The debt crisis started in August 1982 when Mexico informed its creditors that it was unable to service its vast foreign debts. Since then a series of countries have experienced profound difficulty in servicing their external debts, with dire consequences for their social and economic development. With their creditworthiness damaged these countries have experienced difficulty in attracting foreign capital to support their programmes of economic reform. Over the years, a succession of debt relief plans has been devised to ease their debt burden.[140] These plans have had mixed results.

Officially the debt crisis was over in 1994, except for around 40 severely indebted countries, who mainly through poverty have been unable to service their debts.

The cancellation of unpayable debt of the heavily indebted poor countries has attracted a great deal of interest and is being promoted by some non-governmental organisations, especially Jubilee 2000 Coalition, as an appropriate way of celebrating the Millennium.

Basic Concepts

It is useful to describe some basic concepts that relate to third world debt.

Net Present Value

The concept of net present value is often used when dealing with debt relief. Net present value is the value now of a sum, or sums, of money arising in the future. A given sum of money is worth more now than in the future, both because of uncertainty and because it could be invested now to produce a greater sum in the future.[141] The present value of money in the future is calculated by discounting the future stream of money by a rate of interest equivalent to the rate which it could obtain if invested.[142] Thus £105 in a year's time has a present value of £100 with the interest rate at 5% per annum. In terms of debt, the present value of the debt represents the sum of money that would be needed now to meet the future stream of interest and principal repayments. In short, it is the sum that is required to be invested at the prevailing interest rates in order to generate the equivalent sum to match fully the debt payments over future years.

External Debt

There are a number of different ways of categorising external debt: official or private sector debt; short or long term; and bilateral or multilateral. Debt may also be classified as overseas development assistance debt, which refers to loans provided at very concessional rates for developmental purposes or debt provided in the form of non-bank export credits, which are claims against the indebted country for insured exports. Debt could also be classified as OECD or non-OECD country debt.[143]

The figures on external debt for developing countries are notoriously imprecise, with debtors and creditors sometimes disagreeing on the amounts owed. However, perhaps the best sources of information on the external debt position of countries are the World Bank's publication, Global Development Finance and the OECD's publication, External Debt Statistics.

Classifying Debtor Countries

The World Bank's Debtor Reporting System (DRS) collates data from 136 low and middle income countries. These countries are classified according to their level of indebtedness using both the ratio of present value of total debt service to GNP and the ratio of present value of total debt service to exports. These two ratios help to assess a country's capacity to service its debt. This is because exports provide the necessary foreign exchange to service the external debt and GNP is the broadest measure of income generation in an economy.[144]

If either of these ratios for a particular country exceeds a critical value - 80% for the present value of debt service to GNP and 220% for present value of debt service to exports - the country is classified as severely indebted. A country that has ratios that do not exceed the critical values but has at least one ratio which is three-fifths of the critical value (i.e. 48% the present value of debt service to GNP and 132% for the present value of debt service to exports), is classified as moderately indebted. If both ratios are below the three-fifths value, the country is classified as less indebted. Countries are further classified as low income if 1995 GNP per capita is $765 or less and as middle income if 1995 GNP per capita is more than $765 but less than $9,386.[145]

Combining these criteria allows the following classifications. The numbers in brackets for each category show the number of countries within the World Bank Debtor Reporting System (DRS)[146] and non-DRS countries. For example, there are 38 SILICs, of which all but one provide data to the World Bank.

SILICs: severely indebted low income countries (37+1);

SIMICs: severely indebted middle income countries (12+2);

MILICs: moderately indebted low income countries (12);

MIMICs: moderately indebted middle income countries (19+2);

LILICs: less indebted low income countries (11);

LIMICs: less indebted middle income countries (43+9);

Although these categories are based on a few debt indicators they nevertheless provide a useful way of classifying countries.[147]

Heavily Indebted Poor Countries

Heavily Indebted Poor Countries (HIPCs) is another category that has recently been devised by the international financial community. 41 countries are classified as HIPCs of which 32 are classified as SILICs, seven have received concessional treatment from the Paris Club,[148] and two are lower middle income countries that have become International Development Association (IDA) only countries (Angola and Congo).[149]

The full list of HIPCs is: Angola, Benin, Bolivia, Burkina Faso, Burundi, Cameroon, Central African Republic, Chad, Congo, Cote d'Ivoire, Equatorial Guinea, Ethiopia, Ghana, Guinea, Guinea-Bissau, Guyana, Honduras, Kenya, Laos, Liberia, Madagascar, Mali, Mauritania, Mozambique, Myanmar, Nicaragua, Niger, Nigeria, Rwanda, Sao Tome and Principe, Senegal, Sierra Leone, Somalia, Sudan, Tanzania, Togo, Uganda, Vietnam, Republic of Yemen, Zaire, and Zambia.

Jubilee 2000 Coalition, the non-governmental organisation that has been campaigning for the cancellation of unpayable debt of the poorest countries by the year 2000, has produced a list of 52 eligible countries: the 41 HIPCs plus 11 others.

Foreign Debt Burden of Developing Countries[150]

Table 1 shows the total foreign debt, the foreign debt as a percentage of GNP, and the foreign debt service (interest and amortisation payments on the debt) as a percentage of exports for all developing countries, for developing countries in each geographical region and for the severely indebted countries for four years. The figures for 1980 show the position before onset of the debt crisis, 1990 is a little after the height of the debt crisis and 1995 and 1996 are the latest years that figures are available.

The table shows that total foreign debt of all developing countries was $616 billion in 1980, of which $257 billion related to the debts of Latin America and the Caribbean countries and $84 billion was owed by Sub-Saharan Africa. Total debt levels increased sharply to $1,480 billion

by 1990 and have increased further to $2,177 billion in 1996.[151] In 1996 the total external debts of Latin America and the Caribbean amounted to $657 billion whereas the debts of Sub-Saharan Africa were $235 billion.

In terms of sustainability, the table 1 shows that total foreign debt as a percentage of GNP increased sharply between 1980 and 1990, especially for severely indebted countries. The ratio increased to 1995 for all developing countries, but the only regions showing an increase in this period were Europe and Central Asia and Sub-Saharan Africa.

Foreign debt service as a percentage of exports increased from 1980 to 1990 for all developing countries generally, although severely indebted middle income countries showed a decline. More recently sustainability has tended to improve for all categories except for the severely indebted middle income countries.

In terms of the debt/GNP ratio, the most indebted geographical region is Sub-Saharan Africa but the position of all areas has deteriorated since 1980. A regional breakdown of the debt figures is also provided. For convenience the position of the heavily indebted poor countries is also shown at the bottom of the table.

Forms of Debt Relief

Debt relief can take a number of forms ranging from increasing the repayment period while not providing any financial concessions through to outright debt cancellation. The main forms by which debt relief are arranged are rescheduling, refinancing, buy back and debt cancellation.

Debt Rescheduling

Under debt rescheduling, debt payments are deferred. The debtor country pays interest on the amount rescheduled (unless the initial loan was interest free). This rescheduling may be on concessional or non-concessional terms and will usually form part of a multilateral package of debt rescheduling. Under non-concessional rescheduling the debtor is simply given more time to pay, in much the same way that the period for repaying a mortgage may be extended. Under such an arrangement the net present value of the debt is not reduced. With concessional rescheduling the net present value of the debt is reduced as a lower interest rate is renegotiated.

Debt Refinancing

Debt refinancing is where new money is provided as either a grant or a loan to a country in order that it can repay what it owes. This may or may not be provided on concessional terms.

Debt buy back

Debt buy back is a form of debt relief whereby donors purchase all or part of a debtor country's outstanding commercial debt from its creditors at an agreed (reduced) settlement price.

Debt Cancellation or Debt Forgiveness

Debt cancellation or debt forgiveness is a specific and highly concessional form of debt relief. With cancellation the level of the official debt is reduced in net present value terms. With total debt cancellation, of course, all eligible debts are reduced to zero.

Debt Default

This is where a country fails to pay. The guidelines[152] from DfID state that the UK policy is not to countenance this form of debt relief.

In short, concessional debt relief reduces debt in net present value terms whereas non- concessional debt relief does not. Concessional debt relief may be provided in the form of a lower rate of interest and/or some cancellation of the stock of debt. An outline of successive debt relief plans is set out below.

The UK provided £51.3 million in the form of total debt relief in 1996/97.[153] However, it should be pointed out that this figure is not necessarily the same figure as that which affects the Exchequer.

Outline of Successive Debt Relief Plans

The following section outlines the various approaches to providing some relief on official bilateral debt.

Bilateral Official Debt

In the UK there are two main forms of bilateral official debt; aid debt which has been provided by DfID and debt that represents an outstanding claim held by the ECGD. The vast majority of bilateral debt with HIPCs relates to outstanding claims held by the ECGD. DfID assistance is generally provided in the form of grants and what aid debt there was has generally been forgiven over the years as it fell due.

In terms of debt relief, there are a number of ways in which debtor countries have in the past been able to gain some relief from the burden of their bilateral official debts. For example, some relief has been provided by refinancing which, as noted above, means that new money is provided as either a grant or a loan to a country in order that it can repay what is owed. A debtor may also benefit from rescheduling whereby more time is given to pay. Under non-concessional rescheduling, the debtor is given more time to pay but the net present value of debt is not reduced. Rescheduling is usually part of a multilateral package of debt relief that is agreed with other government creditors through the so-called Paris Club.

Official bilateral debts are reorganised in the Paris club of official bilateral creditors. The Paris Club has devised a number of arrangements for reducing and rescheduling the debt of the poorest, most indebted countries. The different approaches are outlined below.

Toronto Terms

The Toronto Terms, which were adopted in 1988 following the Toronto (G7) summit, allow eligible countries to receive a reduction of 33 per cent in their payments due over the agreed consolidation period (usually an IMF programme). The remainder is rescheduled at a commercial interest rate over 25 years.

Trinidad Terms/ London Terms

In 1990, John Major proposed that all countries eligible for Toronto Terms and with a proven record with the IMF, could have their stock of Paris Club debt reduced by 67%. In December 1991, the Paris Club creditors adopted a modified form of these proposals. Debt relief on payments falling due over the agreed consolidation period would be increased to 50 per cent, with a commitment made by creditors to consider action on the whole of the stock of a country's debt after a period of three to four years. This would be subject to the debtor government achieving a good record of economic and financial responsibility. These terms are known officially as the London Terms but are also known as the Modified Trinidad Terms or Enhanced Toronto Terms. For example, on 23 July 1992 Zambia was granted enhanced Toronto terms. The agreement was to run for 33 months with some $793 million of debt to be consolidated.

Naples or Full Trinidad Terms

The Paris Club agreed Naples Terms in July 1994 following the Naples (G7) Summit. Naples Terms superseded Trinidad Terms and provide up to 67% debt relief. They also introduced the option of a one-off reduction of 67% in the stock of official bilateral debt owed by the poorest, most indebted countries with an established track record of economic reform and debt servicing. Under the terms there was the possibility of a 67% reduction in the stock of debt for the eligible poorest, most indebted countries, that is, those that continually complied with IMF programmes and Paris Club agreements for three years. Countries with per capita income of $500 or less or with a debt (in net present value terms) to export ratio of 350 per cent or more. These countries would be accorded a 67 percent reduction in debt or debt service.[154]

The aim of the rescheduling is to provide an exit from the unsustainable burden of external debt so that the debtor country is left with a manageable level of debt. The remaining eligible poorest, most indebted countries will be accorded a 50 per cent reduction. In February 1995 Uganda became the first country to be offered a 67 per cent reduction on the bulk of its eligible debt stock. Loans provided as part of official aid are rescheduled rather than reduced under Naples terms.[155]

In the Paris Club the UK has forgiven and rescheduled officially guaranteed export credits on Toronto, Trinidad and Naples terms.

Enhanced Naples Terms

Under the Heavily Indebted Poor Countries (HIPC) Initiative, Paris Club members have agreed to increase the amount of debt relief to eligible countries to up to 80%.

Houston Terms

Houston Terms apply to lower middle countries and do not involve any debt reduction as such. Eligible countries are provided with a more generous repayment period. Instead of a conventional 10-year repayment period, including a grace period of 5 years, the Houston Terms usually allow for a 15-year period, including a grace period of 8 years.[156]

Multilateral Official Debt

Heavily Indebted Poor Countries (HIPC) Initiative

The process of devising debt relief mechanisms resulted in September 1996 in the establishment of an initiative to help Heavily Indebted Poor Countries (HIPCs) by reducing their debt burdens to sustainable levels; a level of debt they can afford to service. The HIPC extends to multilateral debt.

Around 20 poor countries stand to benefit from debt reduction under the initiative. Under the HIPC, countries are required to demonstrate over a period of years a track record of their ability to continue with economic reform backed by the IMF. Typically HIPCs have to wait six years to get the relief that they need. In the view of the UK government, a strict interpretation of the rules would mean that the earliest any HIPC candidate would have seen relief would have been autumn 2002.

Mauritius Mandate

In September 1997 Gordon Brown proposed at the Commonwealth finance ministers' meeting in Mauritius that the international community should work to deal with the debt problem once and for all. Under the plan, all eligible countries should be embarked on the process of securing the necessary debt relief by the year 2000 and, that by that date, at least three-quarters of the countries that required HIPC debt relief would have secured decisions on its size and terms.

141   It is sometimes thought that a given sum of money is worth more now than in the future because of inflation. However, this is not the issue. The concept of net present value would be relevant even in a world free of inflation.  Back

142   The rate of interest used is more precisely called the discount rate. Back

143   In 1996 Russia became a member of the Paris Club of creditor countries. Russia and the Arab countries are non-OECD creditors.  Back

144   See Global Development Finance, 1997 appendix 1 Back

145   ibid. Back

146   The number of DRS countries is based on 1992-95 data. Back

147   A full listing of the classification is given in Global Development Finance 1997, table A1.2 Back

148   The Paris Club is the collective term for about 20 creditor countries, which meets to negotiate debt relief with debtors. The Paris Club is served by staff from the French treasury. The operations and discussions at the Paris Club are somewhat secretive. Different creditor countries will meet, depending upon on whether they have any bilateral debts with the debtor country at the time. Decisions are reached by consensus. Each member of the negotiating team has a veto.  Back

149   "IDA only" means the countries are not able to borrow from the IBRD. Although the World Bank has classified 41 countries as HIPCs, it can also be argued that 4 countries (Nigeria, Liberia, Sudan and Somalia) have such unreliable figures that no assessment has been made. This paper uses the figures for 41 HIPCs unless otherwise stated. IDA is the highly concessional wing of the World Bank. Nigeria is excluded from the aggregate data in the World Bank tables because it is not an IDA-only country and has never received concessional debt rescheduling. Back

150   Figures from Global Development Finance, 1997.  Back

151   1996 are preliminary figures. Back

152   DfID Office Instructions vol. II:B.1 Back

153   Detailed figures showing UK debt relief over successive years are set out in British Aid Statistics. Back

154   World Debt Tables 1994-95, vol. 1, p5-6.  Back

155   Evidence from DfID to International Development Committee. Back

156   More technical details are given in Global Development Finance, volume 1.  Back