House of Commons - International Development

Select Committee on International Development Third Report

DEBT RELIEF

The HIPC Initiative

27. For some countries, the majority of their debt burden comprises loans from multilateral creditors[62]. For example, Uganda owes US$3.4 billion in public and public guaranteed external debt, 75 per cent of which is owed to multilateral creditors[63]. In cases such as this, relief of bilateral debts will clearly not go far enough to achieve sustainability. In response to this, the HIPC Initiative was agreed at the meeting of the IMF and World Bank in 1996, providing for the first time a facility for the relief of multilateral debts for countries which cannot achieve debt sustainability with Paris Club relief alone.

28. The HIPC Initiative is open to all heavily indebted poor countries that are eligible for funding under the IMF Enhanced Structural Adjustment Facility (ESAF) and the World Bank's International Development Association, and that pursue or adopt structural adjustment programmes supported by the IMF and World Bank. The Initiative involves two stages. First the debtor approaches the Paris Club and receives rescheduling of eligible debts falling due within a three year consolidation period, according to Naples Terms[64]. During this time, the country must establish a track record of structural adjustment and reform approved by the IMF and World Bank. The decision point is then reached, marking the end of the first stage. At this point, eligibility for relief under the HIPC Initiative is determined according to an assessment of the sustainability of the debt.

29. Debt sustainability is assessed on the basis of the value of public and publicly-guaranteed external debt in relation to exports, and the ratio of debt service to exports. The use of exports in the calculations reflects the fact that the debtor must be able to generate foreign currency in order to repay its debts. For countries with a very open economy, the assessment is made on the basis of the net present value of the debt in relation to fiscal revenue.

30. Countries whose debt burden cannot be brought to a sustainable level via traditional debt relief mechanisms, namely the Paris Club, then enter the second stage, which involves a further three year period of structural adjustment, with continued Paris Club rescheduling. At the completion point, at the end of the second stage, creditors reduce the debt stock to a sustainable level, with multilateral creditors providing relief on debts owed to them, and the Paris Club providing up to 80 per cent relief on bilateral debts, with other creditors being encouraged to provide equivalent relief. The burden of the relief is shared between creditors in a way which maintains their proportional claims.

31. The HIPC Initiative was welcomed as a major step forward at the time it was agreed in 1996, for several reasons. The Initiative was the first recognition by multilateral institutions of the need for their involvement in the reduction of unsustainable debt [65], and for the first time provided a comprehensive framework for debt relief, which appeared to encompass both bilateral and multilateral creditors[66]. Debt relief would be based in principle on the debtor's ability to pay, rather than the willingness of creditors to finance relief, and there was a clear emphasis on sustainability. Estimates of the ability of debtors to service their loans would include consideration of vulnerability factors such as single-commodity dependency, in addition to financial criteria[67]. Finally, the Initiative was accompanied by promises that poverty reduction would be taken into account alongside fiscal and monetary performance in conditionality attached to the relief.

Progress to Date of the HIPC Initiative:

32. The Chancellor proposed a time-frame for the implementation of the HIPC Initiative in his Mauritius Mandate[68]:

(a) Every eligible poor country should at least have embarked upon the process of securing a sustainable exit from their debt problems by the year 2000;

(b) Firm decisions should have been reached on at least three quarters of those countries concerning the amount and timing of relief by 2000

These targets have been welcomed by NGOs. Jubilee 2000 Coalition, for example, describe the Mandate as "an important marker"[69].

33. So far, 25 of the 41 heavily indebted poor countries have embarked on the process of securing debt relief. In order for the Chancellor's target to be met, a further six must embark on the process before 2000.

34. To date, six HIPCs have confirmed completion points (Bolivia, Burkina Faso, Côte d'Ivoire, Guyana, Mozambique, Uganda), which will lead to debt relief of US$5650 million in nominal terms (US$ 2950 in NPV terms)[70]. Uganda was the first country to benefit from the Initiative, receiving nominal debt relief of US$ 650m, equivalent to about 20 per cent of Uganda's total debt, in addition to relief provided by the Paris Club. It is expected that a further 14 countries will require relief under the Initiative. If the target of three quarters of all eligible countries having confirmed completion points by 2000 is to be reached, this will require the agreement of completion points for a further nine countries over the next eighteen months. Mr Robin Fellgett, HM Treasury, described the targets as "the best sort of targets, in that they are achievable but not easily"[71]. The Government estimate that a total of 14 countries will have reached decision points by 2000. This means that one additional decision point is required for the target to be reached.

35. The Mauritius Mandate provides a welcome impetus for the rapid implementation of the HIPC Initiative. The achievement of the targets will require the generation of sufficient political will in the international community for the original aim of the HIPC Initiative to be fulfilled: the provision of a sustainable exit from problems of unpayable debt. Despite the undoubted efforts of the Government, little has been achieved so far. The Government must continue to press for the rapid implementation of the Initiative at every opportunity.

36. During the two years since the agreement of the Initiative, serious shortfalls have come to light, and some organisations are now sceptical about the ability of the Initiative to achieve its original aim of providing a robust and sustainable exit from future debt negotiations. The shortfalls identified concern four broad areas:

(a) the number of countries eligible for relief under the Initiative,

(b) the timing of relief,

(d) mechanisms for sharing the burden of relief among creditors.

The Number of countries eligible for HIPC Initiative Relief

37. According to Jubilee 2000 Coalition, the Initiative is fundamentally flawed in that it excludes certain countries with an unsustainable debt burden. Jubilee 2000 Coalition have compiled a list of countries which they suggest should be eligible for HIPC relief, using an alternative set of eligibility measures, which include human development. These countries are listed in the memorandum from Jubilee 2000[72]. Their concern is shared by World Development Movement[73], who also highlight the absence of this issue from the Mauritius Mandate.

Rules Governing the Amount of Relief Provided

38. Only debt incurred prior to an agreed "cut-off date" is eligible for relief from the Paris Club and under the HIPC Initiative. This date is set at the time of the approach of the debtor country to the Paris Club. In the Mauritius Mandate, the Chancellor called for the inclusion of post cut-off date debt in relief packages "where necessary"[74]. We welcome this demand, however it does not go far enough. In order to ensure fairness to all debtors, we recommend that the Government advocate the movement of the cut-off date for all recipients of relief, from the time of the approach of the debtor to the Paris Club, to the time an agreement is reached concerning the exit ratios and timing of relief. This would serve the dual purpose of providing increased relief and acting as an incentive for negotiations to proceed without unnecessary delay.

Sustainability Ratios

39. The amount of relief provided under the HIPC Initiative is dictated by calculations of sustainable exit ratios by IMF officials. Exit ratios are calculated on a case-by-case basis, and fall within the range of a ratio of NPV of debt to exports of 200-250 per cent, and debt servicing to exports of 20-25 per cent, or NPV / Revenue of 280 per cent for countries with increased dependence on export revenues, such as Côte d'Ivoire. Jubilee 2000 Coalition and others[75] argue that the sustainability ratio ranges are too high and lead to a failure to provide sufficient relief to achieve debt sustainability. Christian Aid cite the World Debt Tables 1993-94, which stated that a debt to exports ratio above 150 per cent was unsustainable[76]. The increase in estimates of sustainable debt levels has the effect of reducing the amount of debt relief provided, and some witnesses argue that this increase has been implemented in order to reduce the contributions of creditors to debt relief[77]. Oxfam suggest that sustainability ratios should be reduced to between the range of 100 to 150 per cent NVP to exports ratio, and 10 to 15 per cent debt servicing to exports. Shriti Vadera, Executive Director, SBC Warburg Dillon Read, told us that "the sustainability ratios which are being considered are certainly not viewed as attractive by foreign investors"[78]. David Watkins of Oxfam said that "reducing the debt service ratio of a country like Mozambique or Ethiopia to 20 per cent in a sense is an abuse of the term "reduced" because they have not actually been paying more than 12 per cent or 14 per cent as it is" [79]. The Chancellor told us that the potential benefits of debt relief can only be realised if a sustainable economic solution is provided[80]. We are concerned that the sustainability ratios which are currently being applied will not provide an economically sustainable solution.

40. In addition, we are concerned that the result of the HIPC Initiative will not be developmentally sustainable, because the domestic spending needs of debtor governments in areas such as health, education and social sectors are not taken into account in assessments of debt sustainability. Both of the measures used cover external government debts, and do not include other liabilities which impact upon the ability of the government to service the debt. Domestic debt is excluded[81], yet the level of domestic debt has clear implications for the sustainability of external debt. The majority of Kenya's debt, for example, is not external but internal, and this has clear implications for the sustainability of Kenya's external debts. Rwanda's external debt is around US$ 1 billion, and in addition to this, domestic debt of US$ 223 million is owed[82]. We are concerned that this will not be taken into account in assessments of Rwanda's ability to sustain debt under the HIPC Initiative. Furthermore, for countries which do not qualify for relief under the fiscal sustainability criteria, fiscal revenue is not taken into account. These exclusions, in addition to the exclusion of other liabilities such as private debt, which affect the ability of the debtor to service its debts, could lead to over-estimations of the ability of the debtor to repay debts. We recommend that the Government press for the inclusion of liabilities other than external debt in calculations of debt sustainability. In particular, domestic debt must be included.

41. Vulnerability criteria feature in calculations of debt sustainability in an unregulated way, and the application of the criteria remains unclear. Calculations are not published, and this has led to suspicion among observers concerning their application. For example, David Woodward claims that "the lack of transparency in the application of the vulnerability criteria was exploited to set the NPV/export thresholds for Uganda and Bolivia at exactly the levels below which burden-sharing problems would arise, apparently to avoid a dispute between the multilateral agencies and the Paris Club"[83]. Whether or not this is the case, it is clear that the lack of transparency in the application of vulnerability criteria makes scrutiny of the process impossible. We recommend that the Government argue for the publication of calculations of debt sustainability, showing how vulnerability criteria have been applied.

42. The IMF are responsible for calculating sustainable exit ratios. This has been contested on the basis of two arguments. First, the role of the IMF has traditionally been focussed on short-term activities, which casts doubt on whether it is the appropriate body to make long-term estimations of debt sustainability[84]. Secondly, Jubilee 2000 Coalition argue that the IMF as a creditor should not have responsibility for dictating sustainability ratios because it is not independent. Instead, an independent body should be responsible, or alternatively, a board comprising nominees of the debtor and creditor. The Government has argued for "a stronger debtor voice in negotiations that today seem too often to be concluded behind closed doors"[85]. We agree. It is particularly important that debtors play an active role in assessments of the sustainability of their debt, and also in the design of conditions attached to debt relief, which we discuss below.

Timing of Relief Under the HIPC Initiative

43. Paris Club debt relief is conditional upon the completion of a three year programme of structural adjustment. Debt relief under the HIPC Initiative is conditional upon the completion of two three-year programmes. The purpose of this requirement is to avert "moral hazard". Moral hazard refers to the argument that debt relief should not be given to a debtor that pursues economic policies which will prevent any benefit being reaped, and that debt relief must not be perceived to reward countries which have failed to display financial prudence. The six-year requirement is one of the key criticisms of the Initiative levelled by NGOs and academics. For example, David Woodward claims that the requirement represents "a deliberate delay in the potential benefits of the HIPC Initiative" [86], and argues that the process must be accelerated as an immediate priority[87]. Oxfam say the time-frame is "overly long"[88], and that it must be reduced from six to three years, in line with the Paris Club requirement[89]. The Bretton Woods Project, CAFOD, Jubilee 2000 Coalition and Christian Aid also advocate a reduction in the track record requirement. We agree that the six year track record requirement is too long, and that three years would be an adequate amount of time to avert moral hazard. Not only does the delay in receiving debt relief, resulting from the six-year track record requirement, lead to further economic damage[90], but also to an increase in the cost of providing relief, because the amount of debt owed increases due to interest and further loans, and the capacity of the debtor to pay is reduced as a result of the continued presence of the debt overhang. Furthermore, the implementation of a six-year track record requirement does not address the fundamental issue, which is whether the conditionality achieves its aims, and whether genuine policy changes are adopted as a result of conditionality. These issues concern the nature of the conditions, and the length of the period of conditionality is not the key factor, as we discuss below.

44. Some flexibility has been evident, for example, Uganda received relief in April 1998, following first and second stages of one year each, in recognition of a decade track record of structural adjustment. Gordon Brown told us: "it would not be the best idea for us to re-open the question of the qualifying times as the stipulated dates are given, but I think you can see from the way the process has worked that where countries have become part of the process there has been a willingness to consider completing it in a far earlier time than six years"[91]. We welcome assertions made by the Government that the HIPC Initiative must be implemented as rapidly as possible. We are concerned, however, that flexibility in the application of the present rules of the Initiative will not be the most appropriate way to ensure rapid and effective implementation. There are conflicting arguments surrounding flexibility. Some claim that flexibility within the HIPC framework makes it vulnerable to political manipulation. For example, in their submission to this inquiry, Oxfam argue that there is "enough flexibility within the case-by-case approach to allow opponents of debt relief to obstruct implementation"[92]. On the other hand, some organisations advocate increased flexibility in the timing of relief under the Initiative to take account of the particular circumstances of debtors, for example the World Development Movement[93].

45. Kevin Watkins, Oxfam, argues that this issue is secondary to a question of political will, pointing out that: "there are advantages to flexibility in any framework if that framework is applied with imagination and commitment to addressing the problems which the framework is intended to address ... the bottom line is that however you cast the rules, if you do not have the political will to make this work, then frankly you can forget it"[94]. We believe that flexibility is a positive approach only to the extent that it is applied in a positive way. For example, during our visit to Uganda, we were told that Uganda's debt relief would not be front-loaded in its delivery. Front-loading skews the relief so that more is provided early in the period of relief. Since our return, it has been agreed that Uganda's debt relief will be front-loaded, resulting in additional transfers of around US$14 million in 1998, and US$20 million per year for the following two years[95]. We welcome the positive exploitation of flexibility in favour of Uganda in this instance, however as a more general point, the lack of transparency in the HIPC process has led to some suspicion concerning the flexible application of the time frame. For example, CAFOD, Christian Aid and others claim that Uganda's debt relief was delayed by one year, with the completion point having been expected in April 1997 in view of Uganda's extensive track record of structural adjustment and reform[96]. World Bank officials in Uganda told us that no such delay had taken place. Whether or not there was a delay, this highlights the need for transparency, as the secrecy which surrounds debt relief agreements has led to uncertainty and has ultimately damaged the credibility of the Initiative. If it is to work, the Initiative must not only be technically and economically workable, but it must be perceived to be credible by debtors, creditors, and outside observers. The Government has called for increased transparency in the process[97]. We welcome this, and argue that the secrecy now shrouding the process has led to many of the weaknesses of the Initiative.