The Issue

Contents:  A History of Debt; Debt Relief Initiatives; Difficulties; What is Needed?;

A History of Debt

While many developing countries were experiencing a wave of post-independence optimism in the 1970’s, a new neo-colonial chapter was being constructed as OPEC countries – rich with the spoils of rising escalating oil prices – deposited their wealth in western banks to be lent zealously to the developing world. While some of this lending was directed to worthwhile infrastructure projects a great deal was squandered on corrupt regimes and arms sales with next to no economic returns.

Oil prices continued to rise and developing countries were forced to borrow more and more to fund spending in economic development (such as manufacturing and industry) and the provision of services (such as schools and hospitals). A higher demand for these goods at high prices however led to a reduction in the value of a country’s exports relative to what they needed to import (terms of trade) leading to a currency depreciation (the value of their currency falling relative to other currencies). This meant that it became more difficult for developing countries to finance debt repayments which were borrowed in US dollars. At the same time, the oil crisis had led to an unstable economic climate leading to a rise in interest rates meaning that the cost of servicing the debts increased and countries found it even more difficult to pay back.

The effect was that many countries were trapped in a cycle of unpayable debt as a result of external forces acting upon their economies. The debt is deemed unpayable, as in political terms, the amount that countries were able to raise through taxation or other revenue was not sufficient to cover the cost involved in repaying that debt.

When debt servicing was possible this was to the detriment of expenditure on the very basics of development. Instead of investing in schools and hospitals, or subsidising essential tradable goods, countries used any available money to repay developed countries. Had these loans not have been serviced then this would have caused a banking crisis in rich countries. Instead the result was that poor countries found themselves trapped in a cycle of never-ending debt repayment and accumulation. Indeed many countries continue to service very old loans despite having paid back well over the original value as it rises faster than they can repay it.

Debt Relief Required…

Momentum began to build through the 1990’s when people began to realise the harmful impact that debt was having on poor countries ability to lift themselves out of poverty. Not only this but it was also clear that the rich counties were using the unequal power relations that emerged from these debt obligations to influence, and sometimes dictate, the economic policies in poor countries. This was done under the paradigm of the free-market, neo-liberal ‘Washington Consensus’ and imposed structural adjustments to poor economies which, rather than benefit poorer nations, further entrenched their poverty and underdevelopment.

The situation caused outrage among many, leading to the beginnings of a movement calling for full debt relief on the basis that:

·    Countries spent more on debt repayment than basic services
·    Money was lent to corrupt and oppressive regimes with no benefit to the populations who are now forced to repay the money.
·    Many of the debts were at unfavourable rates and were susceptible to economic shocks which harmed their terms (for example  a currency depreciation in relation to the dollar)
·    Many of the loans were contracted illegally

Heavily Indebted Poor Countries Initiative (HIPC)

As a result of heavy lobbying by NGO’s and campaigners the World Bank and IMF fully acknowledged the problem of developing country debt in 1996. A list of 40 low income countries who suffered from an unsustainable debt burden was compiled and,  after thousands marched in Birmingham for the G8 summit in 2008 calling for debt to be put on the agenda, the Heavily Indebted Poor Countries Initiative (HIPC) was born. The aim of the initiative was to provide ‘fast, deep and broad’ debt relief which freed revenue for poverty reduction and social investment.

·    HIPC aims to cancel all multilateral (owed to financial institutions), official bilateral (owed to other individual countries) and commercial debts (owed to private companies) to eligible countries.
·    Of the 40 eligible countries, 36 have received some debt relief having passed ‘decision point’ with 29 receiving full debt relief having passed ‘completion point’.¹
·    $72 billion in nominal terms and $58.5 billion in 2009 NPV² terms has been granted under HIPC.
·    HIPC reduced the debt stock of the post decision point countries by 40%
·    The largest share of the debt relief was granted by Paris Club creditors and equalled $27.1 billion in end 2009 NPV terms

Multilateral Debt Relief Initiative (MDRI)

The HIPC initiative was then supplemented by the Multilateral Debt Relief Initiative (MDRI) which was again the result of pressure from campaigners and the general public. This time under the Make Poverty History banner aimed at the G8 summit in Gleneagles in 2005.

·    MDRI aims to cancel remaining multilateral debt incurred before 2004 (2003 for the WB) owed to the IMF, the International Development Association (concessional lending arm of the World Bank), the African Development Fund (concessional lending arm of the African Development Bank) and the Inter-American Development Bank (provided relief to five HIPC’s in the western hemisphere)
·    Same eligibility requirements as HIPC, therefore the same countries.
·    So far $45 billion in nominal terms and $26.6 billion in end 2009 NPV terms has been granted in debt relief under MDRI
·    MDRI has reduced the debt stocks of the 35 post-decision point countries by 60% since HIPC.
·    The amount being cancelled per country varies from $340 million for Guyana to $3.9 billion for Uganda
·    Estimated saving to poor countries on debt repayment of $1.25 billion a year

In total nearly £120 billion in debt relief has been granted under these two initiatives . Between 2001 and 2008 this meant a reduction in debt service of 2% of GDP for the 35 HIPC countries and was correspondingly matched with a 2% increase in poverty reducing expenditure³. This demonstrates that the HIPC and MDRI are undoubtedly of benefit to developing countries by allowing money to be directed from debt repayment to poverty reduction. Debt relief is not however a panacea. Half of post-completion point countries are unlikely to meet their MDG’s and progress has been slow in poverty reduction throughout all low income countries.

Difficulties

It is clear from the evidence that while debt relief is necessary for poverty relief and economic development it is certainly not sufficient. There are shortcomings of the debt relief process, that if addressed, would enhance its benefits substantially. These include loosening eligibility requirements and reducing the difficult, and sometimes harmful, conditions countries need to satisfy to fully qualify. There is also an essential need for a platform which provides a more long-term solution to the developing country debt crisis - the urgency of which has been accelerated by the financial crisis and its negative impact upon countries levels of debt an their ability to pay it back.

Eligibility + Conditionality

There are a number of eligibility requirements which countries need to satisfy to receive debt relief. These fall under three categories: eligibility for World Bank lending; a ‘good’ track record of economic and institutional policies and performance; and a debt which is deemed ‘unsustainable’. The World Bank lending and ‘good’ policy criteria focus heavily on institutional policies, financial management standards and macroeconomic objectives while debt sustainability is determined by having an external debt which is at least 150% the value of its annual exports and/or at least 250% of Government revenue.

The strict eligibility requirements are an obstacle to achieving the poverty reduction capabilities of debt relief. Firstly, an extremely poor country with high levels of poverty and a debilitating level of debt should not be refused debt relief on the basis that certain macro-economic indicators (such as the level of inflation) fail to satisfy the subjective assessment of World Bank staff. Especially when the accumulation of that debt was often due to reckless lending by developed countries. Countries such as Eritrea, Sudan and Somalia are in this position. And secondly, by selecting debt sustainability indicators which take purely economic assessment this ignores the social consequences of that debt. Bangladesh for example is being made to suffer for having what is deemed as an ‘affordable’ debt, despite ranking 146th in the world in terms of human development and having annual debt repayments of $2.1 billion - more than it receives annually in aid.

While eligibility is strictly defined and restricts much needed access to debt relief, the conditions that countries have to satisfy once admitted to the process are often positively harmful. Countries are frequently required to implement a number of structural changes to their economies - dictated by the dominant neo-liberal dogma professed by the World Bank and IMF – which are harmful to the poor. This normally includes a reduction in Government spending which retracts resources from already thin public service provision on such things as healthcare or education. An example from Malawi involved the IMF demanding that expenditure on subsidised fertilizer be stopped, this was despite being a necessary defence against falling harvests which only a couple of years before had caused a devastating famine. Privatisation of state owned enterprises is also often a target for debt relief conditions. In Nicaragua for example privatisation of the national electricity company led to a 300% price rise, pricing the poor out of the market and causing frequent blackouts.

Conditionality does not only harm the poor, it also harms governance. As countries are continually subjected to the conditions of international donors this undermines their accountability to their own populations. Instead of public consultation and discussion, decisions around Government spending, public service provision and industry and utility are made by rich countries who impose their ideology on poor countries, often in the face of strong opposition. The effect is a lack of ownership and national commitment to one policy or another, leading to severe inefficiency and poor economic performance.

Debt Sustainability (and the financial crisis)

While strict eligibility requirements and harmful conditions dampen the potential impact of debt relief it is clear that positive impacts can still be generated. However it is now becoming clear that the initiatives fall short of providing any kind of long term solution to the debt crisis and that alternative action will need to be taken to ensure long term debt sustainability.

The current initiatives fail to achieve this objective for two reasons. Firstly there is no obligation for commercial and private creditors to participate in the schemes, and secondly the initiatives only aim to reduce debt to a maximum of ‘HIPC thresholds’. In addition the MDRI initiative only forgives debt which was incurred prior to 2004.

Consequently debt still remains following the completion of these initiatives. This existing debt is then coupled with new loans and the level of debt once again deteriorates to dangerous levels. This is an impossible situation for a country who depends on development assistance yet who is unable to sustainably absorb that new debt.

The Global financial crisis of which began in 2007 amplified the debt sustainability dangers faced by developing countries and has raised significant questions over long-term debt financing. As GDP growth slows, exports and government revenues decrease and fiscal commitments increase this reduces a country’s ability to repay its debt and the ratio of debt service to debt holdings permanently increases. The result is that many countries now find themselves either in a position of debt distress or at high risk of debt distress. This applies to countries at every stage throughout the HIPC and MDRI process, highlighting the shortcomings of these initiatives in providing any kind of lasting solution to levels of debt in developing countries.

The IMF has declared that it predicts no ‘systematic debt difficulties’ across lower income countries as a result of the crisis, however this prediction is based upon strong assumptions around strong economic growth (which is already faltering) and reduced Government spending (the like of which may be essential to sustain levels of public services). However strong these assumptions it is clear that in the medium term developing country debt will continue to grow as more debt is piled on top of already precarious debt positions.

What is Needed?
 
Long term solutions to the debt crisis requires significant changes in the financial architecture rather than one off or reactionary measures. It is only through such changes that that unfair balance of power which currently operates can be addressed and the world’s poorest countries can begin to reclaim their economic independence. The first step in this process is a comprehensive debt audit.

A Debt Audit

A comprehensive debt audit is crucial in addressing past injustice and clearing the way for a new and fair arena for lending and borrowing. A debt audit is a public examination of a country’s existing sovereign external debt in order to ascertain whether that debt was accumulated justly and legitimately. In doing so any debt that was, for example, accumulated as the result of projects or schemes which oppressed the population, harmed the environment or was lost to corruption can then be identified and the true cost of that debt exposed.

A debt audit therefore empowers and informs governments and citizens to make the difficult decisions necessary to overcome past injustice and forge a prosperous future. Often this may be a decision to repudiate (that is, refuse to pay back) debts of this nature and there has increased movement by southern governments in this direction.⁴ Importantly however it should be western governments who are recognising the legitimacy and authority of the findings of southern governments debt audits by agreeing to cancel an debt found to be unjust and illegitimate.

Responsible Lending

While debt audits will clear past injustice, future fairness depends on structural adjustments to the current framework for lending and borrowing. The key component of such structural adjustments is the recognition of the responsibility of lenders as much as that of borrowers. Internationally recognised legal standards for financing should be implemented which recognise this notion and also contains other provisions to ensure that future lending is in the interests of both creditor and borrower.

The Eurodad Charter for Responsible Financing is such a document. Among its components are:
·    Fair terms and conditions regarding interest rates, payback period and fee’s and charges.
·    Transparency throughout, including public disclosure of all loan details and the opportunity for public discussion and debate.
·    Respect for human rights and international standards, including an ex-ante impact assessment which makes an assessment against international standards.
·    That repayment difficulties and disputes are solved fairly and efficiently, and that provisions for the resolution of such difficulties are made as part of the loan agreement.

The international adoption of such a document would ensure that all future lending maintained the interests of both lender and borrower and discouraged excess debt accumulation, ensuring that significant lending was met by high returns and not high levels of debt.

An International Debt Court

An equally important measure in the transformation towards a more just system of international finance is the establishment of an international debt court. Bankruptcy law in the UK and many other countries protects individuals who find themselves unable to pay back their debts by organising what proportion of their debts an individual can pay pack, distributing this around all creditors, and then allowing that individual to make a fresh start.

Countries on the other hand have no such option. Instead they are forced to repay debts at a slower pace than they grow, resulting in a vicious circle of never-ending repayment from which they can never escape and from which their populations suffer.

An international debt court would avoid such harmful eventualities by providing a platform in an independent space, such as the UN, where debt disputes could be settled fairly. This means that the responsibility of lender as well as borrower would be taken into account, the legitimacy of debt would be established and the ability of the borrower to repay determined, taking into account the impact of that repayment on the welfare of that countries population. Such a court would also discourage irresponsible lending as lenders feared for the repayment of questionable loans.

These reforms would make international lending a great deal fairer, setting the conditions for southern governments to scale-up their fight against poverty and begin to close the inequality gap in power and wealth which defines north-south relations and locks countless of people into a state of un-achieved potential.

For more in-depth information on all the issues covered in this article click here

[1]For more information on the steps involved in the HIPC process visit http://www.jubileedebtcampaign.org.uk/Heavily%20Indebted%20Poor%20Countries%20initiative+97.twl

[2] NPV = Net Present Value. This is a measure of how much debt is worth to a country in today’s money when the time value of money is taken into account. It is the most accurate measure of the debt value.

[3] IMF

[4] Repudiation comes with the risk of being ostracised from the world’s financial markets. However this risk is consistently overstated as lending has been seen to quickly renew, even in the face of full scale default, as lenders recognise that any debt they accumulate can quickly be sold on safely in credit default swaps.