Debt Forgiveness: Does it Help the Poor?

Published on 19th October 2009

Anti-debt protest                                      Photo courtesy

 

 

 

 

 

 

 

 

 

 

As part of debt-forgiveness measures to Heavily Indebted Poor Countries (HIPC), the UK Government has proposed legislation that will limit the activities of the secondary debt market, also pejoratively known as ‘vulture funds.’ In their report they argue that debt relief allows HIPC countries to reduce unmanageable debt and increase spending on health and education.  

To date, debt reduction packages under the HIPC Initiative have been approved for 35 countries, providing US$51bn in debt-service relief. But the total cost of providing assistance to the 40 countries that have been found eligible or potentially eligible for debt relief under the enhanced HIPC Initiative is estimated to be about $71bn in end-2007 net present value terms. According to the IMF, “Countries must meet certain criteria, commit to poverty reduction through policy changes and demonstrate good track-record over time”. However, HIPC countries tend to feature undemocratic governments, limited civil liberties, human rights abuses, corruption and public institutions that obstruct economic growth and improvements in human wellbeing. 

One might hope that once granted debt relief, a country will break the cycle of accumulating unsustainable debt.  History however shows us that this has not happened.  As early as 1979, UNCTAD forgave $6bn debt to 45 poor countries. There followed a period of increased recognition from the World Bank and other lenders of the problem of unsustainable debt and increasingly concessionary loans to poor countries. Through the 1990s further debt relief was granted to poor countries, which is what led to the 1996 HIPC Debt Initiative. 

According to William Easterly in The Elusive Quest for Growth, “In spite of efforts to ensure that poor countries are able to achieve more sustainable levels of debt, the World Bank data show that from 1989 to 1997, total debt forgiveness was $33bn and new borrowing was $41bn”. In other words, far from enabling these countries to achieve sustainable debt, it allowed most of them to accumulate more.  Furthermore, Easterly observes “New borrowing was the highest in the countries that got the most debt relief.  There is a statistically significant association between average debt relief as a percentage of GDP and new net borrowing as a percentage of GDP.” 

Debt relief not only failed to put poor countries on a more sustainable debt basis, it failed to increase economic growth.  From the start in 1979 to 1998, per capita income fell in the typical HIPC country. This persistent weak policy and institutional framework accounts for Easterly’s statement that “debt forgiveness grants aid to those recipients that have best proven their ability to misuse that aid.”  Essentially, debt forgiveness has rewarded poor policies and has led to further indebtedness. This cycle of debt forgiveness and further accumulation of debt does not aid the poor.   

Of the 40 countries eligible or potentially eligible for HIPC Initiative assistance, 26 are receiving full debt relief from the IMF and other creditors after reaching their Completion Points. Of the 26 HIPC post-Completion Point countries, half of them rank in the bottom one-third of Transparency International’s Corruption Perceptions Index, and 19 in the bottom third of the World Bank’s 2010 Doing Business Report. None of them rank in the top third in either of these indices. According to Freedom House’s Freedom in the World (FIW) index, an index that compiles statistics on personal and civil liberties, only three of the post-Completion Point countries are classified as “Free”, 18 are classified as “Partly Free,” and three (Cameroon, Mauritania and Rwanda) are classified as “Not Free.”

The UK government aims its proposals at secondary markets or ‘vulture funds’ that buy up debt because it could lead to ‘unjust enrichment.’ The report fails to discuss the individuals and governments in many HIPC countries who were responsible for the accumulation of debt and who furthermore used it for their own personal and unjust enrichment.  This situation is revealed in the Al Jazeera exposé of debt relief and corruption in the Republic of Congo (Brazzaville) where the political leadership misappropriated funds for their personal benefit and are now attempting to use US lawmakers to limit secondary markets and absolve their legally binding debts. Similarly, the UK efforts to limit secondary markets could further enrich the political elites in other poor countries who have misappropriated funds.  

Limiting secondary markets would increase the cost of borrowing to poor countries.  Without the option of a secondary market, original creditors will face higher risks and therefore be forced to charge higher interest rates or, as is more likely, will avoid lending to poor countries altogether. By allowing secondary markets to function fully and permitting legal action in the UK against debtors, poor countries could be set along the path toward improved credit worthiness and more sustainable levels of debt.  

The idea that Western governments have the right and duty to protect poor countries from the same rights and obligations as richer countries is both patronising and damaging. In attempting to protect poor countries from secondary markets, the UK government is implying that these countries are somehow incapable of living up to the obligations that would be expected of other countries.  As long as these patronising attitudes toward poor countries persist, it is unlikely that they will ever enter the globalised economy and be in a position to lift their people out of poverty.  Legislation on secondary markets only helps to preserve the status quo of many years whereby the ruling elites in many HIPC countries have maintained economic policies that frustrate private enterprise and limit wealth creation. 

If secondary markets were allowed to function fully, an important message would be sent to all HIPC countries; namely that debt should no longer be accumulated on an unsustainable basis and that, moving forward, all legally binding contracts would be honoured.  The political elites in HIPC countries may disapprove of this, but it would serve the individuals of those poor countries better and contribute to more pro-growth and pro-development policies.  Secondary markets can be the force behind greater accountability among political elites in HIPC countries – accountability that has been sorely lacking. 

By Richard Tren and Jasson Urbach 

Richard Tren is a director of the health advocacy group Africa Fighting Malaria and Jasson Urbach is an economist at the Free Market Foundation. The views expressed in the article are the authors'.


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