties meeting their external debt-service obligations on a timely basis. These difficulties can be traced to a combination of several factors, including (1) exogenous shocks, such as a deterioration in the terms of trade, and adverse weather conditions; (2) civil strife; (3) the lack of sustained adjustment or implementation of structural reforms; (4) the lending policies of many creditors, especially the provision of loans on commercial interest rates with short repayment periods; (5) the lack of prudent debt- management policies by debtor countries, driven in part by excessive optimism by creditors and debtors about the prospects for increasing export earnings to build debt-servicing capacity; and (6) the lack of careful management of the currency composition of external debt. All these factors contributed to increasing the debt burden of HIPCs.
In several important respects, the external position of HIPCs differs widely from country to country. For example, in 1994, for some HIPCs the external current account was in surplus while for others, deficits exceeded 100 percent of exports. In addition, scheduled debt-service obligations varied widely, from less than 20 percent of exports for some countries to more than 100 percent for others, while the actual debt service paid ranged from 5 percent of exports to as much as 50 percent. Finally, HIPCs were, and continue to be, indebted to a variety of creditors, including Paris Club bilateral creditors, non-Paris Club bilateral creditors (notably Russia), commercial banks, and multilateral institutions. In recognition of the highly varied external positions among HIPCs, the international financial community has addressed the debt problems of these countries in a manner that ensures that debt relief is given in support of adjustment by debtors on a case-by-case basis, and is tailored to the individual circumstances of the debtor country.
Traditional Debt Relief Mechanisms
In recognition of the need to address the debt burden of low-income countries, the international financial community (including Paris Club creditors, non-Paris Club bilateral and commercial creditors, and multilateral institutions) has during the past decade introduced and implemented a wide range of instruments, “traditional mechanisms,” which were designed to alleviate the debt burden of these countries. In general, for the different categories of creditors, the main trend has been a move toward increasing the concessionality of external assistance to the low-income countries.
The traditional mechanisms for addressing the debt problems of low-income countries can be summarized as follows: (1) the adoption of stabilization and economic reform programs supported by concessional loans from the International Monetary Fund and the World Bank; (2) in support of these adjustment programs, flow rescheduling agreements with Paris Club creditors on concessional terms followed by a stock-of-debt operation after three years of good track records under both IMF arrangements and rescheduling agreements; (3) agreement by the debtor country to seek at least comparable terms on debt owed to non-Paris Club bilateral and commercial creditors facilitated by IDA debt-reduction operations on commercial debt; (4) bilateral forgiveness of ODA debt by many creditors; and (5) new financing on appropriately concessional terms.
This process has significant advantages in that it ensures that new concessional financing and debt relief both under flow reschedulings (directly) and under stock-of-debt operations (via the required track record) are given in support of an adjustment effort by the debtor. Moreover, the process provides for a case-by-case treatment of individual debtors—reflecting, as noted above, their widely different external positions—both by creditors (with Paris Club creditors tailoring effective debt relief to financing needs) and by donors (in the consultative group process).
Paris Club Creditors
In the early 1980s, Paris Club creditors provided reschedulings for low-income countries on nonconcessional “standard terms” with relatively short grace (five years) and maturity (ten years) periods, and on market-related interest rates. Although the reschedulings for the low-income countries were more comprehensive in coverage and provided for more cash relief than for other debtors, many of these countries continued to have difficulties adhering to the resulting repayment schedules, and the rescheduling of interest led to rapid debt accumulation. By the late 1980s, Paris Club creditors recognized that repeated reschedulings on standard terms during a long period did not provide a solution to the debt problems of the low-income countries, and that for most of the low-income countries their debt problems required not only cash-flow relief but also debt reduction. Thus, in late 1988, Paris Club creditors agreed to provide concessional reschedulings for low-income countries on “Toronto terms,” a menu of options for debt and debt-service reduction to reduce the net present value (NPV) of rescheduled amounts by up to a third. While these reschedulings provided for substantial debt reduction, it became increasingly obvious that for many low-income countries more far-reaching concessions would be needed if their debt situation was to be improved on a durable basis.
Thus, in December 1991, creditors introduced “London terms” and increased the level of debt relief on eligible debt in NPV terms to 50 percent. Subsequently, in December 1994, the level of concessionality for most countries was again increased to 67 percent of eligible debt in NPV terms under “Naples terms.” Under both London and Naples terms, the flow rescheduling agreements included a “goodwill clause,” in which participating creditor countries agreed to consider a stock-of-debt operation for countries that had established a good track record of performance for at least three years under an IMF-supported program and on debt-service payments to Paris Club creditors. Such a stock-of-debt operation was viewed as an “exit rescheduling,” and creditors had to be confident that the debtor country would be able to meet future debt-service obligations without the need for additional debt relief. Since early 1995, six countries (Benin, Bolivia, Burkina Faso, Guyana, Mali, and Uganda) have agreed on comprehensive stock-of-debt operations with Paris Club creditors under Naples terms.
Commercial and Non-Paris Club Bilateral Creditors
To ensure concerted support by the international community, Paris Club rescheduling agreements include a “comparability clause,” under which the rescheduling country commits itself to seek at least comparable debt relief from commercial and non-Paris Club bilateral creditors. The clause is intended to ensure equitable burden sharing among the various categories of creditors. In addition, in recent years, low-income countries were able to buy back most of their debt to private creditors, which was being traded in the secondary market at a large discount from the face value using funds from the IDA Debt Reduction Facility and from bilateral donors.
With respect to official creditors outside the Paris Club, there has been little progress in normalizing relations between creditors and debtors.1 Discussions between Russia, the major creditor in this group, and the Paris Club on Russia’s possible participation in the Club are ongoing, and Russia has indicated a willingness to provide substantial debt relief on its claims on low-income countries.2
Multilateral creditors have participated in the efforts of the international community by helping debtor countries to design and implement adjustment and structural reform programs that have been supported by, among other things, concessional loans from the IMF and the World Bank. Multilateral financing during the past decade can be characterized by three major trends: (1) the share of multilateral debt in the total for HIPCs has increased as multilaterals continued to make large-scale contributions to the financing of these countries; (2) increasingly, financing has been provided on concessional terms, especially from the IMF (first under SAF and then under ESAF) and the World Bank (through IDA, including supplemental credits under the Fifth Dimension Facility, which provides financial support to IDA-only countries with outstanding IBRD debts to cover part of their interest obligations on these loans), providing de facto debt relief as more expensive debt (such as nonconcessional exposure to the IMF) was replaced by concessional debt (such as ESAF); and finally (3) despite the increase in multilateral debt to HIPCs, debt-service payments on multilateral debt have remained relatively stable at about 8.5 percent of exports a year in the period 1985–95, reflecting the increased concessionality of loans.3
Positive Net Resource Transfers and New Financing on Concessional Terms
It is important to note that the amounts of grants and new loan disbursements from the creditor and donor community to most HIPCs have exceeded actual debt-service payments on interest and amortization, and as a result net transfers were positive. For example, multilaterals as a group provided to the 41 HIPCs positive net disbursements averaging more than $3 billion a year during the period 1990–95, positive net transfers averaging about $1.5 billion a year during the period 1985–94, and about $2 billion in 1995. Official bilateral creditors and donors have, through forums such as Consultative Group meetings and the Special Program of Assistance for Sub-Saharan Africa, provided new concessional financing in the form of grants or highly concessional loans partly to meet the financing requirements identified under adjustment programs. Thus, in 1994, inflows of grants and concessional assistance from official donors were more than three times actual debt service paid. During the past five years, net resource flows (gross flows less principal repayments) including bilateral grants to HIPCs have averaged about 8 percent of GNP.
The Debt Initiative for HIPCs
The traditional mechanisms for dealing with the debt problems of low-income countries are sufficiently robust to deal with the debt burden of many HIPCs and to reduce their external debts to sustainable levels (see definition below). As noted earlier, the external positions of HIPCs vary widely, and indeed, some countries (such as Ghana, Kenya, and the Lao People’s Democratic Republic) have never received concessional reschedulings from the Paris Club. Others, such as Equatorial Guinea and Vietnam, are unlikely to need the full use of traditional debt-relief mechanisms to reach debt levels that are sustainable. However, even with sound economic policies and full use of traditional mechanisms for rescheduling and debt reduction and the continued provision of concessional financing, several countries still are not expected to reach sustainable levels of debt within reasonable time horizons. To deal with this problem, the Bretton Woods institutions jointly proposed and put in place, in September 1996, the HIPC Debt Initiative, which aims to reduce the debt burdens of all eligible HIPCs to sustainable levels, provided they adopt and pursue strong programs of adjustment and reform. This Initiative builds on and completes the arsenal of instruments available to the international community to deal decisively with the debt problems of the low-income countries and allows them to exit, once and for all, from the rescheduling process.
An important benefit of exiting from the rescheduling process is a return to normal relations with the international financial community, characterized by spontaneous financial flows and the full honoring of commitments. In addition, repeated reschedulings involve significant costs for policymakers and create uncertainty about future debt relief, and may foster the belief on the part of borrowers that financial contracts need not be honored. The Initiative would also reduce what is known as the “debt overhang,” namely, the negative impact of a large external debt burden on economic growth. A debt overhang can contribute to investment disincentives and could delay private capital flows required to generate sustainable growth. While the debt burden is only one problem amid a host of challenges faced by these countries, the removal of the debt overhang via implementation of the HIPC Debt Initiative will permit HIPCs to focus on the policies required to tackle other impediments to sustainable growth, including inadequate physical infrastructure, untrained workforces, and weak institutions.
Main Objectives of the Initiative
The Initiative is intended to deal in a comprehensive manner with the overall debt burden of eligible countries and to reduce it to a sustainable level within a reasonable time horizon. The Initiative involves a commitment made at the decision point—after a three-year track record—by the international financial community to provide sufficient debt relief to reduce the debt burden of eligible countries to sustainable levels, provided the country completes a further three-year period of strong policy performance.
A country can be considered to achieve external debt sustainability if it is expected to be able to meet its current and future external debt-service obligations in full, without recourse to debt relief, rescheduling of debts, or the accumulation of arrears, and without unduly compromising growth. Key indicators of external debt sustainability include the net present value of the ratio of debt to exports and the debt-service ratio. On the basis of experience of a large number of countries, target ranges for determining debt sustainability have been established. Sustainable debt levels under the Initiative will be defined on a case-by-case basis within the range of 200–250 percent for the ratio of debt to exports expressed in net present value terms and 20–25 percent for the ratio of debt service to exports. Of course other factors play an important role, and while countries with indicators above these thresholds may be more likely to encounter debt-servicing difficulties, it is also true that countries that have had debt-servicing difficulties and accumulated arrears or rescheduled had widely differing debt burdens. Thus, other country-specific “vulnerability factors,” such as the concentration and variability of exports, the fiscal burden of external debt service, external debt in relation to GDP, the resource gap, the level of international reserves, and the burden of private sector debt, would need to be taken into account in determining whether to target the lower or the upper end of the two ranges.
Key Features of the Initiative
The HIPC Initiative4 is based on the following six guiding principles, which have been endorsed by the Executive Boards of the IMF and the World Bank and by the Interim Committee and the Development Committee: (1) the objective of the HIPC Debt Initiative should be to target overall debt sustainability on a case-by-case basis, thus providing a durable exit strategy from the rescheduling process; (2) action would be envisaged only after the debtor country has shown, through a track record, an ability to put to good use whatever debt relief would be provided; (3) new measures will build, as much as possible, on existing traditional mechanisms; (4) additional action will be coordinated among all creditors involved, with broad and equitable participation; (5) actions by the multilateral creditors will preserve their financial integrity and their preferred creditor status; and finally (6) new external financing for the countries concerned will be on appropriately concessional terms.
The HIPC Initiative has been developed with the following key building blocks: (1) eligibility will be limited to IDA-only and ESAF-eligible countries that have established a strong track record of performance under IMF- and World Bank-supported programs and that are not expected to achieve a sustainable external debt situation after the full use of traditional debt-relief mechanisms; (2) eligibility will be based on a debt sustainability analysis: at the decision point (after the first three-year track record), the staffs of the IMF and the World Bank would jointly recommend targets for the completion point (after the second three-year track record) for the NPV of the ratio of debt to exports and the debt-service ratio based on this analysis within the ranges mentioned above after giving full consideration to the vulnerability indicators; (3) performance criteria would need to be met for the country during the second stage to receive support under the Initiative—these criteria would include macroeconomic indicators, progress on key structural reforms, and social reforms (e.g., improving basic health care and education, and reducing poverty); and finally (4) all relevant creditors are expected to participate.
Figure 1.HIPC Initiative: Summary
Regarding the last point, Paris Club creditors have indicated a willingness to provide debt reduction in NPV terms of up to 80 percent, on a case-by-case basis, with a flow rescheduling during the second stage, and a stock-of-debt operation (equivalent to an NPV debt reduction of up to 80 percent on eligible debt) at the completion point. Other non-multilateral creditors would be expected to provide debt relief on terms at least comparable with the Paris Club. Multilateral creditors are expected to take action to reduce the burden of their claims on a given country at the completion point if the planned actions by bilateral and commercial creditors are insufficient to achieve a sustainable debt position by the completion point. This debt relief would be provided by multilateral creditors in accordance with their own charters in a way that would preserve their preferred creditor status.
An 80 percent NPV reduction on eligible debt would be sufficient to achieve debt sustainability for most of the countries that are likely to be eligible for action under the Initiative. However, for some of the most heavily indebted countries, this level of debt relief by the Paris Club along with comparable action by other official bilateral and commercial creditors might not achieve debt sustainability, consistent with preserving the preferred creditor status of multilateral institutions, in that it might imply multilateral creditors providing more debt relief, after the full use of traditional mechanisms, in relation to their claims in NPV terms than bilateral creditors. These cases would need to be discussed with Paris Club and other creditors on a case-by-case basis as they arose.
Key Steps in Implementing the Initiative
For those HIPCs that would require the full use of traditional mechanisms and enhanced assistance under the Initiative to achieve debt sustainability, the following key steps are envisaged:
(1) The first stage of the Initiative builds on the existing three-year track record needed to qualify for a stock-of-debt operation from Paris Club creditors (see Figure 1 for more details). During this stage, the country establishes the required good track record of policy implementation, and makes full use of the traditional debt-relief mechanisms (Naples terms rescheduling with 67 percent NPV reduction).
(2) As the country completes the first stage and reaches the decision point, the Boards of the IMF and the World Bank would decide the country’s eligibility for the Initiative on the basis of a comprehensive debt sustainability analysis agreed on jointly by IMF and World Bank staffs and the country’s authorities. The assessment would indicate whether the full application of traditional debt-relief mechanisms (Paris Club stock-of-debt operation on Naples terms involving a 67 percent NPV reduction, with at least comparable action from official bilateral and commercial creditors) would be sufficient for the country to reach a sustainable level of debt by the completion point. There are three possible outcomes: (a) a country is deemed to have a sustainable external debt situation at the completion point—in this case, the country would not be eligible for assistance under the Initiative, and would request a stock-of-debt operation on Naples terms; (b) a country is considered to be a borderline case (see Figure 1), in which case it could request to defer a stock-of-debt operation by Paris Club creditors to the completion point and request a flow rescheduling on Naples terms during the second stage; and finally (c) a country is deemed to be eligible for assistance under the Initiative.
(3) In the last outcome, a “preliminary HIPC Debt Initiative document” would be prepared jointly by Bank and IMF staffs discussing eligibility and recommending country-specific debt sustainability target ranges.5 Consistent with these targets and the assumed action by bilateral and commercial creditors, the staffs, after consultation with concerned creditors, would recommend the required action by multi laterals.
(4) During the second stage of the Initiative, Paris Club creditors would provide flow reschedulings involving up to 80 percent NPV reduction as needed on a case-by-case basis, and commit to provide at the end of the second stage—the completion point—a stock-of-debt operation with NPV reduction of up to 80 percent, provided there was satisfactory implementation of the IMF- and World Bank-supported adjustment program. Other bilateral and commercial creditors would be expected to offer at least comparable terms for the flow rescheduling and for the stock-of-debt operation. Donors, bilateral creditors, and multilateral institutions would provide financial assistance in the form of grants and concessional loans. The World Bank would provide IDA grants and supplemental HIPC IDA allocations during the second stage.
(5) At the completion point, provided the country has met the performance criteria under the Initiative, the stock-of-debt operation (involving up to 80 percent debt reduction in NPV terms) committed to by Paris Club creditors would take effect, and multilateral institutions would provide the committed reduction in the NPV of their claims necessary for the total debt burden to reach a sustainable level—unless actual debt-service indicators fall outside the agreed-on target range. The IMF would provide assistance to a country at the completion point through a special ESAF grant or loan, which would be paid into an escrow account and used to cover debt service to the IMF. The World Bank would provide assistance at the completion point via the HIPC Trust Fund. Most other multilaterals are currently seeking the appropriate institutional approvals to enable them to participate in the Initiative including, in many cases, via the HIPC Trust Fund.
(6) The six-year performance period under the Initiative would be implemented flexibly on a case-by-case basis, with countries receiving credit for already established track records in the first stage. Exceptionally, the second stage of three years might be shortened for countries that already have sustained records of strong performance.
(7) A key element of the Initiative would be the provision of external finance on appropriately concessional terms to prevent a buildup of future debt-service problems.6 Thus, the ESAF programs accompanying the stages of the HIPC Debt Initiative would involve restrictive limits on all nonconcessional borrowing. There would also be a focus on building up HIPCs’ debt-management capacity to help avoid the future recurrence of excessive indebtedness. In this respect, private lenders would also be encouraged to exercise restraint.
(8) Support under the Initiative would remain available to countries embarking on IMF- and World Bank-supported programs before October 1,1998. A comprehensive review of the Initiative would be held by then to decide whether to extend it.
Status of Implementation of the Initiative
Six countries (Benin, Bolivia, Burkina Faso, Guyana, Mali, and Uganda) have agreed on stock-of-debt operations on Naples terms with Paris Club creditors and can be considered to have established the first three-year track record required under the Initiative. Bank and Fund staffs are currently working actively on agreeing debt sustainability analyses with the country authorities on these and other countries that could reach the decision point in 1997, with the objective of first discussions in the two Boards of a group of countries early in 1997.7
The HIPC Debt Initiative is not a panacea for all the economic problems of HIPCs. Even if, hypothetically, all the external debts of HIPCs were forgiven, most would still continue to need significant levels of concessional external assistance; as noted earlier, currently their receipts of such assistance are much larger than their debt-service payments. Given their high levels of poverty and limited domestic resources available to meet the costs of social programs that address the needs of the poor, most HIPCs are likely to continue to be dependent on aid. The HIPC Debt Initiative is not a recipe for the cessation of aid to HIPCs; if it results in a withdrawal of aid, it will fail. Given, however, the pressures on aid budgets in major donors, which are likely to continue for the foreseeable future, continuing aid will be most effective if it catalyzes private financial flows, particularly investment. As noted earlier, there is a limit to the extent to which these flows can be debt creating, if future overindebtedness is to be avoided. This suggests a focus on the institution building necessary to attract such private investment as well as support for putting in place necessary infrastructure: many HIPCs face serious infrastructure and institutional problems. Some HIPCs also need to address problems of governance, particularly as they influence investor confidence, such as the establishment of appropriate commercial codes of conduct, functioning judicial systems, and the effective application of the rule of law. To attract foreign investors, who can provide significant technology transfer, HIPCs need to provide much more information in a transparent way, remove red tape, and strengthen legal systems—on such issues as property rights—and financial systems, including payment and settlement systems. HIPCs are inevitably competing with the rest of the world in attracting such foreign investment, and given adverse investor perceptions, have to offer attractive combinations of rate of return relative to risk.8 These are difficult issues that are likely to take a long time to resolve even with the full support of the international community. Most HIPCs will need to continue to pursue adjustment and reform policies to meet the economic aspirations of their citizens for long after they have benefited from Naples terms stock-of-debt operations or from enhanced debt relief under this Initiative.
The HIPC Debt Initiative is intended to complete the array of instruments available to the international community for dealing with debt problems of low-income countries. The Initiative deals with the external debt of HIPCs in a comprehensive way that involves all creditors, and thus establishes a new paradigm for international action. By no means will all HIPCs need enhanced assistance under the Initiative to achieve sustainable debt levels. However, for those HIPCs for which traditional debt-relief mechanisms are unlikely to result in debt sustainability, the Initiative involves a commitment by the international community to take such additional action as may be required to reduce the debt burden to sustainable levels, and for the country to exit from the rescheduling process, provided the country is prepared to adopt and pursue strong programs of adjustment and reform. Hence, the Initiative provides for the achievement of debt sustainability for all HIPCs that adopt appropriate economic policies. The Initiative thereby should eliminate debt as an impediment to economic development and growth. In consequence, it enables and encourages HIPC governments to focus on the difficult policies and reforms required to remove the remaining impediments to achieving sustainable development.
Major non-Paris Club bilateral creditors include China, Kuwait, the Libyan Arab Jamahiriya, Russia, and Saudi Arabia; Kuwait sometimes participates in Paris Club reschedulings.
As indicated, for example, in the terms provisionally agreed on with Nicaragua.
According to the World Bank Debtor Reporting System, the ratio rose to 11.5 percent in 1995, reflecting the clearance of Zambia’s arrears to the IMF. Excluding Zambia, it remained at about 8 percent in 1995.
A target range for the NPV debt-export ratio would be specified (plus or minus 10 percentage points of the target) to allow for some variability in the outcome without the need for creditors to adjust their committed action.
Such problems should also be reflected in the current NPV ratio of debt to exports.
Such discussions have been conducted on Bolivia, Burkina Faso, Côte d’Ivoire, and Uganda[editors’ note].
Risk can be reduced through such action as participation in investment insurance programs, such as that of the Multilateral Investment Guarantee Agency.