Confronting the Multilateral Debt Burden

Key Points

  • Multilateral debt increased as a proportion of total debt during the 1980s, adding a new dimension to the debt crisis in the 1990s.
  • Multilateral debt is contributing to the economic and social crises of the world’s poorest nations.
  • One-quarter of total bilateral aid is diverted to service multilateral debt.

Multilateral debt, the result of lending by the International Financial Institutions (IFIs), is contributing to the economic and social crisis that is overtaking many Low Income Countries (LICs). Loans by the International Monetary Fund (IMF), the World Bank, and regional multilateral development banks (MDBs) have burdened nations with increasing debt payments.

Established more than fifty years ago to reconstruct Europe after WWII and to stabilize the global monetary system, the IFIs have since become dominant players in the global economy. The strict structural adjustment programs of the IFIs and their insistence that servicing debt is more important than satisfying basic needs are among the main causes of the development crisis besetting poor nations.

When the unsustainability of LIC indebtedness first gained international attention in the early 1980s, multilateral debt was relatively small. Between 1980 and 1995, however, LIC multilateral debt surged 400 percent to more than $300 billion. In 1995 multilateral debt constituted 22 percent of total LIC debt.

The multilateral debt problem is most pronounced among the heavily indebted poor countries (HIPCs), also known as severely indebted low income countries (SILICs). Most of the HIPCs are in sub-Saharan Africa, where multilateral debt constitutes 28% of total external debt and accounts for 50 percent of total debt-servicing costs. Each year these impoverished nations have to make debt payments of $3 billion more than what comes into the area in new multilateral loans.

Because of the MDBs’ preferred credit status, their debt-payment schedules must be honored before those of other creditors. Oxfam-UK estimates that nearly one-quarter of total bilateral aid (government aid to individual countries) is diverted annually to service multilateral debt. This recycling of aid to pay debts also occurs within the World Bank: An estimated $2 of every $3 in aid from its concessional facility, the International Development Association (IDA), bounces back to the World Bank in the form of debt payments.

Until recently most attention to the debt crisis focused on commercial debt-the unpaid loans from private banks. In the 1970s there was a surge in indiscriminate lending to the LICs by foreign banks, flush with profits from higher oil prices. By the end of the decade, rising U.S. interest rates and the advent of a global recession meant that many indebted LIC nations were unable to meet the rising cost of servicing their debt-and the debt crisis began.

The U.S. recognized that unsustainably high levels of privately issued foreign debt threatened the integrity of the international financial system. Immediately following Mexico’s 1982 suspension of debt payments, the U.S. acted to inject more liquidity into the South by increasing bilateral and multilateral flows to indebted nations. These new funds were tied to structural adjustment programs (SAPs) that required recipient nations to restructure their economies along neoliberal principles. Debt restructuring plans, such as the Baker Plan (1985) and the Brady Plan (1989), focused primarily on reducing the exposure of commercial banks and stabilizing the international monetary system by rescheduling, restructuring, and converting private debt.

Increased multilateral lending substituted for declining private capital flows, facilitated the partial conversion of overdue private debt to multilateral debt, and helped indebted countries maintain their debt-payment schedules. In 1986 the IMF created the Structural Adjustment Facility as a source of short-term concessional credit for indebted nations, and the World Bank began to condition its loans on the implementation of structural adjustment agreements.

Multilateral debt stock and debt-service obligations began to mount as a proportion of total debt. Commercial debt continued to constitute the largest portion of debt in many middle-income nations, but decreased private capital flows and stagnating exports resulted in a deepening dependence by the HIPCs on multilateral debt. Multilateral lending, while providing short-term debt relief beginning in the late 1970s, has led to a new type of debt crisis in the 1990s.

Problems with Current U.S. Policy

Key Problems

  • The IFIs and creditor nations recognize the need for debt reduction for the world’s most heavily indebted nations.
  • The IMF opposes debt reduction and instead favors using its ESAF to extend concessional loans.
  • The U.S. has not yet used its leadership and influence to redirect the IFIs away from their infatuation with structural adjustment.

The IFIs did adopt a debt-relief strategy at their annual meeting in early October 1996, but it fell far short of what is needed to resolve the debt crisis. Although the new plan may represent a conceptual advance, its details (such as they can be divined from official communiques and reports) reveal that the IFIs are not really committed to “debt relief.” A more accurate label would be “enhanced refinancing.”

The multilateral IFIs have long been insisting that debt relief should be implemented only after bilateral creditors grant higher levels of relief than has so far been available. In their premeeting proposals, the IFIs had recommended that the Paris Club (the consortium of the major creditor-countries dominated by major industrial G-7 nations) increase its most generous terms from the current level of 67% to 90% relief for heavily indebted countries.

Gathering immediately before the IFI meeting, the G-7 finance ministers, however, decided to raise relief levels only up to 80% and only under heavily qualified terms. The 80% level, for example, only applies to debts contracted before a country’s initial application to the Club for debt relief, which means that debts that in some cases have been accumulating for more than ten years since an initial application will not be affected by the new relief terms.

The debt relief figure also does not apply to debt resulting from programs designated as “development assistance.” Given these restrictions, the European Network on Debt and Development calculates that the HIPC plan will actually result in an average effective reduction in total debt of only 16.7%.

Eligibility is measured by “debt sustainability,” which is determined according to the ratio of external debt to the value of a country’s exports. The IFIs are notoriously optimistic in their projections of export earnings, and the 200-250% debt/export ratio often does not include those countries most damaged by multilateral debt burden. Moreover, as a country’s export earnings rise, it can become ineligible for debt reduction. According to NGO critics, the fact that a few months of coffee price increases can endanger the eligibility of such debt-ridden countries as Bolivia and Uganda for relief five years down the road exposes the hollowness of the HIPC initiative and the apparent IFI goal of eliminating as many countries as possible from the list of potential beneficiaries.

In addition, the IFIs insist that debtor nations “demonstrate their commitment to sound economic policy” over a lengthy time frame before receiving relief. Countries hoping to benefit from the HIPC plan will be required to undergo at least three additional years of IFI-directed structural adjustment, regardless of how long they have already been implementing such programs. Those countries that have not, according to the IFIs, completed three years of unblemished adherence to SAPs will be obligated to endure six full years of structural adjustment. The IFIs’ time frame requirements are among the clearest indicators that their staff live in a world of statistics and bureaucratic definitions rather than one in which hunger, deprivation, and death have real meaning.

With the new HIPC plan, the IFIs continue to adhere to their failed conditionality policies. The IMF, which initially was reluctant to join the multilateral debt initiative, put its name to the plan as a way of obtaining perpetual funding for its Enhanced Structural Adjustment Facility (ESAF), the first and harshest hoop of structural adjustment that desperate countries must jump through. The IMF’s logic for calling ESAF lending “debt relief” is that it will lower countries’ annual payments because of slightly more concessional repayment terms, though it will increase the total amount of debt and the length of the debt-payment schedule.

The past failure of structural adjustment programs to create a framework for stable and equitable development raises questions about the wisdom of linking debt relief to such adjustment programs. By using structural adjustment as the centerpiece of debt relief, the IFIs demonstrate their insensitivity to the social, political, and environmental impacts of their policies.

Establishing the ESAF as a permanent facility of the IMF would increase the already immense power of the IMF to shape the development strategies of poor nations. Moreover, although concessional lending would reduce the debts poor countries owe over the long term, that reduction would neither lower the total debt principal nor provide the immediate relief that many nations need.

The U.S. Treasury does support the sale of a portion of the IMF’s gold stocks to help solve the multilateral debt crisis. Yet even if the IMF does indeed sell some of its gold stocks, it will use the resulting funds for enhanced refinancing rather than for direct debt relief.

The U.S. government, as the leading contributor to the IFIs, has a large stake in multilateral debt relief and can exercise decisive influence (see In Focus: The IFIs). With Britain and Canada, it has helped promote the HIPC initiative and has expressed concerns about both the time frame and eligibility requirements for reduction. The Clinton administration has readily supported all official multilateral debt-reduction proposals, knowing that the proposals will be funded by the IFIs, which allows the president to avoid seeking congressional approval.

The U.S. has not yet used its leadership and influence to redirect the IFIs away from their infatuation with structural adjustment and toward more comprehensive debt-relief policies that would create a stronger base for sustainable and equitable development. Instead the U.S. has steadily decreased its own levels of development assistance and increasingly tied the little aid it offers to counterproductive structural adjustment programs.

Toward a New Foreign Policy

Key Recommendations

  • Multilateral debt reduction should be granted immediately to the world’s poorest nations.
  • Debt reduction should be delinked from structural adjustment programs.
  • Funding for the reduction of multilateral debt should come from IFI reserves, IMF gold sales, and World Bank earnings.

Confronted with the accumulation of unpayable multilateral debts by LICs, the industrial nations and IFIs have finally recognized that solutions are needed. The HIPC plan, however, is more a way to manage debt than a step toward serious debt relief. It continues what some NGOs have called the “sado-monetarism” of the IFI approach to development rather than establishing a foundation for sustainable and equitable development in the LICs. The U.S. should embrace the following principles and objectives in its negotiations with IFIs over debt reduction strategies:

Debt relief should be immediately offered to the world’s poorest nations. The current six-year time frame for debt reduction is far too long, and the world’s poorest nations need debt relief now.

More inclusive eligibility requirements for reduction should be offered. According to the debt-sustainability standards currently accepted by the IFIs, only eight to twenty nations would be eligible for debt relief. More inclusive standards would accommodate as many as thirty nations that need immediate and complete debt relief.

A more realistic definition of debt sustainability is needed. When estimating sustainable debt, the IFIs often overestimate the future growth prospects of poor nations and ignore the probability of external price shocks and deteriorating terms of trade, thereby underestimating the future debt burden. The current definition of sustainable debt burdens used by the IFIs should be replaced by a more flexible, case-by-case system of analyzing debt. For many of the poorest nations, there is no such thing as a sustainable debt burden. Even with more prosperous nations, for which sustainability
analysis is more appropriate, a shorter period such as 3-5 years should be used to measure debt sustainability.

Debt relief should not be tied to structural adjustment. Instead the U.S. should encourage the IFIs to condition their loans and debt relief on a nation’s commitment to equitable development patterns, such as decreased military spending and economic policies that ensure basic needs are met.

Multilateral debt relief should come directly from the IFIs. Instead of mining bilateral aid to cover multilateral debt reduction, the World Bank should dig deeply into its own reserves and the IMF should sell a portion of its gold stocks. The sale of just 10-12 percent of the IMF’s 100 million ounces of gold could grant debt relief for all of sub-Saharan Africa. The proceeds of the sale of IMF gold stocks should be used for direct debt relief, not as a means of allowing the IMF to extend the lending capabilities of the ESAF.

Multilateral debt relief should be accompanied by improved IFI lending policies, bilateral debt relief, and increased bilateral assistance. The U.S. should encourage the multilateral banks to revamp their lending programs to ensure that their loans result in equitable and environmentally sustainable development.

Multilateral debt relief is necessary, but it should not be allowed to strengthen the domination of the IFIs over LIC affairs. Debt relief should be just one element in a complete overhaul of the IFI system. The IFIs should be made accountable to all the world’s nations, not just to the G-7 creditors, and they should be transformed from instruments of Northern control into vehicles for development and economic stability in the South.

The U.S. Congress should oppose funding for the ESAF under any conditions, on the grounds that it is not a program that provides effective assistance or relief to impoverished countries. If the IMF wants to say it is providing debt relief, it must be forced to do so in an honest manner.

As a central player in the Northern consortium of private banks, national governments, and international financial institutions, the U.S. must take a large measure of responsibility for the debt crisis and its terrible impact on the LICs. The current debate over the dimensions and direction of multilateral debt relief offers the U.S. an historic opportunity to reshape North-South relations.

Written by Soren Ambrose (50 Years is Enough) and Ian Stewart (IRC)