House of Commons - International Development

Select Committee on International Development Third Report

DEBT RELIEF

INTRODUCTION

1. The International Development Committee agreed in December 1997 to conduct an inquiry into debt relief which would represent its first consideration of this issue, though not its last. Unsustainable debt is often discussed only in terms of its economic implications. We agree, however, with the Chancellor of the Exchequer that "debt relief is a moral issue"[1] rather than simply an issue of economic development, and we recommend that it be discussed in this context. We intend to monitor further the progress of international debt relief efforts.

2. We invited interested parties to submit evidence responding to the following issues:

(a) The terms and conditions of the Heavily Indebted Poor Countries (HIPC) Debt Initiative and its progress to date.

(b) The policy of the United Kingdom on bilateral and multilateral debt relief, including the Mauritius mandate.

3. We were grateful to receive a number of written responses to this invitation, which proved extremely useful during our deliberations, and which are published with the oral evidence[2] or as Appendices to the Minutes of Evidence[3]. The Committee also thanks everyone who gave written or oral evidence for their contribution to the inquiry. In particular we would like to thank Rt Hon Gordon Brown MP, Chancellor of the Exchequer, and Rt Hon Clare Short MP, Secretary of State for International Development, for giving oral evidence to the Committee. We commend all the evidence to the House to inform any future debate on debt relief.

4. The question of debt relief is one which is obviously of great concern to many people. We congratulate non-governmental organisations (NGOs), in particular Jubilee 2000 Coalition, for their work in raising the profile of this important issue.

5. We recently visited the Great Lakes Region of Africa to collect evidence in connection with this inquiry, in addition to trade and economic development, women and development, and conflict prevention and post-conflict reconstruction. We intend to report our findings in connection with these inquiries in the coming months. We are extremely grateful to all those who assisted in arranging our visit, and for those who were generous in giving their time to meet us and discuss these matters.

The Causes of Unsustainable Debt

6. The sustainability of debt refers to the debtor's ability to service it, given its economic circumstances. The World Bank define sustainability as: "the country's ability to achieve, over a defined period, equilibrium in the balance of payments, and to reach a level of debt by the end of the period that is low enough to make future debt service problems unlikely"[4]. For the purposes of the heavily indebted poor countries initiative, debt is defined as sustainable if it does not exceed twice to two and a half times the level of export revenues, or if the amount of debt service being paid does not exceed 25 per cent of export revenues. We discuss the definition of debt sustainability in further detail below.

7. The circumstances which result in an inability to service external debts obviously differ greatly between countries, but there are some common factors which can be identified. The unsustainable debt burden of heavily indebted poor countries exists to some extent as a result of irresponsible lending policies pursued by bilateral and multilateral creditors. The Government's memorandum to this inquiry acknowledges this responsibility, referring to "what can, with the benefit of hindsight, be seen as lending policies which did not take full account of the true risks of default"[5]. A recent World Bank report also refers to "a lack of selectivity in lending ... most noticeable in the FY 84-89 period when approvals grew rapidly"[6]. The World Bank, in the same report, claims that in recent years selectivity in the approval of loans has increased[7]. Clare Short acknowledged that the African Development Bank "has a terrible record and was allowed to lend totally irresponsibly in the past", but reassured the Committee that "is now undergoing a major process of reform under much better leadership and it is about to have a re-settlement of its constitution that will give donors like us more authority"[8].

8. We welcome the assurances we have received concerning the lending policies of the World Bank and African Development Bank. We note with some concern, however, that World Bank International Development Association (IDA) credits of US$114 million were approved for Uganda on 24 March 1998[9], a matter of weeks before Uganda's completion point under the HIPC Initiative. ( The "completion point" is the point at which a reduction in the stock of debt is implemented, at the end of the HIPC Initiative process. We discuss this process in further detail below.) We recommend that the UK's representatives at the World Bank, IMF, and African Development Bank, report developments in lending policy to us on an annual basis, and provide assurances that the multilateral institutions to which the UK contributes are pursuing lending policies which take a full and realistic account of the ability of the debtor government to repay.

9. The problem of unsustainable debt must also be attributed to debtor countries, in some cases failing to put loans to productive use, either due to misjudgement or corruption, and in others failing to achieve economic growth despite productive use of loans. Robin Fellgett, an HM Treasury Official, explained that "in most cases the single most important factor is simply that the economic policies of the country concerned have not delivered the economic growth that is necessary to repay .. if it borrows and does not invest or invests unwisely, or the economic policy framework within which it is operating does not facilitate growth, the country cannot repay the debt."[10].

10. David Woodward, a development consultant, reminded us in evidence that in some cases the responsibility for unproductive use of loans lay with previous rather than current debtor governments[11]. For example, the bulk of Rwanda's external debt was incurred by the genocidal regime which preceded the current administration. In 1980, Rwanda's total long-term external debt was US$ 190 million; by 1995, this had increased to US$948 million[12]. Some argue that loans were used by the genocidal regime to purchase weapons, and that the current administration, and ultimately the people of Rwanda, should not have to repay these "odious" debts[13].

11. In his address to the meeting of Commonwealth Finance Ministers at Mauritius in September 1997, the "Mauritius Mandate",[14] the Chancellor pledged that the UK would not provide export credits to developing countries for "unproductive expenditure" such as unjustifiable expenditure on arms, for the following two years, and that the Government would seek to secure a more permanent international agreement with other creditor countries[15]. The statement by the G7 Finance Ministers following their meeting in February 1998 showed that some progress had been made in achieving such an agreement informally[16]. We welcome the restriction by the Government of the provision of export credit guarantees to productive expenditure only. We recommend that the Government use the G7 meeting in two days' time to continue to promote an international agreement on the restriction of export credit guarantees to productive expenditure only.

12. Fluctuations in commodity prices and foreign exchange rates have also contributed to the inability of some countries to service their debts[17]. Jubilee 2000 Coalition claim that "if Africa's export prices had kept pace with import prices since 1980, Africa could have repaid all its debt one and a half times over."[18] This point has too often been forgotten in any discussion on debt relief. Adverse weather conditions, such as the recent El Niño phenomenon, drought, or flooding, can also have an impact upon export revenues and economic stability, thus reducing the sustainability of debt[19].

13. In some poor countries, conflict has had a major impact upon both the accrual of debt under corrupt, military or dictatorial regimes, and upon the sustainability of existing debt as a result of the resulting economic instability[20]. For example, following the genocide in Rwanda in 1994, the sustainability of Rwanda's external debt decreased dramatically. The sustainability of debt, which refers to whether or not the debt can be paid, can be measured in a variety of ways. One measure is the value of the debt in relation to Gross National Product (GNP). The net present value[21] of external debt in Rwanda only increased by 4.5 per cent from 1994 to 1995, however such was the impact of the conflict on GNP that the ratio of debt to GNP increased from 49.4 per cent in 1994 to 130.7 per cent in 1995, representing a massive decline in the sustainability of the debt[22].

14. It is clear that responsibility for unsustainable debt lies with creditors, debtors, the impact of unforseen economic circumstances, and conflict. In view of this shared responsibility, creditors and debtors should continue to work together to achieve a joint solution, with each recognising their own role in the creation of the problem and their potential contribution to its solution.

How Much is Owed and to Whom?

15. The total public and publicly guaranteed external debt owed by all developing countries in 1994 was US$1,926.9 billion[23]. Heavily indebted poor countries owe 12 per cent of this total[24]. According to the Government, thirty seven of the countries defined by the World Bank for the purposes of HIPC Initiative as "heavily indebted poor countries"[25], countries which had not resolved their unsustainable debt problems at the time of the official end of the debt crisis in 1994, owe a total of about US$ 100 billion (for the remaining four HIPCs, figures are too unreliable to use)[26]. At the end of 1995, 54 per cent of the debt owed by HIPCs was official bilateral debt, i.e. debt owed to individual governments. 31 per cent was owed to multilateral creditors, i.e. financial institutions which are owned by several share-holders, such as the World Bank and IMF, and regional development banks such as the African Development Bank. The remaining 15 per cent was owed to private creditors[27].

Human Development Implications of Unsustainable Debt

16. Debt in itself is not automatically a problem. Most developing countries need to borrow externally in order to finance domestic investment, it is only when the debt becomes unsustainable that adverse effects arise[28]. There are major economic implications associated with unsustainable debt, which we discuss below, however the impact is ultimately felt by people living in indebted countries. Unsustainable debt has been cited as the single biggest obstacle to tackling poverty[29]. CAFOD cite Cardinal Hume, who pointed out that "whatever the detailed history of today's debt ridden countries, nearly all have one key fact in common; that those who could be blamed the least, the poorest people in the poorest countries, have suffered the most"[30]. It is important that definitions of unsustainable debt should explicitly take human development into account. We therefore agree with the definition of unsustainable debt as "debt which cannot be paid without damaging the prospects of economic and human development" put forward by the World Development Movement[31].

17. The Chancellor told us that "millions of people in the world's poorest countries are suffering because money that could be spent on health and education and on ensuring economic self-sufficiency is currently going to repay debt"[32]. Tearfund point out that "for an impoverished country such as Mozambique to spend more than a third of its GNP on debt repayments while cutting expenditure on health and education is simply wrong"[33]. We agree. Jubilee 2000 Coalition's recent publication, "Chains Around Africa: The slavery of debt in the world's most impoverished continent"[34], demonstrates that in many heavily indebted poor countries, expenditure on debt servicing exceeds spending on education and health[35].

18. With the right terms and conditions, debt relief could have a direct impact upon the lives of the poorest people in the poorest countries. According to the 1997 UNDP Human Development Report: "relieved of their annual debt repayments, the severely indebted countries could use the funds for investments that in Africa alone would save the lives of about 21 million children by 2000 and provide 90 million girls and women with access to basic services"[36]. Oxfam illustrate this point in their recent position paper: Making Debt Relief Work: a test of political will (April 1998), showing how the six countries which have confirmed completion points under the HIPC Initiative have made commitments to using the savings to finance education and health programmes.

19. Unsustainable debt can undermine efforts to reduce poverty, as aid money is effectively recycled to repay debts. Jubilee 2000 Coalition told us that "for every one dollar in aid given to developing countries, eight dollars now comes back in debt service; at the same time, we lend them a further eleven dollars, a large part of which .. is used to finance the eight dollars"[37]. Jubilee 2000 Coalition further point out in their recent paper[38] that in 1996, for every US$1 received in aid grants, Africa paid out US$1.31 in debt servicing. Oxfam estimate that between a third and a half of bilateral aid flows are being recycled in the form of debt refinancing"[39]. On the other hand, UK Government officials told us that the UK provided £264 million of bilateral aid to heavily indebted poor countries in FY 1996/97 (not including Commonwealth Development Corporation investments or non-aid debt relief), which represents several times the amount of debt repayment received by the Export Credits Guarantee Department (ECGD), which is around £40 million per year[40]. In 1995, the most recent year for which figures are available, the total official development assistance (ODA) from OECD Development Assistance Committee (DAC) countries[41] was US$60.1 billion. The total debt service paid by developing countries in the same year was US$194 billion[42]. The fact that the amount of debt service paid annually by developing countries exceeds aid flows from OECD DAC countries to developing countries by some US$133.9 billion is clearly unacceptable. We also note, however, that if export credits and private flows (including direct investment, international bank lending, and NGO grants) are included in the equation, the total net resource flows from DAC countries to developing countries exceed debt service payments by US$225 billion.

Economic Effects of Unsustainable Debt:

20. Not only may there be an immediate impact of unsustainable debt on the resources available to the poor people in the debtor country, but the economic prospects of heavily indebted poor countries can be blighted by the "debt overhang". Shriti Vadera, Executive Director, SBC Warburg Dillon Read, told us in evidence that "if we are talking about genuine, self-sustaining economic recovery, foreign investment is a key condition and the debt overhang is a deterrent not only directly but also because investors are concerned about exchange rate and interest rate fluctuations and the lack of domestic liquidity as a result of the overhang"[43]. Foreign investment is not a panacea for indebted countries[44], but it is a likely to be a necessary condition for sustainable economic recovery[45], which itself is a precondition for effective poverty eradication[46].

21. There are clear economic advantages to debtor countries in receiving deep and sustainable debt relief. However, some debtor countries appear to be concerned that debt relief may adversely affect their creditworthiness in international capital markets. For example, Kenya has declined to apply for concessional debt relief, in order to demonstrate its ability to "stand on its own two feet"[47], showing that the impact of debt relief upon creditworthiness is an issue of serious concern to some debtor countries. David Woodward argues that debt relief will damage the creditworthiness of the debtor only to the extent that it is expected to default again[48]. Jubilee 2000 Coalition point out that since heavily indebted poor countries already lack creditworthiness, this issue is irrelevant and should not prevent debt relief being granted. There is as yet no evidence on the potential adverse effect of debt relief on creditworthiness. We recommend that creditworthiness be monitored in those countries which benefit from the HIPC Initiative. We believe, however, that the fact of debt relief is less important in assessment of creditworthiness than how such debt relief has been used. If it results in an effective macroeconomic framework and a productive economy we doubt that the debt relief will deter investors.

Bilateral Debt Relief: The UK

22. The UK is the sixth largest creditor to heavily indebted poor countries, and is owed less than four per cent of their outstanding bilateral debt[49], about £1.5 billion[50]. Most official development assistance (ODA) debt owed to the UK has now been cancelled. Since 1978, the UK has written off about £1.2 billion of ODA loans. In addition, it was announced in September 1997 that £123 million of ODA debt to lower-income Commonwealth countries would be written off[51]. Bilateral UK aid is now provided in grant rather than loan form. We welcome the provision of UK bilateral aid as grants rather than loans.

23. Most debt owed to the UK is not ODA debt, but is owed to the Export Credits Guarantee Department. The level of unsustainable debt owed to ECGD raises questions about past commercial decisions of this department. ECGD should re-examine its policies to ensure such debt burdens do not recur. The ECGD acquires sovereign debt by taking over the title of debts owed to British exporters. ECGD is obliged to maximise the recovery of outstanding debt, and debt forgiveness can therefore only be made if it is in the interests of the proper financial management of its portfolio, for example if it is thought that partial forgiveness will increase the likelihood that the remaining debt will be recovered[52]. Rescheduling and relief of ECGD debt is negotiated at the Paris Club, discussed below.

24. Tearfund call for the unilateral cancellation of all debt owed to the UK by the poorest countries[53]. Jubilee 2000 Coalition suggest that unilateral action in the cancellation of debt would be effective as a tactic for shaming other creditors into similar actions[54]. Oxfam agree, and suggest that unilateral action in the cancellation of debt is also valid if it automatically unlocks further relief from other creditors[55]. For example, the recent donation by the UK of US$10 million to Mozambique's debt relief package provided a lead which was then followed by other creditors, leading to the accumulation of the necessary funds to finance the package. In these circumstances, Oxfam would support unilateral action. Oxfam also point out a potential disadvantage to unilateral action: "if the UK were to write off its debt to a particular country, it could exclude itself from further discussions on that country's debt, thereby reducing its potential leverage over other creditors"[56]. A further argument against unilateral action as a general policy is that the benefits may be reaped by other creditors rather than the debtor, as David Woodward explained: "Given the principle of reducing debt to a specific level, if unilateral action reduces debt before that stage is reached there is a risk that the effect will simply be a saving on the debt reduction which is required from other creditors"[57], rather than benefiting the debtor. This risk must be taken into account when considering unilateral action.

25. Oxfam suggest that the way forward is not to pursue a general policy of unilateral action, but to reserve unilateral action for particular circumstances, and that the general policy should be to focus on the implementation of international initiatives. This has been the policy of the Government. In the Mauritius Mandate, the Chancellor launched targets for international action, providing a time frame for the implementation of Paris Club Naples Terms and the HIPC Initiative. We consider these targets in detail below. The Chancellor has also discussed the issue with the G7 Finance Ministers in February 1998[58], and debt relief will be on the agenda at the forthcoming G7 meeting in Birmingham[59]. Given the small proportion of debt owed to the UK by heavily indebted poor countries, and the disadvantages of unilateral action, we welcome the general focus of the Government on international debt relief efforts, with unilateral action reserved for occasional cases where it will unlock relief from other creditors, such as the recent donation of US$10 million to finance the debt relief package of Mozambique, which, as we noted above, provided a lead for other creditors to make similar donations.

The Paris Club

26. The Paris Club is a group of bilateral creditors which was established in the 1950s to consider rescheduling official bilateral debt owed to them[60]. The Paris Club only considers official bilateral debts, and excludes private non-guaranteed debt. In 1988, the Paris Club agreed terms under which it was possible to reduce the official bilateral debt burden of some of the most heavily indebted countries. Various "terms" for debt relief were agreed[61], culminating in the agreement of "Naples Terms" in 1994, allowing reduction in the stock of debt owed to its creditors by up to two thirds at the end of a consolidation period of one to three years, in addition to rescheduling of debts due during the consolidation period. During the past 20 years, the Paris Club has rescheduled or reduced official bilateral debts of over US$300m in net present value terms. The UK has cancelled £1.8 million of official bilateral debt through Paris Club agreements in the past decade.

1 Q.254. Back

2 pp. 1-92 Back

3 pp. 93-114 Back

4 Global Development Finance 1998, p. 55. Back

5 Evidence p.1. Back

6 World Bank Report no. 16594, "Adjustment Lending in Sub-Saharan Africa: An Update" May 1997, paragraph 8. Back

7 Ibid. para 8. Back

8 Q.281. Back

9 World Bank News, Vol XVII, No. 7, April 2 1998. Back

11 Q.172. Back

12 World Development Indicators, 1997. Back

13 "Rwanda: Kigali vows to repay debts left by former foes" The Black World Today, 13 November 1997. See: www.tbwt.com/articles/africa/africa207.htm Back