HIPC Initiative: The IMFs Response

to Critics

September 1998
The Moral Argument
Debt Service and Social Expenditure
Eligibility for HIPC
Timing of Debt Relief
Poverty Reduction

Dissemination of Information
Definition of Debt Sustainability
Choice of Target Ranges
Interim Relief

THE MORAL ARGUMENT
Criticism: The HIPC Initiative is a halfhearted response of the rich
world to the overwhelming debt problems of poor countries. On
moral grounds, the right decision would be an unconditional
cancellation of all debts owed by HIPCs.
Response: Calls for a full cancellation of the HIPC countries entire
external debt of over US$200 billion are unrealistic, and raise false
expectations. This is particularly true as aid resources have become
increasingly limited in recent years, and net official development
assistance (ODA) has fallen to a historic low of 0.22 percent of donor
GNP in 1997 (compared to a UN target of 0.7 percent), reflecting
creditors/donors budget constraints. Against this background, debt
cancellation for HIPCs, unless it was entirely additional to existing
aid flows, would only imply lower aid flows to other poor countries
an outcome which is clearly not desirable.
Even if the international community were prepared to cancel all HIPC
debt, it needs to be understood that the HIPC Initiative is not a
panacea, and debt is only one of many problems these countries face.
Unconditional debt relief is not the right tool for promoting the
ultimate goals of sustainable development and poverty reduction.
These goals are best attained by providing debt relief in a process,
such as under the HIPC Initiative, which encourages the adoption of
appropriate policies by the recipient country designed to stimulate
private sector-led growth and focuses on an improvement in social
indicators. Conditionality is an integral part of this process. It ensures
that the debt relief provided is used effectively, particularly through
promoting health and education expenditures, and encourages the
continued provision of aid flows to the countries concerned. This is
particularly important given the dependence of HIPCs on such
inflowsa dependence which would continue even if all debt were
forgiven.
In short, unconditional debt cancellation risks debt relief being
squandered on corruption, military expenditure, or grandiose projects
with little if any benefit in terms of sustainable growth or poverty
reduction. In addition, this could further erode support for aid flows in
developed countries.
DEBT SERVICE AND SOCIAL EXPENDITURE
Criticism: High external debt service in HIPC countries is responsible
for insufficient social spending. Despite the HIPC Initiative,
scheduled debt service in most HIPCs exceeds the level of spending
on health and education.
Response: It is simplistic and misleading to compare scheduled debt
service in HIPCs with their level of social spending, as this recognizes
neither the debt relief provided to these countries nor the offsetting
inflows of foreign aid. A closer look at a sample of 27 HIPCs, for
which recent data are available, shows that, on average, actual debt
service paid even prior to HIPC assistance is considerably below
scheduled debt service; for most HIPCs, debt-service payments are
actually lower than government budgetary expenditures on health and
education. Moreover, as a result of incomplete accounting, budgetary
spending in these sectors often does not capture the substantial
outlays financed directly (outside the budget) by bilateral donors and
NGOs.
Regardless of the level of debt service, however, it is the net
payments(i.e., debt service payments minus financial inflows from
abroad) that determine a countrys financial relations vis--vis the
international community. Based on this measure, HIPCs receive on
average twice as much by way of external assistancegrants and
concessional loansthan they pay by way of debt service, and in
some HIPCs (such as Mozambique, Tanzania, and Uganda) this ratio
is much higher. On average, net inflows of external assistance to
HIPCs are equivalent to around 10 percent of GDP and remain
essential for HIPCs to continue their recent improvements in social
indicators.
ELIGIBILITY FOR HIPC
Criticism: The eligibility criteria under the HIPC Initiative are overly
restrictive. The restriction to poor countries below the IDA
operational cutoff level of per capita income excludes some highly
indebted countries that could benefit from relief.
Response: The eligibility criteria under the HIPC Initiative reflect a
broad-based consensus of member governments that the poorest
countries should have the highest priority in concessional debt relief.
The IDA-only and ESAF-eligibility requirements ensure this by
linking eligibility for HIPC assistance to the poverty status of a
country.
TIMING OF DEBT RELIEF
Criticism: The performance period to receive HIPC assistance is too
long, and unnecessarily delays the receipt of debt relief at a high cost
in terms of forgone social services.
Response: Assistance under the HIPC Initiative is committed by the
international community after a country has established a three-year
track record of successful performance under IMF- and World Bank-
supported adjustment programs, and is provided after a further three
years of performance. This requirement reflects the belief that debt
relief without true adjustment and reform would be wasted, and is
intended to ensure that countries are in a position to use the additional
resources effectively.
The HIPC Initiative process encourages countries to tackle the whole
range of factors currently limiting their growth performance,
including poor infrastructure, the lack of effective policy making
institutions, and governance problems. Such difficult issues will take
time to be resolved, and the claim that the overall six-year adjustment
record required under the Initiative is unduly long is neither consistent
with the severity of the problems these countries are facing nor with
the experience of successful reformers.
That said, the flexibility embodied in the HIPC Initiative,
nevertheless, provides credit for past performance. As a result,
Uganda already reached its completion point and received its
assistance under the HIPC Initiative in April 1998one and a half
years after the adoption of the Initiativeand a number of other
countries, including Bolivia, Guyana, and Mozambique, are expected
to follow soon. For six of the first seven countries to whom HIPC
assistance has been committed up to September 1998, the period
between the decision and the completion points was less than 3 years.
POVERTY REDUCTION
Criticism: The HIPC Initiative does not give sufficient weight to
poverty reduction objectives.
Response: The HIPC Initiative has always emphasized the need to
link debt reduction with effective long-term policies for economic and
social development, including poverty alleviation. For this reason,
social development criteria are developed jointly with country
authorities and explicitly incorporated into HIPC conditionality.
However, poverty reduction is not a simple task, and governments
abilities to absorb the financial resources provided to them are often a
constraint when they seek to implement social programs expeditiously
and efficiently. Moreover, when considering the resources available
for social development, it should be recognized that most HIPCs are
already receiving large positive net transfers from creditors and
donors that enable them to pursue their development agenda. Debt
relief should not be seen as a substitute for continued inflows of
development finance.
Thus, the link between the HIPC Initiative and poverty reduction
objectives needs to be viewed in the broader perspective of the
countrys overall poverty alleviation efforts. These are supported by
the international community through various instruments, including
lending, policy dialogue, and social expenditure reviews, with a view
to accelerate the pace of progress toward the goals of poverty
reduction and social development adopted by the OECDs
Development Assistance Committee in 1996 for the 21st century.
Movement toward these goals will be monitored under the HIPC
Initiative.
DISSEMINATION OF INFORMATION
Criticism: Outside audiences do not receive sufficient access to key
information and documents on the HIPC Initiative, nor are they
adequately involved in the debate about HIPC debt relief for
individual countries.
Response: In disseminating information, IMF and World Bank staff
endeavor to strike a balance between being responsive to concerns
expressed by outside commentators, and maintaining the integrity of
the confidential consultative process with the country concerned and
among creditors and donors. Staffs have prepared regular press
releases and other public information documents, and are maintaining
web sites on the Initiative. To open further the process and improve
transparency about the basis of decisions made under the Initiative,
the Boards of the IMF and the World Bank decided that the decision
and completion point documents would be made public after
consultation with the countries concerned, beginning in September
1998.
DEFINITION OF DEBT SUSTAINABILITY
Criticism: The definition of debt sustainability, based on the external
public debt- and debt service-to-exports ratios, is too narrow. Debt
relief should instead be based more on the governments debt-
servicing capacity, in order to establish a closer link to social
expenditure.
Response: The Initiative has always focused on the achievement
ofexternal debt sustainability. Certain categories of debt are omitted
from its definition of external debt sustainability for practical reasons
(debt owed by private citizens, for example, cannot be practically
subsumed under rescheduling agreements). Nevertheless, high levels
of external private debt or a large domestic debt-service burden for
the government are potential vulnerability factors that play a role in
setting the country-specific debt sustainability targets.
As for exports, they are admittedly only one of several indicators for a
countrys capacity to generate resources to service its external debt.
While GDP might be another indicator, it involves serious
measurement and comparability problems in the countries concerned.
Also, in the particular context of debt service crowding out social
expenditures, a governments ability to generate fiscal revenue is key.
The HIPC Initiative has tried to balance the various theoretical
considerations in a workable approach that centers on exports as a
reliable and comparable measure across countries, but focuses on
fiscal revenues in highly open economies where the use of exports
may exaggerate the countrys payment capacity. To address moral
hazard, this fiscal/openness criterion is only applied in countries with
sufficiently strong revenue performance (i.e., a revenue-to-GDP ratio
of at least 20 percent).
CHOICE OF TARGET RANGES
Criticism: The target ranges established under the HIPC Initiative are
too high to attain the stated objective of debt sustainability.
Response: The specific ranges for the debt sustainability indicators
(i.e., 200-250 percent for the NPV of debt-to-exports ratio and 20-25
percent for the debt-service ratio) are consistent with the findings in a
recent research project undertaken in this context.
1
Nevertheless, the
Boards of the IMF and the World Bank have thus far followed a
cautious approach by agreeing for most countries on targets towards
the lower end of these ranges and, for some cases, by choosing NPV
of debt-to-export targets below 200 percent under the fiscal/openness
criteria. In any case, the debt-service ratio typically falls well below
the 20 percent threshold after HIPC assistance.
INTERIM RELIEF
Criticism: The measures to provide assistance during the interim
period should be strengthened. If the interim period is to be as long as
three years, interim measures should provide greater cash flow relief,
and more multilateral creditors should provide interim relief to allow
for needed expansion of development expenditures.
Response: The IMF and World Bank, as well as other multilateral
institutions, provide substantial financing during this period through
the provision of ESAF and IDA loans. Beyond this, there are several
forms of HIPC assistance available during the interim period between
the decision and completion points. In general, official bilateral and
commercial creditors are expected to provide flow reschedulings on
enhanced terms, involving an 80 percent NPV reduction, during this
period, except for countries that have already benefited from a stock-
of-debt operation on Naples terms. In addition, multilateral creditors
may, at their discretion, advance some of their assistance to the
interim period. However, multilateral HIPC assistance provided in the
interim period is not additional and only brings forward assistance
that would otherwise have been received later.

1
S. Claessens, E. Detragiache, R. Kanbur and Peter Wickham, "Analytical Aspects
of the Debt Problems of Heavily Indebted Poor Countries," in Z. Iqbal and R.
Kanbur, External Finance for Low-Income Countries, Washington, D.C., 1997, pp.
21-49.

External Relations Department International Monetary Fund