Sony Kapoor shows why do we need total multilateral debt cancellation for HIPCs? And how can this be achieved?

Abstract
The Millennium Development Goals - a set of time bound targets aimed at reducing poverty & hunger and increasing human development - adopted by the UN general assembly in 2000, are now accepted as guiding principles by most major donor agencies. This paper highlights the costs of reaching these targets-with an emphasis on Malawi, Mozambique, Tanzania and Uganda. It then goes on to estimate the resource gap faced by these countries and shows how total debt cancellation is necessary but not sufficient to plug this gap.

Even the partial debt cancellation promised under the Highly Indebted Poor Countries (HIPC) Initiative is being rendered less effective due to the violation of the central concept of equal burden sharing amongst creditors; the International Monetary Fund (IMF) and the World Bank have refused to contribute their fair share by pleading poverty. In response to calls for additional debt cancellation, they say that any further use of their resources for this purpose would seriously endanger their financial soundness and sustainability. This paper uses rigorous financial analysis to show how both the IMF and the World Bank have ample resources to cancel all the HIPC debt owed to them - hence contribute to the achievement of the MDGs - without compromising their own operations. We also show how the Bank and the Fund can go beyond just debt cancellation and finance higher grants out of their resources.

The paper also seeks to interpret the arguments presented here in the context of the findings of the evaluation of international debt relief by the Operations Evaluation Department (IOB) of the Dutch Ministry of Foreign Affairs. In fact three of the four countries studied in detail here are also used as case studies in the IOB report; so the findings of this paper have an added relevance.

Executive Summary
This paper makes the case for higher levels of debt cancellation and grant (aid) flows for the Heavily Indebted Poor Countries (HIPCs) and shows how some of the additional resources needed for this can be mobilized by multilateral financial institutions such as the IMF and the World Bank. 

The paper is in three parts:

Part A uses Malawi, Mozambique, Tanzania and Uganda as case studies to highlight that both additional debt cancellation and higher grant (aid) flows are needed by the HIPCs in order to meet the MDGs; Part B shows how the World Bank and the IMF have ample resources not just to finance further debt relief but also to increase grant aid; Part C links the findings of Parts A and B to the results of the evaluation of International Debt Relief carried out by the Policy and Operations Evaluation Department (IOB) of the Dutch Ministry of Foreign Affairs

Part A
The United Nations, the World Bank and the New Economics Foundation have all estimated that massive additional resources ($45-$75 billion every year till 2015) are needed globally in order to meet the Millennium Development Goals. This paper takes an in-depth look at Malawi, Mozambique, Tanzania and Uganda - all HIPC countries in Sub Saharan Africa - and finds that they need a total of about $72 billion between 2000 and 2015. Of this, they can only raise $12 billion domestically and depend on external sources for the rest.

The international community has rallied behind the Millennium Development Goals, and has widely accepted that debt-servicing capacity should be assessed relative to the country's need for achieving the goals. However, despite this, these four countries will be paying more than $3 billion in debt service - 25% of the total domestic resources available to spend on meeting the MDGs. So instead of funding basic needs such as health and education, the HIPCs are forced to divert scarce resources for the repayment of debts.

We show that total debt cancellation for HIPCs would release precious resources to fight poverty, hunger and disease. It would also demonstrate that both developed countries and multilateral institutions such as the IMF and the World Bank are fully committed to helping HIPCs meet the MDGs.

However this is by no means enough; it would still leave a resource gap of more than $57 billion. It is expected that less than half - $27 billion will be financed by grant flows. The balance $30 billion would need to financed through additional grants, concessional loans or through market loans.

We find that out of these three options, additional grants is the only one that is sustainable in the long run; concessional loans would lead to high debt to GDP ratios and defeat the very spirit of the HIPC initiative and market loans would become unsustainable long before they could plug even part of the resource gap.

However, not every dollar given as a grant can be used to finance MDG spending; on current practice as much as 30% of total grants are 'tied' - recipients are forced to buy expensive goods and services from the donor country. A significant proportion of the grant also goes towards administrative costs etc. So only a part of grant aid can be used for meeting the MDGs. This means that the total amount of grant aid required is much higher than estimated.

The paper finds that for these four countries total debt cancellation accompanied by a near doubling of grant aid is the only way to finance meeting the MDGs in a sustainable way.

We also show how our conclusion of the need for additional debt cancellation and higher grant flows can be generalized to all HIPCs.

Part B
Of the more than $26 billion (NPV) of debt owed by the HIPCs to the IMF and the World Bank, these institutions have agreed to cancel less than a third - $8 billion (NPV) that too funded mostly through bilateral sources. Both have pleaded poverty saying that any additional debt cancellation through the use of their resources would seriously endanger their financial soundness and sustainability.

As a result the HIPC countries will be left with unsustainable levels of debts - debts that can only be repaid at great human cost to their citizens. Altruism and idealism aside, the debt of the HIPCs is also uncollectible; they cannot afford to pay, and the Fund and the Bank must bear some responsibility for the accumulation of unsustainable levels of debts. This would also help reduce the moral hazard that has come about because the multilateral institutions have repeatedly been bailed out by bilateral donors; grants and loans from donor countries have often been used to repay IMF and World Bank loans.

Using rigorous financial analysis this paper shows that both the IMF and the World Bank have ample resources to cancel all of the nearly $18 billion (NPV) HIPC debt owed to them without in any way jeopardizing their normal operations.
In fact this paper finds that even after writing off all the HIPC debt owed to them, the Fund and the Bank will have resources that can be used to increase grants to HIPC countries. 

While trying to highlight their self proclaimed paucity of resources, the IMF and the World Bank have sought to underplay their considerable financial strength, which is underpinned by their distinctive political and financial structure and their special role within the international financial system. They have incorrectly made implicit comparisons with the private sector to highlight their 'poverty'.

However, their unique status based on implicit guarantees from donor (mostly G7) countries makes them highly resource rich. By factoring these benefits in, we show that both the IMF and IBRD are overcapitalised and are not using their resources most efficiently.

We recommend that the IMF should sell some of its gold reserves directly into the market over a period of a few years and use the proceeds to bankroll the full cancellation of the HIPC debt owed to itself and that the IBRD mobilize its internal resources by using a combination of retained earnings and future income allocations to fully bankroll the total cancellation of the HIPC debt owed to the World Bank group
In response to the growing call for additional debt cancellation, the IMF and the World Bank have written a joint paper[1] criticising the concept and claiming how it would seriously jeopardize their finances; we also rebut all the arguments presented here.

Part C
The evaluation of international debt relief carried out by the IOB concludes that debt relief to date has been insufficient and shows how additional debt relief can prove highly beneficial to HIPCs by releasing resources and reducing debt overhang.
Our calculations support these findings by quantifying some of the resources that can be generated through additional debt cancellation. We also highlight the urgent need for total HIPC debt cancellation in order to meet the MDGs.

The IOB also says that the repeated bailout of multilateral creditors by donor countries has created a moral hazard. This moral hazard has resulted in excessive and irresponsible multilateral lending which is at least partly to blame for the current unsustainable levels of HIPC debt. The IOB specifically recommends that the bilateral donors should stop funding the cancellation of multilateral HIPC debt.

Our analysis of the financial position of the IMF and the World Bank shows that the IOB recommendations can immediately be implemented by making these institutions fund their own share of HIPC debt cancellation. Moreover, by making a case for total debt cancellation we show how the moral hazard problem highlighted by the IOB can be mitigated further.

The IOB further suggests that future aid flows should be skewed in the favour of grants over concessional loans.

We support the IOB findings by showing how concessional loans can lead to unsustainable levels of debt and in fact go a step further in recommending that all future aid flows to HIPCs be in the form of grants not loans.

The IOB argues against the usefulness of ex-ante conditions on debt relief.
We agree with the IOB and suggest in common with many others that debt relief be contingent only on an assessment of need to meet the MDGs. We then make a case that all HIPCs face a resource shortfall in financing the MDGs and hence already fulfil this condition. We conclude that further HIPC debt relief should be totally unconditional.

On many other points too, our conclusions and IOB findings reinforce each other and enhance the credibility of the analyses in both the papers.

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