Sunday, July 22, 2007

Q. 3.8: The Enhanced Heavily Indebted Poor Country (HIPC)

7.4 The Enhanced Heavily Indebted Poor Country (HIPC)
Debt Initiative

Closely linked to the PRGF and the PRSP process is the Enhanced Heavily
Indebted Poor Countries (HIPC) Initiative, which was prompted by the belief of
several governments and by strong arguments by non-governmental organisa-
tions that poverty in low income countries could not be addressed only by
concessional loans and domestic policies with poverty reduction. Instead, it was
argued, that an external constraint – high inherited levels of foreign debt –
crippled individual countries’ capacity to overcome poverty. Surely, it was
argued, a country that pays more each month in interest and debt payments to
foreign creditors than the money it pays for running schools or hospitals has
spending priorities that are not conducive to poverty reduction or to growth. To
put it another way, it is often asked why a government should cut its budget
expenditure to support a surplus on the current account of the balance of
payments (as in old stabilisation programmes) when the former involves a cut
in funds for schools, medicine and social programmes and the latter is used to
finance the servicing of old debt.
The priority given to paying creditors was enforced by the creditors themselves
and by the discipline required for a country’s credibility in international capital
markets. Proposals to ‘forgive’ or ‘cancel’ debt through HIPC or other mechanisms
were opposed by many creditor countries. One ground for opposition
was the argument that ‘cancelling’ debt would not necessarily lead to the debtor
country putting more resources into poverty reduction or economic growth
strategies. Nevertheless, the IMF and the World Bank launched the original
HIPC initiative in 1996 as the first comprehensive effort to eliminate unsustainable
debt in the world’s poorest, most heavily indebted countries. It was a
complex programme involving long application and approval processes, and it
included measures justified as an attempt to ensure that reduction of debt led to
benefits.
In October 1999, the international community agreed to make the initiative
broader, deeper and faster by increasing the number of eligible countries,
raising the amount of debt relief each eligible country would receive, and
speeding up its delivery. This agreement occurred at a summit meeting of the
heads of state of the G-7 industrial countries in Cologne, Germany. The Cologne
summit agreed to improve the debt relief package in place since 1996 and to
initiate a new framework, which came to be known as the Enhanced HIPC
Initiative.
The enhanced HIPC initiative does not set out to completely forgive all indebtedness
of low-income countries. Instead, it focuses on achieving a level of
indebtedness in each country that is the beneficiary of the initiative, which will
enable that country to continue to service its indebtedness in a sustainable
manner.
To achieve this objective, the initiative examines, for each country, the actual
level of indebtedness as well as its debt-servicing burden. And it matches these
actual circumstances with a theoretical level of indebtedness and debt servicing
that could be considered to be sustainable. This theoretical level is held constant
for all countries, so that once debt relief has been provided, they will be able to
have reached a comparable level of sustainable indebtedness.
The theoretical sustainable levels are predetermined and are based on the levels
the large industrial countries, to whom the debt is owed, consider to be reasonable.
For this reason, the Cologne summit decided that the initiative would
provide sufficient debt relief to each eligible country to enable it to reduce the
net present value of its debt to a maximum of 150 percent of its exports or 250
percent of its government revenue. The G-7 summit also decided that the
assistance would be provided in addition to debt-relief mechanisms that had
prevailed up until the summit meeting.
7.4.1 Two stages in the HIPC process
Eligible countries qualify for debt relief in two stages. In the first stage, the
debtor country needs to demonstrate the capacity to use prudently the assistance
granted by establishing a satisfactory track record, normally of three
years, under programmes supported by the IMF and the International Development
Association (IDA). As you have seen, this means that the country must
have embarked on a PRGF arrangement with the IMF. And in turn, this also
means that the country must have completed at least an interim-PRSP. In the
first stage, a detailed assessment is also made, to determine the debt relief needs
of the country. If a country’s external debt ratio is found to be above the predetermined
threshold for the value of debt to exports (or in some instances above
the predetermined level of the value of debt to fiscal revenues), that country is
considered eligible to qualify for debt relief assistance.
The second stage occurs when it is formally decided to begin providing a
country with debt relief. This moment is known as the ‘Decision Point’. The
Decision Point occurs when the IMF and the World Bank Executive Boards
agree that the country has qualified for debt relief. After reaching the Decision
Point under the initiative, the country must then implement a full-fledged
poverty reduction strategy, which has been prepared with the broad participation
of civil society and an agreed set of measures aimed at enhancing economic
growth and contained in the PRGF financing arrangement. The Decision Point
also marks the point at which the international community commits to provide
assistance by a particular future date in an amount that would enable the
country to achieve debt sustainability.
During this stage, the IMF and the IDA grant interim relief, provided that the
country stays on track with its IMF- and IDA-supported programmes. In
addition, countries that have made loans bilaterally (mainly Paris Club creditors,
countries that participate in ‘Paris Club’ negotiations with indebted poor
countries) are expected to grant debt relief on highly concessional terms. The
end of the second stage is marked by a further decision, that the country has
completed the requirements to receive debt relief. This moment is known as the
‘Completion Point’. The Completion Point is again marked by successful Board
decisions by the IMF and the World Bank Executive Boards. Once the Completion
Point has been reached, the IMF and the World Bank’s IDA provide the
remainder of the committed debt relief, while Paris Club creditors enter into a
highly concessional stock-of-debt operation with the country involved. Other
multilateral and bilateral creditors need to contribute to the debt relief on
comparable terms.
When the HIPC initiative was originally launched, countries were obliged to
wait for a further three years after the Decision Point before the Completion
Point could be reached. This delayed the receipt of debt relief for recipient
countries, including those that had achieved all of the requirements set out by
the IMF. To speed up the delivery of debt relief, the concept of ‘floating Completion
Points’ was introduced when the Enhanced Initiative was launched in
1999. Consequently, debt relief can now be delivered more quickly by introducing
‘floating’ completion points not linked to a rigid timeframe, but rather
determined by progress toward implementing measures that will reduce
poverty in a sustainable manner. The actual time period between a country’s
decision and completion points has become flexible and now depends on how
quickly the country can formulate and implement its own poverty reduction
strategy, sustain macroeconomic stability and put in place mechanisms to
safeguard and track the use of funds freed by debt relief. Several countries have
subsequently benefited by receiving earlier debt relief.
7.4.2 Qualifying thresholds for debt relief
The sustainability targets under the original HIPC framework were set in the
light of empirical research that had examined largely middle-income countries,
and many non-governmental organisations felt that low-income countries had
less capacity to sustain external debt. Thus, in 1999, the World Bank and the IMF
carried out a review of the HIPC Initiative in broad consultation with such civil
society organisations and public officials. As a result of this review, the international
community agreed to enhance the Initiative and committed itself to
providing faster, broader, and deeper debt relief. Under the enhanced HIPC the
qualifying thresholds have been lowered, and more countries became eligible
for debt relief and some previously eligible countries, such as Mozambique and
Uganda, were able to seek greater relief.
Countries have been able to qualify through one of two routes – either by
demonstrating an unsustainable debt-to-export level, or under the ‘fiscal
window’ by demonstrating an unsustainable debt-to-government revenue level.
The ability to qualify under either approach was taken after the Cologne Summit,
in recognition of the fact that some low-income countries confronted low
levels of exports, while others manifested very low levels of government
revenue; and that both challenges directly influenced the ability of these countries
to achieve levels of indebtedness sustainable in the medium and longer
term. Accordingly, after the Cologne Summit, the debt-to-exports target was
lowered to 150 percent, from 200–250 percent under the original HIPC initiative,
and the debt-to-fiscal revenue target was set at 250 percent (down from 280
percent under the original initiative) for countries qualifying under the fiscal
window.
7.4.3 Debt relief to date
The Enhanced HIPC Initiative represented a substantial improvement over the
original debt relief programme established in 1996. In terms of the enhanced
initiative, approximately 37 countries, most of which are sub-Saharan African
countries, are expected to qualify for assistance aggregating approximately
US$51.1 billion in net present value terms.
By September 2003, debt-relief packages had been approved, at least up to the
Decision Point, for 27 countries under the enhanced HIPC Initiative framework.
The agreements together with other debt relief sources have resulted in a
reduction in the total external debt stock of these countries by approximately
two-thirds, with the total external debt stock of these countries being reduced
from $54 billion to approximately $20 billion in net present value terms. The
corresponding savings in total future debt service payments (in nominal terms)
is estimated at US$53 billion.
The IMF’s most recent estimates are that the average annual debt service due for
these countries is expected to be about 24 percent lower during the period
2001–2006, compared to the level in 1998–99. In addition, debt service as a
percentage of exports has declined from 16.9 percent in 1998, to an estimated 9.8
percent in 2003. As a share of government revenue, debt service is expected to
decline from over 25 percent in 1998 to below 15 percent after 2003.
7.4.4 Ongoing challenges with the HIPC Initiative
Notwithstanding progress, there are many significant challenges with the
Enhanced HIPC Initiative. These include those described here:
• post-Completion-Point sustainability
• pace of debt relief
• fiscal dimension of unsustainable debt
• insufficient attention to human development goals
• diversion of aid resources
• HIPC debt to non-Paris Club members
• HIPC-to-HIPC debt.
Post-completion-Point sustainability
Even countries that have achieved the Completion Point are experiencing
significant difficulties in remaining in a situation of sustainable indebtedness.
The terms of trade have shifted against these countries, usually due to external
factors beyond the control of member authorities; and this has rendered their
debt sustainability ratios clearly unsustainable. For these members, the current
HIPC framework provides no remedies, because there is no provision for
additional relief after the completion point.
Pace of debt relief
The pace of debt relief has been slow. The HIPC initiative was launched in 1996
and there remain many countries that have not received any relief at all. Many
developing countries consider that the reason for the slow pace of relief has
been the design of the HIPC initiative, in particular the two-stage qualifying
process and the arduous requirements which countries must achieve before
receiving debt relief.
Fiscal dimension of unsustainable debt
It is frequently argued that the HIPC debt sustainability ratios do not adequately
consider the fiscal capacity of governments, and for this reason place
unsustainable fiscal burdens on member countries emerging from the HIPC
initiative. Accordingly, the fiscal threshold of 250 percent is considered to result
in countries achieving debt relief yet still remaining in a situation of unsustainable
indebtedness.
Insufficient attention to human development goals
Similarly, it is argued that the HIPC framework, which focuses on macroeconomic
variables to determine debt sustainability, does not take adequate
account of the objectives of human development – in particular the financing
needs necessary to achieve certain basic levels of social development and
human and institutional capacity, all of which are necessary to ensure a sustainable
exit from unsustainable levels of debt.
Diversion of aid resources
A further emerging difficulty with the HIPC framework is that net aid resources
to developing countries have not increased despite the initiative. As a consequence,
it is argued that there has been, at best, a diversion of aid resources,
rather than a necessary increase in the overall quantum of financial resources to
developing countries.
HIPC debt to non-Paris Club members
An emerging challenge to the HIPC initiative has been the recent expansion in
litigation by creditors who are not part of the Paris Club arrangement, against
HIPC governments. These creditors refuse to be bound by the terms of the HIPC
and are increasingly securing judgment against HIPC countries. This process
subverts the overall intention of the HIPC framework. Note that the challenge is
similar to the challenge of trying to coordinate creditor action in the case of the
large emerging markets, which was examined in Unit 6. For if some creditors
achieve a better outcome than others, in securing a higher proportion of repayment
than the average for the remaining creditor group, the incentive to achieve
a collective agreement between the broadest spectrum of creditors and the
debtor country is weakened.
HIPC-to-HIPC debt
A further challenge to the Enhanced HIPC Initiative is the presence of a situation
in which both debtor and creditor are HIPC countries. An example is the
case of Burundi, which is a creditor to Uganda. Both HIPC members can be
argued to have an important basis to claim, at least in terms of principles of
economic development, with Burundi claiming that it is entitled to be repaid the
loans it originally made to Uganda, and Uganda claiming that as a Heavily
Indebted Poor Country, it is entitled to secure debt relief from Burundi.
In fact, both countries have limited financial capacity and neither should be
placed in a position where they find themselves litigating against each other.
The large industrial country creditors have recognised this challenge, but thus
far no systematic resolution of the problem has been found. Consequently,
developing countries have argued that the HIPC framework, which did not
foresee this challenge, ought to be revised to provide a remedy for this type of
circumstance.

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