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Eurodad: Comments on the Cologne Initiative


The WEED memo is an excellent analysis of the German government position. The point about the 200%-of-exports threshold in paragraph 2 of the Initiative was particularly well-made, as there is no empirical evidence that this ratio will in any way ensure a "lasting solution to the debt problem". Also, the question of whether Germany will forge on ahead with the Initiative unilaterally even if there is no agreement in the G7 or Paris Club is a very good one.

A couple of additional points struck us:

Paragraphs 2 & 3: "exceptional cases"
"...the target figure should be set at 200% with some flexibility in exceptional cases"; "...total cancellation of commercial debt in exceptional cases"

These references to "exceptional cases" beg the question, what exactly is an "exceptional case"? As the plight of Honduras and Nicaragua have demonstrated, HIPC countries - as a result of their excessive debt burdens - are already highly susceptible to disasters which can plunge them even further into a debt crisis. Hurricane Mitch showed the impact of natural disasters, and the World Bank has already considered the case of "Post-Conflict Countries". Countries with "odious" debts are another case in point. The point is that there are already many such "exceptional cases", and for countries as impoverished as HIPC countries, there is the potential for many more to become so.

Policy-making that only deals with "exceptional cases" after some disaster, natural or man-made, has occurred will always be a policy that reacts too late to avoid needless suffering. It will be consistently a case of "closing the stable door after the horse has bolted". Prevention is always better than cure, and in the long run it will be cheaper for creditors too. As usual, the approach to debt relief seems to be dictated by short-term financial considerations, rather than long-term development potential.

Paragraph 7 - the debt cycle
"In the case of countries that have qualified under HIPC, we support new credit and financing arrangements serving in particular to improve the debt service capability. This relates principally to projects increasing a country's capacity for exports and to earn foreign exchange."

For Eurodad, this was one of the most disappointing parts of the whole Cologne Initiative. It demonstrates a fundamental lack of understanding of the financial dynamics that led to the debt crisis in the first place, and a lack of recognition that the current HIPC Initiative can only manage the debt crisis, and is not a far-reaching cure to the debt problem.

Vicious cycle

The problem here comes in three parts:

HIPC countries are looking for debt reduction, not to increase their "debt service capability". (1) The last thing that a country that has just been granted debt relief needs is more debt. The vicious cycle where "new money" goes to service "old debts" needs to be broken.

On the first point, there is a fundamental lack of logic to the proposal in this section of the Initiative. If a country is granted relief such that debt levels are "sustainable", then surely it does not, by definition, need to improve its debt servicing capability. The whole point of the debt relief process is that debt needs to be reduced so that any remaining debt does not prevent sustainable development. It is not that the debt-servicing capacity should be increased.

On the second point, the last thing that a country needs after it has been granted debt relief is to instantly start borrowing again - this is one of the reasons why previous debt initiatives have failed. If the HIPC Initiative is ever to succeed, it must ensure that debt levels are reduced once and for all: if a country needs to borrow again, then this is a sure sign that there has been insufficient debt reduction. And as WEED points out, the need is for assistance in the form of grants, not new debt. If the IFIs are serious about their targets for improving growth prospects in HIPC economies, then they should realize that the surest way to prevent this is by saddling these economies with further debt.

The third point is linked to this. Currently, a high percentage of all new borrowing is not for specific projects designed to create economic growth, but to pay off the "structural" debt stock of old loans: without these loans, HIPC countries would quickly become insolvent. This reliance on new loans to pay off old loans is a cycle of "debt dependency". The other way in which countries can generate "new" money to pay off old loans is through boosting export earnings which generate foreign currency. Again, the money generated from these activities goes to pay off the "structural" stock of government debt.

"New money paying off old debt"

So, up until now there has been a constant cycle of "new money going to pay off old debt", which in and of itself has prolonged and deepened the debt crisis. The new German government plan does not seem to escape from this old pattern.

It is clear that debt reduction is needed in order to break the cycle of dependency on new loans to pay off old debt. But at the same time, the "new" money from export earnings needs to be used to generate growth, not to pay off the structural stock of government debt, nor to increase debt service capabilities, as the German initiative seems to be suggesting. Taking on new debt to increase export earnings in order for a country to carry structurally higher levels of debt will not enable that country to escape from the debt cycle. It would be just another way of continuing the cycle of "debt dependency".

In summary:
Debt must be reduced so that foreign exchange earnings can be reinvested and used to fuel a country's economic growth. After debt reduction, foreign exchange earnings should not be channelled just to pay off the "structural" stock of government debt. It certainly should not be the case, as the new German initiative suggests, that even more debt should be taken on to boost the capacity to pay debt.

[The folly of relying on export earnings to boost the "debt capacity" of a country is illustrated by a recent World Bank report. Most HIPC countries export raw materials and commodities, the prices of which "may never fully recover from their historic lows of the past 18 months" (2). This is compounded by the fact that if ESAF programmes stressing increased exports are followed in many countries simultaneously, then export earnings will by definition be driven down as market prices drop in response to over-supply.]

Conclusion

The use of new money to pay for old debts that has contributed to the old cycle of indebtedness needs to be broken once and for all, so that there will not be a new debt crisis in ten years' time. If the Cologne Initiative is to be successful, it needs to ensure that economic orientation of HIPCs moves from paying off loans (through constant borrowing and increasing reliance on export earnings to pay debt service) to using export earnings for investment for future growth and for consolidating government revenues. Future borrowing must be only for specific programmes that can generate their own revenues to pay back the loans without adding to the general stock of government debt.

Eurodad is currently developing these ideas, in order to show that the forthcoming HIPC review needs to re-examine the idea of "debt sustainability" if the current debt crisis is to be solved and future ones avoided.

Endnotes

(1) In the long term, a "side-effect" of a stronger economy would be an increased capacity to deal with debt, but the point is that this should not be a short-term "direct" aim.

(2) Global Commodity Markets, published by the World Bank, quoted in the Financial Times, 3 January 1999, p. 17. The net real economic impact of commodity prices halving (therefore halving export earnings in $ terms) is identical to the total level of annual debt servicing in $ terms doubling.

Eurodad, the European Network on Debt and Development, is a network of NGOs in 15 European countries which coordinates the activities of NGOs working on debt, structural adjustment, financial flows and markets in developing countries. The Eurodad Secretariat is at 46 Rue Dejoncker, B-1060 Brussels, Belgium. E-mail: eurodad@agoranet.be ; website: www.oneworld.org/eurodad.

 


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