UN Second Committee, 10 October 2008

Debt Restructuring in Low-Income Countries: problems and possible solutions

Dr Geske DijkstraErasmus University Rotterdam

Why such a long debt crisisin low-income countries?

• Persistent country characteristics (bad policies) → low growth and high debts → debt relief → bad policiesMoral hazard with debtors (Easterly)

• High debt and low growth → debt relief → more loans (moral hazard with creditors) and, through conditions, bad policies → lower growth

Overview

• Debt restructuring in 1980s and 1990s, and problems

• 1999 HIPC initiative and 2006 MDRI did not resolve these problems

• New problems in recent years with DSF, vulture funds

• Possible solutions

Creditor responses to debt problems in 1980s & 1990s

• Private creditors: no new loans, writing-off• Official creditors, bilateral and multilateral:

– Maintained fiction of lack of liquidity, not solvency

→ Combined rescheduling with new loans and grants

– IMF agreement always condition for rescheduling

Bilateral creditors: Paris Club

• Rescheduling of debt service, with increasing percentages of forgiveness during the 1990s

• But only on debt service due during period of IMF agreementUsually ESAF, 3 years

• No stock cancelations

Effects of debt relief,Evaluation in eight countries

Limited effects on stocks and flows

Causes:

• Debt relief too limited

• Wrong modalities: mostly on flows, not on stocks

• Too many new loans, mainly from multilateral development banks

-4

-2

0

2

4

6

8

10

12

14

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

Bilateral plus grants

Bilateral

Multilateral

Private

Net transfers on debt, Sub-Sahara Africa, in US$ billion

Moral hazard

Multilaterals were preferred creditors, so were bailed out by bilaterals

→Inefficient use of aid money of bilaterals

→Moral hazard with IFIs, so more new loans

→Perpetuation of debt unsustainability

IMF agreement as condition

• IMF three roles: gatekeeper, creditor and arbitrage: financing gap→Always new agreement in countries with high multilteral debt→ More new multi-loans → No selectivity, adverse selection→ Weakened position of debtor, dragging on of debt problems

• Uncertainty for debtors• Conditions not always appropriate

Changes with HIPC, 1999

• More debt relief, more cancellation instead of rescheduling

• But:– Not enough for debt sustainability

Financing by bilaterals→ Moral hazard continued

– Conditionality became more extensive than ever

→ Uncertainty and adverse selection continued

22 HIPCs: Average share of multilateral loans in total new loans

0

20

40

60

80

100

120

Ben Bol BF Cam Gam Gui GB Guy Hon Mad Mw i Mal Mau Moz Nic Nig Rw a STP Sen Tan Uga Zam

90-99 00-06

Multilateral Debt Relief Initiative(MDRI) 2006

• Debts reduced for HIPC graduates• But: same conditionality → uncertainty

continues for other potential HIPCs• Debt sustainability?

– Not all creditors included, vulture funds & litigation: free riding on international agreements

– Domestic debts– New foreign loans, so ...

Debt Sustainability Framework(DSF)

• Criteria: size of debt, plus policies, measured by CPIA

• Consequences:– Lower expected sustainability → more IDA

grants → new adverse selection– Additional conditionality on new borrowing:

sanctions

Conclusions: (persistent) problems

• World Bank (IDA) loans: still moral hazard, perpetuate debt problems

• IMF conditionality continues– Some countries still no access to HIPC– Leverage IMF increased: budget support

• New problem: Free riding by vulture funds

Problems and solutions

• Moral hazard WB• IMF Conditionality:

– Conflicting roles– Problem of contents of

conditions: IMF represents donors and creditors, lack of accountability

• Vulture funds

• IDA grants, not loans• IMF:

– Gatekeeper only: PSI– Proposed: International

arbitrage, no funds (Bolton & Skeel)

• Better:– More limited role IMF in

poorest countries – Independent arbitrage

• Changes in legislation creditor countries