Jubilee 2000: Reports: Full report: Unfinished Business - The world's leaders and the millennium debt challenge

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In this report we make an urgent call on the Group of Seven leaders (G7). We want them to complete the unfinished business of the Cologne summit, and meet again before the year 2000 to agree to cancel the unpayable debts of the poorest countries.

In making this urgent appeal, we call on G7 leaders to face economic reality. The report seeks, within the limitations of our own resources and information, to define this reality.

a) providing an honest assessment of the real costs of debt cancellation, showing how these costs fall well below the exaggerated and unreal claims of creditors;

b) exposing the extraordinary lengths creditors go to mask the reality of sovereign government insolvency;

c) revealing the extent to which losses made by private and public international creditors are transferred, without public consultation, to taxpayers in both creditor and debtor countries;

d) placing the cost of debt cancellation within the context of the enormous international financial sector.

The cost of debt cancellation for Jubilee 2000's 52 countries will bring some economic pain to official and private creditors. However, this pain will be as a pinprick compared to the excruciating pain and loss suffered by millions of the world's poorest people. Furthermore, the creditors' pain may well induce renewed economic activity in developing countries and act as a spur to international trade and growth.

Jubilee 2000 supporters believe that the dawn of a new millennium gives us all a chance to start again. To recognise and admit to losses and errors. To wipe the slate clean, and in the words of John Maynard Keynes, to make a “bonfire” of unpayable debts. To complete unfinished business.

There is precious little time for G7 leaders to meet again to give us all this opportunity of a fresh start. We hope this report goes some way towards focusing their minds.

After the Group of Seven (G7) leaders met in Cologne, Germany in June 1999 they claimed to have agreed to write off up to $100 billion of debt owed by the world's most impoverished nations. Whilst this was heralded as a step forward, analysis from the Jubilee 2000 Coalition reveals that the Cologne initiative will give a little to a few countries and nothing to many others. The International Monetary Fund (IMF) itself admits that Mali, the eighth poorest country in the world, will pay more in debt service after the Cologne initiative than it does now. One in four children in Mali will still not live to see their fifth birthday. Even Zambia—where life expectancy will shortly fall to 33 years—will still pay more on debt service than on health and education combined. Once again, creditors have failed to grasp the nettle and cancel enough debt to free resources for poverty reduction.

Creditors often state that one of the major barriers to greater debt cancellation is cost. “Where will we find the money to pay for this initiative?” is often heard as a response to the millions around the world that support the call for poor-country debt cancellation to celebrate the millennium. Indeed, the build-up to the annual meetings of the World Bank and IMF was dominated by attempts to persuade intransigent creditors to come up with funds to pay for the Cologne initiative.

Jubilee 2000 asks these institutional creditors to take a large dose of reality. Using the value of poor country debt as traded on the secondary markets, it makes an honest assessment of the likely cost of cancellation. Much of this debt is worth a fraction of its face value. In total the 41 Heavily Indebted Poor Countries (HIPCs) owe $200 billion in face value terms, which is only worth $24 billion at market value.

The 52 Jubilee 2000 countries have $354 billion debts on paper, but these are worth only $109 billion at market rates and would cost only $71 billion to cancel. Spread out over 20 years, this is less than $4 per year—only one penny a day—for each person in the industrialised world. This cost is likely to be even less as Jubilee 2000 acknowledges that some countries can pay some of their debts.

There is no better time than now. Both the US and Britain have reported huge budget surpluses. In the context of a world where Bill Gates' wealth is worth more than the national income of 30 poorest countries put together, debt cancellation has to be affordable. If bilateral and multilateral creditors used the secondary market assessment as a guide to valuing the debt, they would have little difficulty in finding the resources needed for cancellation.

Sadly they have yet to bite the bullet. Jubilee 2000 Coalition director Ann Pettifor shows the lengths to which the international financial community will go to bail out speculators and political allies. After the crisis of the Asian tiger economies, the IMF prioritised the interests of foreign banks with a massive $120 billion bail-out of creditors who made bad lending decisions. Money can be easily found to protect the private sector from the discipline of market forces.

Various convoluted systems, including the Multilateral Debt Fund and HIPC Trust Fund, use `aid' to pay debts to the World Bank and IMF who are being rewarded for lending recklessly. Because funds can be transferred between different government budgets, taxpayers' money—supposedly aid to help the poorest—is instead effectively used to repay debts of impoverished countries to western creditors.

Equally absurd is the practice of keeping bad debts on the books so as to maintain the myth that effectively bankrupt countries are still able to repay those debts, obscuring the reality that they are bankrupt and the loans are worthless. This is particularly foolish, because compound interest makes these debts spiral out of control. Unpaid debts grow exponentially as countries pay interest on interest on interest. In Sub Saharan Africa, 65 per cent of new debt since 1988 has been capitalised interest and arrears.

The debts of the HIPCs have risen by 7.4 per cent per year since 1980 while their economies have grown by only 1.1 per cent per year in the same period. The poorest countries struggle to pay at least some of their scheduled debt service in an effort to try and slow the exponential growth of their unpayable debt. HIPCs are now spending more than 30 per cent of government revenue servicing external debt, with individual countries such as Madagascar and S ~ao Tomé and Príncipe spending over 60 per cent. This is money which comes directly out of the government budget, and is taken away from essential service provision. This not only exacerbates poverty, but also discourages the private investment the international community says it wants to promote.

For the poorest countries, most debt is with the international institutions and western governments, because private commercial lenders have partly been bailed out and have partly taken their losses. When a commercial bank makes a bad loan, it writes it off or at least admits it will only collect part of the money. This standard banking practice led to the development of a `secondary market' in developing country debt, in which bonds and loans are sold off at a deeply discounted value. In contrast, the World Bank and IMF refuse to act like private banks and pretend instead that this money will some day be repaid. So the debt continues to mount – as do the claims as to how much it will cost to cancel the debt.

Cost can no longer be held up as a reason for not providing desperately needed debt cancellation. Creditors have lessons to learn from the realism of the market. Jubilee 2000 urges the leaders of the rich creditor nations not to let the historic opportunity of the millennium pass without doing the right thing for the poorest people in the world. We ask that they meet again before the year is out, to agree a final deal on debt cancellation.

Jubilee 2000 does not want to reward bad governments. That is missing the point and will not prevent the debt mountain from building up again. We ask that the process of debt cancellation and the allocation of funds released be carried out by a transparent and independent process involving representatives from civil society.

By taking the opportunity of the new millennium and injecting it with some meaning, the leaders can start to narrow the “chasm that has widened between the affluent peoples and those whose only aspiration is to eat their fill and quench their thirst, to survive and preserve their dignity.”1

In the past 15 years, the face value of the debts has grown due to compound interest on unpayable bad loans. Do we reward bad lending? Better that we say: “Get real. Admit these loans are worthless and cancel them.”

These loans have almost no value, but to the children of Burkina Faso or Bolivia who do not survive or do not go to school these debts have a real cost. Morality, common sense, and good banking practice all require that the debt be cancelled.

The debts of the poorest countries are both devastating to the people of those countries, and grotesque relative to their income. But they are tiny when looked at within the context of an international financial system that is fabulously wealthy, and has grown at a stupendous rate over the last few years. On paper the debt of Jubilee 2000's 52 countries is $354 billion. The financial assets of the richest countries are estimated at $53 trillion.

This wealth of the financial sector and the virtual explosion in lending and trading in the 1980s stems from two developments. First, the de-regulation, by central bankers, of lending and borrowing on international markets. Second government, or taxpayer, protection of international creditors when things go wrong.

This combination of de-regulation and government protection goes some way to explain why the forest of international lending is so enchanting to bankers. But, as Kunibert Raffer has so cogently argued, these cosy arrangements are also clearly “a market imperfection”.1

Much of the new lending took the form of bond issues rather than bank loans.2 The growth in the bond markets was triggered by two factors: governments lifting controls and giving capital greater freedom to flow around the world, and secondly, decisions by central bankers to allow unlicensed institutions to raise funds in the financial markets. The world bond market grew from less than $1 trillion ($1,000,000,000,000) in

1970 to $7 trillion in 1986 to more than $23 trillion in 1997. It has tripled in size since 1986.3

Another source of wealth is in the trading of national currencies. The City of London alone has a daily volume of $460 billion. New York has a daily turnover averaging about $250 billion; Tokyo $160 billion; Singapore $100 billion, Hong Kong, Zurich and Frankfurt $80 - $90 billion each.4

As a result of this massive growth in the bond and currency markets, finance has become more dominant in the world economy. The combined activities of currency trading, leveraging (buying bonds on borrowed money), and hedging (betting on movements of interest and exchange rates) have become major profit centres for the largest commercial banks, especially in the US. By 1992, financial assets from the advanced nations of the OECD totalled $35 trillion—twice the economic output of the OECD. McKinsey and Company5 predict that the total financial stock will reach

$53 trillion by the year 2000—“triple the economic output of the OECD economies”.6 This is the context in which Jubilee 2000 proposes the cancellation of relatively minor sums—$354 billion at face value, $109 billion at market prices—of poor country's debt.

The inherent risks in global finance's speculation for profit were exposed by the 1994 global bond crash and the crisis caused by the devaluation of the Thai Baht in 1997. In 1994, investors, both public and private, suffered major losses: Metallgesellschaft of Germany lost $1 billion; Glaxo of Britain, $160 million; Orange County, California, $1.7 billion; and Bank Negara, Malaysia's central bank, $4 billion.

The list shows that big companies as well as central bankers and government treasurers joined in the speculation, profitably playing the market swings – and sometimes suffering losses. But in our international lending system, private lenders, unlike poor country debtors, can find protection from the wrath of market forces. In collusion with revered central bankers like Alan Greenspan of the US Federal Reserve, and Michel Camdessus of the IMF, creditors evade both the stern regulation of big government; but also the tough discipline of the market. At home, taxpayers subsidise their failed lending through tax breaks, and rescue them from crises through costly bail-outs. Official creditors like the IMF and World Bank make gross errors in lending and like Soviet-style banks are protected from the consequences of these decisions by taxpayer donations. International creditors find that they even profit from their errors, and the lending community comes to accept the enchanted forest as normal. Magically, losses vanish and commercial banks are rescued. And equally magically, but much later, these losses appear on the balance sheets of ordinary taxpayers.

The irresponsibility of bankers, in particular central bankers, and the anarchy of the `enchanted forest' causes little concern to populations in the west. This may be due to ignorance; but may also be because economies are booming. As Peter Warburton has argued, “anarchy in the global financial markets masquerades as an agent of national prosperity and personal freedom.”7

In 1982 when the Third World debt crisis surfaced, commercial banks held $390 billion in loans to developing nations, while the public agencies held $239 billion. A decade later the private banks' lending totalled $473 billion, but public lending had more than doubled to $591 billion.8 With the wave of a magic wand, the debts of the poorest countries had been converted from commercial bank loans into debt owed to public institutions like the IMF and through them to western taxpayers. Western governments are equally ready to bail out their own banks and companies. The UK government took on £280 million of British Aerospace debt in 1996 for Hawk aircraft, later used by the Indonesian military to terrorise East Timor. The UK found only £71 million that year for development projects in Indonesia. This use of tax revenues to `aid' big business, and the worldwide diversion of losses to taxpayers has continued unabated.

Japan experienced a phenomenal upsurge in the demand for bank borrowing between 1983 and 1989. This fanned the flames of speculation in residential and commercial property and financial assets.9 Japanese property in 1989 was valued as worth more than all of North America. When reality dawned and the crash came, banks had to be rescued. The scale of this rescue may forever be hidden in the darkest recesses of Japan's `enchanted forest'. The savings of ordinary Japanese through their `postal savings system', state pension funds, plus tax money combined to provide more than $600 billion for the bailouts of a few private banks. This is almost twice the total debts of the 52 countries identified by Jubilee 2000 as in need of urgent debt cancellation.

The most flagrant flouting of market forces was the rescue of Long Term Capital Management (LTCM), in September, 1998. The Federal Reserve Bank of New York, acting with the full support of the US Federal Reserve, facilitated a massive private bail-out of this unwise group of hedge-fund managers, which included two Nobel Prize laureates in economics. The injection of capital was $3.6 billion.

The US savings and loan industry (the US equivalent of British building societies) virtually collapsed on a wave of corrupt and reckless lending fuelled by deregulation. But in 1989, the US government spent $150 billion of taxpayers' money to rescue the industry, plus many billions more to clean up the failures of major commercial banks. The US Federal Reserve discreetly helped them `get well' by holding down short-term interest rates around 3 per cent, which enabled the banks to borrow at 3 per cent to acquire huge volumes of long-term bonds that yielded 6-7 per cent thus replenishing their balance sheets by capturing the spread between the two.10

Alan Greenspan's helpful actions towards the domestic US banking sector contrast directly with those of the IMF's Michel Camdessus in South East Asia after the 1997 crash. In Asia the IMF prioritised the interests of foreign banks, with a massive $120 billion bail-out. In contrast to Greenspan's policy, Camdessus imposed high interest rates on the stricken Asian economies, which quickly undermined domestic banks.11

Paul Krugman12 commented that “the Asian crisis has mainly been about bad banking and its consequences and only incidentally about currencies”. East Asian financial intermediaries “were perceived as having an implicit government guarantee, but were essentially unregulated and therefore subject to moral hazard problems. The excessive and risky lending of these institutions created inflation – not of goods, but of asset prices. The overpricing of assets was sustained, in part, by a sort of circular process, in which the proliferation of risky lending drove up the prices of risky assets, making the financial condition of the intermediaries seem sounder than it was.”

The Mexican debacle of 1995 was caused when Wall Street investors borrowed at five per cent and invested in unregulated bonds earning 14 per cent in Mexico. As the crowd herded around Mexico, the inevitable crash followed. These Wall Street investors were rescued from their gross errors of judgement when a Democratic President, Bill Clinton, mobilised $50 billion to compensate them. At the same time, the World Bank assembled the biggest loan it had ever made, to help the Mexican government bail out private banks in Mexico. Those loans were to the government, so the money will not be repaid by the Wall Street and Mexican banks that profited, but by the poor people of Mexico, who will find themselves in debt bondage for some years to come.

These examples of bail-outs and rescues show not only how bizarre are the practices of the international financial institutions; but also how easily money can be found to rescue the private sector, and to protect it from the discipline of market forces. The Japanese government in particular is quick to warn of the risk of `moral hazard' in bailing out the poorest people in the world. Its tough approach in negotiations over poor country debt cancellation, contrasts markedly with its approach to Japan's own private banking sector.

This report seeks to alert taxpayers to a) the way in which apparently cautious bankers use and exploit tax revenues for private sector bail-outs; and b) how western government aid is used to bail out official creditors like the World Bank and IMF whose staff have made bad debts and incurred reckless loans.

The process for diverting taxpayer funds to creditors is as secretive as a sorcerer's cabal in a tangled forest. But the secrecy serves a purpose: it allows central bankers, IMF and World Bank officials to obscure economic reality from taxpayers – while continuing to bleed the poorest, most indebted nations of precious resources. Furthermore, it allows these unelected and unaccountable officials to maintain an economic grip over these nations, undermining their economic sovereignty and autonomy.

Creditors have got lost in the enchanted forest of international finance. This report attempts to steer them towards the light of day and economic reality.

Debt cancellation is “common sense,” said Germany's Chancellor Gerhard Schröder when he announced the measures agreed by the Group of Seven (G7) leaders at their summit in Cologne in June 1999. Common sense is exactly what it is. When the world's poorest countries1 are diverting precious resources from education, health and clean water to pay foreign creditors, economic logic as well as moral duty demands that the first, necessary step in dealing with those countries' problems is to cancel their unpayable debts.

There are many concerns about the outcome of the Cologne summit, including the fear that countries will have to leap through ever-higher hoops to qualify for the debt relief on offer. These concerns are set out in Jubilee 2000's earlier publication, Crumbs of Comfort, and elsewhere. However, the principal problem is that not enough common sense was exercised by the leaders who gathered in Cologne. While the improvements to the existing framework of debt reduction announced at Cologne represent a step forward and a tribute to the power of millions of Jubilee 2000 campaigners around the world, they did not go far enough to meet the fundamental objectives of debt cancellation – to reduce poverty and injustice. Instead, the G7 fell back on the same flawed logic that has dominated the thinking of the major creditor governments and the multilateral institutions they control over the last 20 years. These institutions have consistently failed to apply sound economic principles in the face of the debt crisis and, as the discussion below and in Chapter 3 of this report shows, their policies lead in many cases to tortuous, complex outcomes that are not in the interest of either developing countries or the creditors themselves.

The London Financial Times explained the vital need for debt relief in an editorial earlier this year: “The case for appropriate and radical action is compelling. Debt servicing imposes an impossible burden, particularly in Africa.”2 This view has increasingly been accepted across the political spectrum, and was expressed more recently by the President of Botswana, Festus Mogae, who called for a total cancellation of Africa's debts by donor countries. He said debt repayment put development into reverse “as the resources set aside for development all go into repaying the debts.”3

The Cologne initiative agreed as a joint policy by the G7 nations provided headline writers with impressively high figures for debt relief. $70 billion was the most common figure used, made up of $50 billion of debt to be cancelled under the enhanced Heavily Indebted Poor Countries (HIPC) Initiative and $20 billion of additional official development assistance (ODA) debt cancellation for those countries that qualify. The PR machine was put to good effect; previously agreed bilateral debt reduction was said to be worth a further $30 billion, allowing the more gung-ho of the G7 leaders to proclaim a total debt reduction of $100 billion. British Prime Minister Tony Blair described the summit as “probably the biggest step forward in debt that we have seen for many years.”4

What the G7 failed to recognise is that many countries need complete debt cancellation and they need it now – not in the interminable timeframes left almost untouched in Cologne.

Most importantly, the Cologne summit failed to change the underlying concepts of the HIPC Initiative, even though these concepts defy common sense. The World Bank defines a debt as “sustainable” if “a country is able in all likelihood to meet its current and future external obligations in full without resorting to rescheduling in the future or accumulation of arrears.” This takes no account of poverty or the need to spend on health, education and clean water – indeed, a debt is more “sustainable” if fewer children go to school and money is taken away from education to debt service payments.

From this violation of common sense, the World Bank and IMF go on to define sustainability in terms of the ratio of debt to export earnings, with no explanation of why this should be a valid indicator. Indeed, Harvard economist Professor Jeffrey Sachs, in evidence to the US Congress, said that “the debt-to-export ratio was patently foolish from the start, a construction of the IMF and G7 finance ministries, not a reflection of the economic realities of the debtor countries.”5

The key change proposed in Cologne was simply to revise the number applied to this “patently foolish” criterion. Previously, the World Bank and IMF said that a debt was “sustainable” if the ratio of debt-to-exports (in `net present value'—NPV—terms) is between 200 per cent and 250 per cent. Then last year in their first HIPC review, the World Bank and IMF suggested this be changed to 200 per cent. G7 leaders in Cologne lowered this to 150 per cent. The fact that the G7 and the Bank and Fund should acknowledge in such a short space of time that their assessment of debt sustainability was out by 40 per cent, points to the inadequate and arbitrary nature of the current measures of debt sustainability and the process for arriving at them. It becomes clear that the international community is simply picking numbers out of the air to give a threshold to a criterion that defies common sense.

This threshold is in fact chosen to ensure that some countries qualify and not others. An internal IMF and World Bank paper describes “a potential drawback” of lowering the NPV debt-to-export target to 150 per cent: it would “broaden eligibility beyond the 41 HIPCs” to include Haiti, Cambodia and perhaps two countries seriously affected by the Russian economic crisis, Georgia and the Kyrgyz Republic.6

Many have argued like Professor Sachs that export earnings are an irrational criterion for debt cancellation, and that it makes more sense to look at government revenue and what portion of tax revenue goes to debt service rather than development. Although it satisfies common sense, the World Bank and IMF rejected this, until France demanded that Côte d'Ivoire get debt relief under the HIPC Initiative. Suddenly the Bank came up with a new fiscal criterion – debt would be “sustainable” if the NPV debt was between 250 per cent and 280 per cent of tax revenue, but only if exports were more than 40 per cent of GDP and tax revenue more than 20 per cent of GDP. The G7 at Cologne picked new numbers out of the air, and reduced these three ratios to 200/30/15, respectively.

The main reason for Bank and Fund rejection of the (primarily British-government) proposals to give greater prominence to the fiscal criterion appears to be that the two institutions would have to cancel more debt, and especially that they would need to take into account more problems in the country itself. The internal document notes that “there are serious methodological problems with the fiscal window, including problems on how to deal with the impact of real devaluations and falling revenues on the debt-to-revenue ratio.” The report adds: “The more emphasis is given to the fiscal side, the more likely debt sustainability will be broadened to domestic debt”. Domestic debt service must also be repaid out of tax revenue, and so far the IMF and World Bank have tried to ignore this. If it were realistically taken into account, still more debt would have to be cancelled.

Instead of simply saying they don't want to obey common sense and cancel debt, the IMF and World Bank have created complex and obscure structures to hide the obvious. The result is a Cologne initiative that will give little to a few countries and nothing to many others. Even for the beneficiaries the outcome is likely to be one of buying time, rather than an outright solution. First consider the IMF's own figures for selected HIPCs, based on their own debt sustainability indicators.

The IMF estimates that Mali will gain nothing from Cologne. In fact, this country will have to pay more after it goes through the Cologne initiative than before. Bolivia and Burkina Faso will see only marginal reductions in their annual debt service. Côte d'Ivoire, Uganda, Mozambique and Guyana will all see more substantial falls in their debt service due, though none of these profoundly poor countries will see debt payments cut by half. Analysis by the Jubilee 2000 Coalition suggests that of these, Uganda and Mozambique require total write-off of their debt, if they are to have a chance of meeting the 2015 development targets signed up to by donor countries.7

Further Jubilee 2000 research suggests that countries that qualify for the terms of the Cologne initiative will still be left with intolerable debt service burdens. The IMF and World Bank accept that even after Cologne, 5 of the 41 HIPC countries will not have any debt cancelled. Table 1 shows Jubilee 2000 calculations8 for the remaining 36 countries,9 which shows that 14 countries in addition to Mali will be expected to pay more in annual debt service after HIPC than they do now. World Bank and IMF staff may try to `front load' debt cancellation for a few countries so that debt service payments do not rise in the short term, but this is just a rearrangement of debt and it is clear that these 15 countries will gain little or nothing.

In addition to considering the level of total debt reduction and the effect on debt service, it is clearly essential to assess the impact of the Cologne initiative on ordinary people in some of the poorest countries of the world. Oxfam International, using figures from the US Treasury as well as the World Bank, has evaluated the initiative in these human terms. It concludes:

The Cologne initiative is deeply flawed. It builds on arbitrary and inadequate instruments and fails to meet the central challenge of freeing up substantial resources to be switched to measures designed to reduce poverty. As we find later in this report, under a common sense approach, radical debt cancellation is necessary, achievable and affordable. And as Chapter 2 shows, the price of continued inaction is heavy on those in the poorest countries of the world.

The foreign debts of developing countries are growing at a rate that is simply out of control. For all developing countries, debts have risen from a total of $610 billion in 1980 to $2.3 trillion in 1997. This represents an annual average increase of 8.2 per cent. Over the same period, the annual economic output of the developing countries rose by an average of five per cent per year.1

The trend of debts running out of control is even more marked in the case of the HIPCs. Their debts have risen from $58 billion in 1980 to $199 billion in 1997, an annual increase of 7.4 per cent. Over the same period the GNP of the HIPC economies has grown only 1.1 per cent per year.

These figures hide huge differences amongst individual countries, but the overall trend is clear: debt is accelerating ahead of economic growth, and therefore capacity to pay. Despite collective denial by creditors, the economic logic is irrefutable. It explains why there are regular defaults: by Mexico and much of South America in the 1980s and 1990s; by African governments; by Pakistan and more recently the countries of eastern Europe. Indeed, in many cases defaults are ongoing.

Faced with a simple economic reality of the impossibility of debt repayment, Washington institutions refuse to face reality. They bury their collective heads in the sand (or in a sandstorm of rhetoric and obfuscation) and refuse to simply write off bad debts in the way that a commercial bank would.

When a loan is first made, the creditor makes a judgement on the borrower's capacity to repay. Much lending in the early 1980s failed on this elementary banking principle. Having misjudged capacity to repay; and having failed to collect debt repayments, creditors are now engaging in blind denial. Worse, they are pouring fuel on the fire of bad debts, by refusing to write them off, while continually adding compound interest.

The compounding of interest is an automatic process of adding interest on interest. John Maynard Keynes described it `as a form of magic' whereby debts miraculously increase. If full repayment is not made, interest is charged on the unpaid debt and added to the total, which if left unpaid has interest added again. With the faces of creditors turned the other way, this automatic ratcheting-up of the debt ignores economic reality. Above all it ignores the capacity to pay.

In Sub-Saharan Africa the automatic process of compounding interest is clearly out of control. The share of interest and arrears in total debt rose from 12 per cent in 1988 to 28 per cent in 1996. What is more shocking is that interest and arrears accounted for 65 per cent—two thirds—of new debt since 1988.2 The creditors seem unable to face reality, and stop the process.

The process is reminiscent of Walt Disney's Sorcerer's Apprentice. A precocious Mickey Mouse, in the absence of the sorcerer, and with the task of cleaning up the studio, uses his limited knowledge of magic to bring brushes, pails and mops to life. This works well for a while, but soon turns to anarchy, as water gushes everywhere. Mickey Mouse's limited knowledge is not sufficient to stop the process.

Countries in a de facto bankrupt situation—which most of the HIPC countries are—or in a state of civil war—as was the recent experience of Rwanda, Burundi, and Congo—find their debts rising inexorably, without any qualitative reassessment by the creditor.

One effect of this spiralling escalation is to increase the perceived cost of debt cancellation. “As anyone familiar with basic mathematics can verify,” Professor Kunibert Raffer of the University of Vienna has argued, “creditors unwilling to grant sufficient relief when necessary, increase irrecoverable debts. Claims keep growing on paper, further beyond the debtor's economic capacity to repay. `Phantom debts' come into being, existing only on paper, nevertheless compromising the debtor's economic future and allowing creditors to exert pressure.”3

Where does the money come from to pay debts? The poorest countries use some aid to repay debts, but for the 41 HIPC countries debt service paid in 1997 was $8.7 billion, compared to a total of aid grants of $7.9 billion.

Thus, even after available aid is used, poor countries mainly use their own scarce revenues to repay debts. The money comes from export income, sales taxes and customs duties. But there are limits as to how much tax can be squeezed out of poor people. Indeed, in setting the new `sustainability levels' the G7 leaders in Cologne agreed that they could not expect poor countries to collect more than 15 per cent of GDP as tax revenue. An April 1999 IMF/World Bank paper estimates that 21 out of 38 of the poorest countries collect less than 18 per cent of GDP in tax revenues.4

The United Nations Conference on Trade and Development (UNCTAD) estimates5 that a well-balanced poor country budget requires the country to collect 18 per cent of GDP in tax. This would ideally be spent on: education (mostly at the primary and secondary level) 5 per cent of GDP; public health outlays 3 per cent of GDP; costs of public administration 2 per cent of GDP; and expenses on police and defence 3 per cent of GDP. Infrastructure spending is sure to require at least 5 per cent of GDP, even if the government leaves much of the infrastructure finance to the private sector and focuses its attention on items (e.g. rural roads) that are much harder to finance through the market.

If 18 per cent of GDP is the minimum expenditure and if poor countries can only raise 15 per cent, the circle cannot be squared. Aid is less than debt service actually paid; plausible tax revenues are less than the minimum needed to provide essential services. “There is virtually no room for debt service,” says UNCTAD. “Experience has shown that attempts to collect more than a minimum in external debt servicing result in (a) serious budget deficits; (b) unacceptable cuts in education, public health, or basic infrastructure; or (c) tax rates at levels that jeopardise economic growth.”

Table 2 gives figures for the proportion of government revenue used in servicing external debt. On average for the 52 Jubilee 2000 countries, just under 30 per cent of government revenues are diverted to debt service, and for some cases it is much higher. In 1997, Sao Tomé and Príncipe spent 90 per cent of its revenue servicing debts; Nicaragua 66 per cent; Côte d'Ivoire 63 per cent; Honduras and Madagascar, 61 per cent.

Yet HIPCs pay only half of what they are said to owe. If we consider what these countries should have paid (their scheduled debt service), then we move rapidly into the realms of the impossible and absurd. The average scheduled debt service for the Jubilee 2000 countries for which data is available is 50 per cent of government revenue. Angola, Cameroon, Mali, and Sao Tomé and Príncipe should be giving up all of their government revenue to western creditors and the Democratic Republic of Congo should be paying twice its tax earnings.

To compound the pressure on government budgets, some of the poorest countries have significant domestic debts. Failure by government to service domestic debts can seriously weaken the domestic banking sector. A recent survey by Debt Relief International of 23 countries—18 of which were HIPCs—found that for 13 of these the domestic debt burden exceeded 50 per cent of government revenue.6 Yet, foreign creditors do not take domestic debt into account when assessing sustainability.

The swallowing of scarce government revenues is tearing the heart out of the state in the most indebted developing countries. The end of the colonial era and more recently the end of the Cold War should both have delivered the opportunity for developing countries to embark on a path of sustainable economic development leading to rising standards of living, and the building of strong societies. However, states are being turned into mere tax collectors for the IMF, World Bank and other creditors, and the reluctance of creditors to act decisively condemns these countries to a future of poverty, instability and dependence on the west. In the modern Washington consensus that lies behind the economic structural adjustment plans of the IMF, the emphasis is always on market provision, privatisation, and cuts to government spending in order to restore economic stability. What is ignored is that the private sector cannot operate without the benefit of a stable public sector that provides a healthy and educated work-force, and the roads, railways, water, sanitation and other essential infrastructure. Government is responsible for regulation of the financial sectors and provides the anchor of the economy in the form of the central bank. Finally, it is the public sector that provides the security of the law and the courts that are essential to enforce the contracts that are the basis of commerce. In short, a strong public sector provides the essential fabric of society, without which the result is lawlessness, corruption, and chaos. Without a bold programme of debt cancellation there is no chance of building strong civic institutions that create the space for a strong private sector in the indebted countries.

“Fiddling the books to disguise the fact that loans are bad is the sort of behaviour that is deplored in commercial banks. It must not become IMF policy.”

This quote from the Financial Times in July 1999 was used in reference to IMF lending to Russia. The IMF suspended its lending programme to the Russian government in August 1998 when the government devalued the rouble and defaulted on its domestic debt. Russia has built up over $50 billion of foreign debt since the end of the Soviet era, and needs $4.8 billion to service its debt to the IMF and World Bank in 1999 alone. It has debts in the region of $20 billion to the IMF. In July 1999, it became clear that the IMF would resume lending to Russia. Russia will be able to borrow $1.9 billion in 1999 and $2.5 billion more in 2000. The new loans will keep Russia from failing to make scheduled payments on its old IMF loans. However, Russian officials will not actually see the new funds: the IMF will simply move the money from one account to another in Washington DC.

To any sane person, it is absurd that the IMF and World Bank lends to impoverished countries, so that they, the debtors, can keep up repayments to... the World Bank and IMF. Far from being an exception this is typical creditor behaviour and is one of the many mechanisms used to maintain the façade of a healthy debtor/creditor relationship.

The facts are that the poorest countries simply cannot meet their debt service obligations – only half to two-thirds of scheduled debt service is actually paid. The rest is rescheduled or becomes arrears on the existing debt.

The official creditors have lessons to learn from the realism of the market. Private banks respond much more quickly to the issue of bad debts. They will either write them off and record the loss against the profit and loss account of that year, or they will build up provisions, and then use these to cushion the effect on the profit and loss account for any given year. Alternatively they sell on their debts in the secondary markets which take a realistic view of the status of each debtor country and the value of their debts. Official creditors should be ready to act decisively, by treating debts with the realism that the market would assign. In the next chapter we look at the realism of commercial lending. Here we look at the surreal pretence that leads to the tortuous processes detailed below.

Much of the debt service is paid for by debtor governments themselves, from the meagre tax revenues they collect. But as they get deeper into debt, debtor governments meet their obligations by using increasing amounts of outside money, through a mixture of new loans, aid and `juggling the figures'. The creditors willingly assist to create the myth of solvency.

A significant part of the debt is paid for through grants from `bilateral donors' i.e. the Offical Development Assistance (ODA) departments of western governments, in particular the Scandinavian, Dutch and Canadian governments, but also including the British government. They pay ODA grants into trust funds which are then used to repay loans to the IMF and World Bank. In other words western taxpayers make donations, in the form of aid payments, to the debtor government which in turn are used to pay other creditors – in particular the World Bank and IMF.

The golden rule is that the Bretton Woods institutions, despite some very bad lending decisions which have been well documented elsewhere1, must be repaid.

Former Tanzanian president Julius Nyerere has described the process as it affected his country: “Since 1986 Tanzania has been servicing mainly its multilateral debt, because failure to do so within 60 days after due dates leads automatically to suspension of future disbursements from the multilateral financial institutions and a boycott from the entire donor community. Tanzania has been servicing very little of its debt to the Paris Club creditors. The need for constant rescheduling of this debt, and the practice of capitalising unpaid arrears, means that this category of debt is also mounting up year after year. And so the result of this piling up of arrears; and the constant need to borrow in order to service our debt; and the constant need to service our debt in order to borrow—that is in order to earn the right or privilege to increase our debt burden further...the result is we can no longer get out of this vicious circle.”2

The facts speak for themselves. An examination of some of the `strange-but-true' mechanisms carried out by the creditors reveal they are far removed from reality as they carry out their nonsensical, tortuous processes to create the illusion that bankrupt countries are paying all their debts.

Given that the HIPC Initiative was created with this nonsensical process embedded in it, it is little surprise that it has delivered such poor results to date. The HIPC Initiative was set up in 1996 and hailed by World Bank director James Wolfensohn as `good news for the poor'. Yet, after three years only four countries have received debt relief and two of these are already back in an unsustainable situation again.

The methods of financing the HIPC Initiative bear the hallmarks of a system where the most obvious solution—cancellation of the debt—is avoided at all costs. The HIPC Trust Fund is used to finance debt payments to the World Bank and other regional development banks. Some of the funding comes from the IBRD, (the commercial lending arm of the World Bank), which had by April 1999 transferred $850 million from its profits made from previous lending to poor countries. As mentioned earlier using profits to offset bad loans is what private banks do all the time, but it takes much persuading for the World Bank to behave, effectively, like a bank.

The HIPC Trust Fund provides debt relief in one of three ways: by prepaying a portion of debt owed to multilateral institutions, purchasing and cancelling a portion of the debt or by paying debt service as it becomes due. The principle is that donor countries pay the debts of the HIPCs for them and in addition the World Bank (through IBRD) pays a HIPC so that the HIPC can then pay the World Bank.

The practice is similar at the IMF. The IMF set up the ESAF-HIPC Trust which by March 1999 had received a total of $50 million in aid contributions from nine countries. The IMF added its own funds to these by contributing $120 million from the ESAF Trust Reserve Account, together with a temporary transfer from the same account of $350 million. Each HIPC that qualifies for relief is then given an individual sub-account, and these accounts are used to meet part of the debtor governments payments on existing debt to the IMF.

The IMF is therefore paying itself on behalf of debtor countries that owe it money.

Since 1989 the World Bank has sought to help indebted countries buy back their debt from the private banks at realistic market prices. The secondary debt market is explained in detail in Chapter 4, but in a nutshell through these buybacks the World Bank gives an indebted country money to give to private banks in order to write off debt it is not repaying at a lower cost that if the debt were simply repaid. The World Bank is therefore giving money for private banks, not poor countries, and the banks get some payment for debt that would otherwise not be repaid at all.

A recent example is the Guinea government that bought back $130 million of its own debt to commercial banks in a buyback agreement costing $13.5 million, financed by the World Bank's IDA Debt Reduction Facility and the governments of Norway, France and Switzerland. By the end of 1998, 17 countries had completed buybacks, extinguishing $3.7 billion of debt at a cost of $583 million.

There is clearly a beneficial side to this in reducing the debt overhang, albeit by a relatively small amount. But as in the debt crisis of the 1980s, this is a further example of western taxpayers, through donor funding of the IDA Debt Reduction Facility, bailing out private banks.

As if to invite comparison with logic from another planet, the World Bank found an appropriate name for yet another ingenious device to ensure the beneficiaries of creditors' generosity would be other creditors. The `Fifth Dimension Facility' was established in 1988 by the World Bank in response to the difficulties many indebted countries were having keeping up payments on their market-rate loans to the World Bank (IBRD).

Using the Fifth Dimension Facility, donors (i.e. western taxpayers) subsidise existing loans by reducing the interest rate down to levels that are the same as the concessional loans from the IDA fund. During the 1990s the facility has contributed $1.5 billion shared among 23 countries. Effectively, donors pay the debt service on behalf of a debtor country that cannot pay. Donors keep up the pretence and the World Bank makes a hefty profit.

Bilateral creditors use aid flows to hide the fact that debts are not being repaid.

HIPC countries paid out $8.7 billion in debt service in 1997 and received a total of $7.9 billion in overseas aid.3 For the Jubilee 2000 52 countries, the figures are $22.9 billion in debt service compared with $9.8 billion received in overseas aid.

Flows of aid, generally assumed by the taxpayer to be an honourable attempt to alleviate some of the poverty of impoverished nations, are not all they seem. For highly indebted nations, some aid (usually described as balance-of-payments support) serves as funds to be channelled back into debt repayments.

Although many HIPCs receive more in aid than they pay out in debt service, this is not the case for all of them, as the table below illustrates.

Because of the fungibility of money (the fact that money used in one area frees up money to be used in another), it is estimated that half of this sum of $7.9 billion is effectively coming straight back to creditors through debt service in a senseless merry-go-round.

Even aid that does remain in the country does not become straightforward assistance to debtor governments to help fund their cash-strapped social programmes. As Professor Jeffrey Sachs has argued, these “grants frequently finance extra-budgetary activities established by the donors. In fact, since the governments are bankrupt, donors often attempt to establish these extra-budgetary programs precisely so that they will not be drawn into the fiscal insolvency of the government. The result is profound de-institutionalisation of public activities, with a government that remains insolvent and illiquid, and a bilateral donor process that supports non-governmental activities in lieu of an effective state.”4

Aid therefore is used to repay debts on behalf of indebted countries but it has a secondary function of weakening the sovereignty of debtor governments.

Once a country is deemed eligible to receive HIPC debt relief, it has to wait anything up to six years before receiving full assistance. In the intervening period a multilateral debt fund (MDF) is set up to receive donations from the industrialised countries with the express purpose of paying the debts of that country. MDFs are interest bearing accounts opened by the central bank in the name of the debtor government. The resources of the Multilateral Debt Fund can only be used for debt service payments on multilateral debt, i.e. debts to the IMF, IBRD, IDA, the African Development Fund, the African Development Bank, the Asian Development Fund and the Inter American Development Bank. The main donors to the Funds are Austria, Denmark, the UK, Norway, the Netherlands, Sweden and Switzerland, and the recipient countries together with amounts paid in are listed below:

Uganda's experience of MDFs and the HIPC programme exposed some of the grandiose claims about HIPC. When HIPC debt relief was released at Uganda's completion point in April 1998, the MDF was closed, considered no longer necessary. Uganda had had her debts dealt with by this latest creditor scheme.

However, the debt relief delivered turned out to be less than the annual funds previously paid into the MDF! Uganda found itself worse off by $10 million a year. Faced with this embarrassment, the World Bank agreed to give more of the relief in the early years. This worked for a year, until the world-wide fall in commodity prices yet again exposed the creditors' meanness, and lack of judgement. Uganda was back where it started with an unsustainable debt burden only one year after being trumpeted as the first country to receive HIPC debt relief.

What really makes the MDFs stand out as a ludicrous part of the enchanted forest of the international financial system is this: all the donors mentioned above, including those involved in MDFs, are themselves owed (sometimes substantial) debts through the Paris Club by the very countries on behalf of whom they are repaying debts to the World Bank and the IMF.

Professor Sachs sums it up as follows: “The world has implicitly and explicitly recognised that these countries cannot service debts now or in the foreseeable future. We just hide that fundamental reality in a complex shell game, in which large-scale debt servicing is very imperfectly offset by debt postponements, arrears, new loans and grants from donor governments.

“The shell game, however, is exhausting and debilitating. Virtually every HIPC government spends an enormous amount of time simply staying one step ahead of out right default, and many fail to do even that. In the meantime, there is little long term thinking, and less long term planning to solve critical problems.”5

This chapter looks realistically at the cost for creditors of delivering cancellation of the unpayable debts of the poorest countries. For each category of debt we assess:

How much money will actually be needed to cancel the debt – the `real cost' of cancellation. This is based on Jubilee 2000's honest estimate of the likely cost of cancelling the debt, taking into account the resources available to the main creditor groups.

How much money governments would need to find, the `taxpayer cost' of cancellation.

The summary of these costs for the HIPC countries and the Jubilee 2000 group of 52 countries is:

In 1996 the IMF and World Bank defined 41 countries as potentially eligible under the HIPC programme, based on several criteria.1 It is not a fixed list; since it was first drawn up, Malawi has been added and Nigeria taken off. The UK Jubilee 2000 Coalition argues that there are more countries in need of drastic help. In 1996 we selected 52 countries as in need of major debt cancellation.2 This includes the HIPC 41 as well as 11 other countries such as Jamaica, Bangladesh, and Haiti which are also poor and deeply indebted.

`Face value' is the amount of money originally borrowed, less the principal repaid so far, plus any arrears and unpaid interest which has been added to the debt.

The 41 HIPC countries owe a total of $200 billion to their external creditors3. The (long-term) debt is spread between the World Bank (19.5 per cent), the IMF (4.8 per cent), bilateral governments (42.8 per cent), Regional Development Banks (9.5 per cent), private creditors (9.6 per cent). `Short-term' debt accounts for the remaining 13.8 per cent, but in fact 58 per cent of short term debt is interest arrears on long- term debt (which most people would consider part of long-term debt).

The 52 Jubilee 2000 countries owe $354 billion. This debt is spread between the World Bank (17 per cent), the IMF (3.5 per cent), bilateral governments (39 per cent), Regional Development Banks (9.8 per cent), private creditors (15.5 per cent) and short-term debt (15.2 per cent).

A much more realistic assessment of the value of the HIPC debt is given by the secondary markets which trade commercial debt. The secondary markets developed as a result of the debt crises in the early and mid-1980s. Commercial banks with large amounts of non-performing syndicated loans on their books found it was in their interest to swap loans with other banks and investors, and a market in loan swaps was created in 1983. Four years later Citibank set aside reserves to cover about a quarter of its loan exposure to developing countries. This provisioning openly acknowledged that the bank debt of troubled developing countries, much of which was in arrears, was worth less than its face value. Many banks followed the precedent of Citibank, and the secondary markets were created, enabling traders to buy and sell the debt at a value that took into account the high probability that it would not all be paid back. The markets continue to trade today, just like any other bond market, although for the HIPC debt the market trading is thin, with a handful of specialised operators. Thus the `market value' of debt is what the market is prepared to pay for it. Table 3 shows recent trading prices of debt on the secondary market, as a percentage of face value.

In some cases, countries have found it cheaper to buy their own debt back from banks at a fraction of the face value rather than actually paying the debt, and this has been backed by the World Bank (see Chapter 3). This data is also given in Table 2.

In many cases this debt is practically worthless. The debt of Sudan is worth only 1.5 per cent of its face value, the Central African Republic only 3 per cent, Sierra Leone 4 per cent, Ethiopia 6 per cent. The market confirms the fundamental claim of Jubilee 2000: that the debts are `unpayable'. The market agrees that these countries do not have the capacity to repay.

There is significant divergence amongst the figures, largely because some countries make “heroic efforts,”(to use Julius Nyerere's words4) to pay their debts. Countries such as Ghana and Malawi try hard to meet their foreign credit obligations. This means that the market values their debt considerably higher. Prices for middle-income countries' debt also reflects the probability of repayment. The debt of the Philippines is valued at 88 per cent and Morocco at 80 per cent.

Unlike Jubilee 2000, the market does not assess whether it is moral or just to demand repayment from countries whose repayment of debts is achieved at the cost of human lives. Nevertheless, the clear message from the markets is that, realistically, the debt should be valued at only a small percentage of its face value, with the average of trading prices for HIPC debt set at 18 per cent of face value; and those of debt buy-backs at 15 per cent.

By examining these market values and buy-back prices, and by substituting an estimate of 10 per cent in the absence of either of those (as in the case of Burundi, Chad, Somalia and Yemen), it is possible to estimate much more accurately the true value of the debts of the HIPCs.5

As table 2 shows, the market effectively values HIPC debts at $24 billion. This must be compared with the number put about by the Washington institutions – the face-value of $200 billion, and the grandiose claims of the G7 in Cologne to have cancelled up to $100 billion in HIPC debt. For the 52 Jubilee 2000 countries, the market's realistic valuation of the debt is $109 billion – compared with the face-value of $354 billion.

The real cost of cancellation that falls on creditors is an amount of money that actually has to be found to cancel the debt, and is close to the market assessment. We follow the line taken by the British House of Commons Library6 “that cancelling truly unpayable debt has no further effect on UK public finances since to the cost to the Exchequer has already been incurred [when the loan was made]. In this sense, cancelling unpayable debt is a cost-free option.”

The huge difference between the market assessment and the face value is debt that in reality is worth nothing. The face value amount is still relevant however, because it is this amount that has to be accounted for by each group of creditors in a general write-off. This they can do by drawing on provisions, profits or their capital base. There is no other option if they are to retain their financial credibility. The hugely discounted secondary market value shows that the private banking sector understands this. Someone has already `taken the hit' – the original bond-holder or other investors who have owned the bond and sold it on at a lower price.

Other creditors, through laziness, bad accounting or false judgement, continue to assign value. These creditors are living in a world of make-believe. Ultimately the more realistic the creditor has been over the past years of the debt crisis, the smaller the cost of meeting the Jubilee 2000 demands will be, and the closer the real cost will be to the market assessment. As is shown in Chapter 2, adding compound interest simply makes the situation worse both for debtor and creditor.

Official creditors, in particular, have not yet come to terms with the fact that they lost their money years ago, or at least they do not admit so publicly. But they must do so now. With the HIPC Initiative, the international financial institutions accepted, for the first time, that they too have a serious problem.

Below we examine each of the main creditor groups. For private and bilateral loans, we assume that lenders have already taken the hit, or have at least already made provisions for writing the loan down to market value. Therefore the `real cost' is the market value, because this is the loss that the creditor must take by cancelling debt rather than selling it on the secondary market.

The international financial institutions have not revalued these loans, and we therefore must consider if there are resources to do so – provisions, retained profits, possible revaluation of assets, etc. In general, we show below that the IMF and IBRD have adequate resources, and thus we also take the real value to be the market value. But for IDA and the regional development banks, this is not true, and thus the real cost must include some element to cover the cost to them of lowering the debt to secondary market level.

Finally, we need to ask what it would actually cost OECD taxpayers to cancel the debt – what portion of the real cost actually needs to be funded. We show below that the IMF and IBRD can meet all of the costs of cancellation out of present reserves, assets and profits, and we assume the private sector can also meet cancellation out of profits. Only IDA, the regional development banks, and lending governments cannot do so, and thus their costs must be met by the taxpayers.

This is a cost that would fall on governments and therefore taxpayers in each of the creditor countries. It would be a one-off cost, which when shared by the main industrial countries could be successfully managed within their budgets. Note that the taxpayer cost ($28 billion for HIPC and $71 billion for Jubilee 2000 countries) would not need to be met in a single year and does not need to be cash up front; rather it would be money to compensate for payments not being made by the very poorest people, and thus would be spread out over 20 years or more. It seems unlikely that the real cost would be more than $5 billion in any year. To put it into context, the US Treasury alone raises $5 billion in tax revenues every day.

The International Monetary Fund (IMF) is the single most significant creditor to developing countries, although paradoxically the amount owed to it by the poorest countries is relatively small. Its importance stems from its position of influence rather than from its outstanding loans. It plays the central role in the analysis of a developing country's economy, its progress in economic reform and whether and how much the country deserves debt relief. IMF recommendations are invariably followed by the Paris Club of bilateral creditors, and the IMF verdict has the power to stop much or all of the aid and new loans from both public and private sources.

The HIPC countries owe the IMF a total of $9.4 billion, of which $6.4 billion is outstanding to the ESAF Trust Fund, the fund that disburses loans to support structural adjustment. The 52 Jubilee 2000 countries owe the IMF a total of just over $12 billion.

In a market assessment, the HIPC IMF debt would be worth $1.5 billion, the Jubilee 2000 52 countries $3.3 billion, i.e. significantly less than the face value of $12 billion. Were the IMF to act as a bank it would already have used provisions to write-down the debt to these levels, just as a matter of good accountancy.

Can the IMF afford to write off this debt? The answer is a clear yes. If we consider the full face value of the outstanding loans, it is clear that the IMF has the provisions and the resources to carry out a write-off of the HIPC and Jubilee 2000 country debt. First, these sums should be compared to the overall capital of the IMF. They are dwarfed by the size of the currency contributions, or quotas, of its member countries. Quotas are now worth about $193 billion, although probably about a half of this is available for lending. Second, the Fund maintains various accounts to absorb losses. These include the Reserve Account in the General Department, and the reserve and subsidy accounts in the ESAF Trust Fund. Between them these provisions amount to SDR7 5.8 billion, or $7.8 billion8.

Third, the IMF has its much-publicised assets in gold. The Fund holds 3,217,341 kilograms of gold (103.4 million fine ounces), but due to historical reasons it values the gold far below what the price is in the markets. The IMF's financial statements value it at SDR 3.6 billion on the basis of SDR 35 per ounce. This is equivalent to $4.9 billion. The market price of this gold is approximately $32 billion, however, so the IMF could raise a total of $27 billion simply by re-valuing its current gold holdings – at no cost. This capital gain could be allocated to the Special Disbursement Account, which in turn could transfer assets to the ESAF-HIPC Trust Account.

The IMF could therefore choose to finance a write-off of the debt owed to it by the poorest countries through a combination of existing provisions, a revaluation and sale of a share of its gold. From these sources alone it has a potential $40 billion from which it could draw to fund a full debt relief programme. Thus it has adequate funds to not only to write the debt down to the market value (the real cost) but also to write off the remainder, so it needs no additional funds (and the taxpayer cost is zero).

The outstanding loans to the International Bank for Reconstruction and Development (IBRD) and the cheaper loans of the International Development Association (the IDA) combine to make the World Bank the largest multilateral creditor to the poorest countries. The bulk of its lending is through IDA; indeed one of the key criteria for eligibility in the HIPC initiative is that a country must borrow exclusively from IDA.

The IBRD has substantial funds at its disposal. It is these funds that give the Bank its triple A rating, and these resources dwarf the amount of outstanding loans to the poorest countries. It had a total of $175 billion from member countries subject to call (as at 30 June 1998).9

Table 4 shows that HIPC countries owe the World Bank a total of $39.2 billion: $36.6 billion of this is to IDA, $1.8 billion is to the IBRD and just over $740 million is in arrears.10 The Jubilee 2000 countries owe a total of $45 billion to IDA and $14.5 billion to IBRD.

Professor Sachs reports that IDA loans have a 70 per cent `grant element', which is defined as the difference between market and concessional loans. Thus an IDA loan is equivalent to a concessional loan of 30 per cent of the value, and we therefore apply the secondary market price to 30 per cent of IDA loans.

In a market assessment, the HIPC debt to the World Bank would be worth only $3.2 billion; the Jubilee 2000 52 countries debt would be worth $14 billion. As with the IMF, had the World Bank behaved like a bank, it would already have used provisions to write-down the debt to these levels, as a matter of good accountancy.

Does the IBRD have sufficient provisions and resources to write off its outstanding loans? The answer is yes.

The IBRD has provisioned for $3.24 billion of loan losses; this would cover the writing down of HIPC debt to market level and total write off, and would cover part of the write off of the 52 countries. In addition the bank has capital of about $27 billion, which is made up of $11.3 billion in paid in capital and $16.7 billion in profits (`retained earnings'). The loans to the larger group of Jubilee 2000 countries could be written off against past profits, leaving no cost to be borne by the world's taxpayers.

The IDA loans contain a significant grant element, and as a result these loans cannot be financed through the World Bank's activities in the international capital markets. Instead they are funded separately through donor country contributions or `replenishments'. Cost of cancellation only applies to the 30 per cent which is not a grant.

This 30 per cent of IDA loans must be met by new funds, and thus must be included in real costs and taxpayer costs of cancellation. Donor countries will need to pay in $11 billion to cover HIPCs and a further $2.5 billion to cover all Jubilee 2000 countries.

The remaining multilateral debt is held by the regional development banks, principally the Inter-American Development Bank (IADB), the Asian Development Bank (ADB), the African Development Bank (AfDB) and the African Development Fund. Estimates for the (face value) amounts owed by the Jubilee 2000 countries in their respective regions11 are Latin American and Caribbean countries $7.7 billion, Asian countries $8.7 billion and African countries $18 billion. As far as HIPCs are concerned, Bolivia, Guyana, Honduras and Nicaragua owe just over $1 billion to the IADB, and the exposure of the Asian Development Bank to Laos, Myanmar and Vietnam is also about $1 billion

The total face value of the debts owed to the Regional Development Banks by the HIPCs is $18.7 billion, and by the Jubilee 2000 countries $34.5 billion.

There is less detailed information on the many different regional development banks, but we assume that 40 per cent of these loans consists of grants, which has already been spent. We apply market values to the remaining 60 per cent. The value that the market would assign to the regional development bank HIPC debt is $3 billion; for the Jubilee 2000 52 countries, market value is $14 billion.

Cancellation of the debts owing to the Inter-American Development Bank and the Asian Development Bank could be covered with a combination of existing provisions and capital. The bank capital of the IADB is $94 billion and the Asian Development Bank $48 billion, sufficient to cope with a substantial write-down of the debts of the poorest countries in their respective regions.

The debts of the African countries to the regional development banks are evenly split between the AfDB and the African Development Fund. The AfDB has capital of $20 billion, and a combination of this together with some replenishment from donor countries for the African Development Fund would be sufficient to finance a policy of debt cancellation. The necessary replenishment of capital would be several billion dollars, which when spread amongst the donor community is likely to lead to contributions of a few million dollars for each of the major industrial countries.

To estimate the real cost of cancellation, we first discount the 60 per cent grant element. Next, we assume that each of the three main banks – IDB, ADB, and AfDB – have bad debt provisions of $1.5 billion. Since this is not enough to bring the debts down to market value, the real cost will be higher than the market cost, and this will have to be met by taxpayers.

Debts to bilateral creditors are split between concessional and non-concessional debt. The concessional debt is that arising from official development assistance. In the case of Japan, this is a major share. Non-concessional debt is normally debt that the creditor government takes on from failed private sector projects, which were originally guaranteed by export credit departments. In both cases (HIPCs and the Jubilee 2000 52) the split between concessional and non-concessional is about 60 per cent/40 per cent.

The face value of bilateral debt owed by HIPCs is $84 billion and $137 billion for the Jubilee 2000 countries.12 Within the group of bilateral creditors, G7 countries are owed $90 billion by the Jubilee 2000 52 and $40 billion by HIPC countries. Table 5 gives a full break down.

The Export Credit Guarantee Department (ECGD), which handles all of the non-concessional debt owed to Britain, confirms that, like private creditors, it makes provisions on its bad debts. Generally, this is done by a percentage estimate in addition to what is cancelled at Paris Club meetings. Other governments will have their own individual methods for accounting for write-off, but all will be based on a more realistic value than the face value. US Treasury officials confirmed to Professor Jeffrey Sachs that the US Treasury has a confidential formula which is used to calculate the value of the US bilateral debts: their $6 billion of debt to the HIPC countries is valued under this formula at near $600 million, i.e. at a discount of 90 per cent. Their assessment is that the debt is worth only 10 per cent of its face value.13 Using our method, HIPC debt is discounted by almost exactly the same factor as the US Treasury formula discounts US HIPC debt – 90 per cent.

We calculate that the markets assign a value of $9 billion for the debts of the HIPCs and $30 billion in the case of Jubilee 2000 countries.14

Most of the creditor countries will already have made provisions, and thus the `real cost' of cancellation is the same as the market value – in other words, how much they would make if they sold the debt on the secondary market. But this remaining amount will need to be met by the taxpayers: $9 billion for HIPCs and $30 billion for the Jubilee 2000 countries.

The face value of debts owed by the 41 HIPCs to commercial banks is $19 billion, while the face value owed by the 52 Jubilee 2000 countries to commercial banks is $54 billion.15

The market value of the $19 billion of HIPC debt is only $4.4 billion. The market value of the $54 billion owed by the Jubilee 2000 countries is $31 billion.

Almost all of the banks involved will have built up provisions against the non-payment of these debts. To write off a bad debt, the amount written off will be recorded as a loss against the profit and loss account of that year, or provisions built up in anticipation of non-payment will be used to cushion the effect on the profit and loss account for any given year. In the UK, banks are eligible for tax relief on the provisions that they make, calculated by a matrix used by the Banking Supervision department of the Bank of England.

Private creditors to indebted nations are more in tune with economic reality. They are one group of creditors that do accept substantial write-offs to restructure their debt portfolios. The real cost of full cancellation for them is the same as the market value as assessed by the markets. A write-off of the Jubilee 2000 country debt would be $31 billion. The total capital of the international banks is $11 trillion, or $11 thousand billion16 so these sums are affordable, and we believe the private creditors can cancel the remaining debts without taxpayer subsidy.

Short term debt is particularly difficult to calculate because the available data is not as good as for other debt. Of what the World Bank defines as `short term', in fact 58 per cent of HIPC short term debt is interest arrears on long term debt, and should be treated as long term; of those interest arrears, roughly 80 per cent are with official bodies and 20 per cent with the private sector. Most of the rest of the short term debt will be with the private sector, particularly export credits.

For our calculations, we discount all short term debt at the market rate (which is reasonable because those with the lowest secondary market debt values, such as Somalia, will be unable to obtain private credit, so nearly all the short term debt will be interest.) For the real cost, we simply take the market value. For the taxpayer cost, we assume that half the short term debt is with the private sector and half must be paid for by the taxpayer.

Creditors are using overly complicated and tortuous methods of tinkering with debt instead of facing up to the fact that much of the debt is unpayable and should be cancelled. The analysis shows that if bilateral and multilateral creditors used the secondary market assessment as a guide to valuing the debt, they could find the resources needed for cancellation. Not withstanding the huge benefits for highly indebted nations, the creditors themselves would save money by not having to administer and fund the countless mechanisms to pay debts on behalf of the indebted nations.

A consideration of the international response to the financial crisis of 1997-98 shows that the necessary funds can be found very quickly if the situation merits it in the eyes of the US Treasury and the IMF board. In a matter of months, the IMF and World Bank had between them organised substantial bail-outs for countries that were in financial trouble. The clear message was that if the crisis in the country was likely to have spill-over effects on western countries, the necessary stabilising funds could be found. The total new lending assembled for the rescue packages for South Korea, Indonesia, Brazil, Russia and Thailand was over $180 billion. A significant amount of these funds were found in a matter of weeks. By contrast, we need a maximum $71 billion to cancel all of the debt of Jubilee 2000's 52 poorest countries.

These funds were loans at market rates, rather than grants or write-offs, but the urgency of the response and the size of the capital raised shows what can be achieved when there is political will. They serve as a reminder that the write-off of the unpayable debts of the poorest countries is an affordable proposal.

“The Group of Seven and the Bretton Woods Institutions should aim to end the debt crisis for the poorest countries by 2000. The meagre financial costs contrast with the appalling human costs of inaction.”

“To address the greatest single cause of poverty and injustice across the earth and potentially one of the greatest threats to peace is not just a responsibility that humbles me; it is a responsibility that challenges me, as it challenges you, to action, action to secure debt relief and poverty relief, action to secure it now, action to secure it this year so that the world will not carry all this old injustice into the new millennium.”

Rt Hon Gordon Brown MP,
UK Chancellor of the Exchequer,
St Paul's Cathedral, 7 March 1999.

The need to cancel the unpayable debts of the world's poorest countries is more urgent than ever, and this report shows clearly that the Cologne debt initiative must not be the limit of our ambitions. To make a real difference to the ordinary people of Africa, Latin America and Asia, the world's leaders must be prepared to go much further.

The total debt of 52 of the world's poorest countries has a face value of $354 billion. This report shows that the entire debt could be wiped out at a total cost to the rich world's taxpayers of around $71 billion. The remainder is covered by provisions and readily available assets held by the lending institutions themselves. Jubilee 2000 argues that only the unpayable debts of these countries, to be assessed on a case-by-case basis, need to be written off. Jamaica, Morocco and Nigeria, for example, may well be able to pay a portion of their debts; Mozambique and Honduras clearly cannot. However, $71 billion is the maximum cost to the taxpayer on this basis.

it represents a third of one per cent of the income of the industrialised countries1; and less than the $90 billion worth of Microsoft's co-founder Bill Gates. Since all of these debts are due to be repaid over a long period—20 years or more—the burden of cancellation could similarly be spread over a long period. Over 20 years this would cost each person in the industrialised countries less than $4 per year – just over a penny a day.

For too long, lending nations and institutions have tried to dilute the need for debt cancellation with talk of moratorium, postponement, re-scheduling and reduction in net present value. The need now is not for any of these, but for simple, comprehensive cancellation of unpayable debt. The others are soft options and they explain why the debt crisis has never ended. They ensure debt retains its fictitious face value and thus prevent a real solution being found. Cancellation will solve both the problem of unpayable debt service and the issue of the debt overhang, which acts as a `Sword of Damocles', deterring both public and private investment in an indebted country, and therefore its capacity for economic growth.2

The official creditors can learn from the realism of the market. Private banks do not leave bad debts sitting on the books. They will either write them off and record the loss against the profit and loss account of that year, or they will build up provisions, and then use these to cushion the effect on the profit and loss account for any given year. Or they sell on their debt in the secondary markets, which take a realistic view of the status of each debtor country and the value of their debts. Official creditors should act with conviction and treat debts with the realism that the market assigns, rather than the surreal pretence that hides the breakdown of the debtor/creditor relationship.

These are prosperous times for the richer nations of the world. The US has been going through a period of unprecedented economic growth and prosperity, which has been shared by Canada, Britain and other European countries. Economist Alan Blinder commented in the New York Times that “even though this remarkable expansion will not last forever...there is nothing on the horizon proclaiming that the end is nigh”3 This buoyant economic expansion means that many western governments are facing the prospect of budget surpluses: the US, Britain and Canada will all report budget surpluses in 1998-99.

Politicians and bankers are quick to claim the credit for sound economic management, but a major contributor to this period of low inflation and high growth has been the depressed price of commodities, most of which are at their lowest prices for 20 years. However, today's low commodity prices are contributing to the debt crisis in the third world, by reducing the income from exports available to the HIPCs. The fall of the coffee price, for instance, erased in one year all the benefit HIPC debt relief gave to Uganda.

One of the founding architects of the Bretton Woods Institutions wrote presciently about Germany after the First World War. John Maynard Keynes wrote with palpable anger about the short-sightedness of the world leaders of the day, who were unable to show any vision or generosity in coming to terms with the defeated nations. The demands in reparations that the victorious nations made on Germany led inevitably to its collapse and the devastating consequences that are now known.

Keynes wrote: “The existence of the great war debts is a menace to financial stability everywhere. There is no European country for which repudiation may not soon become an important political issue. The war has ended with everyone owing everyone else immense sums of money. Germany owes a large sum to the Allies; the Allies owe a large sum to Great Britain; and Great Britain owes a large sum to the United States. The holders of war loan in every country are owed a large sum by the state; and the state is in its turn owed a large sum by these and other taxpayers. The whole position is in the highest degree artificial, misleading and vexatious. We shall never be able to move again, unless we can free our limbs from these paper shackles. A general bonfire is so great a necessity that unless we can make of it an orderly and good-tempered affair in which no serious injustice is done to anyone, it will, when it comes at last, grow into a conflagration that may destroy much else as well.”4 His analysis could hardly have been closer to the truth that unfolded.

After the Second World War, things were different. When Germany was in need of substantial debt cancellation, the victorious allies were ready to be far-sighted. The consequences of the Treaty of Versailles and the economic collapse of Germany leading to the Second World War, were still very fresh in the negotiators' minds. So much was cancelled that debt service each year following the agreement fell to 3.5 per cent of Germany's exports. Compare this with the 15-20 per cent considered appropriate for the poorest countries today by the IMF and World Bank.

These lessons from history and the consequences of inaction should serve as a warning to those who could end the debt crisis at the close of the twentieth century.

This report confronts the leaders of the world's most powerful nations with three facts:

In the face of this, the leaders of the G7 who met in Cologne have a choice. They can turn a blind eye and allow the poorest countries to enter the new millennium enslaved by the shackles of the debt burden. Alternatively, they can recognise that there is more to do – and try again. They can cancel the unpayable debts and ensure that through a more independent and transparent process these debts do not build up again. Together, the G7 leaders have at last recognised the debt burden as the first and foremost obstacle to progress and justice in the most impoverished parts of the world. Together, they must now take decisive action. The world's leaders must meet— one more time—before the new millennium begins. Time is short, but no issue is more urgent. Just as President Clinton has persisted with his efforts in the Middle East peace process; just as Prime Minister Tony Blair has worked tirelessly for a new era of peace in Northern Ireland; just as the world's major powers responded decisively to aggression and destruction in the Balkans; so they must now come together and find a way to end the single greatest cause of poverty and injustice in the world today. The debt crisis can be solved in this millennium, to ensure the whole world celebrates the arrival of the next.