HIPC Debt Sustainability and Post-relief Lending Policy
William R. Cline1
Center for Global Development and
Institute for International Economics
Revised, September 2003
Introduction and Overview
The international community is committed to moving ahead with debt forgiveness
under the existing HIPC guidelines. These call for reducing the present value of debt to
no more than 150 percent of exports of goods and services or 250 percent of fiscal
revenue (IMF, 2003c). This endeavor is admirable and is an encouraging case of
collective action by the G-7 industrial countries. There has already been significant
progress in reducing HIPC debt. From 1991 through 2001, a total of $48 billion in
interest and principal was forgiven for the HIPC economies (World Bank, 2003). This
means that their external debt, which stood at $179.2 billion at the end of 2001, would
have been 27 percent higher without the regime of HIPC debt reduction. For 26 countries
that met the “decision point,” debt service has fallen from a weighted average of 4.1
percent of GDP in 1998 to 2.4 percent in 2002 and is projected at 2.0 percent in 2004
(IDA, 2003).
A central policy issue is arising, however, as this process moves ahead. After
having received forgiveness of official debt down to these thresholds, should HIPC
countries borrow once again or should assistance to them be limited to grants? It might
seem to follow from the logic of “needed debt relief” that only minimal borrowing should
be allowed after the relief, lest the countries return to over-indebtedness. Such an
approach, however, would pose a new problem: development assistance programs could
be forced either to grind to a halt or to be funded solely on a grants basis, but unless
donors are prepared to bear sharply increased real assistance costs, the volume of grants
would be considerably smaller than that of official loans. Of course, if the industrial
countries are in fact on the verge of a major new push to greatly increase development
assistance, a natural aftermath of HIPC relief would be to use a significant part of the
additional resources precisely to shift the flow of assistance to these countries away from
loans toward grants, to err on the side of caution. It is by no means clear, however, that it
is realistic to assume that the budget constraint on assistance resources will be so
generously relaxed as to afford wholesale replacement of loans by grants with no
shrinkage in the volume of flows.
This paper considers the underlying analytics of debt sustainability as a basis for
evaluating guidelines for future official assistance to HIPC countries.2 It finds that a
stark alternative between downsizing assistance and piercing debt ceilings should not be
1
I thank without implicating Stephen Radelet, David Roodman, and John Williamson for comments on an
earlier draft.
2
Annex A briefly considers the debt of other low-income countries.
2
binding. The reason is that the particular debt thresholds identified in the HIPC initiative,
while perhaps salutary for mobilizing concerted donor relief, do not seem to warrant rigid
interpretation as levels that should not be exceeded in the future. The ceilings do not
appear to have been arrived at in a very rigorous manner. They do not distinguish
between real and nominal interest. They have used rough adjustments from rough past
rules of thumb applicable to middle-income countries borrowing from private capital
markets to reach conclusions about ceilings relevant for poor countries borrowing from
multilateral agencies and governments. The various calculations and even statistical tests
seem often to have used often ill-defined measures of net present value of debt that are
not directly comparable to market debt of middle-income countries in the past.
The “economics of charity” hold that it will generally be more efficient for both
donors and recipients to provide a larger-volume flow of concessional loans rather than a
smaller-volume flow of grants having the same real (grant-equivalent) cost to the donors.
The reason is that the rate of return on investment in the recipient country will generally
be higher than that in the donor country. This same rule holds that when return is lower
in the recipient country, grants should be the form of assistance. This analytical
framework also tends to favor continuation of official lending after post-HIPC relief
rather than avoidance of any form of assistance other than grants. In essence, the
principal criterion for whether a post-forgiveness economy should borrow or receive only
(lesser) grants should be whether the expected real return on domestic investment
exceeds the real cost of interest on official lending. In many cases this test will be met,
because the real interest rate on official lending is close to zero.
The paper begins with a review of the various conceptual frameworks that have
been used to examine debt sustainability. These include the “external transfer” problem
of inadequate foreign exchange to service foreign debt; the “internal transfer” problem of
inadequate fiscal revenue to service public debt; the notion of a “debt overhang” that
discourages private investment; the moral argument that “odious debt” should be
absolved; concerns about low quality and high administrative costs of aid; and the idea
that debt should be forgiven down to the point where the government has sufficient free
resources to meet basic social needs.
The main analysis then begins with a “fiscal sustainability” framework usually
applied to emerging-market economies rather than HIPCs. Because the real interest rate
is the central driving force in defining the burden of debt in this approach, and because
the real interest rate on HIPC debt is close to zero, the fiscal sustainability framework
quickly leads to skepticism about whether the debt-carrying capacity of HIPCs has been
appropriately gauged. The discussion reaches an estimate that on average the real interest
burden of HIPC government debt stands at 3 percent of fiscal revenue plus grants, or 0.5
percent of GDP, not to first appearances an oppressive burden (although these estimates
for 2000 already reflect the benefits of some years of HIPC forgiveness). The discussion
then makes allowance for uncertainty about debt rollover and persistence of grants, but
finds that in practice rollover of amortization coming due has been high and the variance
of grants has been moderate.
3
The analysis then turns to the existing HIPC ceilings based on present value of
debt. It considers the proper discount rate for obtaining present value, and then goes
through an exercise asking whether a prudent finance minister with a target limit on
exposure to use of revenue for debt service would find the current thresholds about right.
The answer seems to be that he or she might be prepared to venture somewhat higher
debt ratios than the post-forgiveness HIPC ceilings. The analysis suggests that
probabilistic treatment of key variables could be used to obtain an analogue to “value at
risk” approaches used in financial analyses, along the lines of: how low would the debt
have to be reduced to assure up to a probability of x that no more than y percent of
government revenue would have to be used to service debt.
The estimates conclude with a look at the aggregate HIPC debt profile after target
forgiveness. It would require about a 30 percent cut in debt from end-2000 levels to meet
the HIPC target ceilings. The question is then raised, at that point would there be a
conflict between renewed borrowing and keeping the debt ratios within the ceilings? The
answer seems to be: not for the HIPCs as an aggregate. Nominal export growth of say 6
percent would raise the export base sufficiently to be compatible with about a 50 percent
increase in annual level of gross loan disbursements without raising the debt/export ratio
above the post-forgiveness ceiling. Presumably the dilemma between new borrowing and
holding down the debt ratios could arise in individual countries, however. If so, the
overall thrust of this paper is that there would likely be appropriate room for a flexible
rather than rigid application of the target ratios, and hence scope for additional
borrowing.
This note does not identify definitive alternative measures or thresholds. The
estimates and examples here do suggest, however, that the HIPC system needs to be
improved in several dimensions, including consideration of real interest rate, attention to
the expected amount of rollover and grant support rather than a focus simply on gross
debt service, attention to key differences between past debt difficulties in middle-income
countries and the context of HIPC countries facing greater likelihood of sustained new
lending and grants, and others. Finally, the analysis does not address the extent to which
new assistance should be discounted because of poor quality (tied and/or earmarked aid).
The analysis, which instead is focused on financial sustainability, could be adjusted to
take such considerations into account.
Alternative concepts of the debt burden
Before turning to the debt of low-income countries, it is useful to review the
principal concepts that have dominated the literature on developing-country debt.
External transfer – In the 1970s and through the mid-1980s, the principal framework for
analyzing debt sustainability was the idea that there could be an “external transfer
problem.” This was also in a period when exchange rates tended to be fixed, capital
controls tended to be present, and there was a broad perception that the “foreign
exchange constraint” was a binding limit on growth (e.g. Chenery and Strout, 1966). It
was in this framework that the early literature on debt rescheduling naturally focused on
4
the ratio of external debt service to exports of goods and services (e.g. Frank and Cline,
1971). The classic example of debt servicing disruption prompted by the external
transfer problem was when Mexico ran out of foreign exchange reserves and was forced
to suspend payment on its debt to foreign banks in August of 1982, inaugurating the Latin
American debt crisis of the 1980s.
Internal transfer – Later in the 1980s the diagnosis of debt problems began to focus as
well on the “internal transfer problem,” namely the fiscal challenge of raising enough
revenue from the domestic public to enable the government to pay interest and
amortization on its external debt. The internal (or fiscal) transfer issue became more
significant in part because typically sizable exchange rate depreciations were part of the
adjustment process, and these shrank the nominal value of GDP relative to external debt
and hence ballooned the burden of debt service as a fraction of GDP and revenue (as has
happened recently once again in the case of Argentina).
Debt overhang – In the late 1980s as debt policy evolved from concerted rescheduling
(Baker Plan) to forgiveness (Brady Plan), the notion of a “debt overhang” gained
popularity. Krugman (1989) postulated a “debt Laffer curve” relating the “expected
value” of the debt (vertical axis) to the total face amount of debt (horizontal axis). The
idea was that in the benign zone the curve lay along the 45° line as the two were equal;
but that once debt became so large the market questioned ability to repay, the curve
began to fall below the 45° line; and at a certain “inflection point,” the expected value of
debt began to fall again as the face amount of debt rose further. The financial alchemy
inherent in this proposition was that for a highly indebted country, both the country and
its creditors would be better off if the creditors forgave debt down to the inflection point.
The debt overhang notion invoked such arguments as the proposition that foreign
investors would stay away from a highly-indebted country because they would fear that
the government would have to tax away a large fraction of their profits in order to make
payments on its debt. The empirical search for the debt Laffer curve in the late 1980s
was not particularly successful, however. Cline (1995, p. 163) suggested that one
prominent set of results purporting to identify the debt Laffer curve inflection point
actually did not do so in terms of its own equations (Sachs and Huizinga, 1987). Other
empirical studies on secondary-market prices did not find significant incidence of debt
overhang (Claessens, 1990; Cohen, 1990).
In recent years the debt overhang notion appears to have become more loosely
defined as a situation in which debt discourages growth, without the more stringent
requirement that forgiving some of the debt would benefit both the debtor and the
creditor by raising the expected value of the debt that was left. Thus, Pattillo, Poirson
and Ricci (2002) conduct cross-country statistical analysis relating growth to the relative
level of debt and control variables, seeking to identify thresholds at which more debt
seems to reduce growth performance and hence constitutes a debt overhang.
The more recent use of the debt overhang concept would seem to risk watering it
down to a nearly meaningless notion. In the extreme, a debt overhang would be
5
identified whenever it could be argued the country would be better off without the debt
than with it. But that would virtually always be the case if adverse market feedbacks are
not taken into account. The Pattillo et al approach is not this extreme, but implicitly
makes the strong assumption that the sole condition required for debt to pass the
inflection point on the debt Laffer curve is that it be large enough to reduce the growth
rate. While there is a qualitative link of this definition to the original idea of the
overhang, on grounds that with slower growth the probability of successful honoring of
the debt could go down, there does not appear to be a rigorous attempt to identify just
how much slower the growth would have to be to trigger nonpayment. It would seem
appropriate to use caution in interpreting this literature as a meaningful grounds on which
to identify appropriate debt thresholds for triggering forgiveness, even though the
International Monetary Fund (2003c) appears to have embraced this approach.
Odious debt – Another recent trend has been to revive the notion of “odious debt,” which
dates from legal arguments made in 1898 at the time of the Spanish American War when
U.S. authorities saw no reason why Cuba should honor debt that had been “imposed” on
it by colonial rulers Although there is appeal to the idea that debt contracted and looted
by former dictators, for example, might not have the same standing as debt used to build
a hydroelectric dam, the odious debt slope is a slippery one indeed. The notion was
certainly not approved by the G-7 when it refused to absolve Russia of external debt
contracted by the Soviet Union, for example, and its use would at least seem to require
establishing generally accepted principles ex ante rather than allowing arbitrary
application ex post (Kremer and Jayachandran, 2003). That would suggest it is too late to
use the odious debt idea to justify forgiveness of existing debt, even if an ambitious
international convention might make it relevant for future debt.
Administrative costs and low-value debt – Much of the HIPC discussion appears to
invoke at least implicitly a close cousin of odious debt: the idea that the economic value
of official assistance received by HIPC debtors has been considerably less than its face
value because the aid has been tied to provision of high-cost services by nationals of the
donor country, and/or because servicing the debt involves burdensome negotiations with
donors about new loans that exhaust the scarce administrative capacity of poor country
governments and hence debilitate growth. Thus, Birdsall and Williamson (2002, p. 71)
cite estimates that tying reduces the value of aid by 15 to 30 percent (and by 50 percent
for technical assistance grants, but these do not contribute to debt).
Basic needs approach? -- It is sometimes suggested that the amount of debt relief needed
by a HIPC could be calculated by determining how much in revenue is needed to address
basic human needs, and then forgiving debt or debt service down to the point where the
revenue that is left over from the needs-based budget is sufficient to cover the remaining
debt service. There would seem to be at least two challenges in making this approach
operational. The first is the elastic notion of what needs are basic, and what percent of
GDP it costs to provide them. The second is the dependence of any such calculation on
the specification of a scenario about new official disbursements. As will be discussed
below, for most HIPC countries new aid disbursements have in fact systematically
exceeded repayments coming due. Under such circumstances, depicting the donor
6
relationship as a drain on revenue that otherwise could go to finance the meeting of basic
needs would seem questionable. Indeed, where (as usually) there are positive net
disbursements, and especially if these are greater than interest payments, implementing a
basic needs approach would implicitly require specifying a target for even greater net
resource transfers (i.e. the amount of disbursements in excess of principal repayments and
interest) sufficient to finance a fiscal deficit large enough to cover the basic needs target
in question. In other words, the underlying premise would be that the donors owe the
country not only enough to cover interest and amortization on official debt but also an
additional amount sufficient to cover a target fiscal deficit. Even in the world of official
assistance to low-income countries, this implicit obligation of donors would seem a bit of
a stretch.
Fiscal sustainability approach – Perhaps the most recent major framework for analyzing
debt sustainability is the approach of fiscal sustainability, set forth below.3 Essentially
this approach identifies the primary (non-interest) fiscal surplus that is necessary to
prevent an upward spiral in the ratio of public debt to GDP. In the context of a
recapitulation of approaches to the debt burden, however, it is useful to recognize that the
fiscal sustainability framework is in the tradition of the “internal transfer problem.” It
does not distinguish between debt owed to foreigners and debt owed domestically,
although in actual calculations such factors as the currency of denomination of the debt
can be important in projecting the likely path of the public debt/GDP ratio.
Concepts overview – It is clear that there are numerous alternative approaches to thinking
about the burden of debt, and how much debt is sustainable. This paper will focus on two
of them: the fiscal sustainability approach, and the more traditional “external transfer
problem” as gauged by the various debt/exports ratios. There are ambiguities even in
these (for example, in how to make “debt” estimates comparable through present value
calculations). Even when these measures might suggest one diagnosis about whether
further debt forgiveness is needed, and correspondingly about whether a post-relief
country is ready to borrow again, adherents to other frameworks (debt overhang, basic
needs, etc.) could well reach alternative conclusions.
Loans versus grants
At the most general level, the idea that debt needs to be forgiven down to a
threshold implies that afterwards new borrowing should be limited to amounts that do not
raise debt above that threshold (e.g. modest amounts that allow debt to grow by no more
than the export base). All other new official assistance should be in grants. There has
already been an escalation in the loans versus grants debate, spurred by former US
Treasury Secretary Paul O’Neill in his efforts in 2001-02 to shift IDA toward grants
instead of loans.
The discussion of loans versus grants does not always seem to reflect a clear
economic framework, however, and often seems to be phrased in a general manner in
3
Relatively early presentations include Blanchard et al (1990), Buiter (1990), and Fischer and Easterly
(1990).
7
which more is better and grants are better than loans. The proper terms for the issue
should consider a budget constraint, and seek to maximize the benefit to the recipient for
a given cost to the donor at that budget constraint. Historically, donors favored long-term
concessional loans over grants in part because they believed the loans conferred a greater
sense of discipline and business-like orientation to the development process. The need
for the HIPC initiative suggests that this objective has often not been met.
In part, however, the choice of loans also reflected a judgment that loans could be
more cost effective for both donor and recipient. Schmidt (1964) first set forth the
“economics of charity” applicable to the loan versus grant decision. In a word, assistance
should be given as a loan if the rate of return on investment is higher in the recipient
country than in the donor country; it should be given as a grant if the reverse is true.
Consider a given amount of present-value donation from the standpoint of the donor.
The donor can either give an outright grant of 100, or can extend a concessional loan that
has the present value of 100. The face value of the loan will be considerably higher than
100, because the concessional interest rate on the loan is below the opportunity cost of
the donor.
Suppose the real interest rate on the concessional loan is 0.5 percent annually, and
the maturity is 30 years. Then if the donor’s real opportunity cost of public capital is 2.5
percent (e.g. a long-term treasury bond rate of 5 percent with long-term inflation
expected at 2.5 percent), a loan with a face value of 410 can be extended with the same
present value cost to the donor of 100.4 So the donor will be indifferent between offering
a grant of 100 or a loan of 410.
There is an important point to be made already with this formulation of donor
cost: if proper discounting is used, the trade-off between the face volume of the loan and
the grant can be relatively steep. It is at least implicitly for this reason that the IMF
(2003c) worries about “very tight financing constraints” that could result from proposals
to halt lending and shift to grants-only for countries bumping up against debt ceilings.
Namely, the amount of grants donors would be willing to make equivalent in economic
cost to the present volume of concessional loans could be on the order of only one-fourth
as much in face volume, potentially posing a liquidity squeeze.
Now consider the choice from the standpoint of the recipient. A country with
sound policies and prospects of investment returns of 5 percent in real terms would do
well to accept the loan of 410, because the present value of the stream of repayments
discounting at a 5 percent real rate would be only 230, leaving a net value of 410230=180. The value of the loan to this country would be 80 percent higher than the value
of the grant of 100 that the donor would be equally willing to offer. In contrast, for
another recipient country with poor policies and structural difficulties limiting the rate of
return on aid to only 1 percent in real terms, the discounted present value of the stream of
repayments on the loan would amount to 381, leaving a net benefit of only 410-381 =29,
far below the benefit of 100 from the grant. The point of indifference between the 410
4
That is: the discounted present value of the stream of the payments on this loan amounts to 310, so the
net cost to the donor is 410 -310 =100.
8
loan and the 100 grant for the recipient turns out to be where the real rate of return for the
recipient just equals the real opportunity cost of the donor. This confirms the principle of
the “economics of charity:” use loans if the return in the recipient country is higher than
the opportunity cost in the donor country, and grants in the reverse case.
The issue of loans versus grants may, of course, turn more on political
considerations, or on money illusion, than on an economic evaluation of this type. To
some recipients and to advocates of shifting to grants, it could seem unduly stingy of the
donor to offer only 24 cents in a grant as the alternative to a dollar in a loan (the ratio in
the example just given). Even at a technical level the trade-off can be ambiguous. The
present discount rate applied by the OECD’s Development Assistance Committee in
calculating the grant-equivalent of a loan is, astonishingly, still 10 percent, although
world inflation has imploded since the days when this might have made sense. The
practice is understandable from the standpoint of donors who wish to get as much credit
as possible for the value of their assistance, but it overstates the grant equivalent in an era
of low inflation and low donor government bond rates. Thus, DAC would thus treat a 3
percent nominal loan for 30 years as having a grant element of 48 percent, or twice the
grant element of the same loan as just evaluated (which used a real interest payment of
0.5 percent, and assumed 2.5 percent inflation and a real donor government bond rate of
2.5 percent). The driving force in the difference is that the DAC implicitly assumes a real
donor discount rate of about 7.5 percent, which is far higher than DAC governments pay
on their own long-term bonds. Ironically, donors could be hoist on their own pitard,
because the current grant-equivalent approach would provide a highly advantageous
option to recipient governments if it were used as the basis for offering a choice between
loans or grants. Thus, using the DAC rates, a recipient country ineligible for an extra $1
in loans because it is at its debt ceiling would be made an offer of 48 cents in outright
grants instead (assuming legislatures generously concurred with the DAC rates), rather
than only 24 cents as in the analysis above. Even then some recipient governments might
find the trade-off relatively steep.
Fiscal sustainability
With this brief review of the central issues in mind, we can turn to the main focus
of this study: the application of alternative debt sustainability concepts to the HIPCs.
The first of these concepts is that of fiscal sustainability.
By now it is widely recognized that the condition for maintaining a constant ratio
of government debt to GDP is achieving a fiscal performance of: sp = d(i*-g), where sp is
the primary (non-interest) fiscal surplus as a fraction of GDP, d is the ratio of debt to
GDP, i* is the real interest rate on the debt, and g is the real growth rate (see Annex B).5
It is also widely considered that among industrial countries, government debt should be
held to somewhere in the vicinity of 50-60 percent of GDP (the latter being the
5
More specifically, the primary surplus is defined as “the difference between total revenue (excluding
grants) and non-interest domestic expenditure (excluding foreign financed capital expenditure”) (IMF,
2003d, para. 26). The revenue concept thus excludes grants (f), so it is appropriate to subtract them off in
obtaining the required “own” primary surplus (sp).
9
Maastricht criterion), and that in developing countries where the revenue base is lower
relative to GDP, the debt ratio target should be somewhat lower.6
This debt sustainability condition has been applied most frequently to emerging
market economies, where market concern has typically focused on whether the debt to
GDP ratio has shown a rising trend or is stable. In these economies there is little or no
revenue from international grants. In contrast, in low-income countries such grants can
be substantial relative to GDP. Thus, for the Highly Indebted Poor Countries (HIPCs),
grants from abroad were an average of 4.5 percent of GDP in 1999-2000 (World Bank,
2002a, 218). For these economies, then, the fiscal sustainability criterion is less stringent,
because foreign grants are available to pay some part (or all) of the interest due on debt.
The natural modification of the sustainability condition is thus:
1) s p = d (i * − g ) − f
where f is the amount of foreign grants as a fraction of GDP. If grants are large enough,
the primary fiscal balance can be negative and still be consistent with fiscal sustainability.
To obtain an idea of reasonable government profiles for thinking about fiscal
sustainability, Table 1 reports debt, interest, and revenue ratios for several major
emerging market economies. The data are for the consolidated central government, but
in most cases refer to the bulk of the public sector.7
6
Japan’s aberrant debt/GDP ratio of 140 percent is sustainable only because its real interest rate is close to
zero.
7
Note that the total debt figure for Brazil is public sector net debt (deducting foreign reserves and other
assets). The table reports public sector debt from IMF (2002a) rather than the central government debt
from IMF (2002b), and imputes the interest based on the average rate in the latter.
10
Brazil
Chile
Colombia
Indonesia
Mexico (a)
Philippines
Poland
South Africa
Thailand
Average
Median
Table 1
Central Government Debt Profiles for
Selected Emerging Market Economies
(percent of GDP)
Revenue Interest
Debt
Int./Rev. %
1998
25.9
3.8
43.3
14.8
2001
22.8
0.5
15.6
2.1
1999
12.4
3.3
29.3
26.8
1999
18.1
3.9
45.2
21.6
2000
14.8
4.1
46.0
27.7
2001
15.5
4.8
65.5
31.0
2001
31.0
2.9
40.4
9.4
2001
27.8
4.9
46.8
17.4
2001
17.7
1.2
30.0
7.1
20.7
3.3
40.2
17.5
18.1
3.8
43.3
17.4
a. Alternative estimates: interest, 2.1; debt, 23.5; int./rev. 14.2
Source: IMF, Government Finance Statistics Yearbook, 2002; IMF Article IV
Consultation 2002, Mexico; Ministry of Finance, Brazil;
IMF, International Financial Statistics
Table 1 suggests that for emerging market economies, central government
revenue is typically about 19 percent of GDP, interest payments about 3.5 percent of
GDP and 17 percent of revenue, and government debt about 40 percent of GDP.
Table 2 reports consolidated central government revenue and grants for 16 HIPCs.
Revenue is about 15 percent of GDP, or about 4 percentage points below the benchmark
for the higher-income emerging market economies listed in table 1. Grants average about
3 percent of GDP. This is consistent with the 4.5 percent of GDP figure from the World
Bank aggregates for HIPCs, noted above. However, table 2 suggests that this average
disguises large variability, with several countries receiving grants on the order of 6
percent of GDP and several others at or close to zero. The median for grants is only 1
percent of GDP (for 14 countries).
Now consider benchmark values for equation 1) for the two sets of countries. For
the emerging market economies, from table 1 the debt to GDP ratio is d = 0.4. For the
real interest rate, we can consider a US treasury bond rate plus a spread of perhaps 300
basis points. Under normal conditions the real US treasury rate would be say 3 percent,
so the real interest rate for emerging markets would be i* = 6.0%. This is broadly
consistent with the interest data shown in table 1.8 As for the growth rate, in the 1990s
real GDP in middle-income countries grew at 3.5 percent annually (World Bank, 2001).
8
The nominal interest rate is implicitly approximately the ratio of the interest payments as a percent of
GDP to debt as a percent of GDP, which is about 8 to 10 percent in the table and hence broadly consistent
with 6 percent real interest rate, although the complication of domestic versus external public debt and use
of end-of-current year rather than previous year in the table means the comparison is far from exact.
11
On this basis, as shown in table 3 the target primary surplus to maintain the debt ratio
constant is a benchmark 1.0 percent of GDP.
Table 2
Consolidated Central Government Revenue and Grants
Selected Highly Indebted Poor Countries
(% GDP)
Burkina Faso
Burundi
Cameroon
Congo, Dem. Rep.
Congo, Republic
Cote d Ivoire
Ethiopia
Madagascar
Myanmar
Nicaragua
Rwanda
Sierra Leone
Sudan
Uganda
Vietnam
Zambia
Average
Median
Revenue
11.4
15.8
14.4
4.3
31.5
19.8
22.4
11.7
5.6
29.8
10.5
7.1
10.1
12.5
20.2
21.3
15.5
14.4
1992
1999
1999
2001
2001
2001
1999
2000
1999
2000
1993
1999
1998
1998
2001
1998
Grants
n.a.
2.50
n.a.
4.61
0.25
0.60
0.96
3.61
0.01
6.06
6.80
5.40
0.00
5.99
1.09
6.70
3.19
1.10
Table 3
Stylized parameters for debt sustainability
d
i*
g
f
target sp
Low income: HIPCs
1.06
0.5
3.0
4.5
-7.2
Middle income: EMEs
0.40
6.0
3.5
0.0
1.0
For the HIPCs, the ratio of total debt to GDP was an average of 106 percent in
1999-2000.9 However, this is a nominal measure, and it is widely recognized that some
adjustment must be made for the fact that the debt is largely on concessional terms. The
standard practice is to discuss the present value of debt relative to GDP, as examined
below. For purposes of equation 1), however, we can consider directly the nominal value
of debt and explicitly take into account the low real interest rate on it.
9
In contrast to the emerging market economies, several of which have large domestic debt, the estimates
here for the HIPCs refer only to external debt. For the HIPCs it is a close approximation, however, that all
of the external debt is public debt, and that there is no public debt except for external debt.
12
In 1999-2000, HIPC interest payments averaged $3.1 billion, against the 19981999 end-of-year debt stocks averaging $198 billion, so the apparent average interest rate
was 1.6 percent (World Bank, 2002). A country-by-country compilation for the 41
HIPCs considering interest paid, interest due but unpaid, and interest originally due but
forgiven, results in a total accrual-basis interest rate averaging 2.3 percent in 1998-2000
(calculated from World Bank, 2002). During this period, consumer price inflation in
creditor countries weighting by their shares in claims on HIPCs was an average of 1.8
percent annually (IMF, 2003). So the real interest rate on HIPC debt was 2.3-1.8 = 0.5
percent annually. As for growth, for 29 HIPC countries with GDP data available, in the
1990s growth averaged 2.7 percent on an unweighted basis, and 3.7 percent weighting by
population (World Bank, 2002). So 3 percent is a reasonable parameter for HIPC
growth.
The debt sustainability profile for the HIPCs in table 3 shows the at first
surprising result that the HIPC does not need to run a primary surplus at all; instead, it
can incur a primary fiscal deficit equal to 7.2 percent of GDP without boosting its debt
ratio further above the already seemingly (but in reality not so) high level of about 100
percent.
This finding helps illuminate what HIPC debt relief is really all about. It is
essentially a policy strategy that seeks to boost further the fiscal support provided by the
donors to the poor countries to enable them to run deficits. The essence of the strategy
has to be the judgment that these countries need to run even larger fiscal deficits than
they can currently finance, and a reduction in payments on donor-held debt is therefore
desirable. Note further that because debt is about 100 percent of GDP and the nominal
interest rate is 2.3 percent, the nominal interest burden stands at 2.4 percent of GDP. If
this is added to the “sustainable” primary deficit of 7.2 percent of GDP, this means that
there can be an overall nominal fiscal deficit of 9.6 percent of GDP and fiscal accounts
will still be compatible with debt sustainability. Essentially, donor financing of fiscal
deficits makes far higher rates possible than could be contemplated elsewhere.
The perceived fiscal pressure from HIPC debt is presumably greater because of
the uncertainty of rollover of existing debt, especially rollover at unchanged concessional
interest rates. The fiscal sustainability equation assumes that all debt principal payments
are replaced by new borrowing. It is thus worth thinking about the vulnerability of debt
servicing by considering the cash flow exposure of the government, equal to interest plus
amortization due. The logical base against which to compare this amount is either
domestic revenue, the narrow (pessimistic) variant, or domestic revenue plus external
grants, the broader (optimistic) variant. This indicator of perceived fiscal vulnerability is
thus:
2) v =
i * +π + α
I + A Dt −1 (i * +π + α )
,
=
≈d
τYt + fYt
τ+f
R+G
13
for the optimistic variant, and d(i*+π+α)/τ for the pessimistic variant. The variables in
equation 2) are as follows: I, interest payments; A, amortization; R, government
revenue; G, government grants from abroad; D, the stock of public debt; Y, nominal
GDP. The parameters are as before, and additionally: π, the donor rate of inflation; α,
the amortization rate; and τ, the domestic tax rate.
On the basis of tables 2 and 3, we have for HIPCs: i* = 0.005; τ = 0.15; d =
1.06; f =.045. Birdsall and Williamson (2002, p. 81) cite World Bank estimates placing
the revenue rate τ at an average of 19 percent of GDP for decision-point HIPCs, so the
use of 15 percent here is conservative. Donor inflation is set at the 1998-2000 rate, π =
.018. Amortization for the HIPCs in 2000 was $6 billion, or 3.36 percent of end-1999
debt, consistent with 30 year maturities; so α = 0.033. These parameters place the HIPC
fiscal vulnerability ratio at v = 0.30 if grants (f) are included in the denominator (equation
2), and at 0.40 in the conservative or pessimistic variant in which grants are excluded
from the fiscal base.
For the emerging market economy (EME) sample, from tables 1 and 3 the
corresponding parameters are: i* = 0.06; τ = 0.19; d = 0.40; f =0. As for maturity,
some countries such as Brazil rely on relatively short-term domestic debt, but this has
proven manageable to roll over. Mexico’s external public debt has an average maturity
of 10 years, so a plausible benchmark for the relevant debt might be an amortization rate
of α = 0.10. Equation 2) then gives a vulnerability ratio for emerging market economies
of v = 0.40. The fiscal vulnerability of HIPCs is thus either lower or virtually the same as
that of EMEs.
These comparisons thus suggest that the lower ratio of nominal debt to nominal
GDP in the emerging market economies, and the higher revenue base, tends to offset the
lower interest rate, longer maturity, and availability of grants to the HIPC countries,
leaving their fiscal vulnerability ratios identical under the pessimistic hypothesis
excluding grants in the fiscal base. In the optimistic variant including grants, HIPC fiscal
vulnerability is somewhat lower (by one-fourth) than that of the emerging market
economies. These estimates mean that both sets of countries stand exposed to potentially
using 30-40 percent of their fiscal revenue and grant income base to service public debt
in the event that creditors do not provide rollover.
It is useful further to identify a “fiscal burden” ratio that evaluates the debt burden
under certainty, rather than focusing on vulnerability. In this case, given the likelihood
that principal can be rolled over, the true burden stems only from the real interest. The
relevant fiscal base is the revenue plus the certainty-equivalent value of grants. This
measure would then be:
3)b f = d
i*
τ + λc f
14
In equation 3, there is no burden from amortization because debt can be rolled over (or,
equivalently, the country is reducing its liabilities when it repays and hence experiences
no net burden). Inflation is not added because it is not a real cost. In the denominator,
the revenue base once again appears in the tax revenue rate τ. The contribution of grants
(f) is shrunk by multiplying by the fraction λc , which is close to unity if continued grants
are highly likely, but can be low if the flow of grants is undependable. Similarly, to the
extent that grants are worth less than full face value because they are tied to specific
donor services, or because they are earmarked for projects that would not otherwise be at
the top of the country’s priority list, the shrinkage factor λc can be thought of as making
allowance for this as well.
The fiscal burden ratio using HIPC parameters and setting the certainty-equivalent
fraction at λc = 0.5 amounts to: bf = 1.06 [0.005/(0.15+.0225)] = 0.086. That is, the
annual real burden from interest on the public debt is about 3 percent of the certaintyequivalent of revenue plus grants. This low ratio stems from the very low real interest
rate on HIPC debt, one-half of one percent. The same ratio for the emerging markets
turns out to be 0.126. That is, real interest is 13 percent of the revenue base (their finance
ministries more than tithe to their creditors), or about four times the burden for the
HIPCs.
The economic significance of this comparison is that the real burden of public
debt tends to be much higher in the emerging market economies than in the HIPCs
because the near-zero real interest rate and the availability of grants in HIPCs much more
than offsets the lower debt ratio to GDP in the emerging markets. This result reinforces
the debt vulnerability ratio finding. The intuition is reasonable: it is the uncertainty of
principal rollover and continuation of grants, not the inherent real interest burden, that
makes HIPC debt burdensome relative to fiscal capacity. A further interpretation that
could be argued is that it would be desirable for the HIPCs to have a lower rather than
equal or higher debt vulnerability ratio than the emerging market economies, because
they are less able to cope with the adverse outcomes. It could similarly be argued that
even if the real burden of debt for the HIPCS is only one-fourth that for the emerging
market economies, even this ratio is too high given their greater poverty (implicitly, their
higher marginal utility of free revenue at the lower percapita income level). Still other
arguments could be added, such as the view that it is the HIPCs’ export prices that should
be used to deflate nominal interest, rather than donor consumer prices, and that falling
commodity prices mean the real interest rate is much higher than estimated here. This
argument is unpersuasive, however, because the long-term trend in terms of trade for low
income countries remains a subject of extensive debate.10
We can begin to translate the fiscal parameters into a framework for HIPC debt
forgiveness if we consider a probabilistic approach in which the donor policy is to seek to
assure that up to a certain probability threshold, debt service obligations by the country
will not exceed a given target fraction of revenue plus grants. For this purpose, it is
possible to incorporate elements of both the vulnerability ratio (equation 2) and the
10
For sub-Saharan Africa did fall annually by 1.2 percent in 1983-92, but they then rose annually by 2.3
percent in 1993-02, albeit with wide annual fluctuations in both periods (IMF, 2001; 2003).
15
certainty-equivalent-burden ratio (equation 3) by treating the variables as stochastic, or
having probability distributions around expected paths.
It is useful to think of a “debt servicing duress” (DSD) measure that takes account
of both cash flow and likelihood of refinancing access. This ratio is:
4) z t =
Dt −1 (i * +π + α [1 − β ])
(i * +π + α [1 − β ])
≈d
τYt + fYt
τ+f
where β is defined as the ratio of gross new borrowing to amortization coming due. This
is a cash flow measure equivalent to the vulnerability measure (equation 2) except that it
omits that portion of amortization that is covered by new borrowing.
It is possible to think of both the numerator and denominator of equation 4) as
random variables with probability distributions. The principal focus of this variability
from the standpoint of the HIPC country would be the rollover rate β and the grants rate f,
although the revenue rate τ could also be subject to the business cycle.
If we define x ≡ d(i*+π+α[1-β]) and y ≡ τ+f, and if we assume that both x and y
are random variables with log-normal probability distributions, then we know that z is
also a random variable with a log-normal probability distribution. Specifically, if x is
log-normal, µx and σx2 are respectively the mean and variance of the logarithm of x, and
similarly for y, then z will be log-normal with mean of the logarithm of z being µz =µx µy and variance of the logarithm of z being σz2=σx2+σy2 (Aitchison and Brown, 1963, p.
11).
Let h(z) be the probability distribution function of z. Then:11
5)h( z ) =
1
2π σz
e
−
(ln z − µ z ) 2
2σ z2
We can then evaluate the cumulative density function of this distribution. Suppose the
objective is to ensure that, with a probability of 90 percent, the debt servicing duress ratio
does not exceed a certain threshold, such as z* = 0.25 (i.e. no more than 25 percent of
revenue plus grants will be required to service the debt). Let H(z) be the cumulative
density function corresponding to h(z). If debt is at a level that meets the policy
objective, then H(z*) ≥ 0.9. That is, the cumulative probability that z is equal to z* or less
will be greater than or equal to 90 percent.
Now suppose we find that instead, H(z*) = k << 0.9. This means that well less
than 90 percent of the probability distribution will have been traversed by the time z
reaches the threshold level. Then policymakers will wish to forgive the debt by a fraction
11
In equation 5) the use of π refers to the standard mathematical value of pi, not inflation.
16
φ such that for the reduced debt the DSD ratio, which is z’ =(1-φ)z, the cumulative
distribution function reaches 90 percent at the desired threshold, or H(z’*) =0.9.12
Table 4 provides information relevant to the probability distribution of the debt
rollover fraction β. For 41 HIPC countries in the years 1986-2000, it displays selected
quantiles in the distribution of the ratio of new disbursements to principal repayments for
long-term and IMF debt. The striking overall pattern is that far from failing to achieve
rollover, for most countries over most of the period new disbursements have far exceeded
principal repayments. For purposes of equation 4) above, in the spirit of gauging the risk
that principal will not be rolled over, we can impose a ceiling of 1.0 on β. However, in
practice the ratio of new disbursements to repayments has been much higher, averaging
in the range of 6 to 8 in the late 1980s, 3 to 5 in the early and mid-1990s, and about 2 by
the late 1990s and 2000. The median disbursements/ repayments ratio was about 3 in the
early part of the period and about 1.8 in the later part. There is a clear pattern of decline
over the 15 year period. Nonetheless, the rollover ratio is essentially always at least unity
for all but the bottom 15 percent of countries up through 1994. By 1995 and after the
rollover rate is still close to unity or well above for the 25th percentile and above, but falls
to about 60 percent for the 20th percentile, 40 percent for the 15th percentile, and by the
final two years is at zero for the bottom 10th percentile (Liberia, Somalia, Sudan, and
Zaire).
Table 4
Ratio of New Disbursements to Repayments, 41 HIPCs (a)
Percentile in distribution:
10%
15%
20%
25%
50%
1986
1.25
1.39
1.53
1.56
3.27
1987
1.17
1.41
1.55
1.62
3.04
1988
1.46
1.52
1.69
1.79
2.91
1989
1.44
1.50
1.71
1.76
2.83
1990
1.28
1.30
1.50
1.70
2.66
1991
0.42
0.96
1.16
1.23
2.38
1992
1.34
1.54
2.07
2.27
3.20
1993
1.22
1.37
1.53
1.74
3.30
1994
0.53
1.22
1.31
1.42
2.35
1995
0.18
0.56
0.94
1.11
1.81
1996
0.17
0.82
1.03
1.08
2.14
1997
0.11
0.43
0.55
1.07
2.28
1998
0.14
0.55
0.63
0.87
1.79
1999
0.00
0.32
0.57
0.90
1.46
2000
0.00
0.31
0.64
0.94
1.80
a. Long-term debt plus IMF
Source: World Bank, Global Development Finance 2002
75%
5.23
4.87
6.09
4.28
5.87
3.68
5.53
5.98
3.79
3.14
3.36
3.24
2.63
2.35
2.62
90%
15.00
13.73
23.71
12.89
16.44
14.04
11.40
13.11
8.11
5.92
7.47
6.09
4.05
5.13
3.65
AVG
5.79
6.08
7.84
6.69
8.26
4.79
5.23
4.86
3.36
3.04
2.84
2.61
2.04
1.99
1.95
In broad terms these data suggest that the rollover risk is limited for most
countries, and that where rollover collapses, the reasons center on governance problems
(witness the list in the bottom decile just cited) rather than creditor unreliability. To be
sure, there is likely some element of “forced lending” present in the robust rollover rates.
12
From equation 4), z is proportional to the debt ratio d, so after debt reduction we will have z’ = z(1-φ).
17
Thus, Birdsall, Claessens and Diwan (2002) find that where multilateral debt has already
become substantial, bilateral lending tends to be higher to countries with “bad” policies
rather than good, suggesting pressure to provide bilateral funds to help avoid arrears to
multilateral organizations. Nonetheless, this syndrome suggests that bilateral donors will
be especially happy to provide new lending to countries with good policies, as a pleasant
contrast to lending under duress to countries with bad policies. Of course, if total new
disbursements were substantially lower than amortization due, lending under duress
would siphon away new lending from countries with good policies, leaving them with
less than full rollover. Instead, however, average new disbursements have typically been
two to three times as large as amortization coming due (table 4), leaving enough to lend
to good-policy countries in amounts that cover, or more often more than cover, their
amortization due.
Similarly, whatever their other faults, official donors to the HIPCs seem to be
much steadier partners than private creditors to emerging markets (where net
disbursements swung from some $202 billion in 1996 to -$16 billion in 1999; IIF, 2000,
2002). Overall, the new disbursements record casts considerable doubt on one
component of the “uncertainty” argument for debt relief, the debt rollover ratio. The data
essentially say this has not been a problem except for the bottom 15-20 percent of the
HIPC group. It would seem questionable to base strategy for the entire group around
concerns relevant only to the bottom tier, especially when it is recognized that the
membership in this tier tends to be driven by poor performance rather than bad luck.
What about the other component, the flow of grants? Table 5 reports the
experience of 38 HIPCs in 1991-2000. It shows that grants amounted to an unweighted
average of 9.9 percent of GDP, with a median of 7.7 percent of GDP. This estimate from
the World Bank (2002a) is considerably higher than the overall (weighted) average for
1999-2000, or 4.5 percent of GDP as noted above. The difference appears to reflect the
fact that the larger countries tend to get smaller grants relative to GDP, and to a lesser
extent the fact that even the unweighted average was lower in 1999-2000 (at 8.3 percent)
than for 1991-2000 as a whole. At the median, the standard deviation is 1.8 percent of
GDP. This suggests that on average, there is only about a one-sixth chance that a typical
HIPC country receiving 7.7 percent of GDP in grants will instead in a bad year receive
less than 5.9 percent of GDP.13
These data convey two messages. First, the grant fraction f used in the analysis
above may be an underestimate (4.5 percent of GDP rather than 7.7 percent). Second,
although there is indeed some variability in f, this variability does not seem particularly
high. The exception is for the top end of the distribution, where very large fractions of
GDP in grants also tend to go along with wide fluctuations and hence cannot be counted
upon. Thus, at the 90th percentile, grants average 20.5 percent of GDP but the standard
13
The probability is 67 percent that a random variable will be within one standard deviation of its mean, so
the chances are 33 percent that it will be outside this range, of which only half is the case where it is below
rather than above the mean.
18
deviation is 7.6 percent.14 Both of these findings tend to point in the same direction as
the results on debt rollover: risk from variability in assistance does not seem to be a
pervasive problem for the HIPCs. This in turn tends to focus attention away from the
“fiscal vulnerability” measure (v, equation 2) and the “debt servicing duress” measure (z
in equation 4), and toward the “fiscal burden” measure (bf , equation 3). That is: if the
rollover fraction β is usually close to unity (or higher), and the grants fraction “ f “ tends
to be relatively predictable for the country in question, then the vulnerability ratio which
does not take account of likely rollover at all (equation 2) and the duress ratio which is
concerned about a low rollover ratio (equation 4) become of much less relevance than the
fiscal burden measure which ignores principal repayment and instead focuses wholly on
the real interest burden. Focusing on the interest burden is, in fact, the position taken in
my earlier analysis of African debt (Cline, 1995, chapter 7).
Suppose we return, then, to a focus on the interest burden relative to the base of
revenue and grants. Suppose we select as the main fiscal benchmark of debt
sustainability the fiscal burden (equation 2). Suppose we estimate the “certainty
equivalent” fraction λc on the basis of the grants fraction adjusted downward by one
standard deviation. On the basis of the table 5 estimate at the median, this places λc at:
(1-[7.7-1.8])/7.7 = 0.76. If we conservatively estimate f at 4.5 percent of GDP based on
the IMF fiscal data (rather than 7.7 percent based on World Bank external grants data),
this places our central estimate of the fiscal burden ratio at: bf =
1.06[0.005/(0.15+{.76x.045})] = 0.029.
In short, on average the real interest burden of the HIPC government’s debt is 3
percent of fiscal revenue plus grants (with a conservative benchmark for the latter at one
standard deviation below the median). This also amounts to 0.53 percent of GDP. The
fiscal case for forgiveness then turns on a) whether a particular country has a much
higher ratio than this “typical” ratio; and b) whether even this typical ratio is too high, a
judgment which is implicit in the policy framework within which all HIPC countries are
supposed to be eligible for debt forgiveness rather than just those among them with debt
higher than the median.
Overall, it would seem difficult to make the case in the end that it is the real fiscal
burden that necessitates HIPC debt relief. It does not seem unduly burdensome to
allocate 3 percent of revenue plus conservatively estimated grants to pay real interest.
Nor does it seem unduly burdensome to devote half of one percent of GDP to this
purpose.
14
Note that in table 5 the standard deviation reported at the specific percentiles in the distribution are
calculated by applying the average ratio of the standard deviation to the mean for the specific country that
stands at the percentile in question plus the same ratio for the two countries flanking it in the distribution.
19
Table 5
HIPCs: Grants as a Percent of GDP, 1991-2000
Average
Angola
Benin
Bolivia
Burkina Faso
Burundi
Cameroon
Central African Republic
Chad
Comoros
Congo, Dem. Rep.
Congo, Rep.
Cote d'Ivoire
Ethiopia
Gambia, The
Ghana
Guinea
Guinea-Bissau
Honduras
Kenya
Lao PDR
Madagascar
Malawi
Mali
Mauritania
Mozambique
Nicaragua
Niger
Rwanda
Sao Tome and Principe
Senegal
Sierra Leone
Sudan
Tanzania
Togo
Uganda
Vietnam
Yemen, Rep.
Zambia
Average:
Percentile:
7.4
6.7
4.7
10.6
12.2
2.4
8.3
6.6
8.5
2.8
7.7
4.1
9.3
7.7
3.9
5.0
20.5
4.9
3.4
7.2
7.4
13.3
8.9
14.3
29.0
25.5
9.7
21.7
42.3
7.2
10.5
3.1
10.7
5.4
7.9
1.3
2.1
12.6
9.9
10
2.8
15
3.4
20
4.1
25
4.9
50
7.7
75
10.6
90
20.5
Source: World Bank, World Development Finance 2002
Standard
Deviation
1.3
0.5
0.7
0.8
2.2
0.3
0.7
0.6
0.8
0.4
2.2
0.7
1.2
1.3
0.4
0.3
1.2
1.5
0.5
0.5
1.2
1.5
0.7
0.9
3.0
5.2
1.0
7.0
3.7
0.8
1.6
0.5
1.4
0.6
0.6
0.2
0.1
1.4
0.6
0.4
0.5
0.7
1.5
1.8
1.3
7.6
20
The diagnosis that the real fiscal burden of debt is not sufficiently high on average
to be a compelling basis requiring HIPC debt forgiveness immediately raises the question
of why the perceived need for debt relief is so high. One answer may be that it is not the
internal (fiscal) transfer problem but the external (balance of payments) transfer problem
that dominates. A related argument could be that especially in the external sector, such
shocks as a collapse in the terms of trade pose crises in particular countries and in
particular years that are not captured by the overall fiscal and refinancing averages. It
would be possible to carry out statistical analyses relating change in arrears to terms of
trade and other such factors to test for the dominance of this type of problem.
An alternative answer is more political-economic. Debt relief involves an
interaction of creditor willingness and debtor “need.” Once the systemic program of
HIPC relief was mounted by international policy-makers, it is understandable that
policymakers in eligible countries will have found it attractive to enroll for relief that they
might have been able to avoid on strictly economic and fiscal grounds. A major part of
the reluctance to default is policymaker fear of the adverse impact on future access to
capital markets. If the donor community is offering a program of debt reduction, and
moreover arguing that the program will enhance rather than curb future access to capital
markets, this usual inhibition will have the sign reversed.
Payments arrears were already building up before the development of the HIPC
relief program, however, so at least some portion of the debt-forgiveness equilibrium
represented an outward shift of debtor demand rather than in creditor supply. Once
again, however, it is not necessarily the bad luck of external shocks that caused mounting
arrears. There are also likely numerous cases in which domestic policies and poor
governance were instead the driving force. Figure 1 provides at least some evidence in
this direction. The Heritage Index of Economic Freedom is available for 20 of the 41
HIPCs considered here for 1995, the mid-point of the time horizon examined above. This
index ranges from 1 for best performance to 5 for worst. The figure divides the 20
countries into ascending quintiles by average increase in interest arrears (as a percent of
previous-year debt) during the period 1987-2000. For the four countries with the best
payments performance, this arrears buildup pace was -0.13 percent. For this quintile, the
average Heritage index (HIEF) was an intermediate 3.19. At the other extreme, for the
quintile with the worst arrears record, interest arrears rose at an annual average of 1.27
percent of debt, while the governance index was a poor 4.08. The correlation between
arrears buildup and adverse governance is consistent for four out of the five quintiles.
Among the three influences of bad luck (external shocks), bad governance, and a
favorable shift in the international policy climate toward debt relief, it is not overly
surprising that the equilibrium in the political-economic market for HIPC debt relief
shifted outward to the right. Returning to the diagnosis above that the real fiscal burden
does not seem to have been the centerpiece of the need for such relief, it should be noted
that Birdsall and Williamson (2002) conclude the opposite. They instead suggest (p. 80)
as a fiscal criterion that “no low-income country should be expected to spend more than
10 percent of government revenue on debt service,” a standard they cite as originating
with Oxfam. Noting that the “decision point” (i.e. better-performing) HIPCs collect
21
about 20 percent of GDP in tax revenue, Birdsall and Williamson set 2 percent of GDP as
the corresponding ceiling for debt service.
Figure 1
Change in Interest Arrears and Adverse Governance
(percent of debt and index)
1.5
4.2
4
1
3.8
3.6
0.5
3.4
0
1
-0.5
2
3
4
5
arrears
HIEF
3.2
3
There would seem to be two central problems with this approach. First, it does
not distinguish between interest and amortization. On the basis of table 4 above, it is
difficult to make the case that amortization is a major problem. If it is not, then the
underlying economic burden is solely that of interest payments. That raises the second
problem: Birdsall and Williamson do not distinguish between real interest and the
inflationary component of interest. Considering that the inflationary component provides
an erosion of the real stock of debt, it should be excluded from the real burden.
These considerations would lead us to expect that using a threshold of debt
service at 2 percent of GDP for fiscal sustainability will exaggerate the amount of debt
relief needed from the standpoint of the fiscal burden. With the average debt ratio at 106
percent of GDP, amortization at 3.3 percent of principal, and the nominal interest rate at
2.3 percent (the parameters discussed above), debt service would typically be 6 percent of
GDP. The Oxfam-Birdsall-Williamson criterion would thus seem to imply forgiving
two-thirds of the debt. There might be grounds for doing so, but they do not include the
real burden of interest. As noted, the approach here finds that on average the HIPC
country pays real interest of 3 percent of revenue plus risk-adjusted grants, which
translates into 0.5 percent of GDP.
A final note on the fiscal burden issue concerns two further points regarding the
diagnosis of generally high rollover of debt. One question is whether this approach
doesn’t introduce a moral hazard in view of pressure on donors to roll over principal
regardless of debtor country policy quality. The answer is: no. A country with bad
policy should not be a candidate either for automatic debt rollover or for HIPC relief.
Indeed, the whole point of the HIPC “decision point” process was to ensure that the
incentive structure was to elicit good policies rather than reward bad ones.
22
A second question is whether a framework assuming high rollover doesn’t fail to
address aid graduation. All of the analysis of this section could be modified to
incorporate graduation, but this nuance would be unlikely to alter the basic diagnosis by
much. One reason is that a reasonable graduation timetable would be perhaps 30 years
for complete repayment of existing official concessional debt. Even if there were no
market-related lending (official non-concessional or private) to help refinance the
resulting amortization, it would be in relatively easily managed amounts starting out at
about 3 percent of GDP (with an initial debt/GDP ratio of about unity) and falling as
nominal GDP rises. This in turn would imply an initial belt tightening of the nominal
fiscal deficit from an average 10 percent of GDP to 7 percent, a fiscal trimming that in
some ways might have salutary properties in its own right in terms of weaning the
government from fiscal dependency. Another reason is that in practice, considering that
the HIPC countries are at the bottom of the developmental spectrum, there are good
grounds for envisioning their graduation process as appropriately more distant in the
future than an immediate launching of a three-decade graduation.
Present value of debt and HIPC thresholds
The approach actually applied to debt sustainability in the HIPC process has been
different from the fiscal sustainability approach considered above. Instead, two
benchmarks have been applied as indicating the threshold of unsustainable debt burden.
Both involve the “net present value of debt” (NPVD) in the numerator. One of the ratios
places the value of exports of goods and services in the denominator, and the other places
government revenue in the denominator. HIPC forgiveness in the late 1990s eventually
adopted 150 percent of exports of goods and services, and 250 percent of government
revenue, as the thresholds beyond which the net present value of debt became
unsustainable. These thresholds in turn had been adjusted to provide for a margin of
safety, as the level originally identified in HIPC discussions was a range of 200-250
percent of exports of goods and services (IMF, 2003).
There is considerable merit in using the NPV concept, but there are also
considerable ambiguities. The most important concerns the proper discount rate. In the
past, the World Bank has used a standard discount rate of 10 percent. The HIPC
exercise, in contrast, has used the commercial interest reference rate (CIRR) specific to
each donor, which is measured as the donor’s long-term government bond rate in nominal
terms.15
It is striking that the discussion of NPV has generally ignored the question of real
versus nominal interest rates. Viewed from a historical perspective this is a major
omission. One of the things that has happened to increase the burden of concessional
debt is that world inflation has fallen, so that the real interest rate on debt has tended to
rise. Figure 2 shows the average interest rate on official loans to countries now classified
15
According to the IMF (2003c), the CIRR estimated by the OECD for the HIPC initiative is the
government bond rate. In contrast, the World Bank (2002a) reports that the OECD calculates present value
using the official export credit lending rate. The two rates should be similar in any event.
23
as HIPCs at the final year of each of the past four decades, as well as the three-year
average consumer price inflation in industrial countries for each of these years. It is
evident that whereas the real interest rate on official loans was consistently negative in
previous decades (especially in the 1970s and 1980s), it has now entered a period of nearzero levels. Global disinflation has increased the burden of concessional debt because
typical concessional interest rates have not changed much from the 2-3 percent range
whereas industrial country inflation has fallen from 5 percent or more to 2 percent or less.
Figure 2
Nominal and real interest rates on official loans to HIPCs
(percent)
15
10
int-nom
5
inflation
0
int-real
-5
-10
1970
1980
1990
2000
Source: World Bank (2002); IMF (2003a)
As for the two different official-community conventions –discounting by 10
percent or by the weighted CIRR – the measured NPV varies sharply with the choice.
The average maturity of new lending for HIPC countries in recent years has consistently
been at about 35 years (World Bank, 2002, p. 219). For the five years 1998-2002,
average long-term treasury bond rates for the five major donors, weighted by their shares
in HIPC debt, amounted to 4.8 percent. So the CIRR discount rate is only half the rate
often used by the World Bank. Using the average (nominal) interest rate of 1.5 percent
reported by the World Bank for new official lending to HIPCs in 2000, the discounted
present value of such a loan amounts to 71 percent of face value discounting at the CIRR
of 4.8 percent, but only 43 percent of face value discounting at 10 percent.
There is also the question of whether the discount rate should reflect the
opportunity cost of the donor government (the CIRR) or that of the recipient. The IMF
(2003b) notes that the rationale for using the CIRR is that the recipient government could
use the funds to place assets earning interest in donor government bonds. Generally the
recipient ought to be able to do better than that in terms of real return by investing in its
own economy, where capital is more scarce than in the donor economies. A higher
domestic rate of return would mean a higher discount rate for evaluating the burden of
the debt.
24
The tradition of social cost-benefit analysis, for its part, would suggest
discounting the future stream of consumption equivalents at the social rate of time
preference (SRTP). This, in turn, is the rate of myopic pure time preference (which I
have argued, following Ramsey 1928, should be zero), plus the expected rate of growth
of percapita consumption multiplied by the elasticity of marginal utility (Cline, 1992,
chapter 6).
The SRTP for HIPCs will tend to be high from the standpoint of likely elasticity
of marginal utility near subsistence, but it will tend to be low from the standpoint of poor
growth performance. At the starvation level the marginal utility of consumption should
jump toward infinity. The normal range of 1 to 2 for the (absolute value of) the elasticity
of marginal utility would tend to be too low for HIPCs. On the other hand, HIPC growth
per capita has been low. For sub-Saharan Africa (which has a large overlap with the
HIPC grouping), in the decade 1990-2000 real GDP grew at only 2.4 percent annually
while population grew at 2.6 percent (World Bank, 2002b). Taken literally, this negative
percapita growth would lead to a negative SRTP rather than a positive discount rate.
That is, because the population will be poorer in the future, their economic effects should
be over-counted rather than discounted.
With some advance in policy and governance reform, and in view of an
encouraging revival of industrial country concern about growth in Africa (as reflected for
example in the Bush administration’s proposed increase in aid to strong performers under
the Millenium Challenge Account), it is reasonable to contemplate positive average real
percapita growth for the HIPCs going forward. Even so, a modest rate such as 1 percent
would seem more reasonable than a high rate such as the 9.2 rate officially reported for
China in the 1990s, or even the 4.2 percent rate recorded in India. With an elasticity of
marginal utility of 2.5 (relatively high) and 1 percent percapita growth, the SRTP would
be only 2.5 percent. This is in real terms, however, so it is approximately the same as the
nominal CIRR of 4.8 percent.
The main thrust of these various considerations about the proper discount rate
would seem to be that the recent convention of using the CIRR is reasonable from the
standpoint of pragmatic results. The alternative of discounting at the World Bank’s
earlier 10 percent rate would seem to ignore the fact that the HIPCs have had extremely
poor growth performance so their social rate of time preference is low and their likely
return on capital has been low. Discounting at 10 percent will tend to give an unduly low
estimate of the meaningful burden of the debt.
Table 6
Present value of HIPC debt under alternative discount rates
(2000; $ billions and percentages)
Discount rate:
Nominal: long term
short-term
4.8% (CIRR)
157.8
32.7
10%
157.8
32.7
25
total
Present value: long-term
short-term
total
Exports, goods & services
GDP
Revenue
PVD/XGS
PVD/GDP
PVD/REV
190.4
112.0
32.3
144.3
73.4
187.6
37.5
196.5
76.9
384.8
190.4
67.8
31.5
99.3
73.4
187.6
37.5
135.3
52.9
264.8
Note: IMF included in short-term. Assumes average interest rate of 2.5 percent and maturity of 35 years
on long-term debt. Source: World Bank (2002a).
The debt/exports threshold
The HIPC policy debate seems to have evolved in the following way. First, past
experience was reviewed on debt levels at which countries got into trouble. Typically
that evidence was for middle-income countries with predominantly commercial debt.
Debt/export ratios in excess of 250 percent were typically considered to be excessive.
Next, there was a recognition that the concessional debt needed to be converted to a
discounted present value equivalent to be comparable to the traditional commercial
benchmarks. Then an appropriate threshold for a safe ratio of NPVD to exports of goods
and services was suggested to be 200-250 percent, with the lower range implicitly an
adjustment for greater vulnerability for the poor countries than for the middle-income
countries. Subsequently this threshold was downscaled to 150 percent, to give a margin
of safety.
In this evolution, there does not seem to have been much attention to a crucial
difference between the middle-income debtors and the HIPCs. The debt problems of
Latin American and other middle-income countries in the 1980s and early 1990s were
typically in circumstances in which these countries were no longer receiving significant
capital flows from abroad (defined as net capital flows minus net interest payments).
Private flows dry up in crises, whereas public flows to the HIPCs have tended to be much
more stable. This distinction would have suggested that at least from the standpoint of
the “external transfer problem,” the debt/exports ratio could safely be higher for the
HIPCs than for the middle-income countries, not lower. Implicitly the official
community’s decision to the contrary stemmed from the judgment that the greater
vulnerabilities or simply greater poverty of the HIPC countries more than offset the
greater dependability of their capital flows.
Cline (1995) suggested that the best gauge of the debt burden was the ratio of
interest (or net interest deducting earnings on reserves) to exports of goods and services
or to GDP. On this basis also, the HIPC threshold should presumably have been a higher
rather than lower ratio of present value of debt to exports (or GDP) than for the middleincome countries, simply because the interest rates are much lower. Thus, in 1999-2000
the average interest on new debt (including from private creditors) was 2.15 percent for
HIPCs but 9.1 percent for severely indebted middle-income countries (World Bank,
26
2002a). Before adjusting to net present value, the four-fold ratio of the middle-income
interest rate to the HIPC interest rate would imply nominal debt ratios could safely be
four times higher for the later. Even after converting to present value, an interest-only
criterion would suggest that HIPC debt ratios (to exports or revenue) could safely be
three times as high for HIPCs as for middle-income countries, rather than only about half
as high.16
The same conclusion can be drawn from other traditional benchmarks. Consider
the threshold of 25 percent for the debt-service ratio.17 For a middle-income country
borrowing from private capital markets, with a maturity of 10 years and an interest rate of
perhaps 10 percent, a 25 percent debt service ratio would correspond to debt equal to 125
percent of exports of goods and services. But for a low-income HIPC borrowing for 30
years at 3 percent, the corresponding debt ratio would be 400 percent of exports of goods
and services.18 This ratio would then be adjusted downward by using the present value of
debt rather than the face value. But the ratio of present value to face value using the
CIRR for official lending is about 0.7, as discussed above. So appropriately adjusted, the
debt/exports ratio corresponding to the traditional 25 percent debt service ratio would be
not 125 percent (the middle-income, market-borrower threshold) but 280 percent (i.e.
0.7x400 percent). This is not too far from the upper end of the originally identified
threshold for HIPC (200-250 percent NPVD/X), but a long ways from the 150 percent
benchmark eventually adopted to provide a cushion. Moreover, as noted above, because
aid donor flows are less volatile than private credit flows, the direction of adjustment
presumably would have been upward rather than downward from the standpoint of
volatility and predictability. In the end it is only from the standpoint of lower income, it
would appear, that adjustment downward would be warranted.
The overall thrust of these considerations is that there has been a less than
rigorous process of identifying the safe level of debt for HIPCs, and that it has tended to
make inappropriate inferences from the experience of middle-income countries whose
conditions are quite different. This discussion also highlights, however, the same
conclusion as reached when considering the fiscal burden of HIPC debt: the real problem
seems to be lack of assurance about debt rollover, rather than a fundamental real burden
of debt that bears low interest and near-zero interest in real terms. This anxiety persists
despite the empirical record of high rollover rates on official debt.
A recent statistical study cited by the IMF (2003c) might seem to remedy the lack
of a rigorous basis for the HIPC thresholds. Using data for 93 developing countries
during 1969-98, the study (Patillo, Poirson and Ricci, 2002) finds that “the average
impact of debt becomes negative at about 160-170 percent of exports or 35-40 percent of
GDP.” Unfortunately, there would seem to be several questions about these results. The
study does not specify how the net present value of debt is estimated, and in particular
16
That is: [9.1/2.15]x0.71 = 3.0.
This threshold dates back to the 1970s, though by the mid-1990s several Latin American economies were
successfully sustaining far higher debt-service ratios.
18
That is: with S = arD where a is the amortization rate, r is the interest rate, D is debt, and S is debt
service, then D/X = [S/X][1/(ar)]. If S/X = .25, then with a=.033 and r =.03, D/X = .25/(.063) = 3.96.
17
27
what discount rate is used to obtain it. The study pools middle-income countries relying
on private capital markets with poor countries relying on concessional official assistance,
which should make one cautious about interpreting the results. There appears to have
been no weighting in the regressions, suggesting that the usual problem of dominance by
the sheer number of smaller African economies will have influenced the results. It is not
persuasive that this set of estimates corroborates the current HIPC threshold, especially
considering that when read carefully the study really finds that debt begins to exert a
negative influence on growth at levels of only about 80 percent of exports of goods and
services. More fundamentally, it is by no means clear tha the appropriate grounds for
judging when a country’s debt should be forgiven is a threshold associated with a
negative influence of debt on the growth rate.19
Tailoring the straitjacket
The most recent concern in IFIs implicitly seems to be that the HIPC debt relief
process has painted donors into a corner by imposing relatively low debt levels as
thresholds requiring relief, with the consequence that it has become difficult to do
business with new official loans lest these ceilings promptly be violated once again. The
IMF (2003c) seems to have begun to talk about how various countries have various
capacities, so that one size does not fit all. One can surmise that this could be an
attractive approach for loan officers seeking to get on with lending programs but facing a
formula-imposed debt ceiling. If one really thought that the existing benchmark ceilings
for HIPC debt were definitive, the appropriate response to any donor-agency search for
such flexibility would be one of criticism. The review of economic considerations on
debt burden presented above, however, tends to lead to the conclusion that the existing
benchmarks are at best indicative rather than definitive and rigorously established, and
that indeed under certain circumstances higher benchmark debt levels could safely be
supported.
Consider a Prudent Finance Minister’s (PFM) threshold. Suppose the PFM
wishes to assure that up to a 90 percent probability, the country will not face net debt
servicing requirements in excess of 10 percent of revenue. Suppose revenue is 15 percent
of GDP, average maturity is 30 years, the average interest is 2.5 percent, and grants
received are 4 percent of GDP (all slightly less favorable than the HIPC averages
discussed above). Suppose that in the 10 percent worst-of-all-worlds case, the PFM
judges that foreign grants could fall to one-third their normal level, gross disbursements
of new debt could fall to two-thirds their normal level, and revenue could fall to 80
percent of its normal level. Suppose that in the past, the country has been receiving gross
disbursements that place it at only the 25 percentile in table 4, or at 94 percent rollover.
The PFM thus seeks to ensure that: (.025 + .033)D - .33(.04Y)-.67(.94x.033D)
≤0.1x0.8x0.15Y. This turns out to require that D/Y ≤ 0.645. Applying the standard 0.7
19
Indeed, neoclassical economics would predict that a higher accumulation of debt used prudently to build
up the capital stock would raise the level of GDP but also boost the incremental capital output ratio, thereby
reducing the rate of growth for a given investment and savings rate; yet this would not mean that the extra
debt had been detrimental instead of beneficial or that it should be forgiven.
28
ratio of present value of HIPC debt to face value using the CIRR, this corresponds to a
present value of debt to GDP ratio of PVD/Y ≤ 0.45. Applying in turn the HIPC average
ratio of GDP to exports of goods of services, or 500 percent (World Bank, 2000b), this
corresponds to PVD/XGS ≤ 225%. Applying the country’s revenue ratio of 15 percent, it
also corresponds to PVD/REV ≤ 300%.
It turns out that the Prudent Finance Minister for this country would judge it safe
to borrow more than judged desirable by HIPC benchmarks from the standpoint of the
external transfer indicator, namely 225 percent of exports of goods and services rather
than 150 percent. He would also judge it safe to borrow more than considered desirable
by the HIPC internal transfer benchmark of PVD/REV = 250 percent of revenue (IMF,
2003c). It is also of relevance that his resulting PVD/GDP ratio, at 45 percent, would be
significantly below the Maastricht criterion, as would be appropriate.
Now suppose the Prudent Finance Minister is also schooled in neoclassical
economics, and believes that it is socially efficient to borrow more if the real domestic
social rate of return on capital is greater than the real interest rate on the funds borrowed.
When he considers that the real interest rate on borrowed funds is close to zero, then he
will be inclined to judge it desirable to take on somewhat more debt, up to his PFM
thresholds identified above. Whether the international financial institutions will agree
with him will depend in part on the extent to which the HIPC benchmarks have become a
straitjacket that prevents additional lending.
Analysis along these lines could be much more fully developed by the use of
probability distributions and Value At Risk (VAR) type exercises, as suggested in the
brief discussion above of a log-normal distribution for a Debt Servicing Duress ratio.
Presumably the range for possible collapse of new financing and of grants will be greater
where governance is worse, suggesting lesser scope for piercing the standard HIPC
benchmark debt ceilings in such cases.
Implications for lending policy
To obtain an operational sense of the implications of this analysis, consider postrelief debt trends for the HIPC group as an aggregate. Based on table 6 above, it would
require forgiving 24 percent more of HIPC debt to reduce the NPVD/exports ratio to the
target of 150 percent, and forgiving 35 percent to reduce NPVD/revenue to 250 percent.
Suppose we use 30 percent as the amount of remaining forgiveness to be completed.
This would reduce the NPV of debt to $101 billion and the nominal value to $133 billion.
Suppose that thereafter nominal export volume rises at 6 percent annually (2.5 percent for
inflation and 3.5 percent real). Nominal debt could then rise by 6 percent or by $8 billion
annually.
For 2000-01, the average of new disbursements of long-term debt (plus IMF)
amounted to $8.4 billion annually (World Bank, 2003). Debt amortization paid and
rescheduled (and hence debt amortization due) averaged $7 billion. With a 30 percent
cut in debt, amortization due would fall to $4.9 billion yearly. If debt can rise by $8
29
billion annually, annual gross disbursements could amount to $12.9 billion. This implies
that in the first year after completion of forgiveness, disbursements could rise to an
annual level about 50 percent above their recent rate without causing resulting debt to
pierce the debt ratio ceilings.
Would such an increase be compatible with ambitious calls such as the UK
initiative to double the level of global concessional assistance? In 2000, official creditors
provided loan disbursements of $5.4 billion and grants of $8 billion to the HIPC group.
If these amounts were doubled as part of a global development assistance upscaling,
disbursements to HIPC could rise to about $11 billion in loans and $16 billion in grants.
Adding disbursements from private creditors ($1.7 billion in 2000), new gross loan
disbursements would reach $12.7 billion, almost exactly the amount just identified for
compatibility with remaining within the debt ceiling.
It would appear, then, that for the HIPC group as a whole, there should be no
imminent conflict between even an ambitious expansion of development assistance and
adherence to the relatively austere HIPC debt ceilings. Correspondingly, the need to shift
massively from loans to grants would not be urgent. This room for maneuver might not
hold for selected individual countries, however. It is for individual countries where
expanded lending might put debt ratios above the target ceilings, then, that the main
analysis of this study is most relevant. In such cases, the implication would be that it
could be better to allow the country the opportunity to secure substantial additional
concessional lending than to forgo such lending for the purpose of remaining strictly
below the HIPC ceiling debt ratios, simply because these ratios probably do not warrant
strict adherence.
Finally, the analysis here might also be interpreted to imply that donors might do
better to increase concessional lending to HIPCs rather than forgive their existing claims.
Which such an interpretation might, at least in some cases, be appropriate in technical
terms, in terms of political economy it would seem to make more sense to proceed apace
with the current implementation of HIPC forgiveness. There is a concrete process under
way that commits donors to agreed forgiveness, so the collective action problem has been
solved. Even if theoretically a HIPC country might be better off under an alternative
scenario in which donors instead committed to increased concessional lending of equal
present value, following the analysis above of loans versus grants and of likely undue
parsimony in the HIPC debt ceilings, the HIPC-relief bird in hand would seem preferable
to the alternative two-bird lending volumes in the bush.
30
Annex A
Debt in the Big 5 and Little 20 non-HIPC Low-Income Economies
The World Bank (2001) identifies 65 countries with a combined population of
2.46 billion as “low income,” below $755 per capita income in 1999. This cut-off just
misses China ($780) but includes India ($450). The low-income countries divide into
three economic groupings, from the standpoint of debt: the big 5 (GB5) with a combined
population of 1.6 billion (comprising Bangladesh, India, Indonesia, Nigeria, and
Pakistan); 40 HIPC economies with combined population of 653 million; and 20 other
low-income economies with combined population of 215 million, of which half is in
eight former-Soviet states.
It is perhaps no coincidence that the five most populous low-income countries do
not have typical HIPC debt problems. There is a well-known size bias in the distribution
of official development assistance that leads to lower percapita lending to larger
economies.20 Since the great bulk of HIPC debt is owed to official donors, the populous
economies have presumably escaped HIPC-type problems in part because they did not
receive proportionally as much official assistance.
Even so, the big 5 are by no means immune to debt problems. Even India, which
has kept external debt relatively low and improved its policy and growth performance in
the 1990s, has consistently run relatively large fiscal deficits, which could eventually
raise questions about the sustainability of its domestic debt. Nigeria obtained a Brady
deal in 1992 that essentially provided 60 percent forgiveness on its debt to banks. During
the course of the 1990s Nigeria built up relatively large arrears to the official sector, but
these were cleared with a Paris Club rescheduling in 2000, and the oil export base in
principle makes the country one of the stronger low-income economies. Bangladesh has
kept its external debt constant at about $15 billion for several years, avoided arrears, and
reduced its ratio of debt to exports of goods and services from a peak of 467 percent in
1990 to 216 percent in 2000 (World Bank, 2002a; IMF, 2003b).
Pakistan and especially Indonesia have experienced greater debt difficulties. In
the face of a payments squeeze, in 1999 Pakistan carried out a successful exchange offer
for foreign bonds that in effect stretched maturities while modestly boosting interest rates
(to 10 percent). In Indonesia, the East Asian financial crisis in 1997 devastated the
private sector. Although the government itself had not been a large external debtor to
private creditors, its heavy contingent liability that materialized in support to a collapsed
banking system meant that its external debt to official donors and the IMF soared from
$17 billion at the end of 1997 to $40 billion at the end of 2000 (World Bank, 2002a;
IMF, 2003b). At the same time, the dollar value of its GDP imploded from $227 billion
in 1996 to $153 billion in 2000 as its exchange rate fell 73 percent against the dollar.
Birdsall and Williamson (2002) argue that Indonesia should qualify for HIPC debt relief,
although they recognize that Indonesia alone could require $49 billion out of the total $79
billion bill for their proposed deepening and widening of HIPC debt relief (p. 91).
20
This has long been recognized. For an early statistical analysis, see Cline and Sargen (1975).
31
Arguably Indonesia could instead gradually work its way back into the fold of EMEs
with more normal market access to capital markets, while relying on a domestic
bankruptcy system to finish up the workout process for loans owed abroad by private
corporations.
In short, the central question about the large non-HIPC low-income countries is
whether or not Indonesia needs HIPC-type debt forgiveness. The answer is not obvious.
For example, at about 25 percent of GDP Indonesia’s debt to official creditors including
the IMF is far smaller than the 85 percent ratio for the HIPCs (World Bank, 2002a). As
for the 20 smaller non-HIPC low-income economies, about half of their combined
population is in former-Soviet Union (FSU) economies. These seem for the main part to
be closer to EME status than HIPC status. Indeed, one large economy in this group,
Ukraine, successfully carried out a market-rate unilateral exchange offer for its foreign
bonds in 1999, rather than defaulting and seeking forgiveness.
The other half of the Little 20 include several African countries (including Chad,
Kenya, Ghana, Senegal, and Zimbabwe), as well as North Korea, Myanmar, Nepal,
Yemen. In some ways the most interesting question about these economies is how they
have managed to escape the conditions that would characterize them as in need of HIPC
relief. Although for some the answer may simply be that so far HIPC-inclusion has been
too stingy,21 for others presumably the answer is that they have been doing something
right to stay out of acute debt problems.
21
Birdsall and Williamson (2002) would add Nepal and Zimbabwe (as well as Indonesia and Nigeria from
the Big 5) to the HIPC-eligible list.
32
Annex B
The Fiscal Sustainability Condition
Let D be government debt, Y the nominal value of GDP, i* the real interest rate, π
the inflation rate, g the real growth rate, d the ratio of government debt to GDP, sp the
primary (non-interest) fiscal surplus as a fraction of GDP, and t the time period. Then
we have:
1) Dt = Dt −1 + (i * +π ) Dt −1 − s p Yt
That is, the debt rises in the current year by the amount of interest payments, which equal
the real interest rate plus inflation multiplied by last year’s debt, minus the amount of the
non-interest fiscal surplus, which equals the primary surplus as a fraction of GDP
multiplied by GDP. Considering that Yt = Yt-1(1+g+π), or current nominal GDP equals
the previous year’s GDP augmented by the nominal growth rate (real rate plus inflation),
and substituting and simplifying, we have:
2)
Dt Dt −1 (1 + i * +π ) − s p (Yt −1 [1 + g + π ]) d t −1 (1 + i * +π )
=
− sp
=
Yt
Yt −1 (1 + g + π )
1+ g +π
The stability condition requires that the debt to GDP ratio remains unchanged
~
over time at d . So we can write:
~
~
3)d (1 + g + π ) = d (1 + i * +π ) − s p (1 + g + π )
Rearranging, we have:
~
d (i * − g )
4) s p =
1+ g +π
Where inflation is moderate (e.g. in single digits), this primary surplus rate will be
~
close to sp ≈ d (i * − g ) . For example, if the debt to GDP ratio is to be held constant at 50
percent, the real interest rate is 7 percent, the real growth rate is 4 percent, and inflation is
10 percent, then the required primary surplus is approximately 1.5 percent of GDP ( =
0.5x[7-4]), or more exactly after taking account of the denominator in 4), 1.32 percent of
GDP (=1.5%/1.14).
33
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