Spring Meetings 2004 Dialogues

The purpose of this session was to discuss the new debt sustainability framework that the International Monetary Fund and the World Bank are working on. Simonetta Nardin, Senior Public Affairs Officer, IMF External Relations Department, moderated the discussion. The principal speakers were Gobind Nankani, World Bank Vice President and Head of the Poverty Reduction and Economic Management Network; Timothy Lane, Assistant Director of the IMF’s Policy Development and Review Department; Henry Northover, Policy Advisor to the Catholic Agency for Overseas Development (CAFOD); and Barbara Kalima, Coordinator/Director-African Forum and Network on Debt and Development AFRODAD (Zimbabwe).

Gobind Nankani was asked to give a brief introduction and status report the Heavily Indebted Poor Countries (HIPC) initiative; Timothy Lane then described the key elements of the new framework. Henry Northover and Barbara Kalima critiqued the work; the presenters responded and comments and questions were taken from the floor. The discussion was wide ranging and the debate constructive.

Meeting Notes

Gobind Nankani: Debt remains one of the most challenging issues facing developing countries. It is a high priority for the World Bank and the International Monetary Fund (IMF) and both are strengthening their work in this area. Good progress has been made on HIPC. Thirteen countries have now reached completion point and about two–thirds of the countries are already at decision point or beyond and they are now receiving debt relief. Now the focus is shifting to a broader set of concerns all low-income countries face and this includes the Millennium Development Goals (MDGs) and the agreements that came out of the Monterrey Summit.

The twin challenges being faced by the Bank and the IMF are: how to be sure countries do in fact make rapid progress toward the MDGs while at the same time maintaining a stance in which their debts are sustainable. And the framework tries to ask what kind of configuration of loans and grants would make the most sense given the country’s debt situation, given its policies and given its vulnerability to shocks? The framework is still a work in progress and is being developed in very close consultation between the institutions, with the boards, and with all of the stakeholders, including country authorities, civil society representatives, donor governments and others. Essentially what the debt sustainability framework has done is to raise for the international community the whole question of loans versus grants.

Timothy Lane: The basic motivation for this debt sustainability framework is to have some way of preventing a recurrence of the kind of debt distress that so many countries have experienced in the past. With many countries now reaching their completion points for HIPC it is necessary to have an analytical framework both to give advice to the countries and to guide IMF/World Bank lending, and that is particularly important in the context of financing the MDGs.

A couple of years ago, in the wake of Argentina’s collapse, the Fund developed a framework for analyzing debt sustainability in countries that have significant access to financial markets. But the problems of low-income countries are very different from the problems of emerging market countries and the same framework could not be applied.

In low income countries the issue is more can you service the debt over the next 20, 30, 40 years, so it is important to consider debt service as well as the stock of debt.  It is also important to consider the various constraints on the country’s ability to service debt: the limited total resources, the country’s ability for foreign exchange and fiscal constraints such as a limited tax system which makes it difficult to raise revenues to pay for debt services and which in turn limits their ability to meet other needs.

Another thing about debt sustainability in low-income countries is that the debt is primarily concessional since it is at very low rates. For that reason a framework is needed that encompasses concessional as well as non-concessional debt, and which finds a way of weighting the two kinds of debt.  Countries are also extremely vulnerable to shock, and there is a need to have more structure than we have in analyzing middle income countries; the reason being that international financial institutions in this case have a slightly different stake in the situation. They are creditors as well as advisors.

The Framework

There are two key elements to the framework:

One is a forward-looking analysis of debt dynamics and how they are likely to evolve. This involves projections; it means making assumptions about growth rates and interest rates and exchange rates and key variables that affect how the debt is likely to evolve over the next 20 years. And it involves stress tests, which look at what happens if the assumptions don’t come true.

The other element is to look at what levels of debt are dangerous. And for that reason there are indicative thresholds which are designed to give a warning of when debt distress is turning out to be likely.  Those thresholds are an element that is still being defined. The thresholds are country specific and based on an assessment of policy. So the logic is that countries with good policies could make good use of borrowed money and are more likely to service the debt they thereby incur.

Another key element is that there has to be some allowances for judgment in the way the framework is applied. This is different from the rules-based approach of the HIPC initiative, where there is an effort to calculate a systematic, uniform, even-handed way of determining how much debt relief each country is entitled to. The judgment approach is necessary because advising a country on a course to follow in the future requires detailed knowledge of what is happing in the country; and it has two broad implications: one is that those countries that already have high debt ratios should be receiving highly concessional financing probably mainly in grants, and in terms of a forward-looking element, the need to tailor their borrowing strategy to how the debt is going to evolve in the future.

There are a number of aspects of the framework that still need to be resolved in addition to the threshold question. One is how to incorporate the analysis into Fund and Bank operations. Another is how to collaborate effectively. And then there are some broad issues: One is that the HIPC initiative needs to be completed. The second issue is the need for grants and grant money. The third issue is how to deal with countries that are actually experiencing shocks.

Henry Northover: There are several things that are welcomed in this paper: the country specific approach, the more flexible approach, the use of a broader set of indicators, the discussion of financing the MDGs, and the role of the bilaterals.

Weaknesses in the paper:

There are some methodological and technical weaknesses. There is an over reliance on the Country Policy and Institutional Assessment (CPIA), which is heavily subject to the judgment of the country staff and which has too narrow criteria or standards of measure by which to judge a sort of pervasive and persistent influence of debt distress that is fundamentally the common thing unique to all low-income countries: All low-income countries suffer from deep, widespread and persistent levels of poverty and a lack of resources with which to address that.

So our essential point is that the higher the magnitude of the development challenges faced by recipient governments, the lower their contractive debt capacity. Fundamentally we are dealing with high levels of poverty and a lack of usable revenue available to those governments to tackle it and that’s fundamentally the prism for judging how much debt a country can afford to sustain.

There is another key missing element which is that in all the variables the paper is using to measure debt sustainability there is no major mention of the critical constraint facing governments and that is the requirement for a poverty reduction program, so those countries face a political choice: They can maintain debt service obligations, finance their poverty reduction strategy, or finance the MDGs which they are obliged to do by virtue of being signatories to the Millennium declaration. So there is a tradeoff which is essentially not touched on by the paper.

Also this paper sidesteps the issue of whether further debt relief could actually benefit the whole idea of maximizing the financing available to these countries. Because if the MDG commitment is to be taken seriously, we would argue there is an urgent need to reconsider the role debt relief can play in the attempt to mobilize additional development resources. There is a further benefit of further debt stock reduction which is not touched on by this paper and this is a positive interaction between debt relief and economic growth.

We have to fashion the criteria of debt sustainability around what we want to achieve by it. But it is curious that the IMF has not treated the growth relationship seriously in this paper because there has seemed to be a theoretical consensus view in the IMF that we need growth to achieve the MDGs. It seems to me that low-income countries are more likely to achieve MDGs if they are growing faster, and second, low-income countries can afford to take on higher levels of concessional financing the faster their economies grow. So we should be tailoring these instruments around maximizing growth prospects and also maximizing the potential of achieving the MDGs.

Lastly on weaknesses in the paper, by imposing a more flexible approach to debt sustainability, the proposal introduces a large measure of judgment or even discretion by the international financial institutions (IFIs). There is a real question about confusion of responsibility of the IFIs. There is the clear case of conflict of interest. On the one hand the IFIs are creditors, but on the other hand there is a suggestion in this paper that the IFIs are going to retain a monopoly hold on what constitutes debt sustainability and thresholds. I would suggest that this is an unacceptable conflict of interest. In the longer term prudent analysis of debt sustainability ought to be carried out by recipient governments themselves, and in the short term there should be at least some institutional independent peer-review mechanism, which should be housed outside the Bank and the Fund and the bilateral creditors, which should be making some judgments about debt sustainability.

Barbara Kalima: The whole debt sustainability question needs to be revisited. We need to take another look at how loans are contracted and who is involved in that process and what mechanisms are available in order to ensure transparency and accountability. For instance, we need to look at the extent to which parliaments make use of the legal frameworks/legislation available to veto loans that would not benefit the poor people. We also need to examine civil society’s involvement in stetting priorities for development.

The core issue is that the creditors themselves, especially at the country level have an influence in pushing our governments to agree to taking on loans, and this has actually led to irresponsible borrowing.

From our joint research with Christian Aid (2004) “Owning the Loan – poor countries and the MDGs”, it is clear that government and international financial institutions often negotiate and sign loan agreements in a non-accountable and non-transparent way. In some cases, the government may overrule their parliament’s objections to a loan and often parliament end up rubberstamping new lending agreements. Recently, the Ugandan government overruled parliamentary and broader CSO objections to power-purchase agreements between the government and AES, a private US-based power company to build a dam near Bujagali Falls. The government took an IDA grant to guarantee future repayments of its debts to the private company that will build, own and operate and eventually transfer the project. The government is currently. Ugandans are concerned about the future environmental and social impact of this project.

In Tanzania in the 1970s, the Work Bank lent Tanzania US45 to develop it cashew-nut industry, in part to build processing plants. But the Bank overestimated the market for cashew nuts exports and the business never really took off. Few plants were ever fully operational but most of them completely dormant. Much of the equipment was bought from Japan and now Tanzania owes Japan more than it owes any other donor - US661 million. Italy ranks third in its list of government creditors, at US$203m.Mnay of these debts are associated with the cashew-nut fiasco.

Today despite enhanced HIPC debt relief, the government of Tanzania is still paying off about half of its debt to the World Bank and some of its debts to the Japanese government.

Similarly, in Mozambique during early 1990s, the World Bank insisted that the government reduce tariffs on cashew nut exports, despite opposition from the government, the cashew nut-processing industry and trade unions. The World Bank country representative, then believed that trade liberalization would bring better prices to peasant cashew-nut farmers. Only after 10,000 cashew nut processing job losses did the World Bank agree to let the government raise the tariffs on exports again.

If we are serious about taking measures of avoiding another debt crisis by 2015, we need serious scrutiny of the process by which aid recipient countries agree to take on the terms and conditions of IFI loans, a process in which every stakeholder in the development process is involved; the politics at the national level and in the donor organizations examined. This should help avoid lending and borrowing mistakes, which in the past have led to the build up of unsustainable debts that now have to be paid off at the cost of financing MDGs.

There is a false illusion among many donors that the huge resource gap for meeting the MDGs will be filled by the right mix of loans and grants. It is being said that there’s going to be a serious move towards increased grants given than loans; what is the basic rationale behind that? Does that represent a new sense of political commitment or will from the international community and the IMF itself, when for 30 years most rich countries have failed to meet the 0.7% of their GNP in aid flows? What is the real motivation to give grants by the IMF? What is the real incentive for them to increase expenditure towards grants? We seriously need to examine this move.

In the forward looking approach, you are looking at good policy procedures and institutions for accessing lending programs, and we’re saying that if the IMF and the World Bank are really serious about having these countries come back on track in terms of economic growth and development, they can not continuously talk about thresholds and benchmarks which are always not yielding positive results. As CSOs we are concerned about this and it is has to stop!

If we take the assumptions made on the eligibility criteria for HIPC under the Debt sustainability analysis, in which countries needed to meet their debt to export ratio of 150%, very few countries if not none managed to meet this criteria due to low export earnings resulting from fluctuating and declining commodity prices, low external sector viability and underdevelopment of their financial sectors. Some might say Uganda was among the best of examples that managed to meet this threshold. But where is Uganda today? Uganda is still left with the same unsustainable levels of debt repayments, and its social indicators continue to deteriorate.

There is need for deeper analysis of HIPC and its impact on these countries because there has not been any genuine debt relief that it has brought to these countries and there is no subsequent economic growth to show for it. It is time to that we held these IFIs accountable for their wrong projections and failed projects. They need to stop talking about thresholds at the expense of human life. We need to give the statistics a more human face.

As for the recipient countries, there is need to decide how they will deal with problems of drought and food security, for instance, and how they would deal with short falls in their budgets; it is not the IMF’s duty to come into these countries with false projections/calculations which in most cases have been not only harmed our economies but led to loss of lives.

Gobind Nankani: Regarding the CPIA: if there were some other means than this we would use them, we have tried to improve CPIA over time and currently an external review panel is looking at it to give the board an independent assessment. It is however also quite well-regarded by other institutions that have tried to come up with similar indicators.

Regarding the second question about debt service costs of HIPC countries, and is this a hindrance in the attempt to finance the MDGs: The whole question of countries trying to attain MDGs has to be seen in a wider framework than just debt relief, certainly debt relief is one of the sources of financing the MDGs and so is additional aid and so is progress on removing barriers to entry for agricultural exports from developing countries and so on.

On the issue of debt sustainability analysis, the Bank and the Fund see themselves as working with countries to make the analysis work.

Timothy Lane: Just to elaborate a little more on the CPIA. It certainly is a good summary measure but we are also looking for and trying other measures.

The point about deep and pervasive poverty and really capturing the effect in these measures. We tried to see whether per capita income would have a role empirically as a predictor of where the country would run into debt distress. It showed up in some formulations but not in others but we’ll probably look at it further. In theory we think it would be appropriate.

The point about debt relief helping growth: We certainly generally agree that more money transferred to low income countries in any form is going to help them. The question really is what is the most appropriate form of transfer. There are advantages and disadvantages to debt relief. The main disadvantage is that it favors countries that have been favored in the past that have not been able to service the debt, so it may not be the most effective way to use the available amount of aid resources to fight poverty. It may be better to use additional resources for other kinds of aid that are more targeted to development needs and for achieving a net flow of financing that will help them finance the various social and other sorts of spending that are important.

Just picking up on what Gobind said, the fund has no desire to be a monopoly of policy advice. The objective is developing the capacity of low-income countries to do their own analysis and to make decisions that also involve a high degree of public participation.
Of course capacity is the flip side of responsibility. Low-income countries are responsible for their debt but they have to be capable of managing that debt and we have to do what we can to help them.

The question from Barbara, what is the basic rationale for moving toward grants: If debt  is not serviced, then you are essentially providing grants but it is a very non-transparent and inefficient way of doing it, so it makes a lot more sense to decide up front that we are providing grants. It enables both the countries and the grantmakers to have a sound basis for planning.

First Round of Questions /Comments

Mauricio Diaz, program coordinator for Asonog, Honduran Association of NGOs opened the discussion with a first question: Is there any HIPC country that has received debt relief that has also achieved higher economic growth, political stability and poverty reduction?

Q -- The second speaker from Ireland was interested in the Poverty and Social Impact Assessment unit (PSIA) being set up in the IMF and how it fit into the debt sustainability analysis of the IMF. She also said that it would be critical that this team not be made up of macroeconomists only but that it would be a multidisciplinary team capable of dealing with all the dimensions of poverty.

Q -- The third speaker from France had two concerns. First, he questioned the ability of the IMF to do the job of sustainability analysis, encouraged more stakeholder involvement, and asked about a multi-stakeholder study group in the UN to evaluate the HIPC initiative. The second concern was about moving away from the rules-based approach to debt sustainability and he said that some rules, like human rights could not be negotiated and that achieving the MDGs in human rights should be a major criteria for debt relief.

Vikram Nehru, a HIPC specialist at the Bank answered the first question: There is no question that growth rates in HIPC countries are higher over the past three to four years, than they were prior to 1999 and the macroeconomic indicators are better but that doesn’t necessarily mean that HIPC is responsible for that. The rest of Africa, for example has done better as well, but even relative to other low-income countries HIPC countries seem to have done slightly better. Still, HIPC is only one part of many things that are likely to affect growth. All HIPC does is reduce debt stock. As far as poverty rates go, there isn’t enough data at this point to say.

Timothy Lane: About the new PSIA unit.  The idea of that is that there should be some in-house capability to internalize these assessments and bring them into Fund’s work. The World Bank still takes the lead in actually undertaking them. As far as how it fits into debt sustainability analysis there is not a direct link. The IMF is still struggling with how to bring a one-dimensional measure, per capita income in, so the multi-dimensional one is probably work to be done in the future.

Moderator: Regarding the multi-stakeholder approach and independent evaluation of HIPC, the framework will be discussed at the UN.

Gobind Nankani: The Operations Evaluations Department (OED) of the Bank undertook an evaluation recently of HIPC and concluded that it was actually effective in providing a foundation for countries to progress to the position of being able to do well on debt sustainability issues. The key word was foundation. There were also four recommendations all fully accepted by management: 1) There was a mismatch of expectations from the stakeholders. 2) The projections were overly optimistic, 3) Expenditures from savings the HIPC generates should not be restricted to the social sector but to any sector that is pro-poor in its orientation. and 4) There should be a lot more rigor about not rushing countries to the completion point prematurely. So there is a fresh OED evaluation and there will be two evaluations of the PRSP process available in the summer.

On the MDGs themselves, the institutions are very much on record supporting the MDGs. There is a lot that needs to be done, and both the Bank and the Fund are working to prepare alternative financing instruments for the MDGs, which will be presented to the fall meeting.

Second Round of Questions/Comments

Q -- The first speaker, from Denmark, said that Honduras was a case that should be looked at in terms of HIPC because Honduras reached the decision point almost four years ago and has gone through the PRSP process but has not been able to attain an agreement. At the same time the country has been passing through three quite extreme shocks and at the end of the day, when the Fund decides to give Honduras the program, the focus is on teachers’ salaries. Teachers in Honduras are making too much. So this needs to be looked at with the IMF talking about flexibility.

Q -- The second speaker, from the US, wanted to know how many countries this new framework covers.

Q -- The third speaker, from Canada, said it seemed as though initially HIPC was supposed to provide a robust exit from debt burden and that now the discussion had moved to sustainability. Instead of being about moving forward, it is about keeping our heads above water. But still even if we are going to succeed in sustainability the question of country ownership has to be taken into account, and the IFIs’ activity is undermining country ownership especially in the PRSP. How are we going to move toward the even more modest goals of sustainability?

Q -- The fourth speaker from Germany suggested that there be a wall between the lending and the assessment of sustainability functions of the IMF/World Bank.

Timothy Lane: On how many countries fit within the framework. The new framework is intended to be applied to all low-income countries eventually but it doesn’t cover the countries that are currently between their decision and completion points in HIPC because they have another set of targets and criteria for their debt.

On the question of building a wall between the lending functions and the assessment of sustainability. It is an interesting question, it could be useful because of the creative tension that it could create but its not clear that it would be the most effective way of actually mobilizing decisions on debt relief and on financing.

On the question of ownership: in the whole picture of sustainability, we 100 percent agree that building ownership is an essential priority. This framework is dealing with a very narrow aspect of a broad agenda, which is can you pay your bills. It is a small part of the process but it is a troublesome part.

Gobind Nankani: The question of ownership is an important and difficult one. In the PRSP progress report that was put out last fall, there was the point that there is a wide variance in the degree to which there is real ownership, and a broad consultative process in countries.

Regarding grants, resource mobilization is important, and it is important to recognize that for an institution like IDA, forty percent of available funding is based on reflows, pay back, so IDA could not keep increasing its share of grants without running out of money.

Round Three of Questions/Comments

The first speaker from Ireland in round three spoke about the question of 100 percent debt cancellation and whether there were resources already built up in the IMF and the Bank to cancel debt. There are two debates she said: First, are the IMF and the World Bank overcapitalized and second if they are and without endangering the institutions, what is the best of that money? Are the IMF and the Bank open to having a debate on these issues?

The second speaker from the US in round three had two questions.  The first question was  should countries be recategorized and should there be a category for countries that will never be able to pay.  The second question pertained to, what the speaker described as a two-tiered system at the IMF and the World Bank, where they both use their own resources and also try to trigger resources from donors to contribute to development. Regarding the idea of grants for the Millennium Development goals, the British have an idea, the American have another idea, what can the Fund and the Bank do to draw these various ideas together and help everyone to work together as a group?

Before responses to the questions, the moderator asked for comments and questions from Henry and Barbara.

Henry Northover: In completing the framework, will there be another look at the dynamic between further debt relief and the issue of concessional finance? If there is the strong supposition that higher levels of growth will be achieved with further debt relief then that would suggest that debt relief has efficiencies over and above other forms of finance, and that further debt relief could actually push us further toward the MDGs.

Barbara Kalima: We need a guarantee that five years down the road these two institutions will not come back to this room and say without apologies that they mismatched their objectives, which have contributed to wrecking the economies of third world countries.

Gobin Nankani: On the question of 100 percent debt relief and the Bank and IMF resources, the short answer is that there isn’t the financial capacity.

Just to follow up on the use of HIPC savings: The first evidence regarding the uses made of HIPC savings is very favorable; social sector expenditures have gone up in all those countries that have begun to get HIPC relief, that means 27 countries. The big challenge in the next five years will be the degree to which the volume of grants can be mustered to make the new framework functional.

Comment from Ben Kalmason, of the Bank and IMF UK Executive Director's Office.  From a quite narrowly defined paper dealing with a quite narrowly defined set of issues there has been discussion of a wide range of issues that shows how interconnected all of these things are. And the comments on particular country cases and generic policy are very useful. I think one of the biggest issues is about resources and the way in which those resources are going to be provided, and there is a very big finger pointing at the donor community to see how it stands up to the commitment that it has already made at Monterrey. These are difficult issues, and I’m sure in five years time we will still be grappling with some of them but I hope we will be further down the road.

Timothy Lane: I really can’t speak to the question of whether the Fund is overcapitalized. We don’t feel overcapitalized, but certainly the Fund is looking to help meet the development objectives from our resources. About countries that have not yet reached the HIPC initiative, and recategorization there is a lot of discussion about how to make sure they don’t get left out. Then the question of creditor coordination, that’s obviously going to be an important part of the package but it is something that we don’t have a final answer for yet. Of course there is a lot of coordination by donors meetings, but exactly how this is going to change with the new framework we will still have to figure out.

Just to wrap up, I really appreciated all of the comments and questions. They were very interesting and it was a very interesting discussion and we will try to take the issues that were raised on board in our thinking going ahead.

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