debt cancellation

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					                  debt cancellation

The Challenge                                                                                          QUICK FACTS
Developing countries spent years repaying billions of dollars in loans, many of which had              $93 billion of debt
been accumulated during the Cold War under corrupt regimes. Years later, these debts
became a serious impediment to poverty reduction and economic development in many                      has been canceled in sub-Saharan
poor countries. Governments began taking on new loans to repay old ones and many coun-                 African countries since 1996.
tries ended up spending more each year to service debt payments than they did on health
and education combined. Wealthy countries and international financial institutions have                Lesotho paid $47 million
taken action to relieve debt burdens in many of the most impoverished countries, but debt
                                                                                                       to its creditors in 2006, an amount
burdens remain an issue for two main reasons:
                                                                                                       equivalent to two-thirds of the
First, not all poor countries were able to benefit from the first two rounds of debt cancella-         development assistance it receives
tion. Some countries, for example, were excluded from the original HIPC deal because they              each year.
had done a relatively good job in managing their debts. Today, these countries still spend
a significant portion of their resources servicing debt. In 2006, for example, Lesotho paid            3.1 million more
$47 million to its creditors, an amount equivalent to two-thirds of its annual development
assistance inflows.
                                                                                                       Tanzanian children
                                                                                                      enrolled in school after the government
A second, emerging challenge is that a significant number of countries which benefited from           used its savings from debt relief to
the first rounds of debt cancellation are now accumulating new debts. The World Bank and              eliminate school fees in 2001.
IMF estimate that more than half of the countries that were included in HIPC and MDRI are
now under high or moderate risk to reincur unsustainable debt levels. One reason for this is
that many countries are facing shortfalls of promised development assistance. Additionally, an increasing percentage of the aid is being given
as loans now instead of grants. Compounding these shortfalls of aid has been the economic stress on developing countries as a result of the
financial crisis and growing costs for essential imports like fuel and fertilizers. More countries have been forced to take out new loans and
often reach out to new donors like China, who tend to offer loans with less favorable interest rates. Combined, these trends are increasing
the likelihood that the number of countries reincurring unsustainable debt levels will increase.

The Opportunity
Beginning in 1996, industrialized countries sought to cancel many poor countries’ debt through two vehicles: the Highly Indebted Poor Coun-
try (HIPC) Initiative and the Multilateral Debt Relief Initiative (MDRI). Combined, these two initiatives have cancelled nearly $110 billion worth
of debt, $93 billion of which was in African countries. In exchange for this debt relief, qualifying countries agreed to channel their debt savings
to poverty reduction activities. As a result, poverty reducing spending by HIPC-countries has increased by the same amount by which their
debt service decreased. For example, many African governments used debt savings to help abolish primary school fees, Mozambique used
its debt service savings to vaccinate children against tetanus, whooping cough and diphtheria, as well as to install electricity in schools and
to build new ones, while Cameroon used its debt savings to launch a national HIV/AIDS plan for education, testing and prevention, including
of mother-to-child transmission.

To build on these successes, donors need to take three steps. Firstly, the success can be replicated in other countries. Donors should explore
extending debt cancellation to certain other poor countries that spend a significant portion of domestic resources servicing debt, but were
excluded from debt relief because their debt levels did not meet the HIPC threshold (as was the case in Kenya and Lesotho).

Secondly, the successes can be preserved by delivering development financing increasingly in the form of grants rather than loans so that
accessing finance in order to reach the Millennium Development goals is not tantamount to reaccumulating unsustainable debt. Loans for
development should be given on highly concessional forms.

Thirdly, the international community should establish a sovereign debt workout mechanism. If despite all efforts some countries fall back into
unbearable debt burdens, it is essential to avoid debt rescheduling dragging on for decades. A sovereign debt workout mechanism would
provide an arbitration panel structure similar to the WTO, where cases of state insolvency could be worked out in a fair transparent and
orderly manner.

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