[stop-imf] IMF and WB on 100% Debt Cancellation

[Robert Weissman]

From=20the IMF website at:
http://www.imf.org/external/what/what.htm
Posted July 10th.

(forwarded from change-imf list)


Debt Relief under the Heavily Indebted Poor Countries (HIPC)
Initiative
A Factsheet

The IMF's Poverty Reduction and Growth Facility (PRGF) A
Factsheet

01/07

100 Percent Debt Cancellation? A Response from the IMF and the
World Bank

By IMF and World Bank Staffs July 2001

Contents

I.   The strategy for reducing poverty
II.  The HIPC Initiative: What has been done?
III. Total debt relief by multilateral institutions
     -Would it help the attack on worldwide poverty?
IV.  Maintaining the Capacity to Finance Development
V.   The Way Forward


At the close of the last millennium, the international community
succeeded in achieving an ambitious and important goal in our
shared fight against poverty. In 1999, we committed ourselves to
"deeper, broader and faster" debt relief to every eligible country
which could translate the resources into better prospects for its
poor. By the end of June 2001, agreements were in place-with relief
flowing-to 23 countries, 19 of them in Africa, for debt service relief
amounting to some $34 billion. And we are committed to helping
the remaining HIPCs do what is necessary to access debt relief
under the Initiative.

The progress to date is a crucial step in the fight against poverty,
but much more needs to be done. The deep concerns of civil
society in many countries helped to spur the international
community to action in the HIPC Initiative. Now some debt relief
campaigners are calling for a complete cancellation of all HIPC
debts. Some are focusing their efforts on the international financial
institutions. Is this really the best way to ensure that resources are
available to attack poverty and promote development in the low-
income countries?

This note considers the implications of proposals to cancel 100
percent of multilateral debt. First, it sets debt relief in the context of
a broad strategy to fight poverty. Second it looks at the existing
approach to poor country debt relief through the HIPC Initiative.
Third, it turns to the fundamental question of what would be gained
by such a proposal. Finally, the implications for development
finance are looked at, including who would end up paying.

I. The strategy for reducing poverty

Many factors contribute to poverty in developing countries:
economic and political history, poor economic management, weak
governance, armed conflict and such external factors as
deteriorating terms of trade and climatic problems. In about half of
the 80 poorest countries, unsustainably high external debt has also
become a key constraint on development.

Reducing world poverty is today's central development challenge.
To do this we need to follow through on a comprehensive strategy
to reduce poverty, based on the twin pillars of home-grown efforts
by all the HIPCs to create the basis for sustained pro-poor growth,
and on more decisive support from the international community.

Africa's leaders have reaffirmed their countries' responsibility to
address the local obstacles to poverty alleviation. They recognize
the importance of sustaining reform to avoid unsustainable debt
burdens, and to restore investor confidence. Their efforts should
focus on implementing national poverty reduction and growth
strategies. This means creating delivery capacity for social policy,
better expenditure management, and the many other elements of
economic, social, political and institutional reform. For its part, the
international community must respond by providing more official
development assistance on appropriate terms, opening markets for
poor countries, assisting with building capacity, and providing well-
targeted debt relief.

The HIPC Initiative should be seen as part of this comprehensive
approach. It is removing debt as a constraint in poor countries'
struggle against poverty. It sets the stage for determined countries,
supported by the international community, to overcome other
constraints to exiting from poverty.

II. The HIPC Initiative: What has been done?

The agreements in place for the 23 countries mentioned above,
with other sources of debt relief, reduce their total debt by two-
thirds, bringing their indebtedness to levels below the average for all
developing countries. Cash debt service savings in these countries
are also substantial-about US$1.1 billion annually in the next three
years. Debt service payments as a percentage of exports, GDP
and government revenues will fall dramatically.

This is real progress. One important reason the Initiative is working
is that, for the first time, debt relief is delivered within a framework
that is transparent and comprehensive, and that, crucially, provides
for equitable participation by all parties. Also unique, is that relief is
delivered only to those countries which have demonstrated the
commitment and capacity to use the resources effectively. These
principles reflect the fact that debt relief comes at a cost. In a world
of scarce development resources it is crucial to ensure that debt
relief will actually make a difference in the lives of the poor.

These countries have been receiving an average of about $10 billion
per year in grants and concessional loans. After HIPC debt relief is
taken into account, their debt service obligations will fall to less
than $2 billion per year (of which 10 percent is owed to the World
Bank and 12 percent to IMF). In addition, a number of creditor
governments have recently signaled their intention to provide
additional debt reduction beyond the HIPC Initiative. These are
welcome initiatives, although it is essential that the relief is not
offset by reductions in aid flows. The figures above illustrate the
importance of maintaining new flows of assistance if debt relief is to
add to poverty reduction efforts: a decline of just 10 percent in new
flows would wipe out the benefits of HIPC debt relief, and a total
cancellation of debt would be offset by a cut of 20 percent in aid
flows. Since total debt cancellation would require concerted action
by all creditors, many of which continue to provide assistance, total
cancellation would seriously jeopardize the overall flow of financial
support for the poorest countries.

III. Total debt relief by multilateral institutions-Would it help the
attack on worldwide poverty?

What is the argument for total debt cancellation? Some argue that
the further reduction of debt service obligations would allow the
HIPCs to make more poverty-related investments. But the HIPC
Initiative is already changing the picture. So far, after debt relief,
social expenditures in the 23 HIPCs mentioned above are projected
to rise by an average of some US$1.7 billion per year during 2001-
2002. Most of these resources will be directed toward health,
education, HIV/AIDS programs, basic infrastructure and
governance reform. And contrary to the statements of some debt
campaigners, HIPCs will spend on average much more-not less-on
priority social investments than on debt service. After HIPC relief,
these countries will spend about 2 percent of GDP on debt service-
well below the level in other developing countries-compared to
about 7 percent on social expenditures.

To be sure, the HIPCs have a continuing need for targeted
investment that benefits the poor. But the critical question is
whether complete debt cancellation is the most effective and
equitable way of supporting these efforts.

The debt reduction under the HIPC Initiative should be seen as a
one-time action, the first step toward enabling the HIPCs to stand
on their own feet. Their growth and poverty reduction strategies
need financial support, which for many will mean a need for a much
higher level of concessional official aid for many years to come. In
time, they will become able to gain access to private international
capital, including both direct investment and further borrowing.

Credit is an indispensable means of financing development, and for
decades has helped developing countries become active
participants in the global economy. It must, however, take place in
a climate of mutual trust. It should be on appropriate terms, it
should not be used to excess and must not be allowed to become
unmanageable for the debtor. Equally, creditors should have
confidence that loans can and will be repaid.

Some object to the very concept of poor countries borrowing for
their development. But borrowing remains a crucial part of external
assistance. In fact, HIPCs already receive significant net transfers
of assistance in the form of highly concessional loans, especially
from multilateral institutions. Most multilateral institutions,
including the World Bank through IDA and the IMF through the
PRGF, provide resources to poor countries through cooperative
arrangements on highly concessional terms. This is a unique
source of concessional finance for the world's neediest countries
which operates on the principle that developing countries borrow
from and pay back into the same sources of financing. The
preferred creditor status of the IMF, World Bank and other
international financial institutions ensures that they are able to
continue to provide financial support to their members on a
sustainable basis, even in very difficult circumstances.

Of course, good results from borrowing were not seen everywhere.
Some countries, for many different reasons, have not experienced
significant gains. In HIPCs, unsustainable debt is a result. The
international community has a collective obligation to address this
problem. The HIPC Initiative is doing this. But we must also be
there to support the future development needs for all countries.
That is why the goal of the Initiative is to help countries achieve
debt sustainability, and is focussed specifically on the most highly
indebted poor countries. Total debt cancellation for those countries
alone would come at the expense of other borrowing countries,
including those non-HIPCs which are home to 80 percent of the
developing world's poor. Those who call for 100 percent
cancellation for the HIPCs alone, must recognize that this would be
inequitable for other poor countries.

IV. Maintaining the Capacity to Finance Development

Supporters of 100 percent debt cancellation must be honest about
the costs. The total public external debt for low-income countries
stands at some $460 billion. HIPCs and many other poor countries
will rely on external financing for their development needs long into
the future. A growing portion of this need is being met by bilateral
and multilateral agencies on concessional terms. Total cancellation
could imperil these funds. It would also undermine the confidence
of existing and potential investors whose funds are vital for the long-
term development of the low-income countries.

Beyond the flows from bilateral donors, the only other concessional
financing comes from multilateral agencies, primarily the
multilateral development banks and the IMF. These concessional
flows are financed in two main ways: (i) budget allocations by
developed countries; and (ii) repayment of the concessional loans
made previously by these agencies. Of course, the community of
shareholders could make a special budget allocation to pay for the
cost of additional debt relief or new financing by the multilateral
agencies, but at present there is little support in donor countries to
do so. In these circumstances, what would be the effect on these
agencies of a complete cancellation of the debt owed to these
institutions?

IDA finances nearly half of its new commitments (about $6.5 billion
annually) from repayments and investment income. As IDA has no
provisions for losses arising on its credits to members, this means
that write-offs would be a direct dollar-for-dollar reduction in IDA's
ability to make future credits to poor countries. In effect, credits
would be cut in half. Alternatively, to maintain future IDA lending at
this level, contributions from the developed countries would have to
double, a response which seems highly unlikely.

The regional development banks (IDB, AfDB, AsDB) also have soft
lending windows, and face even greater constraints, since they are
also dependent on the contributions from the developed countries.
Indeed, the AfDB continues to face an uphill task in securing full
financing of its share of HIPC costs under the existing
arrangements. Total debt cancellation would likely cripple these
institutions.

The IMF's Poverty Reduction and Growth Facility is also funded by
contributions and borrowed resources. Although it is now close to
being a permanent facility, its future operations will be financed
purely by reflows. Debt cancellation would deplete the resources of
the PRGF Trust and force closure of the facility. No resources
would remain available for future concessional IMF lending, and the
IMF would have to withdraw from providing concessional support to
its poorest members.

But what of the nonconcessional resources of the multilaterals?
The question is often asked whether the "hard" lending facilities of
multilateral development banks and the IMF can pay for debt relief
provided by the "soft" lending windows-beyond the substantial
contributions to IDA & HIPC already being made from IBRD net
income. The fact is that the hard lending windows already use their
paid-in capital and reserves to underpin lending to developing
country members. Provisions are taken against expected losses
related to exposure on the balance sheets of multilateral
development banks, and cannot be used to write off losses on
other balance sheets without putting the institution at risk of going
out of business.

The IBRD's equity capital is leveraged at a rate of about 5:1 through
the issuance of AAA-rated debt. Therefore, its capacity to lend
would be reduced by $5 for every $1 distributed to debt relief in
respect of the concessional lenders' balance sheets. Furthermore,
it is likely that the write-off would result in a weaker equity capital
position for the Bank and therefore an increased cost of lending to
its borrowers. Debt cancellation, with substantially reduced
borrowing, at higher cost, would have a serious impact on IBRD-
eligible borrowers, which are home to 80 percent of the world's
poorest people.

The IMF: For the Fund, total debt cancellation in the absence of full
funding by bilateral donors would do serious damage by
fundamentally changing its role as an anchor for the international
financial system based on the revolving character of its resources.
Debt cancellation would not only eliminate PRGF lending, but also
impair the Fund's financial integrity. The IMF's gold reserves are a
fundamental strength in its financial position, giving it increased
credibility and the capacity to assist its broader membership in
crisis situations. The 1999 decision by the membership to use, as
an exceptional one-time measure, income from the investments of
the profits from limited off-market gold sales to help finance the
IMF's contribution to the HIPC Initiative had a substantial cost to
the institution and its members. Additional sales would put at risk
the confidence of members in the Fund's solidity, and thus its
ability to lend.

V. The Way Forward

We have made a great deal of progress in implementing the
enhanced HIPC Initiative, but there is much more to do. The next
challenge is to move forward with debt relief agreements for those
countries which have yet to qualify for HIPC relief because of
conflict or severe governance problems. With countries committed
to peace and stability, we believe HIPC relief can contribute to the
transition from conflict to sustainable development, and we hope to
move forward with these countries as swiftly as possible. But more
than just debt relief, we look forward to being there to support their
development over the long term.

We believe the best way for the international community to support
the poverty reduction strategies of the low-income countries is by
opening their markets to the exports of poor countries and by
increasing new concessional flows. Mr. K=F6hler and Mr. Wolfensohn
have indicated that they would gladly join a campaign to convince
industrial countries to move to the longstanding UN target for
official development assistance of 0.7 percent of GNP within ten
years. With current levels of foreign aid at some 0.24 percent of
GNP, the difference between the figures is worth $100 billion per
year, far more than the net flows generated by even the most
ambitious of debt relief proposals. This financing needs to be
complemented by greater access to industrial country markets so
that developing countries can earn their way in the global economy.
These are targets worth pursuing to achieve the International
Development Goals.