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close this bookPutting Life Before Debt (CI - CIDSE, 1998, 38 p.)
close this folderPART II: Reducing Debt
View the documentEarly Attempts to Reduce Debt
View the documentHeavily Indebted Poor Country (HIPC) Initiative
View the documentShortcomings of the HIPC Initiative

Early Attempts to Reduce Debt

Mexico's announcement of a unilateral moratorium on its debt repayments was a shock to the financial community. It galvanized citizen's groups - churches, NGOs, and others who experienced the impact of the debt crisis - to step up their advocacy on debt. In response, the major creditors - commercial banks, governments (also known as bilateral creditors,) and international financial institutions - sought new ways to address the problem.

Commercial banks: Through the Brady Plan of 1989, commercial banks reduced about twenty percent of the commercial debt owed by middle income debtor countries (commercial debt of Mexico, Brazil, Argentina, Costa Rica, Morocco, the Philippines, and Peru was reduced by about 35%). In the process, the banks were supported by guarantees from governments and international financial institutions, in effect shifting the credit risk from commercial to bilateral creditors.

Bilateral creditors: The bilateral creditors fall into two categories: Paris Club and non-Paris Club. The Paris Club is primarily the group of wealthy donor nations which also belong to the Organization for Economic Cooperation and Development (OECD). The non-Paris Club major donors include Eastern Europe, the former Soviet bloc (with the exception of Russia, a new member of the Paris Club since 1997), and the Arab states.

Bilateral creditors were the first to provide debt relief in the early 1980s. Today, the Paris Club provides qualifying countries with some reduction or rescheduling of debt. The criteria are strict, but if a country qualifies, it can get a 67% reduction of a portion of its outstanding debt, up to 80% under the Heavily Indebted Poor Country Initiative. The portion of the debt eligible for reduction is that which:

· has not previously been rescheduled
· is not concessional
· was incurred prior to the cut-off date - the date when the country first requested assistance from the Paris Club. For most countries, the cut-off date is in the early 1980s. The debt incurred since then is ineligible for relief.

Often, the net result is that debt relief is insignificant. (Note: non-Paris Club donor nations have on occasion provided relief on Paris Club terms.)

International Financial Institutions: The international financial institutions include the World Bank, International Monetary Fund (IMF), and regional development banks. They are governed by member nations, virtually every nation in the world. These institutions raise the majority of their capital on international financial markets at very favorable conditions because of their triple A rating - a rating received because their borrowing is guaranteed by all the member nations. Because the international financial institutions offer the best terms available and have been given a special role in the international financial system, they insist on preferred creditor status, which means that they must be paid back prior to other creditors. If the debtor country does not make payments on its loans on time, it is considered off track and will ordinarily not receive loans from other creditors.

Until the HIPC Initiative was approved in 1996, the international financial institutions would not allow rescheduling or cancellation of their loans - although in practice they did so by enabling countries to pay off old loans by taking out new ones at lower interest rates and longer terms.

Heavily Indebted Poor Country (HIPC) Initiative

In October 1996, the World Bank and IMF reached an agreement on the first ever comprehensive debt reduction plan to enable the debtor country to pay back its loans without compromising economic growth and without building up arrears again in the future. The initiative is designed to reduce the multilateral, bilateral, and commercial debt of HIPCs over a period of about six years to a sustainable level, a level at which the country is considered able to make debt payments.

As a condition of debt relief, the country has to implement SAPs approved by the World Bank and IMF. The HIPC Initiative allows some flexibility so that a country that exceeds the eligibility criteria established by the World Bank and IMF by having already demonstrated a record of reform, might get relief in a shorter time.

Under the initiative, after the eligible country has established a track record of economic reform over a period of three years, the Paris Club creditors provide a 67% reduction in eligible debt stock. This point is called the decision point. All other creditors (non-OECD bilateral creditors and commercial banks) are supposed to provide comparable reductions6. If these actions do not result in a sustainable debt, the country moves to the second three-year stage, during which time it might get support from the international financial institutions for economic reform and poverty reduction. At the end of six years, provided the country has established an acceptable track record by implementing required economic reforms, it will receive up to 80% reduction in eligible Paris Club debt stock. This point is called the completion point. The second period of three years might be shortened for countries which already have a track record of strong performance. At the completion point, the multilateral creditors provide debt relief only if all other reductions are not enough to reduce the country's debt to a sustainable level.

Shortcomings of the HIPC Initiative

Too few countries eligible. There are 41 countries classified by the World Bank as HIPCs, yet only a few will get relief through the HIPC Initiative as it is currently designed. Like Paris Club debt relief, qualifying for HIPC is difficult and countries that do qualify will likely find its impact limited. For example, Nicaragua may not qualify for relief under the HIPC Initiative because of its poor track record in carrying out structural adjustment programs. To qualify, Nicaragua would have to start an economic reform program which would likely require drastic cuts in government expenditures. Such reductions in a country still recovering from civil war and considered the second poorest country in the hemisphere would be devastating for its people, far worse than the benefits that a small amount of debt relief would bring.

BOX 2:

COUNTRIES ELIGIBLE FOR HEAVILY INDEBTED POOR COUNTRY INITIATIVE

HIPC

Expected
Decision point

Expected
Completion point

Uganda

April 1997

April 1998

Bolivia

September 1997

September 1998

Burkina Faso

September 1997

September 1999

Cote d'Ivoire

1997

2000

Mozambique

1997

1999

Guyana

1997

1998

Source World Bank IMF (through Eurodad)

BOX 3:

QUALIFYING FOR HIPC INITIATIVE IS DIFFICULT AND RELIEF INADEQUATE

To qualify, countries must be:

IDA-only and heavily indebted. IDA-only means the average annual per capita income of the country must be less than US $900. Most highly indebted countries have average annual per capita incomes under US $400.

Have a strong track record of performance under an IMF-supported structural adjustment program. If the country strays, it has to wait longer for relief.

Exhaust all existing debt relief mechanisms without reaching a sustainable level of debt. Sustainable means: I) the Net Present Value of the country's debt does not exceed 200-250% of its annual export earnings; and 2) the country's annual debt service does not exceed 20-25% of its annual export earnings. Specific targets within these ranges are determined on a case by case basis.

Too little relief: Bilateral and multilateral creditors are not writing off debt, rather, they are raising money to pay for debt reduction. As a result, they want to minimize its cost. Some powerful G-7 countries, as well as some middle income countries that are unlikely to be eligible for HIPC debt relief, have not committed sufficient resources to bilateral debt relief. The IMF will provide multilateral relief only through an existing fund, the Enhanced Structural Adjustment Facility. The World Bank, on the other hand, has set aside $2 billion for debt relief - an important commitment - but will release it only after bilateral creditors show their financial commitment by contributing to a separate debt relief fund.

Narrow definition of debt sustainability: The HIPC Initiative is designed to restore the debtor country's ability to repay its loans. The amount of debt considered sustainable was decided by looking at what middle income Latin American countries actually paid to service their debt. The concept did not take into account the fact that many Latin American countries paid their debt at the expense of the welfare of their people, paying more than they should have. The percentage of exports that went to debt service then became the standard for what low income countries were considered able to pay.

Too long a wait: Eligible countries have to establish a track record of economic reform for at least three years before receiving bilateral relief and six years before receiving multilateral relief.

Connection with structural adjustment policies (SAPs): The HIPC Initiative requires countries that want debt relief to carry out SAPs. SAPs can reform economies in positive ways but can also contribute to poverty.

Arbitrary cut-off dates for Paris Club relief: The cut-off date is the date the country first requests assistance from the Paris Club. Debt that builds up after this date is not eligible for reduction under the HIPC Initiative.