external debt in post-conflict countries

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External Debt in Post-Conflict Countries PATRICIA ALVAREZ-PLATA DIW Berlin, Germany and TILMAN BRU ¨ CK * DIW Berlin, Germany Humboldt University, Berlin, Germany Households in Conflict Network (HiCN), Brighton BN1 9RE, UK Summary. In the development literature, there exists no systematic study of external borrowing in post-conflict countries. We address this gap by analyzing statistical and case study evidence from three African countries. We find that many war-affected countries face rising debt arrears and dete- riorating relations with creditors. Rebuilding trust between lenders and borrowers is hence a crucial but often slow process. Furthermore, donors to war-affected African countries have been slow to grant exceptional debt relief based on odious debt or on financial requirements. Debt relief for post-conflict reconstruction should embrace a more forward looking and more generous condition- ality. Ó 2007 Published by Elsevier Ltd. Key words — post-conflict reconstruction, debt, HIPC, aid, institutions, Africa 1. INTRODUCTION External borrowing is a core element in nearly all poor countries’ development strate- gies, including almost all war-affected develop- ing countries. Foreign loans can be used to finance public spending aimed at increasing growth, development, and security. However, external borrowing can also be used for private gains or for financing warfare. Similarly, over- coming conflict requires raising and redirecting scarce public finances, including borrowed funds, from war-related activities toward sus- tainable development. Both processes—using external borrowing wisely and building peace—are massive and interrelated challenges for poor countries and donors alike. Despite substantial research on external debt management and on post-war reconstruction in developing countries, surprisingly few studies have addressed the issue of external debt man- agement by post-conflict countries. There is lit- tle knowledge on how debt, aid, growth, and conflict interact in developing countries. Given the special problems faced by countries at war or emerging from war, and the importance of external debt to the post-war transition in these countries, it is useful to assess the case for spe- cial debt management strategies, including debt relief, for post-conflict economies. A key moti- vation for this study is that unresolved debt issues in the post-war conflict can significantly hinder the international community’s commit- ment to reconstruction and limit the scale of its involvement. There is then a real risk that a lack of unresolved debt issues leads to under- investment in peace and development and hence to a resumption of conflict. This applies * We are grateful for the helpful comments on earlier drafts of this paper from Gilles Alfandari, Jim Boyce, Leonce Ndikumana, Barney Rubin, John Toye, and three anonymous referees. We also appreciate the excel- lent research assistance provided by Wolfgang Ha ¨rle, Nico Jaspers, Anja Schewe, and Sascha Su ¨ ßspeck. The usual disclaimer applies. Final revision accepted: March 21, 2007. World Development Vol. 36, No. 3, pp. 485–504, 2008 Ó 2007 Published by Elsevier Ltd. 0305-750X/$ - see front matter doi:10.1016/j.worlddev.2007.03.002 www.elsevier.com/locate/worlddev 485

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Page 1: External Debt in Post-Conflict Countries

World Development Vol. 36, No. 3, pp. 485–504, 2008� 2007 Published by Elsevier Ltd.

0305-750X/$ - see front matter

doi:10.1016/j.worlddev.2007.03.002www.elsevier.com/locate/worlddev

External Debt in Post-Conflict Countries

PATRICIA ALVAREZ-PLATADIW Berlin, Germany

and

TILMAN BRUCK *

DIW Berlin, GermanyHumboldt University, Berlin, Germany

Households in Conflict Network (HiCN), Brighton BN1 9RE, UK

Summary. — In the development literature, there exists no systematic study of external borrowingin post-conflict countries. We address this gap by analyzing statistical and case study evidence fromthree African countries. We find that many war-affected countries face rising debt arrears and dete-riorating relations with creditors. Rebuilding trust between lenders and borrowers is hence a crucialbut often slow process. Furthermore, donors to war-affected African countries have been slow togrant exceptional debt relief based on odious debt or on financial requirements. Debt relief forpost-conflict reconstruction should embrace a more forward looking and more generous condition-ality.� 2007 Published by Elsevier Ltd.

Key words — post-conflict reconstruction, debt, HIPC, aid, institutions, Africa

* We are grateful for the helpful comments on earlier

drafts of this paper from Gilles Alfandari, Jim Boyce,

Leonce Ndikumana, Barney Rubin, John Toye, and

three anonymous referees. We also appreciate the excel-

lent research assistance provided by Wolfgang Harle,

Nico Jaspers, Anja Schewe, and Sascha Sußspeck. The

usual disclaimer applies. Final revision accepted: March21, 2007.

1. INTRODUCTION

External borrowing is a core element innearly all poor countries’ development strate-gies, including almost all war-affected develop-ing countries. Foreign loans can be used tofinance public spending aimed at increasinggrowth, development, and security. However,external borrowing can also be used for privategains or for financing warfare. Similarly, over-coming conflict requires raising and redirectingscarce public finances, including borrowedfunds, from war-related activities toward sus-tainable development. Both processes—usingexternal borrowing wisely and buildingpeace—are massive and interrelated challengesfor poor countries and donors alike.

Despite substantial research on external debtmanagement and on post-war reconstruction indeveloping countries, surprisingly few studieshave addressed the issue of external debt man-agement by post-conflict countries. There is lit-tle knowledge on how debt, aid, growth, andconflict interact in developing countries. Given

485

the special problems faced by countries at waror emerging from war, and the importance ofexternal debt to the post-war transition in thesecountries, it is useful to assess the case for spe-cial debt management strategies, including debtrelief, for post-conflict economies. A key moti-vation for this study is that unresolved debtissues in the post-war conflict can significantlyhinder the international community’s commit-ment to reconstruction and limit the scale ofits involvement. There is then a real risk thata lack of unresolved debt issues leads to under-investment in peace and development andhence to a resumption of conflict. This applies

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486 WORLD DEVELOPMENT

even to the many war-affected countries in theheavily-indebted poor countries (HIPC) initia-tives, which have prescribed ineffective modali-ties for these countries. In short, external debtcan be one of the causes of the conflict trap.

Our paper analyses three related issues. First,we survey recent trends of external borrowingfor conflict-affected countries and ask if thesetrends can be explained by the special burdensand needs of these countries. We will thusestablish that post-conflict countries indeedare different from non-conflict economies withrespect to debt. Second, we examine policyoptions concerning debt forgiveness (based onboth wider moral and narrower economic con-cerns) and the effects of external borrowing onaid for post-conflict economies. Third, weinvestigate the institutional framework ofpost-conflict debt management, especially con-cerning multilateral debt.

Our analysis draws on the literature from thedistinct fields of external borrowing and post-conflict reconstruction, aggregate quantitativeevidence covering all developing countries,and country case study evidence. We structureour analysis along the three perspectives of his-torical context, policy options, and institutionalframework, supporting our general findings oneach issue with case study evidence from threeheavily indebted poor post-conflict economiesin Sub-Saharan Africa.

The choice of country case studies for thispaper was motivated by their diverse experienceof conflict funded by debt (in the case ofMozambique), piece-meal debt relief policiesbeing negotiated over years, using up scarcedomestic capacities (in the case of Uganda),and unusual post-war institutional relations(in the case of the Democratic Republic of Con-go (DRC)), thus mirroring the experience ofmany war-affected economies, even if that partof our analysis is not statistically representa-tive.

From a historical perspective, we demon-strate that the post-conflict environment posesspecial challenges and experiences unique cir-cumstances concerning debt, arrears, and aidas well as trust and institutional relations.Mozambique serves as an example of howwar and debt are strongly intertwined, callinginto question the responsibilities of the donorcommunity in forgiving badly lent debt.

From a policy perspective, we identify theshortcomings of existing analytical and policyapproaches for dealing with heavily indebtedwar-time economies, in particular in the HIPC

framework. We sketch how protracted the mul-tilateral debt relief process has been for Ugan-da, thus squandering the opportunity toaccelerate post-war reconstruction. Debt reliefcould have been granted prior to the cessationof violence to accelerate the post-conflict transi-tion to peace and prosperity.

From an institutional perspective, we derivethe need for a coherent and consistentapproach to post-war reconstruction, wheredebt policy and debt management are but onestrand of a successful transition from war topeace. The case of the DRC indicates how veryworthwhile efforts in debt accounting can belost if not met by similar progress on othermacro-economic or poverty alleviation policies.On the side of the donors, there is a massivechallenge for policy coherence. On the side ofthe borrowers, there is a massive challenge forbuilding trust. Both are crucial for coping withdebt and both are mutually re-enforcing.

We acknowledge that some of these issues areof a normative character. In our study weemphasize the positive criteria and choicesinvolved in these decision making processes.We do not argue that war-affected economiesfollow different laws of economics. Instead,our analysis identifies many similarities be-tween developing countries with or withoutconflict. However, severe conflict sharpens therelated debt and development challenges, thusraising the stakes and requiring even morefocused and sustained policy responses. Inshort, we argue that what is a good debt policyfor war-affected countries may also be a gooddebt policy for other developing countries,but that the reverse is not always true.

The paper is structured as follows. Sections 2and 3 provide a conceptual framework for theanalysis of post-conflict debt, drawing onrecent trends and analyzing issues and policiesin debt relief. Section 4 assesses the experiencesof the three case studies Mozambique, Uganda,and the DRC. Section 5 concludes.

2. ARE POST-CONFLICT COUNTRIESDIFFERENT?

(a) Aggregate trends

Table 1a summarizes some salient features ofrecent trends in external borrowing, aid, percapita growth and governance for 38 low-in-come countries (LICs), which were at war, ina post-war period or without conflict in the pre-

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Table 1a. Summary debt indicators

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Mean

Debt/GNI (%)

LICs (all) 118 116 118 127 146 138 124 135 150 151 144 137 137 134LICs (no conflict) 106 110 101 109 121 117 108 107 122 127 126 120 122 115LICs (in war) 134 98 152 156 314 280 227 231 225 178 160 140 160 189LICs (post-war) 46 59 83 95 91 117 99 183 168 206 182 175 165 128

Debt/export (%)

LICs (all) 661 666 689 640 576 540 577 508 544 546 509 507 548 578LICs (no conflict) 440 368 335 327 332 308 275 294 425 412 424 393 411 365LICs (in war) 1,174 1,600 1,404 1,567 1,545 1,711 1,891 914 881 1,137 767 1,045 1,872 1,347LICs (post-war) 823 841 1,115 958 703 666 660 567 663 509 619 591 503 709

Aid/GNI (%)

LICs (all) 18 18 18 17 23 22 17 14 14 13 14 14 14 17LICs (no conflict) 18 19 19 18 20 22 15 14 13 13 14 13 12 16LICs (in war) 16 9 9 9 41 4 3 7 14 9 11 9 15 12LICs (post-war) 17 17 15 16 15 19 16 13 13 15 17 19 19 16

GDP per capita growth (%)

LICs (all) �2.4 �2.0 �4.8 �2.4 �3.1 1.9 1.8 3.3 0.3 1.1 0.5 1.4 0.6 �0.3LICs (no conflict) �0.8 �1.9 �3.8 �0.7 �2.3 2.0 1.7 1.7 0.3 1.0 �0.4 0.6 �0.3 �0.2LICs (in war) �10.9 �4.2 �11.3 �15.1 �17.6 �2.1 4.3 �2.5 �3.0 �2.8 �4.6 1.8 2.8 �5.0LICs (post-war) �2.2 3.7 �2.4 1.1 �1.2 6.3 2.0 13.6 3.4 3.1 4.3 2.4 2.3 2.8

Governance

LICs (all) – – – – – – �0.8 – �0.8 – �0.9 – �0.9 �0.8LICs (no conflict) – – – – – – �0.6 – �0.6 – �0.7 – �0.7 �0.7LICs (in war) – – – – – – �1.6 – �1.0 – �1.4 – �1.3 �1.3LICs (post-war) – – – – – – �1.0 – �1.0 – �1.1 – �1.1 �1.1

Sources: World Bank’s Global Development Finance and World Development Finance, Kaufmann et al. (2006), andown calculations.Notes: Only severely and moderately indebted LICs for which data were available are taken into account.

EXTERNAL DEBT IN POST-CONFLICT COUNTRIES 487

ceding 12 years. Data for countries in the pre-war years are not shown separately but in-cluded in the category ‘‘all.’’ The data on warstatus is derived from the UCDP/PRIO dataseton Armed Conflicts (1946–2003) where war isdefined to result in a minimum of 1000 battle-related deaths per annum. 1 The data on debt,aid, and growth are derived from the WorldBank’s GDF and WDI statistics while the gov-ernment effectiveness indicator is taken fromKaufmann, Kraay, and Mastruzzi (2006). Thelatter is a composite index and measures thequality of public services, the quality of the civilservice and the degree of its independence frompolitical pressures, the quality of policy formu-lation and implementation, and the credibilityof the government’s commitment to such poli-cies. Its scores lie between �2.5 and 2.5, withhigher scores corresponding to better out-comes. The series are based on all severely

and moderately indebted LICs for which datawere available in the period 1990–2002. Notethat we do not differentiate our analysis in thissection by the cause or the type of conflict,which is likely to affect the nature of its effects(Stewart & FitzGerald, 2001).

Debt stocks as a share of GNI have remainedfairly constant for most LICs since 1990. LICsat war, however, have experienced above aver-age indebtedness peaking in the mid-1990s.LICs emerging from war also saw rising debtlevels in the 1990s; however, these levels havebeen falling since 2000.

Given the weak export performance of war-af-fected countries, both war-time and post-warLICs have much higher debt-to-export ratiosthan peace-time economies. The position of thepost-war economies in this regard has, however,been improving steadily over time and converg-ing with the overall mean in recent years.

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488 WORLD DEVELOPMENT

Foreign aid to war-time countries is lowerthan to any other group of countries. Interest-ingly, aid to peace economies has been fallingin relative terms in recent years. Since 1999,aid to post-war economies has been higher inrelative terms than aid to peace or war-timeeconomies.

Mean annual GDP per capita growth was�0.3% for all LICs, �5.0% for countries inwar but 2.8% for post-war economies. As canbe expected with growth rates, these valuesshow strong fluctuation across years withineach category. However, all groups of countriesshow an improvement toward the second halfof the period of observation.

The indicator of government effectiveness,while not being available for earlier years, sug-gests that conflict-affected countries have lowergovernment effectiveness than countries alwaysat peace. Overall, all LICs have below averagegovernment effectiveness indicators (zero beingthe mean of all countries world-wide).

To assess whether in fact there is a systematicdifference between conflict-affected countriesand those that did not experience a conflict inthe period under observation (1989–2002), wefirst construct a ‘‘conflict’’ dummy identifyingcountries that suffered a war, and then run sev-eral regressions in which this dummy and aconstant are used as explanatory variables;the debt and governance indicators of Table1a are our dependent variables. While this isonly a simple approach which does not permitcausal inference, it provides a formal test ofthe claim that conflict-affected countries aresystemically different from other countries.We find that the conflict dummy is highly sig-nificant (at the 1% level) for both the debt-to-exports ratio and the governance indicatorand weakly significant (at the 10% level) forthe debt-to-GNI ratio (data not shown, becauseof space limitations, but available upon

Table 1b. Composition of public and publicly gand publicly gua

Country-group 1990 1991 1992 1993 19

Multilateral creditors

Conflict-affected (average) 20.1 21.2 26.1 24.3 25No conflict (average) 28.5 30.3 33.5 35.1 36

Bilateral official creditors

Conflict-affected (average) 59 58 61 56 5No conflict (average) 53 53 55 54 5

Sources: World Bank’s Global Development Finance and W

request). It is not significant in the analysis ofgrowth-per capita, which is not surprising giventhe apparent difference in growth rates acrosscountries in war and after war. These resultssupport our conclusion of the initial inspectionof Table 1a, namely, that conflict-affecteddeveloping countries are different from non-conflict-affected countries, especially concern-ing debt.

The sources of official debt between conflict-affected and peace-time economies have chan-ged over time (Table 1b). Conflict-affectedcountries (including both war-time and post-war countries) doubled the share of debt frommultilateral creditors in the period 1990–2002while peace-time economies only raised thatshare by 50%. In turn, conflict-affected coun-tries reduced their share of bilateral debt by aquarter while peace-time economies reducedthat share by only 10%. By 2002, the conflict-affected countries have less debt as a share oftotal debt with bilateral official creditors thandoes the reference group. This also implies that,for better or for worse, bilateral donors haveless influence on policy conditionality in thesecountries vis-a-vis the multilateral lenders. Atthe same time, this trend heightens the needto monitor and optimize multilateral policiesfor war-affected countries.

In summary, the data indicate that during awar debt levels rise and after a war debt lev-els fall. Debt sustainability indicators worsenfor two reasons during war: debt levels riseand indicators of economic activity worsen.Furthermore, debt for conflict-affected coun-tries has been multilateralized over the last15 years, with bilateral lenders strongly reduc-ing their exposure to war-affected economies.These data hence demonstrate that war-af-fected countries do indeed have differenttrends with respect to their foreign debt thando peace-time countries.

uaranteed debt (as percentage of total publicranteed debt)

94 1995 1996 1997 1998 1999 2000 2001 2002

.7 27.5 28.8 30.4 31.3 35.0 35.5 38.3 40.8

.0 37.3 38.2 40.2 40.9 41.7 42.4 43.1 45.8

6 56 55 55 54 50 50 47 453 52 52 48 48 48 49 50 48

orld Development Finance, and own calculations.

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EXTERNAL DEBT IN POST-CONFLICT COUNTRIES 489

(b) Arrears with multilateral donors

Post-conflict countries with external debt ar-rears face severe difficulties to accessing muchneeded funds from the international commu-nity as the international community is not usu-ally willing to lend or donate to countries inarrears on debt. For multilateral donors,arrears are a problem as they signal the endof business as usual for assistance to a country(Birdsall, Claessens, & Diwan, 2003). Re-estab-lishing a working institutional relationshipbetween a heavily indebted war-affected devel-oping country on the one hand and the multi-lateral institutions on the other hand is thuscrucial for resolving a debt crisis.

Bilateral donors respect the primacy of multi-lateral donors in this respect and treat breachesof contract by borrowers with multilateral cred-itors as a signal that contracts with bilateralcreditors will not be honored any further,either. However, the issue of how to deal withcountries in arrears is not yet well establishedby the international community. Furthermore,war-affected countries find this process evenmore challenging than other developing coun-tries.

Normalizing relations with multilateraldonors in a post-war setting generally requiressix steps. First, an indebted country must forma working internationally recognized govern-ment, thus articulating a functioning voice inthis process. Second, the government mustestablish the domestic political will to normaliz-ing relations and build up some minimal mana-gerial capacity for debt management. This lastpart is particularly difficult for war-affectedcountries. Third, the country, assisted by theinternational community such as the IMF,must undertake a stocktaking exercise (alsocalled ‘‘debt reconciliation’’) to establish thelevel, the nature, and the lenders of the out-standing stock of foreign debt. Post-war coun-tries may face problems in completing thisstep if records were lost during the war (as hap-pened in Liberia).

Fourth, a country has to formally re-estab-lish its relations with the IMF and other inter-national donors and their agencies to startbuilding some trust. Trust may be built up,for example, by starting nominal but regularpayments to an international financial institu-tion. Fifth, the government has to develop anational debt management policy and startimplementing this policy with its partners. Thisshould address in particular the issue of arrears.

Without starting to clear arrears, a developingcountry cannot re-establish working relationswith the international donor community. Final-ly, the government can enter into debt reliefnegotiations with its Paris Club and non-ParisClub donors.

Arrears to international financial institutionsmay delay the commencement of peace build-ing (beyond the signing of the peace deal) andpostpone reconstruction unless a post-war gov-ernment succeeds in obtaining bridge loansfrom bilateral official creditors. Bridge loansare very short-term loans, often only lasting afew days, by bilateral lenders to developingcountries keen to fulfill their obligations tomultilateral institutions but unable to do sofrom their own resources. Once the multilaterallending resumes upon receipt of the bridgeloan, the resources from the multilateral loancan then be used to repay the bridge loan—potentially leaving an indebted country finan-cially no better off than before. Surprisingly,bridge loans by bilateral donors appear to helpgovernments gain credibility with multilateraldonors.

The paradox of bridge loans is that theyallow a developing country to gain short-termcredibility by appearing more financially liquidthan they are. However, the multilateral lenderknows that this creation of liquidity is an arti-fact, established by willing donors. The benefitsof bridge loans entail the resumption of multi-lateral lending in the longer term, the commit-ment of bilateral donors to that country andthe prevention of a significant loss of reputationassociated with default to international lenders.The costs of bridge loans include the burden oncapacity by donors and recipients to arrangethe bridge loans and the financial cost of suchshort-term lending.

An innovative approach to overcominglarge and protracted arrears to the multilat-eral institutions by post-conflict countrieswas developed by IDA in 1999 (Michailof,Kostner, & Devictor, 2002). The IDA autho-rized the limited use of grant financing tosupport economic recovery during the pre-ar-rears clearance phase. However, by 2001 onlyone out of the five post-conflict countries inAfrica with large and protracted arrears thatcould have qualified for these IDA grantsdid indeed qualify, namely, the DRC. There-fore, arrears continue to be a key obstacleto establishing sustainable and workable debtmanagement strategies for post-conflicteconomies.

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(c) Exceptional burdens and needs

War-affected economies can be expected tocarry extra burdens in terms of their develop-ment agenda as a result of excessive, war-in-duced mortality, morbidity and refugeemovements, excessive asset destruction, capitaldepreciation and capital flight, possibly infla-tion, a large trade deficit, and a considerablebudget deficit (Stewart & FitzGerald, 2001).Phrased differently, conflict changes relativeprices in an economy and hence changes incen-tive structures (Collier & Gunning, 1995).

From a debt management point of view thekey effect of conflict is the reduced solvencyof these countries. This war-induced burden issharpened further by the fact that post-conflictcountries have weaker institutions and capaci-ties for raising domestic debt, for negotiatingexternal financial support, and for coordinatingaid than do other developing countries. This isrelated to the fact that rebels often target theeffectiveness of the government, thus leaving apost-war government weak in areas like tax col-lection. Having less remaining debt (or at leasthaving comprehensive debt restructuring) low-ers the burden on constantly re-negotiatingdebt service in future years. Mozambique is agood example of how such negotiations canabsorb much time and efforts of the indebtedcountry (see below).

Furthermore, expectations are crucial for thesuccess of post-war transition. Negative expec-tations about the prospects of peace can damagethe peace process, reduce domestic consump-tion and investment, and prevent the return offlight capital, thus increasing the war-burdenon the economy (Collier & Gunning, 1995).Unresolved foreign debt represents unresolveddonor relations, thus de-stabilizing interna-tional expectations and signaling the interna-tional critique of war-time or post-war-timemacro-economic conditions.

In addition to having higher burdens, post-war countries have high financing needs forthe (re-) construction of public goods, for theprovision of public infrastructure and for cur-rent expenditure. This is composed of boththe costs of making peace, such as demobiliza-tion programs, and the costs of establishingworking institutions. Thus, post-conflict coun-tries have higher financing needs than evenother developing countries with a similar out-put but not carrying the burdens of previouswar. This implies a further case for debt relief

for post-conflict economies, which will be ad-dressed in the next section.

3. DEBT RELIEF AND POST-CONFLICTRECONSTRUCTION

In the sparse literature on external debt pol-icy in post-conflict economies, there are severalarguments for shifting the balance betweencreditor and debtor rights toward deeper debtrelief for post-conflict economies, includingthe exceptional burdens and needs of post-con-flict economies as argued above, debt overhangeffects, and odious debt. All these argumentsfavor early and significant debt relief to achievea successful transition to peace and prosperity.However, the effects of debt relief for post-con-flict economies will also depend on the scale ofadditionality, that is on the degree of substitu-tion between debt and aid, which will be con-sidered in this section as well. First we offer abrief review of the existing literature on debtand growth, which generally speaking doesnot consider the special role of conflict.

(a) Debt and growth

To assess the potential economic effects ofdebt relief, it is important to consider first therelationship between debt and growth. Accord-ing to the literature, moderate debt levels areexpected to have a positive effect on growth,whereas high accumulated debt stocks arelikely to be associated with lower growth. Thereare three channels through which external pub-lic and publicly guaranteed debt can negativelyaffect a country’s economic and social condi-tions, which we discuss in turn.

First, public debt must be serviced using bud-getary resources, which in turn must derive fromincreasing government revenue, increasing thefiscal deficit, or decreasing expenditures in otherareas. As shown by the experience of severalLatin American countries during the 1980s, debtservice requirements are in fact often met bydecreasing public investment and social spend-ing. Serieux (1999) concludes that the restric-tions imposed on the government budget by thedebt burden appears to have jeopardized growthin the HIPC countries by reducing investment inboth human and physical capital. This channelmight be even more pronounced in conflict-af-fected countries, which face exceptional fiscalburdens and needs (as argued above).

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EXTERNAL DEBT IN POST-CONFLICT COUNTRIES 491

Second, there may be uncertainty about theextent to which a country can service its exter-nal debt using its own resources, about futurereschedulings (involving corresponding changesin government policies), and about the extent ofadditionality. Moreover, most emerging econo-mies are unable to borrow abroad in terms oftheir own currencies and are indebted in US-dollars. Thus, if the indebted countries do notreduce their international reserves, the requiredforeign exchange must be extracted from exportearnings, foreign direct investments or foreignaid—unless the debt is refinanced. Any of therequired measures creates uncertainty abouthow (or if at all) external debt will be serviced,and thus could result in investment delays orthe misallocation of investments, consistentwith the literature on investments under uncer-tainty. Thus, high levels of foreign debt mayreduce growth.

Third, the most common argument on how ahigh debt burden can lead to lower growthrates relates to the issue of debt overhang(Krugman, 1988; Pattillo, Poirson, & Ricci,2002). This strand of the literature points outthat if the future debt grows larger than thecountry’s repayment ability, the expected debtservice will be an increasing function of thecountry’s output level. The returns from invest-ing in the country thus face a high marginal taxby the external creditors, and investment is dis-couraged. As current investment falls, futuregrowth decreases. Debt relief in this case cancontribute to higher growth rates by improvingthe incentives to invest. Thus, for a country suf-fering from debt overhang, the creditors canincrease the expected value of their claims byforgiving some of the debt.

Pattillo et al. (2002) report on an empiricalstudy examining the relationship between debtand growth in about 100 developing countries,identifying a non-linear relationship across allcountries and without considering the role ofconflict. They find an inverted-U relationshipbetween the net present value of debt andgrowth of annual per capita output and con-clude that the overall contribution of debt togrowth becomes negative at about 160% ofdebt to exports in NPV terms. Cohen (1997)also discusses the non-linear effect of debt with-out considering the role of conflict. He findsthat the probability of debt rescheduling, whichis positively correlated with external indebted-ness, significantly lowers growth. Accordingto his analysis, debt becomes excessive around

the 50% debt-to-GDP or 200% debt-to-exportratios.

(b) Debt relief and growth

Moral hazard considerations would suggestthat the prospect of eventual debt relief mayinduce a desire to contract high levels of debtby developing countries. It could be argued thatin a conflict setting the moral hazard issue isheightened to the extent that governmentsmay deliberately risk violent conflict as a wayof achieving debt relief. However, while itappears plausible that in many countries (suchas Mozambique) foreign debt was used to fundongoing wars, there appears to be no case of agovernment starting war with the objective ofachieving debt relief. Instead, military, politi-cal, and other economic motives always appearto be leading determinants of conflict. Whilemoral hazard may be an important issue indebt relief generally, it does not seem to be aspecial concern in the case of post-war debt re-lief.

Debt relief might promote growth throughthree channels (Addison, Hansen, & Tarp,2004): by reducing uncertainty concerning debtrepayments, by lowering the debt service pay-ments (thus making additional resources avail-able for public investment), and by reducing thedebt overhang effect. For the post-war context,Menzies (2004) shows how a creditor pursuingthe recovery of some debt and the attainmentof humanitarian goals can balance these con-siderations within an optimal contract frame-work. Such framework must recognize thepotential conflict between different policies,including the ending of a civil war. In a time-horizon relevant for many policymakers, therepayment of foreign creditors by post-warcountries is a substitute for the attainment ofpeace. Thus, debt forgiveness could increasethe chance of peace.

Addison and Murshed (2003) argue that debtrelief may reduce political grievances throughbroad-based public spending. This emphasizesthe need to view economic and political pro-cesses jointly in the post-war period. Alterna-tively, debt relief could free resources to buyoff the war party. However, even if debt reliefwere forthcoming, the fiscal system may betoo degraded to achieve the promised transfer.Moreover, a given fiscal transfer that wouldhave prevented war might be insufficient toachieve peace once war has started. The timing

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of debt relief is hence critical to achieving aneffective macro-economic impact of debt relief.

Analyzing the factors determining the alloca-tion of debt forgiveness for a large number ofemerging and developing countries, Neumayer(2002) in fact finds that a country’s need is animportant factor of debt forgiveness, whereascreditors’ political interest—with the exceptionof US military grants—is not. His results fur-thermore suggest that in the past debt forgive-ness has not been used to honor countrieswith good governance. He recommends tochange this, as linking good governance withhigher debt relief would generate the rightincentives for highly indebted countries. East-erly (2002) comes to the conclusion that moreresources went to countries with bad policiesthan poor countries with good policies in thepast two decades. He says that the ‘‘creepingprocess of debt relief’’ over the past 20 yearsmight be responsible for new borrowings andthe resulting worsening of debt ratios, as wellas for delayed reforms. Thus, he also appealsto change the rules for debt relief and arguesfor a once-and-for-all program, instead of agradual program of increasing relief.

Moreover, debt relief in the case of HIPCsmay not stimulate investment and growth asthese countries do not suffer from debt over-hang. In fact, HIPC countries often receive po-sitive net transfers from creditors rather thannegative ones (Arslanalp & Henry, 2006; Bird-sall et al., 2003). However, as debt stocks arevery high in these countries, the continued reli-ance on disbursements leaves these countries ina very perilous situation, with a high degree ofpolicy uncertainty stemming from future donorbehavior. A further obstacle to investment andgrowth in these countries derives from a lack ofbasic economic institutions. Therefore, the en-ergy and resources devoted to the HIPC initia-tive could be more effectively employed asdirect foreign aid.

Despite the strong case for accelerated debtrelief for post-conflict economies based onuncertainty or exceptional burdens, severalauthors demonstrate that much debt reliefand aid is motivated by other, less altruistic rea-sons. Chauvin and Kraay (2006) find a correla-tion between debt relief and the quality ofpolicy but not between debt relief and level ofindebtedness. Their findings suggest that whilemultilateral debt is more likely to be forgiven,countries may be persistently indebted. Kanbur(2000) views concerns over debt servicing to bea key reason for the failure to enforce condi-

tionality. In accordance with Claessens,Detragiache, Kanbur, and Wickham (1997)and Birdsall et al. (2003), Kanbur also arguesthat foreign aid is often granted to ensure ‘‘nor-mal relations’’ with regular debt servicing. This,however, also provides a safety net for privatecreditors and reduces the risk of lending toregimes that are not creditworthy. Addisonand Murshed (2003) and Kanbur (2000) recom-mend that peace-building governments shouldreceive faster debt relief, ensuring that peaceis not delayed by the inevitable difficulties thatwar-time governments face in meeting donorpolicy conditionality. Therefore, debt reliefshould be monitored for its effect on growth,poverty reduction, and peace building and toprevent it from being squandered on politicaldonor priorities unrelated to genuine develop-ment objectives.

(c) Odious debt and debt relief

An important normative case for debt reliefis based on the concept of odious debt. Thiscould be defined as debt incurred by a dictatornot for the needs nor in the interest of the soci-ety but to strengthen the despotic regime. Odi-ous debt is hence not an obligation for thenation but it is the personal debt of that dicta-tor and its regime. The interesting questionfrom an economic point of view is how odiousdebt can arise in the first place, given that odi-ous debt carries a high risk of default, and howsuch debt may be managed or forgiven onceincurred.

There have been numerous approaches fromlegal and moral scholars to formulate a theoryof odious debt (Hanlon, 2006). One earlyapproach dates back to Alexander Sack, a pro-fessor of law and former minister in the Tsaristgovernment in the early 20th century, who triedto formalize the legitimacy of foreign debt inlight of the Bolsheviks repudiation of Russiandebts after the Russian Revolution (Sack,1929).

An alternative approach based to odiousdebt rests on two criteria. First, a regimemust have the ability to use debt contraryto the interest of the population. This crite-rion shifts the responsibility for the debt fromthe overall population to the ruling regimealone. Second, the debt must pass a certainthreshold to harm future economic develop-ment. If both conditions are fulfilled, it isvery likely that at least part of the externaldebt is odious.

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EXTERNAL DEBT IN POST-CONFLICT COUNTRIES 493

What makes odious debt special is the factthat it has been incurred on behalf of a country,which by definition cannot become bankrupt.In the private sector, in contrast, loans usedunproductively may lead to non-payment inthe case of a borrower’s bankruptcy. This en-sures that lenders have a strong incentive tocontrol the use of their funds and the otheractivities of the lender to minimize their risk.In the context of nominally sovereign statesand volatile governance structures in manydeveloping countries, this approach cannot bereplicated entirely, even with policy condition-ality.

From a positive economic point of view, ad-verse selection and moral hazard also apply toborrowers unconstrained by democratic con-trol: the more dictatorial a regime is, the morelikely it is to seek a loan despite its unsuitabilityto do so (adverse selection) and to act contraryto the interests of the lender (moral hazard).Therefore, policy conditionality is necessarybut not sufficient to prevent odious debt. An-other necessary condition to prevent future in-stances of odious debt is to make possible theeconomic bankruptcy of a state as a means ofdisciplining potential lenders.

Furthermore, one could also call for theintroduction of state-level bankruptcy from anethical point of view. Incidentally, this casecould and has been made for the forgivenessof non-odious debt, as in the Jubilee 2000 andDrop-the-Debt campaigns or even, implicitly,in the HIPC initiatives. In both incidents theargument is that the repayment of an excessivelevel of debt damages the development pros-pects of the country and its population. Thespecial ethical argument in the case of odiousdebt is that such debt was never intended tosupport development and probably nevershould have been given in the first place. Thusthe repudiation of odious debt may also sup-port the establishment of justice in a post-con-flict society (Hellsten, 2005).

There are some historical precedents for thedoctrine of ‘‘odious debt,’’ with a new govern-ment repudiating the debt accumulated by aprevious regime. During the Spanish–AmericanWar in 1898, for example, Spain lent money tothe Cuban regime for military expenditures.After its victory, the United States proclaimedthat neither Cuba nor the United States shouldbe responsible for repaying the debt, as it didnot benefit the people of Cuba but insteadhad only strengthened the old regime. In theParis peace treaty, Spain ultimately acknowl-

edged this debt being odious and accepted itsrepudiation. Another example is the Russianrevolution in 1919, where the Soviet govern-ment repudiated the Tsarist debts on the samegrounds. Similarly, in the Treaty of Versaillesthat same year, the Polish debts to Prussia werealso repudiated under the odious debt doctrine.

Singular debt write-offs by governments ofdeveloped countries occasionally take place atimportant bilateral or multilateral summits,for example, at the G8 summit in Gleneagles(Giles & Cave, 2005). This is then a precedentfor a global institution formalizing the condi-tions under which such write-offs beyond exit-ing institutions such as the Paris Club of theHIPC initiatives are granted. However, thereis no internationally accepted institution withthe authority to measure or to declare the ‘‘odi-ousness’’ of sovereign debt. Accepting unilate-ral repudiation of debt without the blessing ofsuch an institution may undermine efforts tostrengthen the enforcement of internationalproperty rights and thus decrease the efficiencyof intra- and inter-temporal trade.

In a case study of the DRC, Ndikumana andBoyce (1998) argue for debt relief based on thedoctrine of odious debt. They review the evi-dence that the official and private creditors ofthe Mobutu regime knew, or should haveknown, that there was a high risk that theirloans would not be used to benefit the Congo-lese people. Based on an estimate of capitalflight, Ndikumana and Boyce conclude thatduring 1968 and 1990 Zaire was in fact a netcreditor to the rest of the world, exporting morecapital than it imported.

Hence the way the debt was acquired andspent can determine if and how such debtshould be repaid. For example, the relative gen-erosity of the international donor communityvis-a-vis the DRC in forgiving debt (see below)was also based implicitly on the notion thatmuch of the DRC’s debt was odious.

To prevent future odious debt from beingcontracted, a global institution such as theUN Security Council or the planned UN Peace-building Commission (Annan, 2005) might begiven the authority to rate a sovereign state‘‘odious.’’ We propose that this institutionshould use a set of quantitative and qualitativecriteria to make an ultimate and binding judg-ment on the odiousness of a regime. Such insti-tution could impose a loan sanction ongovernments that are in danger of immoraland excessive borrowing. All debt accumulatedafter this cut-off point would be deemed

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494 WORLD DEVELOPMENT

illegitimate and thus not repayable (Jayachan-dran and Kremer, 2006; Jayachandran,Kremer, & Shafter, 2005). From a positive eco-nomic point of view, this option encourageslenders (especially if they are not themselvesmembers of the Security Council) to scrutinizetheir lending activities more carefully. Further-more, it opens an avenue to conduct ‘‘ethicaldebt relief.’’

Clearly this is only a very brief proposal. Theexact mechanisms, strengths, and weaknessesof such a proposal may merit further research.However, the main conclusion of this section isthat, in principle, such an institution could helpachieve two things. First, it could reduce the fu-ture incidence of odious debt by changingincentive structures and thus behavior. Second,it could grant ex post debt relief in cases notcovered by current debt relief initiatives suchas HIPC, thus establishing explicitly ethicaldebt relief under special circumstances.

(d) Debt relief and additionality

Additionality exists if debt relief does notlead to lower levels of other non-debt-relief-re-lated aid flows (that is crowding out) for thedebtor concerned. A broader definition of addi-tionality would request debt relief to lead togreater aggregate resources being made avail-able to the individual debtor receiving the re-lief.

A difficulty in assessing additionality stemsfrom the counterfactual challenge of how toestimate what would have happened to aid vol-umes (or other economic indicators generally)in the absence of debt relief (or in the absenceof conflict). We assume that debt restructuringsare additional if debt forgiveness and/or debtrelief is positively correlated with aid, approxi-mated through grants including technical coop-eration, where our proxy for aid does not takeinto account the concessional loan disburse-ments. Table 2 contains total debt forgiveness,total debt relief including reschedulings andthe proxy for aid flows. To calculate these ser-ies, we used data from the Global DevelopmentFinance database.

Overall, there is a positive and high correla-tion of 0.57 between debt rescheduling and debtforgiveness, pooling all the data in Table 2. Thecorrelation coefficient for debt relief and grantsfor pooled data is also positive but only 0.16. Interms of additionality, this implies that grantsand debt restructuring move in the same direc-tion. The rescheduling-forgiveness additionality

maybe more important in practice than therescheduling-aid additionality.

Using cross-country data, Hansen (2004)analyses the impact of both aid and externaldebt reduction on growth and investment. Heargues that it is of particular interest to lookat the impact on growth when both debt servicepayments and aid flows are reduced. Decreas-ing debt service payments that are accompaniedby falling grant levels may have a negative im-pact on growth. Furthermore, aid additionalitycan also enhance private sector confidence asinvestors observe that donors are committedto the country in the long term. Thus, addition-ality seems to play an important role for thebeneficial effect of debt relief on growth.

Ndikumana (2004) examines in an economet-ric analysis whether and to what extent debt re-lief has been accompanied by decreasingdevelopment aid flows, grants, and other formsof concessional external financing. Using bothdata from the donor side and data from the re-cipient side enables him to analyze to what ex-tent donors reduced their disbursements ofODA and grants following debt restructuringsas well as to what extent countries that have re-ceived debt restructurings subsequently receivedless ODA and other forms of concessionaldevelopment finance. While he finds that thesupply of ODA and grants declined in the1990s, he does not find a direct causal link be-tween the volume of debt restructuringsawarded and the volume of official developmentfinancing disbursed, which confirms our analy-sis of the data.

(e) The HIPC initiative

The main institutional arrangements for debtrelief in the cases of commercial bank debt,bilateral debt, and multilateral debt held bydeveloping countries are the London Club,the Paris Club, and the HIPC initiative, respec-tively. Given the trend toward multilateral debtfor conflict-affected countries, we will focus ouranalysis on the HIPC initiative.

The HIPC initiative was conceived in 1996by the multilateral donor community to helpthe most indebted and poorest developingcountries escape their development trap(Addison et al., 2004). HIPC assistance isdetermined by bringing the net present valueof external public debt down to a criticalthreshold. The key threshold was specified ini-tially as a debt-to-export ratio of between200% and 250%.

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Table 2. Debt relief and aid grants: Mozambique, Uganda, and the DRC (US$ million, unless otherwise indicated)

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Mozambique

Total rescheduling 0 343 141 376 134 136 219 187 114 229 469 2 269 0Total forgiveness (incl. interest forgiven) 0 1,174 237 24 36 63 323 131 223 28 536 46 2,556 35Total debt relief 0 1,517 378 399 170 199 542 318 337 257 1,005 48 2,825 35Total debt relief as % of debt stock 0 34 9 14 4 4 5 4 5 8 17 1 62 1Total debt relief as a % of GNI 0 65 16 24 9 10 25 12 10 7 27 1 90 1Grants (incl. technical cooperation) 672 841 1,001 920 861 876 1,003 631 680 824 782 899 822 1,872Grants as percentage of GNI 32 36 44 55 47 44 47 24 21 23 21 26 26 55

Uganda

Total rescheduling 29 5 6 92 34 0 172 0 0 158 18 38 0 1Total forgiveness (incl. interest forgiven) 0 51 1 14 156 7 41 0 0 627 11 189 33 128Total debt relief 29 56 7 106 191 7 213 0 0 785 29 227 33 130Total debt relief as % of debt stock 3 3 0 4 6 0 6 0 0 20 1 6 1 3Total debt relief as a % of GNI 1 1 0 4 6 0 4 0 0 12 0 4 1 2Grants (incl. technical cooperation) 264 348 420 455 381 440 548 467 492 483 489 659 512 577Grants as percentage of GNI 5 8 13 16 12 11 10 8 8 7 8 11 9 10

Democratic Republic of Congo

Total rescheduling 976 390 0 0 0 0 0 0 0 0 7 0 0 3,518Total forgiveness (incl. interest forgiven) 153 24 0 0 0 0 0 0 0 0 2 0 0 3,553Total debt relief 1,129 414 0 0 0 0 0 0 0 0 9 0 0 7,072Total debt relief as % of debt stock 15 5 0 0 0 0 0 0 0 0 0 0 0 83Total debt relief as a % of GNI 13 5 0 0 0 0 0 0 0 0 0 0 0 135Grants (incl. technical cooperation) 365 520 584 196 131 259 216 182 162 137 152 191 269 566Grants as percentage of GNI 4 6 7 2 1 5 4 3 3 2 4 5 6 11

Source: World Bank Global Development Finance database and own calculations.Notes: Total forgiveness corresponds to the change in debt stock due to debt forgiveness or reduction, including principal and interest arrears forgiven. Total debt reliefincludes total debt rescheduling in addition to forgiveness.

EX

TE

RN

AL

DE

BT

INP

OS

T-C

ON

FL

ICT

CO

UN

TR

IES

495

Page 12: External Debt in Post-Conflict Countries

496 WORLD DEVELOPMENT

The initiative was revised in 1999 (IMF &World Bank, 1999) because of ongoing contro-versies over its modes of operation and its effec-tiveness (Fedelino & Kudina, 2003; Hjertholm,2003; IDA & IMF, 2001; Sanford, 2004; Sun,2004). The enhanced HIPC initiative allowedfor broader and deeper debt relief (coveringmore countries and cutting more debt), acceler-ated debt relief (granting debt relief at the deci-sion point and bringing the completion pointforward), and strengthened the link betweendebt relief and poverty alleviation (adoptingpoverty reduction strategy papers, PRSPs,which prioritize the use of freed resources forpoverty alleviation). However, the revisions didnot account for the unique circumstances ofwar-affected HIPCs (for a rare exception, seeIMF & World Bank, 2001). These circumstancesare outlined and discussed below.

Even in peaceful economies, the assessment oflong-term debt sustainability should shift from asingle debt indicator to a more complex and com-prehensive system of indicators (IDA & IMF,2001). There are three key determinants of sus-tainability: the existing stock of debt, the develop-ment of fiscal and external debt managementcapacity, and economic growth and new conces-sional external financing. Both debt sustainabilityand the development process generally requirethe analysis of policies, institutions, exogenousfactors, and debt management over the long term.

However, the strong focus of the HIPC initia-tive on a narrow and short-term range of debtsustainability indicators may be misleading oreven counterproductive in a post-war economy.On the one hand, private financial flows in theform of remittances of returning flight capitalmight be important for funding development inpost-war countries. These sources of fundingare not currently included in the HIPC debt sus-tainability analyses. On the other hand, giventhat civil wars always weaken the state and itsability to raise taxes, the levels of domesticallymobilized public resources will be even lower ina war-affected developing country than in otherdeveloping countries.

Furthermore, the weakness of institutions inwar-affected countries implies that export reve-nues may be accruing to non-state and evennon-taxable actors, thus weakening the abilityto service debts. This point is particularly acuteif these exports are recorded in the statistics.This suggests that debt as a share of exportsmay be a less useful, if not an overly optimistic,indicator for assessing debt sustainability thanit is in peaceful HIPCs.

The HIPC initiative effectively aims to maxi-mize the consistent repayment of albeit reduceddebts, thus potentially placing a stronger fiscalburden in terms of its debt payments on coun-tries emerging from war and international isola-tion (like Uganda and Mozambique) than forcountries remaining isolated (like Sudan or Libe-ria). Therefore, such high debt service burden inabsolute (measured in US-dollars per capita) andrelative (measured in share of total spending)terms may reduce the fiscal peace dividend andhence prosperity in such a weak state.

Linked to the low share of government in theeconomy is the issue of weak institutionalcapacities in post-war economies. The assess-ment of track records in post-conflict countriesshould extend beyond macro-economic stabil-ity and also pay attention to consolidatingpeace, security, and poverty reduction (IMF& World Bank, 2001). Such generalized assess-ment of sustainability should then use bothquantitative indicators of economic and pov-erty alleviation performance but could also in-clude qualitative information, for example, toaddress the issue of odious debt.

The need for a stable, medium-term track re-cord is a key element of the HIPC initiative.However, the usual requirement for a three-year period of good policy seems problematic.For countries with a good prospect for peace,it is worth reducing the time lag between thedecision and the completion points, and front-loading debt relief so that the government hasadditional resources to offer for redressinggrievances. This assumes that the peace divi-dend is large enough to compensate success-fully for the foregone revenue from conflictbusinesses (Addison & Murshed, 2003).

The analysis of the HIPC initiative from thepoint of view of conflict economies suggests thatpost-conflict economies require both new formsof conditionality and an enhanced scale of debtrelief. The fact that war-affected HIPCs includesome of the worst performers in terms of foreigndebt and human development do not change ourconclusions, instead they sharpen them.

4. CASE STUDY EVIDENCE

(a) Mozambique: the paradox of high debt andhigh aid

Mozambique, which had only become inde-pendent in 1975 following years of warfare, suf-fered another devastating conflict from the

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Table 3. Debt summary: Mozambique, Uganda, and the DRC (US$ million, unless otherwise indicated)

Mozambique Uganda Democratic Republicof Congo

Lastpre-war

1984

Firstpost-war

1993

Mostrecent2002

Lastpre-war

1980

Firstpost-war

1989

Mostrecent2002

Lastpre-war

1996

Firstpost-war

2001

Mostrecent2002

Debt stocks

Total debt stocks 1,438 5,212 4,609 687 2,177 4,100 10,840 11,519 8,726Long-term debt outstanding 1,354 4,859 4,039 535 1,846 3,690 9,285 7,587 7,391Short-term debt outstanding 84 164 371 63 105 153 1,083 3,556 764Of which interest arrears,

official creditors4 145 243 10 22 79 585 2,997 409

Of which interest arrears,private creditors

3 2 9 33 2 108 178 53

Principal arrears, officialcreditors

46 731 189 30 51 200 376 4,798 578

Principal arrears, privatecreditors

1 49 2 52 83 28 674 488 482

Debt flows

Disbursements 834 186 270 83 312 162 3 0 415Disbursement multilateral

%0.6 78 89 8 46 84 0 0 99

Disbursement bilateral % 75 20 10 13 40 13 100 0 1Disbursement private % 24 2 0 78 13 3 0 0 0

Debt indicators

Total debt/exports (%) 673 1,402 363 208 784 370 130 .. ..Total debt/GNI (%) 43 287 135 4 42 71 2 241 159Total debt service

(% of GNI)1 7 2 0 4 1 20 .. 17

Debt composition

Multilateral debt/total debt(%)

4 15 32 12 45 77 20 18 28

Bilateral/total PPG debt (%) 78 81 44 40 29 11 67 66 69Private/total debt PPG (%) 17 3 0 46 18 1 9 6 4

Aid and GNI

Aid (% of GNI) 8 65 60 9 9 11 6 6 15Aid per capita (current US$) 19 79 112 9 27 26 12 5 16GNI, PPP (real 2002

million $)7,647 9,793 18,293 16,288 33,819 56,977 31,605 32,697

GNI per capita, PPP(real 2002 $)

565 652 990 .. 974 1,370 1,479 630 630

Net resource flows and net

transfers

Net resource flows 990 821 2,395 112 415 815 152 279 776Foreign direct investment,

net inflows0 32 348 0 �2 185 25 82 117

Net flows on debt, totallong term

822 152 227 51 241 135 3 0 167

Grants, excluding technicalcooperation

168 636 1,820 61 177 494 124 197 492

Net transfers on debt 817 20 41 118 187 93 0 0 0

PPG = public and publicly guaranteed debt; PPP = purchasing power parity.Source: World Bank’s Global Development Finance and World Development Finance.

EXTERNAL DEBT IN POST-CONFLICT COUNTRIES 497

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498 WORLD DEVELOPMENT

early 1980s till the end of 1992, when a peaceaccord ended the civil war (Newitt, 1995). Theeconomy was badly damaged by both conflicts(Addison & de Sousa, 1999; Colletta, Kostner,& Wiederhofer, 1996). GNI per capita wasUS$652 in 1993 (Table 3) and the national pov-erty headcount of Mozambique was 69.4% in1996 (Government of Mozambique, 1998).Since then, Mozambique has experienced sus-tained growth. The average annual GDP percapita growth for the period 1995–2002 was5.6% (World Bank, 2005). GNI per capita roseto US$990 in 2002 while the national povertyheadcount of Mozambique dropped to 54.1%in the same year (Government of Mozambique,2004).

Until the late 1970s, Mozambique did notaccumulate noteworthy amounts of externaldebt. Shortly after stepping into its prolongedcivil war, Mozambique’s external debt in-creased rapidly and soon became unsustain-able. By 1993, Mozambique’s debt-to-GNIratio reached nearly 300% and the externaldebt-to-export ratio even added up to 1400%(Table 3). These tremendously high ratios alsoreflected strongly reduced output indicators.Public and publicly guaranteed long-term mul-tilateral debt stock doubled in only four years,reaching nearly US$700 million in 1992. How-ever, despite a significant modification ofMozambique’s composition of external debt,the share of concessional debt remained con-stant and at a very high level by the end ofthe civil war.

Mozambique’s exports of goods and servicesper capita increased slowly throughout the1990s and accelerated in recent years. Theexternal financial balance of Mozambique sincethe end of the war was supported by a high andrising level of foreign aid. During the 1990s,with the exception of 1990, aid and debt for-giveness ran more or less parallel. In particular,above average debt forgiveness did not result indecreasing aid flows. From 1999 on, however,aid and debt forgiveness ceased to move inthe same direction. Yet significant debt forgive-ness resulted in only very small decreases of aidflows. Foreign direct investment only started tomake a contribution to net resource flows in re-cent years and then only on a modest scale (Ta-ble 3).

Mozambique thus experienced the paradoxi-cal situation of being one of the most heavilyindebted but at the same time most aid-receiv-ing developing countries in the world. Thismakes the case of Mozambique unique. Its les-

sons, however, may be relevant for other con-flict-prone poor countries like Nicaragua,Haiti, Angola, or Sierra Leone. The case ofMozambique therefore demonstrates debtaccumulation during conflict as well as theimportance of peace for development shouldbe addressed by lenders and donors explicitly.Overall, Mozambique has escaped very slowlythe paradox of being heavily indebted andheavily aid-dependent.

(b) Uganda: slow road to debt reconciliation

Uganda has suffered a series of internal andinternational conflicts and political coups inits recent history (Nannyonjo, 2005). The cur-rent president, Yoweri Museveni, led a rebelgroup which came to power in 1986, endingthe country’s civil war. He has since cautiouslymoved the country to a managed form ofdemocracy and cooperates close with multilat-eral and bilateral donors. Uganda’s GNI percapita has increased from US$974 in 1989 toUS$1,370 in 2002 (Table 3).

While Uganda’s external debt started increas-ing in the 1970s, the rapid rise of the country’sdebt stock to unsustainable levels began in theearly 1980s (Table 3, Barungi & Atingi, 2000).In fact Uganda’s external debt stock duringthe war of 1981–88 grew by 14% a year on aver-age, while it grew by 6% a year on average dur-ing the 1990s.

There is a striking modification in the com-position of external debt from 1980 to 1989.In the period before the war, Uganda borrowedmainly from private creditors followed by bilat-eral official creditors; multilateral debt in 1980accounted for only 11% of total debt. Giventhe nature of war finance in Uganda, this maysuggest that donors implicitly enabled the con-tinuation of the war. During the war, borrow-ing from multilateral creditors increasedsharply both in absolute and relative terms,thus accounting for about 45% of total debtin 1989. This section will therefore focus onthe management of Uganda’s multilateral debt.

In 1995, a number of bilateral donors set up aMultilateral Debt Fund for Uganda, into whichthey paid funds to help Uganda repay its debtobligations to multilateral creditors. Furtherexternal arrears to multilateral creditors werecleared either through concessional reschedul-ing (US$10.6 million from the Arab Bank forEconomic Development in Africa, BADEA)or in cash payments (amounting to US$4.9 mil-lion) by March 1998.

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EXTERNAL DEBT IN POST-CONFLICT COUNTRIES 499

Uganda was the first country to qualify fordebt relief under both the first HIPC and theenhanced HIPC initiative. Before assistancefor Uganda under the HIPC initiative wasgranted, the NPV of debt-to-export ratio atthe end of June 1997 stood at 243%. The yearin which Uganda first received debt relief underthe HIPC initiative was 1998. In total, as a re-sult of both initiatives, Uganda was granteddebt relief amounting to US$1 billion in NPVterms to be delivered over a period of 20 years.Uganda received substantial cash savings, aver-aging US$60 million per annum over fouryears, accounting for almost a quarter of thetotal budget support over the period.

The HIPC initiative for Uganda left room forinvolving a variety of donors. The AfricanDevelopment Bank and the IMF participatedin the HIPC initiative through the HIPC TrustFund, which was set up and funded by donorsto support the HIPC initiative over and abovethe donors’ legal obligations. This enabled thebuy back of most of the AfDB loans withown contributions, as well as through donorcontributions. The Nordic Development Fund(NDF) also participated in the HIPC TrustFund by paying debt service falling due on be-half of the debtor rather than through a debtbuyback. BADEA agreed with the Ugandanauthorities to provide its HIPC assistancethrough a concessional rescheduling of arrears,over 10 years with two years grace at zero inter-est. Such different initiatives can combine tomake a strong impact on a country’s indebted-ness, though the coordination costs for theUgandan government are probably significant.

Debt relief for Uganda was generally addi-tional to other aid, although there were someexceptions in 1993 and 1998 (Table 2). Theoverall trend was an increase in the provisionof grants in the first half of the 1990s, with aslight decline after 1995, but an increase againafter 1999. On the one hand, and as in the caseof Mozambique, debt relief in Uganda did notcome along with a substantial increase of netresource flows (accounting for new debt andaid). This augurs badly for the ‘‘flow’’ effectof the HIPC initiative. On the other hand, for-eign direct investments did increase by 2002,contributing almost a quarter to the net re-source flows (Table 3).

The case of Uganda shows how slow andpainstaking the process of debt reconciliationcan be for post-conflict countries even underfavorable institutional circumstances. In part,this is because the complexities of the negotia-

tions bind scarce capacities. In part, this is be-cause rules and institutions are very complexand each agreement covers only a small partof the problem.

(c) DRC: fast but unsustainable action

The DRC suffered several devastating wars inits recent history, with one conflict lasting from1996 to 2001 (Clement, 2004; Ndikumana &Boyce, 1998). The DRC is one of Africa’s mostresource-rich countries which has suffered fromdomestic and international mismanagementand corruption, with its resources fuellingmuch of the war efforts (an incidence of a ‘‘re-source curse’’). The DRC continues to be char-acterized by ongoing political instability andextreme poverty. The DRC’s GNI per capitadropped from US$1,479 in 1991 to US$630 in2001 with foreign direct investment alsoremaining low (Table 3).

During 1970–94, the DRC borrowed overUS$9 billion abroad. Even though externalborrowing slowed substantially after 1994, theDRC’s external debt stock remained at a veryhigh level, reflecting in part the sharp increaseof arrears in the 1990s. Initially, the DRC’sborrowing was mainly from private creditors.As the private creditors started to shorten theirexposure to the country after the debt crisis of1976, official borrowing increased in the1980s. There were nearly no disbursements dur-ing the civil war. Nonetheless, by 2001 theDRC’s external debt amounted to US$11.7 bil-lion, with arrears accounting for 70% of the to-tal (Table 3). According to the Congolesegovernment, war-related expenditure and asharp decline in the collection of revenue result-ing from weakened state institutions resulted ina significant fiscal deficit, which had to be fi-nanced through the accumulation of domesticand external arrears. The overall deficit of thegovernment, for example, amounted to 45%of revenue in 1998 and 81% in 2000. Theincreasing amount of arrears is also reflectedin the dramatic change in the ratio of long-termto short-term debt.

Since early 2001, the DRC has made someprogress toward peace. In contrast to otherconflict-affected countries, the internationalcommunity and in particular the IMF adoptedquite a proactive and speedy approach to debtrelief. In February 2001, an IMF mission vis-ited Kinshasa and in December 2001 a meetingof donors, with the participation of a Congo-lese delegation, took place in Paris to gather

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Table 4. HIPC relief: Mozambique, Uganda, and the DRC

Original HIPC initiative Enhanced HIPC initiative

Nominal debt service relief Decisionpoint

Completionpoint

Nominal debt service relief Decisionpoint

CompletionpointUS$

millionAs % of

total debtAs % of

GNIUS$

millionAs % of

total debtAs % of

GNI

Mozambique 3,700 44.6 101.0 April 1998 June 1999 600 8.5 17.4 April 2000 September 2001Uganda 650 16.8 10.4 April 1997 April 1998 1,300 37.1 22.6 February 2000 May 2000Democratic Republic

of Congo– – – – – 10,389 93.0 192.9 July 2003 Floating

Source: IMF and World Bank.Notes: Status as of March 2005.

500W

OR

LD

DE

VE

LO

PM

EN

T

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EXTERNAL DEBT IN POST-CONFLICT COUNTRIES 501

support from the international community. Al-ready at the beginning of 2002, the IMF sent amission to negotiate a medium-term programthat would be supported by a three-yeararrangement under the Poverty ReductionGrowth Facility. However, this fast moving ap-proach was not matched by progress on othereconomic, political and institutional fronts,thus squandering an opportunity to translatedebt relief into peace building and sustainabledevelopment.

Debt reconciliation between the DRC andthe international community began in 2001during several joint IDA–IMF missions basedon late 2000 debt statistics. Furthermore, ameeting of donors took place in Paris inDecember 2001 with the participation of a Con-golese delegation. After the end of the war, ittook one year to reach an agreement concern-ing the clearance of arrears. By end of 2003,the loan-by-loan debt reconciliation processwas completed with all of the DRC’s multilat-eral creditors except the BDEGL. Given thatthe war had only ended in 2000, this was aremarkably fast process, which had been madepossible also due to the good personal relation-ships of the national and international negotia-tors. Overall, about 83% of the net presentvalue of the DRC’s total stock of external debtoutstanding at the end of 2002 was reconciledby August 2003, when the HIPC decision pointdocument for the DRC was finalized (Table 4).

However, the DRC exhibited ongoing weak-nesses on the institutional side of debt manage-ment in this period. The IMF Country Report03/267 found that the principal agency chargedwith handling debt issues still did not have thetechnical and financial means to fulfill its man-date as of August 2003. The DRC lacked aclear process for the formulation of debt poli-cies and debt statistics were not published.

The DRC hence represents a case where theresource curse could not be converted into a re-source blessing. On the one hand, post-warcredibility was built fairly quickly. On the otherhand, the opportunities offered by this progresswere subsequently not fully exploited. This mir-rors the concerns expressed in the literature(Addison & Murshed, 2003) that the willing-ness of a country and the donors to implementdebt relief is only a necessary but not a suffi-cient condition for converting debt relief intodevelopment, with strong state institutionsbeing one of the other necessary ingredientsfor success. This is a general lesson relevantfor all indebted and conflict-affected countries.

5. CONCLUSIONS AND POLICYIMPLICATIONS

We analyze the role of and the institutions forexternal debt in post-conflict developing coun-tries. We show that external debt in post-conflictcountries exhibits different patterns and is moresubstantial than for non-conflict economies.There are other significant differences betweenconflict and non-conflict developing countries,such as the increased levels of uncertainty inthe post-war period, the weaker economic insti-tutions in war-affected countries, the higherfinancial needs for reconstruction, the higherdependence on foreign aid, and the normativeissue of odious debt. Furthermore, conflictcountries as a group exhibit worse debt sustain-ability indicators than non-conflict countries. Inlight of these substantial differences it is surpris-ing that we find that existing debt relief strategiesby private, bilateral, and multilateral lendersmostly do not take account of this special statusof post-conflict economies. Furthermore, ourcase study evidence indicates that the nature ofthe conflict, which is crucial in shaping peaceand growth prospects, had no impact on the nat-ure of post-war debt policies.

One message following from our analysis isthat clearing arrears with multilateral donors inthe post-conflict period is key to normalizingrelations with donors. However, this process isvery fragile and requires strong political commit-ment by both sides. The donors need to provideforesight and trust while the borrowers need torebuild their exceptionally low institutionalquality. Otherwise, even successful debt reconcil-iation may not yield successful post-conflictdevelopment, as was demonstrated for the caseof DRC. Thus pro-poor-growth political institu-tions are even more important in heavily-in-debted, conflict-affected economies.

Debt relief and grant flows did not behave assubstitutes in Mozambique, Uganda, and theDRC. Countries that received more debt reliefalso received more aid; Mozambique beingthe front runner. The HIPC debt relief for bothMozambique and Uganda appears to havebeen additional to aid. However, part of thisstory may be related to some countries in someyears benefiting from their ‘‘moment in thesun.’’ That is, some countries may benefit fromspecial, temporary circumstances of either a po-sitive (an election) or a negative nature (a natu-ral disaster), which forces the donors to grantabove average debt relief and/or aid disburse-ments.

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Debt for post-conflict economies has becomemultilateralized in recent years. Yet the HIPCinitiative was not designed to benefit post-con-flict economies quickly once their fightingended. Given that the wars in Mozambiqueand Uganda had ended before the HIPC initia-tive took effect, both countries could not benefitfrom the debt relief as quickly as the DRCcould some five years later. In the cases ofMozambique and Uganda, it is not clear whythe enhanced HIPC initiative required anotherperiod of track record of the recipient countriesgiven that each had completed a track recordboth before and after the first decision pointin the late 1990s. If these two successful devel-oping economies are required to fulfill thesestringent requirements, then it is clear thatmore vulnerable post-conflict economies willfind it even more difficult to comply with HIPCconditionality.

Furthermore, it is important to make cautiousassumptions concerning the suitable level andthe choice of debt sustainability indicators. Gi-ven the possible interdependency of peace andprosperity, taking a broader view on financingreconstruction is strongly advisable. We recom-mend for donors to consider granting debt reliefeven before the fighting ends, thus acceleratingthe effective relief. This will require new politicalcommitments to advance planning in debt reliefby donors to an extent that does not currentlyexist. Post-conflict countries should therefore re-ceive special treatment under the HIPC initia-tive, with faster and deeper debt relief linked tobroader policy conditionality. Specifically, sus-tainability criteria should be defined both quan-titatively and qualitatively (including issues ofpeace sustainability), conditions could be for-ward looking instead of being backward looking(again including peace conditionality), and the

track record could be shortened or abolisheddepending on individual circumstances andmay even start during a war. In short, we findthat war-affected HIPCs currently are not welltreated by the HIPC initiative as it does not ac-count properly of their special needs and circum-stances.

There is an imperfect regulatory frameworkin place at the moment at the global level con-cerning the adjudication of the so-called odiousdebt, which admittedly is a normative issue. Inthe contexts of recent high-profile regimechanges, such as the post-conflict economiesof Afghanistan and Iraq, the focus of the debtsustainability analysis has increasingly shiftedfrom the responsibilities of the borrowers to-ward the responsibilities of the lenders forensuring that debt is used sustainably. Wetherefore propose to establish the policy instru-ment of ‘‘debt sanctions’’ to strengthen the exante regulatory framework for debt relief. Aninternational institution such as the United Na-tions should be given the mandate to declare aregime odious and thus withdraw from futurelenders the right to enforce debt repaymentson debts contracted after that day. Institution-alizing such form of political rating on govern-ments would signal to investors that lendingunsustainably carries a high risk of genuine de-fault and would prevent war-mongering, clep-tocratic, or oppressive regimes from financingtheir activities with new loans. Arguably, theinternational donor community is not yet wellprepared for such forms of conditionality andthe types of comprehensive policies and moni-toring it would require. However, from thepoint of view of poverty alleviation, growth,and peace in developing countries, such policymerits a lot of attention.

NOTE

1. This dataset classifies conflicts into three groups:Minor-armed conflicts: at least 25 battle-related deaths ina year and fewer than 1000 battle-related deaths duringthe course of the conflict. Intermediate-armed conflict: atleast 25 but fewer than 1000 battle-related deaths in a

year and an accumulated total of more than 1000 deaths.War: at least 1000 battle-related deaths in a year(Gleditsch, Wallensteen, Eriksson, Sollenberg, & Strand,2002). In the following, we will always refer to the war

definition and will use conflict and war as synonyms.

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