Debt Relief for Low-Income Countries and the HIPC Initiative
Author: Mr. Kamau Thugge and Mr. Anthony R. Boote

Contributor Notes

Authors E-Mail Address: aboote@imf.org, kthugge@imf.org
Publication Date:
01 Mar 1997
eISBN:
9781451844108
Language:
English
Keywords:
WP; right; net present value; debtor country
Download PDF (1.4 MB)

The paper describes the debt burden of low-income countries and the traditional mechanisms that have been implemented by the international community to alleviate this burden. While these mechanisms are sufficient to reduce the external debts of many heavily indebted poor countries (HIPCs) to sustainable levels provided these countries implement sound economic policies, they are likely insufficient for a number of countries. To deal with these cases, the World Bank and the IMF have jointly proposed and implemented the HIPC Initiative. The paper describes this Initiative and suggests that it should enable HIPCs to exit from the debt rescheduling process.

Abstract

The paper describes the debt burden of low-income countries and the traditional mechanisms that have been implemented by the international community to alleviate this burden. While these mechanisms are sufficient to reduce the external debts of many heavily indebted poor countries (HIPCs) to sustainable levels provided these countries implement sound economic policies, they are likely insufficient for a number of countries. To deal with these cases, the World Bank and the IMF have jointly proposed and implemented the HIPC Initiative. The paper describes this Initiative and suggests that it should enable HIPCs to exit from the debt rescheduling process.

I. Traditional Debt Relief Mechanisms

Background

Since the onset of the debt crisis in the early 1980s, which affected both middle- and low-income countries, the debt situation of middle-income debtor countries has improved significantly. Many of these countries have benefitted from concerted support by the international financial community in the form of Paris Club flow reschedulings (Table 1), Brady stock-of-debt deals, and adjustment programs supported by the multilateral financial institutions. These instruments have proved to be effective mechanisms for allowing countries to normalize relations with external creditors and to resume sustainable growth. Recent years have witnessed a re-entry to international capital markets by many middle-income countries that had been most severely affected by the debt crisis.

Table 1.

Status of Paris Club Rescheduling Countries (as of December 31, 1996) 1/

(Dates refer to end of current or last consolidation period) 2/

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Source: Pans Club.

Includes agreements of the Russian Federation and Turkey with official bilateral creditors.

In the case of a stock-of-debt operation, canceled agreements, or arrears only rescheduling, date shown is that of relevant agreement.

“*” denotes rescheduling on London terms, and “**”denotes rescheduling on Naples terms (stock treatment underlined).

Defined here as countries that obtained lower middle-income but not concessional terms with Paris Club reschedulings; stock treatment underlined.

For some countries, this inevitably represents an element of judgment: in certain circumstances, for example if hit by an external shock, further reschedulings may be required. Some of the low-income countries may be eligible for enhanced action under the proposed HIPC initiative.

The last of the three stages of debt reduction under the 1991 agreement has not yet been implemented.

Rescheduling of arrears only.

Limited deferral of long-standing arrears to three creditors on non-concessional terms.

Nonconcessional rescheduling at the authorities’ request.

The 1994 rescheduling agreement was canceled at the authorities’ request.

Agreement includes a reprofiling of the stock of certain debts at the end of the consolidation period.

Agreement subject to entry-into-force clause.

Former Socialist Federal Republic of Yugoslavia.

Fund arrangement in place, on which a rescheduling is expected.

Last rescheduling on Toronto terms.

However, heavily indebted poor countries (HIPCs), most of which are in Sub-Saharan Africa, have continued to experience difficulties meeting their external debt-service obligations on a timely basis. These difficulties can be traced to a combination of several factors, including: (i) exogenous shocks, such as a deterioration in the terms of trade, and adverse weather conditions; (ii) civil strife; (iii) the lack of sustained adjustment or implementation of structural reforms; (iv) the lending policies of many creditors, especially the provision of loans on commercial interest rates with short repayment periods; (v) the lack of prudent debt management policies by debtor countries, driven in part by excessive optimism by creditors and debtors about the prospects for increasing export earnings to build debt-servicing capacity; and (vi) the lack of careful management of the currency composition of external debt. All these factors contributed to increasing the debt burden of the HIPCs.

In several important respects, the external position of the HIPCs differs widely from country to country (Table 2). For example, in 1994, for some HIPCs the external current account was in surplus while for others, deficits exceeded 100 percent of exports. In addition, scheduled debt-service obligations varied widely from less than 20 percent of exports for some countries to more than 100 percent for others, while the actual debt service paid ranged from 5 percent of exports to as much as 50 percent. Finally, the HIPCs were, and continue to be, indebted to a variety of creditors, including Paris Club bilateral creditors, non-Paris Club bilateral creditors (notably Russia), commercial banks, and multilateral institutions (Table 3 and Chart 1). In recognition of the highly varied external positions among the HIPCs, the international financial community has addressed the debt problems of these countries in a manner that ensures that debt relief is given in support of adjustment by debtors on a case-by-case basis, and is tailored to the individual circumstances of the debtor country.

Chart 1.
Chart 1.

Developing Countries: Public External Debt by Creditor, 1980-95 1/2/

(In billions of U.S. dollars)

Citation: IMF Working Papers 1997, 024; 10.5089/9781451844108.001.A001

Sources: World Bank Debtor Reporting System (DRS); and IMF staff estimates.1/ Medium- and long-term public and publicly guaranteed debt; including to the IMF.2/ The estimates for 1995 are provisional.
Table 2.

Some Characteristics of the External Debt of HIPCs

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Excluded are those HIPCs for which no debt sustainability analysis has been prepared (Angola, Burundi, Central African Republic, Liberia, Myanmar, and Somalia).

Excluding workers’ remittances.

Defined as the standard deviation in export values over the 10-year period 1986-1995 (1985/86-1994/95), in percent of the average

Current account balance excludes interest and net official transfers.

1995.

Imports of goods and services.

After assumed debt rescheduling/relief, including Paris Club stock-of-debt operation on Naples terms, where applicable.

Excluding grants.

Note: For Nicaragua and Mali, government refers to central government only.

Table 3.

External Debt of Heavily Indebted Poor Countries: Characteristics of Existing Debt

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Sources: World Bank Debtor Reporting System; and IMF staff estimates.

Using World Bank methodology for calculating NPV of debt, and the current year exports (1994); debt ratios allow cross-country comparison of the debt-service burden but must be interpreted with care.

✓ indicates whether Paris Club concessional rescheduling has taken place.

✓ indicates significant debt to the respective creditor.

Stock-of-debt operation on Naples terms was agreed in 1995 or 1996

Exit rescheduling, no stock-of-debt clause.

Figures for 1993.

Traditional mechanisms for dealing with the debt problem of the HIPCs

In recognition of the need to address the debt burden of the low-income countries, the international financial community (including Paris Club creditors, non-Paris Club bilateral and commercial creditors, and multilateral institutions) has over the past decade introduced and implemented a wide range of instruments, “traditional mechanisms,” which were designed to alleviate the debt burden of these countries. In general, for the different categories of creditors, the main trend has been a move toward increasing the concessionality of external assistance to the low-income countries.

The “traditional mechanisms” for addressing the debt problems of low-income countries can be summarized as follows: (i) the adoption of stabilization and economic reform programs supported by concessional loans from the IMF and the World Bank; (ii) in support of these adjustment programs, flow rescheduling agreements with Paris Club creditors on concessional terms followed by a stock-of-debt operation after three years of good track records under both IMF arrangements and rescheduling agreements; (iii) agreement by the debtor country to seek at least comparable terms on debt owed to non-Paris Club bilateral and commercial creditors facilitated by IDA debt-reduction operations on commercial debt; (iv) bilateral forgiveness of ODA debt by many creditors; and (v) new financing on appropriately concessional terms.

This process has significant advantages in that it ensures that new concessional financing and debt relief both under flow reschedulings (directly) and under stock-of-debt operations (via the required track record) are given in support of an adjustment effort by the debtor. Moreover, the process provides for a case-by-case treatment of individual debtors—reflecting, as noted above, their widely different external positions—both by creditors (with Paris Club creditors tailoring effective debt relief to financing needs) and by donors (in the consultative group process).

Paris Club creditors

In the early 1980s, Paris Club creditors provided reschedulings for low-income countries on non-concessional “standard terms” with relatively short grace (5 years) and maturity (10 years) periods, and on market-related interest rates. Although the reschedulings for the low-income countries were more comprehensive in coverage and provided for more cash relief than for other debtors, many of these countries continued to have difficulties adhering to the resulting repayment schedules and the rescheduling of interest led to rapid debt accumulation. By the late 1980s, Paris Club creditors recognized that repeated reschedulings on standard terms over a long period did not provide a solution to the debt problems of the low-income countries, and that for most of the low-income countries their debt problems required not only cash-flow relief but also debt reduction. Thus, in late 1988, Paris Club creditors agreed to provide concessional reschedulings for low-income countries on “Toronto terms,” a menu of options for debt and debt-service reduction to reduce the net present value (NPV) of rescheduled amounts by up to a third (Table 4). While these reschedulings provided for substantial debt reduction, it became increasingly obvious that for many low-income countries more far-reaching concessions would be needed if their debt situation was to be improved on a durable basis.

Table 4.

Evolution of Paris Club Rescheduling Terms

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Source: Paris Club.

Since the 1992 agreements with Argentina and Brazil, creditors have made increasing use of graduated payments schedules (up to 15 years maturity and 2-3 years grace for middle income countries; up to 18 years maturity for lower middle-income countries.

DR refers to the debt reduction option; DRS to the debt-service reduction option; CMI denotes the capitalization of moratorium interest; LM denotes the nonconcessional option providing longer maturities. Under London, Naples and Lyon terms there is a provision for a stock-of-debt operation, but no such operation took place under London terms.

These have also been called “Enhanced Toronto” and “Enhanced Concessions” terms.

Most countries are expected to secure a 67 percent level of concessionality; countries with a per capita income of more than USS500, and an overall indebtedness ratio on net present value loans of less than 350 percent of exports may receive a 50 percent level of concessionality decided on a case-by case basis. For a 50 percent level of concessionality, terms are equal to London terms, except for the debt-service reduction option under a stock-of-debt operation which includes a three-year grace period.

These terms are to be granted in the context of concerted action by all creditors under the Debt Initiative for Heavily Indebted Poor Countries (HIPCs).

Before June 1992, 14 years.

Interest rates are based on market rates (M) and are determined in the bilateral agreements implementing the Paris Club Agreed Minute. R = reduced rates.

The interest rate was 3.5 percentage points below the market rate or half of the market rate if the market rate was below 7 percent.

Reduced to achieve a 50 percent net present value reduction.

Reduced to achieve a 67 percent net present value reduction; under the DSR option for the stock operation the interest rate is slightly higher reflecting the three year grace period.

Reduced to achieve an 80 percent net present value reduction.

The reduction of net present value depends on the reduction in interest rates and therefore varies. See footnote 8.

Thus, in December 1991, creditors introduced “London terms” and increased the level of debt relief on eligible debt in NPV terms to 50 percent. Subsequently, in December 1994, the level of concessionality for most countries was again increased to 67 percent of eligible debt in NPV terms under “Naples terms” (Box). Under both London and Naples terms, the flow rescheduling agreements included a “goodwill clause”, in which participating creditor countries agreed to consider a stock-of-debt operation for countries which had established a good track record of performance for at least three years under an IMF-supported program and on debt-service payments to Paris Club creditors. Such a stock-of-debt operation was viewed as an “exit rescheduling,” and creditors had to be confident that the debtor country would be able to meet future debt-service obligations without the need for additional debt relief. Since early 1995, six countries (Benin, Bolivia, Burkina Faso, Guyana, Mali, and Uganda) have agreed comprehensive stock-of-debt operations with Paris Club creditors under Naples terms.

Commercial and non-Paris Club bilateral creditors

To ensure concerted support by the international community, Paris Club rescheduling agreements include a “comparability clause” under which the rescheduling country commits itself to seek at least comparable debt relief from commercial and non-Paris Club bilateral creditors. The clause is intended to ensure equitable burden sharing among the various categories of creditors. In addition, in recent years, low-income countries were able to buy back most of their debt to private creditors which was being traded in the secondary market at a large discount from the face value using funds from the IDA Debt Reduction Facility and from bilateral donors (Table 5).

Table 5.

Commercial Bank Debt and Debt-Service Reduction Operations, 1987-August 1996 1/

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Source: IMF staff estimates.

Debt and debt-service reduction are estimated by comparing the present value of the old debt with the present value of the new claim, and adjusting for prepayments made by the debtor. The methodology is described in detail in Annex 1 of Private Market Financing for Developing Countries (Washington: International Monetary Fund, December 1992). The amounts of debt reduction contained in this table exclude debt extinguished through debt conversions. Year in parenthesis refers to the date of the agreement in principle.

The figure for debt-service reduction represents the expected present value of the reduction in future interest payments arising from the below-market fixed interest rate path on the new instruments relative to expected future market rates. The calculation is based on the estimated term structure in interest rates for U.S. treasury bond at the time of agreement in principle.

Excludes past due interest and includes debt restructured under new money options for Mexic (1989), Uruguay (1991), Venezuela (1989), the Philippines (1992), Poland (1994), Panama (1995), and Peru (1995); the Philippines’ (1989) new money option was not tied to a specific value of existing debt.

Excludes prepaymet of principal and interest through guarantees.

Cost at the time of operation’s closing. Includes principal and interest guarantees, buy-back costs, and for Venezuela, resources used to provide comparable collateral for bonds prior to 1990. Excludes cash downpayments related to past due interest.

Includes estimated value recovery clauses.

The illustrative scenario assumes an allocation of 40 percent to the par bond, and 30 percent to the discount and FLIRB bond, respectively, excluding a buyback of US$1.5 billion.

The illustrative scenario assumes an allocation of 10 percent to the buyback option, and 45 percent to the par and discount bond options, respectively

With respect to official creditors outside the Paris Club, there has been little progress in normalizing relations between creditors and debtors.2 Discussions between Russia, the major creditor in this group, and the Paris Club on Russia’s possible participation in the Club are ongoing, and Russia has indicated a willingness to provide substantial debt relief on its claims on low-income countries.3

Multilateral creditors

Multilateral creditors have participated in the efforts of the international community by helping debtor countries to design and implement adjustment and structural reform programs which have been supported by, inter-alia, concessional loans from the IMF and the World Bank. Multilateral financing over the past decade can be characterized by three major trends: (i) the share of multilateral debt in the total for HIPCs has increased as multilaterals continued to make large-scale contributions to the financing of these countries; (ii) increasingly, financing has been provided on concessional terms, especially from the IMF (first under SAF and then under the ESAF) and the World Bank (through IDA including supplemental credits under the Fifth Dimension Facility which provides financial support to IDA-only countries with outstanding IBRD debts to cover part of their interest obligations on these loans) providing de facto debt relief as more expensive debt (such as nonconcessional exposure to the IMF) was replaced by concessional debt (such as ESAF); and finally (iii) despite the increase in multilateral debt to the HIPCs, debt-service payments on multilateral debt have remained relatively stable at about 8½ percent of exports per year in 1985–1995 reflecting the increased concessionality of loans.4

Paris Club Naples Terms

Key elements of Naples terms, which at end-1994 replaced the previous concessional (Toronto or London) terms, for low-income countries are

• Eligibility. Decided by creditors on a case-by-case basis, based primarily on a country’s income level. Countries that have previously received concessional reschedulings (on Toronto or London terms) are eligible for Naples terms.

• Concessionality. Most countries receive a reduction in eligible non-ODA debt of 67 percent in net present value (NPV) terms. Some countries with a per capita income of more than $500 and a ratio of debt to exports in present value terms of less than 350 percent--decided on a case-by-case basis--receive a 50 percent NPV reduction.

• Coverage. The coverage (inclusion in the rescheduling agreement) of non-ODA pre-cutoff date debt is decided on a case-by-case basis in the light of balance of payments needs. Debt previously rescheduled on concessional (either Toronto or London) terms is potentially subject to further rescheduling, to top up the amount of concessionality given.1

• Choice of options. Creditors have a choice of two concessional options for achieving a 67 (or 50) percent NPV reduction,2 namely

a debt reduction (DR) option (repayment over 23 years with 6 years’ grace), or

a debt-service reduction (DSR) option, under which the NPV reduction is achieved by concessional interest rates (with repayment over 33 years).3 4

There is also a commercial or long maturities (LM) option, providing for no NPV reduction (repayment over 40 years with 20 years’ grace).5

• ODA credits. Pre-cutoff date credits are rescheduled on interest rates at least as concessional as the original interest rates over 40 years with 16 years’ grace (30 years’ maturity with 12 years’ grace for 50 percent NPV reduction).6

Flow reschedulings provide for the rescheduling of debt service on eligible debt falling due during the consolidation period (generally in line with the period of the Fund arrangement).

Stock-of-debt operations, under which the entire stock of eligible pre-cutoff date debt is rescheduled concessionally, are reserved for countries with a satisfactory track record for a minimum of three years with respect to both payments under rescheduling agreements and performance under IMF arrangements. Creditors must be confident that the country will be able to respect the debt agreement as an exit rescheduling (with no further reschedulings required) and there must be a consensus among creditors to choose concessional options.

1Under such topping up, the NPV reduction is increased from the original level given under Toronto or London terms to the new level agreed under Naples terms, namely 67 or 50 percent.2For a 50 percent NPV reduction, the DSR option provides for repayment over 23 years with 6 years’ grace and the LM option for repayment over 25 years with 16 years’ grace.3For flow reschedulings, there is no grace period, and for stock-of-debt operations the grace period is three years.4There is, in addition, a capitalization of moratorium interest (CMI) option, which also achieves the NPV reduction by a lower interest rate over the same repayment (and grace) periods as the DSR option.5Creditors choosing this option undertake best efforts to change to a concessional option at a later date when feasible.6Creditors can also choose an option reducing the NPV of ODA debt by 67 (or 50) percent

Positive net resource transfers and new financing on concessional terms

It is important to note that the amounts of grants and new loan disbursements from the creditor/donor community to most HIPCs have exceeded actual debt-service payments on interest and amortization and as a result net transfers were positive. For example, multilaterals as a group have provided to the 41 HIPCs positive net disbursements averaging over US$3 billion a year from 1990–95 and positive net transfers averaging about US$1.5 billion a year over the period 1985–94 and about US$2 billion in 1995 (Table 6). Official bilateral creditors and donors have, through fora such as Consultative Group meetings and the Special Program of Assistance for Sub-Saharan Africa, provided new concessional financing in the form of grants or highly concessional loans partly in order to meet the financing requirements identified under adjustment programs. Thus in 1994, inflows of grants and concessional assistance from official donors were more than three times actual debt service paid. Over the last 5 years, net resource flows (gross flows less principal repayments) including bilateral grants to HIPCs have averaged around 8 percent of GNP (Table 7).

Table 6.

Heavily Indebted Poor Countries: Net Disbursements from Multilateral Institutions, 1980-95 1/

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Sources: World Bank Debtor Reporting System (DRS); and IMF staff estimates.

Medium and long-term public and publicly guaranteed debt; including lo the IMF.

Annual average of net disbursements in percent of exports of goods and services is calculated only for selected years due to the lack of export data.

Total for 1995 excludes exports of Lao P.D.R., Mozambique and Vietnam, for which data were not available.

Exports of goods and services of the countries for which data for 1995 is not available are estimated on the basis of a stylized nominal export growth of 6 percent per annum.

Table 7.

Heavily Indebted Poor Countries (HIPCs): Net Concessional Flows, Debt Service Due and Paid, 1990 - 1994 1/

(In Percent of GNP)

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Source: World Bank DRS.

Net concessional flows consist of net concessional flows from multilateral and bilateral creditors and grants, (excluding technical cooperation). Debt service due and debt service paid include payments related to the regularization of arrears.