Policy & Advocacy
Analysis by USCCB Staff of Agreement on Debt Cancellation, July 7, 2005
July 7, 2005
The communiqué issued by the G8 Finance Ministers at the conclusion of their London meeting on June 10 and 11 announces their agreement on new debt relief for poor countries. The Ministers state that the new relief will provide “additional development resources” to the Heavily Indebted Poor Countries (HIPCs) to help them achieve the goals of the Millennium Declaration (MDGs) while “ensuring that the financing capacity of the international financial institutions is not reduced.” The main features of the Ministers’ proposal are:
- 100% cancellation of the debt owed to the World Bank’s International Development Association (IDA), the African Development Fund (AfDF) and the International Monetary Fund (IMF) by HIPCs which have reached their “Completion Point”, i.e., those that have met the conditions for full and irrevocable debt reduction available under the existing HIPC debt relief program.
- Donors would provide additional contributions to IDA and AfDF to offset “dollar for dollar” the foregone principal and interest payments of the debt cancelled.
- The cost of covering IMF debt cancellation would be met by use of existing IMF resources, except that in cases where projected obligations cannot be made from existing resources (e.g., Somalia, Liberia and Sudan), donors commit to provide the additional resources necessary.
- Upon cancellation of the IDA and AfDF debt of post-Completion Point countries, gross assistance flows to these countries will be reduced by the amount cancelled.
- The additional donor contributions to IDA and AfDF under the agreement will be allocated to all IDA and AfDF recipients based on existing performance-based allocation systems.
The Ministers’ proposal requires the approval of the shareholders of the IMF, World Bank and African Development Bank. This is expected to be accomplished by the time of the World Bank/IMF annual meetings in September.
How many countries will benefit and how much debt will be canceled?
There are eighteen countries that have reached their Completion Point (CP).1 Most of the debt of these countries owed to governments, including 100% of the debt owed to the United States, has already been canceled under the HIPC and other debt relief programs. A substantial amount of debt owed to international financial institutions (IFIs) has also been canceled under the HIPC program. Nevertheless, a large amount of IFI debt remains outstanding.2
The eighteen CP countries will receive debt stock cancellation totaling about $40 billion from IDA, the AfDF, and IMF immediately following formal approval of the G8 agreement, as long as they are current in their debt payment obligations to these IFIs. The cancellation is expected to translate into annual debt service savings totaling just over $1 billion each year, on average, for the next ten years. The fourteen African CP countries will benefit relatively much more than the four Latin American and Caribbean (LAC) countries.3 This because debt owed to the Inter-American Development Bank, the LAC countries’ largest creditor, is not covered by the agreement.
How much additional resources would be generated for the “Completion Point”countries by the debt cancellation?
According to Steven Radelet of the Center for Global Development, the portion of annual CP country savings attributable to IDA and AfDF debt cancellation is estimated at $650 million. Initially at least, these savings would be fully offset by a reduction in new disbursements from the two IFIs. Many of the CP countries, however, should benefit from the additional donor contributions to be made to IDA and AfDF to make up for their lost debt service payments. These contributions would be allocated among all IDA and AfDB countries in accordance with the IFIs’ normal performance criteria. Thus, how much of the additional IDA resources any of the eighteen CP countries will receive will depend on how they rate vis-à-vis other IDA countries in terms of country performance. Those with the strongest policies and institutions, as judged by the World Bank, will get more of the funds than others. The fact that the eighteen have met the CP performance requirements suggests that their ratings should be relatively high. Those countries, however, that receive low ratings should expect to receive no additional resources.
With respect to the $400 million in annual IMF debt service savings, the agreement does not call for any offsetting reduction in disbursements. Nevertheless the availability of these savings could influence future IMF decisions on the amount of new lending to CP countries.
Will HIPC countries which have not reached their Completion Point be eligible for debt cancellation?
Cancellation of IFI debt is potentially available to all 38 HIPC countries. Thus an additional 20 countries would benefit once they reach their Completion Point. Nine of these have met the requirements for the first key stage in the HIPC process—the “Decision Point”—and thus are receiving interim HIPC relief. According to the April 4, 2005 HIPC progress report of the World Bank and IMF, five of these4 are expected to reach their Completion Point in the last quarter of 2005 or the first quarter of 2006, and the remaining four5 before the end of 2006. Thus all nine countries could receive IFI debt cancellation in 2005 or 2006. However, past experience suggests that substantial slippage is likely for some countries. As for the remaining 11 countries, many are affected by conflict and the timing of their Completion Points is highly uncertain.6
Is there any possibility that countries not currently eligible for the HIPC program will be able to benefit from the debt cancellation agreement?
The G8 agreement is limited to HIPC countries and no new countries have entered the HIPC program since 2001. However, the Ministers’ communiqué raises the possibility of additional countries qualifying for the HIPC program and eventually for the debt cancellation provided by the new agreement. The Communique states: “We are also committed, on a fair burden sharing basis, to cover the costs of countries that may enter the HIPC process based on their end-2004 debt burdens.” The Communique does not elaborate on this statement, and it is not clear what its practical implications will be. Presumably the debt burdens of the new entrants would have to meet the same threshold requirement that applied to the current 38 participants, the principal one being a debt-to-export level above 150%.
Based on available data, there are a substantial number of low-income countries that are likely to have end-2004 debt burdens above the HIPC threshold. However, HIPC debt relief is available only for countries that remain above the threshold after taking full advantage of bilateral debt relief available from the Paris Club of official creditors. Thus, it is not possible to know which new countries might qualify without further information, and in any event, it would likely be a number of years before any new entrants could reach the Completion Point required for IFI debt cancellation.
The HIPC thresholds for country eligibility were established in 1999, and it is possible that the IFI shareholders would reexamine them for new entrants. One reason for doing this would be to take into account the framework recently approved by the World Bank’s Executive Directors for determining country eligibility for IDA grant financing.7 The relevance of this framework to HIPC eligibility is that it incorporates the concept of debt sustainability. It includes a matrix of debt burden indicators that take into account the Bank’s country performance assessments as well as vulnerability to external shocks.
When the indicators were applied to individual countries, 42 were found to be at high risk of debt distress and, therefore, entitled to receive new IDA financing entirely in the form of grants. An additional five countries were at “moderate” risk of debt distress and eligible for 45% grant financing. The list is subject to refinement upon completion of more detailed country-by-country debt sustainability analyses, but until these are completed, the indicators will determine grant eligibility. This decision by IDA represents a major shift in policy because IDA traditionally has provided its assistance almost entirely in the form of loans.
A breakdown of the 47 countries eligible for grant financing shows that it includes 29 of the 38 HIPCs plus 18 other countries. (See attached table.) This means that there are 18 non-HIPC countries that are rated as having a risk of debt distress that is equal to or greater than the HIPC countries. Because of the ten-year grace period on the repayment of IDA credits, the non-HIPCs will begin receiving the financial benefit of receiving grants (rather than loans) only ten years from now. In the meantime they will carry the full burden of existing debts.
One of the 18 non-HIPCs is Lesotho, a small land-locked African country. Upon learning of the G8 Ministers debt cancellation agreement, Lesotho Finance Minister Timothy Thahane told Reuters that one of the reasons Lesotho was not classified as a HIPC country was that it had never defaulted on its debt. “It is important.” he said, “that those who have paid their debts well, who run their mega-finances well, should be rewarded with debt forgiveness.” While perhaps not all of the 18 non-HIPCs have run their finances as well as Lesotho, considerations of consistency and fairness argue for using the World Bank’s new debt sustainability thresholds to determine the eligibility of new countries for HIPC debt relief and IFI debt cancellation.
What will the cost of the debt cancellation be for the United States?
The Administration has not made public the cost of the agreement to the U.S., and Treasury officials have indicated that some of the details of the financing arrangements are still being worked out. However, the Administration is not expected to request new Congressional appropriations, at least for several years. The intention is to finance the initial cost of IDA/ADf debt cancellation by early encashment of regular U.S. contributions to these institutions. This accelerated encashment will provide a financial benefit to IDA and AfDF which is roughly estimated at $200 million over three years. A more precise estimate of how much it will amount to and for how long it will cover the US. share of costs cannot be determined without further information on the specifics of the arrangement. Presumably, however, the accelerated encashment will be sufficient to cover costs through FY08. This is because the Ministers’ Communiqué says, “Additional funds will be made available immediately to cover the full costs during the IDA-14 and AfDF-10 period.”
With respect to IMF costs, the Ministers’ Communiqué states that it should be financed from existing IMF resources “without undermining the Fund’s financing capacity,” While the details of the financing arrangement have not yet been disclosed, the principal source of funds is expected to be the corpus of the IMF fund established with the net proceeds of the revaluation of IMF gold that took place in 1999.8 IMF staff have been instructed to assess the financial implications of the new proposal. The results of this review should provide the basis for a final decision by the IMF shareholders as to whether IMF’s existing resources are sufficient to cover costs for the 27 (or more) countries.
Apparently referring to some of the 11 HIPC countries which have yet to reach the Decision Point, the Communique says, “in situations where other existing and projected debt relief obligations cannot be met from the use of existing IMF resources (e.g., Somalia, Liberia and Sudan), donors commit to provide the extra resources necessary.” The three countries named are likely to be years away from qualifying for IFI debt cancellation, so that the near term cost implications of this statement may be minimal.
Will Nigeria benefit from the agreement?
The G8 Ministers “welcomed Nigeria’s progress in economic reform…noted it move to IDA-only status, and encouraged them to continue to reform.” It stated: “We are prepared to provide a fair and sustainable solution to Nigeria’s debt problems in 2005, within the Paris Club.9 Todd Moss of the Center for Global Development commented as follows:
The change in IDA status is a small but critical step as it now allows the Paris Club to treat Nigeria like any other poor country and opens the door to a possible write-down of as much as two-thirds of the debts Nigeria owes to its bilateral creditors (albeit not the debts owed to the World Bank and IMF). Inclusion in the G8 announcement is an important signal that the creditors are serious about reaching a deal soon—perhaps even as soon as [the G8 Summit].
(On June 30, 2005, the Paris Club of major creditor countries announced an agreement in principle on major bilateral debt reduction for Nigeria. Under the agreement, Nigeria would pay back $6 million in arrears, and the Paris Club would grant “Naples terms” for the approximately $26 billion of remaining eligible debt. This would result in the cancellation of close to $18 billion. Nigeria would buy back the $8 billion balance at a market-related discount still to be negotiated.)
For additional information on debt relief, please contact Gerry Flood, USCCB Counselor on Debt, at 202-541-3167 or firstname.lastname@example.org.
1 Benin, Bolivia, Burkina Faso, Ethiopia, Guyana, Ghana, Honduras, Madagascar, Mali, Mauritania, Mozambique, Nicaragua, Niger, Rwanda, Senegal, Tanzania, Uganda, and Zambia
2 Most commercial creditors have not provided HIPC relief, but this debt amounts to less than 5% of HIPC country debt
3 Bolivia, Guyana, Honduras and Nicaragua
4 Cameroon, Chad, The Gambia, Malawi and Sierra Leone
5 Democratic Republic of the Congo, Guinea, Guinea-Bissau and Sao Tome and Principe
6 According to the World Bank and IMF, Burundi and the Republic of Congo are expected to reach their Decision Point in 2005 and Cote D'Ivoire possibly in 2006, but they make no projections for Central African Republic, Comoros, Liberia, Myanmar, Somalia, Sudan and Togo; and Laos has not applied for HIPC relief.
7 See "Debt Sustainability and Financing Terms in IDA 14: Further Considerations on Issues and Options" International Development Association November 2004
8 The interest earned from investment of these proceeds is used to finance the cost of IMF debt relief under the existing HIPC program.
9 "IDA-only" status is granted to very low income countries. It means that the country is eligible for the highly concessionary IDA funds but not the (more expensive) ordinary resources of the World Bank.