Fridays Academy: The Initiative for the Heavily Indebted Poor Countries (HIPCs)

Like every Friday, from Raj Nallari and Breda Griffith's lecture notes.

In September 1996, the World Bank and the IMF together launched the Initiative for the Heavily Indebted Poor Countries (HIPCs) with the ‘aim of reducing the external debt burden of all eligible HIPCs to a sustainable level in a reasonably short period of time’ and provided that the countries carried out a ‘strong programs of macroeconomic adjustment and structural reforms’ (Andrews et al., 1999).  A country was judged to have reached a sustainable level of external debt if it could meet its current and future external debt-service obligations in full without accessing debt relief, rescheduling of debt, accumulation of arrears and without compromising growth.  At the outset, 41 countries were identified as being heavily indebted poor countries; 32 of these had a GNP per capita in 1993 of $695 or less, a NPV of debt to exports of 220 percent or higher or a NPV of debt to GNP of 80 percent or higher.  The remaining nine countries were those that had received or were eligible for concessional rescheduling from the Paris Club official creditors.  Furthermore, these countries were eligible for IDA loans and for the ESAF and were required to show strong track records of performance under IMF and World Bank sponsored programs (Andrews et al., 1999).    

The HIPC Initiative was based on the following principles:

• The initiative targets overall debt sustainability on a case-by-case basis, thus providing a permanent exit from the rescheduling process.
• Creditors envisage providing debt relief only after the debtor country has demonstrated the capacity to use prudently whatever debt relief is granted.
• Additional debt relief is granted on top of existing (traditional) debt relief mechanisms.
• Debt-relief measures under the Initiative are coordinated among all creditors involved, with broad and equitable participation
• Steps taken by multilaterals are in line with their status as preferred creditors and will preserve their financial integrity.
• New financing for the HIPCs is on appropriately concessional terms.

In 1999, the HIPC was enhanced and was then known as the Enhanced HIPC Initiative. Based on a review and consultation exercise incorporating the World Bank, IMF and a public consultative process, the enhanced HIPC provided deeper, faster and broader debt relief and a stronger focus on poverty reduction through the preparation and adoption of a new vehicle -  the poverty reduction strategy paper (PRSP).   

Deeper debt relief provided for lowering the NPV of debt to export target to 150 percent from 250 percent and dropping the requirement for a country-specific vulnerability analysis; lowering the NPV of debt-to-fiscal revenue target to 250 percent from 280 percent; a lowering of the export to GDP ratio from 40 to 30 percent and revenue to GDP ratio from 20 to 15 percent and changing the basis for debt relief to actual data based on the year prior to the decision point (rather than on projections for the completion point).

Faster debt relief allowed interim relief by the international financial institutions between the decision and completion points and the introduction of floating completion points which allowed assessment of a country’s performance to be based on specific outcomes of policy reform and macroeconomic stability rather on the length of track record.

Broader debt relief facilitated a ‘greater safety margin for the achievement of debt sustainability providing a clear and permanent exit from unsustainable indebtedness at the completion point’ (Andrews et al., 1999).

Poverty reduction and improvement in social indicators of well-being was an integral part of the HIPC Initiative and for many countries reaching their completion points substantial progress was made in these areas. However, the fact that progress was very uneven—not all countries developed poverty reduction strategies and/or identified specific targets for improvements in poverty and social indicators—led to the requirement for a specific nationally-owned Poverty Reduction Strategy Paper (PRSP) when a country reached its decision point under the Enhanced HIPC Initiative.  A nationally-owned comprehensive poverty reduction strategy would recognize that (i) rapid economic growth, macroeconomic stability and structural reforms are critical for poverty reduction, and (ii) the identification of specific goals in the context of the MDGs for 2015 are essential for the design of the PRSP.  The PRSP is carried out in consultation with community groups, non-government organizations and donor groups.

As of August 2005, 38 countries potentially qualified for HIPC assistance.  Thirty-two of these countries are in Sub-Saharan Africa.  Eighteen countries had reached ‘completion point’ and were receiving irrevocable debt relief.  Ten countries had reached their decision points’ and were receiving interim relief. Social difficulties including internal civil strife, cross-border armed conflict and governance challenges hamper the progress of the remaining ten countries in achieving debt relief.  

In June 2005, the G-8 proposed debt cancellation to Heavily Indebted Poor Countries under the Multilateral Debt Relief Initiative (MDRI). The MDRI will provide additional financial support to countries that have graduated from the Enhanced HIPC Initiative.  Unlike the HIPC the MDRI does not propose any parallel debt relief on the part of official bilateral, private creditors or multilateral organizations beyond the IMF, IDA and the AfDF.  The MDRI is aimed to help these graduated countries along the path to achieve the MDGs and also to preserve the financial capacity of the international financial institutions (IFIs).  It is envisaged that the bulk of the debt relief be provided by IDA, which is expected to implement the MDRI in July 2006 at the start of its financial year. The IMF began implementation in January of 2006. Each relevant IFI can decide for itself its approach to the coverage and implementation of the MDRI.  The IMF Executive Board modified the original G-8 proposal to include all countries with per capita income of US$380 a year or less, whether HIPC or not, to receive MDRI debt relief financed by the IMF’s own resources. HIPCs with per capita income above that threshold will receive MDRI relief from bilateral contributions administered by the IMF (IMF, 2006).  The full stock of debt owed to the IMF at end 2004 that remains outstanding when the country qualifies for relief is eligible for MDRI.  Requirements for qualification include having reached the HIPC completion point and also showing satisfactory performance in (i) macroeconomic policies; (ii) implementation of a poverty reduction strategy; (iii) public expenditure management.  Based on these criteria, 19 countries are deemed eligible for MDRI.  These include 17 HIPCs that had reached completion point and 2 non-HIPC countries whose per capita income was below $380.  The cost of the debt relief amounted to US$3.4 billion that included remaining HIPC assistance and was delivered on January 6, 2006.

Conclusion

Mounting external debt adversely affects economic growth and the capacity for poverty reduction.  The debt overhang hypothesis point to the role played by investment in affecting economic growth – large debt stocks reduce investment that in turn reduces growth. Reduced government resources, because of commitments to debt servicing/reducing debt stocks directly affect spending for poverty reduction.  Beginning from the late 1980s, debt stocks became unsustainably high in many low-income countries. The international financial community realized that debt stocks would remain high in the environment of  few growth opportunities, weak macroeconomic adjustment and stability, threats from civil strife and unacceptable high levels of poverty unless deep debt relief was introduced.