From debt reduction to a pathway towards development

A short history of debt crisis

RomaTre - HDFS

January 2015

Massimo Pallottino

maxpallottino@gmail.com

Debt - History 2

Debt: an everlasting history

Debt and debt crisis is not something new: the idea of financing (economic and politic) ventures, at individual as well as at state level is found in pre-modern and in modern history.

Kindleberger: phases of (a) growth; followed by ‘bubbles’ or (b) manias; and ending in (c) crisis. (Hanlon, 2012)

Debt - History 3

What debt are we talking about?

Private Vs. Public (Sovereign debt)

Internal Vs External

Privatly owned Vs Publicly owned (bilateral or multilateral)

Short term Vs. long term

Concessional Vs market terms

Debt - History 4

Multiple dimensions

Economic dimensions

Social dimensions (the social costs of debt and its service)

Internal political dimensions

External political dimensions (power issues related to to borrowing and servicing – or not servicing)

Juridical dimensions (legitimacy of debt)

Debt - History 5

Old history

• 60’: investment policies in a stable monetary context (USD convertibility)

• Expansion of international trade, with a steep increase of USA imports, funded by a USD emission

• 1971: USD-gold convertibility discontinued, and increase of the raw materials

• Had USA strong reasons to oppose oil increase? The opportunity for exploitation of domestic reserves and comparative advantages vis-à-vis Germany and Japan

• 1973-74 first oil shock: OPEC countries’ revenues increase and are fed into the international banking system

• Interest rates decrease• Prices increase (inflation, but in a context of economic stagnation)

Debt - History 6

The situation in the ‘70

• LDCs need investments and infrastructures• Interest rates are low and being indebted is ‘cheap’• Big international banks lend to LDCs: states cannot go

bankrupt!• In some cases interest rates end up being negative in real

terms!• Debt stock increases steeply• The use of the available financial resources is often

inefficient (geopolitical reasons, corruption)

Debt - History 7

1979: the second oil shock

• Oil prices increases again, up to twenty times the price of 1973! New inflationary and contractionary pushes for the world economy

• New UK prime minister: Margaret Tatcher, and new USA president Ronald Reagan

• The answer to the oil and inflation increase is based on ‘monetarist’ recipes: the inflation is caused by an excess monetary mass

• USD becomes stronger and interest rates increase

Debt - History 8

The crisis• From 1979 onward the public finance crisis in the LDCs is acknowledged as

structural• LDC are faced with a steep increase in the value of debt• In 1982 Mexico declares debt default, followed by other countries• Structural adjustment policies are based on the ‘monetarist’ approache: in a first

phase they are supposed to produce a stable economic environmnet (internal and external stabilisation), and in a second phase to provoke the restructuring of the offer, through the following measures

Reduced public spendingPrivatisationsPrice liberalisation No custom taxesNo subsidies Competitive currency devaluation

Debt - History 9

How to face debt crisis?

Trading on secondary markets

Buy back options

Restructuring/rescheduling

Cancellation

Debt swaps (Debt-for-equity, Debt-for-development,Debt-for-nature Swap)

Debt - History 10

The options in the ‘80

Solving the creditors’ problems…Baker plan (1985): involuntary lending, creditors’ coordination, and structural conditionalitiesBrady plan (1989): the principle of the reduction of debt is acknowledged. Buyback Debt for equity swaps Par bond swaps , where face value is conserved, but

interest rates are reduced to a flat rate of 6% New financial resources

Debt - History 11

From restructuring to debt cancellation

1987 Venice Terms: debt payment is postponed and the interest rate is cut1988 Toronto Terms: non-ODA debt is reduced of a further 33%1991 London Terms: already restructured debt is reduced of 50%1995 Naples Terms: all debt is reduced to 67%. Debt service issue is considered for the first time1996 Lyon Terms: Net Present Value of the stock is reduced up to 80%. Heavily Indebted and Poor Countries Initiative - HIPC1999 Cologne Terms: HIPC II or enhanced

Debt - History 12

A turning point

Debt reduction policies are acknowledged as substantially ineffective

Structural adjustment programmes are acknowledged as substantially ineffective

A big mobilisation of the international civil society (Bimingham, 1998; Cologne 1999)

Debt - History 13

Cologne: HIPC II - enhanced

Objectives: To increase the debt cancellation To accelerate the debt cancellation To widen the number of beneficiary countries To guarantee that funds are used for poverty

reduction

The Bank and the Fund change their traditional facilities

Debt - History 14

Sustainability in HIPC II

Debt is unsustainable when: Its debt NPV/Export ratio is higher than 150%

(debt NPV/public income 250% in the fiscal window)

Fiscal window: export/GNP >30% and budget income/GNP > 15%

(See the note of the ppt for explanation)

Debt - History 15

HIPC II path

Debt - History 16

Over and above the HIPC initiative: Evian and MDRI

Towards a ‘taylor-made’ approach: Evian (2003) and the ‘top-up cancellation’

The Multilateral Debt Reduction Mechanism (Gleaneagles, 2005)The MDRI is accessible for the HIPC countries that have reached the completion point; these countries will receive an additional debt cancellation from the IDA, the ADF and the IMF.The MDRI full benefits will be above US$50 billion: about US$37 billion from IDA, US$8.5 nillion from the African Development Fund, and US$5 billion from the IMF.The civil society wins!!!! Additional resources are added, while ‘preserving the financing capacity of the International Financial Institutions’.Different financing mechanisms: IDA and ADF, ‘dollar-per-dollar’; IMF: trust I and trust IIMore recently, also the African Development Bank and the Interamerican Development Bank

Debt - History 17

Comments about the MDRIFlaws: It concerns only those countries that have completed the HIPC

initiative. And the other low-income countries? They are excluded!

Should multilateral debt be cancelled at once, it would amount to about USD 55 billion. However what really matters is what remains available to fund poverty reduction strategies

According to different sources, the development objectives set at the international level would require between 30 and 50 billion USD , yearly.

With the MDRI, about 2 billion USD would be made available: good, but absolutely not enough!

Distributional effect of MDRI Gunter, Rahman, Wodon (2008) “Robbing Peter to Pay Paul? Understanding Who Pays for Debt Relief”, World Development, 36(1)

Debt - History 18

Conditionality

• On which basis has debt cancellation been accessed?

Conditionality

Debt - History 19

Evolving conditionalities

Conditionality in traditional SAPs (’80) The ‘small open econoy’ model (‘one size fits all’) Stabilisation (contraction of internal demand) and structural

reforms (expansion of supply) Crossed conditionalities

The adjustment with a human face (’90) Poverty shields The governance age

After 1999: towards a re-definition of IFI’s role IMF: short-term compensation chamber guardian for the ‘good

policies’ and ‘trafic-light’ WB: investment bank guarantee that the poor is listened to

Conditionality

Debt - History 20

‘Structural’ conditionalitiesConditionality

Debt - History 21

Social conditionalities

PRSP - Poverty Reduction Strategy Paper, introduced with the enhanced HIPC initiative, in 1999

Document that defines the poverty reduction strategies, by the individual countries’ governments, after a wide consultation with all stakeholders A priority for poverty reduction is introduced The role of the civil society is legitimised They are used in the place of the old SAPs

Conditionality

Debt - History 22

Criteria for the PRSPs

They are formulated through a country driven process

They are results-oriented They bear a complex and multi-dimensional

understanding of poverty The define a long term perspective geared

towards poverty reduction They are partnership oriented

Conditionality

Debt - History 23

A synthesis about conditionalities in the PRSP age

The structural and macroeconomic conditionalities are mostly based on the ‘good old models’ of political economy: from this point of view there is no much change in the macroeconomic frameworks of the structural adjustment, and that of the PRSP phaseThe IMF still plays a ‘traffic-light’ roleThe insertion of a priority for poverty reduction is important; but this is somehow instrumentalisedIt is very important to avoid that conditionalities prevent the governments to determine a really ‘country-owned’ policy framework

Conditionality

Debt - History 24

The end of the HIPC initiative31st December 2006: the sunset clause

The grandfathering process

2011: the last ringfencing

Somalia Eritrea Sudan

Côte d’Ivoire

Togo

Nepal

Kyrgyz RepublicLaosButhan

Zimbabwe

Comoros

Guinea-Bissau

C. African Rep.

3 Pre-Dec. Point

Guinea

Chad

Haiti

Dem. Rep. Congo

Burundi

Liberia

Rep. of Congo

Afghanistan

1 Interim Countries

Niger Gambia

Zambia

Nicaragua Guyana

Uganda

MozambiqueGhana

Tanzania

Mauritania Ethiopia

Sierra Leone

Mali

Cameroon

Senegal

Malawi

Burkina Faso S.Tomé Príncipe

Madagascar

Bolivia Rwanda

Honduras

Benin

35 Post-Completion-

Point Countries

The current

situation

Situation as at September 2013

Debt - History 25

The outcomes of HIPC/MDRI

The current

situation

Debt - History 26

Effects on the social expenditure

The current

situation

Debt - History 27

‘Sustainable’ debt relief

HIPC/MDRI Status of Implementation - September 2008

HIPC/MDRI Status of Implementation - September 2011

The current

situation

Debt - History 28

Debt’s burden yesterday and today (DOD DPPG TDS INT constant billion USD)

The current

situation

LDC External Debt 1973 1985 1997 2000 2002 2004 2006 2008 2010 2012All Less Developed Countries

Total ext. debt 72,52 598,60 1.135,74 1.183,74 1.237,93 1.338,73 1.186,81 1.320,81 1.528,94 1.765,60Debt service 8,57 76,30 162,00 163,92 160,86 166,95 206,40 183,11 155,52 182,33Of which interests 2,67 38,25 54,27 60,59 48,99 49,43 51,57 54,49 50,23 80,98

Sub Saharan Africa

Total ext. debt 10,87 77,20 168,76 161,83 170,64 194,20 124,34 136,40 161,79 199,72Debt service 1,26 7,90 9,22 10,10 8,41 9,23 18,78 10,62 9,53 15,04Of which interests 0,34 3,08 3,22 2,92 2,52 2,69 3,47 3,37 3,02 5,03

Low Income Countries

Total ext. Debt 6,93 45,91 92,39 90,48 95,31 107,68 83,93 94,28 96,39 104,09Debt service 0,45 2,32 2,89 2,51 2,39 2,40 2,66 3,20 3,48 4,81Of which interests 0,14 0,96 0,99 0,73 0,78 0,80 0,82 1,12 0,87 1,37

Debt - History 29

A synthesis of the international debt reduction initiatives

In many countries, following the debt reduction initiatives, the debt service has been stabilised or reduced. But these benefits have not been fairly distributed, and have not always been enough.Many countries that would have needed debt cancellation have been excluded from HIPC/MDRI.Furthermore, the HIPC/MDRI exercises had been conceived as ‘one shot’ in order to solve the debt crisis. It has NOT been so! Risk of further debt distress still remainsWe need to go beyond a perspective dominated only by the creditorsThe measurement of debt sustainability has proved to be insufficient: there is a need for a better integration of human development dimensionsThis would pave the road for wider and deeper cancellation, including many countries (middle income) that are currenlty excludedDebt cancellation should be additional to other development financeBut the landscape is evolving: there are changes in the composition of the national ‘sovereign’ debt

The current

situation

Debt - History 30

System or ‘ad hoc’?

“While preserving the core principles of the HIPC Initiative, IDA and the IMF have continued to make use of the flexibility available in the framework governing the Initiative. Judgment has continued to be used in the area of completion point triggers. The Boards granted waivers to Afghanistan and Liberia for missed triggers on the basis that they had been substantially implemented and sufficient progress had been made toward the underlying objectives. Comoros reached its decision point following the progress made on clearance of its arrears, which will count as debt relief provided by its multilateral and official bilateral creditors. Flexibility was also exercised in the area of preparation and implementation of poverty reduction strategies.”

HIPC/MDRI Status of Implementation - September 2010

The current

situation

Debt - History 31

A new approach to debt risk: the principles of DSA

(i) a standardized forward-looking analysis of debt and debt-service dynamics under a baseline scenario, alternative scenarios, and standardized stress test scenarios (also referred to as bound tests); (ii) a debt sustainability assessment based on indicative country-specific debt-burden thresholds that depend on the quality of policies and institutions in the country; and (iii) recommendations on a borrowing (and lending) strategy to limit the risk of debt distress, while maximizing the resource envelope to achieve the Millennium Development Goals (MDGs)

The current

situation

Debt - History 32

The new sustainability approach

The Debt Sustainability Analysis (DSA), a ‘traffic light system’ that, however,does not cope with MDG related needsdoes not promote mutual responsibilitystill promotes the ‘one size fits all’ modeldoes not look ad private and national debtdoes not consider the wider policy environment (trade, financial flows, etc.)

The current

situation