Global Policy Forum

By Allan H. Meltzer and Adam Lerrick

The World Bank/International Monetary Fund (IMF) meeting in Prague last month marked the first anniversary of the agreement to relieve the highly indebted poor countries (HIPCs) of their debt burdens. The richest countries joined with the international financial institutions (IFIs) in a pledge to staunch what Nigeria's President Obasanjo calls "the gushing wound of an ever-penetrating debt repayment lance."

The pledge has some bright spots and many flaws. Two-thirds of the total $125 billion in claims is bilateral. The rich countries agreed to write these off for countries that qualify by agreeing to reforms. The principal IFIs should do the same. Instead of using their ample reserves set aside for just this purpose, they have asked member governments to contribute $3.6 billion of new funds (the U.S. share is $1 billion). Instead of canceling their entire $45 billion HIPC debt, more than $30 billion will still be owed to the IFIs. If the four largest IFIs used half their reserves, they could cancel their entire debt. Instead of a permanent solution, the program is partial and temporary.

The original program identified 40 countries. The current plan provides relief for only 32 nations. The General Accounting Office (GAO) recently reported to Congress that the continuing need for development financing by the HIPC economies is almost certain to require a new round of forgiveness in the next 10 or 15 years. The GAO notes that the IFIs are wishing the problem away. To make the solution to the debt overhang appear permanent, the IFIs assume that annual growth of exports, GDP and government revenues will average 7 to 12 percent in the HIPC economies in nominal dollar terms for the next 20 years. Past performance does not justify this optimism. In comparison to successful developing countries, they suffer by every measure — health, education, climate, infrastructure, civil order, government probity and rule of law. Even with the best of intentions and effort, these deficiencies cannot be repaired quickly enough to sustain the assumed growth rates.

When pressed, proponents of the plan invoke China's dramatic achievements — a nation with a high savings rate, an established industrial base, considerable infrastructure, and an ability to attract capital from the developed world. For the minimal $14 billion IFI relief plan for 32 countries, there is a $5 billion unfilled financing gap even after the $3.6 billion donor contribution. This deficit rises to $9 billion, when four additional countries that will soon qualify are included. Funds will be exhausted within five years; thereafter, $700 million to $1.2 billion more will be required annually for the next two decades. A few years from now, there will be another desperate demand for more relief funding, possibly called by another name. Perhaps the development banks will seek "replenishments" for the International Development Association (IDA) arm of the World Bank and its regional counterparts.

The IFIs have positioned themselves as donors of last resort. But it is the taxpayers of the industrial world who will pick up the bill for as much as 70 percent of IFI losses, 84 percent of the HIPC initiative, and 94 percent of total debt forgiveness. Realism joins with humane concern in the Meltzer Commission's unanimous support for total HIPC debt relief if accompanied by reform. Effective default occurred long ago, and the debts are uncollectible. IFI lending that exceeds current payments of HIPC principal and interest simply serves to maintain a "no default" fiction while escalating debt burdens. But forgiveness of past obligations will be an empty gesture if new funds finance regional wars, presidential jets, rutted roads, unfinished schools or end up in personal accounts of corrupt officials held abroad.

Reform must be real, not just a vague promise to support social and economic development. Governments must be held accountable and so must the IFIs. Unfortunately, the World Bank is doing the opposite. At the development banks, the free fall toward generalized lending must stop. The G-7 governments have shifted to outright grants instead of loans. The Meltzer Commission proposed that the development banks do the same. Without loans, there is no debt and no future debt problem. Grants must be for specific purposes. The results of aid funds must be independently audited to assure performance.

The United States government has already contributed $7 billion to relieve bilateral debt burdens and $440 million to help the IMF meet its goal. The administration seeks an additional $600 million to reimburse the IFIs. A further $1.5 to $2.5 billion is waiting in the wings for 2005 and beyond. Past efforts to relieve debt burdens have failed. Tough questions must now be answered: Is the current initiative enough to put the debt problem behind us? What reforms are needed by the countries and the IFIs to give the program a reasonable chance of success? What are the total funding demands, not the piecemeal contributions? Why shouldn't the IFIs be required to absorb the cost of their past mistakes as a first step in the reform of these institutions?

Allan H. Meltzer, a professor of political economy at Carnegie Mellon University, was chairman of the International Financial Institution Advisory Commission of the U.S. government. Adam Lerrick served as the senior adviser to the commission.

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