With rigorous economic research and practical policy solutions, we focus on the issues and institutions that are critical to global development. Explore our core themes and topics to learn more about our work.
In timely and incisive analysis, our experts parse the latest development news and devise practical solutions to new and emerging challenges. Our events convene the top thinkers and doers in global development.
It’s been almost 10 years since I sat down for coffee with Ngozi Okonjo-Iweala in Davos. A former World Bank VP and then Nigeria’s finance minister, she was looking for assistance in what became, 15 months later, a $30 billion debt reduction deal with Nigeria’s bilateral creditors. I’m proud that CGD played a role in securing a deal; forgiving the debt of an oil-rich country burdened by corruption was controversial and complicated (see Todd Moss’s April 2006 blog post here). A first step was more political than financial: persuading Nigeria’s creditors in Europe that Nigeria was eligible for IDA status. At that and every subsequent step during two rounds as finance minister (including managing a reduction in Nigeria’s regressive fuel subsidies), Minister Okonjo-Iweala’s contribution has been fundamental in her own country’s struggle to become a better economy and democracy.
In the meantime, Ngozi Okonjo-Iweala has served as vice president and then managing director under the last three presidents of the World Bank, and in 2012 was a candidate for the presidency at the World Bank.
So it is a thrill for me that Ngozi is now joining CGD as a distinguished visiting fellow. In the immediate future she will be working on the challenge of deepening and broadening financial services (credit, savings, insurance) for the world’s small farmers, bringing her own extraordinary experience and economic savvy to that tough issue.
When the world’s finance ministers and central bank governors assemble in Washington later this month for their semi-annual IMF meeting, they will no doubt set aside time for yet another discussion of the lingering debt problems in the Eurozone or how impaired bank debt could impact financial stability in China. They would do well to also focus on another looming debt crisis that could hit some of the poorest countries in the world, many of whom are also struggling with problems of conflict and fragility and none of which has the institutional capacity to cope with a major debt crisis without lasting damage to their already-challenged development prospects.
Nearly two decades ago, an unprecedented international effort—the Heavily Indebted Poor Countries (HIPC) Debt initiative—resulted in writing off the unsustainable debt of poor countries to levels that they could manage without compromising their economic and social development. The hope was that a combination of responsible borrowing and lending practices and a more productive use of any new liabilities, all under the watchful eyes of the IMF and World Bank, would prevent a recurrence of excessive debt buildup.
Alas, as a just-released IMF paper points out, the situation has turned out to be much less favorable. Since the financial crisis and the more recent collapse in commodity prices, there has been a sharp buildup of debt by low-income countries, to the point that 40 percent of them (24 out of 60) are now either already in a debt crisis or highly vulnerable to one—twice as many as only five years ago. Moreover, the majority, mostly in Sub-Saharan Africa, have fallen into difficulties through relatively recent actions by themselves or their creditors. They include, predictably, commodity exporters like Chad, Congo, and Zambia who have run up debt as they adjusted (or not) to revenue loss from the collapse in oil and metals prices. But they also include a large number of diversified exporters (Ethiopia, Ghana, and the Gambia among others) where the run-up in debt is a reflection of larger-than-planned fiscal deficits, often financing overruns in current spending or, in a few cases, substantial fraud and corruption (the Gambia, Moldova, and Mozambique).
The increased appetite of sovereign borrowers has been facilitated by the willingness of commercial lenders looking for yield in a market awash with liquidity, and by credit from China and other bilateral lenders who are not part of the Paris Club. It is striking that between 2013-16, China’s share of the debt of poor countries increased by more than that held by the Paris Club, the World Bank and all the regional development banks put together.
Nor do traditional donors come out entirely blameless. Concessional funding for low-income countries from the (largely OECD) members of the DAC fell by 20 percent between 2013–16, precisely the period in which their other liabilities increased dramatically. As for the IMF and World Bank, while it may have been wishful thinking to hope they could prevent a recurrence of excessive debt, it was not unreasonable to expect that they would have been more aware as this buildup was taking place and sounded the alarm earlier for the international community. There is also a plausible argument that excessively rigid rules limiting the access of low-income countries to the non-concessional funding windows of the IMF and World Bank left no recourse but to go for more expensive commercial borrowing, with the consequences now visible.
How likely is it that these countries are heading for a debt crisis, and how difficult will it be to resolve one if it happens? The fact that there has been a near doubling in the past five years of the number of countries in debt distress or at high risk is itself not encouraging. And while debt ratios are still below the levels that led to HIPC, the risks are higher because much more of the debt is on commercial terms with higher interest rates, shorter maturities and more unpredictable lender behavior than the traditional multilaterals. More importantly, while the projections for all countries are based on improved policies for the future, the IMF itself acknowledges that this may turn out to be unrealistic. And finally, the debt numbers, worrying as they are, miss out some contingent liabilities that haven’t been recorded or disclosed as transparently as they should have been but which will need to be dealt with in any restructuring or write-off.
The changing composition of creditors also means that we can no longer rely on the traditional arrangements for dealing with low-income country debt problems. The Paris Club is now dwarfed by the six-times-larger holdings of debt by countries outside the Paris Club. Commodity traders have lent money that is collateralized by assets, making the overall resolution process more complicated. And a whole slew of new plurilateral lenders have claims that they believe need to be serviced before others, a position that has yet to be tested.
It is too late to prevent some low-income countries from falling into debt difficulties, but action now can prevent a crisis in many others. The principal responsibility lies with borrowing country governments, but their development partners and donors need to raise the profile of this issue in the conversations they will have in Washington. There is also an urgent need to work with China and other new lenders to create a fit-for-purpose framework for resolving low-income country debt problems when they occur. This is not about persuading these lenders to join the Paris Club but rather about evolution towards a new mechanism that recognizes the much larger role of the new lenders, and demonstrates why it is in their own interest to have such a mechanism for collective action.
Traditional donors also need to look at their allocation of ODA resources, which face the risk of further fragmentation under competing pressures, including for financing the costs in donor countries of hosting refugees. Finally, the assembled policymakers should urge the IMF to prioritize building a complete picture of debt and contingent liabilities as part of its country surveillance and lending programs, and to base its projections for future economic and debt outcomes on more realistic expectations. They should also commission a review to examine the scope for increased access to non-concessional IFI funding for (at least) the more creditworthy low-income borrowers.
It is the poor and vulnerable that pay the heaviest price in a national debt crisis. They have the right to demand action by global financial leaders to make such a crisis less likely.
International actors have criticized decisions by the Trump administration to reject the Paris Climate Accord, abandon the Trans Pacific Partnership, and withdraw from a United Nations declaration intended to protect the rights of migrants. However, there is one international body, the Paris Club, whose members may be rooting for the United States to leave. That’s because, in the absence of congressional action, continued US membership in the Paris Club could impair the economic prospects of some of the poorest countries in the world.
Some context on the Paris Club
The Paris Club, which first convened some 60 years ago, is a group of government representatives whose most important function is to negotiate agreements to reduce or relieve outstanding debt between debtor countries and Paris Club members. Over the years, the Club has concluded 433 agreements with 90 different debtor countries, with the number of agreements peaking at 24 in 1989. In recent years, as shown in the chart below, there has been little to no activity:
Paris Club Agreements by Calendar Year
In its negotiations with debtor countries, the Club operates in accordance with six principles:
Case by case: The Paris Club makes decisions on a case-by-case basis in order to tailor its action to each debtor country's individual situation.
Comparability of treatment: A debtor country that signs an agreement with the Paris Club agrees to seek comparable terms from all bilateral creditors, including non-Paris Club commercial and official creditors.
Conditionality: Agreements with debtor countries will be based on IMF reform programs that help ensure the sustainability of future debt servicing.
Consensus: Paris Club decisions cannot be taken without a consensus among the participating creditor countries.
Information sharing: Members will share views and data on their claims on a reciprocal basis.
Solidarity: All members of the Paris Club agree to act as a group in their dealings with a given debtor country.
The United States has historically played a major role in the Paris Club, due, in part, to the large number of loans and guarantees it has extended to other countries over the years. But as the result of a shift from loans to grants, US credit exposure to sovereign governments has fallen dramatically—from over $90 billion USD in 1999 to roughly $35 billion today—and much of what remains is in the form of guarantees. The number of countries that owe the United States money or have a guarantee has dropped from 135 to 85 over the same period.
US Government Credit Exposure to Official Obligors
Here’s the problem:
In cases where the US government is still a creditor, the consensus principle (cf. principle 4 above) stops any Paris Club debt negotiation from proceeding without US participation, but the United States is unlikely to participate in any agreement that requires debt reduction due to current budget constraints.
At the beginning of each negotiation process, the IMF seeks assurances (“financing assurances”) from individual Paris Club creditors that they are willing to provide the debt relief needed to fill the financing gap built into the debtor country’s IMF program (cf. principle 3 above). Historically, the US Paris Club representative has not provided such assurances without having the necessary authorization and appropriation of funds for debt reduction from Congress.
Under the Federal Credit Reform Act of 1990, an appropriation by Congress of the estimated cost of debt relief—on a net present value basis—is required for debt reduction. And there is a value for all debt owed to the United States, even if it hasn’t been serviced in decades (which is the case for several countries that currently owe money to the United States).
Unfortunately, the United States currently lacks any authorization or appropriation for debt relief so it is not in a position to provide the IMF with any financing assurances. Moreover, the outlook for future US funding isn’t great. The administration’s FY 20198 budget request seeks reduce the foreign assistance budget by almost 30 percent and there is no request to authorize debt relief. Congress, too, has shown little interest in providing funding for debt relief. Appropriators consistently rejected requests to fund the US commitment to the Multilateral Debt Relief Initiative—to the point where the Obama administration stopped asking.
What’s more, the US budget process itself creates an enormous obstacle to future US participation in Paris Club agreements. The process for formulating a budget begins almost a year before the fiscal year begins, which means that Treasury Department planners are asked to anticipate the need for funding almost two years in advance of an actual request for financing. This is at odds with events in the real world, where liquidity and solvency issues in debtor countries can evolve quickly.
To date, neither the executive nor the legislative branch have demonstrated a willingness to establish “rainy day” funds for unforeseen emergencies. In the past, this problem has been avoided by packaging a request for debt relief money as part of a large, multilateral initiative such as the Heavily Indebted Poor Country Initiative, or by including it in a supplemental budget request for an emergency, such as defense spending for Iraq or the emergency spending for Tsunami relief. But amid growing budget pressures, future debt relief cases are unlikely to be able to take advantage of these vehicles.
The United States and the Paris Club are likely to confront this US funding problem head on when a country from sub-Saharan Africa comes to the Paris Club for debt relief, whether that’s one of the three remaining HIPC Initiative countries—Sudan, Somalia, and Eritrea—or a country currently in debt distress such as Zimbabwe.
A potential nightmare scenario
In the summer of 2018, the IMF and the Government of Somalia agree on a staff-monitored program (SMP) that meets the standards needed for HIPC debt relief. Somalia fulfills the SMP requirements and requests an IMF funded program in 2019. So, in July of 2019, the IMF requests financing assurances from Paris Club members, at which point the United States refuses to provide assurances—due to the absence of authority and lack of funding—and stops Somalia from receiving debt relief despite support from every other creditor. Condemnation of the US position begins.
What can be done to prevent this nightmare scenario? I offer three potential options:
In the FY 2019 budget, Congress should re-institute language authorizing a transfer of resources from State Department to Treasury to cover the cost of bilateral debt relief. While the Treasury Department has been the US agency that has traditionally had to include the appropriation for debt relief in its budget, it makes more sense for State Department to take on this role, particularly given that Treasury has almost $2 billion USD in unmet commitments to the multilateral development banks.
Like many states have done to protect themselves from unforeseen emergencies, the executive branch should work with Congress to establish a “rainy day” fund that can be tapped when needed to cover the cost of bilateral debt relief. Congressional oversight could proceed by subjecting its use to a rigorous congressional notification process.
The executive branch and Congress should work to secure an understanding that the loans extended to countries before the Federal Credit Reform Act went into effect and which have not been serviced in decades are “uncollectible” and that no authorization and/or appropriation is required for the United States to participate in a Paris Club debt treatment agreement (the legal basis for doing this is subject to interpretation).
In the absence of one of these three options or some other creative means to address the lack of funding for bilateral debt relief, the United States will find itself in the position of preventing some of the poorest countries in the world from normalizing their relations with the international financial community—stifling their access to support for critical development needs. The administration and Congress can work in concert to avoid this truly untenable position, but if they fail, the United States may no longer be welcome in Paris.
As my colleague Sarah Rose aptly points out in a recent blog post, USAID is promoting domestic resource mobilization as a central component of USAID’s “journey to self-reliance” framework. But even for countries that are far away from graduating from foreign aid, the importance of domestic resource mobilization for maintaining macroeconomic stability and sustained economic growth is well documented. A look at the experience of countries that have received HIPC debt relief validates this point and underlines the need for attaching a high priority to tax policies and practices in international assistance programs for low income countries.
In 2008, a number of HIPC Initiative beneficiaries had yet to receive full debt relief from the initiative. Almost half were either in debt distress or were at a high risk of debt distress. By 2014, 35 of the 36 countries that have benefited from HIPC debt relief had reached the completion point of the process and had considerable amounts of debt wiped off their books. The impact with respect to reducing debt distress was impressive. However, as can be seen in the chart below, since 2014 there has been a steady increase in the risk of debt distress among HIPC beneficiaries, a rather alarming development given the billions of dollars that have gone into the initiative and the conditions attached to it.
A recently released report by the IMF entitled, “Macroeconomic Developments and Prospects in Low Income Developing Countries (LIDCs)” explains in great detail the reasons for the elevation in the risk of debt distress among low income countries, including the HIPC Initiative beneficiaries. One of the primary reasons was a decline in commodity prices that led to a drop in revenues for many commodity exporters not matched by a reduction in expenditures. But even among diversified exporters there has been a deterioration in fiscal balances leading to rising debt levels, with declining revenues the main factor in roughly one quarter of the cases.
While the IMF report shows that declining revenues are not the only reason countries face an increased risk of debt distress, a look at the record for HIPC Initiative beneficiaries shows there is clearly a strong link. The chart below shows the weighted average change in the domestic revenue to GDP ratio among three groups of HIPC beneficiaries, those currently rated at low risk of debt distress, those rated at moderate risk of debt distress, and those at a high risk of debt distress or in debt distress. The change is recorded as the difference between the revenue to GDP ratio in the year before the country received HIPC debt relief (completion point) and 2016:
Among all 36 HIPC beneficiaries, the weighted average increase in the domestic revenue to GDP ratio has been 9.8 percent, from 16.2 percent to 17.8 percent. For the five countries currently regarded as having a low risk of debt distress, the average ratio increased almost 30 percent, from 15.6 percent to 20.2 percent. For the 18 countries deemed to have a moderate risk of debt distress the average ratio increased a little over 11 percent. For the 13 countries at high risk or in debt distress, the average ratio actually fell a little over one percent (from 17.2 percent to 17.0 percent). It would have been a much greater decline absent Mozambique, which has fallen into debt distress due to malfeasance but has greatly increased its domestic revenue to GDP ratio since reaching HIPC completion point.
While countries in the high risk/in debt distress category have generally seen a decline in government revenues as a share of GDP, there are some notable exceptions. Both Afghanistan and Haiti, ranked as “high risk” due to weak institutional capacity rather than elevated debt levels, have had success in increasing tax revenues. According to the Inter-American Development Bank, tax collection in Haiti reached an average 14 percent of GDP during 2015-2016, up from 11 percent in 2008-2009 despite the devastating effects of the earthquake. In Afghanistan, revenue as a share of GDP rose from a low of 8.7 percent in 2014 to 10.3 percent in 2015 and well over 11 percent in 2016.
Much of the success in Afghanistan and Haiti is due to a concerted effort by government authorities with the support of the international donor community and international financial institutions. The embodiment of this collaborative approach is the little known Addis Tax Initiative (ATI), which was launched at the at the 3rd Financing for Development Conference in Addis Ababa in 2015. ATI is not a new international fund, but rather a pledge among like-minded countries to increase resources and attention on the basic practice of collecting taxes in a fair, efficient, and effective manner in order to fund government programs in a sustainable manner. It deserves the international community’s continued support through prominent references in communiques by the G20 and other groups. At the same time, more donors—including the United States—should fund the Revenue Mobilization Trust Fund at the IMF.