The Moral Argument Debt Service and Social Expenditure Eligibility for HIPC Timing of Debt Relief Poverty Reduction

Dissemination of Information Definition of Debt Sustainability Choice of Target Ranges Interim Relief

 
THE MORAL ARGUMENT

Criticism: The HIPC Initiative is a halfhearted response of the rich world to the overwhelming debt problems of poor countries. On moral grounds, the right decision would be an unconditional cancellation of all debts owed by HIPCs.

Response: Calls for a full cancellation of the HIPC countries entire external debt of over US$200 billion are unrealistic, and raise false expectations. This is particularly true as aid resources have become increasingly limited in recent years, and net official development assistance (ODA) has fallen to a historic low of 0.22 percent of donor GNP in 1997 (compared to a UN target of 0.7 percent), reflecting creditors’/donors’ budget constraints. Against this background, debt cancellation for HIPCs, unless it was entirely additional to existing aid flows, would only imply lower aid flows to other poor countries—an outcome which is clearly not desirable.

Even if the international community were prepared to cancel all HIPC debt, it needs to be understood that the HIPC Initiative is not a panacea, and debt is only one of many problems these countries face. Unconditional debt relief is not the right tool for promoting the ultimate goals of sustainable development and poverty reduction. These goals are best attained by providing debt relief in a process, such as under the HIPC Initiative, which encourages the adoption of appropriate policies by the recipient country designed to stimulate private sector-led growth and focuses on an improvement in social indicators. Conditionality is an integral part of this process. It ensures that the debt relief provided is used effectively, particularly through promoting health and education expenditures, and encourages the continued provision of aid flows to the countries concerned. This is particularly important given the dependence of HIPCs on such inflows—a dependence which would continue even if all debt were forgiven.

In short, unconditional debt cancellation risks debt relief being squandered on corruption, military expenditure, or grandiose projects with little if any benefit in terms of sustainable growth or poverty reduction. In addition, this could further erode support for aid flows in developed countries.

DEBT SERVICE AND SOCIAL EXPENDITURE

Criticism: High external debt service in HIPC countries is responsible for insufficient social spending. Despite the HIPC Initiative, scheduled debt service in most HIPCs exceeds the level of spending on health and education.

Response: It is simplistic and misleading to compare scheduled debt service in HIPCs with their level of social spending, as this recognizes neither the debt relief provided to these countries nor the offsetting inflows of foreign aid. A closer look at a sample of 27 HIPCs, for which recent data are available, shows that, on average, actual debt service paid even prior to HIPC assistance is considerably below scheduled debt service; for most HIPCs, debt-service payments are actually lower than government budgetary expenditures on health and education. Moreover, as a result of incomplete accounting, budgetary spending in these sectors often does not capture the substantial outlays financed directly (outside the budget) by bilateral donors and NGOs.

Regardless of the level of debt service, however, it is the net payments (i.e., debt service payments minus financial inflows from abroad) that determine a country’s financial relations vis-à-vis the international community. Based on this measure, HIPCs receive on average twice as much by way of external assistance—grants and concessional loans—than they pay by way of debt service, and in some HIPCs (such as Mozambique, Tanzania, and Uganda) this ratio is much higher. On average, net inflows of external assistance to HIPCs are equivalent to around 10 percent of GDP and remain essential for HIPCs to continue their recent improvements in social indicators.

ELIGIBILITY FOR HIPC

Criticism: The eligibility criteria under the HIPC Initiative are overly restrictive. The restriction to poor countries below the IDA operational cutoff level of per capita income excludes some highly indebted countries that could benefit from relief.

Response: The eligibility criteria under the HIPC Initiative reflect a broad-based consensus of member governments that the poorest countries should have the highest priority in concessional debt relief. The IDA-only and ESAF-eligibility requirements ensure this by linking eligibility for HIPC assistance to the poverty status of a country.

TIMING OF DEBT RELIEF

Criticism: The performance period to receive HIPC assistance is too long, and unnecessarily delays the receipt of debt relief at a high cost in terms of forgone social services.

Response: Assistance under the HIPC Initiative is committed by the international community after a country has established a three-year track record of successful performance under IMF- and World Bank-supported adjustment programs, and is provided after a further three years of performance. This requirement reflects the belief that debt relief without true adjustment and reform would be wasted, and is intended to ensure that countries are in a position to use the additional resources effectively.

The HIPC Initiative process encourages countries to tackle the whole range of factors currently limiting their growth performance, including poor infrastructure, the lack of effective policy making institutions, and governance problems. Such difficult issues will take time to be resolved, and the claim that the overall six-year adjustment record required under the Initiative is unduly long is neither consistent with the severity of the problems these countries are facing nor with the experience of successful reformers.

That said, the flexibility embodied in the HIPC Initiative, nevertheless, provides credit for past performance. As a result, Uganda already reached its completion point and received its assistance under the HIPC Initiative in April 1998—one and a half years after the adoption of the Initiative—and a number of other countries, including Bolivia, Guyana, and Mozambique, are expected to follow soon. For six of the first seven countries to whom HIPC assistance has been committed up to September 1998, the period between the decision and the completion points was less than 3 years.

POVERTY REDUCTION

Criticism: The HIPC Initiative does not give sufficient weight to poverty reduction objectives.

Response: The HIPC Initiative has always emphasized the need to link debt reduction with effective long-term policies for economic and social development, including poverty alleviation. For this reason, social development criteria are developed jointly with country authorities and explicitly incorporated into HIPC conditionality. However, poverty reduction is not a simple task, and governments’ abilities to absorb the financial resources provided to them are often a constraint when they seek to implement social programs expeditiously and efficiently. Moreover, when considering the resources available for social development, it should be recognized that most HIPCs are already receiving large positive net transfers from creditors and donors that enable them to pursue their development agenda. Debt relief should not be seen as a substitute for continued inflows of development finance.

Thus, the link between the HIPC Initiative and poverty reduction objectives needs to be viewed in the broader perspective of the country’s overall poverty alleviation efforts. These are supported by the international community through various instruments, including lending, policy dialogue, and social expenditure reviews, with a view to accelerate the pace of progress toward the goals of poverty reduction and social development adopted by the OECD’s Development Assistance Committee in 1996 for the 21st century. Movement toward these goals will be monitored under the HIPC Initiative.

DISSEMINATION OF INFORMATION

Criticism: Outside audiences do not receive sufficient access to key information and documents on the HIPC Initiative, nor are they adequately involved in the debate about HIPC debt relief for individual countries.

Response: In disseminating information, IMF and World Bank staff endeavor to strike a balance between being responsive to concerns expressed by outside commentators, and maintaining the integrity of the confidential consultative process with the country concerned and among creditors and donors. Staffs have prepared regular press releases and other public information documents, and are maintaining web sites on the Initiative. To open further the process and improve transparency about the basis of decisions made under the Initiative, the Boards of the IMF and the World Bank decided that the decision and completion point documents would be made public after consultation with the countries concerned, beginning in September 1998.

DEFINITION OF DEBT SUSTAINABILITY

Criticism: The definition of debt sustainability, based on the external public debt- and debt service-to-exports ratios, is too narrow. Debt relief should instead be based more on the government’s debt-servicing capacity, in order to establish a closer link to social expenditure.

Response: The Initiative has always focused on the achievement of external debt sustainability. Certain categories of debt are omitted from its definition of external debt sustainability for practical reasons (debt owed by private citizens, for example, cannot be practically subsumed under rescheduling agreements). Nevertheless, high levels of external private debt or a large domestic debt-service burden for the government are potential vulnerability factors that play a role in setting the country-specific debt sustainability targets.

As for exports, they are admittedly only one of several indicators for a country’s capacity to generate resources to service its external debt. While GDP might be another indicator, it involves serious measurement and comparability problems in the countries concerned. Also, in the particular context of debt service crowding out social expenditures, a government’s ability to generate fiscal revenue is key. The HIPC Initiative has tried to balance the various theoretical considerations in a workable approach that centers on exports as a reliable and comparable measure across countries, but focuses on fiscal revenues in highly open economies where the use of exports may exaggerate the country’s payment capacity. To address moral hazard, this fiscal/openness criterion is only applied in countries with sufficiently strong revenue performance (i.e., a revenue-to-GDP ratio of at least 20 percent).

CHOICE OF TARGET RANGES

Criticism: The target ranges established under the HIPC Initiative are too high to attain the stated objective of debt sustainability.

Response: The specific ranges for the debt sustainability indicators (i.e., 200-250 percent for the NPV of debt-to-exports ratio and 20-25 percent for the debt-service ratio) are consistent with the findings in a recent research project undertaken in this context.¹ Nevertheless, the Boards of the IMF and the World Bank have thus far followed a cautious approach by agreeing for most countries on targets towards the lower end of these ranges and, for some cases, by choosing NPV of debt-to-export targets below 200 percent under the fiscal/openness criteria. In any case, the debt-service ratio typically falls well below the 20 percent threshold after HIPC assistance.

INTERIM RELIEF

Criticism: The measures to provide assistance during the interim period should be strengthened. If the interim period is to be as long as three years, interim measures should provide greater cash flow relief, and more multilateral creditors should provide interim relief to allow for needed expansion of development expenditures.

Response: The IMF and World Bank, as well as other multilateral institutions, provide substantial financing during this period through the provision of ESAF and IDA loans. Beyond this, there are several forms of HIPC assistance available during the interim period between the decision and completion points. In general, official bilateral and commercial creditors are expected to provide flow reschedulings on enhanced terms, involving an 80 percent NPV reduction, during this period, except for countries that have already benefited from a stock-of-debt operation on Naples terms. In addition, multilateral creditors may, at their discretion, advance some of their assistance to the interim period. However, multilateral HIPC assistance provided in the interim period is not additional and only brings forward assistance that would otherwise have been received later.