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Africa: Debt Relief Update

AfricaFocus Bulletin
May 30, 2006 (060530)
(Reposted from sources cited below)

Editor's Note

Debt relief has become a significant vehicle of resource transfer to countries under the World Bank/IMF HIPC program, concludes a new internal World Bank evaluation. But in eight countries completing the program, debt ratios already again exceed the Bank's sustainability level of 150 percent debt-to-exports ratio.

The report notes that net transfers to HIPC countries doubled from $8.8 billion in 1999 to $17.5 billion in 2004. These additional resources have increased budget flexibility on supporting social programs. But changes in exchange rates as well as new borrowing have left program graduates Rwanda, Ethiopia, Uganda, Tanzania, Mauritania, Burkina Faso, Ghana, and Mali with newly unsustainable levels of debt.

This AfricaFocus Bulletin contains brief excerpts from the report "Debt Relief for the Poorest: An Evaluation Update of the HIPC Initiative" by the World Bank Independent Evaluation Group. The full report is available at http://www.worldbank.org/ieg.

Other recent reports on the current status of debt relief can be found at the Eurodad website (http://www.eurodad.org). A study of the current status of debt relief and related economic policies in Zambia, by the Jesuit Centre for Theological Reflection in Zambia, is available on Eurodad and also at the Centre's website (http://www.jctr.org.zm).

For earlier AfricaFocus Bulletins on Africa's debt, visit http://www.africafocus.org/debtexp.php.

++++++++++++++++++++++end editor's note+++++++++++++++++++++++

Debt Relief for the Poorest
An Evaluation Update of the HIPC Initiative

The World Bank Independent Evaluation Group
http://www.worldbank.org/ieg

2006

[excerpts only. For full text visit http://www.worldbank.org/ieg.]

Main Messages

  • HIPC has channeled additional resources to qualifying countries.
  • HIPC has reduced debt ratios to half their levels before debt relief. But debt ratios have increased since completion point, and in eight countries, once again, exceed HIPC thresholds.
  • Six of eight post-completion-point countries with a new debt sustainability analysis have only a moderate risk of debt distress. But all eight remain vulnerable to export shocks and still require highly concessional financing and prudent debt management.
  • Debt sustainability requires policy actions by governments and external partners to improve repayment capacity.
  • Countries that are not yet at completion point face serious challenges in managing their economies that will affect their prospects for reaping the potential benefits of debt reduction.
  • In future debt relief efforts, donors will have to ensure that the resulting allocation of concessional resources rewards better-performing countries overall.

Executive Summary

In the past decade, debt relief has become an increasingly significant vehicle for delivering development aid, with emerging debt reduction proposals now aiming to provide 100 percent debt cancellation. This review updates the March 2003 evaluation of the Heavily Indebted Poor Countries Initiative (HIPC), Debt Relief for the Poorest: An OED Review of the HIPC Initiative, ...

Since the 2003 evaluation, 12 countries have progressed to receiving irrevocable debt relief and two more countries have qualified for relief. About $50 billion has been committed in nominal debt service relief under the Enhanced HIPC Initiative2 to decision-point countries, of which $15.4 billion has been committed since the previous evaluation. This update builds on the 2003 evaluation and finds that many of its conclusions remain relevant for the HIPC Initiative and are potentially instructive for future debt relief initiatives.

Debt Sustainability.

The Enhanced HIPC Initiative has reduced $19 billion of debt in 18 countries, thereby halving their debt ratios. But in 11 of 13 post-completion-point countries for which data are available, the key indicator of external debt sustainability has deteriorated since completion point. In eight of these countries, the ratios once again exceed HIPC thresholds. Changes in discount and exchange rates have worked to increase debt ratios. The effect of improved exports and revenue mobilization on debt ratios has been offset by new borrowing. Six of eight post-completion-point countries with new debt sustainability analyses are considered to have only a moderate risk of debt distress, but all remain vulnerable to export shocks and still require highly concessional financing and sound debt management. Debt reduction alone is not a sufficient instrument to affect the multiple drivers of debt sustainability. Sustained improvements in export diversification, fiscal management, the terms of new financing, and public debt management are also needed, measures that are outside the ambit of the HIPC Initiative.

Policy Performance.

Countries past the completion point started out with higher scores on key policy ratings than other low-income countries and they still score higher. Countries not yet at completion point both decision-point and pre-decisionpoint countries have, on average, the lowest ratings of all low-income countries and face serious challenges in managing their economies that will affect their prospects for reaping the potential benefits of debt reduction. Even though the initiative has granted poorer performing countries more time to begin a reform program supported by the World Bank and the IMF, they are held to the same track record requirements as countries that became eligible earlier. Fiscal and debt management are areas of particular weakness in many HIPC countries.

Poverty Reduction.

Debt relief was intended to contribute to poverty reduction. The requirement to develop and implement a country-owned poverty reduction strategy has been an important and beneficial outcome of the initiative. These strategies have tended to emphasize social sector spending rather than a more balanced approach to growth and poverty reduction. By continuing to track public expenditures deemed "poverty reducing," the initiative's approach to poverty reduction has leaned toward channeling additional resources to social expenditures. The emphasis on expenditures has prompted the Bank and the IMF to do more to upgrade public expenditure management systems in HIPC countries. These efforts have resulted in only modest improvements.

Creditor Participation.

The HIPC Initiative was innovative in its attempt to seek a comprehensive approach among all creditors to debt reduction. The multilaterals and Paris Club creditors have committed most of their share of debt relief. But the initiative's structure as a voluntary agreement has hindered efforts to achieve full participation of all creditors. The sluggish participation of non Paris Club and commercial creditors, who were not involved in shaping the initiative's design, has generated a shortfall of 8 percent of total expected HIPC assistance.

Additionality of Resources.

HIPC has channeled additional development resources to its qualifying countries. Net transfers to HIPC countries doubled from $8.8 billion in 1999 to $17.5 billion in 2004, while transfers to other developing countries grew by only a third. Debt relief has become a significant vehicle of resource transfer to HIPC countries. In the past year, eight additional non-HIPC low-income countries have become potentially eligible for HIPC. The repeated extension of the deadline for eligibility has significantly expanded the reach of the initiative. The emergence of proposals for future rounds of debt relief suggests that debt relief is becoming an ongoing mechanism for resource transfer.

Implications for Future Debt Relief Efforts.

The experience under HIPC suggests five lessons for future debt relief efforts.

  • Debt reduction is not sufficient for debt sustainability. Future initiatives need to be clear about the objectives of debt relief and how their outcomes will be measured. In addition, to ensure debt sustainability they need to stress the importance of other policy actions by governments and external partners to improve repayment capacity.

  • Does debt relief add to or substitute for other aid flows? To demonstrate that future debt relief initiatives are additional, donors will need to establish what net transfers both multilateral and bilateral would be in the absence of debt relief.

  • The initiative is delivering an increasing share of concessional resources to HIPC countries. Since non-HIPC countries do not have access to these resources, donors will need to ensure that the resulting pattern of resource allocation rewards better performers overall.

  • Debtors cannot oblige creditors to participate in debt relief under voluntary initiatives. Involving both creditors and debtors at the design stage of proposals for debt relief can be an important step in disseminating information about the workings of the initiative and securing the cooperation of all creditors.

  • Future debt relief initiatives may also be expected to continually revisit and extend deadlines for eligibility. Extensions of the deadline keep open the opportunity for countries to receive debt relief, while holding all countries to the same standards. On the other hand, they could provide incentives to countries to increase their borrowing in order to avail themselves of debt relief.


Chapter 1: Evaluation Essentials

Introduction

In the past decade, debt relief has become an increasingly significant vehicle for delivering development aid. The international community has recently galvanized itself to provide another round of debt relief. This review updates the March 2003 evaluation of the Heavily Indebted Poor Countries Initiative (HIPC), Debt Relief for the Poorest: An OED Review of the HIPC Initiative (OED 2003).

At that time, six countries had received irrevocable debt relief at completion point (CP) under the Enhanced HIPC (E-HIPC) Initiative, and 20 had qualified and were receiving interim relief at decision point (DP) (see appendix A for a description of how the initiative works). Since then, 12 of those countries have progressed to completion point, and two more countries have qualified for relief. Around $50 billion has been committed in nominal debt service relief to decision-point countries under E-HIPC, of which $15.4 billion has been committed since the 2003 evaluation (World Bank and IMF 2003a, 2005d).

...

The 2003 evaluation found the HIPC Initiative to be highly relevant in addressing a key obstacle facing many poor countries, and noted that the initiative would succeed in substantially achieving its fundamental goal of reducing the excessive debt burden of the qualifying countries, if the anticipated debt relief was delivered in full. But it found that achieving the expanded objectives of the initiative a "permanent" exit from debt rescheduling, promoting growth, and releasing resources for social expenditures targeted at poverty reduction would require actions by donors and HIPC governments beyond the scope and means of the initiative. HIPC governments would need to have sound policy frameworks and balanced development strategies, and the international community would need to assist countries to enhance their exports and build needed institutional capacities, while ensuring that HIPC debt relief is truly additional to other aid flows.

...

The 2003 evaluation recommended that the Bank clarify the purposes and objectives of the initiative, which had progressively become more ambitious. In its first progress report issued after the 2003 evaluation, the Bank stated that the key objective of E-HIPC was "to deal comprehensively with the overall debt burden of eligible countries by removing their debt overhang within a reasonable period of time and providing a base from which to achieve debt sustainability and exit the rescheduling cycle" (World Bank and IMF 2003d, emphasis added). This is a less ambitious formulation than the earlier one of providing a "permanent exit from rescheduling."

The poverty reduction objective of "freeing up resources for higher social spending" was neither specifically included in that progress report as an objective, nor explicitly removed.

The Bank and the IMF continue to track debt service payments and "poverty reducing" expenditures in monitoring the HIPC Initiative, suggesting that the freeing up of resources for poverty reduction remains an objective. From the perspective of creditors and civil society, poverty reduction is the primary if not the sole objective of debt relief. It has proved challenging for the Bank to manage the enduring expectations of the international community for the initiative. The HIPC Initiative remains imbued with the responsibility of not just achieving debt sustainability but freeing up resources for achieving poverty reduction and the MDGs.

Design Allows Countries More Time to Become Eligible for Relief.

Since March 2003, design changes have allowed countries, without an International Development Association (IDA)- or International Monetary Fund (IMF)-supported program in place, more time to become eligible for relief. The original two-year deadline for meeting the E-HIPC eligibility requirements has been extended three times (see appendix B for details). Only four of the 14 countries that benefited from the extensions have managed to reach decision point since 1998. Ten countries are still predecision point).

In 2004, when the deadline was extended to end-2006, the Executive Boards of the Bank and IMF decided to close the initiative to new entrants by "ring-fencing" a final list of countries potentially eligible for assistance under the initiative (World Bank and IMF 2004d). In September 2005, staff identified eight potentially eligible low-income countries (LIC) that were not on the original list of 38 countries (World Bank and IMF 2005d).9 Staff had not assessed these countries' eligibility earlier, mainly owing to the lack of data on their debt.

The repeated extension of the deadline for eligibility and the resulting increase in the number of eligible countries has significantly expanded the reach of the initiative. The emergence of proposals for future rounds of debt relief suggests that debt relief is becoming an ongoing mechanism for resource transfer. This experience under HIPC suggests that future debt relief efforts may also be expected to continually revisit time frames for eligibility. Extensions of the deadline keep open the opportunity for countries to receive debt relief, while holding all countries to the same standards. On the other hand, they could provide incentives to countries to increase their borrowings in order to avail themselves of debt relief.


Box 1.1. Findings from the 2003 Evaluation

Objectives and Design.

The HIPC Initiative has acquired multiple objectives, while the instruments at its disposal have remained the same. The objective of promoting growth by removing the debt overhang has been maintained, the expectations of what it can deliver on debt sustainability have increased, and creating fiscal space for increased social expenditures has been added as an explicit objective. Debt forgiveness does not guarantee additionality, and without additional resources, it is unclear how the initiative, as it is designed, will create fiscal space. Management should clarify the objectives and ensure the consistency of the design with the main objectives.

Commitment of HIPC Assistance and Its Additionality.

Achieving even the more modest objective of reducing debt to a level that provides countries with a reasonable chance of sustaining their external debts, would require full creditor participation to deliver the promised level of relief. The HIPC Initiative assumes that all creditors will participate, but cannot assure this. Achievement of the objective of increased fiscal space for social expenditures rests on the key assumption that debt relief will be additional to other aid transfers. There is not enough evidence yet to definitively determine the full impact of debt relief.

Debt Sustainability.

While the use of the debt inventory methodology for assessing the current level of debt is a positive feature of the initiative, the methodological basis underlying the projections of future levels of debt remains unclear. The lack of transparency of the economic models behind these projections and the overly optimistic growth assumptions have made debt sustainability analyses ambiguous (in regard to their reliability as assessments of future debt sustainability). More realistic growth forecasts and better risk analysis of the projected debt burdens in the debt sustainability analyses would provide a better assessment of each country's likelihood of meeting the initiative's debt sustainability threshold.

Maintaining Policy Performance.

The track record requirement for sustained policy and structural reforms has been applied flexibly to bring more countries into the program. But the progressive relaxation of the requirement for "millennium rush" countries that qualified in late 2000 raises the risk of not achieving the HIPC objectives, as these countries face a tougher challenge in meeting the necessary conditions to reach their completion point. It is critical to maintain the standards for policy performance to ensure that the risks to achieving and maintaining the initiative's objectives are minimized.

Balance between Pro-Poor Growth and Social Expenditures for Poverty Reduction.

The initiative places a heavy emphasis on social expenditures as the primary means of poverty reduction. This is evident in conditions set for completion point and the focus in progress reports and the IMF's Poverty Reduction and Growth Facility (PRGF) reviews on tracking social expenditures. The initiative's performance criteria should be better balanced between growthenhancing and social expenditure priorities and be supported by additional diagnostic work on the efficiency of public expenditures, identifying sources of growth and developing appropriate sectoral strategies as the basis of appropriate benchmarks.

Source: OED 2003.


AfricaFocus Bulletin is an independent electronic publication providing reposted commentary and analysis on African issues, with a particular focus on U.S. and international policies. AfricaFocus Bulletin is edited by William Minter.

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