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Debt Relief and the Development Architecture

by Nancy Birdsall and Brian Deese

The now famous international movement to reduce the debts of the world’s poorest countries (culminating in the HIPC, or Heavily Indebted Poor Country initiative) is part of a larger effort by the international donor community to redefine the business of development assistance, or better the ‘development architecture’. This effort is based on an acceptance of historical fact: over the past two decades, despite billions of dollars in development assistance lending, there has been little growth or poverty reduction in many of the world’s poorest countries.

There is an emerging consensus that part of the reason why so much development assistance contributed to so little development was that the donor community was not very selective. That is, official creditors and donors did not lend based on an assessment of a country’s policies, institutions, or capability to use resources effectively to stimulate the private investment and social institutions critical to growth. Therefore, much of the money went to governments who were ether unwilling or unable to use it for the benefit of their citizens. The success of debt relief, then, involves two leaps of faith. First that the internal problems of recipient countries— corruption, lack of accountability and in some cases absorptive capacity—are receding. Second that the official donor community will reform its entrenched bureaucracy and be more selective in its new lending and grantmaking.

Debt Relief for Development

Faith aside, there are good reasons to believe that debt relief can be an efficient mechanism to transfer resources to poor countries and may help transform the development architecture to leverage positive change in the way the donor community engages with poor countries.

The first has to do with past donor and creditor behavior. Over the past two decades the HIPC countries received massive amounts of external assistance—almost all from official donors and creditors—while achieving low or negative per capita growth, which resulted in an everincreasing stock of outstanding official debt. In the 1990s, the donor community resorted to a combination of rescheduling and fresh additional resources in a good faith effort to help these countries avoid arrears and stay eligible for the benefits of multilateral lending and engagement with the international community. As Figure 1 shows, these additional resources exceeded the countries’ debt service burdens, and indeed there was no ‘debt tax’ on the HIPC countries.

But in the resulting debt game, the donors increasingly transferred resources based on a country’s debt situation, rather than on its potential to use resources well. Birdsall, Claessens, and Diwan (2001) show that in the 1990s those countries in Sub-Saharan Africa with the highest debt (and specifically a high portion of that debt owed to the multilateral institutions) received the bulk of transfers, independent of their policy or institutional environment. In this group, only the lending by the World Bank’s IDA remained ‘selective’. (Among the lower debt countries, the donors as a group were reasonably selective.)

Reducing the debt stocks of these countries provides an opportunity for donors to get out of this vicious refinancing game and reintroduce selectivity in their new lending and grantmaking. This is good news even if debt relief does not end up being additional—if instead debt relief simply substitutes one form of ‘aid’ for new loans and grants. Why? It would liberate donors to channel more funds to countries with reasonably good economic management and adequate absorptive capacity. That could initiate a virtuous circle, crowding in private investment in these countries and generating growth. But while reducing the debt stock opens the door for this positive change in donor behavior, it in no way guarantees it. Those most passionate about securing debt relief for the poorest countries should now be equally adamant about demanding that the donors change their past behavior and that selectivity is one of the pillars of the post-HIPC development architecture.

Ownership of Development Strategy

A second virtue has to do with the nature of debt relief itself. In recent years the donors have begun to emphasize the need for the recipient countries to take charge and ‘own’ the design of their development strategies (this is the goal of the Poverty Reduction Strategy Paper (PRSP), one of the central conditions for the receipt of debt relief under the HIPC initiative). But another result of the ‘debt game’ has been an increasing donor presence in the most indebted countries that flies in the face of this goal. Behind the positive net transfers in Figure 1 is a story of increased gross transfers and increased debt service. As Table 1 illustrates, most of those gross transfers in the 1980s and 1990s have apparently come in the form of discrete project support, which means an increasingly large aid bureaucracy for poor country finance ministries to manage.

Debt relief is a form of untied budget support that may help reverse this trend. For countries with good policies and institutions, debt relief will reduce somewhat the burden of coordinating with an endless list of donors and aid agencies on dozens of projects, and, along with the PRSP, can encourage ownership and domestic management of the poverty reduction and growth strategy. Here again, debt relief provides an opportunity, but no guarantee, as the resources released from debt relief are only a small fraction of the resources needed by the highly aid dependent HIPCs if they are to have any shot at achieving the development goals put forth at last year’s Millennium Summit. For example, in the four countries that have received full debt relief under HIPC, the annual debt service savings represent only 14 per cent of official net transfers in recent years (Table 2). Yet if the PRSP really does represent a new way of doing development planning in poor countries (and initial assessments are guardedly optimistic on this point), then the untied budgetary resources released from debt relief may help solidify an ‘ownership’ pillar of the development architecture, working in concert with increased donor selectivity.
 

This article draws on Nancy Birdsall, Stijn Claessens and Ishac Diwan ‘Will HIPC Matter: The Debt Game and Donor Behavior in Africa’, presented at the WIDER conference on Debt Relief in Helsinki in August 2001 (available at www.wider.unu.edu under debt conference papers) and Nancy Birdsall and John Williamson with Brian Deese ‘A Golden Opportunity: From Debt to a New Development Architecture’, Center for Global Development/Institute for International Economics (forthcoming).

Nancy Birdsall is President of the Center for Global Development in Washington DC, and was the Executive Vice-President of the Inter-American Development Bank from 1993-1998. Brian Deese is a Research Assistant at the Center for Global Development. Further information on CGD can be found at www.cgdev.org.