Statement of Thomas H. Hart Director of Government Relations
DATA – Debt AIDS Trade Africa

“Debt Relief for the Poorest Countries: Accomplishments and Ways Forward”
Hearing of the Subcommittee on Domestic and International Monetary Policy, Trade, and Technology of the Committee on Financial Services U.S. House of Representatives

April 20, 2004

Mr. Chairman, Ranking Member Maloney, members of the subcommittee, I appreciate the opportunity to share the views of my organization DATA – Debt, AIDS, Trade, Africa – on the important issue of debt relief for the poorest countries.

While DATA is a relatively new organization, we are probably best known by our co-founder, Bono, lead singer of the Irish rock band U2. Bono has been a champion of fighting AIDS and poverty in Africa for many years. He and many of the people who now make up DATA’s staff – myself included – began this work as part of the Jubilee 2000 debt relief campaign several years ago. That global campaign helped instigate the current debt relief program, the Enhanced Heavily Indebted Poor Country (HIPC) Initiative, that you are considering today.

The Enhanced HIPC program got its launch in the United States from the leadership of this subcommittee and full committee at the time. I want to thank Mr. Leach, Mr. Bachus, Mr. Frank, and Ms. Waters, as well as many others, who led the legislative effort, along with the Clinton Administration and then-candidate Bush, to push the global agreement to provide debt relief. Your legislation provided the essential authorizing framework and the political momentum to approve the new program and get it funded. Given that history – perhaps parentage – this Subcommittee is taking an appropriate look at what has been accomplished, what problems exist, and what steps might be taken in the future. Having been here 5 years ago at this program’s creation, I am honored to bring you my perspective on these important issues.

Congress and the Administration should be applauded for supporting the HIPC initiative. For an investment of under $1 billion spread over several years, the U.S. has leveraged $30 billion from other donors, writing off $50 billion worth of debt stock – a significant “clearing of the books” of decades-old debt, providing a fresh start to these countries. It also freed up $1 billion a year in debt service for 27 of the poorest countries that are now building schools, clean water wells and AIDS prevention programs with this money. It has not, however, provided a lasting solution to the debt crisis and could be improved.

Debt Relief – Essential but Not Sufficient

Debt relief is not, nor was it ever intended to be, a panacea for its recipient countries. While its benefits are real, debt relief is only part of a comprehensive development strategy to help poor countries reach poverty reduction and development goals. Shifting from loans to grants, additional and effective development assistance, as well as better trade terms are all critical to poor countries. Debt relief, and even 100% debt cancellation, cannot address all the problems of needy countries. Debt relief is a first, critical, but not sufficient step.

Background

Over the last several decades, poor countries accumulated large international debts, built up through Cold War-motivated lending, natural disasters, as well as decisions by corrupt dictators. These debts became a serious impediment to poverty reduction and economic development in the world's poorest countries. Many poor countries spent 30-40 percent of their annua l budgets paying back decades-old debts, much more than they spent on health and education combined.

Worse yet, most borrowed more money in order to cover their payments on old debt, creating a vicious cycle of indebtedness.

In 1996, the World Bank, IMF, and their member governments agreed to provide debt relief to approximately 40 of the world’s poorest and most indebted nations. The first HIPC Initiative was designed to cancel some bilateral and multilateral debt for eligible countries in order to reduce their external debt burdens to “sustainable” levels.

After adopting IMF and World Bank supported economic and governance reform programs for three years, poor countries could receive relief on debt service payments. Then, if reforms continued, they would become eligible for cancellation of some debt stock. Under this 1996 plan, only 7 countries qualified for debt service relief with few resources freed for poverty reduction and development.

Then, under the banner of “Jubilee 2000,” the religious community and other advocates around the world raised the concern that crushing debt burdens continued to push the poorest countries deeper into poverty, diverting scarce resources from health, education, and other development needs. This movement united under a call for deeper, faster and broader debt relief for the poorest countries, through a fair and transparent process to correctly balance in the interests of creditors and debtors. Campaigns emerged in more than 60 countries, and inspired support from numerous luminaries such as Pope John Paul II, Billy Graham, Desmond Tutu, Pat Robertson, Muhammad Ali, and of course Bono. But the real heroes and inspiration for this movement were the grassroots groups and anti-corruption campaigner in the Global South – like the Uganda Debt Network – who called upon the developed world to do more, and who monitor the ongoing use of funds released by HIPC.

In response, the G7 and then the Boards of the World Bank and IMF adopted the “Enhanced HIPC Initiative” in 1999. It was designed to provide deeper debt relief for more countries more quickly, and more directly tie the provision of debt relief to country-led poverty reduction plans. The agreement obligated each creditor government to (a) write off its own bilateral loans to qualified poor countries, (b) authorize the IMF to use internal gold resources to write down its loans, (c) contribute to a pool of funds to write off multilateral debts, and (d) approve a new process for debt relief and new lending at the World Bank and IMF that had poverty reduction as its focus, not economic austerity programs.

Congress, led by this Committee, provided essential authorizing legislation and appropriations allowing the U.S. to participate in this initiative – which triggered other countries’ participation – in the fall of 2000.

Between fiscal years 2000 and 2004, Congress appropriated $860 million to fund the Enhanced HIPC initiative in both bilateral debt relief and contributions to cut multilateral debt.

Progress and Impact

Since 2000, 27 poor countries have qualified for the HIPC program – all but four of them are in sub-Saharan Africa (country list attached). The benefits of this program for these 27 countries have been measurable.

Reducing “debt overhang” – Upon completion of the program, these countries will see their debt stock reduced by two-thirds, cutting $52 billion in nominal terms¹. Getting rid of this “debt overhang” reduces a strong incentive for capital flight. The average amount governments actually have to spend on debt service has gone from 25% of their budgets to 15%.

Civil Society and Transparency – An important part of the HIPC program has been the inclusion of civil society and greater government transparency in the creation of country poverty reduction plans. Recipient governments must engage in a broadly participatory consultation process with civil society, business, labor, academic, religious and others to determine the poverty reduction priorities for the country. This Poverty Reduction Strategy Paper (PRSP) process has not been perfect, to be sure, but still represents a significant new approach to improving country ownership by non-government actors, as well as enhancing transparency.

Debt Service to Poverty Reduction – One of the conditions for receiving debt relief was the recipient government’s agreement to use the debt service savings for poverty reduction. More than $1 billion annually in debt service is now staying in these 27 countries to fight poverty. Evidence collected by the World Bank shows that, indeed, recipient countries are using this $1 billion in the ways intended – in fact expenditures on poverty reduction in these countries has risen by nearly twice that amount. By another measure, spending on poverty reduction as a share of total government spending rose from 41% to 54% (1998-2004). And spending on military in these countries has risen by only an inflationary 2% in this time.

According to research conducted by Jubilee USA Network, the successor organization to the U.S. chapter of Jubilee 2000, this debt relief is working on the ground to help people’s lives (paper attached).

• Tanzania has used its savings from debt relief, averaging around $80 million a year, to increase education spending and eliminate school fees. An estimated 1.6 million children have returned to school.
• Uganda used the bulk of debt relief savings to fund universal primary education, more than doubling the school enrollment rate to 94%, which has contributed to Uganda’s remarkable decline in HIV rates. It also dug many clean water wells.
• Mozambique has used substantial debt savings of around $70 million annually to vaccinate children against tetanus, whooping cough and diphtheria, as well as to build and electrify schools.
• Cameroon’s $140 million per year savings were used to launch a national HIV/AIDS plan for prevention, education, testing, and mother-to-child transmission abatement.

Room for Improvement

While the Enhanced HIPC initiative is a significant step forward in reducing unpayable debt stock and freeing up some resources for poverty reduction, more needs to be done.

1. Uneven results – The impact on recipient countries in terms of debt service has been very uneven. Currently Burkina Faso is the only one of the 27 countries that spends less than 5% of revenues servicing debt. 19 of these countries spend more than 10%. The Gambia spent around 35% of revenues servicing debt in 2003.
2. Remaining debt – Much of the progress to date has been to eliminate large chunks of old debt stock – the “debt overhang” – which was not being paid back. To a smaller extent the HIPC program, as noted above, freed up money for poverty reduction. Unfortunately, the 27 currently qualified HIPCs continue to pay $2.3 billion annually on debt service, with the World Bank and IMF as the two largest remaining creditors. These are badly needed resources that could address major crises facing their nations, including fighting poverty, preventing HIV/AIDS, rebuilding infrastructure and putting children into school.
3. Debt sustainability – The Enhanced HIPC Initiative does not provide a credible guarantee that these countries will reach or maintain “debt sustainability,” the purported objective of the program. Currently, debt sustainability is defined as reaching 150% of debt stock to exports. HIPCs graduating from the program are struggling to reach the 150% debt/export ratio, and there is little expectation they will maintain that level. The World Bank’s own analysis concludes that in order for HIPCs to be sustainable under the current program, countries would have to grow at almost 8% a year, twice the rate as they did over the last 20 years. Also, because the current program is tied to exports, shocks to commodity prices have had a severely negative impact on many countries’ debt sustainability. Such was the case for Niger, which recently was approved to have its debt relief “topped up” so that it could graduate the HIPC program within the 150% limit.
   
   Ethiopia also is nearing its graduation above the 150% threshold due to shifting global interest rates. While not an “exogenous shock” that the HIPC program fully anticipated, the World Bank has found that the impact has made it harder for Ethiopia to maintain debt sustainability and recommends it receive greater relief.
4. Process and Conditions – The HIPC program’s biggest structural weakness is the process continues to be driven and controlled by creditors. In a domestic bankruptcy procedure, courts usually balance the interest of creditors with basic needs and financial capacity of debtors to arrange a suitable outcome. No such disinterested party exists in the HIPC program. One of the concrete results of this imbalance is some of the conditions associated with debt relief have been harmful to the goals of poverty reduction – such as the imposition of user fees on education, health, water, and sanitation.
5. More countries – More poor countries could benefit from both bilateral and multilateral debt reduction, in the same way the current 27 HIPC-qualified countries have. The original HIPC framework identified 42 heavily-indebted poor countries, and this list did not include Nigeria, Haiti, Bangladesh, Kenya, or many others that could benefit. As we have seen recently in Iraq, any reconstruction and development package should include substantial debt relief as a way of easing the financial pressure on a burdened country and freeing up resources to meet critical needs.

Debt Legislation

Over the last couple of years, DATA and a broad coalition of churches and other NGOs have supported an effort to address the first 4 of these shortfalls, by changing the way debt relief is measured for the qualified HIPCs. With the leadership of Mr. Frank and Mr. Smith of New Jersey here in the House, and Senators Santorum and Biden in the Senate, legislation was introduced to make a simple change to the Enhanced HIPC initiative to free up additional debt service and lead to greater debt sustainability. This legislation was enacted into law last year as part of the global HIV/AIDS bill, Public Law 108-25.

The legislation urged the Administration to negotiate with international partners a change to the HIPC program. Instead of defining the goal of debt sustainability as simply 150% debt stock to exports, the legislation proposed that countries should pay no more than 10% of annual government revenue on debt service and, in the case of a country hard hit by a health crisis such as HIV/AIDS, no more than 5% of revenue. The majority of the 27 HIPCs would qualify for the 5% health crisis level. Adding this debt service-to-revenue formula would more closely link debt relief to a countries ability to pay, and limit some of the volatility that changing exports have had on current debt sustainability measures.

Also, such a change would lower overall debt levels. Comparing apples to apples, under the current system, the 27 HIPCs pay an average of 15% of their budgets on debt service. The legislation would reduce this level to 5 or 10 percent.

The Department of the Treasury’s estimate of the cost of this proposal is roughly $1.3 billion over 3 years to all creditors (Treasury’s report to Congress on this proposal is attached). Data to assess the costs to the U.S taxpayer are not readily available. However, if the same financing mechanism used currently is applied to this proposal, the cost to the U.S. could be as low as $26 million per year for 3 years². For recipient countries, this would result in an additional debt service savings of $430 million each year, increasing by nearly 50% the amount of resources freed up from debt service for poverty reduction. Therefore, with a modest increase in expense to the program, we could dramatically increase its impact on poor countries.

The Administration expressed concern with draft versions of the legislation about the debt service-to-revenue formula. In response, Congressional sponsors authorized Treasury to come up with a similar formula or mechanism that would accomplish the same goals of deeper relief for qualified HIPCs. For simplicity, the legislation is designed to operate within the existing structure of the HIPC program – it does not seek to expand the number of countries (although it requests a report on the feasibility of expansion), and it does not change the basic rules or financing of the program.

Despite this legislation being law for nearly a year, the Administration has not pursued negotiations with international partners to implement its provisions.

Additional Debt Relief Proposals

In addition to the change already in law, the Subcommittee might consider additional proposals for deeper and broader debt relief:

1. Cancel 100% of debts to the World Bank and IMF – Because several major bilateral donors (led by the United States) have written off 100% of their debts to HIPCs, the World Bank and IMF could do the same from their own resources. To finance the IMF’s share of the current HIPC program, the IMF revalued its gold holding and used the interest from the proceeds to write off HIPC loans. The World Bank used a portion of its substantial annual net profits to help write off HIPC debts. Such holdings could be used to expand their own debt write-offs.
2. Debt-for-AIDS conversion – As the world mobilizes resources to fight the crisis of HIV/AIDS, debt conversions could be considered. Essentially, an agreement would be reached that a recipient country take all or a portion of its annual debt service payments and commit those to fighting AIDS. This could be done bilaterally or to support programs through the Global Fund to Fight HIV/AIDS, TB and Malaria.
3. Debtor-creditor process and conditions – Congress has and should continue to review IMF and World Bank structural adjustment conditionality to ensure conditions are not harmful to the goals of poverty reduction and sustainable development. Independent arbitration mechanisms should be considered to fairly balance the competing interests of debtors and creditors.

Funding Shortfalls in the Current Program

Both the Administration and General Accounting Office raise concerns about the funding shortfall for the current program. This shor tfall is a key reason cited for not pursuing changes like the new debt legislation discussed above. But these funding challenges can be met.

1. There is a $650 million shortfall in the HIPC Trust Fund to cover the costs of the expected 33 countries that will qualify. This “shortfall,” however, is not a surprise and the Congress has already appropriated half of the $150 million the U.S. has agreed to cover of this amount, and is likely to fund the other half in the 2005 budget.
2. The other major funding gap is to reimburse the World Bank’s IDA program for its debt relief. GAO estimates this may cost $6 billion from 2006-2020. The solution is to ask the World Bank to continue to do what it has done for the first 5 years of the HIPC program – take a portion of its substantial annual profits to pay for its share of HIPC debt relief. According to annual reports, the World Bank has transferred $200-300 million annually from net profits to the HIPC Trust Fund. But it plans to stop at the end of 2005 – thus the massive funding shortfall from 2006 to 2020.
3. Another large asset exists at the IMF – millions of ounces of gold. The IMF holds 100 million ounces of gold, provided by its founders after World War II. The IMF continues to value this gold at 1950’s prices – roughly $45/ounce. For the current HIPC program, the IMF revalued a small portion (around 13%) of its gold holdings at current rates, then invested the proceeds and used the interest income to pay down its HIPC loans. At a time when the international donor community is seeking financing for the current HIPC program, changes to it, as well as development financing for the Millennium Development Goals, such a mechanism could again generate large additional resources.

Debt Relief as Development Financing

As stated earlier, DATA believes debt relief needs to be part of a package of assistance, including direct assistance and trade, to help poor countries reach poverty reduction and growth goals. It makes little sense to cancel debt while cutting aid or depressing trade. Similarly, it makes little sense to give large sums of development assistance while recipient countries recycle this money into debt service payments to creditors.

Converting a portion of the World Bank’s IDA lending to grants is a good strategy to avoid HIPCs from falling steadily back into unsustainable debt. The Administration’s efforts in this regard should be applauded – so long as there are ongoing increases in development financing overall. Deeper cancellation of old stock piles of debt, toge ther with converting future loans to grants, are complementary efforts to remove and prevent poor countries from staggering debt burdens.

While it is difficult to assess the relative merits of debt relief compared to aid, trade, or other forms of development finance, debt relief under the HIPC program has several features that make it an effective form of assistance:

1. Donor Coordination – HIPC debt relief, like any bankruptcy proceeding, requires all the creditors to act together in a coordinated fashion. Donor coordination brings efficiency for the recipient country (limiting the transaction costs of dealing with dozens of different donors with different rules and paperwork) as well as clearer goals and accountability.
2. Country ownership – Country ownership of development initiatives, where funding supports country priorities rather than donor priorities, is critical to program success. Through the PRSP process, the recipient government engages in a participatory process with civil society to design a country-owned poverty reduction plan, increasing the ownership over that plan.
3. Untied aid – Because debt relief through the HIPC program provides support directly to recipient government budgets, the countries themselves make spending decisions, using local contractors or NGOs, which are often less expensive and more attune to country priorities than donor-required contractors.
4. Leveraging more assistance – In the HIPC program, every dollar of U.S. taxpayer money was multiplied 30 times by contributions from other donors. When donors agree to act together in this way, with each contribution dependent on others, contributions are multiplied. A similar (although less dramatic) example of this is the leveraging impact of the Global Fund for HIV/AIDS, TB and Malaria. Every dollar from the United States to the Fund has been matched by $2 from other donors.

Reaction to the General Account Office April 2004 report

GAO provided an assessment of the costs of the existing HIPC framework, additional relief proposals, and of reaching economic growth targets.

The presentation of its findings leaves the reader with sticker shock – $375+ billion in total assistance to reach economic growth and debt relief goals. Intentional or not, this presentation gives the impression tha t poor countries are hopelessly far away from their goals and need an unrealistic amount of assistance.

However, a closer look paints a different picture.

1. The estimate covers 18 years.
2. The estimate is global – the U.S. would cover only a share of that (12% according to the GAO).
3. The estimate includes existing development assistance – traditional aid – and support for export earnings, in addition to costs for debt relief. While I agree poor countries need these and other components of development, this report and hearing are meant to focus on debt relief. A comprehensive look at what these countries need to achieve poverty reduction goals (like the Millennium Goals referenced in the report) is worthwhile, but needs to be put in that context.

Interestingly, using GAO’s assumption that the U.S. would cover 12% of this total, the U.S. would cover $52 billion over 18 years. That is roughly $3 billion per year for the 27 HIPCs. While I do not have total U.S. aid expenditures for these 27 countries, combined U.S. spending on debt relief, the new HIV/AIDS initiative, Millennium Challenge Account, export financing and traditional aid may be close to that level already.

GAO’s analysis of deepening debt relief to 5% of revenues also overstates the reality. While its analysis seems accurate, it is not analyzing the legislation Congress passed. First, GAO assumes all 27 countries would be lowered to 5%, rather than just those that suffer a public health crisis. Treasury’s report indicates that 9 of the 27 would be at 10%, thus lowering the cost.

Second, GAO assumes the 5% level would be held for 18 years, rather than the 3 years in the law.

Third, GAO states the approach “could provide an incentive for countries to pursue irresponsible borrowing policies” by guaranteeing countries would not have to pay more than 5% of its revenue on debt service. The legislation, however, only applies to debt incurred in the past, in order to avoid the incentive GAO critiques.

Conclusion

The Enhanced HIPC Initiative has been a significant stride forward, and a good investment by Congress and the Administration. The United States’ contribution has been multiplied 30 times by other donors, and written off 50 times its worth in debt stock. Poor countries have not only escaped from under decades of old debts, they are saving more than $1 billion in annual debt service, now putting that money to work in their countries fighting poverty. A new system of civil society participation and transparency exists, so people have a greater voice in where funding goes.

Congress has asked the Administration to go a step further, deepening debt relief for qualified countries. Again, this would be a worthwhile investment. Consider: the total cost of the current program has been $30 billion, providing roughly $1 billion in annual debt service relief. Treasury estimates going to a 5 and 10 percent formula would cost an additional $1.3 billion, which would provide another $430 million in annual debt service relief. In other words, for a small 4% increase in cost to the program, the 27 HIPCs could achieve a 50% increase in benefit – a good return for the additional investment.

I hope the Subcommittee will consider this and other mechanisms for deeper debt relief, as part of a comprehensive strategy to help the poorest countries reach their growth and poverty reduction goals.

Thank you.

Attachments:

1. HIPC country list and table
2. Jubilee Debt works
3. Treasury report