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Multilateral Debt Cancellation: a Briefing
by Sony Kapoor
Jubilee Research at the New Economics Foundation
For Debt and Development Coalition Ireland
December 2004
1. Background
Debt owed to the IMF, World Bank and other multilateral banks[1] has grown rapidly in recent years and these are now significant creditors of low income countries. Because there are serious consequences for countries which default on payments to these bodies, multilateral debt is the most onerous debt.Campaigns for debt cancellation through the 90s pressed for cancellation of debt owed to multilateral institutions. Partly in response to this, the World Bank and the IMF launched the Heavily Indebted Poor Country (HIPC) Initiative in 1996 and the Enhanced HIPC in 1999. This initiative aimed to enable countries to achieve debt sustainability but was very limited in what it actually achieved and defective in the way it did this. While it did result in some debt being cancelled, it was a far cry from the cancellation of unpayable debt called for by Jubilee 2000 debt campaign which aimed to give a fresh start to the new millennium to debt burdened countries.
Renewed calls for cancellation of unpayable multilateral debt were for many years ignored until public pressure has finally put it on the G-7 agenda. This is a belated recognition of the seriousness of the debt-poverty trap that many of the poorest countries in the world face. Various proposals for multilateral debt cancellation have now been put on the table by G7 countries - the UK and US.
A Fair and Transparent method to deal with unpayable debt
Whilst this is very encouraging, in some ways these proposals are an extension of the discredited HIPC initiative and suffer from some of the same limitations such as limited country lists and the lack of a fair and transparent procedure to deal with all unpayble debt. Debt campaigners have long been advocating a systemic resolution to the problems of unpayable sovereign debt. This is embodied in the proposal for a Fair and Transparent Arbitration Process (FTAP, also known as Jubilee Framework).
The FTAP seeks to
- enshrine the principle that basic human rights take precedence over creditor rights,
- ascertain the legitimacy of creditor claims, identifying those which may be odious [2]
- give the affected people a right to be heard.
The arbitration panel which would decide whether and how much debt should be repaid would be independent and not under the control of creditors.
Under such a framework the level of debt which a country can repay would be linked to human development indices/human rights rather than arbitrary debt service/export ratios[3]. The adoption of a FTAP would also help make lending more responsible, as lenders would have to take responsibility for irresponsible or illegitimate lending, reduce the moral hazard[4] and make debt reduction available to countries that need it rather than restricting it to arbitrary lists.
The call for cancellation of unpayable multilateral debt and for the establishment of a fair and transparent procedure to deal with debt mutually reinforce each other. Cancellation of unpayable multilateral debt can be seen as a step towards the establishment of a FTAP as the need for further debt cancellation for the poorest countries has already been clearly established based on the recognition that the poorest countries would not otherwise be able to meet Millennium Development Goals[5].
Cancellation of unpayable multilateral debt will set a precedent for the human rights (or need based financing) approach to debt cancellation - a central theme of the FTAP. This in turn would highlight the need to extend debt cancellation to other poor countries that are short of resources to meet the MDGs or where creditor rights are being implemented at the cost of human rights. The UN Millennium Campaign points out that many developing countries are saddled with such high levels of debt that paying off just the annual interest costs more than what is spent on health care and education combined.[6]
Growing burden of multilateral debt
Multilateral debt has grown significantly over the past few years, both in terms of amounts outstanding and as a share of total debt outstanding. This is partly because multilateral institutions are cancelling less debt than other creditors. While most G7 countries are cancelling 100% of debt owed to them, the MFIs are cancelling only a third of debt owed to them. Also, since multilateral development banks and the IMF are treated as preferred creditors most multilateral debt is serviced regularly. This means that compared to other forms of debt relief, multilateral debt cancellation is most efficient as each dollar of debt cancelled results in an equivalent benefit for the debtor country. For other forms of debt, cancellation may not release as much because a significant proportion of this debt is not being repaid regularly in any case.Irresponsible lending
Multilateral financial institutions (MFIs) are subject to a moral hazard under the current system and this has resulted in some irresponsible lending. As there is agreement internationally that multilateral debts must be serviced, donor countries have provided grants to ensure that debts to these institutions do not fall into arrears. A report by the Netherlands highlights this point: 'Bilateral donor funds were used on a large scale to bail out multilateral creditors. Thanks to this bailout International Financial Institutions avoided a substantial part of the cost of their imprudent lending policies which caused moral hazard'[7] . For example, in the case of the Democratic Republic of Congo, the institutions continued to lend to the Mobutu regime despite knowing that a large chunk of the funds were being diverted by the dictator into his personal accounts. If they had known that they would be held responsible for this and other irresponsible lending decisions and stood the risk of losing money, then they may have acted differently.
2. Why is multilateral debt cancellation so important?
Multilateral debt has grown significantly over the past few years, both in terms of amounts outstanding and as a share of total debt. Multilateral creditors such as the World Bank, IMF, African Development Bank are now the largest creditors for most poor countries - especially those that are included under the HIPC initiative.
For the whole group of low income countries[8] - 61 countries with a Gross National Income (GNI) less than $735 per capita - external debt outstanding has gone up 430% since 1980 and now amounts to $523 billion. Debt owed to multilateral institutions has increased 793% to $154 billion over the same period and now accounts for 30% of the total debt owed by the low income group of countries.
G R A P H I C - clicl to enlarge!
For the Heavily Indebted Poor Countries, external debt has gone up 320% since 1980 to $189 billion. Debt owed to multilateral institutions has increased 800% to $70 billion so it now constitutes a full 37% of the total debt up from 14% in 1980.For low income countries including non-HIPCs the biggest increase in multilateral debt happened between 1980 and 1994 when it increased by 684% from $19 billion to $130 billion. This was partly as a result of the debt crisis of the 1980s when private debts were en-masse converted to multilateral debts as poor countries used loans from MFIs to repay some of the private creditors that they could not otherwise afford to repay.
G R A P H I C - clicl to enlarge!
The preferred creditor status of the multilateral institutions ensures that almost all debt owed to them is serviced regularly. This is different from the debt owed to bilateral and private sector creditors, significant proportions of which are in arrears - not serviced regularly by resource poor countries.So cancellation of bilateral and private sector debt may sometimes be just a paper transaction involving cancellation of debt that was not being repaid in any case. Such a transaction while effective in reducing debt outstanding may not free up any resources. The cancellation of multilateral debt, on the other hand, almost always frees up resources (cash that would have otherwise gone into servicing debt) and reduces debt overhang.
This means that compared with the cancellation of other forms of debt, multilateral debt cancellation frees up more resources and hence is more efficient.3. What is happening to multilateral debt?
As the graph illustrates the share of multilateral debt for low income countries and HIPCs has been steadily increasing. In the case of HIPCs this has rapidly climbed from 28% of the total debt in 1997 to 37% by 2002 - a rise of 9% in just five years. The completion of the HIPC initiative would see this ratio rise to 40% (the last column in the graph).
G R A P H I C - clicl to enlarge!
For the first 27 countries that reached decision or completion point the share of multilateral debt is expected to be 61% after the completion of the HIPC initiative up from 38% before the HIPC initiative. Multilateral debt will be by far the largest component of residual debt for most countries that will reach HIPC completion point i.e. successfully pass through the HIPC process. The World Bank's concessional lending arm, the International Development Association (IDA) is now the single largest creditor for most completion point countries.
This has come about as a result of the failure of the burden sharing mechanism under HIPC. This central principle of the HIPC process implied that all the creditors would share the burden of the debt cancellation equally. While G7 countries have committed themselves to cancelling 100% of the HIPC debts owed to them the MFIs are cancelling less than a third (See Graph). Of the money mobilized thus far for multilateral debt cancellation, more than half has come from bilateral funding and of the rest an even larger proportion is expected to be funded not by the multilaterals' own resources but through even more bilateral contributions. This has the effect of turning grants into loans[9] - as the money contributed by the donor countries is then recycled as additional loans by the institutions.
G R A P H I C - clicl to enlarge!
The Multilateral Financial Institutions have pleaded poverty saying that any additional debt cancellation through the use of their resources would seriously endanger their financial soundness and sustainability. While trying to highlight their self proclaimed paucity of resources, the MFIs have sought to underplay their considerable financial strength, which is underpinned by their distinctive political and financial structure and their special role within the global economy.
G R A P H I C - clicl to enlarge!
The above graph shows that only a small proportion (less than a third) of the HIPC debt owed to Multilateral Financial Institutions will be cancelled under the HIPC initiative. The IMF has agreed to cancel only about $2 billion (NPV[10]) of the more than $7 billion (NPV) of debt owed by the HIPCs. The World Bank has committed itself to cancelling about $6.4 billion (NPV) of the total $19.2 billion (NPV) owed to it by the HIPCs. Multilateral debt cancellation through the use of own resources is a way of redressing this imbalance and is perhaps an additional motivating factor in the recent momentum behind the proposal. This would also help reduce moral hazard inherent in a system where the multilateral organizations can expect to be repaid despite having made some irresponsible lending decisions.4. The problems with existing debt mechanisms
In 1996, an average of $136 million was being transferred every day from the 61 poorest countries (including HIPCs) to wealthy countries in the form of total debt servicing. In 2002, the figure stood at a not much lower flow of $121 million every day. Most of the reduction has come through debt relief provided to some of these countries under the HIPC mechanism.
Despite this, the HIPC group of countries is still paying almost $8 billion (2002) in debt servicing (interest and principal repayments). While this is less than the over $10 billion of debt service paid in 1995 it is hardly the radical reduction that is needed by the countries and does not meet the 'deeper, broader and faster debt relief' theme of the HIPC process[11].
In fact, this figure constitutes about 75% of the total (non-technical) grant flow of $10.3 billion that reached the HIPCs in 2002. This part of the grant flow represents the amount of aid money that is potentially available for use on meeting the MDGs. This implies that about 75% of the usable grant flows is immediately recycled back into debt repayments for the HIPC group.
Of the countries that have already reached HIPC decision point, 4 countries (Mali, Niger, Sierra Leone and Zambia) actually have annual debt service payments due in 2003-2005 that are higher than their annual debt services paid in 1998-2000; 5 countries, Ethiopia, Guinea-Bissau, Honduras, Nicaragua, and Uganda are paying almost as much in debt service payments as before HIPC.
Debt levels post-HIPC remain unsustainable in many countries. Uganda currently has debt to exports ratio of 300%, and Ethiopia will not reach the HIPC target of 150% until 2020 even after top up debt relief it received at completion point.[12] On average HIPC countries in Africa are still spending 15% of their revenue on servicing debt, with some (e.g. the Gambia) spending over 25%.
G R A P H I C - clicl to enlarge!
The graph above clearly shows that while HIPC debt repayments have come down somewhat and aid levels have increased the additional resources fall far short of the near doubling of flows to the HIPCs that is needed for meeting the MDGs[13]. The resource gap and its pernicious impact on development was best summed up by Gordon Brown, the UK chancellor of the exchequer[14] (quoting from the UNDP Human Development Report 2003) "…Our best estimate is that it (halving of poverty) will not be achievable in Sub Saharan Africa for at least another hundred years…".
5. Benefits of Multilateral Debt Cancellation
The following graph clearly shows that most HIPC debt stock reduction to date has come in the form of writing off debt in arrears - cancelling debt that was not being repaid in any case. In fact, more than 80% of the debt stock reduction thus far can be accounted for by a reduction in arrears.
G R A P H I C - clicl to enlarge!
This does not mean that only debt in arrears has been cancelled since a reduction in arrears has also occurred as an integral part of the HIPC process which also intended to get countries out of arrears into servicing reduced amounts of debt regularly. To explain: Let us say there are two types of debt: X which is in arrears and Y which is being repaid regularly. Under the HIPC process even if debt Y is cancelled, a condition for cancellation may be that the country will have to start servicing debt X regularly. So the resources released by the cancellation of debt Y may be partly eroded by the reduction in the arrears of debt X. This means that the advantages accruing from a reduction in debt service due to an overall reduction in debt stock have been mostly eroded by an increase in debt service occurring as a result of decrease in arrears.Cancellation of multilateral debt should be given top priority since it is mostly not in arrears. Thus the cancellation of multilateral debt would actually release additional resources rather than resulting in just a decrease in arrears as has happened under the HIPC process thus far. It is critical to ensure that these additional resources are then not diverted into starting to service debt in arrears but that they are used for development expenditure.
MFIs are de facto treated as preferred creditors. Historically, even when countries have defaulted on both private and official repayment obligations they have continued to repay multilateral debt. This is because a default on multilateral debt obligation would result in a country being cut off completely from international credit and leave it unable to access much needed funds.Also, it is well nigh impossible for a country even to get debt cancellation if it is in default of its multilateral obligations. Until a country has signed up to an IMF program the Paris Club group of creditor countries would not even consider it for debt relief on debt owed to rich countries.
The graph above shows the amount of debts in arrears and the total outstanding debts of HIPC countries. In 1995 before the start of the HIPC program, more than a third of HIPC debt was in arrears (i.e. was not being repaid). This figure has come down to about a quarter in 2002 already and is expected to disappear almost completely by the end of the HIPC program. Since the MFIs are preferred creditors, most of the arrears were on private and bilateral official debt.
This has meant that $1 of bilateral debt cancellation has released less than $1 of resources as a significant part of the debt owed was already not being repaid. In fact for some countries, the HIPC process has increased the debt servicing burden. On the other hand, every $1 of multilateral debt relief would release $1 in resources that are available for meeting the MDGs as most multilateral debt was being repaid regularly by the HIPC countries even before the HIPC initiative. This makes multilateral debt relief the most efficient form of debt relief.
Multilateral debt cancellation is an effective contribution to development financing. Unlike aid flows - a third of which are in the form of 'tied aid' or 'technical assistance' - all resources allocated to multilateral debt cancellation end up in the budget of the recipient country and hence can be used for development purposes.
6. Prospects for Multilateral Debt Cancellation
Both British Treasurer Gordon Brown, and the US Treasury Secretary John Snow, made public statements about the need for 100% debt cancellation of multilateral debt of the poorest countries before the IMF and World Bank AGMs last September. Since then Gordon Brown has produced a draft proposal and is seeking support from other rich countries. The US has not published a written proposal to date.Among the questions debt campaigners are asking in relation to these proposals are:
- which countries will be eligible for cancellation
- what conditions will countries have to fulfil in order to become eligible
- how much debt will be cancelled
- how will the debt cancellation be financed - will it be funded with new money or will it be funded out of current aid.
Debt and Development Coalition Ireland:
calls for cancellation of unpayable multilateral debt
calls for the establishment of a fair and transparent process to deal with debt
proposes that the sale of IMF gold should be the first port of call for financing multilateral debt cancellation
The sale of IMF gold can mobilize as much as $35 billion. Either the principal raised or the interest earned on invested principal can be used for the cancellation of multilateral debt owed not just to the IMF but also to other multilateral institutions. A major advantage of this proposal is that this source of funds would be additional and hence not come at the cost of other development monies.The next G8 meeting is in Scotland in July 2005. This will be their opportunity to take the decisive step to cancel unpayable multilateral debt.
[1] E.g. African Development Bank, Inter American Development
Bank
[2] Odious debt can be defined as debt lent to repressive regimes
from which the people did not benefit. Subsequent governments should
not be held responsible for debts accrued by such regimes, eg. Iraq
[3] under the Heavily Indebted Poor Country Initiative a country's
debt is considered 'payable' or sustainable if the ratio of debt to
exports is below 150%
[4] Moral hazard is the irresponsible behaviour that results
from the knowledge that one would not be held to account for one's
actions
[5] See 'The Unbreakable Link' - Romilly Greenhill Jubilee
Research and 'Resource Rich BWIs, 100% Debt cancellation and the MDGs'
- Sony Kapoor Jubilee Research
[6] www.millenniumcampaign.org
[7] Ministry of Foreign Affairs, Netherlands 'Results of Intenational
Debt Relief l990-1999' 2004 page 3
[8] For a full list see http://www.worldbank.org/data/countryclass/classgroups.htm#Low_income
[9] Ministry of Foreign Affairs Netherlands 'Results of International
Debt Relief 1990-1999' 2004 page 146
http://www.euforic.org/iob/detail_page.phtml?&username=guest@euforic.org&password=9999&groups=IOB&&lang=en&page=publ_nlSV
[10] NPV - Net Present Value. All debt is not the same and it varies
in terms of the interest rates, the period of repayment and other terms.
In order to ensure comparability between debts owed at different terms,
finance professionals use the concept of the Net Present Value which uses
some assumptions to define how much the debt issued under various terms
would be worth today.
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