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UNRISD News Number 20

Spring/Summer 1999

THE LAST WORD

Debt Relief: Taking Stock of Lessons Learned and Furthering Social Development

Eveline Herfkens

A quarter of a century after the eruption of the debt crisis in Latin America, debt is, unfortunately, still at the forefront of the development agenda. In a worldwide campaign, the Jubilee 2000 Coalition (http://www.oneworld.org/jubilee2000/) is calling for cancellation of the unpayable debts of the world's poorest countries by 2000, through a fair and transparent process. It is a moral imperative that the poor should benefit from debt relief as they never did from borrowing. Indeed it is primarily they who have paid for the debt crises.

A great achievement of the past decades has been a gradual recognition by all parties concerned that over-reliance on debt-related finance can seriously jeopardize development. Before this was recognized, many donors and international financial institutions (IFIs) treated the problem of debt as one of illiquidity. It has taken time to acknowledge that debt is sometimes a problem of insolvency, signifying the inability of the economy to service its external obligations in the long term. The agenda for debt-related assistance, represented by the Brady Plan in the 1980s and the Heavily Indebted Poor Country (HIPC) Initiative in the 1990s, has been refined and endorsed by all the relevant actors. Now, if a developing country's economic performance is hampered by an unsustainable level of debt, it can obtain special financial assistance from donors and IFIs. A country must meet certain economic criteria to qualify, but this condition is based on the notion that debt relief can only contribute to economic growth and poverty reduction in a favourable policy environment. This framework for debt relief is, in principle, a good one. Developing countries freed from the "debt overhang" are in a better position to increase private investment rates. This is a pre-condition for higher economic growth rates. Ultimately, without economic growth, there can be no poverty reduction.

Having said this, I do believe that the development impact of debt relief can be enhanced.

First, developing countries must spend the resources at their disposal as a result of debt relief in social sectors, such as sanitation, basic education, basic healthcare and food security. It is thus important that the link between debt relief in general—and the HIPC Initiative in particular—and social development be strengthened. We must ensure that debt relief is translated into higher expenditure for social development. Only sound economics and good governance can create an environment that will make it possible to transfer the benefits of debt relief to the poor. Tackling corruption and promoting respect for human rights, gender issues and the rule of law are essential elements of good governance.

Second, donors should take into account the debt profile of developing countries when choosing aid instruments. Donor financing should always be on a grant basis, as is the case in the Netherlands, especially when recipient countries are burdened by high levels of debt. Too often donors use aid instruments that exacerbate precarious levels of indebtedness, sometimes in conjunction with export schemes that have a questionable impact on development. In this connection, it must be emphasized that developing countries also have a responsibility to limit their borrowing to sustainable levels.

Third, debt relief, when it is required, should be provided expeditiously. However, many creditor countries are reluctant to write off their loans to developing countries and to finance international debt relief operations, even though economic analysis demonstrates the need to do so. Additional debt relief requires extra financial resources, and all creditors should pay their share. If debt relief is covered out of development assistance budgets or the reserves of the World Bank, other developing countries—some of them as poor as the HIPC countries—will lose out. The G-7 in particular should play a more prominent role than is currently the case. Although several G-7 summits have underlined the need for debt relief, two thirds of the pledges so far come from Scandinavia, Switzerland and the Netherlands. The German decision to contribute to the HIPC Trust Fund is therefore commendable; I hope that Chancellor Schröder is really willing to pay the price attached to his proposals. I was pleased to note that Great Britain pledged US$ 50 million after the last meeting of the OECD Development Committee and hope that other major creditors will follow.

I cannot escape the conclusion that, up to now, the World Bank has been forced to compensate for a lack of willingness among the richer countries to pay their share. This is unacceptable, because it implies a shift of the burden to borrowing countries. Other donors reward heavily indebted countries that adhere to sound development policies by cancelling official debts and by participating in multilateral and commercial debt write-offs. The Netherlands is a good example: between 1990 and 1998, 2.7 billion Dutch guilders (approximately US$ 1.4 billion) was spent on debt relief operations through multilateral, bilateral and commercial instruments.

Fourth, while IFIs in principle cannot provide development finance on a grant basis, they can provide loans on highly concessional terms. As these loans must eventually be repaid, it is imperative that IFIs continuously monitor and evaluate the development effectiveness of their loan portfolios. More work could be done in this field.

If these points are taken seriously and integrated into effective development policies, the overcrowded development agenda will gradually be relieved of one issue that has been on it for much too long. Then, instead of repaying debts, poor countries will be able to use scarce funds to better ends: for the promotion of social justice and sustainable development.

Eveline Herfkens is Minister for Development Co-operation of the Netherlands. She was an Executive Director at the World Bank and was a member of the UNRISD Board in 1997 and 1998.

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