The IMF plays a central role, through its policy guidance and financial support, in helping member countries cope with external debt problems. The IMF’s ultimate objective is to ensure that debtor countries achieve sustainable growth and balance of payments viability and establish normal relations with creditors, including gaining access to international financial markets. The basic elements of the IMF’s debt strategy have remained the same, even though the instruments it uses have evolved over time:
promote growth-oriented adjustment and structural reform in debtor countries,
maintain a favorable global economic environment, and
ensure adequate financial support from official (bilateral and multilateral) and private sources.
Debtor countries seeking to reschedule their official bilateral debt typically approach the Paris Club—an informal group of creditor governments, mainly those of the Organization for Economic Cooperation and Development. Under such agreements, debtor countries generally reschedule their arrears and the current maturities of eligible debt service, with repayment stretching over many years. To ensure that such relief helps countries restore balance of payments viability and achieve sustainable economic growth, the Paris Club links debt relief to the formulation of an economic program supported by the IMF. In deciding on the coverage and terms of individual rescheduling agreements, Paris Club creditors also draw on the IMF’s analysis and assessment of countries’ balance of payments and debt situations.
Over the past two decades, rescheduling has helped some distressed middle-income countries return to financial stability. For low-income countries, the Paris Club began not only to reschedule, but also to reduce, their debts in the late 1980s.
New approach needed
Although the terms for Paris Club reschedulings became increasingly concessional over the years to bring more lasting relief, many poor countries did not grow as rapidly as had been hoped and their debt remained high. For these low-income, heavily indebted countries, creditors recognized the need for a new approach.
Launched in 1996, the original Heavily Indebted Poor Countries (HIPC) Initiative marked the first time that multilateral, Paris Club, and other official bilateral and multilateral creditors combined efforts to reduce the external debt of the world’s most debt-laden poor countries to “sustainable levels”—that is, levels that will allow these countries to service their debt through export earnings, aid, and capital inflows without compromising long-term, poverty-reducing growth. This exceptional assistance, which entails a reduction in the net present value (see box below) of the public external debt of the indebted country, aims to free up resources that debtor countries can use to reduce poverty and invigorate growth.
Assistance under the HIPC Initiative is limited to countries that have per capita incomes low enough to qualify for World Bank and IMF concessional lending facilities and face unsustainable debt burdens even after traditional debt relief (see box, page 6). The vast majority of the eligible countries are in Africa.
Following a review of the HIPC Initiative and extensive public consultations, a number of modifications were approved in 1999 to provide deeper, broader, and faster debt relief to eligible countries and to strengthen the links between debt relief, poverty reduction, and social policies.
But the enhanced HIPC Initiative is no panacea. Debt relief—no matter how generous—is only the first step to economic recovery for heavily indebted poor countries. These countries can achieve long-term debt sustainability only if they directly address the underlying causes that triggered the debt problem in the first place. To avoid slipping back into a situation where poverty-reducing investments are sacrificed to mounting external debt repayments, these countries must use the debt-relief proceeds to create the basis for sustained growth and poverty reduction.
Net present value of debt
The face value of the external debt stock is not a good measure of a country’s debt burden if a significant part of the external debt is contracted on concessional terms with an interest rate below the prevailing market rate. The net present value of debt takes into account the degree of concessionality. It is defined as the sum of all future debt-service obligations (interest and principal) on existing debt, discounted at the market interest rate. Whenever the interest rate on a loan is lower than the market rate, the resulting net present value of debt is smaller than its face value, with the difference reflecting the grant element.
What has the HIPC Initiative achieved?
By July 2002, 26 countries had reached their decision points under the enhanced HIPC Initiative, with commitments for over $40 billion of debt relief (in nominal terms) over time. This initiative, along with other debt relief, will reduce these countries’ external debts by about two-thirds, from $62 billion in net present value terms to $22 billion. Resources are being allocated to education; health care, including HIV/AIDS prevention and treatment; rural development and water supply; and road construction. Six countries—Bolivia, Burkina Faso, Mauritania, Mozambique, Tanzania, and Uganda—have received unconditionally all debt relief committed under the initiative. Two additional countries, Cote d’Ivoire and the Democratic Republic of the Congo, have been considered for HIPC relief on a preliminary basis and are expected to reach their decision points soon.
The first challenge is to bring more heavily indebted poor countries to their decision points. What makes this challenge particularly difficult is that many of the countries that have not yet qualified for HIPC relief are either engaged in, or have recently ended, domestic or cross-border armed conflict. Their need for debt relief is particularly acute because they suffer from abject poverty and face major reconstruction tasks. Many are also struggling with severe governance problems. These countries require help to develop a track record of good policy performance that will allow them to move toward their decision points and begin receiving debt relief. The second challenge is to keep the countries that have reached their decision points on track to implement sound, poverty-reducing policies so that they can reach their completion points under the HIPC Initiative and achieve sustainable growth.
Why not just forgive all the debt?
There have been repeated appeals to the international community to simply erase all the debt of the world’s poorest countries, but such a step would not be the most effective or equitable way to support the fight against poverty with the limited resources available. Today’s greatest development challenge—reducing world poverty—requires a comprehensive strategy that includes the efforts of the poorest countries to help themselves, as well as increased financial assistance from the international community and improved access to industrial country markets. Debt relief under the HIPC Initiative is only one element of the international support for poor countries that removes debt as an obstacle to growth. For many years to come, these countries will continue to need financial support on concessional terms to help them implement their growth and poverty reduction strategies and stand on their own feet.
Total debt cancellation would imperil the funds that multilateral creditors would have for future lending and would come at the expense of resources available to other developing countries, some of which are equally poor but have less external debt. Over 80 percent of the world’s poor live in countries that are not HIPCs. For the IMF, total debt cancellation would exhaust the resources that finance the Poverty Reduction and Growth Facility (PRGF) and the HIPC Initiative, and the IMF would have to stop providing concessional support to its poorest members.