From debt reduction to a pathway towards development A short history of debt crisis RomaTre - HDFS January 2015 Massimo Pallottino

Debt: an everlasting history Debt and debt crisis is not something new: the idea of financing (economic and politic) ventures, at individual as well as at state level is found in pre-modern and in modern history. Kindleberger: phases of (a) growth; followed by ‘bubbles’ or (b) manias; and ending in (c) crisis. (Hanlon, 2012) Debt - History2

What debt are we talking about? Private Vs. Public (Sovereign debt) Internal Vs External Privatly owned Vs Publicly owned (bilateral or multilateral) Short term Vs. long term Concessional Vs market terms Debt - History3

Multiple dimensions Economic dimensions Social dimensions (the social costs of debt and its service) Internal political dimensions External political dimensions (power issues related to to borrowing and servicing – or not servicing) Juridical dimensions (legitimacy of debt) Debt - History4

5 Old history 60’: investment policies in a stable monetary context (USD convertibility) Expansion of international trade, with a steep increase of USA imports, funded by a USD emission 1971: USD-gold convertibility discontinued, and increase of the raw materials Had USA strong reasons to oppose oil increase? The opportunity for exploitation of domestic reserves and comparative advantages vis-à- vis Germany and Japan first oil shock: OPEC countries’ revenues increase and are fed into the international banking system Interest rates decrease Prices increase (inflation, but in a context of economic stagnation)

Debt - History6 The situation in the ‘70 LDCs need investments and infrastructures Interest rates are low and being indebted is ‘cheap’ Big international banks lend to LDCs: states cannot go bankrupt! In some cases interest rates end up being negative in real terms! Debt stock increases steeply The use of the available financial resources is often inefficient (geopolitical reasons, corruption)

Debt - History7 1979: the second oil shock Oil prices increases again, up to twenty times the price of 1973! New inflationary and contractionary pushes for the world economy New UK prime minister: Margaret Tatcher, and new USA president Ronald Reagan The answer to the oil and inflation increase is based on ‘monetarist’ recipes: the inflation is caused by an excess monetary mass USD becomes stronger and interest rates increase

Debt - History8 The crisis From 1979 onward the public finance crisis in the LDCs is acknowledged as structural LDC are faced with a steep increase in the value of debt In 1982 Mexico declares debt default, followed by other countries Structural adjustment policies are based on the ‘monetarist’ approache: in a first phase they are supposed to produce a stable economic environmnet (internal and external stabilisation), and in a second phase to provoke the restructuring of the offer, through the following measures Reduced public spending Privatisations Price liberalisation No custom taxes No subsidies Competitive currency devaluation

Debt - History9 How to face debt crisis? Trading on secondary markets Buy back options Restructuring/rescheduling Cancellation Debt swaps (Debt-for-equity, Debt-for- development,Debt-for-nature Swap)

Debt - History10 The options in the ‘80 Solving the creditors’ problems… Baker plan (1985): involuntary lending, creditors’ coordination, and structural conditionalities Brady plan (1989): the principle of the reduction of debt is acknowledged. Buyback Debt for equity swaps Par bond swaps, where face value is conserved, but interest rates are reduced to a flat rate of 6% New financial resources

Debt - History11 From restructuring to debt cancellation 1987 Venice Terms: debt payment is postponed and the interest rate is cut 1988 Toronto Terms: non-ODA debt is reduced of a further 33% 1991 London Terms: already restructured debt is reduced of 50% 1995 Naples Terms: all debt is reduced to 67%. Debt service issue is considered for the first time 1996 Lyon Terms: Net Present Value of the stock is reduced up to 80%. Heavily Indebted and Poor Countries Initiative - HIPC 1999 Cologne Terms: HIPC II or enhanced

Debt - History12 A turning point Debt reduction policies are acknowledged as substantially ineffective Structural adjustment programmes are acknowledged as substantially ineffective A big mobilisation of the international civil society (Bimingham, 1998; Cologne 1999)

Debt - History13 Cologne: HIPC II - enhanced Objectives: To increase the debt cancellation To accelerate the debt cancellation To widen the number of beneficiary countries To guarantee that funds are used for poverty reduction The Bank and the Fund change their traditional facilities

Debt - History14 Sustainability in HIPC II Debt is unsustainable when: Its debt NPV/Export ratio is higher than 150% (debt NPV/public income 250% in the fiscal window) Fiscal window: export/GNP >30% and budget income/GNP > 15% (See the note of the ppt for explanation)

Debt - History15 HIPC II path

Debt - History16 Over and above the HIPC initiative: Evian and MDRI Towards a ‘taylor-made’ approach: Evian (2003) and the ‘top-up cancellation’ The Multilateral Debt Reduction Mechanism (Gleaneagles, 2005) The MDRI is accessible for the HIPC countries that have reached the completion point; these countries will receive an additional debt cancellation from the IDA, the ADF and the IMF. The MDRI full benefits will be above US$50 billion: about US$37 billion from IDA, US$8.5 nillion from the African Development Fund, and US$5 billion from the IMF. The civil society wins!!!! Additional resources are added, while ‘preserving the financing capacity of the International Financial Institutions’. Different financing mechanisms: IDA and ADF, ‘dollar-per-dollar’; IMF: trust I and trust II More recently, also the African Development Bank and the Interamerican Development Bank

Debt - History17 Comments about the MDRI Flaws: It concerns only those countries that have completed the HIPC initiative. And the other low-income countries? They are excluded! Should multilateral debt be cancelled at once, it would amount to about USD 55 billion. However what really matters is what remains available to fund poverty reduction strategies According to different sources, the development objectives set at the international level would require between 30 and 50 billion USD, yearly. With the MDRI, about 2 billion USD would be made available: good, but absolutely not enough! Distributional effect of MDRI Gunter, Rahman, Wodon (2008) “Robbing Peter to Pay Paul? Understanding Who Pays for Debt Relief”, World Development, 36(1)

Debt - History18 Conditionality On which basis has debt cancellation been accessed? Conditionality

Debt - History19 Evolving conditionalities Conditionality in traditional SAPs (’80) The ‘small open econoy’ model (‘one size fits all’) Stabilisation (contraction of internal demand) and structural reforms (expansion of supply) Crossed conditionalities The adjustment with a human face (’90) Poverty shields The governance age After 1999: towards a re-definition of IFI’s role IMF: short-term compensation chamber  guardian for the ‘good policies’ and ‘trafic-light’ WB: investment bank  guarantee that the poor is listened to Conditionality

Debt - History20 ‘Structural’ conditionalities Conditionality

Debt - History21 Social conditionalities PRSP - Poverty Reduction Strategy Paper, introduced with the enhanced HIPC initiative, in 1999 Document that defines the poverty reduction strategies, by the individual countries’ governments, after a wide consultation with all stakeholders A priority for poverty reduction is introduced The role of the civil society is legitimised They are used in the place of the old SAPs Conditionality

Debt - History22 Criteria for the PRSPs They are formulated through a country driven process They are results-oriented They bear a complex and multi-dimensional understanding of poverty The define a long term perspective geared towards poverty reduction They are partnership oriented Conditionality

Debt - History23 A synthesis about conditionalities in the PRSP age The structural and macroeconomic conditionalities are mostly based on the ‘good old models’ of political economy: from this point of view there is no much change in the macroeconomic frameworks of the structural adjustment, and that of the PRSP phase The IMF still plays a ‘traffic-light’ role The insertion of a priority for poverty reduction is important; but this is somehow instrumentalised It is very important to avoid that conditionalities prevent the governments to determine a really ‘country- owned’ policy framework Conditionality

Debt - History24 The end of the HIPC initiative 31st December 2006: the sunset clause The grandfathering process 2011: the last ringfencing SomaliaEritreaSudan Côte d’Ivoire Togo Nepal Kyrgyz Republic Laos Buthan Zimbabwe Comoros Guinea-Bissau C. African Rep. 3 Pre-Dec. Point Guinea Chad Haiti Dem. Rep. Congo Burundi Liberia Rep. of Congo Afghanistan 1 Interim Countries NigerGambia Zambia Nicaragua Guyana Uganda Mozambique Ghana Tanzania Mauritania Ethiopia Sierra Leone Mali Cameroon Senegal Malawi Burkina Faso S.Tomé Príncipe Madagascar Bolivia Rwanda Honduras Benin 35 Post- Completion- Point Countries The current situation Situation as at September 2013

Debt - History25 The outcomes of HIPC/MDRI The current situation

Debt - History26 Effects on the social expenditure The current situation

Debt - History27 ‘Sustainable’ debt relief HIPC/MDRI Status of Implementation - September 2008 HIPC/MDRI Status of Implementation - September 2011 The current situation

Debt - History28 Debt’s burden yesterday and today (DOD DPPG TDS INT constant billion USD) The current situation LDC External Debt All Less Developed Countries Total ext. debt 72,52598, , , , , , , , ,60 Debt service 8,5776,30162,00163,92160,86166,95206,40183,11155,52182,33 Of which interests 2,6738,2554,2760,5948,9949,4351,5754,4950,2380,98 Sub Saharan Africa Total ext. debt 10,8777,20168,76161,83170,64194,20124,34136,40161,79199,72 Debt service 1,267,909,2210,108,419,2318,7810,629,5315,04 Of which interests 0,343,083,222,922,522,693,473,373,025,03 Low Income Countries Total ext. Debt 6,9345,9192,3990,4895,31107,6883,9394,2896,39104,09 Debt service 0,452,322,892,512,392,402,663,203,484,81 Of which interests 0,140,960,990,730,780,800,821,120,871,37

Debt - History29 A synthesis of the international debt reduction initiatives In many countries, following the debt reduction initiatives, the debt service has been stabilised or reduced. But these benefits have not been fairly distributed, and have not always been enough. Many countries that would have needed debt cancellation have been excluded from HIPC/MDRI. Furthermore, the HIPC/MDRI exercises had been conceived as ‘one shot’ in order to solve the debt crisis. It has NOT been so! Risk of further debt distress still remains We need to go beyond a perspective dominated only by the creditors The measurement of debt sustainability has proved to be insufficient: there is a need for a better integration of human development dimensions This would pave the road for wider and deeper cancellation, including many countries (middle income) that are currenlty excluded Debt cancellation should be additional to other development finance But the landscape is evolving: there are changes in the composition of the national ‘sovereign’ debt The current situation

Debt - History30 System or ‘ad hoc’? “While preserving the core principles of the HIPC Initiative, IDA and the IMF have continued to make use of the flexibility available in the framework governing the Initiative. Judgment has continued to be used in the area of completion point triggers. The Boards granted waivers to Afghanistan and Liberia for missed triggers on the basis that they had been substantially implemented and sufficient progress had been made toward the underlying objectives. Comoros reached its decision point following the progress made on clearance of its arrears, which will count as debt relief provided by its multilateral and official bilateral creditors. Flexibility was also exercised in the area of preparation and implementation of poverty reduction strategies.” HIPC/MDRI Status of Implementation - September 2010 The current situation

Debt - History31 A new approach to debt risk: the principles of DSA (i) a standardized forward-looking analysis of debt and debt-service dynamics under a baseline scenario, alternative scenarios, and standardized stress test scenarios (also referred to as bound tests); (ii) a debt sustainability assessment based on indicative country-specific debt-burden thresholds that depend on the quality of policies and institutions in the country; and (iii) recommendations on a borrowing (and lending) strategy to limit the risk of debt distress, while maximizing the resource envelope to achieve the Millennium Development Goals (MDGs) The current situation

Debt - History32 The new sustainability approach The Debt Sustainability Analysis (DSA), a ‘traffic light system’ that, however, does not cope with MDG related needs does not promote mutual responsibility still promotes the ‘one size fits all’ model does not look ad private and national debt does not consider the wider policy environment (trade, financial flows, etc.) The current situation