We have been following with interest Eurodad's forum on sustainable development, and I would like to begin by thanking Jon Wolsey for his work in moderating this and previous Eurodad online fora, which have provided a lively global dialog on some of the most pressing issues facing the world economy.

In the same spirit, a number of our staff have studied closely Eurodad's "bottom-up" approach to assess debt sustainability. It grapples with a number of difficult issues, particularly the question of determining "affordable debt service". Eurodad's proposed methodology consists of four steps:

1. Estimating the overall resource envelop available to the government. External loans are not included, although external grants are included.

2. Calculating the amount needed to achieve Millennium Development Goals (MDGs), and subtracting this amount from the overall resources available.

3. Subtracting repayments to domestic creditors from the overall resource envelope.

4. Assuming that no more than one-third of the remaining resources be used to service foreign debt - this is the "affordable debt service".

This is an interesting approach. My colleagues, however, have raised a number of concerns about the proposed methodology, which I would like to share. More broadly, this alternative approach to debt sustainability raises several issues related to the strategy for achieving the MDGs embodied in the Eurodad paper with which my specialist colleagues and I are uncomfortable.

Methodological concerns

The assumption (step 1) that loan disbursements be omitted from the resource envelope available to low income countries seems inappropriate. We are especially confounded by the rational given for the omission of such loans (most of which are provided by multilateral development banks), namely that they are used to finance activities that are not directly profitable and should therefore be omitted. Many activities that are clearly linked to poverty reduction (for example, much of health and education spending) are not "directly profitable", but nonetheless are financed from the resources available to governments - including loans.

Otherwise, the proposals in steps 1 and 2 above are already encompassed in the PRSP process. Poverty Reduction Strategy Papers (PRSPs) are expected to evaluate both the resources available to countries, including through HIPC relief, and the resources needed to achieve the MDGs. Any remaining financing gaps would be covered with the assistance of bilateral and multilateral partners (notably through donors roundtables) and this assistance would be channeled into PRSP priorities.

The assumption in step 4 that no more than one-third of remaining resources be used for debt service seems to be rather arbitrary. We would be interested in the reasoning behind this, or any empirical evidence of the appropriate level of debt service for a low-income country supporting EURODAD's approach. Similarly, we wonder what the approach would be if the "residual" resources available for spending were insufficient to meet the other needs of the government.

In any event, the rest of the methodology could not be applied in practice in most HIPCs. For most of them, the entire envelope of available resources (according to the definition in step 1 above), even after full debt cancellation, would not be sufficient to achieve the MDGs, and financing gaps would remain.

Questions of development strategy

Debt relief is clearly not enough. We agree that more resources should be devoted to poverty-reducing spending to achieve the MDGs by 2015. In our view, debt relief is only one component in the package of support that the international community needs to provide to low-income countries. Additional financing, on appropriately concessional terms or in the form of grants, is also necessary.

The paper is not justified in implying that the current HIPC framework is insufficient to address "the pressures that higher levels of debt service can exert on other essential public expenditures..." The latest available country data indicate that the average ratio of debt service to government revenue (excluding grants) is projected to fall from 24 percent in 1998-88 to 12 percent in 2001-05. It is an even smaller share of the total resource envelope. If there are pressures, perhaps they come from "nonessential" spending. In any event, the impact of HIPC is clear: the average ratio of social expenditure to GDP is projected to rise from 1.4 percent in 1999 to 4.1 percent over 2001-05.

We wonder why there is no mention of the disincentive effects that would arise from providing less debt reduction for countries that are less indebted or have higher government revenues. Surely such effects would be enormous, especially given that meeting the MDGs is expected to take (at least) 13 years and, based on our interpretation of the approach outlined in the paper, debt relief would be provided on a rolling basis. Would countries not have the incentive to accumulate debt and seek to avoid increasing (or even reduce) revenues in order to have more debt service written off? Similarly, would countries have an incentive to avoid meeting the MDGs as quickly as possible for fear of losing out on debt relief? We agree with the paper's premise that moral hazard is a serious issue when providing debt relief, and have attempted to address it within the HIPC framework.

We doubt that poor countries would not exploit natural resources if their debt burdens were completely removed, as implied in the paper. Countries utilize the resources under their control for many reasons other than to accumulate foreign exchange in order to service external debt. Indeed, natural resources do tend to generate large budgetary windfalls which could be used for poverty-reducing activities.

The paper does not discuss the role of the private sector and the need for capacity building in low-income countries as means to increase the productive capacity of countries. There is no way around the fact that low-income countries need to promote private investment, including foreign investment, to accelerate growth, and reduce poverty. This requires sound macroeconomic policies and structural reforms. Not only do such reforms raise growth by increasing investment, but they also increase, along with capacity-building efforts, the efficiency with which a country's resources are used. Expanding the resource envelope in this way is surely the most sustainable way to finance economic growth and poverty reduction.