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Making sense of the Kln (Cologne) Debt Initiative

There was a lot of confusion as to the implications for the poor countries of the final decision of the G-7 leaders at their Summit in Cologne (Kln) in June. Joseph Hanlon summarises and interprets the Kln Debt Initiative.


THE new Initiative is based entirely on the present World Bank and International Monetary Fund Heavily Indebted Poor Countries (HIPC) Initiative and makes no fundamental changes. No new countries qualify for consideration (although more of the 41 who qualify will actually receive debt 'relief') and the underlying process remains unchanged. None of this takes effect immediately, but is passed to the World Bank and IMF to implement.

Note that most decisions were taken by three different groups, each of which issued a statement:

* finance ministers of the G7 group of industrialised countries,

* leaders of the G7, and

* leaders of the G8 (G7 plus Russia).

The amount of debt can be defined in two ways:

* The 'nominal', 'book', or 'total' value of the debt (EDT) is the actual amount of money owed now.

* The 'net present value' (NPV) is the amount of money that would be required to pay off the debt now.

Finally, note that normally in English the conference city is known as Cologne, but all G7/G8 official texts use the German name and call it the 'Kln Debt Initiative', and we have followed that usage here.

NPV is less than EDT for low-interest aid loans; NPV is higher than EDT for commercial loans. For the HIPC countries, it is estimated that present value (NPV) of the debt is 54% of the normal value of the debt (EDT) because of the high proportion of concessional (low-interest) loans given to very poor countries.

'Sustainability' and amount of debt to be cancelled

Under HIPC enough debt is to be cancelled to reach the level defined as 'sustainable'. There is a choice of two definitions of when a debt is 'sustainable', and both are changed. In addition, there are changes to ODA (aid) debt and Paris Club (bilateral commercial) debt.

Export criterion

Under the present HIPC, debt is 'sustainable' if the NPV is between 200% and 250% of annual earnings from exports of goods and services (XGS). With only one exception, this has been set at 200%. So, presently: NPV/XGS < 200%.

Under the Kln Debt Initiative this is reduced to 150%.

Fiscal criterion

Under the present HIPC, a handful of countries with high levels of exports and a large tax base can use an alternative 'fiscal' definition of sustainability: If exports are more than 40% of GDP and government revenue (DBR) is more than 20% of GDP, then debt is sustainable if the NPV is less than 280% of annual government revenue: If XGS/GDP > 40% and DBR/GDP > 20%, then NPV/DBR < 280%.

Under the Kln Debt Initiative, all three numbers are reduced: the qualification criteria to 30% and 15% and the sustainability level to 250%.

Paris Club

The Paris Club of bilateral creditors negotiates with debtors over bilateral debt, which for these countries mainly means export credits which have been nationalised by the creditor because the debtor has defaulted. But in some cases, bilateral aid debt is also considered. Under the present regime:

* Paris Club bilateral debt is first reduced by Naples terms, which involves the cancellation (or equivalent shifts in accounting) of two-thirds of qualifying bilateral debt - both defaulted export credits and aid debt.

* Then under the HIPC 'burden-sharing' agreement, all debt is proportionately reduced as needed to meet the HIPC criteria. The Paris Club at this point only deals with defaulted export credits and other non-aid debt; aid debt is proportionately cancelled by individual governments.

Under the present HIPC, the Paris Club will not cancel more than 80% of outstanding eligible debt (although it did go higher for Mozambique). Under the Kln Debt Initiative, the Paris Club will 'forgive up to 90% and more in individual cases if needed'. Naples terms will be extended to HIPC countries where debt is deemed to be 'sustainable'.

Aid (ODA) debt

Loans which are sufficiently concessional (long-term and low-interest) are counted as Official Development Assistance (ODA). In 1978 the United Nations Conference on Trade and Development (UNCTAD) agreed a resolution calling for ODA loans to be ended and replaced by grants. Only four countries continue to make significant ODA loans - Japan (19% of ODA in 1997), Spain (18%), France (5%) and Germany (4%). At their meeting in Kln, 21 years after the UNCTAD agreement, the G8 actually backtracked; it only agreed to 'increase the share of grant-based financing in ODA'.

Most donor countries have now cancelled ODA debt. The G7 said that in addition to improvements in HIPC, 'we call for full cancellation on a bilateral basis, through various options,' of ODA debt. Japan is by far the largest ODA creditor, and this wording is intended to allow Japan to continue using its system whereby debtor countries make payments on ODA debt, but these payments are returned to the country as tied aid to be used for the purchase of Japanese goods.

Summary of Kln changes

Export criterion: NPV/XGS < 150%

Fiscal criterion: if XGS/GDP > 30% and DBR/GDP > 15%, then NPV/DBR < 250%.

Paris Club: cancellation of up to 90% and higher in individual cases

ODA: cancellation on top of HIPC improvements.

How much money is involved

Cancellation already on offer:

* $25 billion (bn, 1,000 million) under present HIPC

* $30 bn under Naples terms for countries as they qualify.

New cancellation under Kln Debt Initiative:

* $25 bn in additional HIPC cancellation

* $20 bn of ODA debt.

These are nominal (total) values, based on World Bank and G7 finance ministry estimates. Thus the total debt cancellation now on offer is $100 billion, and this is an increase under Kln of $45 bn.

A series of very confusing numbers have been put by the G7 in its 18 June statement and by various finance ministries, suggesting that this cancels half or even two-thirds of total debt. The G7 statement talks of 'the debt stock of countries possibly qualifying under the HIPC initiative [of] some US$130 billion in nominal terms'. This figure is arrived at by excluding short-term debt and by excluding publicly guaranteed private debt (which is included in HIPC calculation) and by excluding the debt of several HIPC countries which will still not qualify for debt relief even under the new Kln criterion. Jubilee 2000 does not consider this acceptable. The total debt of the 41 countries defined by the World Bank as HIPCs is $207 billion, while the total debt of the 52 countries highlighted by the UK Jubilee 2000 Coalition is $370 bn.

Of the $207 billion HIPC country debt, approximately $100 billion is not being serviced - mainly with the agreement of the IMF and World Bank as most of these countries have Bank and Fund programmes. This means the Bank and Fund have already admitted that this money will never be paid. So the $100 billion now on offer is only equivalent to the money that it is already accepted will never be paid - in effect this much debt can be written off without real cost since it would never have been paid.

NPV vs. nominal: The G7 estimate that NPV debt is 54% of nominal debt. The $50 bn nominal HIPC cancellation corresponds to $27 bn NPV, while the G7 say their figure of $130 bn corresponds to $71 bn NPV.

Even the G7 finance ministers admit that 'the final costs of the initiative are subject to many uncertainties.' In practice, the figures given here are only estimates by the international financial institutions (IFIs) and finance ministries, and it is impossible to find detailed estimates for individual countries. Indeed, the IMF and World Bank have distributed estimates, but refuse to disclose how they are arrived at - even to governments. Frustrated finance ministries privately admit even they cannot check what the IMF and World Bank are saying.

Timing

Under the present HIPC, after successfully completing three years of a World Bank and IMF adjustment (ESAF - enhanced structural adjustment facility) programme, a country goes to 'decision point', when the Bank and Fund agree that a country can receive debt relief and set additional conditions. The 'completion point' when debt relief is granted normally occurs after a further three years of successfully following the ESAF programme and meeting the additional decision-point conditions. This second three year period can be reduced if there have been more than three years of ESAF before the decision point. The Kln Debt Initiative makes several changes to this.

Floating completion point

The G7 finance ministers declared: 'While implementation of debt relief must continue to be predicated on sound economic policies over two stages, debtor countries should be allowed to advance the 'completion point' through improved performance. The second stage could thus be shortened significantly if a country meets ambitious policy targets early on ('floating completion point').' Officials in several countries said that decision and completion points would be made the same, but this clearly was rejected.

Dates

Under the present HIPC, the sustainable level is determined by the IMF based on projections of export earnings or tax revenue. Under the Kln Debt Initiative, 'the amount of debt reduction should be determined at the 'decision point' on the basis of the situation prevailing at the time' - in other words, actual rather than projected export or tax earnings.

Under the present HIPC, debt is only cancelled at completion point. The G7 finance ministers said 'the debt service burden of qualifying countries should be alleviated more quickly through provision of 'interim relief' by the IFIs even before debt reduction is implemented at the 'completion point'. This is already current practice in the Paris Club for bilateral debts, and the IFIs should provide comparable treatment.'

Three years instead of six years?

Combining the fact that debt cancellation is determined at decision point and that there will be 'interim relief' between decision and completion points, this is being billed as effectively granting debt relief after three years instead of six. However, the lack of incontrovertible backing for this interpretation in the texts of the various statements at Kln must give some cause for concern.

By the year 2000

In addition, the G7 heads of government 'call on the IFIs and Paris Club to .. work with the HIPC countries to ensure that three-quarters of eligible countries have reached their decision point by the year 2000.'

The three conflict countries (Liberia, Somalia and Sudan) will clearly not meet the deadlines. Of the remaining 38, 33 are now estimated to be unsustainable under the Kln terms (seven more than under the original HIPC terms) and the other five will only receive Naples terms by the Paris Club, according to the British Treasury. Of the remaining 38, three-quarters (28 or 29) should reach decision point by the end of 2000. This is likely to include most of the five who will not qualify. So it is expected that around 24 countries will have some debt cancellation promised by the end of the year 2000.

Civil society and poverty reduction

The G7 leaders say the Kln Debt Initiative 'should be built on an enhanced framework of poverty reduction, developed by the IFIs in consultation with other institutions and with civil society'.

The G7 finance ministers say: 'Integrating their efforts, the World Bank and IMF should help qualifying countries with the drafting and implementation of poverty reduction plans for the effective targeting of savings derived from debt relief, together with increased transparency of budgetary procedures to protect social expenditure. Throughout programme design and implementation, there should be consultations with broader segments of the civil society. Such dialogue will be the basis for deepening the sense of 'ownership' with governments and citizens in debtor countries when necessary adjustment programmes are to be adopted.'

The World Bank and IMF are directed by the G7 finance ministers 'to develop ... specific plans for such an enhanced framework for poverty reduction' in time for the annual meetings in September.

The G8 leaders 'urge the International Monetary Fund (IMF) to give more attention to this issue [development of sound social policy] in designing its economic programmes and to give particular priority to core budgets such as basic health, education and training to the extent possible, even during periods of fiscal consolidation'. The G8 welcome the efforts of the World Bank to work with the UN on social policy and 'invite the World Bank and the IMF to work together ... in the design of adjustment programmes that ensure the protection of the most vulnerable'.

There is a noticeable difference of views on the role of debt relief in this respect. The G8 leaders say 'the central objective of this [Kln debt] initiative is to provide a greater focus on poverty reduction by releasing resources for investment in health, education and social needs.' By contrast, the G7 finance ministers continue to talk of Kln as an attempt to 'reinforce the [HIPC] Initiative so as to enhance the prospects for a robust and lasting exit for qualifying countries from recurrent debt problems.'

Increased conditionality and IFI power

Increased debt cancellation has been won only at the price of increasing the power of the IMF. Debt reduction is even more strictly linked to ESAF, and the IMF and World Bank have been given the power to impose additional conditions on 'poverty alleviation'. The words 'adjustment', 'reform', 'sound policies' and 'good governance' are liberally sprinkled through the documents.

The G7 finance ministers said, 'there will have to be a strong link between debt relief, continued adjustment, improved governance and poverty alleviation. ... The pursuit of sound social policies should be integrated with structural adjustment programmes that debtor countries are expected to implement. ... The World Bank and IMF should adapt their support under the 'Policy Framework Papers' (PFP), in particular the IMF's programmes under the Enhanced Structural Adjustment Facility.'

G7 leaders left it to the IMF and World Bank to develop a new 'framework for poverty reduction', and it seems clear that ministers and leaders intend social conditions to be added on to the present ESAF and HIPC decision-point conditions - subject to a bit of extra protection of social spending. 'Consultation' is required, but decisions will continue to be taken by the Bank and Fund; in particular, they will determine if a government has what the G7 finance ministers call 'sound economic policies' and does not make 'unproductive expenditure'.

Furthermore, it has been left to the IMF and World Bank to set out the rules for the new 'floating completion point,' and they will surely retain the power to decide if a country has met the conditions.

Funding and frontloading

All three statements stress that the IFIs will need 'additional substantial financing'.

The G7 leaders agreed that the IMF should sell up to 10 million ounces of gold. Later briefings indicated that this would be for both debt relief and IMF ESAF loans.

In addition, the G7 leaders called for governments to donate to the HIPC Trust Fund to pay some IFI costs, and called on 'the private sector to reinforce the objectives of this initiative, through contributions to a Millennium Fund to help finance debt relief'.

The G7 finance ministers' statement implicitly recognises that the Kln Debt Initiative is largely about reducing the 'stock' of debt and not the 'flow' - the actual debt service payments. To reduce flow, the G7 finance ministers propose that 'after the 'completion point', the IFIs could frontload debt stock reduction in a way to reduce debt service payments more strongly in early years.'

But two press briefings by the British Treasury spokesperson in Cologne on 18 and 19 June both stressed that 'the degree of reduction in debt service payments depends crucially on frontloading, and thus on how much money is put into the Millennium Fund.'

In effect, then, the Kln Debt Initiative itself will have relatively little impact on actual debt service payments for most countries. Instead, reducing actual payments will depend on private and government donations to the HIPC Trust and Millennium funds. (Third World Resurgence No. 107, July 1999)

Joseph Hanlon is policy officer of the Jubilee 2000 Coalition, author of Peace without profit: How the IMF blocks rebuilding in Mozambique, and a visiting senior research fellow at the Open University, Milton Keynes, United Kingdom.

 


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