The HIPC Initiative
- Kamau Thugge, and Anthony Boote
- Published Date:
- December 1999
The traditional mechanisms for dealing with the debt problems of low-income countries are sufficiently robust to deal with the debt burden of many HIPCs and to reduce their external debts to sustainable levels (see definition below). As noted earlier, the external positions of the HIPCs vary widely and indeed some countries such as Ghana, Kenya, and the Lao People’s Democratic Republic have never received concessional reschedulings from the Paris Club. Others, such as Equatorial Guinea and Vietnam, are unlikely to need the full use of traditional debt-relief mechanisms in order to reach debt levels that are sustainable. However, even with sound economic policies and full use of traditional mechanisms for rescheduling and debt reduction and the continued provision of concessional financing, a number of countries are not expected to reach sustainable levels of debt within a reasonable period of time. To deal with this problem, the IMF and World Bank jointly proposed and put in place in September 1996 the HIPC Initiative that aims at reducing the debt burdens of all eligible HIPCs to sustainable levels, provided they adopt and pursue strong programs of adjustment and reform. The Initiative builds on instruments available to the international community to deal decisively with the debt problems of the low-income countries and allows them to exit, once and for all, from the rescheduling process.
An important benefit of exiting from the rescheduling process is a return to normal relations with the international financial community, characterized by spontaneous financial flows and the full honoring of commitments. In addition, repeated reschedulings involve significant costs for policymakers and create uncertainty about future debt relief and may foster the belief on the part of borrowers that financial contracts need not be honored. The Initiative would also reduce what is known as the “debt overhang,” namely the negative impact of a large external debt burden on economic growth. A debt overhang can contribute to investment disincentives, and could delay private capital flows required to generate sustainable growth. The HIPCs face a host of formidable challenges, of which the debt burden is only one problem. However, the removal of the debt overhang by implementing the HIPC Initiative will permit these countries to focus on the policies required to tackle other impediments to sustainable growth, such as inadequate physical infrastructure, untrained workforces, and weak institutions.
The Main Objectives of the HIPC Initiative
The Initiative is intended to deal in a comprehensive manner with the overall debt burden of eligible countries and to reduce it to a sustainable level within a reasonable period of time. The Initiative involves a commitment made at the decision point—after a three-year track record—by the international financial community to provide sufficient debt relief to reduce the debt burden of eligible countries to sustainable levels, provided the country completes a further three-year period of strong policy performance.
A country can be considered to achieve external debt sustainability if it is expected to be able to meet its current and future external debt-service obligations in full, without recourse to debt relief, rescheduling of debts, or the accumulation of arrears, and without unduly compromising growth. Key indicators of external debt sustainability include the NPV of debt-to-exports ratio and the debt-service ratio. On the basis of experience of a large number of countries, target ranges for determining debt sustainability have been established. Sustainable debt levels under the Initiative will be defined on a case-by-case basis within the range of 200 percent to 250 percent for the debt-to-exports ratio expressed in NPV terms and 20 percent to 25 percent for the ratio of debt service to exports. Of course, other factors play an important role, and while countries with indicators above these thresholds may be more likely to encounter debt-service difficulties, it is also true that countries that have had debt-service difficulties and accumulated arrears or rescheduled had widely differing debt burdens. Thus, other country-specific “vulnerability factors,” such as the concentration and variability of exports, the fiscal burden of external debt service, external debt in relation to GDP, the resource gap, the level of international reserves, and the burden of private sector debt, would need to be taken into account in determining whether to target the lower or the upper end of the two ranges.
In addition, for countries with very open economies (an export-to-GDP ratio of at least 40 percent) and making strong efforts to generate revenue (with a minimum threshold of fiscal revenue in relation to GDP of 20 percent) an NPV debt-to-export target below 200 percent at the completion point can be considered. For countries meeting these two openness and fiscal revenue thresholds, the NPV debt-to-export target will be set at a level that achieves a 280 percent ratio of the NPV of debt to revenue at the completion point. This modification of the interpretation of the Initiative was agreed to ensure that a small number of very open economies were able to attain a sustainable external debt situation from a fiscal point of view.
Some Key Features of the HIPC Initiative
The HIPC Initiative is based on six guiding principles that have been endorsed by the Executive Boards of the IMF and the World Bank and by the Interim and Development Committees (see Figure 2 and the Annex for a more detailed description of the Initiative). These are (1) the Initiative should target overall debt sustainability case by case, thus providing a durable exit strategy from the rescheduling process; (2) action would be envisaged only after the debtor country has shown, through a track record, an ability to put to good use whatever debt relief would be provided; (3) new measures will build on existing mechanisms as far as possible; (4) additional action will be coordinated among all creditors involved, with broad and equitable participation; (5) actions by the multilateral creditors will preserve their financial integrity and their preferred creditor status; and (6) new external financing for the countries concerned will be on appropriately concessional terms.
Figure 2.The HIPC Initiative: Summary
The Initiative has been developed around the following key building blocks: (1) eligibility will be limited to IDA-only and ESAF-eligible countries that have established a strong track record of performance under adjustment programs supported by the IMF and the World Bank and that are not expected to achieve a sustainable external debt situation after the full use of traditional debt-relief mechanisms; (2) eligibility will be based on a debt sustainability analysis (DSA); at the decision point (after the first three-year track record), the staffs of the IMF and the World Bank will jointly recommend targets for the completion point (after the second three-year track record) for the NPV of debt-to-exports ratio and the debt-service ratio based on this analysis within the ranges mentioned above after giving full consideration to the vulnerability indicators; (3) the country would need to meet performance criteria during the second stage to receive support under the Initiative; these criteria would include macroeconomic indicators, progress on key structural reforms, and social reforms (for example, improving basic health care and education, and reducing poverty); and finally (4) all relevant creditors will be expected to participate.
As regards burden sharing between creditor groups, the Boards of the Bank and the IMF as well as other multilateral creditors have broadly supported a proportional approach toward sharing the burden of costs of the HIPC Initiative between multilaterals and official bilateral and commercial creditors. Under this approach, the costs of the HIPC Initiative would be shared by bilateral and multilateral creditor groups in proportion to the present value of their outstanding claims at the completion point. For this calculation, the claims of bilateral creditors would be measured after the full application of traditional forms of debt relief, that is, Naples terms from Paris Club creditors involving a 67 percent NPV reduction on eligible debt, and at least comparable action by other bilateral and commercial creditors. This is the basis on which all cases currently considered (see below) have been prepared.
Paris Club creditors have also endorsed proportional burden sharing, flexibly interpreted, with multilateral creditors. Specifically, they have indicated a willingness to provide debt reduction in NPV terms of up to 80 percent, on a case-by-case basis, with a flow rescheduling during the second stage, and a stock-of-debt operation (equivalent to an NPV reduction of up to 80 percent on eligible debt) at the completion point. Paris Club creditors have also indicated a readiness to consider carefully the appropriate coverage of debt subject to 80 percent NPV reduction to achieve debt sustainability. Other nonmultilateral creditors would be expected to provide debt relief on terms at least comparable with the Paris Club. Multilateral creditors for their part would provide assistance on a proportional basis (as defined above) in accordance with their own charters in a way that would preserve their preferred creditor status.
Key Steps in Implementing the HIPC Initiative
For those HIPCs that would require the full use of traditional mechanisms and enhanced assistance under the Initiative to achieve debt sustainability, the following key steps are envisaged:
The first stage of the Initiative builds on the existing three-year track record needed to qualify for a stock-of-debt operation from Paris Club creditors (see the Annex for details). During this stage, the country establishes the required good track record of policy implementation and makes full use of the traditional debt-relief mechanisms (Naples terms rescheduling with 67 percent NPV reduction).
As the country completes the first stage and reaches the decision point, the Executive Boards of the IMF and the World Bank would decide the country’s eligibility for the Initiative on the basis of a comprehensive DSA agreed jointly by IMF and World Bank staff members and the country’s authorities. The assessment would indicate whether the full application of traditional debt-relief mechanisms (Paris Club stock-of-debt operation on Naples terms involving a 67 percent NPV reduction with at least comparable action from official bilateral and commercial creditors) would be sufficient for the country to reach a sustainable level of debt by the completion point. There are three possible outcomes: (1) a country is deemed to have a sustainable external debt situation at the completion point, in which case the country would not be eligible for assistance under the Initiative and would request a stock-of-debt operation on Naples terms; (2) a country is considered to be a borderline case (see Figure 2 and the Annex), in which case it could request to defer a stock-of-debt operation by Paris Club creditors to the completion point and request a flow rescheduling on Naples terms during the second stage; and (3) a country is deemed to be eligible for assistance under the Initiative.
In the last outcome, a preliminary HIPC Initiative document would be prepared jointly by IMF and World Bank staff members discussing eligibility, and recommending country-specific debt sustainability target ranges.4 Consistent with these targets and the assumed action by bilateral and commercial creditors, the IMF and World Bank staff members, after consultation with concerned creditors, would recommend the required action by multilaterals, which would be proportional to that provided by bilateral creditors as a group.
During the second stage of the Initiative, Paris Club creditors would provide flow reschedulings involving up to 80 percent NPV reduction as needed on a case-by-case basis and commit to provide at the end of the second stage—the completion point—a stock-of-debt operation with NPV reduction of up to 80 percent, provided the adjustment program supported by the IMF and the World Bank is implemented satisfactorily. Other bilateral and commercial creditors would be expected to offer at least comparable terms for the flow rescheduling and for the stock-of-debt operation. Donors, bilateral creditors, and multilateral institutions would provide financial assistance in the form of grants and concessional loans. The World Bank would provide IDA grants and supplemental IDA allocations during the second stage.
At the completion point, provided the country has met the performance criteria under the Initiative, the stock-of-debt operation (involving up to 80 percent debt reduction in NPV terms) committed to by Paris Club creditors would take effect and multilateral institutions would provide the committed reduction in the NPV of their claims proportional to that provided by bilateral creditors as a group—unless actual debt-service indicators fall outside the agreed target range. The IMF would provide assistance to a country at the completion point through a special ESAF grant or loan that would be paid into an escrow account and used to cover debt service to the IMF. The World Bank would provide assistance at the completion point via the HIPC Trust Fund. Most other multilaterals are currently seeking the appropriate institutional approvals to enable them to participate in the Initiative including, in many cases, via the HIPC Trust Fund.
The six-year performance period under the Initiative would be implemented flexibly on a case-by-case basis, with countries receiving credit for already established track records in the first stage. Exceptionally, the second stage of three years might be shortened for countries that already have sustained records of strong performance.
A key element of the Initiative would be the provision of external finance on appropriately concessional terms to prevent a buildup of future debt-service problems.5 Thus, the ESAF programs accompanying the stages of the HIPC Initiative would involve restrictive limits on all nonconcessional borrowing. Efforts would be made to build up the HIPCs’ debt-management capacities to help avoid the future recurrence of excessive indebtedness. In this respect, private lenders would also be encouraged to exercise restraint.
Support under the Initiative would remain available to countries embarking on adjustment programs supported by the IMF and the World Bank before October 1, 1998. A comprehensive review of the Initiative would be held by then to decide whether to extend it.