Unit 4 Macro: Overseas Aid and Economic Development - Debt Relief and Debt Cancellation

Many of the world’s poorest countries have been for many years saddled with high levels of external debt owed to other governments, institutions such as the IMF and foreign companies and individuals.

The current near $5tn of external debts owed by developing countries costs them more than $1.5bn a day in repayments – and much of that comes from the poorest countries

Most of the world’s poorest countries have limited access to international capital markets – their sovereign debt does not have an official credit rating.

Without conditional loans from the IMF, World Bank and others, they would have to pay interest rates many times higher on private sector loans.

Some developing countries have chosen to borrow from other emerging economies such as China or Brazil as a way of avoiding conditional loans from international institutions

Countries with persistent trade deficits end up accumulating large external debts, so too a government where spending greatly exceeds annual tax revenue leading to high fiscal deficits

External debt (share of gross national income) for a selection of Sub Saharan African countries

External Debt Data (End of 2011)

The stock of developing countries’ external debt increased to $4.9 trillion at end 2011, but at an average of 22 percent, remained moderate in relation to Gross National Income (GNI), and to exports (an average of 69 percent).

High income countries have, on average, a much higher level of external debt: 126 percent of GDP for G7 countries in 2011 compared to 19 percent for the top ten developing countries. General government debt (external and domestic) is also much higher, with an average of 76 percent in Euro-zone (17) countries in 2011, more than twice the comparable ratio for the largest borrowers among developing countries.

External debts can act as a severe constraint on growth and development – often times, the interest on existing debt takes up a large percentage of a nation’s export revenues or annual tax revenues. These debt repayments have an opportunity cost, they might be better used in supporting development policies.

Debt Relief - Debt Jubilee Campaign

To what extent should richer nations be prepared to write-off external debts of poor countries? The Jubilee Debt Campaign pushes for debt cancellation and debt relief avoiding where possible conditions built into debt reduction agreements that create further problems for vulnerable countries.

One option is to reschedule debt payments and change the nature of the interest rate paid on these loans. In July 2012 a United Nations report made the case for introduced indexed loan repayments where the interest rate is tied to a country’s rates of economic and/or export growth. This would help balance the risk of loans more equally between lender and borrower. In good years when growth of GDP is strong, the borrower country would repay more of their debts. During hard times (i.e. a recession caused by a fall in export revenues), the rate of interest on debt would fall.

Djibouti (East Africa)

The Djibouti government’s external debt has increased significantly over the last decade from 40 per cent of GDP in 2001 to 70 per cent in 2009, and now stands at $700 million. For 2012, the IMF predicts the government will spend 14 per cent of revenues on foreign debt payments. Since 2001, over 70 per cent of lending to the country has been from multilateral institutions such as the IMF, World Bank and African Development Bank. In May 2012 the IMF agreed to lend a further $10 million to help the country meet its debt and import payments. As part of the loan programme the Djibouti government has agreed to reform diesel fuel subsidies, freeze any hiring in the public sector, except for health and education and freeze public sector pay, except for the lowest salary band. Inflation is 4% this year.

Djibouti has not been considered eligible for the Heavily Indebted Poor Countries (HIPC) initiative, which allows countries to have some debts cancelled in return for following IMF and World Bank economic policy conditions.

Source: Jubilee Debt Campaign Website, accessed, August 2012

Debt Write-off for Sudan

The UK is expected to wipe as much as £740m off Sudan’s debts in the next few years. The country defaulted on its £173m debt to the UK in 1984, since when it has not made a single repayment. But the government has charged nominal interest rates of 10-12 per cent a year since, leaving Sudan with a current bill of £678m and rising.

The department said that “By cancelling debts, we are freeing up money that can then be spent tackling poverty and providing essential services such as schools and hospitals to their people.” If Sudan’s debt is formally cancelled in 2013-14, it would account for about 7 per cent of the UK’s aid budget.

Source: Adapted from newspaper reports, August 2012

Heavily Indebted Poor Countries Initiative (HIPCI)

This is an initiative to provide debt relief to heavily indebted low income countries. Under the Initiative, the International Monetary Fund (“the IMF”) and World Bank calculate the proportionate reduction required in the country’s external debts in order to return them to 150% of the country’s annual exports, which is considered to be a sustainable level. All creditors – multilateral, bilateral and commercial – are expected to provide the proportionate reduction that will achieve this.

Debt Relief for the Comoros

The International Monetary Fund (IMF) has agreed to US$176 million in debt relief for the Comoros, representing a 59 percent reduction of its future external debt service over a period of 40 years. The requirements met by Comoros included the maintenance of macroeconomic stability, reforms on telecommunications and energy, a national measles vaccination campaign for children to achieve 90 percent coverage nation-wide, and improvements in debt management.

Source: International Monetary Fund, December 2012