Tag: debt relief

Many developing countries are facing a renewed debt crisis. This is directly related to Covid-19, which is now sweeping across many poor countries in a new wave.

Between 2016 and 2020, debt service as a percentage of GDP rose from an average of 7.1% to 27.1% for South Asian countries, from 8.1% to 14.1% for Sub-Saharan African countries, from 13.1% to 42.3% for North African and Middle Eastern countries, and from 5.6% to 14.7% for East Asian and Pacific countries. These percentages are expected to climb again in 2021 by around 10% of GDP.

Incomes have fallen in developing countries with illness, lockdowns and business failures. This has been compounded by a fall in their exports as the world economy has contracted and by a 19% fall in aid in 2020. The fall in incomes has led to a decline in tax revenues and demands for increased government expenditure on healthcare and social support. Public-sector deficits have thus risen steeply.

And the problem is likely to get worse before it gets better. Vaccination roll-outs in most developing countries are slow, with only a tiny fraction of the population having received just one jab. With the economic damage already caused, growth is likely to be subdued for some time.

This has put developing countries in a ‘trilemma’, as the IMF calls it. Governments must balance the objectives of:

  1. meeting increased spending needs from the emergency and its aftermath;
  2. limiting the substantial increase in public debt;
  3. trying to contain rises in taxes.

Developing countries are faced with a difficult trade-off between these objectives, as addressing one objective is likely to come at the expense of the other two. For example, higher spending would require higher deficits and debt or higher taxes.

The poorest countries have little scope for increased domestic borrowing and have been forced to borrow on international markets. But such debt is costly. Although international interest rates are generally low, many developing countries have had to take on increasing levels of borrowing from private lenders at much higher rates of interest, substantially adding to the servicing costs of their debt.

Debt relief

International agencies and groups, such as the IMF, the World Bank, the United Nations and the G20, have all advocated increased help to tackle this debt crisis. The IMF has allocated $100bn in lending through the Rapid Financing Instrument (RFI) and the Rapid Credit Facility (RCF) and nearly $500m in debt service relief grants through the Catastrophe Containment and Relief Trust (CCRT). The World Bank is increasing operations to $160bn.

The IMF is also considering an increase in special drawing rights (SDRs) from the current level of 204.2bn ($293.3bn) to 452.6bn ($650bn) – a rise of 121.6%. This would be the first such expansion since 2009. It has received the support of both the G7 and the G20. SDRs are reserves created by the IMF whose value is a weighted average of five currencies – the US dollar (41.73%), the euro (30.93%), the Chinese yuan (10.92%), the Japanese yen (8.33%) and the pound sterling (8.09%).

Normally an increase in SDRs would be allocated to countries according their IMF quotas, which largely depend on the size of their GDP and their openness. Any new allocation under this formula would therefore go mainly to developed countries, with developing economies getting only around $60bn of the extra $357bn. It has thus been proposed that developed countries give much of their allocation to developing countries. These could then be used to cancel debts. This proposal has been backed by Janet Yellen, the US Secretary of the Treasury, who said she would “strongly encourage G20 members to channel excess SDRs in support of recovery efforts in low-income countries, alongside continued bilateral financing”.

The G20 countries, with the support of the IMF and World Bank, have committed to suspend debt service payments by eligible countries which request to participate in its Debt Service Suspension Initiative (DSSI). There are 73 eligible countries. The scheme, now extended to 31 December 2021, provides a suspension of debt-service payments owed to official bilateral creditors. In return, borrowers commit to use freed-up resources to increase social, health or economic spending in response to the crisis. As of April 2021, 45 countries had requested to participate, with savings totalling more than $10bn. The G20 has also called on private creditors to join the DSSI, but so far without success.

Despite these initiatives, the scale of debt relief (as opposed to extra or deferred lending) remains small in comparison to earlier initiatives. Under the Heavily Indebted Poor Countries initiative (HIPC, launched 1996) and the Multilateral Debt Relief Initiative (MDRI, launched 2005) more than $100bn of debt was cancelled.

Since the start of the pandemic, major developed countries have spent between $10 000 and $20 000 per head in stimulus and social support programmes. Sub-Saharan African countries on average are seeking only $365 per head in support.

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Questions

  1. Imagine you are an economic advisor to a developing country attempting to rebuild the economy after the coronavirus pandemic. How would you advise it to proceed, given the ‘trilemma’ described above?
  2. How does the News24 article define ‘smart debt relief’. Do you agree with the definition and the means of achieving smart debt relief?
  3. To what extent is it in the interests of the developed world to provide additional debt relief to poor countries whose economies have been badly affected by the coronavirus pandemic?
  4. Research ‘debt-for-nature swaps’. To what extent can debt relief for countries affected by the coronavirus pandemic be linked to tackling climate change?

The Paris Club is the name given to the grouping of 19 rich countries which meets in Paris monthly to consider the cancellation or rescheduling of official loans to poor countries (see Sloman Economics 7th edition, pages 784–5). For many of the 40 heavily indebted poor countries (HIPCs), this debt relief has been substantial, with 36 of the HIPCs receiving full or partial cancellation of their debts (see Sloman Economics7th edition, pages 788–90).

On 17 November it was the turn of the Democratic Republic of the Congo. The Paris Club cancelled 97.6% of the debt owed to its members by the DRC – $7.35 billion. As the Paris Club press statement says:

The representatives of the Paris Club creditor countries and Brazil met with the representatives of the Government of the Democratic Republic of the Congo (DRC) on 17 November 2010 and agreed on a reduction of the debt following the DRC having reached its Completion Point under the enhanced initiative for the Heavily Indebted Poor Countries (enhanced HIPC Initiative) on 1 July 2010.

As a contribution to restoring the DRC’s debt sustainability, the Paris Club creditors will provide a cancellation of USD 7350 million, fulfilling all their commitments under the enhanced HIPC initiative.

However, the Paris Club did have some reservations. These are explored in the articles below.

Articles
Paris Club cancels more than half of DR Congo’s debt International Business Times, Palash R. Ghosh (19/11/10)
Creditors agree Congo debt write-off, flag worries Reuters, Brian Love and Katrina Manson (18/11/10)
Paris Club and Brazil Cancel $7.35 Billion of Congo’s Debt Bloomberg Businessweek, Michael J. Kavanagh (18/11/10)
DR Congo gets US$ 7bn debt cancellation afrol News (18/11/10)

Paris Club Press Release
DRC Paris Club (17/11/10)

Questions

  1. Explain the process whereby HIPCs receive debt relief.
  2. What were the reservations expressed by the Paris Club in granting debt relief to the DRC?
  3. To what extent is there a moral hazard in granting debt relief? Explain.
  4. What can Paris Club members do to reduce the moral hazard?
  5. Find out what other debt relief has been given by the Paris Club to HIPCs over the past few months and whether concerns were expressed in those cases.