Debt Relief Initiatives and their Impacts on African Countries

3149 words (13 pages) Essay in Economics

08/02/20 Economics Reference this

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Introduction:

Less developed countries (LDCs) in various parts of the world rely on foreign aids, grants, and loans to finance their required services. Over time, many of these countries have accumulated debt that is unsustainable. Debt relief is a tool that provides further assistance to these countries in order to facilitate their economic development. Countries with an unsustainable amount of debt are called Highly Indebted Poor Countries (HIPCs) (The World Bank, 2018; (Dessy & Vencatachellum, 2007; Easterly, 2002).  This paper mainly discusses debt relief programs and their impacts on the economic development of the recipient countries. Since most of the countries receiving debt relief are located in Africa, this paper analyzes the impact of debt relief in Africa as a region, especially sub-Saharan African Countries.

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It starts with providing brief history of the debt relief programs through the World Bank and International Monetary Fund (IMF). It explores the relationship between debt relief and foreign aid; whether or not they are applied simultaneously. Research suggests that there is a net positive transfer of resources in HIPCs which means debt relief is an addition to the foreign aids (Powell & Bird, 2010). It further discusses that debt relief has a positive impact on public education expenditures, while there is no correlation between debt relief and public health expenditures (Nannyonjo, 2001). The paper also looks at the impact of debt relief on various types of investments (e.g. public, private, and foreign). It highlights that such initiatives have a positive correlation with public investments (Djimeu, 2017). Some of the constraints that hinder the success of such initiatives are lack of governance structur, institutional reform, corruption, political instability, and capital flights. These are discussed in detail later in the paper.

Background:

Organizations such as the World Bank, International Monetary Fund (IMF) and donor countries such as the G-8 have been long involved in various ways to help low-income countries. These include financial aids, grant programs, concessional loans, debt relief, and debt re-structuring. In 1996, the World Bank, IMF, and other commercial creditors started an initiative to manage the unsustainable debt burdens of the lowest income countries (The World Bank, 2018). This initiative was called the Heavily Indebted Poor Country (HIPC) initiative. Altogether, 39 countries were eligible under this initiative. Out of the 39 countries, 33 of them are in Africa. The United Nations (UN) established the Millennium Development Goals (MDG) in the year of 2000. To further supplement the HIPC initiative and aide in reaching MDGs, these entities started a Multilateral Debt Relief Initiative (MDRI) in 2005 (IMF, 2018). The primary goal of the MDRI initiative is to fully relieve these countries of their remaining debt for poverty reduction purposes (Dessy & Vencatachellum, 2007). This proposed debt relief would enable these countries to invest more on social services and thus enabling them to reach the UN Millennium Development Goals faster. A significant portion of the discussion involved sub-Saharan African (SSA) countries since they make up most of the MDRI eligible countries. Under the MDRI, the G-8 countries who are the primary lenders decided that they would double their aid to Africa by 2010 and that these countries will be relieved from the debt payments (Powell and Bird, 2010).

Relationship between debt relief and foreign aid:

Scholars such as Birdsall, Claessens, and Diwan (2003) have found that countries with higher debts are recipients of comparatively higher aids from donors. This means that there is a positive flow of net resources into the indebted country since they are identified as countries going through greater economic crisis. On the other hand, accumulation of debts over the years is considered as an indicator of poor institutional capacities and lack of sound government policies. Being that these countries are accumulating more debt after continuously receiving more aids and grants, donor countries may be reluctant to approve new aids (Powell & Bird, 2007). It is important to explore whether or not the objectives of MDRI being that it would increase the amount of aid and decrease debt payments were being pursued simultaneously. Powell and Bird examined this relationship between debt relief and foreign aid in SSA countries since the 1980s. They also looked into net resource transfer to the region as a whole. If debt relief and aids are provided simultaneously to some countries while overall transfer of aid decreased in the whole region, then this assistance is not considered equitable (Powell and Bird, 2010).

Research from scholars such Marchesi and Missale suggests that Highly Indebted Poor Countries (HIPCs) receive foreign aids as an addition to the debt relief (2004). Additionally, the findings suggest that there is a net positive transfer of resources in HIPCs as opposed to non-HIPCs. Non-HIPCs have a negative correlation with debt relief and foreign aid. In the case of African countries, debt relief has been complementary to other aids. This means that further aids, as suggested through the MDRI, were provided to the African HIPCs on top of debt relief. This resulted into an overall larger net transfer of resources from donor countries (Powell & Bird, 2010). With sub-Saharan Countries (SSAs), the donors focused on providing further grants instead of the conventional concessional loans. It was also apparent that the debt stock to GDP ratio did not negatively impact aid transfers, which is one of the concerns discussed above (Powell & Bird, 2010).

Relationship between debt relief programs and social expenditures in Africa:

The HIPC initiative and the MDRI are not the first debt relief programs implemented by the G-8 countries (or G-7 depending on the time) in conjunction with the World Bank and IMF. They differ from previous programs due to having a particular emphasis on Africa, implementing write-offs for all debts rather than discounts, and requiring that monies freed up in the budget by debt relief be specifically allocated to poverty alleviation purposes (Burnside and Fanizza, 2004; Dessy & Vencatachellum, 2007; Easterly 2002). Dessy & Vencatachellum ( 2007) investigated the historical relationship between debt relief and social expenditures between 1989-93 and 1994-98. The amount of debt relief received by African countries between1989-2003 was $60 billion, which is approximately 10% of their GDP. Their investigation indicated that debt relief within these periods had increased resource allocation in public education and public health. By further looking into countries instead of the overall region, it identified that debt relief in conjunction with institutional reforms were the basis of increased expenditure in public health. However, public education expenditures were not dependant on institutional reforms.  For example, Uganda allocated all its debt relief monies in poverty alleviation programs in the fiscal years of 1998-99 and 2000-01. In 2000-01, public health accounted for 13% of the budget compared to 2.9% in 1998-99 (Nannyonjo, 2001).

On the other hand, Dessy & Vencatachellum’s study on low-income African Countries found that debt relief coupled with improved political institutions has statistically significant positive correlation with public health and education expenditures. However, the correlation between debt relief and public health expenditures is statistically insignificant when only debt relief is taken into account (2007). Additionally, debt relief alone has a negative impact on public education expenditures (Dessy & Vencatachellum, 2007). This is consistent with the above-discussed theory that HIPCs are more prone to consume the debt relief amount than investing it in social sectors.

Impacts of debt relief on investments:

Debt relief programs such as the HIPC initiative and MDRI have been responsible behind increased public investments in many sub-Saharan (SSA) countries. A study conducted by Djimeu found that HIPC initiative is responsible for an annual 1.76% and 3.14% increase in public investment at the decision point and post-completion period of MDRI respectively (Djimeu, 2017). However, the study failed to find any correlation between this initiative and private sector investments. HIPC initiative does not encourage foreign direct investment either (Djimeu, 2017). This provides strong evidence that without significant institutional and governance structure reform; debt relief on its own will not attract private investment or foreign direct investment to supplement economic growth.

Long-term and short-term impacts of debt relief:

Since the early 1990s, various measures were taken to address the economic crisis in Africa. At that time most sub-Saharan African countries had comparatively high inflation rates, high budget deficits, and unsustainable debt to GDP ratios (Henry, 2007). HIPC initiative was a measure undertaken by the IMF and World Bank to tackle this economic crisis. A study conducted by Henry looked into the relationship between economic growth and debt relief in both the short run and long run (2007). It focused on World Bank data for the years 1990 to 2015, which were divided into 5-year increments for short-term results. According to the empirical data provided by Henry (2007), debt relief had no statistically significant influence on GDP in the short run; however, it had a positive impact on economic development in the long run. In the long run, there were positive correlations between debt relief and increased enrolment in schools, regulating corruption, improved political condition, and resource accumulation. It also reduced trade deficits both in the short and long run for African countries receiving assistance under the HIPC initiative. Debt relief did not have any significant impact on inflation in either the short or long run. However, many African countries experienced a short-run surge in inflation during the debt relief programs. The underlying factors behind this increase varied for different countries. For Ethiopia and Uganda, increasing currency production was responsible for 40% and 13% of the inflation increases (Simpasa et al., 2011). Kenya and Tanzania experienced the inflation increase due to surge of oil prices which accounted for 20% and 26% increase respectively (Simpasa et al., 2011).

Determinants of success:

As discussed earlier, without positive institutional reforms in African countries, debt relief initiatives will fail to attain one of its primary purposes of increased social expenditures. It is also documented that without proper institutions, HIPCs became further indebted even after continued debt assistance during 1980-1997 (Easterly, 2002). According to the study conducted by Easterly, HIPCs had performed worse on broad policy reforms based on World Bank’s ‘Country Policy and Institutional Assessment’ between 1980-97 (Easterly, 2002). Corruption due to flawed political institutions negatively impacted the success of debt relief programs.  IMF programs were also vulnerable during political instability, especially during the election period in HIPCs (Aisen & Veiga, 2008).

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Scholars such as Dreher have suggested that the World Bank and the IMF should distribute debt relief and foreign aids with conditions such as extent of distribution in various programs and policy reforms (Henry, 2007). The current MDRI program does incorporate some of these suggestions. The MDRI program is divided into two steps; decision point and completion point. Under the first step, countries must demonstrate that they have already undergone policy reforms through prior World Bank and IMF programs and submit a poverty alleviation strategy. This will grant them interim relief from debt. In order to receive full relief, they have to further demonstrate satisfactory reforms as advised by the donor organizations for at least one (1) year (Henry, 2007). However, this strategy does not ensure commitment to the poverty reduction strategy in the long-run as a condition to the full debt relief.

In addition to the poor governance structure of the highly indebted African countries, bad governance structure of the IMF and the World Bank is also responsible for failure of some debt relief programs (Woods, 2000). In order to ensure the success of such programs, scholars such as Svensson (2003) suggested that the World Bank introduce competition among recipients for distribution of aids (Henry, 2007). The disbursements of the current programs do not focus on macroeconomic performances of the recipient countries.

Capital flight:

One other constraint in the success of debt relief program is capital flight. A 2003 study by Ndikimana and Boyce explored the relationship of capital flight and borrowing in SSA countries. The study focused on the years 1970-1996. It was identified that for every dollar of loaned money, approximately 80 cents was illegally extracted out the country. Overall, the total amount of capital for the 30 SSA countries under this study was $187 billion which adds up to $274 billion with interest (Ndikimana & Boyce, 2003). This study suggested that debt relief will only achieve its objectives if the IMF and the World Bank impose transparent lending and debt management requirements to prevent capital flight. Furthermore, it stated that debt relief strategies will not be fully successful in stimulating economic development until the impacted African governments adopt measures for capital repatriation (Ndikimana & Boyce, 2003).

Concerns with debt relief programs:

One of the primary concerns raised against debt relief programs is that increasing debt service will encourage a cycle of defaulting debts. One theory is that countries after debt relief programs will reduce its assets to remain eligible for future concessions. Alternatively, they will increase their expenditures in an unsustainable manner to ultimately reach their previous state of indebtedness (Easterly, 2002; Dessy & Vencatachellum, 2007). Among the HICPs which are mostly African countries, data suggests that there is significant positive correlation between debt relief and new borrowing (Easterly, 2002). It is also considered unfair to countries that have handled debt payments in a sustainable manner (Dessy & Vencatachellum, 2007). Furthermore, governments of HIPCs could overestimate the portion of available funds due to debt relief; especially, if only a small amount of services were being funded through debt relief. As a result, debt relief may not bring the anticipated increase in social services expenditures.

Countries without proper policies and governance structure may not benefit from debt relief programs either. For example, Haiti had staggering 484% of external debt to exports ratio in 1997, which is way above the sustainable percentile of 20-25% (Easterly, 2002). This was mainly due to corruption and government expenditures in unproductive sectors such as large military and government employment. Most of the amount did not make it to the poor. Another concern is that granting continuous debt relief may result into countries borrowing while accounting for debt relief mechanisms in their budgets and expenditures. Many of these debt relief programs have been based on conditions such as policy reforms.  According to a World Bank report published in 1994, many African countries failed to undertake such policy reforms during the historical adjustment loan period (World Bank, 1994).

Conclusion:

The primary objectives of debt relief programs are to foster economic development and to attain a sustainable external debt to GDP ratio. It is meant to encourage increased social expenditures and increased investments. The World Bank and IMF have commenced debt relief initiatives several times. The Highly Indebted Poor Countries (HIPCs) initiative was started in 1996 with a focus on African countries. This was further expanded to provide full relief of debts for HIPCs as the Multilateral Debt Relief Initiative (MDRI) in 2005. This paper mainly discusses debt relief programs and their impacts on the economic development of the African countries, especially sub-Saharan African countries. It discusses findings on the above-mentioned debt relief programs from various studies. In African countries, debt relief programs are complementary to various foreign aids. As intended by the MDRI, the donor countries provide additional grant to the recipients of debt relief. It is also perceived that debt relief is associated with an increased expenditure in public education. However, with respect to expenditures in public health sector, this increase is only seen in African countries with comparatively better institutions. In the long term, such initiatives promote increased public investments. However, there is no significant statistical correlation between debt relief and inflation, private investment, and foreign direct investment. In addition to institutional reform, debt relief is constrained by corruption, capital flight, and political instability. Approximately, 80 cents per $1 is flown out of the recipient countries through illicit means. This is one of the primary reasons behind debt relief having no significant impact on economic growth in African countries. The current debt relief initiative (i.e. MDRI) has incorporated requirements such as following through a poverty reduction strategy, increased policy and institutional reforms to address some of these constraints. However, scholars such as Dessy & Vencatachellum and Easterly suggest that further requirements are necessary to be implemented to ensure success of debt relief programs.

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