Mercy Global Concern - 2005

Background Note on Debt

The situation: Need for more debt relief

ActionAid/Oxfam and Eurodad recently examined European government approaches to aid, debt and trade . The findings were that far too little is being done by many governments. On debt relief, unfortunately; the HIPC Initiative has so far failed to reduce debt to sustainable levels in most countries where it is in place. Even those countries which have qualified for HIPC are paying $2.8 billion a year to their creditors, money which could instead go on development spending.

Bilateral debt
Most creditor countries have agreed to cancel 100 per cent of the bilateral debts owed by the 42 countries in the Heavily Indebted Poor Countries (HIPC) initiative. In some cases; they have included other low-income countries in their debt relief lists; as well. However, some countries have been very slow in delivering their promises. Ital: promised an ambitious lift of up to €4 billion to HIPC countries and other low-income, but has delivered €2 billion so far; Germany HIPC debt relief has been provided to only 6 countries (out of a €6 billion figure; has delivered only €2 billion); Slovakia delivered debt relief to all HIPC countries; Czech Republic, Hungary and Poland cancelled some debt for some HIPC countries.

Additional debt relief
Debt relief should be additional to the aid previously announced. France, The Netherlands and Belgium, for example, have falsely inflated aid statistics because debt relief payments are included in them. These payments are largely for export credit debt and often more an export subsidy than a development transfer.

Multilateral debt
Ireland was the first EU member state to argue for multilateral debt cancellation, in 2002. Since then, other EU countries have either contributed to the HIPC Trust Fund or pushed their neighbours to do so (UK and The Netherlands; for example, are late with their contributions. France does not see the need for multilateral debt cancellation).
The most promising proposal for funding debt cancellation in a genuinely additional manner is to use IMF gold. This is currently an undervalued asset sitting in the IMF’s vaults, worth around 40 billion Euros. Some EU members; such as the UK, Germany and Italy back the use of this gold. Others, like the Netherlands are not yet backing the gold revaluation proposal.

Panel No. 1 “Debt sustainability: what it implies for policy makers, private sector and civil society”

The International Monetary Fund (IMF) has adopted an approach (IMF 2002) that defines a sustainable foreign debt situation as one in which the government could continue to service its obligations without an “unrealistically large” future correction to the balance of income and expenditure. The IMF strengthened its approach for assessing public and external debt sustainability by adopting a new framework, which was further enhanced in 2003. This framework focuses on crisis prevention and potential vulnerabilities and is designed for countries with financial market access. IMF now performs debt-sustainability analysis more frequently based on deeper country-specific analysis (see Issues Paper 11-15). Still, the Bretton Woods Institutions act as both creditors and centralised assessors of debt sustainability, which represents a clear case of conflict of interests. The official “Issues Paper” rightly acknowledges that the “sustainability of foreign debt has been defined in both macroeconomic and social terms”. This second approach was developed by NGOs and “looks at the social and development imperatives of a government’s expenditure and its revenue-raising capacity, calculates the funds that could be made available for debt servicing, and compares that to actual obligations. Even the US adopted legislation calling on the Bretton Woods institutions to limit external debt servicing by HIPCs to 10% of revenues, except in the case of countries with public health crises, where the prescribed limit was set at 5% of revenues” (Issues Paper 11).

Panel No. 2 “Debtor-creditor relations in good times and bad”

The 1990s witnessed the growing severity and frequency of debt crises for middle-income countries. These new and more rapid crises have largely arisen from the integration of the capital markets in emerging market economies and the introduction of IMF-recommended capital account liberalisations. The resulting huge inflows of volatile capital – leading to crises in Mexico, Asia, Russia and Argentina – have made it necessary for the IMF to organise increasingly expensive rescue packages. But even these “rescues” have led to criticism of the IMF for bailing out private lenders with public money at the expense of the longer-term development prospects of millions of people. In other cases such as former Yugoslavia or, more recently Iraq and Sri Lanka, the readiness of bilateral and multilateral creditors to grant substantial debt relief is guided by strong political interests – adding to the lack of transparency and inequality of the present international debt management procedures.

While the debt crises in middle-income countries have led to increasing costs, debt-restructuring packages have become more complicated. There is now a greater diversity of creditors (including banks, bond holders, trade financiers) involved in restructuring exercises. Debt restructuring packages that require collective action and coordination between creditors and debtors have become even more difficult to reach. Even the IMF stated, “the present process for restructuring is more prolonged, more unpredictable and more damaging to the country and its creditors than would be desirable.” Moreover, the absence of a “predictable and equitable process makes it more difficult to attract long-term capital to the emerging market asset class” (Anne Krueger, 2002). At the Financing for Development Conference 2002 the following paragraph was adopted:

“To promote fair burden-sharing and minimize moral hazard, we would welcome consideration by all relevant stakeholders of an international debt workout mechanism, in the appropriate forums, that will engage debtors and creditors to come together to restructure unsustainable debts in a timely and efficient manner. Adoption of such a mechanism should not preclude emergency financing in times of crises.” (Monterrey Consensus, para 60)

In 2001 the IMF put forward its proposals for a new Sovereign Debt Restructuring Mechanism (SDRM) in which some of the principles of domestic insolvency procedures were applied to sovereign countries. However, the SDRM had substantial flaws: It involved a cumbersome decision-making procedure that retained most of the inequities of existing processes. Primarily addressing public debt owed to private sector creditors the SDRM failed to deal with multilateral debt and bilateral creditors. More important the SDRM did not comply with basic demands regarding impartiality, transparency and a poverty perspective. IN April 2003 the IMF’s SDRM initiative was blocked. Opposition mainly came from the US Treasury Department which did not want to see a legally binding framework, preferring the voluntary inclusion of so called ‘Collective Action Clauses’ (CAC) in bond contracts instead. Also emerging market countries were reluctant. Their main concern was that their borrowing conditions would be negatively affected by the simple existence of a debt workout mechanism that would bail-in private creditors stronger than before.

The voluntary inclusion of CAC may be a small step forward to creditor coordination in new bond contracts. However, they do not offer an exit to any of the already existing contracts. Nor do they allow for civil society in debtor countries to be heard. The concerns of emerging market countries on the other hand clearly reflect the coercive power of the international financial markets. While the status quo gives centrality to the interest of creditors (including multilateral institutions), resolving a debt crises can only work when the basic human needs and rights of the poor are met. Also voluntary Codes of Conduct cannot provide a sufficient answer to this systemic problem of a one-sided bias, as they keep all control on procedures and results in the creditors’ hands.