Like every Friday, from Raj Nallari and Breda Griffith's lecture notes.
External debt began to be a problem for developing countries in the 1980s. Middle-income countries were borrowing from private creditors, chiefly commercial banks, while low-income countries without access to private finance borrowed either directly from other governments or from their export credit agencies (ECAs) or through private loans insured for payment by ECAs. Official creditors were willing to take the risks of what was called “national interest” lending and saw the provision of commercially-priced export credit guarantees as a compliment to the grants and concessional loans being made as part of their official development assistance (ODA).
The international financial community in recognizing the adverse effects of large debt stocks on growth, poverty reduction and external viability offered assistance in the form of debt relief from official and multilateral creditors. This took place mainly through Paris Club reschedulings, reduction in the stock of outstanding debt under the Brady plan, and concessional financing from international financial institutions.
The outcomes from the debt relief initiatives saw a decrease in the external debt of middle-income countries. However, many low income countries, especially in Sub-Saharan Africa continued to suffer from heavy external debt burdens and high rates of poverty even after initial debt relief operations had been implemented. Poor countries, particularly in Sub Saharan Africa continued to face difficulties in meeting their external debt commitments due to a confluence of factors, including the accumulation of nonconcessional debt from official export credits, poor debt management practices, worsening debtors’ terms of trade, weak macroeconomic policies and poor governance, civil wars and drought (see Daseking and Powell).
A Taxonomy of Initiatives
As low income debt burdens increased, and as the private sector began pulling out, official creditors stepped into the void and provided assistance in the form of non-concessional flow reschedulings at the Paris Club. Assistance was also provided in the form of new lending by multilaterals, with the World Bank, the IMF and multilateral development banks continuing to support the adjustment programs of debtor countries.
Paris Club reschedulings were used extensively by low income countries: between 1976 and 1988 81 non-concessional flow rescheduling that allowed for payments close to US$23 billion to be delayed were agreed with 27 countries. These same countries came to be identified as heavily indebted poor countries (HIPCs). The debt reschedulings facilitated the financing of adjustment programs and provided cash flow relief. However, despite these reschedulings, the debt service paid by these countries increased from about 17 percent of exports on average in 1980 to 30 percent in 1986 and low income country debt burdens also increased.
The increasing debt stocks were seen as unsustainable and a number of debt relief initiatives were introduced during the late 1980s and the 1990s. In 1987, Nigel Lawson, the then UK Chancellor of the Exchequer argued that Paris Club reschedulings for low income countries should be conducted at below-market rates of interest. Thus for the first time, governments were being asked to accept concessional reschedulings on ECA debts. The French proposed a reduction of 33 percent in payments falling due and the US accepted rescheduling based on longer grace periods. The combination of the suggestions from the UK, French and US governments came to be called the Toronto terms and together facilitated a reduction in the net present value of eligible debt by up to one third. The Toronto terms marked the beginning of a number of schemes targeted at debt relief for poor countries.
The enhanced Toronto terms or London terms introduced in December 1991 aimed at reducing the net present value of debt up to one half. Subsequently, in January 1995, the Naples terms provided for a reduction in net present value of debt up to two thirds. In the context of the HIPC initiative, creditors agreed to an 80 percent reduction in net present value in November 1996 – the Lyon terms. The Cologne terms introduced in November 1999 allowed the concessionality of debt relief operations to be reduced by 90 percent reduction of net present value.
Thus, under the Toronto terms, 20 low-income countries received debt reschedulings amounting to almost US$6 billion of payments falling due being either partially cancelled or rescheduled on a concessional basis. Following the introduction of Naples terms in January 1995, creditors agreed that, after three years of good performance by a debtor country, they would be prepared to consider an agreement covering the full stock of eligible debt, not just the debt service flows falling due. Seven agreements covered the full stock of debt under the Naples terms with a total of approximately $17 billion of payments being either partially forgiven or rescheduled on concessional terms, i.e. at low interest rates over the medium and long term.
Creditors were by and large able to control the growth of low income debt payments through concessional rescheduling techniques. Average paid debt service ratio for HIPCs peaked at about 30 percent of exports in 1986, falling to 17 percent on average in 1997. Aggregate debt service for the HIPC as a group fell to 14 percent of aggregate exports in 1997 lower than for the Moderately Indebted Low-Income Countries. Moreover, rescheduling ensured that official transfers remained positive to low-income countries (Daseking and Powell).
From 1987 onwards new initiatives aimed at promoting debt relief for low-income countries were also introduced by multilateral institutions. At the G-7 summit in Venice in 1987, the IMF unveiled its plan—the Enhanced Structural Adjustment Facility (ESAF)—for new concessional IMF lending for low income countries. The ESAF would be financed by grants from wealthier member countries. The ESAF succeeded the structural adjustment facility (SAF) that was established in 1986 and was itself succeeded by the Poverty Reduction Growth Facility (PRGF) in 1999. The ESAF was available to low-income member countries facing protracted balance of payments problems and provided resources at an annual interest rate of 0.5 percent, repayable over 10 years, including a grace period of 51/2 years. The PRGF has the same terms.
Next week: the Initiative for the Heavily Indebted Poor Countries (HIPCs)