HIPC: Too little, too late

Why has the Heavily Indebted Poor Countries debt initiative failed to meet the needs of these poor countries? The following paper, prepared by Oxfam International before the Cologne Summit, analyses some of the reasons for its failure.

THE Heavily Indebted Poor Countries (HIPC) is failing because of three main problems with the design of the framework. First, the eligibility requirements and linkage to performance under IMF adjustment programmes have caused long delays. The second problem is that the criteria used to determine whether debt stock and debt servicing are sustainable provide limited debt relief, while at the same time excluding many countries. The IMF and World Bank estimate that only half of the 41 most highly indebted poor countries are theoretically eligible to receive debt relief through HIPC. The third problem is that HIPC's links to poverty reduction are too weak.

1. Time frame and track record
Countries entering HIPC must complete two successive IMF Enhanced Structural Adjustment Facility (ESAF) programmes - up to six years - although this can be reduced for exceptional performers. This eligibility requirement, coupled with inflexible interpretation, leads to serious delays in providing debt relief through HIPC.

The stated intention is to avert 'moral hazard' by ensuring full compliance with economic reforms prior to debt relief. In effect, this is a brutal application of the 'carrot-and-stick' approach to very poor countries. Before HIPC, countries had to comply with three years of IMF reforms before receiving Paris Club debt relief. HIPC added another three years to this. However, there is now growing consensus amongst some creditor countries that three years, rather than six, should also be sufficient for HIPC.

Creditors are recognising that forcing countries to wait for up to six years for debt relief is counter-productive and inequitable. It is counter-productive because debt sustainability is needed to support economic reform; to remove the debt overhang, and to promote economic self-reliance. At the same time, sustained improvements in policy and financing of priority areas are best achieved when governments can provide resources from their own budgets to achieve these ends. A lengthy time period is inequitable because it subordinates the needs of poor people to the budgetary claims of creditors.

The second aspect of the time frame is the problem of further delays related to compliance with IMF programmes. Oxfam International has argued that compliance with IMF ESAF programmes for HIPC countries is not appropriate, not least because these programmes have failed to generate growth and have impacted negatively on the poor.

At the same time, compliance requirements can lead to delays in HIPC implementation. A recent external review of ESAF found that only a quarter of 36 ESAF programmes reviewed were completed without significant delays. This has grave implications for the progress of the majority of countries going through HIPC. Unlike Uganda or Bolivia, most HIPC countries are not seen as model reformers by the IMF and World Bank. Many are 'off-track' with their IMF programmes and could suffer lengthy delays in receiving debt relief.

Even with flexible interpretation of its track record, after over a decade of strong reforms Uganda was required to go through another year of compliance. This resulted in a Decision Point in April 1997 to a Completion Point in April 1998. The cost of this delay was estimated at $190 million. In effect, Uganda was punished for being the first country to be considered under HIPC. Certain powerful creditors, such as the US, did not want too favourable a precedent to be set by Uganda.

The implication of this precedent for other, less well-performing HIPC countries, is that they have almost no chance of progressing rapidly through HIPC. For instance, Nicaragua has been undertaking substantial and deep economic reforms since the early 1990s, covering areas such as inflation, taxation, privatisation, public sector restructuring and retrenchment, and demobilisation. Targets have largely been achieved with relative success, in a difficult political environment.

The devastating impact of Hurricane Mitch has meant that creditors have had to take short-term action on Nicaragua and Honduras, and a debt moratorium is now in place. However, while the decision point for Nicaragua is proposed for 1999, at the moment it is unlikely that the IMF will agree to further flexibility in the timeframe, even after the devastation of Hurricane Mitch, and Nicaragua will still have to wait until 2002 to receive limited HIPC debt relief.
a) By the end of 2000, four years after the agreement of the initiative, only six countries will have received debt relief through HIPC.
b) Countries with dire human needs, such as Tanzania, Zambia and Nicaragua, will have to wait until 2002 and far beyond for debt relief.

2. Sustainability thresholds are not appropriate for poor and indebted countries
The debt sustainability thresholds in HIPC are inappropriate for poor and indebted countries, firstly because the export criteria do not provide for debt sustainability, and secondly because the fiscal criteria do not address the impact of debt servicing on the national budget, while at the same time excluding the majority of these countries. Rather than addressing the debtors' problem of 'ability to pay', these criteria are more focused on the creditors' 'willingness to afford'. With these criteria, half of HIPC countries will not benefit from the framework at all.

Export criteria

The existing export criteria in HIPC were developed on the basis of experience in the 1980s with middle-income Latin American countries saddled with mostly commercial debt. These criteria are:
a) ratio of debt stock to exports in the order of 200-250%
b) ratio of debt service to exports around 20-25%.

There are serious questions as to whether these thresholds are appropriate for HIPC countries. By comparison with middle-income countries in Latin America, HIPC countries have poor infrastructure, acute levels of poverty and appalling social indicators. They also have a far weaker export base and are especially vulnerable to external shocks, such as falling commodity prices. In this decade, for instance, commodity prices have fallen around 50% from 1990s highs, for commodities such as coffee, cotton, maize, sugar and copper. The impact of the financial crisis in East Asia, Russia, Brazil and beyond, means that a global recession is driving commodity prices down, where non-energy prices dropped by 13% from end-1997 to end-1998. For a large number of HIPCs, a few commodities make up the majority of exports. For instance, Uganda, which relies on coffee for over 50% of its exports, has seen benefits from HIPC wiped out by the fall in coffee prices.

In Oxfam International's view, these indicators must be adjusted to take into account the true position of HIPC countries, and should be lowered to at least 150% for net present value debt to exports, and 15% debt service to exports. More appropriate ratios such as these would allow higher numbers of countries to benefit from the framework, while at the same time ensuring a complete exit from unsustainable debt.

Fiscal criteria

Because debt distress is measured under HIPC primarily on the basis of export criteria, the fiscal burden placed on government budgets from debt servicing is not sufficiently addressed. The fiscal criteria developed for HIPC also fail in this respect, and not least because they exclude an overwhelming majority of HIPC countries.

The existing fiscal criteria apply if net present value debt stock to revenue is greater than 280%. However there are two eligibility conditions. First, countries must meet revenue collection levels of over 20% of GDP. The second condition is that exports must be greater than 40% of GDP. The fiscal criteria were a later addition to the HIPC framework. The French Government was especially keen to add this particular set of fiscal criteria to ensure that Cote d'Ivoire, which would not have qualified for HIPC on debt-to-export criteria alone, could enter the initiative.

Only four HIPCs meet the fiscal criteria: Cote d'Ivoire, Guyana and possibly Congo Democratic Republic and Mauritania. Although the majority of HIPCs have debt stock to revenue above 280%, most have revenue collection under 20% of GDP, and few have exports over 40% of GDP.

While there are concerns that countries make best efforts to raise revenues, the revenue collection criteria under HIPC are unrealistic. The majority of HIPCs start from a very low revenue base, since incomes are so low. In Uganda, for instance, which has over a decade of successful reforms under IMF and World Bank programmes and is seen as one of the best performers in Africa, revenue as a percentage of GDP was just over 11% in 1997/1998.

However, even with modification, these fiscal criteria may not be the most appropriate approach, since they do not fully reflect the burden that is placed on the budget by debt servicing. In HIPCs, average debt service to government revenue stood at 40% in 1996. This can be seen in a range of HIPC countries:
a) Nicaragua's debt servicing absorbed two-thirds of the budget in 1997 ;
b) In 1997, Niger and Ethiopia used almost half of the government budget on debt servicing;
c) In 1996, debt servicing absorbed 44% of the Zambian budget, and 35% in Malawi.

Even when countries pass through HIPC, they remain with a heavy burden of debt on the national budget:
a) Mozambique will receive HIPC benefits in the middle of 1999, of a reduction in nominal debt stock of $2.9 billion, yet the immediate effect is only an 11% reduction in debt servicing, from $108 million to $96 million. In one of the poorest countries in the world, recovering from decades of conflict, debt servicing will remain more than government health and education spending combined.
b) Mali will receive HIPC debt relief in 2000, with a proposed reduction in debt service of some $12 million, from $99 million to $87 million. This is a reduction equal to 10% of the education budget; after HIPC, debt service will remain more than the basic education budget in a country where almost 70% of adults are illiterate.

An alternative fiscal indicator would recognise the burden that debt servicing places on the national budget, and thus on human development. Oxfam International has proposed that a 10-15% ceiling be placed on the portion of government revenue that is allocated to debt servicing. This approach would ensure that debt servicing is constrained to reasonable limits. However, a more radical approach to debt relief is required, one that is driven by human development concerns, rather than by the needs of creditors.

3. HIPC does not take into account human development concerns
The major problem with HIPC as it stands, is that it has little impact on poverty reduction. While the debt overhang is partly reduced, with consequent benefits in future investment growth, governments see little immediate impact on reducing domestic resources allocated to debt servicing. Oxfam International, along with some governments and many other agencies, have argued that debt relief should be linked more closely to poverty reduction.

Poorest in the world

The IMF and World Bank have attempted to do this to some extent within HIPC. At the moment, increases in social sector spending form part of the wide range of conditionalities that debtor governments must comply with before receiving debt relief through HIPC. Conditionalities have included, for instance, targets for increases in education and health spending, where countries have to meet these targets before being allowed to go through HIPC. This is a flawed approach.

Firstly, HIPC countries are among the poorest in the world. If attempts are made to address poverty through HIPC, it requires a more integrated approach than simply tacking-on conditionality near the end of a process. The process of bolting on social sector provision to flawed macroeco-nomic approaches has already been discredited by the World Bank itself. Poverty reduction should be built into the debt relief process from the start, in the same way as it should be built into macroeconomic policies. Thus poverty reduction concerns should properly influence the development of appropriate debt sustainability thresholds.

Secondly, as long as governmental budgets are heavily constrained by debt servicing, they are in a weak position to make major commitments to increased social sector spending. Reallocations can take place between military and social sector expenditure; reduction of parastatal subsidies, or within sectors, for example, from tertiary to basic education. However, when HIPC countries on average use 40% of their national budgets on debt servicing, this seems to be a somewhat backward approach.

We strongly contend that external debt servicing diverts finance away from social sector spending but the IMF's standard response is that this is a misleading argument, partly because HIPC countries are net recipients of external finance. They receive more in grants and loans than they allocate in external debt servicing. While net external flows may be positive, the IMF appears to ignore the fact that the majority of these countries have extremely high levels of poverty and human suffering. They will not meet, according to current trends, internationally agreed human development targets into the next millennium. Aid alone, while of vital importance, has not provided and will not provide enough resources for sustainable improvements in development in HIPC countries. Debt relief will also be required.

If the IMF and World Bank are committed to seeing the world's poorest and indebted countries make progress in reducing poverty, they need to ensure that debt relief is provided earlier on, and deep enough, so that investments in poverty reduction, in health and in education, in rural roads and in the productive capacity of the poor, can be made. (Third World Resurgence No. 107, July 1999)

The above is an extract from Oxfam International's submission to the Heavily Indebted Poor Countries (HIPC) Debt Review (Oxfam International Paper, April 1999).