Poor Country Debt Relief, Rich Country Shenanigans

July 30, 2001 • Commentary

Relieving the foreign debt of 41 poor countries was high on the agenda of the G-8 industrialized countries’ leaders when they met in Italy recently. Those nations, mostly in Africa, have about $200 billion in foreign debt that they cannot repay. President Bush wants to help these countries in a way that “doesn’t merely drop the debt,” but also helps “stop the debt.” He knows that debt forgiveness is only a “short term fix.”

No world leader, unfortunately, has proposed a credible debt relief plan that offers a long‐​term solution.

Instead, the United States and other rich countries are supporting a $29‐​billion initiative of the World Bank and International Monetary Fund for heavily indebted poor countries (HIPC). Under the HIPC initiative, countries must first begin World Bank and IMF adjustment programs. Only then do they receive debt reduction and become eligible for further lending.

But that approach will stimulate further foreign aid flows to the highly indebted countries and do nothing to ensure that the proper policies for growth are in place. The Bank and the Fund, we are told, will avoid keeping the poor countries on the borrowing treadmill by applying strict conditionality — providing aid only on the condition that reforms are implemented. If history is any guide, there is little hope that they will succeed. Highly indebted poor countries have been receiving IMF and World Bank aid based on strict conditionality for some 20 years. Numerous studies, both inside and outside the World Bank, have concurred with a recent Bank paper that found that, “There is no systematic effect of aid on policy.”

IMF money has also turned countries into loan addicts. A review of the record finds that at least 70 countries have been depending on Fund credit for 20 or more years and that once a country receives IMF aid, it is likely to become dependent on that credit for most, if not all, of the following years.

The reasons for the poor performance are long and well known, including that the multilateral aid agencies have no ability to enforce their conditions and that they have a bureaucratic incentive to lend regardless of the outcome. There is thus little reason to believe that conditional lending will work any better now than in the past. Nor is there reason to believe that debt relief will work better now than in the past. As World Bank economist William Easterly has documented, donor nations have been forgiving poor countries’ debts since the late 1970s and the result has been … more debt. From 1989 to 1997, the 41 highly indebted countries saw some $33 billion of debt forgiveness, yet still find themselves in an untenable position. They have been borrowing ever larger amounts from aid agencies.

Easterly notes, moreover, that private credit to the HIPCs has been virtually replaced by foreign aid, and that foreign aid itself has been lent on easier and easier terms. Thus, when the World Bank and IMF call for debt forgiveness, it is the latest in a series of failed attempts by rich countries to resolve poor countries’ debts. And it is an implicit recognition of the failure of past loans. Indeed, 96 percent of HIPC long‐​term debt is public or publicly guaranteed.

Given the multilateral aid agencies’ complicity in creating the poor countries’ current plight, we should expect the Bank and the Fund to be held fully accountable for their bad loans. But the agencies are not actually writing off their losses, as commercial banks would be forced to do under similar conditions. Rather than jeopardize their credit standing, they are instead creating a separate lending facility — the HIPC Trust Fund — which is being managed by the World Bank. In what amounts to a financial shell game, this Trust Fund is raising funds to be used to channel money through debtor countries to pay back old multilateral debts.

To add insult to injury, the World Bank and the IMF are asking donor nations for more money to cover the multilaterals’ bad debts. As economist Adam Lerrick has pointed out, rich countries will be paying for 60 percent of the multilaterals’ losses even though those aid agencies have plenty of resources to cover their entire share of the debt.

It is difficult to hold citizens of highly indebted poor countries responsible for the gross abuses and policy mistakes of their rulers who received generous support from western aid agencies. Many of those countries, after all, contracted those debts under authoritarian governments. It is also difficult to support the HIPC initiative when it is being used to bail out the World Bank and IMF with little long‐​term prospect of helping the highly indebted poor countries. Debt relief will only be a long‐​term fix as long as further flows of much‐​misnamed foreign aid are halted.

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