Africa: Multilateral Debt Cancellation

AfricaFocus Bulletin
Jan 18, 2005 (050118)
(Reposted from sources cited below)

Editor's Note

"Given the urgency and need for immediate action, we urge the G8 to
begin immediately and in particular for G7 finance ministers to
reach agreement on 100 percent multilateral debt relief at their
February 4th meeting," African finance ministers said in Cape Town
after concluding a meeting with British finance minister Gordon
Brown. But despite Brown's high-profile African visit, accompanied
by pledges of debt cancellation and increased aid, debt campaigners
still have questions about the details of Britain's plan and the
will of other rich countries to act.

A new briefing for the Debt and Development Coalition Ireland,
excerpted below, noted that "various proposals for multilateral
debt cancellation have now been put on the table by G7 countries -
the UK and US. ... 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 unpayable debt."

Another AfricaFocus Bulletin sent out today contains statements on
debt from the African Social Forum in December and from a
submission by the UK Jubilee Debt Campaign to Prime Minister Tony
Blair's Commission for Africa. For related news on debt, see
http://allafrica.com/debt. For previous AfricaFocus Bulletins on the topic, see http://www.africafocus.org/debtexp.php.

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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

[Excerpts. Full text, including graphs, available at
http://www.debtireland.org/resources/
papers-briefing-Multilateral-Debt-Cancellation.htm (type URL on one
line)]

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.

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.

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%
...

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.

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.

... only a small proportion (less than a third) of the HIPC debt
owed to Multilateral Financial Institutions will be cancelled under
the HIPC initiative. ... 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%.

...

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. ...

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. ...


... $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] http://www.millenniumcampaign.org

[7] Ministry of Foreign Affairs, Netherlands 'Results of
Intenational Debt Relief l990-1999' 2004 page 3
http://www.euforic.org/iob

[8] For a full list see
http://www.worldbank.org/data/countryclass/classgroups.htm

[9] Ministry of Foreign Affairs Netherlands 'Results of
International Debt Relief 1990-1999' 2004 page 146

[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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