Abstract

The creation and initial implementation of the HIPC Initiative has raised widespread interest in the issue of debt relief and prompted suggestions for strengthening the Initiative among religious groups, nongovernmental organizations, the media, international organizations, and governments.8 In response, the World Bank and IMF jointly launched a comprehensive review of the HIPC Initiative in early 1999 through a public consultative process.

The creation and initial implementation of the HIPC Initiative has raised widespread interest in the issue of debt relief and prompted suggestions for strengthening the Initiative among religious groups, nongovernmental organizations, the media, international organizations, and governments.8 In response, the World Bank and IMF jointly launched a comprehensive review of the HIPC Initiative in early 1999 through a public consultative process.

Review of the HIPC Initiative

The consultations were undertaken in two stages. In addition to requesting general views on the HIPC Initiative, the first stage addressed possible modifications to the framework of the Initiative. Responses were solicited from the public on a range of issues relating to the design of the Initiative, including eligibility criteria, the definition of debt sustainability, track record requirements and the timing of debt relief, and links to macroeconomic and structural policy reforms. In addition, views were sought on how to ensure that the mix of resources provided—including balance of payments and budgetary support plus debt relief—best promotes broad-based growth and development. Suggestions were also sought for the financing of any additional cost arising from changes in the HIPC Initiative framework. The second stage focused on strengthening the link between debt relief and poverty reduction. Views were also solicited on how the debt relief provided could be most effectively used to foster social development, and whether more weight should be given to reducing debt-service burdens in the short term rather than the debt overhang. Also sought were suggestions for improving debt management within HIPCs.

The review process brought out three clear messages: a general acknowledgement by most commentators that the HIPC Initiative is a positive step toward a solution to unsustainable debt in that it provides a comprehensive framework for debt relief from all creditors and aims to reduce debts to a sustainable level; widespread calls for speedier implementation of the Initiative; and a desire for a more direct linking of debt relief to poverty reduction measures.

In particular, these suggestions included proposals to:

  • deepen debt relief through lower target ranges for the NPV of debt-to-export ratio, fuller treatment of the fiscal dimensions of the external debt problem through lower target ranges and thresholds for the fiscal/openness window, greater emphasis on reducing the debt-service burden and lowering post-HIPC Initiative debt service so that governments can adequately meet priority development spending;

  • broaden debt relief to cover more countries by lowering targets and shortening the performance period;

  • accelerate the delivery of debt relief by shortening the performance period requirement, placing greater weight on past performance and, related to the Jubilee 2000, to heed the call for the forgiveness of debts before the new millennium;

  • foster greater ownership by debtor governments of policy targets and a more participatory and transparent process in designing development strategies, increasing the poverty focus of economic and social programs, and ensuring that the savings from debt relief are used exclusively for poverty alleviation; and

  • strengthen transparency and accountability in debt management by making information about new borrowing arrangements and debt restructurings public, conducting periodic audits into the proper use of borrowed funds, and encouraging a greater involvement of civil society in the HIPC Initiative process.

As a result of the review and consultation exercise, and in line with the proposals endorsed by the June 1999 Group of Seven summit in Cologne, the Boards of the World Bank and IMF in August and September 1999 considered a number of specific modifications for enhancing the Initiative and strengthening the links between debt relief, poverty reduction, and social policies.9 These modifications were endorsed by the Interim and Development Committees at the fall 1999 IMF-World Bank Annual Meetings.

Modifications to the HIPC Initiative

The enhanced framework of the Initiative incorporates a lowering of targets and thresholds, modified performance requirements, and a strengthening of the link between debt relief and poverty reduction (see Box 1). The modifications also considerably simplify the design and implementation of the Initiative and reduce uncertainties over the amount of debt relief for HIPCs. At the same time, the enhanced Initiative builds on the basic elements that have guided the HIPC Initiative since its inception—notably, the full and equitable participation by all creditors and a focus on sustainable development. These modifications—in particular the strengthening of the Initiative’s contribution to the goal of poverty reduction—are closely related to the reform of the ESAF, the IMF’s main vehicle for providing support to its low-income member countries. In September 1999, the Interim Committee approved the replacement of the ESAF by a new Poverty Reduction and Growth Facility (PRGF) aimed at making poverty reduction efforts a key and more explicit element of a growth oriented economic strategy.10

The main modifications to the HIPC Initiative may be summarized as follows:

Deeper debt relief by:

  • lowering the NPV of debt-to-export target to 150 percent from 200-250 percent, thereby replacing the current target range with a single target. A country-specific vulnerability analysis would no longer be required;

  • lowering the NPV of debt-to-fiscal-revenue target to 250 percent from 280 percent and a lowering of the eligibility thresholds for the openness of an economy (export-to-GDP ratio) from 40 to 30 percent and for the revenue effort (revenue-to-GDP ratio) from 20 to 15 percent; and

  • changing the assessment base for debt relief under the Initiative, with calculation of debt relief now based on actual data for the year prior to the decision point rather than on projections for the completion point. In most cases, this change in the calculation is likely to result in higher assistance since the debt ratios targeted under the Initiative have typically declined as economic reforms take hold. In addition, as a result of this change, there will no longer be a need for automatic reassessment at the completion point of the amount of assistance to be provided.

Implementation of the HIPC Initiative: Major Changes

Simplification

  • Calculation of assistance at decision point on actual data, not projections, for the completion point.

  • Apply single NPV of debt-to-export target to all countries rather than decide target on a country-specific basis within target range.

  • Elimination of borderline option.

Modifications

  • Lower NPV of debt-to-export (150 percent) and debt-to-revenue target (250 percent), with lower thresholds for latter (30 percent export-to-GDP, and 15 percent revenue-to-GDP).

  • Floating completion points, with the timing of completion points tied to implementation of key structural reforms and the poverty reduction strategy.

  • Earlier delivery of assistance both from decision and completion points.

Principal Changes

Elimination of:

  • Projections of position at completion point as basis for assistance;

  • Vulnerability analysis as a basis for country-specific determining targets; and

  • Target ranges for the completion point.

This will permit a much simplified preliminary HIPC Initiative document that could focus on the track record and proposed timing of the decision point, key structural policies, and enhanced framework for poverty reduction.

Forward-Looking Focus in Decision Point Document Switched to:

  • Identification of key structural policies to which floating completion points would be tied;

  • Enhanced framework for poverty reduction;

  • Country-by-country assessment of appropriate levels for interim relief and front-loading of the delivery of assistance in the light of absorption capacity and projections of key debt indicators; and

  • Steps to improve debt management.

At completion point: discretionary reassessment for debt situation with the option of providing more assistance if, as a result of external factors, there has been a major upward deviation in debt outcomes. This would be decided on a case-by-case basis, consulting all creditors involved.

Faster debt relief through:

  • providing interim relief by international financial institutions between the decision and completion points;

  • front-loading the delivery of the remaining debt relief provided by international financial institutions after the completion point. The acceleration of assistance through front-loaded and interim relief should not, however, exceed the country’s absorptive capacity and the resulting time profile of debt relief should not jeopardize the achievement of debt sustainability over the medium term; and

  • introducing floating completion points under which the assessment of a country’s performance in the second stage is based on specific outcomes on policy reform and the maintenance of macroeconomic stability, rather than the length of the track record. The use of floating completion points provides an incentive to implement reforms quickly, thereby permitting strong performers to reach the completion point earlier. It also allows HIPCs greater ownership over the reform timetable.

Broader debt relief through:

  • a greater safety margin for the achievement of debt sustainability, providing a clear and permanent exit from unsustainable indebtedness at the completion point. This will increase the number of countries that could potentially qualify for HIPC Initiative assistance to 36 from 29, and possibly more (see Box 2).11

Strengthened Links Between Debt Relief and Poverty Reduction

From the outset, progress in social sector policies and in poverty reduction has been an integral part of the design of the HIPC Initiative. Indeed, as with conditions on macroeconomic and structural reforms, countries must meet performance requirements in the social sectors to receive HIPC Initiative assistance. In the early cases in which countries reached their completion points, they made significant progress in implementing social reforms, aided by higher budgetary allocations for social spending. More generally, in most HIPCs, budgetary spending on health and education has been larger than actual debt-service payments, and HIPCs have typically received twice as much by way of aid flows than they have paid in debt service (see Box 3). Progress in addressing poverty in the early cases under the Initiative, however, has been uneven. For example, not all countries have developed comprehensive poverty reduction strategies and, where these are in place, they have typically not incorporated specific targeted improvements in key social indicators.

Building on the progress to date, the enhanced framework for poverty reduction is based on the premise that the best way to ensure a robust link between debt relief and poverty reduction is to make HIPC Initiative debt relief an integral part of broader efforts to implement outcome-oriented poverty reduction strategies using all available resources. This requires a nationally owned, comprehensive poverty reduction strategy which recognizes that:

  • sustained poverty reduction requires rapid economic growth, and that macroeconomic stability and structural reforms are essential for moving to a higher path of sustained growth;

  • poverty is multidimensional, and poverty reduction requires more than the delivery of improved social services;

  • broad-based participation of civil society and strengthened governance is essential to the sustained implementation of an anti-poverty strategy; and

  • focusing on transparent outcome-oriented goals (in the context of the International Development Goals for 2015,12 such as the objective of halving poverty) and establishing mechanisms for the broad-based monitoring of related indicators is essential for the design and implementation of a poverty reduction strategy.

Countries Expected to Qualify for HIPC Initiative Assistance

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Countries not requiring assistance under original HIPC Initiative but now eligible for reconsideration for assistance under the enhanced HIPC Initiative.

Countries that have already received assistance under the original HIPC Intiative (i.e., have reached the completion point).

Countries to which assistance had been committed under original HIPC Initiative (i.e., had reached the decision point).

The country has indicated that it does not want to be considered for assistance under the enhanced HIPC Initiative.

Countries that would benefit from assistance under the enhanced HIPC Initiative but that were considered unlikely to benefit from the original HIPC Initiative.

HIPCs: Debt Service Due Versus Paid, Social Spending, and External Inflows

What is the likely magnitude of the reduction in annual debt-service payments that could result from the implementation of the enhanced HIPC Initiative? Any estimates of the nominal decline in debt-service payments are inevitably tentative. Nonetheless, they illustrate the significance of the possible cash-flow impact of debt relief in relation to current levels of GDP, exports, gross inflows of foreign aid, and social spending for a sample of HIPCs.

Before turning to this issue, recent data on HIPCs’ debt-service payments should be placed in a similar context. Some commentators have argued that debt-service payments by HIPCs have often exceeded social spending by a substantial margin. However, it is important to base these comparisons on actual debt service payment—this is, after debt relief—rather than scheduled debt service, which is the concept used in balance of payments methodology. Most HIPCs have benefited from a significant reduction in the debt service burden before assistance under the HIPC Initiative, but this debt relief is not reflected in a corresponding decline in scheduled debt service as recorded in the balance of payments. For example, in 1998 scheduled debt service on Mozambique’s public external debt amounted to $396 million, whereas debt service actually paid in 1998 was $109 million, or slightly more than one-quarter of the scheduled amount.1 By comparison, Mozambique’s expenditure on health and education in 1998—excluding some spending financed by external aid flows—amounted to about $120 million.

Comparing debt service paid and social spending alone also provides only a partial view of the relationship between international official resource flows and social spending. Again, Mozambique illustrates the point: in 1998, gross external financing (in new loans and grants) amounted to almost $713 million. Thus, after debt-service payments, the net official resources flow to Mozambique in 1998 was nearly $604 million, or more than four times the recorded total of education and health spending.

A similar picture is evident for many other HIPCs. The Figure illustrates for the first seven cases, as well as all 28 HIPCs where data are available, the relationship between debt service paid in 1993–97, gross external financing, and social spending. Gross external financing inflows significantly exceed social spending and debt service paid for the seven HIPCs that have reached their decision point. Gross inflows of external assistance averaged some 14 percent of GDP for this group, while their expenditures on health and education averaged about 6 percent of GDP, and debt service paid, about 7 percent. Aggregate data reveal a similar picture for the broader group of 28 HIPCs for which data are available. While average service paid was some 6 percent of GDP for this group and social spending averaged 5 percent of GDP, for most of these countries social spending actually exceeded debt service paid.

Implementation of the enhanced HIPC Initiative framework for the seven countries that have reached decision points would result in lower debt service payments, on average by about one-third, or some 2 percent of GDP, in the five years after the completion point, compared with the five years to 1997. While these calculations are only illustrative and differ in individual HIPCs, they indicate relative magnitudes. At these levels, the savings from debt relief could represent a significant contribution to social spending in HIPCs even though other official development flows are likely to remain the major source of external resources available for this purpose (see Figure).

uch03fig01

External Debt Service Paid, Gross External Financing, and Social Spending

(In percent of GDP, average for 1993-97)

Source: IMF estimates.Note: Comprehensive data on social spending are not available for all HIPCs, but only for 28 countries. Social spending is defined as health and education spending. Excludes countries where only one category of spending is available, and those where only partial expenditure (current or capital) are available.
1 A rescheduling of payments falling due actually increases the scheduled debt service recorded in the balance of payments, as a result of the additional payments due resulting from the rescheduling. A counterbalancing item of debt relief obtained is shown in the financing section of the balance of payments. The difference between these two items is the cash debt service expected to be paid.

The nationally owned poverty reduction strategy would be reflected in a new vehicle—a Poverty Reduction Strategy Paper (PRSP)—which, to the extent possible, should be in place when a country reaches its decision point under the HIPC Initiative. However, on a transitional basis, the decision point could be agreed while a poverty reduction strategy is being formulated. In all cases, progress in implementing the poverty reduction strategy would be required by the completion point. Although the PRSP would initially be introduced in countries qualifying for HIPC Initiative assistance, it would eventually be extended to all countries eligible for the Poverty Reduction and Growth Facility and resources from the World Bank’s IDA and serve as the basis for all Bank and IMF lending to low-income countries.

The PRSP would:

  • outline the poverty reduction strategy and be produced by the authorities in close collaboration with the World Bank, IMF, and other multilateral institutions and donors, in a way that ensures transparency and broad-based participation in the choice of goals, the formulation of policies, and the monitoring of implementation, with ownership by the government;

  • ensure consistency between a country’s macroeconomic, structural, and social policies (including their sequencing) and the goals of poverty reduction and social development, including establishing priorities in these areas. It would also indicate the country-specific resource needs to achieve the 2015 International Development Goals;

  • address the obstacles to rapid growth and diffusion of the benefits of participation in this growth to the poor and propose actions to deal with these obstacles; and

  • be endorsed by the Executive Boards of the World Bank and the IMF as the framework for each institution’s lending operations, and be published. It should also serve as a basis for support by donors, regional development banks, and other multilateral institutions.

These enhancements to the HIPC Initiative are part of a coherent strategy to help poor countries move on to a sustainable faster growth path and to have the IMF and World Bank focus on poverty reduction as a fundamental goal of their operations in these countries. In line with this, the key element in the transformation of the IMF’s ESAF into the Poverty Reduction and Growth Facility is to base future lending to low-income member countries on the comprehensive, nationally owned, and outcome-oriented poverty reduction strategy elaborated in the country’s PRSP. The complementarity of macroeconomic, structural, and social policies will now be given greater recognition, and the PRSP will provide a new vehicle to integrate these policies—including their costs—in a mutually reinforcing manner. Furthermore, greater emphasis will be placed on good governance—especially full transparency and effective monitoring of government budgets and the efficiency of social expenditures. PRSPs will also provide a new framework for closer collaboration between the World Bank and the IMF.

Costs and Financing

The total cost of the enhanced HIPC framework is estimated at $27.4 billion in 1998 NPV terms ($50 billion in nominal terms) for 33 HIPCs expected to qualify (excluding Liberia, Somalia, and Sudan),13 or more than double the total cost of $12.5 billion estimated for the previous framework. Given the magnitudes involved, decisions on the enhancements to the Initiative have proceeded in parallel with agreement on additional financing for the IMF’s contribution to the HIPC Initiative, as well as that of other multilateral creditors, and the World Bank in particular. Under the enhanced framework, the shares of HIPC Initiative costs for bilateral and multilateral creditors are estimated to remain roughly equal. Overall costs to multilateral creditors are projected to rise to $13.3 billion under the enhanced framework (excluding Liberia, Somalia, and Sudan) from $6.2 billion under the original framework.

Paris Club bilateral creditors have agreed to increase debt reduction in NPV terms to up to 90 percent or more, if needed, on commercial loans, on a case-by-case basis, as well as provide additional relief on ODA claims—up to full cancellation—on a bilateral basis.

Non-Paris Club official creditors and commercial creditors would be expected to provide debt relief on terms comparable with those of the Paris Club. A number of HIPCs have encountered difficulties in obtaining such comparable relief from bilateral creditors not participating in the Paris Club. Particular concern has been expressed by some developing countries about the impact on their economies of providing terms comparable to the Paris Club on their claims on HIPCs. Efforts by all sides will need to be intensified in order to attain more satisfactory outcomes where all creditors contribute their share in making the enhanced Initiative a success in providing HIPCs with a durable exit from their external debt problems.

Some regional multilateral creditors are likely to face difficulties in financing enhancements to the HIPC Initiative from their own resources and would need to rely on bilateral contributions to cover their full share of the expected additional debt relief. The IMF’s contribution to the enhanced HIPC Initiative is expected to rise to $2.3 billion from $1.2 billion under the original framework. This is to be financed by additional bilateral contributions and off-market gold sales. The World Bank’s share of financing is expected to increase to $5.1 billion from $2.4 billion under the original framework, and is to be financed through bilateral contributions to the HIPC Trust Fund and from the Bank’s own resources. Funding efforts to help cover the Bank’s costs and those of other multilateral institutions are continuing.

Preliminary IMF staff estimates indicate that at the end of 1997, the debt stock, in present value terms, of countries likely to receive assistance under the Initiative was about $100 billion (or some $137 billion in nominal terms); after full application of traditional debt-relief mechanisms, this would be reduced to about $72 billion in present value terms. Implementation of the enhanced HIPC Initiative would further reduce this stock of debt by almost $27 billion. In short, external debt of these countries would decline by about 60 percent of its end-1997 value as a result of full application of traditional debt-relief mechanisms and the enhanced HIPC Initiative.14

Implementation

The enhanced HIPC Initiative will be implemented in accordance with the principles that have guided the Initiative since its inception, notably that debt relief be additional and its financing should not compromise other resource transfers to poor countries; that the financial integrity of multilateral financial institutions be maintained; and that cost sharing be on a broad and equitable basis. It builds on existing mechanisms for providing debt relief from the Paris Club and other official bilateral and commercial creditors, as well as from multilateral creditors.

Assistance resulting from the modifications to the HIPC Initiative is to be available to all qualifying countries, including those that have already reached their decision and completion points under the original framework of the Initiative. The approach to providing retroactive treatment detailed below ensures that countries are not penalized for early qualification for HIPC Initiative assistance, allows revised debt targets established under the Initiative to apply at the time that enhanced assistance is provided, and ensures that the country’s policy performance remains satisfactory at the time any additional assistance is provided. In particular, the timing of the proposed additional debt relief should be determined, among other things, on an assessment of progress in designing and implementing a comprehensive poverty reduction strategy.

  • Existing commitments made on the basis of the original framework (for example, for Mali, Burkina Faso, and Côte d’Ivoire) would, with continued strong policy implementation, be delivered at the existing completion points.

  • Evaluation of enhanced debt relief would be based on countries’ current situations so as to ensure that the country will be at, or below, the newly established debt sustainability thresholds. This would require an updated debt sustainability analysis, based on the latest available macroeconomic and external debt data, as well as discount rates, as the basis for calculating the required topping-up of HIPC Initiative assistance.

  • Proposals for enhanced assistance would be submitted to the Executive Boards of the World Bank and IMF for approval in principle. Board approval would allow the staffs to seek agreement to enhanced assistance from the Paris Club and other multilateral creditors consistent with proportional burden sharing. Once the participation of all creditors in the enhanced HIPC assistance was confirmed, and their financing assured, the additional assistance would be committed by the Bank and IMF Boards, and could be delivered in part during the interim period, namely the period between the decision and the completion points.

Supporting Policies

As stated earlier, the HIPC Initiative is not a panacea for the economic and poverty problems of the HIPCs. Even if, hypothetically, all of the external debt of the HIPCs was forgiven, most of these countries would still depend on significant levels of concessional external assistance for many years. As implied by the time horizon of the International Development Goals for 2015, significant poverty reduction can only be achieved through sustained economic growth, which will require efforts over many years. The effectiveness of the enhanced HIPC Initiative depends on its success in fostering the continued implementation of the policies required to achieve poverty reduction and sustainable development. This includes sustaining sound macroeconomic policies and structural reforms—including forcefully addressing problems of governance, accelerating public sector reform, and further liberalizing trade, exchange, and financial systems. These policies must be supported by higher aid flows—from the current historically low levels—that are well targeted. Both the experience of the donor community and research on aid effectiveness show that aid can have a significant effect on growth and poverty reduction when it is accompanied by a strong policy environment and a sustained adjustment effort. Indeed, there is scope for a better allocation of aid resources to countries with severe poverty but good policies.15

Unfettered and guaranteed access for all exports from low-income countries to industrial country markets is also crucial for higher growth and the integration of HIPCs into the world economy. Finally, prudent debt management in the HIPCs, reinforced by restraints by industrial countries on nonconcessional lending—including eschewing any lending for nonproductive purposes, including through the use of officially guaranteed export credits—remains central to ensuring a durable exit from an unsustainable debt burden.

The adoption of the nationally owned Poverty Reduction Strategy Paper represents a new paradigm for integrating poverty reduction efforts through coherent macroeconomic policies, structural reforms, and social policies consistent with this overarching goal. The international community must now move rapidly to support the country-specific implementation of PRSPs. This poses a major, and critically important, challenge to all parties involved in efforts to improve the quality of life of the poor of the world as we approach the new millennium.

8

The HIPC initiative and ongoing consultations in this context with civil society have been catalytic in facilitating a broader debate on development and poverty reduction with the World Bank and the IMF. These discussions revealed a strong desire to discuss broader issues of development, aid flows, and poverty reduction, and frequently raised concerns about the current state of development assistance.

9

Both these papers, prepared jointly by IMF and World Bank staff, as well as the summary of the proposals for changing the HIPC Initiative discussed by the Executive Boards of the Bank and IMF in April, are posted on the websites (http://www.imf.org) of the Bank and IMF. See Modifications to the Heavily Indebted Poor Countries (HIPC) Initiative, July 23, 1999, and Public Information Notice (PIN) No. 99/76, and HIPC Initiative: Strengthening the Links Between Debt Relief and Poverty Reduction, August 26, 1999.

10

See Overview: Transforming the Enhanced Structural Adjustment Facility (ESAF) and the Debt Initiative of Heavily Indebted Poor Countries (HIPCs) on the IMF’s website (http://www.imf.org).

11

Eligibility under the enhanced HIPC Initiative will be assessed on a case-by-case basis and is not limited to the countries included in the group of 41 HIPCs that was established early on for analytical purposes. Rather, if a country meets the criteria of the enhanced Initiative, it could be eligible for assistance: that is, a country that is IDA-only and ESAF (PRGF)-eligible, has established a minimum three-year track record of satisfactory performance under World Bank- and IMF-supported programs, and at the decision point has debt ratios—after the full use of traditional debt-relief mechanisms—above the sustainability targets. Countries that have not yet adopted those programs would need to do so by the end of 2000, the deadline (sunset clause) for meeting the entry requirement.

12

See Glossary of Terms for a fuller description of these goals.

13

Policy slippages as well as armed conflict or domestic unrest in some countries could delay these countries’ decision points. Total costs in 1998 NPV terms including Liberia, Somalia, and Sudan are estimated at approximately $19 billion under the original framework and $36 billion under the enhanced framework.

14

See Daseking and Powell, “From Toronto Terms to the HIPC Initiative: A Brief History of Debt Relief to Low-Income Countries,” IMF Working Paper No. 99/142, October 1999. This paper also estimates that traditional debt relief mechanisms (that is, before HIPC Initiative assistance) provided relief to HIPCs in present value terms of at least $30 billion from Paris Club creditors, including the Russian Federation, and non-Paris Club official bilateral and commercial creditors.

15

See Burnside and Dollar, “Aid, Policies and Growth,” Policy Research Working Paper No. 1777, World Bank, 1997, and Collier and Dollar, “Aid Allocation and Poverty Reduction,” Policy Research Working Paper No. 2041, World Bank, 1999.

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