Global Policy Forum

Background

The Heavily Indebted Poor Countries (HIPC) Initiative will figure prominently on the agenda of the IMF-World Bank annual meeting in Prague from 19-26 September. Nine countries are currently receiving debt relief under the Initiative. Current plans are for this number to rise to 20 countries by the end of the year. The stated aim is to leave heavily indebted countries with a sustainable debt profile, and to provide resources for poverty reduction. IMF-World Bank staff reports, prepared for the annual meeting, have cited large financial gains for the HIPCs amounting to over $28bn.

Research carried out by Oxfam suggests these headline figures grossly exaggerate the real benefits of the HIPC Initiative. In the first in-depth analysis of the implications of the Initiative for government finances, the research suggests that the annual budget savings for most countries will be modest. Some countries - including Senegal, Tanzania and Zambia - will emerge from the HIPC debt relief process in the perverse position of paying more on debt servicing.

Debt repayments will continue to absorb a disproportionately large share of government revenue, amounting to more than 15 per cent in six countries, and to over 40 per cent in Zambia, Cameroon and Malawi. All but three of the twelve countries reviewed in the Oxfam research will continue to spend far more on debt servicing than on health and primary education after they have received debt relief.

The picture that emerges from the Oxfam research raises fundamental questions about the adequacy of the enhanced HIPC Initiative. While the Initiative will significantly reduce both the stock of unpayable debt and the amount that countries would have to pay without debt relief, it does not go far enough. Far deeper levels of debt reduction are needed to leave governments with the capacity to finance basic services. Oxfam recommends that a 10 per cent ceiling should be set on the proportion of government revenue allocated to debt servicing.

Part of the problem with the existing HIPC framework is its narrow perspective on debt sustainability. Repayment capacity is currently defined primarily in terms of the debt-to-export ratio. Oxfam wants to see a more poverty-focussed approach to debt sustainability in which human needs figure more prominently. It argues that more weight should be attached to the budgetary burden of debt and the diversion of public finances away from poverty reduction initiatives.

As a group, the heavily indebted countries suffer from some of the deepest and most pervasive levels of poverty in the developing world. Over half of the population lives below the $1-a-day poverty line, one-in-six children die before the age of five from poverty-related diseases, and almost 50 million children are not in school. To demand that governments in these countries spend more on debt servicing than on the basic health and education needs of their citizens is economically irrational, morally unacceptable, and at variance with the HIPC Initiative's proclaimed goals of providing a poverty-focussed debt relief framework.

The enhanced HIPC Initiative

The enhanced HIPC Initiative adopted by the Boards of the IMF-World Bank at the 1999 annual meeting, following the Group of Seven summit in Cologne, aimed at accelerating and deepening debt relief. Under the reformed framework, which marked a step forward, the threshold targets for net present value of debt-to-exports has been lowered to 150 per cent.

Much has been made by the World Bank, the IMF and the wider creditor community of the generosity of the new HIPC Initiative. Headline figures suggest that the amount of debt relief provided to a group of 32 countries will double to $28bn (in net present value terms), reducing the average debt-to-export ratio by 41 per cent to 138 per cent at decision point, and to less than 100 per cent by 2005.

Comparing post-HIPC Initiative debt servicing with the amount that countries would have to pay in the absence of debt relief points to significant benefits. For the nine countries expected to have reached decision point, total debt service relief amounts to $9.1bn – three times the amount projected under the original HIPC Initiative. This figure will rise to $20bn if the target of debt relief for 20 countries by the end of the year is achieved.

Documents prepared for the annual meeting in 2000 highlight dramatic improvements in the debt profile of the HIPCs. The debt/GDP ration is projected to fall from 47 per cent to 28 per cent, and the debt service ratio from 15 per cent to 9 per cent. Scheduled debt payments will fall by $800m.

Such indicators have been used to present a positive picture of the enhanced HIPC Initiative, notably for media consumption. Unfortunately, they tell only part of the story. In particular, they fail to capture the impact of debt relief on government revenue and budgets. Despite repeated requests from non-government organisations IMF-World Bank staff have failed to provide any assessment of the proportion of government finance that will be diverted to debt servicing after debt relief. This fiscal dimension of debt is critical to any assessment of the potential of the HIPC Initiative to deliver on commitments to poverty reduction made by the creditor community.

The debt relief deficit

In an attempt to assess the real implications of the HIPC Initiative for government budgets, Oxfam has analysed post-HIPC debt service projections for 13 countries. Eight of these countries have reached their decision point and benefit from assistance under the enhanced HIPC framework. Another four are expected to received enhanced HIPC support this year. The potential budgets effects of debt relief were captured by taking the average annual level of debt repayment projected for the three years after countries reach decision point. This figure was then compared with government revenue in the decision point year.

The findings suggest that the benefits of the HIPC Initiative in terms of reduced debt servicing will be significant for a small group of countries, negligible for a larger group, and non-existent for several (Figure 1 & 2):

Increased debt servicing for three countries. Zambia, Tanzania and Senegal all face an increase in debt service payments. The largest increase will be in Senegal, where debt service payments will almost double to $171m, reflecting the large pre-HIPC Initiative gap between scheduled and actual payments. In Zambia an increase in repayment to the IMF will raise annual debt servicing by $75m, or one-third. Limited benefits for four countries. Debt service payments will fall by less than 20 per cent for Burkina Faso, Honduras, Guinea, Malawi, and Mauritania. Significant savings for five countries. Debt servicing will fall by 30 per cent or more for Bolivia, Cameroon, Mozambique, Rwanda and Uganda.

One of the aims of the HIPC Initiative is to release resources that could be used to reduce poverty from debt servicing. Given the limits imposed on revenue raising capacity by low average incomes, and the huge scale of unmet basic needs, this is an important objective.

The data derived from the Oxfam research strongly suggests that unsustainable debt will remain a formidable obstacle to poverty reduction efforts. As shown in Figure 3, debt servicing will continue to absorb a large share of government revenue in most countries, amounting to 40 per cent of total revenue in Zambia 25-35 per cent of the total in Cameroon, Guinea, Senegal and Malawi 15-20 per cent in Honduras, Mozambique, Tanzania and Mauritania 13-14 per cent in Burkina Faso and Mauritania.

Implications for public investment in basic services and human development

The limited budget savings provided through enhanced HIPC Initiative debt relief means that some of the world's poorest countries will continue to transfer far more to their creditors, than they are able to invest in basic services. Figure 4 summarises data for twelve countries on projected post-HIPC Initiative debt servicing, and actual spending on health and primary education in 1999. It shows that: there are eight countries in which debt service payments will exceed the budgets for health and education in five of these countries (Zambia, Tanzania, Senegal, Mauritania and Cameroon) debt repayments will exceed the combined health and education budgets after debt relief.

It is difficult to square these public-spending outcomes with a genuine commitment to a poverty-focussed debt initiative on the part of the donor community. As a group, the heavily indebted countries are massively off track for achieving the human development targets set for 2015. These include the halving of extreme poverty, universal primary education, and a two-thirds reduction in child mortality. If current trends continue, each of these targets will be missed by a wide margin. The incidence of poverty is falling only marginally, and the absolute number of poor people is increasing. Projecting current trends towards 2015 shows that there will be 57 million children out of school in 2015 – 10 million more than today. The child mortality rate will be 18 per cent lower than in 1995, compared to a target rate of 66 per cent. This gap translates into 2 million additional child deaths.

The prospective scenario for individual heavily-indebted countries underlines the enormous human development costs implicit in the debt service projections summarised above.

Burkina Faso. Under the HIPC Initiative, Burkina Faso will continue to allocate around 13 per cent of government revenue to debt servicing, or around $40m per annum. This amount may appear small from the industrialised world. But in a country where almost one in four children die before the age of five from poverty-related diseases, spending on debt will represent double the spending on health. Debt servicing will also exceed the education budget, even though Burkina Faso has among the world's lowest school enrolment and adult literacy rates. Fewer than a quarter of girls attend school.

Zambia. In the three years after HIPC debt relief Zambia will be allocating around 40 per cent of government revenue to debt servicing – one of the highest levels in the world. These resources are urgently needed for investment in poverty reduction. Zambia is one of the countries worst affected by HIV/AIDs. Nearly 13 per cent of children are orphans (the highest rate in the world), and child mortality rates are rising. During the 1990s the proportion of children suffering from chronic malnutrition has risen from 39 per cent to 53 per cent. As in other HIPC countries, poor health and education indicators are linked to wider patterns of deprivation, with over half of the population living below the extreme poverty line.

Senegal. The newly elected government has committed itself to ambitious reforms in health and education as part of a renewed national commitment to poverty reduction. However, its capacity to deliver on the commitments made will be compromised by foreign debt servicing. Average debt repayment will be equivalent to double the combined health and primary education budgets. There is now a real danger that debt servicing will undermine the Quality Education for All programme that aims to achieve universal primary school enrolment by 2008. Although aid flows will partially compensate for debt servicing, development assistance for education will represent less than half of government debt repayments.

Malawi. One of the few HIPC countries to have made rapid progress in education: expenditure on education has doubled as a proportion of GDP to 5 per cent, with a major redistribution in favour of primary schools. Free education was introduced in 1994, leading to an increase in enrolment of around 3 million by 1997. Health spending has also increased. Despite these positive budget trends, Malawi faces immense problems. There is an urgent need to improve the quality of education and to increase the rate of transition to secondary school. Several key health indicators – such as infant mortality – have stagnated, partly as a consequence of HIV/AIDs. Almost 5 million people live below the poverty line. With foreign debt absorbing around one-quarter of revenue, government capacity to address these problems will inevitably be curtailed.

Tanzania. Having entered the HIPC Initiative this year, Tanzania will continue to allocate over one quarter of government revenue to debt servicing for the next three years. This represents more than public spending on health and primary education in a country with over 2 million children out of school, and with 186,000 under-five child deaths each year.

Wider problems

Inadequate levels of debt relief is just one of the problems associated with the HIPC Initiative. Despite repeated pledges from creditors, the pace of implementation remains far too slow. There are also growing concerns about gaps in the Initiative.

There are several reasons for the slow pace of implementation. In some cases, unrealistic conditions have been set under the IMF programmes that eligible countries must comply with in order to receive debt relief. In Honduras, for instance, debt relief has been held up because of IMF insistence on more rapid progress in the country's privatisation programme. In other cases, weak management appears to have been responsible. Malawi could have received debt relief in May had IMF and World Bank staff completed their debt sustainability analysis earlier. The delay may cost Malawi around $50m in interim debt relief, if it enters HIPC in November as planned.

Several countries potentially eligible for debt relief are affected by conflict. Earlier this year the British Chancellor Gordon Brown outlined an initiative aimed at using debt relief as an incentive for peace and reconstruction. The recent cease-fire in the war between Ethiopia and Eritrea provides an important opportunity for the creditor community to put this commitment into practice. Failure to provide Ethiopia with debt relief will leave the government facing chronic public financing problems. Scheduled debt service payments amount to 60 per cent of export earnings.

HIPC initiative eligibility currently extends to a group of around 40 low-income countries. That group does not include Nigeria, which is Africa's largest debtor. Nor does it include chronically indebted lower-middle-income countries such as Jamaica. The next phase of HIPC reform needs to develop strategies for extending the debt relief remit to other countries where unsustainable debt threatens poverty reduction efforts.

An agenda for reform

The enhanced HIPC Initiative is failing to realise its potential. Urgent reforms are needed to deliver on the commitments made by creditors to provide a permanent exit from the debt crisis. Failure to act will undermine efforts to link debt relief to national poverty reduction efforts.

During the annual IMF-World Bank meeting in Prague Oxfam is calling for: A new approach to debt sustainability. It is fundamentally unacceptable for countries suffering widespread extreme poverty to spend more on debt servicing than they invest in the health and education of their citizens. No country emerging from the HIPC Initiative should be required to allocate an amount equivalent to more than 10 per cent of revenue to debt servicing. IMF-World Bank debt sustainability analyses should include projections for the amount of government revenue to be allocated to debt servicing.

Immediate debt relief to countries which commit to a ‘Poverty Fund' in the Interim Poverty Reduction Strategy Paper (PRSP): There is an urgent need to accelerate implementation of the HIPC initiative, and to strengthen the linkage between debt relief and poverty reduction. Current approaches have become unduly bureaucratic, causing delay in the provision of debt relief. New approaches to eligibility are urgently needed. At the decision point governments should be broadly on-track with their macro-economic programmes. But the key requirement for entry into HIPC should be the development of a poverty action fund, detailing how debt relief finance will be allocated to poverty reduction initiatives.

Implementation of the fund would be monitored by government, civil society and donors. Obvious priority areas would include health, education, rural roads, water supply and employment generation programmes. Such an action fund was pioneered in Uganda, where a Poverty Action Fund helped to finance Universal Primary Education, basic health and rural feeder-road programmes. The use of debt relief to eliminate charges for basic education and health is one option with potentially large human development returns. Immediate and generous debt relief for Ethiopia. There is now a real opportunity for using debt relief to underpin the peace in Ethiopia. Having already been assessed under the original HIPC Initiative framework, Ethiopia should immediately be reassessed and provided with debt relief geared towards poverty reduction.

The extension of the HIPC framework. IMF-World Bank staff should review the debt sustainability of countries such as Nigeria and Jamaica not covered by the existing HIPC framework, but facing chronic debt problems.

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