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Date: Sun, 8 Sep 2002 18:42:35 -0500
From: Africa Action <[log in to unmask]>
To: [log in to unmask]
Subject: Africa: Debt Cancellation Update

Africa: Debt Cancellation Update
Date distributed (ymd): 020908
Document reposted by Africa Action

Africa Policy Electronic Distribution List: an information
service provided by AFRICA ACTION (incorporating the Africa
Policy Information Center, The Africa Fund, and the American
Committee on Africa). Find more information for action for
Africa at http://www.africaaction.org

+++++++++++++++++++++Document Profile+++++++++++++++++++++

Region: Continent-Wide
Issue Areas: +economy/development+

SUMMARY CONTENTS:

This posting, one of several on debt cancellation we will
distribute this month, contains brief excerpts from a paper by
Jeffrey Sachs proposing a new framework for resolving the debt
crisis of African and other low-income countries (the full text is
available at http://www.africaaction.org/action/sachsbp.pdf). Since
the paper was published earlier this year, Sachs has also called
for African countries to stop paying their debts and to allocate
the funds to AIDS and other urgent needs. "It's untenable to be
paying debt that could be used to fight the pandemic," Sachs said
in Johannesburg last month. "It's much more than a vicious cycle of
poverty. There's a silent holocaust under way." African
governments, however, fear retaliation by creditors if they should
take such steps.

As with earlier proposals for new debt cancellation frameworks,
such as that by UN Secretary-General Kofi Annan in 2000
(http://www.africaaction.org/docs00/sg0011.htm), and
by the African Forum and Network on Debt and Development
(http://www.africaaction.org/docs02/debt0203.htm) earlier this
year, the primary obstacle to the plan in Sachs' paper is the lack
of political will by creditor nations and institutions.

Reuters reported on September 5 that a new IMF/World Bank report
again acknowledges the failure of the Heavily Indebted Poor
Countries (HIPC) initiative to have more than a marginal impact on
the debt crises of a few countries (see also the summary critique
of HIPC by Africa Action at
 http://www.africaaction.org/action/hipc0206.htm, and a summary by
Jubilee Research of earlier World Bank reports at
http://www.africaaction.org/docs02/debt0205.htm).
Nevertheless, no new initiatives on debt are projected for the
meetings of the international financial institutions at the end of
September.

+++++++++++++++++end profile++++++++++++++++++++++++++++++

Resolving the Debt Crisis of Low-Income Countries

Jeffrey D. Sachs

Harvard University

Brookings Papers on Economic Activity, 1: 2002
http://muse.jhu.edu/journals/
brookings_papers_on_economic_activity/toc/eca2002.1.html
[available at this link to Journal subscribers only]

The idea of bankruptcy for insolvent sovereign borrowers has been
around a long time, at least since Adam Smith's favorable mention
of it in the Wealth of Nations. ... The current international
framework for workouts of distressed sovereign borrowers is
woefully inadequate, lacking both the efficiency and the equity
protections that characterize well-designed bankruptcy systems.
...

Motivations for Bankruptcy Laws

Bankruptcy laws have two somewhat distinct motivations. The first
is to overcome the collective action problems that arise when
multiple creditors confront an insolvent debtor. In the absence
of a bankruptcy law, a creditor "grab race" can undermine the
value of the assets of an insolvent debtor. The bankruptcy law
forestalls the grab race through devices such as the automatic
stay on debt collection that is triggered by the filing of a
bankruptcy petition. ...

The second motivation of bankruptcy law is to offer a "fresh
start" to an insolvent debtor. Whereas the motivation to avoid a
grab race applies in principle to all kinds of insolvent debtors
- businesses, individuals, and municipalities - the motivation
for a fresh start applies only to individuals (Chapters 7, 12,
and 13) and municipalities (Chapter 9) rather than to businesses.
The key instrumentality of the fresh start is the discharge of
debt, which frees the debtor from future collection efforts while
leaving the debtor with some exempt assets and with a future
income stream. ...

The motivation for forestalling a creditor grab race is
efficiency. The motivations for offering a fresh start, however,
include both efficiency and equity. The creditors' claims are
superseded by the higher interest of protecting the autonomy of
the individual vis-.-vis the creditors, and analogously, of
ensuring that a debt-strapped municipality maintains the
sovereignty needed to provide public services to its residents.
For example, under Chapter 9, a municipality's assets cannot be
liquidated to pay creditors, because that would undermine
sovereignty. ... Most important, neither under individual
bankruptcy (Chapter 7 or Chapter 13) nor under municipal
bankruptcy (Chapter 9) do creditors obtain the maximum discounted
value of income and property potentially collectable from the
debtor. Individuals and municipalities are allowed to keep
important property out of the creditors' reach, such as a
homestead up to a certain value, as well as keep most or all
future income. ...

International Sovereign Borrowers

For hundreds of years, sovereign borrowers have experienced
repayment crises, including defaults and restructuring of debts.
... In the age of imperialism in the nineteenth and early twentieth
centuries, creditors often resorted to force or the threat of
force to collect debts, including the removal of insolvent
sovereigns from power. Since the Great Depression, however,
sovereign debt crises have generally been worked out in
negotiations between creditors and debtors, often with the heavy
political engagement of major creditor powers or international
institutions such as the International Monetary Fund (IMF), where
creditors predominate. These negotiations have been characterized
by a high degree of ad hockery and a low degree of systematization
of international rules.

This ad hockery has come at a very high cost. Insolvent countries
have often been locked into decades of instability and
impoverishment. There is certainly no guarantee of a fresh start.
The creditor grab race has often undermined economic stability in
debtor countries, to the detriment of both creditors and debtors.
Debtor nations complain bitterly about the loss of sovereignty to
creditor-led institutions, especially the IMF and the World Bank.
And ad hoc bailouts of private creditors by official lenders - for
example, through IMF loans to debtor governments to maintain debt
servicing to private lenders in the creditor countries - have been
widely seen as creating moral hazard, encouraging future
indiscriminate lending by creditors to weak borrowers on the
basis of expected future bailouts.

The absence of a fresh start for sovereign debtors can have a
particularly pernicious effect on economic and social
development. In a country whose government is insolvent, but that
has not been released from extremely onerous debt servicing, the
provision of public goods is likely to be severely curtailed.
Macroeconomic stability and even public order (in the case that
services such as health, police, and fire services are limited)
can easily be lost. Prolonged political uncertainty and
instability may result, as the sovereign power has limited means
to defend itself against internal insurgencies and external
military threats. ...

Dozens of low-income countries have been stuck for two decades
or more in a persistent debt trap from which they are not
recovering. For these countries, bankruptcy procedures will have
to be considered in the much larger context of the overall
foreign assistance strategy of the creditor-donor community. ...

The rich creditor governments that "own and operate" the
principal international financial institutions - such as the IMF,
the World Bank, and the Paris Club - have failed to acknowledge
the pervasive risks of poverty traps for very low income
countries. During the late 1970s and early 1980s, several dozen
developing countries, including a large number of very poor
countries, fell into serious sovereign debt crises. And although
debt service burdens were rising, inflation-adjusted foreign
assistance per capita in the recipient countries was declining.
The squeeze of rising debt burdens and falling aid levels threw a
large number of poor countries into persistent stagnation or
economic decline. For roughly twenty years the standard
interpretation of this phenomenon was that the countries needed
yet more "structural adjustment" rather than debt relief or
increased foreign assistance.

As debt burdens became more and more untenable, and as sustained
growth in dozens of low-income countries proved elusive, the
official creditors wrote off increasingly large portions of the
debts owed them. But throughout the process, creditors failed to
put sufficient political will or serious analysis into the debt
reduction operations. Debt reduction targets were set and reset
arbitrarily - writing off 30 percent, then 50 percent, and so on-
rather than based on serious assessments of the needs of each
country. ...

For all Paris Club reschedulers during 1975-96, the countries are
classified according to the outcome of the debt restructuring
operations. Since a debt crisis signifies a kind of macroeconomic
pathology, a three-way medical analogy is used: countries are
either cured, in remission, or in chronic crisis. The criteria
for this classification are as follows:

* A country is considered cured of its debt crisis if it is
current on its debt servicing, did not restructure its debt in
the Paris Club during 1997-2001, is not a candidate for relief
under the Heavily Indebted Poor Countries (HIPC) initiative, and
was not under an IMF lending program during 1999-2001.

* A country is considered in remission if it meets the conditions
for "cured" except that it is currently under a lending program
with the IMF.

* A country is considered to be in a chronic crisis if it
required a Paris Club restructuring during 1997-2001, or is a
candidate for HIPC relief, or is in default on its Paris Club
debts. ...

Of the fifty-nine countries shown in table 1 that required a
Paris Club restructuring of their debt during 1975-96, only eight
have been cured: Chile, Costa Rica, Equatorial Guinea, Guatemala,
Jamaica, Morocco, and Trinidad and Tobago. Twelve more are in
remission, and the remaining thirty-nine are in chronic crisis.
... Equatorial Guinea is the only least-developed country
(according to the U.N. classification of those forty-nine
countries with the lowest human development indicators) to
achieve a "cure," and it did it in style: by discovering massive
offshore oil reserves, which led to the fastest per capita growth
rates in the world during the 1990s. But apart from that
anomalous outcome, all of the very poor countries fell into a
persisting debt trap. ...

The unrealism of the current debt treatment of the poorest
countries is also evidenced by endless and thankless rounds of
debt renegotiation and IMF agreements. ...

Reforming the Debt Relief Process for Low-Income Countries

Poor countries that fell into a debt crisis got neither
sufficient help to restore economic growth, nor deep enough debt
reduction to reestablish normal relationships with creditors.
There has been neither an economic recovery nor a fresh start.
When one looks closely at the modalities of debt rescheduling, it
is not hard to understand why. The guiding principle of official
debt relief in the past twenty years has been to do the minimum
possible to prevent outright disaster, but never enough to solve
the debt crisis. In particular, the official creditors (both in
their capacity as bilateral creditors in the Paris Club and as
multilateral creditors through the IMF and the World Bank) have
used arbitrary formulas rather than a serious analysis of country
needs to decide on the level of relief. That remains the case
today. Even now the so-called debt sustainability analysis of the
enhanced HIPC initiative is built on the flimsiest of
foundations. ...

The current definition of debt sustainability in the enhanced
HIPC initiative is as arbitrary as the previous standards, if a
bit more generous. A ratio of debt to exports of 150 percent or a
ratio of debt to government revenue of 250 percent cannot truly
be judged to be sustainable or unsustainable except in the
context of each country's needs, which themselves must be
carefully spelled out. It is perfectly possible, and indeed is
currently the case, for a country or region to have a
"sustainable" debt (and significant debt servicing) under these
formal definitions while millions of its people are dying of
hunger or disease.

For twenty-five years the creditor nations and the IMF in effect
defined debt sustainability as the amount of debt servicing that
could be maintained in practice while still achieving a modicum
of macroeconomic stability. ...with creditors determining what
was or was not sustainable, the flagrantly excessive demands on
the impoverished debtor nations could not be challenged in the
corridors of power. Only in the past couple of years has the
inadequacy of this approach become widely recognized.

Looking forward, debt reduction for the HIPCs should not be based
on arbitrary criteria such as a 150 percent debt-exports ratio,
but rather on a systematic assessment of each country's needs for
debt reduction and increased foreign assistance, measured against
explicit development objectives. The right starting point for
assessing needs should be the internationally accepted targets
for economic development that are (ostensibly) the guiding
framework for the global development partnership between rich and
poor countries. The targets are enshrined in the Millennium
Development Goals (MDGs), a set of eight major goals and eighteen
intermediate targets endorsed by all U. N. members at the
Millennium Summit in New York in September 2000 and recently
reconfirmed by the U. N. membership in the Monterrey Consensus of
the United Nations Conference on Financing for Development in
Monterrey, Mexico, in March 2002. The MDGs are quantified goals
for poverty alleviation, reduction of hunger, reduction of
disease burden, and other targets, mostly for the year 2015.

In practice, what is needed is nothing short of a country-
specific "business plan" for scaling up essential public services
(health, education, basic infrastructure) as part of an overall
strategy for meeting the MDGs. ... The country-level business
plan would provide an assessment of the financial gaps that must
be bridged by development assistance and debt cancellation so
that the country can scale up essential services. The Commission
on Macroeconomics and Health of the World Health Organization
(WHO) recently completed such an exercise for the health sector.
For low-income countries in SubSaharan Africa, for example, it
was found that spending on health care services needs to increase
from 3.9 percent of GNP in 2002 to 13.2 percent of GNP in 2015,
in order to extend the coverage of essential health services to
roughly two-thirds of the population. The commission assumed that
these countries could muster an increase of 2.0 percentage points
of GNP for health out of their own domestic revenues, leaving a
gap of nearly 8 percent of GNP to be provided by donors (a sum
estimated to equal $26 billion a year as of 2015.) ...

The idea of linking debt reduction to a detailed assessment of
the financial requirements for meeting the debtors' essential
needs may seem obvious, even trivial, but it is radically
different from what the creditor-donor nations have done during
the past quarter century. Debts owed by lowincome countries have
been collected, or partially cancelled, without any serious
assessment of actual country needs anchored in specific
development targets. And as we have seen, the results have been
quite miserable. ...

Reforming the Treatment of Highly Indebted Poor Countries

...

What kind of institutional changes are required to reorient the
international system in the recommended direction? I suggest the
following:

* The creditors should understand that, in a sovereign
insolvency, whether under Chapter 9 in the United States or an
international sovereign insolvency, the systemic goal is not the
simple maximization of debt repayments to the creditors.
Repayments to creditors must be placed in the context of
additional objectives: a fresh start for an insolvent sovereign,
preservation of its public functions, and achievement of broad
development objectives. For low-income countries, the basic
standard for debt collection should be to restructure debts in
order to provide a macroeconomic framework within which the
countries can achieve the MDGs.

* Each HIPC should be encouraged - indeed, required, in order to
obtain comprehensive debt cancellation - to prepare medium-term
plans for scaling up its investments in health, education, and
basic infrastructure during the period from now until 2015. The
targets should be set in order to meet the MDGs. These plans
should be designed in conjunction with civil society, as part of
the ongoing poverty reduction strategy process.

* The key U.N. agencies, including the UNDP, WHO, and UNICEF, and
the Bretton Woods institutions should support the countries in
this costing exercise, but they should also carry out independent
estimates of the countries' financing needs and incorporate those
estimates into their own key country strategy documents.

* An independent review panel, with representatives appointed by
both creditor and debtor countries but not representing either,
should review the evidence from the countries and from the
international agencies and make recommendations on the scale of
debt cancellation and increased foreign assistance that should be
granted to each country. For most HIPCs, the objective evidence
will support a complete cancellation of debts, plus an increase
in foreign assistance, all on a conditional basis to ensure that
the increased net resource flow in fact supports the desired
development objectives. The review panel could be convened under
IMF auspices, but the recommendations should not be subject to a
vote by the IMF's creditor-dominated executive board. In
principle, such recommendations should be binding. In practice,
it is almost certain that the rich countries will concur with
such a system only if such a review panel operates on an advisory
basis.

* The United Nations and the Bretton Woods institutions should
provide published yearly updates on the progress of each country
toward each of the MDGs. These assessments would help not only in
monitoring the low-income countries, but in monitoring the
creditor-donor countries as well.

To the extent that the new system is merely advisory to the
creditors, these recommendations may seem unnecessarily modest
and might not resolve many of the political economy barriers that
have blocked a more realistic approach to debt cancellation for
the poorest countries. But ... A transparent process would shine
important public light on the shortcomings of the
creditor-dominated approach of the past quarter century. The
objective evidence would underscore that the poorest countries
are utterly impoverished and face multiple challenges of
education, hunger, water and sanitation, and basic health that
cannot be met without vastly larger flows of resources from the
creditor countries. ...

************************************************************
This material is being reposted for wider distribution by
Africa Action (incorporating the Africa Policy Information
Center, The Africa Fund, and the American Committee on Africa).
Africa Action's information services provide accessible
information and analysis in order to promote U.S. and
international policies toward Africa that advance economic,
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