Tackling global debt issue

The western world has offered $100bn to relieve third world debt. To qualify for western debt relief poor countries must spend six years in one of the International Monetary Fund's (IMF) structural adjustment programmes. These prescribe strict economic reforms.

Between 1970 and 1988 the indebtedness of the developing world soared from around US$20,000 million to over US$100,000 million. Paying back third world debts amounts to an estimated US$16,000 million a year on debts of more than US$1.5 trillion ($1012), or more than two-thirds of the sums granted or being lent to these countries by creditor nations and international agencies. As a result, since 1984 there has been a net transfer of capital from lower-income to upper-income countries so that in cases poor countries finance the development of rich countries. These debts handicap developing countries efforts to control environmental degradation and population growth. Reducing or cancelling debts is widely considered as necessary in order to allow developing countries to support themselves and develop sustainably.

Proposals for solving the debt crisis reflect a range of views about the nature of debt-servicing difficulties and appropriate responses to them. They include ad hoc financing arrangements; case by case debt reschedulings; interest capitalization schemes; formal insurance; stabilization funds; innovative instruments, including equity shares in public enterprises in borrowing countries as swaps with outstanding debt; and comprehensive restructurings, including write-downs or external claims. These proposals all aim to to permit growth of developing countries to be resumed and to restore their creditworthiness while allowing commercial banks to resume "spontaneous" lending. The likely effectiveness of the proposals depends on important considerations of the relationship between and among debtors and creditors:

(1) A distinction needs to be drawn between the individual interests of creditors and their collective interest. For example, if a debtor country is unable to pay full debt service it may be in the collective interest of creditors to defer payment or even to forgive part of the payment rather than provoke a moratorium. On the other hand, it is in the interest of individual creditors to hold out for repayment, in effect by being bought out by other parties. This problem needs to be addressed in any debt reform scheme. A "once-and-for-all" restructuring of developing countries' debt into long-term low-interest loans is included in some proposals, while most maintain that debts should be taken over by a new international agency; questions need to be raised over the availability of additional official capital for this purpose.

(2) Although debtor countries may service their debts by running big trade surpluses, it may be difficult for some countries, at their present levels of development, to keep running trade surpluses sufficiently large to pay all interest, particularly if interest rates rise. To be feasible, a debt reform plan may thus have to to reduce the current interest burden as well as reschedule all principal. Conversion of bank loans into some other long-term asset, particularly long-term bonds, would reschedule the principal, while proposals for reducing the burden of interest payments have included re-lending interest, possibly through an automatic process by capitalizing interest payments. Other suggestions have included replacing fixed claims on a country with shares in the country's foreign exchange earnings or with equity in state-run enterprises.

(3) A permanent solution which settles the problem at a stroke must either reduce the expected burdens on countries to an extent that will avoid the need for a second rescue or make some allowance for future contingencies, such as world recession or higher interest rates. At the same time it must provide banks with the incentive to keep on lending. Measures suggested to deal with future uncertainty range from stabilization funds for fluctuating oil prices and interest rates to setting up a formal insurance scheme to avoid another crisis. Both the distribution of debt burdens and future access to international capital markets depend on which system is chosen.

(4) Since major banks hold claims on developing countries equal to several times their capital, any scheme that implies a large write-down of debt must provide for the continued operation of these banks. This need to maintain bank solvency means that most proposals minimize write-downs as much as possible. Alternative suggestions have included the use of official capital to buy part of developing-country debt.

This strategy features in the framework of Agenda 21 as formulated at UNCED (Rio de Janeiro, 1992), now coordinated by the United Nations Commission on Sustainable Development and implemented through national and local authorities.

The international community recognizes and encourages a more rapid implementation of the progress being made under the strengthened debt strategy in regard to external debt incurred with commercial banks. Some countries have already benefited from the combination of sound adjustment policies and commercial bank debt reduction or equivalent measures.

The World Bank approach combines restructuring of debt service payments with adjustment policies by debtor countries. It covers the collective/individual dilemma by putting pressure on the banks and reduces the interest burden by relending through conventional reschedulings; by keeping the banks involved it minimizes the problem of future uncertainty and maintains the possibility of demanding further loans from existing creditors; and by avoiding write-downs it covers the problem of insolvency. This approach worked better than might have been expected but had to be followed up by multiyear debt restructurings on a case-by-case basis included in overall financial package to support stabilization and adjustment, particularly in sub-Saharan Africa.

In 1993, Paris Club creditors granted debt relief to Costa Rica, Jamaica, and Peru.

In the area of debt, two major developments have taken place in the second half of the decade: the launching of the initiative to deal with the debt of the heavily indebted poor countries (HIPCs) in a comprehensive way; and the mobilization of large-scale rescue packages for middle-income debtor countries in payments crises.