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When I was writing about third world debt a decade ago, I watched Jubilee 2000 and other debt cancellation campaigners pound their way to victory with simplistic claims about the importance of debt cancellation, such as that principal and interest payments were diverting enough government revenue from poor countries' health budgets to kill 19,000 children per day. I wondered: are they naive or am I? On the one the hand, they appeared to misunderstand the accounting, financial, and political realities that govern (and muffle) the impacts of dropping the debt. On the other, I still favored cancellation and admired the campaigners' prowess in making it happen. One movement leader told me that if you want to make a difference, you have to choose a simple message and repeat it over and over (implicitly: fine points be damned). Maybe I was naive in my qualms about this effective tactic for a good cause.
Back in 2000, influenced by Daniel Cohen (HT John Williamson), I came to understand that most highly indebted poor countries were essentially bankrupt. They couldn't pay back. Forgiving the debts of a bankrupt does not cost much. The real tasks for the creditor are to accept that the money is gone (sometimes hard for a lumbering bureaucracy to do) and to learn from the debacle in order to avoid repeating it. The kicker: just as forgiveness costs much less than in might seem, it is worth much less than it might seem. After forgiveness, the bankrupt's pockets remain empty.
How to square this with reports that poor countries were paying billions of dollars a year in debt service to rich donors? Lenders helped borrowers maintain the appearance that they were servicing the loans by making new loans (or grants) to pay back old loans. A guy at the World Bank I had never heard of named Bill Easterly pointed me to one paper with evidence of this "defensive lending." A lady I had never heard of named Nancy Birdsall coauthored another. The more debt service a highly indebted poor country had to pay, the more fresh aid it got---almost one-for-one in some cases. I saw two key implications:
Claims that debt cancellation would free up funds for health and education spending were dubious. Mostly, cancellation would just slow the money merry-go-round. And to the extent that fresh funds were freed up (on net), pinning down how they were spent would be as hard as measuring the effect of a tax cut on education spending. In fact, a careful statistical analysis in 2005 by the Inter-American Development Bank's Nicolas Depetris Chauvin and the World Bank's Aart Kraay would find no impact of debt relief on social spending. Official World Bank tallies of debt-cancellation-induced "poverty-reducing spending" are mostly wishful thinking and public relations.
It was healthy to confront the failure of past lending by canceling the debts. In particular, the whole notion of lending to poor countries deserved critical examination. How did so many institutions effectively miscalculate the ability of poor countries to absorb loans, grow, and repay?
I was hardly alone in thinking these things. In 2001, the Bush Administration initiated perhaps the most important reform coming out of the Jubilee episode, calling for a shift at the World Bank from loans to grants for the poorest countries. The trend since among traditional donors has been that way.
The other mental frame I brought to the hearing was my recent conclusion that the enthusiasm for debt relief for Haiti, as opposed to trade or migration reforms that would create jobs for Haitians there or here, does not arise from any systematic analysis of Haiti's needs. In the short run, the amount of money at stake in a debt deal for Haiti---perhaps $25 million over the next 3 years---is trivial next to what the country needs, next to what it has already received in aid, and next to the billions coming in from trade and emigrants.
Now that you understand how I was hearing the hearing, let's go to the video. After that, a post-game analysis.
For me, the most dramatic moment came early in the testimony of the lead-off witness, Nancy Lee. She is the Deputy Assistant Secretary for the Western Hemisphere at the U.S. Treasury and (full disclosure) spent a year at CGD. That morning, I had scrambled from my home a mile away, stifled impatience through the long line at security, and reached the hearing room just as Nancy began to speak. Not bad! Nancy had merely "returned early this morning from Port-au-Prince," where she had conferred with senior government officials. Nancy described Treasury's ongoing work for and in Haiti. It sounded unsexy but heroic. I was struck by her emphasis on restarting the Haitian banking system and facilitating remittances from Haitians living abroad. Nancy was the only witness not to assert that debt relief for Haiti is "critical" or "urgent" (though she did in her written testimony).
Nancy debuted, in outline, a concrete proposal for Haiti debt relief. Donor governments including the United States would inject new money into, most notably, the Inter-American Development Bank (IDB). The IDB would cancel its Haiti debts. The new funds would be earmarked for IDB grants to Haiti. In addition, IDB loans that have been committed to Haiti but not disbursed would be converted to grants.
Next up was Timothy Adams, an Under Secretary for International Affairs at Treasury in the Bush Administration. He enthusiastically supported debt relief for Haiti. By and large, I enthusiastically supported his other comments. He emphasized the need to end the "cruel hoax" of repeated debt creation and cancellation.
In the Q&A, Adams nailed an underlying problem: lending institutions exist to lend.
Then spoke Melinda St. Louis of Jubilee USA. She called debt relief a critical first step for Haiti. I heard two reasons: Haiti has a terrible, two-century history with debt. And Haiti can't pay the current debt anyway. The first---bad things happened in the past---argues for helping Haiti in all the ways we can, not just relief of debts incurred since 2005 (all that are left). But the second is a pragmatic argument for at least suspending the small amounts of debt service Haiti is currently paying western donors.
I really liked what she said about the absurdities of the current system.
Last came Tom Hart of the One Campaign, which won the Commitment to Development Award in 2008. He applauded debt cancellation programs over the last decade for "freeing up $117 billion so far of debt that couldn’t be repaid and in fact freeing up around $2 billion annually that these countries were paying back." In other words, they couldn't pay the debt, and they were paying it---see discussion of the merry-go-round above. Hart also contradicted Chauvin and Kraay by asserting that debt relief has greatly increased social spending in receiving countries.
Tom appeared to nod rhetorically in my direction. "Debt relief relieves very little immediately." It should be part of a long-term strategy to help Haiti recover.
Yet he closed by asserting that the case for debt relief is "compelling and very, very urgent."
The messages of the debt campaigners have clearly reached the top Republican on the House Financial Services Committee, Spencer Bachus. He expressed a fervent belief in debt relief's power to reach the poor.
Almost everyone said that outright debt cancellation is critical and urgent, but no one made a good argument for why. One proponent seemed to make a good argument for why it isn't.
The most important (and universal) message was that international agencies are still lending too much to the poorest countries. In this way, the system is broken. The bill voted out of the subcommittee right after the hearing acknowledged this critique in urging that new assistance to Haiti be given, not lent. That is a helpful tap of the chisel, but inadequate to reshape the system. On that day at least, there was disconnect between what the experts said and what the legislators did.
Almost everyone said that debt relief should be a part of a bigger, longer-term plan---which was itself hardly discussed. I hope that Congress and interested groups such as One will more systematically review a) what Haiti needs (in part by involving Haitian voices), and b) the U.S. government's full array of options for helping. The closest the hearing came to a broader view was a sentence from Representative Al Green on trade policy---ironic since he is not even a member of this Subcommittee on International Monetary Policy and Trade, only of the parent Committee on Financial Services. Seemingly, determining whether debt relief should be a top priority involves examining competing priorities for Congress's scarce time and political capital.
The testimony made it easy for members of Congress to overestimate debt relief. To that extent, it let Congress off the hook for modest trade and migration reforms next to which the value of debt relief would be a rounding error.
Truthiness was aired and justiness was done.
I suppose that is par for the legislative course: an approximately appropriate response to a partially accurate depiction of reality. Heck, maybe it was a birdie. A bit of good was done.
Still, I am bothered. I understand that you sometimes have to discard scruples to fight the good fight. And I am not interested in preaching from a post one step removed from the hurly burly of policymaking. But the Center for Global Development was founded on the notion that good policy requires good analysis. I have devoted my professional life to that idea. I think it is fair to ask whether Haitians were as well served by the proceedings, including the vote, as they could have been. They were not, not nearly. In hearings to come, I hope experts will help Congress understand that.
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.