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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.