Debt relief: a creditable solution?

UNESCO Courier, Jan, 1999 by Angela Travis

The suffering caused by Hurricane Mitch and the financial tempests rattling the global economy bring new reasons to lighten the debt of the poorest countries

The devastation wrought by Hurricane Mitch in November was horrific. In three days, the hurricane wiped out 20 years of development in the region, according to UN agencies, leaving thousands of people dead and reportedly about three million homeless.

But as governments and international organizations tried to mobilize funds for relief efforts, another debate reared its head: should Nicaragua and Honduras, both low income, heavily indebted countries badly hit by Hurricane Mitch, continue to pay a total of $2 million a day in debt repayments - money which could provide temporary housing for 800,000 people?

The British Secretary of State for International Development, Clare Short, stated early on that debt relief was "an irrelevance" when the priority lay in avoiding cholera and "pulling people out of the mud". But a few days later Chancellor of the Exchequer Gordon Brown called on all creditors to support a two-year moratorium on debt service payments.

This shift in thinking reflects a growing realization as to just how bad things have gotten for the world's poorest nations. Since at least the mid-1990s, a few developing countries have simply stopped servicing a large portion of their debts - that is paying the interest and principal on loans. The reason is simple: their governments are effectively bankrupt. Mozambique and Nicaragua are only able to pay a third of their scheduled debt service (the amount of repayments on all loans). For Nicaragua, this fraction amounts to $221 million a year - three times that which the government spends on health.

Bankrupt states

By 1996, it was clear even to the world's major creditors that something had to be done. When middle or high income countries like Brazil, Jordan or Russia have run into problems managing their debts, the standard approach has been to reschedule or push back their service payments through agreements generally brokered by multilateral organizations like the International Monetary Fund (IMF) or, in the case of commercial lending, by the Paris Club, an informal group of creditor governments with a permanent secretariat in the French Treasury.

But loan rescheduling cannot solve the problems of the poorest countries. Their financial crises have been so extreme that they generally manage to service just half of their total debts.

The World Bank proposed the HIPC (Heavily Indebted Poor Countries) Initiative in 1996 (see box). The aim was to enable poor countries to get a more secure financial footing. This was "good news for the poor," according to the bank president, James Wolfensohn. "This initiative is a breakthrough... It deals with debt in a comprehensive way to give countries the possibility of exiting from unsustainable debt."

Under the HIPC Initiative, creditors agree to share the burden of cutting debts including for, the first time, those stemming from World Bank and International Monetary Fund (IMF) loans. The World Bank determines the "sustainable" level at which a country can manage a debt and the creditors cut their portions respectively. A list of 41 countries has been drawn up, identifying when and how much debt relief should be expected. It is estimated that another 25 countries will eventually be added to the list.

However, the plan looks better on paper than in practice. In short, the HIPC initiative delivers too little, too late, according to critics and non-governmental organizations campaigning for Third World debt relief. Only two countries, Uganda and Bolivia, have had their debts lightened, while another five are slated for assistance in 1999. Others like Tanzania and Ethiopia cannot expect anything until 2002.

In understanding the HIPC shortcomings, it is important to remember that many of the poorest countries have long been paying less than half the scheduled debt service. It's a bit like having two loans, but only being able to pay interest on the second one. If the bank writes off the first loan, your bank balance will look better, but your payments on the second loan continue, so you do not gain any additional benefits.

Consider the case of Uganda, the first country to benefit from HIPC. Under the initiative, its total debt has been reduced by just 11 per cent. The story is the same for Mozambique, due to receive relief in June 1999. Although the country's total debt (about $5.8 billion in 1996) will drop by $1.4 billion, much of this is "unrecoverable" debt - meaning debt the government wasn't expected to repay regardless of HIPC.

Mozambique's debt service will only fall from $112 million a year to $100 million, a saving equivalent to about 80 cents per capita.

While reducing total debt is important to keep a country's books looking healthy, the key to finding new resources to invest in education or health services, for example, lies in cutting those debts that countries actually service and not those considered unrecoverable.