The decision by the International Monetary Fund (IMF) and the World Bank in 1996 to cancel the debts of 26 heavily indebted poor countries (HIPC) that were undertaking reforms outlined, under the HIPC initiative, to decrease their degrees of poverty which led to heated debates between experts in development policy around the world with some supporting it and encouraging other Western nations to follow the same steps while some criticized the move vehemently.
The underlying principle behind the move was that heavily indebted poor countries that were making modest progress in lowering their poverty levels merited a cut in their debt burden so that they could have a temporary break to try to escape poverty while preventing them—once and for all—from restructuring their perpetual debt (Williamson, Nancy, and Deese, 34).
The move by the IMF and World Bank was followed by Paris Club, a group of official lenders who met in Paris, which decided to take the terms laid down in Naples in 1994 one step further and give an 80 percent reduction in the net present value of their debt servicing.
Since then, this initiative has gained momentum particularly after it had been taken up by the G7. In 1998, a consensus was reached to cut HIPC’s debt servicing by a further $50 billion; in return, these countries were to accelerate their domestic programs to fight poverty. This move led to a debt waiver of up to $40 billion by 2002 with more nations joining the program.
Recently, the UK pledged to cancel hundreds of millions of pounds owed to it by a number of the nations that belong to the HIPC group. The move followed a similar one by the US (“Should more countries cancel the debt?”).
Anti-poverty crusaders have welcomed both moves. Is this a positive step in the eradication of poverty in the world’s poorest nations? Should other nations emulate the move? I tend to disagree. I believe that forgiving the existing debt of HIPCs is a quick cosmetic fix that only functions to delay reforms that would permanently end the chain of poverty witnessed in most of the emerging countries.
Besides, a pardon of debt sullies the already negative image the international capital markets have of the heavily indebted nations. Therefore, rich countries should not forgive all debts of developing nations.
Several criticisms serve to support the idea that rich nations should not pardon the debts of heavily indebted emerging countries. First, the move is not new. It had already been suggested in several meetings: in 1977 with UNCTAD; in 1987 in Venice; in 1988 in Toronto; in 1990 in Houston; in 1991 in London; and 1994 in Naples. The failure to approve the pardoning of debts in all of these meetings serves to show the challenges involved in endorsing this idea (Williamson et al., 34).
If all the previous propositions failed to sail through, then we could never be sure that this was the right time to endorse such a move. Second, since these nations’ GDP and export growth rates have been lower in the last decade, they have not managed to lower their percentages of debt to a significant margin concerning these two aggregates, regardless of the huge cost it involved.
Third, rich countries should not pardon developing countries’ debt as it would encourage them to become indebted again with the hope of getting another pardon. This could also act as an incentive for other nations without so much indebtedness to increaser debt margin so that they can receive the same pardon. Pakistan, Nigeria, and Indonesia are applying for a debt pardon under the plan, and the countries that obtained debt reductions totaling $33 billion in 1996 have accumulated $41 billion of debt since then.
The move would also be unfair to countries that have fully serviced their debts. Other nations may see such an opportunity as a chance to fault in servicing their debts presently or in the future. If other developing countries can work hard to maintain their loans, why should we exempt other nations from the course?
A debt given to another country is a contract between two or more nations, or between a society and the lending agency, such as the IMF or the World Bank. Both parties in the agreement must be made to share the weight of the risk; that is, the moral hazard must be applied to both ways. A nation, bank, or multi-lateral agency that has loaned money to a country should not bear the full cost of repaying the loan (“Should more countries cancel the debt?”).
After all, the money is lent from the taxpayers and such a move functions to burden the taxpayers as they have to increase their taxes to cover the written off debts. Multilateral lending agencies have always based their fear of debt cancellation on the subject of moral hazard which can be summarized as “If you borrow money you pay it back” (Williamson et al., 34).
They fear that if a nation fails to pay back its loan and does not face the appropriate penalties, how can they trust it if it may need another loan in the future? It is understandable that developing nations will require a considerable inflow of capital to build their economies and loans will play a significant role in this development process. However, if all debts are pardoned, how will these countries ever convince the lending countries and agencies’ to issue loans to them in the future if they cannot pay their current loans?
While the cancellation of debts may seem like a respite for the developing countries, such a benefit may only be short-lived, the long term effects of this move would outweigh the benefits as the pardoned countries would no longer be able to receive loans. Besides, why should the lender be made solely responsible for any defaults in the repayment of a loan (“Should more countries cancel the debt?”). In essence, writing off HIPC‘s debts would only stifle future development projects that require credits.
A significant percentage of money lent out to developing countries ends up in the pockets of corrupt government officials and contractors. If a developing nation’s government is severely corrupt, then the status quo- no pardon on debt and no additional loans- is best for it gives the government no official resources to misuse and limits its ability to raise private sector funds.
The problem of corruption is partly responsible for the high poverty rates experienced in these countries, hence, writing off their debts without the appropriate penalties or conditions ignores the root of the problems in these countries, letting them continue down the same doomed path of bad leadership, corruption, and financial indiscipline.
Debt relief often comes at a cost to developing countries. For instance, G7 nations, through the IMF, require states to achieve unimaginable economic practices and gain decline themselves (Mason).
They demand that the developing nations “open up your markets” while they cannot allow such practices to be undertaken in their economies. Another demand is to “structurally adjust their economies,” while the nations themselves cannot undertake similar acts although a significant number is spending beyond their means.
Developing nations are also required to lower the prices of their commodities while the developed countries fail to reduce the costs of their imports (Mason). These economic demands only serve to hurt the feeble developing nations’ economies, and when the requirements are finally met, the debt cancellation is of little benefit.
However, there are good examples of nations making good use of debt write-offs to spur growth in important sectors of their economies. For instance, the government of Uganda used savings from this initiative to waive school fees for more than two million children while Mozambique, Senegal and Burkina Faso, are using these funds to fight AIDS.
The World Bank approximates that 40% of funds obtained through debt write-offs are used in the education sector, while 25% is used to improve healthcare services. These success stories are available only in a small number of developing countries.
Instead of writing off debts lent to heavily indebted and developing countries, the lender should ensure accountability of the amount lent. Debt relief should only be used as a last option, particularly if the risk of financial distress is a serious problem.
Works Cited
Mason, Moya K. “Debt Forgiveness.” 2011. Web.
“Should more countries cancel the debt?” BBC News Online. 1999. Web.
Williamson, John, Nancy Birdsall, and Brian Deese. Delivering on debt relief: from IMF gold to a new aid architecture. NJ: Prentice Hall, 2002. Print.