External Debt and Development: Towards a Durable

Solution to the Debt Problems of Developing Countries

Definition:

External debt (or foreign debt) is that part of the total debt in a country that is owed to creditors outside the country. The debtors can be the government, corporations or private households. The debt includes money owed to private commercial banks, other governments, or international financial institutions such as the IMF and World Bank

Historical background

Much present-day states in Africa and the majority of Asia did not have an independent financial existence as recently as World War II. However, not all external debts of these countries were acquired after independence. As a condition of independence in 1949, Indonesia was required to assume the Dutchcolonial government's debt, much of which had been acquired fighting pro-independence rebels the previous four years. In order to receive independence from France, Haiti was required to pay France 150 million francs. (See: Haiti's external debt.)

Egypt, which had not been formally colonized, had been effectively governed as first an Anglo-French and later British protectorate, did not have control over the lucrative Suez Canal because it had sold its 44% share to Disraeli. Denied credit to build the Aswan Dam because of its deals with the Soviets, Egypt's government moved to nationalize the Canal, which links the Mediterranean Sea with the Red Sea (and therefore the Indian Ocean) and was owned by a European corporation, sparking the Suez Crisis.

In the first decades following decolonization, first world and multilateral creditors such as the World Bank and International Monetary Fund lent massively to third world governments. Money was frequently directed towards massive infrastructure projects such as dams and highways. Additional funds focused on an import substitution model of development, creating a capacity to replace imports from industrialized countries. Such policies emerged in a convergence of ideologies towards the concept of industrial development, shared by capitalists, communists and Third World nationalists.

Additionally, a number of dictatorships and arguably neocolonial governments imposed and/or backed by foreign powers received extensive debt-based financing to conduct civil wars or repression against their own population. In Central and South America, these policies fell under the rubric of the national security state, civil wars accumulated substantial debts in Guatemala, El Salvador and Colombia. In Haiti, the father-son dictatorship of François and Jean-Claude Duvalier accumulated massive debts, which the United States pressured then-exiled President Jean Bertrand Aristide to recognize as a condition of his return to power in 1995. Foreign military operations, such as the invasions of East Timor by Indonesia; of Angola and Namibia by South Africa; and of Iran and Kuwait by Iraq also led to massive indebtedness.

Massive lending was followed by the threat of major defaults, such as that of Mexico, in the early 1980s, precipitating what became known as a debt crisis. Faced with the possibility of losing their investments lenders proposed a variety of structural adjustment programs (SAPs) to fundamentally reorient Southern economies. Most called for the drastic reduction in public welfare spending, focusing economic output on direct export and resource extraction, providing an attractive investment climate to multinational investors, increasing the fluidity of investment flows (by replacing foreign direct investment with the opening of stock markets) and generally enhancing the rights of foreign investors vis-à-vis national laws.

As these programs became a prerequisite of lending and other development assistance from all major multilateral creditors, and as Soviet economic assistance evaporated in the late 1980s, SAPs became the dominant economic plan for much of the world's population. Saddled with massive debts, and unable to collectively alter unfavorable terms of trade, many Third World governments were pushed from the role of legislating economic policy to negotiating it. Many of them, such as Jamaica's Michael Manley, have argued they were even pushed into the job of managing an enforced economic transition against the wishes of their populations

Third world debt has long been recognized as a major obstacle to human development. Many other problems have arisen because of the enormous debt that third world countries owe to rich countries. Debt has impeded sustainable human development, security and political or economic stability. How has this happened

When we look at the evolution of debt indicators of developing countries in the context of recent developments in international trade and payments and in international capital markets, we see that the total external debt for developing countries and economies in transition increased by $95 billion or 4% in 2003

The fact that some improvements in net export balances of a small number of countries were seen in 2003 - due to their net export balances - did not prevent the continuing worsening of debt burden in many low- and middle income developing countries in Latin America and the Caribbean, as well a in North Africa and the Middle East.

Debt sustainability, both in terms of its definition and calculation, is critical to the whole debate around debt relief. The Secretary-General's report correctly highlights the complexities attached to this issue. In this regard, the report mentions how debt sustainability, which is affected, inter alia, by vulnerability to external shock, is key to achieving economic growth and sustainable development. Countries have to strike a balance between the objectives of achieving and maintaining debt sustainability, promoting long-term growth and reducing poverty.

In that regard, the Secretary-General's report in document A/59/219 entitled "External Debt Crisis and Development" states that "a more conservative approach than in the past may be warranted. Considering debt to be sustainable as long as new finance is available for debt service payments runs the risk of contributing to the build-up of larger debt burdens in the future, while exposing the economies to sudden changes in market sentiment or in conditions in international capital markets, as has been the case in many of the recent financial crises. Increased attention should thus be given to the volatility of capital flows in national debt sustainability assessments."

There is much debate about whether the richer countries should be asked for money. The legitimacy of such liability is little doubt in terms of international and contractual law, but many arguments in the debate have to do with fairness or practicality of the system currently in place.

Critics of the practical point in this argument might question whether or not unpayable debt truly exists, since governments can refinance their debt via the IMF or World Bank, or come to a negotiated settlement with their creditors. However, this is not an argument that can withstand a glance at the state of the essential services supposedly being provided by many of the heavily indebted countries. There is overwhelming evidence that governments have financed their debts through instigation of austerity policies directed at essential services and subsidies for essential goods. The history of Mali, for example, from 1968 onwards, provides a clear illustration of this. In fact, the requirement that governments should service debts at the expense of their populations is integral to the strategies adopted by the Washington institutions in 1982 to solve the banking crisis triggered by the Mexican Weekend in August that year. Austerity was one of the ways in which interest payments could continue to be serviced, preventing liquidity problems in the US money-centre banks. The same principle is evident in the design of the Heavily Indebted Poor Countries Initiative. While refinancing has taken place (particularly to lessen private creditor exposure subsequent to 1982) this has come with conditions which have caused a crisis of development. Stuart Corbridge [1] has described the 1982 debt crisis as a banking crisis which was transformed into a development crisis, brokered by the Washington Institutions

Consequences of debt abolition

Some economists argue against forgiving debt on the basis that it would motivate countries to default on their debts, or to deliberately borrow more than they can afford, and that it would not prevent a recurrence of the problem. Economists often refer to this as "moral hazard". But some critics and debt relief activists say the problem is not necessarily with borrowers, but with lenders, and thus the moral hazard is not necessarily immoral borrowing, but immoral lending.

Heavily Indebted Poor Countries (HIPC) are a group of 40 developing countries with high levels of poverty and debt overhang which are eligible for special assistance from the International Monetary Fund (IMF) and the World Bank.

The HIPC program was initiated by the International Monetary Fund and the World Bank in 1996, following extensive lobbying by NGOs and other bodies. It provides debt relief and low-interest loans to reduce external debt repayments to sustainable levels. Assistance is conditional on the national governments of these countries meeting a range of economic management and performance targets.

The HIPC program identified 42 countries, 32 of which are in Sub-Saharan Africa, as being potentially eligible to receive debt relief (2004). The 27 countries that have so far received a combined $54 billion in aid are the following:

  • Benin
  • Bolivia
  • Burkina Faso
  • Cameroon
  • Chad
  • Democratic Republic of the Congo
  • Ethiopia
  • Gambia
  • Ghana
/
  • Guinea
  • Guinea-Bissau
  • Honduras
  • Madagascar
  • Malawi
  • Mali
  • Mauritania
  • Mozambique
  • Nicaragua
/
  • Niger
  • Rwanda
  • São Tomé and Príncipe
  • Senegal
  • Sierra Leone
  • Tanzania
  • Uganda
  • Zambia

On June 11, Finance Ministers from the G8 countries announced a debt remission proposal that would cancel multilateral debts owed to the World Bank, the International Monetary Fund (IMF) and the African Development Bank's African Development Fund (AfDF) by 18 low-income countries.

The G8 proposal offers 100% debt stock cancellation for debts owed to three multilateral financial institutions for the 18 countries that have reached their "completion points" through the Heavily Indebted Poor Country (HIPC) Initiative. A further 9 HIPC "decision point" countries, who have not completed or have stalled in their World Bank/IMF programs, might qualify in the near term. The deal could also potentially be extended to the 11 remaining HIPCs that have not yet reached their decision points.

The G8 proposal to actually write off debts owed by HIPC completion point countries marks a breakthrough over the proposals by Canada and the United Kingdom to pay their debt service over a period of 10 years. However, the 18 countries initially covered in the current plan are fewer than the 22 countries (including 4 non-HIPCs) proposed by Canada or the 24 countries (including 6 non-HIPCs) proposed by the UK.

There are at least 62 countries that civil society assessments conclude need immediate 100% debt cancellation in order to meet the goals of halting the spread of HIV/AIDS and halving the proportion of their population living in extreme poverty, hunger and without safe drinking water.

Countries must meet certain criteria, commit to poverty reduction through policy changes and demonstrate a good track-record over time. The Fund and Bank provide interim debt relief in the initial stage, and when a country meets its commitments, full debt-relief is provided.

First step: decision point. To be considered for HIPC Initiative assistance, a country must fulfill the following four conditions:

1) be eligible to borrow from the World Bank's International Development Agency, which provides interest-free loans and grants to the world's poorest countries, and from the IMF's Poverty Reduction and Growth Facility, which provides loans to low-income countries at subsidized rates.

2) face an unsustainable debt burden that cannot be addressed through traditional debt relief mechanisms.

3) have established a track record of reform and sound policies through IMF- and World Bank supported programs

4) have developed a Poverty Reduction Strategy Paper (PRSP) through a broad-based participatory process in the country.

Once a country has met or made sufficient progress in meeting these four criteria, the Executive Boards of the IMF and World Bank formally decide on its eligibility for debt relief, and the international community commits to reducing debt to a level that is considered sustainable. This first stage under the HIPC Initiative is referred to as the decision point. Once a country reaches its decision point, it may immediately begin receiving interim relief on its debt service falling due.

Second step: completion point. In order to receive full and irrevocable reduction in debt available under the HIPC Initiative, a country must:

1) establish a further track record of good performance under programs supported by loans from the IMF and the World Bank.

2) implement satisfactorily key reforms agreed at the decision point.

3) adopt and implement its PRSP for at least one year.

Once a country has met these criteria, it can reach its completion point, which allows it to receive the full debt relief committed at decision point.

List of Countries That Have Qualified for, are Eligible or Potentially Eligible and May Wish to Receive HIPC Initiative Assistance (as of July 1, 2009)

Post-Completion-Point Countries (26)
Benin / Guyana / Niger
Bolivia / Haiti / Rwanda
Burkina Faso / Honduras / São Tomé & Príncipe
Burundi / Madagascar / Senegal
Cameroon / Malawi / Sierra Leone
Central African Republic / Mali / Tanzania
Ethiopia / Mauritania / Uganda
The Gambia / Mozambique / Zambia
Ghana / Nicaragua
Interim Countries (Between Decision and Completion Point) (9)
Afghanistan / Democratic Republic of the Congo / GuineaBissau
Chad / Côte d'Ivoire / Liberia
Republic of Congo / Guinea / Togo
Pre-Decision-Point Countries (5)
Comoros / KyrgyzRepublic / Sudan
Eritrea / Somalia

Question of Corruption and Debt Relief:

Since arriving at the World Bank, Paul Wolfowitz has argued that the biggest barrier to development in many poor countries is a high level of government corruption.

"Corruption is often at the very root of why governments do not work," Wolfowitz argued in a speech in Indonesia in April 2006.

He felt so strongly about the need to fight corruption that he moved on his own to suspend World Bank assistance to several countries because of his dissatisfaction with their anti-corruption efforts. In the process, however, Wolfowitz angered key European governments. He also alienated many staff members who felt he was acting arbitrarily and disregarding the views of development professionals with many years of World Bank experience.

The Republic of Congo, in West Central Africa, is among the countries where corruption allegations have prompted Wolfowitz to try to block international assistance. Nearly 70 percent of the population in the former French colony subsists on less than $1 per day.

The country, however, has 1.5 billion barrels of proven oil reserves and is currently the fifth-largest oil producer in sub-Saharan Africa. Anti-corruption activists in Congo say the government has failed to reveal how it's using its oil revenues, and they suspect that much of the country's wealth is being diverted by its ruling elite.

"It must be said that all the problems we face are tied to this fight against impunity, against corruption, and against the lack of transparency in government," says Christian Mounzeo, an activist with the Publish What You Pay coalition in Congo. Mounzeo's allegations got him in trouble with Congolese authorities earlier this year, and he is currently not allowed to travel outside of his hometown of Pointe-Noire.

Early last year, a British newspaper reported that Congo President Denis Sassou-Nguesso and his entourage had run up hotel bills in New York totaling several hundred thousand dollars while attending a United Nations General Assembly meeting the previous fall. The professional staff of the World Bank and the International Monetary Fund at the time had concluded that Congo qualified for debt relief under the bank's Heavily Indebted Poor Countries (HIPC) initiative and were recommending that the relief be approved.

After Wolfowitz learned of Sassou-Nguesso's extravagant hotel spending, however, he declared that Congo's anti-corruption record was not good enough to warrant the debt relief. A major fight ensued at the World Bank Board of Directors, which is made up of representatives of the governments that provide funding for Bank initiatives.

"Wolfowitz wanted to change the rules in the middle of the game," says a French official who asked to remain anonymous while discussing the Congo negotiations. The World Bank Board, the official says, told Wolfowitz, "You cannot work like this."

The French and other European government representatives argued forcefully that the World Bank needed to remain engaged in poor countries such as Congo, regardless of how corrupt their governments may be.