Developing countries: debt relief initiative for poor countries faces challenges

Official report prepared for the US Congress. Argues that the initiative is not likely to provide recipients with a lasting exit from their debt problems, unless they achieve strong, sustained economic growth.

The main issues raised by the report include:

• Will debt relief release resources for reducing poverty? The report argues that decline in debt service will only “free up” resources for additional poverty reduction if countries continue to borrow at the same level and concessional terms as in the years prior to their qualifying for debt relief. This occurs because countries previously borrowed for several reasons including debt payments, and they will need to continue borrowing after receiving debt relief in order to meet their remaining debt payments and to increase spending on poverty reduction. In order for countries to service their debt after receiving debt relief, World Bank and Fund staffs assume that countries will achieve sustained, strong economic performance. For example, the World Bank and the Fund assume that export earnings will grow an annual average of over 9 percent for 20 years in four of the seven countries GAO analyzed. GAO’s analysis indicated that this assumption may be optimistic, since these countries rely on primary commodities, such as coffee, for much of their export revenue, and the prices of such commodities have fluctuated over time, with export earnings in fact declining in certain years. Failure to achieve the projected levels of economic growth could lead, once again, to these countries having difficulty repaying their debt.
• Can effected countries quickly prepare useful PRSPs?Debt relief under the initiative is to be linked to recipient countries’ preparation of a comprehensive strategy focused on reducing poverty that integrates numerous policies, such as achieving rapid, sustainable growth and improving health care systems. However, linking debt relief and poverty reduction creates tension between quick debt relief and preparing such strategies. Preparing a comprehensive, “country owned” poverty reduction strategy can be complicated and resource intensive. In 1999, World Bank and Fund staffs estimated that it could take countries up to 2 years to prepare such a strategy. However, Uganda, which the staffs consider at the forefront of these efforts, has been working on a strategy for about 5 years. Uganda has prepared a comprehensive strategy, but, according to the staffs, it still needs to provide additional estimates of the cost of poverty reduction programs and strengthen the links between expenditures and poverty indicators. Many actions are required to prepare and implement a poverty reduction strategy, including gaining the support of key stakeholders, such as political leaders with the power to affect change, and collecting and analyzing necessary data, such as data on the extent and major causes of poverty. However, weaknesses in countries’ ability to collect and analyze these data and other challenges may limit these efforts. According to officials from some nongovernmental organizations, such as Catholic Relief Services and Jubilee 2000, the desire to receive debt relief quickly may cause some countries to quickly prepare the strategies, which could diminish the strategies’ quality, or the level of civil society participation, at least in the short term. The World Bank, the Fund, and the U.S. Treasury said that these concerns are mitigated because some countries do not have to prepare a full poverty reduction strategy in order to qualify for debt relief, some countries will receive a significant share of their debt relief after they qualify for the initiative, and because debt relief can be an incentive for countries to prepare the strategies.
• How easy is it to get funding for the initiative?Financing the initiative has proven to be a challenge for many creditors, with some multilateral and smaller bilateral creditors reporting that they are facing difficulties in providing their full share of debt relief and need external funding. For example, some smaller bilateral creditors, such as Tanzania, are themselves potential debt relief recipients and may find it difficult to absorb the costs of forgiving other countries’ debts. For multilateral and smaller bilateral creditors, difficulties in financing their shares stem from legal, technical, and financial restrictions. For instance, the African Development Bank has stated that it is unable to finance its share of debt relief under the initiative solely through its own resources and at the same time maintain an adequate level of reserves and its commitment to future concessional lending. Difficulties in fully financing the initiative could undermine the success of the initiative, since debt relief is supposed to be additional to the assistance that donors and creditors would otherwise provide to low-income countries.

The uncertainties over whether the initiative provides a lasting exit from debt problems, the tension between quick debt relief and preparing poverty reduction strategies, and the difficulties in financing the initiative should not be seen, however, as a reason to abandon efforts to provide debt relief to eligible countries. Heavily indebted poor countries continue to carry unsustainable debt burdens that are unlikely to be lessened without debt relief, but participants and observers may need to have a more realistic expectation of what the initiative may ultimately achieve. [from author's executive summary]