Saving Debt Relief From Itself

Whatever happened to debt relief for the world’s poorest countries? It’s back.

Aficionados of World Bank and IMF affairs will remember the sighs of relief when those two institutions managed, by the close of the year 2000, to fulfill their promise to the donor governments and worldwide church-based Jubilee movement and approve debt relief for more than 20 of the poorest countries in the world.

Debt relief will be back on the agenda this weekend at the semi-annual meetings of the two multilateral behemoths in Washington, D.c= This time there will be less fervor and more pain. The discussions will be arcane – about the right interpretation of complicated rules that govern the process, and their unpleasant implications for the United States and other donor countries that are being called upon to commit more funds to “complete” the process of debt relief for the now 42 eligible poor countries.

Debt relief, in retrospect, turned out to be a good idea. The resources freed up from annual debt payments have helped boost education spending by as much as 55 percent in the 23 African countries currently receiving relief, and health expenditures are up by almost as much as well.

For those poor countries at least relatively capable of national planning and sound economic management, the direct budget support provided by debt relief has offered a cheaper, quicker and more effective alternative than the status quo of negotiating thousands of different projects with 50-plus donors, each with their own standards and reporting requirements.

But the debt relief initiative is now in trouble, and is at risk of failing to deliver on the larger benefits – of stability, increased investor confidence, investment and growth – that so many had hoped the initiative to provide.

The reasons, contrary to the quibbling that will ensue this weekend, have less to do with how the initiative has been implemented, and more to do with the initial design.

At its core, the debt relief initiative, which offers a one-time write-off of countries debt stocks, was designed to address a symptom – excessive debt in poor countries. Yet it did little to get at the root cause – too much lending by official donors, over two decades, even though countries failed to use the resources to invest and grow, and got deeper and deeper into unsustainable debt. Whether donors kept lending to refinance their own non-performing loans, out of fear of abandoning millions of poor people, or because they were ever-hopeful that the next loan to the next reforming government would work, is hard to know. But the outcome is clear and remains little changed – the official creditors are not sufficiently accountable for the loans they make.

Avoiding grappling with these underlying causes, the donors put together an initiative designed to maximize flexibility and minimize upfront costs. They developed rules and formulae to determine the amount of debt relief based in part on their own willingness to pay, rather than on poor countries’ long-term needs for health, education, roads, training, and institution building. They combined these rules with overly optimistic projections about countries’ future growth paths, near 6 percent growth for African countries that have averaged barely 3 percent growth (which is less than 1 percent per capita growth given population increases) over the past two decades. This increased the prospects for long-term debt sustainability on paper, but little more.

The result was an initiative that should never have been expected to achieve all of the real long-term benefits that can come from putting a country on a sustainable debt path: increased investor confidence, more private investment, stability, and growth.

While IMF and World Bank delegates toil away on the details this weekend, we should use the occasion to think about better ways to get at the issues behind debt relief. An important start is to shift more of the World Bank’s lending to the poorest countries into grants – to avoid piling up new debt.

In addition, delegates should consider offering poor countries long-term “insurance” on their debt. Under such a plan, poor countries that demonstrated a commitment to sound economic policies and invested in the health and education of their citizens would be protected for a period as long as ten years, against shocks over which they have no control – weather and price fluctuations – which throw them into unsustainable debt situations. This would contribute to the kind of confidence in the stability of poor countries that is vitally important to private sector development and growth.

At first blush it may sound difficult to determine whether external circumstances caused an increase in debt, the IMF has the history and the technical tools to make such a judgment and the technical soundness of its judgment could be encouraged through public disclosure. The difference with an insurance arrangement would be that the IMF, and its donor members, would finally be accountable for their projections and calculations. If their optimistic projections of growth, exports and commodity prices turn out to be wrong due to factors unrelated to mismanagement or corruption in poor countries, they should be prepared to step up to the plate. The needs of the world’s poor would not then take a back seat to rules and formulae dictated from afar.

While some may worry about the cost of such a proposal, the delegates to these powerful institutions’ meetings need to think seriously about the economic and political costs of allowing for another embarrassing round of debt relief. Insuring against that risk, and finding ways to provide poor countries the full long-term benefits of sustainable debt, seems a far smaller price to pay.

Nancy Birdsall is the president of the Center for Global Development. Brian Deese is a senior policy analyst at the Center for American Progress.