Africa: Multilateral Debt, 01/26/'96

Africa: Multilateral Debt, 01/26/'96

Africa: Multilateral Debt, 1 Date distributed (ymd): 960126

Multilateral Debt Reduction: A Proposed Framework A Position Paper of the Canadian Coalition for Global Economic Democracy

For more information: Inter-Church Coalition on Africa 129 St. Clair Ave. W Toronto, Ontario M4V 1N5 Canada Phone: 416-927-2124 Fax: 416-927-7554 E-mail:

January 12, 1996

This paper represents the position of the undersigned groups in Canada on the issue of multilateral debt. It also represents the position of NGOs internationally who are calling on their governments to take similar action. Over the coming months it is critical that Canada urge a comprehensive and just resolution to the debt crisis in which all the creditors, including the multilateral creditors whose relative position has significantly increased, share the costs. This should be done by insisting that the multilateral debt relief proposal to be considered during the April 1996 semi-annual meetings of the World Bank and IMF contain at a minimum the elements proposed in this paper. We seek your views and response to the positions raised in this paper.


The following recommendations provide the basic framework for a comprehensive and sustainable resolution of the multilateral debt crisis.

1) The creation of a multilateral debt facility (MDF) to cancel or reduce the debts of highly indebted poor and some highly indebted middle income countries;

2) The facility should be used to finance up-front cancellation or reduction of debt stock of eligible countries;

3) The MDF should be funded primarily from existing resources within the Bank and IMF. A $12 billion MDF through the use of the World Bank's Retained Earnings and Loan Loss Provisions as well as its profits from currency fluctuations. The IMF's contribution should be financed through a sale of 10% of its gold reserves. The sale of IMF gold should not be used to finance the Enhanced Structural Adjustment Facility.

4) The conditions attached to debt cancellations would be an agreement by donor and recipient governments to meet agreed upon targets in social sector spending such as basic health and education.

5) The eligibility criteria for multilateral debt cancellation or reduction should be expanded to include the following criteria:

* the relationship between levels of expenditure for debt servicing and social sector needs;
* a degree of co-responsibility for loans that were made for projects that have proven to be failures or loans that were misappropriated.

Multilateral Debt Reduction: Background to Recommendations

1) The creation of a multilateral debt facility (MDF) to cancel or reduce the debts of highly indebted poor and some highly indebted middle income countries

Background: For many years now, NGOs and international debt experts have cited the growing problem of multilateral debt as a key issue in campaigning on debt. Multilateral debt is the debt owed by developing countries to the World Bank and International Monetary Fund (IMF) as well as to regional development banks.

The most severely indebted countries of the developing world are trapped on a debt treadmill forced to take on new loans from multilateral institutions to continue to service their debts or risk default and potential economic collapse. Between 1980-1994, the total developing country multilateral debt rose from US$61.6 billion in 1980 to $313 billion in 1994.

The multilateral debt problem affects the poorest countries with high debts most severely. The World Bank refers to this category of debtors as "severely indebted low income countries" or SILICs. Twenty-five out of the thirty SILICs are in sub-Saharan Africa. Debt servicing obligations to multilateral institutions rose from less than $8.5 billion in 1982 to almost $40 billion in 1994, an almost five-fold increase. In most cases, debt service to multilateral banks takes precedence over all other debt service requirements. While the proportion of outstanding debt to the multilateral banks of the poorest countries is relatively small (about 20%), 48% of actual debt service flows to these institutions.

The problem is especially severe for sub-Saharan African countries. The overall debt of the region stands at $211 billion as of 1994. Over the period 1983-1994 the region paid out a total of $149 billion in debt servicing, $15 billion more than it received in new loans. Over this same period debt servicing to institutions like the World Bank and IMF continued to climb. The IBRD wing of the Bank along with the IMF accounted for $28 billion of the region's debt service between 1983-1994, over $9 billion more than the region received in new loans from these two agencies. The IMF alone has taken almost $5 billion more out of the region than it has provided in new loans over the same period.

One way that the region's debt has been serviced is through the increasing use of the World Bank's IDA Facility (the low interest loan and grant wing of the Bank which is meant to assist the poorest countries) to service IBRD and IMF debt. IMF debt is also being refinanced through the use of its Structural Adjustment Facility and Enhanced Structural Adjustment Facility (SAF and ESAF). The region also experienced an increase in aid flows during the 1980s which enabled it to service its debt.

However, aid flows have seriously declined in the last two years alone and many African countries have been unable to make use of the IMF's SAF or ESAF because of the very stringent conditionalities attached to them. This has put an even greater burden on IDA funds for the purpose of servicing debts. In 1994 over one half of total IDA lending to the region went straight back to the IBRD in the form of debt servicing. Since multilateral debt must be serviced first, several African countries find themselves in a position where debt service to the multilaterals is virtually pre-empting their capacity to service their bilateral and commercial debt obligations.

A Moral Scandal

* African governments annually pay more than $13 bn to their Northern creditors, more than double what they spend on health and primary education combined;
* In 1994 countries like Mozambique and Rwanda who have virtually no debt servicing capacity were still nonetheless obliged to service their multilateral debt;

In spite of receiving bilateral debt relief under the Naples Terms which is supposed to provide up to two thirds reduction in bilateral debt stock, Uganda's debt service burden was only reduced by a paltry 2 percent. This is partly because of the restrictive conditions attached to the Naples Terms but largely due to the fact that the bulk of Uganda's debt is owed to multilateral creditors. The Uganda case illustrates most graphically how inadequate current debt relief mechanisms are. Meanwhile, Uganda spends around $2.50 per person on health compared to $30 per person on debt servicing annually.

* In 1994 Zambia spent thirty times more in debt repayments than it did on education. The World Bank's own poverty studies admit that "serious drops in attendance rates have been observed, disproportionately affecting girls." Between 1989-1993 Zambia made a net transfer to the IMF of $180 million.

* In Nicaragua debt repayments account for more than a third of government spending, double the amount spent for education and clean water provision;

* The labour and skills drain associated with constantly renegotiating debts and new aid packages has been considerable for the poorest countries. There have been over 8,000 renegotiations for Africa alone since 1980.

The World Bank Proposal: A Breakthrough of Sorts

On September 14, 1995 the Financial Times leaked an internal World Bank paper entitled The Multilateral Debt Facility for Heavily Indebted Poor Countries. The document, dated July 25, 1995 outlines a proposal for establishing a debt facility to reduce the multilateral debt obligations of the poorest countries. In terms of recognizing the problem, the Bank document is refreshing and constitutes a major step forward. For the first time, the Bank admits that the status quo is unsustainable in calling for a concerted and comprehensive approach which deals with all components of a country's debt. This very closely echoes what NGOs have been arguing and is the most significant aspect of the document.

The report proposes the establishment of a Multilateral Debt Reduction Facility that would coordinate action for reducing the entire debt burden of these countries to sustainable levels. The proposal involves putting in place a fund designed to service on behalf of eligible countries the principal and interest payments to multilateral institutions over the next fifteen years.

The World Bank proposes to establish an arms length fund called a Multilateral Debt Reduction Facility funded largely from its own sources but hopefully drawing on IMF and bilateral donor contributions. At the country level, commitments by the Facility to servicing multilateral debt would be made up front for a specific period of time, and subject to eligibility criteria based on performance.

The Debt Reduction facility would come into play only after eligible Highly Indebted Poor Countries (HIPCs) received commercial bank and bilateral debt relief at the current maximum terms and are still deemed to have unsustainably high debt obligations. Commercial debt relief provides for up to 85% debt stock reduction while bilateral debt relief is available through the Naples Terms which involve up to a 67% debt stock reduction. Unsustainable debt is defined by the Bank to occur when the present value of a country's debt is more than 220% of its exports.

In the short term only four countries would be eligible: Bolivia, Guinea-Bissau, Nicaragua and Uganda. The candidates in the medium term are: Cameroon, Central African Republic, Guyana, Honduras, Madagascar, Mozambique, Sao Tome, Sierra Leone, Tanzania, Zambia. The long term candidates include: Burundi, Cote d'Ivoire, Equatorial Guinea, Niger, Rwanda and Viet Nam. In the paper's estimation there are 16 other HIPCs (14 of them African) that would not need multilateral debt relief if they were granted commercial and bilateral debt relief at their current maximum terms: Angola, Benin, Burkina Faso, Chad, Congo, Ethiopia, Ghana, Guinea, Kenya, Lao, Mali, Mauritania, Myanmar, Senegal, Togo, Yemen. There are four HIPCs in the arrears category which could become eligible: Liberia, Somalia, Sudan and Zaire.

The MDF proposal is consistent with what the G-7 leaders agreed to in Halifax: "We will encourage: the Bretton Woods institutions to develop a comprehensive approach to assist countries with multilateral debt burdens, through the flexible implementation of existing instruments and new mechanisms where necessary; better use of all existing World Bank and IMF resources and adoption of appropriate measures in the multilateral development banks to advance this objective ... " (G-7 Communique, Paragraph 29)

Since the Financial Times leak, the World Bank President has been quick to point out that the paper was not official Bank policy, nor his own, but only one of several options being put forward. This official distancing points to the highly volatile nature of the internal discussions in the Bank as to how to deal with the multilateral debt issue as well as to the IMF's continued resistance to discussing any serious debt relief proposals. At the annual World Bank/IMF meetings held between October 9-11 the decision was to defer discussion on any proposal until April 1996, when the Bank and IMF hold their semi-annual meetings.

Multilateral Debt Reduction: A Proposed Framework A Position Paper of the Canadian Coalition for Global Economic Democracy

2) The facility should be used to finance up-front cancellation or reduction of debt stock of eligible countries

Background: NGOs and debt experts internationally have argued that only serious up-front debt reduction or outright cancellation along with a commitment to maintain aid levels will offer any hope of economic, social and environmental recovery for the poorest countries. All previous attempts at serious debt relief have not had a significant impact on the overall debt stocks of the poorest countries. For every dollar that was forgiven since 1989 three more have been added.

Why the status quo is no longer possible: Critics of proposals for further debt relief argue that the current mechanisms are sufficient to deal with the debt problems of a relatively small number of countries. The Naples Terms for bilateral debt relief are supposed to reduce the debt burden of the poorest countries. There are also facilities within the Bank and IMF itself to assist highly indebted poor countries. However, as the Uganda case illustrates, the Naples terms had very little impact on the overall debt servicing burden of the country because of restrictive conditions attached to the Naples Terms, and most importantly, because a significant portion of Uganda's debt is to multilateral institutions. The shortcoming of mechanisms within the IMF and Bank such as the ESAF fund of the IMF and the IDA Debt Reduction Facility is that they come with very stringent conditionalities.

Far more disturbing is the increasing use of aid that is being diverted to service multilateral debts. In 1994 alone, over two thirds of all IDA funds went straight back to the Bank in the form of debt repayments. IDA is financed through the aid budgets of donor countries. Moreover, bilateral aid is increasingly being transferred straight into the coffers of the World Bank and IMF. The use of aid funds have simply gone to service debts while the country's overall debt stock continues to rise.

With the serious decline in many donor countries aid programmes, and the decision of the US Congress to reduce drastically cut its existing commitment to IDA as well as threatening to reduce substantially its commitment to the next replenishment, could mean that virtually all future aid funds will be involved in a massive Bank/IMF debt recycling exercise and not for poverty reduction.

Debt relief proposals that only recycle existing debt will never enable poor countries to escape from the debt trap and will increasingly draw on aid resources that are supposed to fund health, education and poverty reduction. The leaked World Bank proposal, while it would involve a measure of debt reduction for eligible countries, spreads this reduction over a period of many years. Only an up-front cancellation or debt reduction will allow poor countries to set realistic poverty reduction and development goals.

3) That the multilateral debt facility be funded primarily from existing resources within the Bank and IMF

A $12 billion MDF could be funded from existing sources as follows:

Source**Amount Available***Suggested Amount for Debt Reduction (US$ bn)

World Bank's Retained earnings**15.5***1.8

Loan loss provisions************ 3.7***1.8

IBRD/IDA Cumulative Translation Adjustment (profits from currency fluctuations)********** 7.8***3.8

IMF Gold Sale*******************40.0***4.6


Background: Funding for the facility should not come from bilateral aid flows. In fact one of the primary goals of reducing multilateral debt obligations should be to substantially lower and eventually eliminate the use of bilateral and IDA funds to service multilateral debt. The sale of IMF gold should not be used to finance the Enhanced Structural Adjustment Facility.

Objections: The three main arguments that are used by the Bank, IMF and donor countries against using existing Bank/IMF resources is that any multilateral debt reduction will a) affect the creditworthiness of the Bank and IMF; b) create a "moral hazard" problem and c) the "no free lunch" argument.

a) The multilaterals fear that debt reduction will affect their creditworthiness. The argument is that the triple A rating of the World Bank would be impaired and thus increase the costs of borrowing in financial markets, which in turn would raise the costs of the loans to developing countries.

The response to this concern is that the effect of a debt reduction would be limited, as the low cost of multilateral borrowing is based more on the financial backing (the callable capital) of the major developed countries. Moreover, the Bank has built up significant reserves and loan loss provisions which could be used without risk to finance multilateral debt reduction.

In fact, it can be argued that continuing to maintain so many badly performing loans in the portfolio of the Bank only harms its credibility and that using some of the Bank's loan loss provisions to deal with this bad debt would serve to improve the credit rating of the Bank. As for the IMF, since it does not borrow from commercial markets but from member countries, the credit rating argument carries no weight. The IMF could easily finance a debt reduction with very little impact on its overall operations.

It should be borne in mind that the role of the Bank and IMF as "preferred creditors" should not be taken to mean that they should behave like "exempt creditors" having no responsibilities for their own miscalculations or to bankrupt debtors. This is even more important given that the IMF's and World Bank's preferred creditor status is increasingly being maintained through the use of aid funds.

Most importantly, it is the impact of this debt overhang on the poorest countries which should be the most important consideration. The fact that this debt burden is more concessional does little to alleviate the human suffering cause by prolonging the crisis.

b) the second argument against multilateral debt reduction is the problem of "moral hazard." It is argued that reducing debts for countries which have borrowed excessively will encourage governments to overborrow in the future, while others will be tempted not to repay.

This is essentially a loanshark's argument. The analogy is not that far-fetched if one considers how, in the 1980s, the Bank and IMF stepped in to rescue commercial banks, in the process becoming the "lenders of last resort."

The same "moral hazard" warning was issued when commercial debt was going to be reduced in the 1980s, and experience has shown that there was little basis for this fear. In fact, many Northern banks emerged much stronger after writing off large portions of Latin America's debts in the 1980s.

The real "moral hazard" may lie with the multilateral creditors: if they are protected from debt reduction, they avoid bearing the costs of their past poor lending decisions which will encourage irresponsible lending in the future. The IMF's decision to lend to sub-Saharan Africa in the 1980s on the basis of the analysis that the problem was one of short-term liquidity turned out to be deeply flawed. In addition, the World Bank should bear some liability for the projects that by its own accounts have been deemed to be failures. One need only mention in passing here the Wapenhans Report that cited a 37% failure rate of Bank projects. Another area that should be addressed is the issue of odious debts. There are several instances of World Bank and IMF knowingly lending to corrupt regimes which should be factored into any discussion of multilateral debt reduction.

c) Some Bank staff have argued that "there is no free lunch" with any debt relief proposal. In other words, every dollar applied to debt reduction from the Bank means one less dollar spent on development projects.

This argument applies only if one restricts the funding of any debt relief proposal to the use of current IDA resources. However, if other sources of funding are considered such as the sale of IMF gold and the use of loan loss provisions then the funds would be additional, i.e. they would free up additional resources and not require the re-allocation of existing aid flows.

d) Finally, many within the IMF and some donor countries, including Canada, have argued that a replenished or "super-ESAF" is the best way of dealing with the debt problems of the poorest countries. We are opposed to this proposal for a number of reasons.

The IMF established the Structural Adjustment Facility (SAF) in 1986 and the Enhanced Structural Adjustment Facility (ESAF) in 1987. Their purpose was to extend concessional lending to low income countries to relieve their debt burden. Loans are available at 0.5% interest for 10 years with repayments starting after 5 years. Funding for the ESAF is made available through contributions of donor countries through their aid budgets. While such a fund seems attractive the experience has been otherwise. First, there are very stringent and unrealistic conditionalities attached to these funds. For this reason, a large portion of the ESAF funds have remained unallocated. Secondly, they have done very little to reverse the net flow of resources from the low and lower-middle income countries. In effect, the ESAF has enabled the IMF to continue lending and exercising its leverage over the poorest countries while these countries are compelled to continue meeting its debt service obligations to the IMF on non-concessional terms.

The IMF is not a development agency. Its original mandate was to provide balance of payments support to countries facing deficits and to regulate exchange controls. In light of the continuing crisis facing the low income countries, the SAF and ESAF have proven to be inappropriate mechanisms for dealing with the debt crisis facing these countries.

The IMF should deal with the debt overhang of poorest countries in a comprehensive and sustainable manner. It should do so by contributing to a Multilateral Debt Reduction facility using its own reserves, through the proceeds from IMF gold sales rather than by the use of donor's aids budgets.

4) The conditions attached to debt cancellations would be an agreement by donor and recipient governments to meet agreed upon targets in social sector spending such as health and education in negotiation with their civil societies

Background: Eligibility for debt relief through the World Bank's proposed facility (as with all other kinds of debt relief) continues to be that countries will have to have a World Bank/IMF approved structural adjustment programme (SAP) in place to be eligible. The continued imposition of these structural adjustment conditionalities will increase the power and control of the World Bank and IMF over the most contentious aspects of their policy agenda. What is needed are agreements among multilateral institutions, donor and recipient government to providing debt relief that would have a measurable impact on poverty reduction. The agreements must also address the issue of self-determination and territorial integrity of indigenous peoples. These agreements would include commitments to increase levels of social sector spending and reduce military expenditures. They could also include commitments to environmental sustainability and the adherence to internationally recognized labour standards. In contrast, the implementation of SAPs means severe cutbacks in social sector spending as well as precluding the emergence of local alternatives and measures towards achieving food security.

5) The eligibility criteria for multilateral debt cancellation or reduction should be expanded to include the following criteria:

* the relationship between levels of expenditure for debt servicing and social sector needs;
* a degree of co-responsibility for loans that were made for projects that have proven to be failures or loans that were misappropriated.

Background: In the case of many highly indebted countries the World Bank's measures of debt sustainability, while useful, is not always an accurate measure of a country's debt servicing abilities. The World Bank's measures involve considering the net present value of debt stock to exports and the net present value of debt service to GNP. The added measures suggested above would provide a more accurate picture of a country's debt service capacity and need for debt relief.

The second measure is needed to restore credibility to Bank's and IMF's lending practices and to acknowledge the need to share some responsibility for past lending mistakes. As mentioned above the preferred creditor status of these institutions should not be taken to mean they should be treated as exempt creditors.

Multilateral debt relief is no longer a question of feasibility but clearly a question of moral and political will. To allow the current situation to persist while the poorest countries and people starve in order to service their debts constitutes one of the most serious moral scandals of our times.

The Canadian Coalition for Global Economic Democracy

Canadian Council for International cooperation (CCIC), Centre International de Solidarit Ouvriere (CISO), Cultural Survival Canada, Friends of the Earth, Inter-Church Coalition on Africa, International Debt Treaty Movement - Toronto, CUSO Oxfam-Canada, Social Justice Committee of Montreal, Sierra Club of Canada, World Wildlife Fund

Message-Id: <> From: "APIC" <> Date: Fri, 26 Jan 1996 08:56:34 -0500 Subject: Africa: Multilateral Debt, 2

Editor: Ali B. Ali-Dinar

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