For decades, poor African countries spent billions of dollars repaying debts to donor countries and international financial institutions. Many of these loans were given for political reasons during the Cold War to prop up particular governments and, in many cases, were wasted by corrupt and unaccountable regimes. These large debts became a serious impediment to poverty reduction and economic development. Countries began taking on new loans to repay old ones. Some countries spent more each year to service debt payments than they did on health and education combined.
While the debt crisis is far from over, industrialized countries have taken action to relieve debt burdens in many of the most impoverished countries, and these commitments have proven effective. Debt relief has been extended through two vehicles: the Highly Indebted Poor Country (HIPC) Initiative and the Multilateral Debt Relief Initiative (MDRI). The HIPC Initiative, started in 1996 and enhanced in 1999, cancels most bilateral debt and some multilateral debt for 40 of the most impoverished countries once they adopt economic and governance reform programs supported by the IMF and the World Bank. The HIPC process is designed to ensure that the debt savings are directed to country-owned poverty alleviation priorities.
At the 2005 G8 Summit, G8 leaders, led by the U.S. and the U.K., took further action to broaden debt relief by adopting the MDRI. For those countries that have completed the HIPC process, the MDRI agreement provides 100% debt cancellation of eligible debts that are owed to the World Bank, the IMF and the African Development Bank.
In total, 41 of the most impoverished countries in the world (34 of which are in Africa) are eligible for debt cancellation. For the 33 countries (27 in Africa) that have received debt relief thus far, it has proved to be immensely effective in achieving development objectives:
Debt relief is estimated to have reduced the debt stock of African Post-Decision Point countries by $86.7 billion, $70 billion of this for African Completion Point countries.
HIPC and the Multilateral Debt Relief Initiative (MDRI) freed up approximately $2.3 billion in debt service savings in 2007 – funds that can now be used to finance development.
African countries have used the funds that they no longer spend on debt service to reduce poverty. Partly because of debt cancellation, Post-Decision Point countries increased the share of their government revenues directed to poverty reduction from 37.8% in 2000 to 55.1% in 2007. In absolute terms, this means an increase in poverty-reducing expenditure from $5.8 billion (6.8% of GDP) in 2000 to $20 billion (9.4% of GDP) in 2007- an increase of $14 billion.
Moving Forward
Debt relief has proven itself an effective tool in the fight against poverty. To ensure that the benefits of debt cancellation are fully realized, the following steps should be taken by the international community:
Donors must mobilize resources to ensure that debt cancellation commitments are implemented and that the resources available for debt cancellation are additional to other development assistance.
Donors should implement an expanded debt cancellation initiative for poor countries that spend a significant portion of domestic resources servicing debt, but were excluded from debt relief because their debt levels did not meet the HIPC threshold.
As poor countries continue to look for ways to finance development, new lending may incur additional debts that can threaten the sustainability of past debt cancellation. To preserve the gains from the HIPC and MDRI initiatives, donors should scale up development flows in the form of grants (as opposed to through new loans whenever possible) and do not impose harmful economic conditions.
The international community should develop a means of arbitrating the origins of debts so that odious and illegitimate debts are dealt with through a fair and transparent process that recognizes creditors’ co-responsibility.
Finally, the international community needs to address the activities of vulture funds and their impact on development. Vulture funds are private financial institutions that buy outstanding debt owed by an impoverished country to a government or commercial creditor. After buying the debt at a steep discount, vulture funds can take legal action to seek repayment of the original amount and more.
