2007 Spring Meetings

Preventing New Rounds of Debt

Friday, April 13, 2007

Background: In 2005, the IMF and the World Bank launched a new Debt Sustainability Framework (DSF) geared towards the prevention of new rounds of unsustainable lending and borrowing. The framework faces tough challenges. Countries which have benefited from recent rounds of debt cancellation find themselves in a position to borrow all over again. Given the lack of sufficient grant finance available and the emergence of new creditors, many low-income countries are resorting to new borrowing at non-concessional rates in order to meet their MDG financing needs. Some argue this practice allows non-participating creditors to unfairly benefit from the debt reduction provided by participating ones. Is the Bank's new "free-rider" policy the right sort of deterrent to this kind of new borrowing? Donors and creditors that have participated in repeated rounds of bilateral and multilateral debt cancellation are calling for "responsible lending". However among other criticisms of the DSF and the free-rider policy highlighted by civil society, is that it does not provide the right incentives for creditors, while punishing the debtor.

Against this backdrop, the purpose of this Panel Discussion moderated by Ms. Debi Kar, from Jubilee USA, was to table alternative proposals to promote "responsible lending" among creditors and engage staff at the Bank in a discussion on them. The panelists (and audience) were asked to react to the following guiding questions: Are the incentives set-out in the DSF and the Bank's free-rider policy suitable to ensure responsible lending practices by the creditors? How would civil society proposals better promote these goals? What are the key requirements for such proposals to be implemented? How could the World Bank and the IMF, at both staff and Board level, play a role in encouraging the adoption of such proposals?

Ms. Lidy Nacpil, International Coordinator, Jubilee South, started by saying that when we talk about issues such as the lack of concessional grants, vulture funds, and preventing future debt, the overarching issue is illegitimate debt. Illegitimate debt is not addressed by the World Bank even though it is of critical importance to the global economy. When referring to illegitimate debt, many times we are referring to illegal debt, but beyond the legality of it, we are talking about debt that is against financial, political, equitable, and ethical norms.

She called to understand the IFIs in the context of grossly unequal parties: unequal in bargaining power and unequal in the results of this huge debt that developing countries face. Vulture funds are, in this context, just one symptom of the larger problem of illegitimate debt. These issues must be addressed and we need to formally challenge the World Bank to acknowledge its complicity in illegitimate debt. 

She ended by issuing a challenge to the World Bank to allow an independent, citizen audit of its own conduct.  Just like any bank would go through an audit, the World Bank needs to be subjected to a transparent audit done by citizen groups.  People should not have to pay bad loans while the World Bank never suffers consequences for them.

Mr. Oscar Ugarteche, LATINDADD, said that the issue of illegitimate debt is not new,  recalling the mid-1970s and examples of the corrupt international financial system.  In 1974 the Westinghouse nuclear power plant was built in the Philippines. This was a power plant that was built on a seismic fault line. Neither the architects, nor the engineers or the construction company were idiots who did not know this. Yet, the plant was built  anyway. Similarly, in 1976 a paper plant that was built on the Peruvian coast.  Paper plants require large amounts of water. The Peruvian coast is a desert.  All of this was completely legal, but completely illegitimate.  It subjected the developing countries to huge amounts of debt, allowed multinationals to make a lot of money, and it harmed the host country.

What is needed is a new system, with new lenders—he continued.  There needs to be a board of arbitration where all debtors, all creditors can go.  If we really mean the MDGs, conditionality should be linked to them. “What kind of sense does it make to talk about the MDGs, say we mean them, and then not do anything towards them?”, he asked.  Conditions on lending should be towards meeting the MDGs, not towards things like decentralization or trade liberalization.  He wondered, instead of today’s system, where all the conditions placed on lending and even grants favor multinationals, what is the proper role of a multinational lender?  Multilateral lending cannot be the extended arm of anyone’s treasury, which is how it is today.  In Latin American countries, on average, a government’s revenue is 12% of its GDP.  Some countries 11%, some 14%, but on average 12%.  However the average expenditures for the government is 20% of its GDP.  12% revenue, 20% expenses.  So how do these countries make up the cost?  They make it up in oil revenues, in foreign investment, which leads to a tax race to the bottom. In Mexico, large foreign corporations pay $10 a year in taxes.  $10, for an entire corporation.  There must be a progressive tax system, but to avoid the race to the bottom, there must be a changing in the multilateral lending system we currently have.

Mr. Aldo Caliari, Center of Concern / CIDSE, announced he would be presenting a CIDSE paper “A Human Development Approach to Preventing New Cycles of Debt.”  He started by stating his concern with “free-riding,” which covered two phenomena. First, creditors not assuming a share of debt relief and, second, developing countries getting into new cycles of debt with non-concessional lenders. What is of concern to us, he said, is that this undermines the benefits of debt reduction, that is, that an increased proportion of the budget would be free from being directed to service foreign debt and could, then, be used to meet the MDGs.

He went on to say that the search for a lasting solution to the debt problem had been stated by the G8 since the late 1990s. Yet, the argument in the paper he was presenting was that it was precisely the approach of the G8 to developing countries’ debt that prevents them from finding such a solution. This approach permeates the HIPC/MDRI initiative, the Debt Sustainability Framework, and the Paris Club Evian approach.

Among the features of this approach the paper develops were: the notion of debt sustainability continues to ignore the MDGs; the donors’ promises on aid and debt relief were not considered at the time of evaluating the sustainability of debt; all contracts are presumed to be valid, so creditors are not held co-responsible, and the debtor is punished –through less access to concessional finance, in the latest Debt Sustainability Framework-- for actions where responsibility is, at least, shared. In addition, the debt sustainability notions not only were arbitrary and failed to balance debtor-creditor views, but they did not even suit all creditors, so it was no surprise many creditors simply chose to ignore it. 

Leaving aside inadequacy to reach the MDGs, or other issues, the system was plainly ineffective to reach its purported goal of stopping unsustainable and irresponsible lending. Creditors know that they are not going to face consequences for lending to borrowers above sustainable levels, and debtors facing shortage of concessional finance have to go for non-concessional borrowing to plug the financial holes.

He ended by recalling the Catholic Social Teaching principles that inspired the position of CIDSE, as a network of Catholic agencies. “The imperative not to engage in irresponsible lending is, indeed, not alien to the teachings of the Church,“ he said. He quoted, as an example, Pope John Paul II: “while high interest rates, irresponsible lending decisions, and corruption all were actors in accumulating massive debt, it would be unjust to impose the burden resulting from these decisions upon those who did not make them.”

Mr. Mark Roland Thomas, Senior Economist, Economic and Policy Department, World Bank, said he would like to start with what he called Aid Arithmetic. A very simple formula, but one that summarizes a basic tradeoff: MDGs + No Aid Increase = Risk another debt crisis. This equation means that if we are serious about both debt sustainability and the MDGs, they require more resources.  So countries need these resources, but without an aid increase, countries will have to turn to borrowing. He showed how this equation could easily be reorganized to illustrate that point: No Aid Increase + Debt Sustainability = No MDGs.  In other words, if we don’t increase aid, and we also want to prevent future debt and the types of illegitimate debt that previous speakers had discussed, we will not meet the MDGs.

Then he entered into the Debt Sustainability Framework and the question raised earlier of whether the DSF factors in the MDGs.  The MDGs are of course central to the World Bank’s mission.  The DSF, meanwhile, is the framework within which the World Bank assesses the risk of poor countries not being able to repay debt.  The DSF looks at a country’s current debt, their current policies, and evaluates the risk of debt distress.  If the World Bank perceives too high a risk of debt distress, it moves towards grants.  But, he said, this should be perfectly clear: the DSF is not a needs assessment.  It does make sense to place the DSF analysis next to a needs assessment, and to use the DSF to consider how those needs could be financed sustainably.  In addition, the DSF is not binding on the borrower.  The World Bank’s role is to offer advice to the country, but ultimately it is the country’s decisions that will determine its debt strategy.  Furthermore, the DSF is not imposed on other creditors.  The Bank makes its information available wherever possible to other creditors, but the Bank’s resulting decisions about financing are in no way binding on them.  “But again, --he said-- I want to emphasize that the World Bank uses the DSF to evaluate risk, and if the risk is too high, we try to move to grants.”

Mr. Thomas also addressed the issue of lender responsibility as an important one. He stated that he was in complete agreement that there needs to be co-responsibility between lenders and borrowers. “If you asked the staff here at the World Bank if the bank shares in the responsibility for the success or failure of a country’s development outcomes, the staff would just stare at you for asking the question at all…”—he said: “… of course, they would agree, the World Bank shares in that responsibility.” “There are 6 different types of co-responsibility that I think are important to consider: success of the lending program, assessing outcomes and addressing failures, preventing wrongdoing, pursuing wrongdoers, restoring assets, and global outcomes.”  In each of these areas, the World Bank accepts – and indeed promotes as part of its mandate – a degree of co-responsibility with country authorities.

However, Mr. Thomas went on to say he would hesitate to let the concept of co-responsibility lead to contract repudiation.  A binding arbitration framework, as has been suggested, where heavily indebted countries could go for debt cancellation has serious problems.  At some point we have to ask, what is the responsibility of the borrower?  For example, we don’t want the borrower in a position where they have an interest in projects failing because then their debts will be cancelled.  Nor would we want the supply of finance to developing countries to dry up because of the risk of litigation or debt cancellation.  Both issues would harm developing countries.

Referring to Ms. Nacpil’s comments on the issue of the World Bank being punished for bad behavior, he suggested the World Bank can be held responsible, and in fact it is.  If the World Bank behaves improperly, it can be “punished” through IDA replenishments.  If the world disagrees with the policies of the bank, the bank risks losing its funding.  So the Bank is accountable for its actions.

(Prepared by Aldo Caliari, Center of Concern)