Theoretical

Theoretical

and

and

Em

pirical

Em

pirical

Foundations

Foundations

of

of

H

IPC

H

IPC

D

ebt

D

ebt

Sustainability

Sustainability

Targets

Targets

Peter Hjertholm

Peter Hjertholm

Central to HIPC is the concept of debt sustainability

Central to HIPC is the concept of debt sustainability

Two perspectives of sustainability:

Two perspectives of sustainability:

1.

1. Development impact

Development impact

, i.e. analysis of the extent to which debt

, i.e. analysis of the extent to which debt

hampers income growth and poverty reduction

hampers income growth and poverty reduction

2.

2. Debt service capacity

Debt service capacity

, i.e. the search for factors that

, i.e. the search for factors that

determine repayment capacity. Also search for level of debt at

determine repayment capacity. Also search for level of debt at

which debt service problems may be expected

which debt service problems may be expected

How are these perspectives integrated into debt sustainability

How are these perspectives integrated into debt sustainability

targets (currently 150 per cent for the NPV

targets (currently 150 per cent for the NPV

debt

debt

-

-

to

to

-

-

export

export

ratio).

ratio).

Sustainability

Sustainability

Development

Development

impact

impact

Two important channels for adverse impact of debt:

Two important channels for adverse impact of debt:

Debt overhang effects

Debt overhang effects

Cash

Cash

-

-

flow effects

flow effects

Sustainability

Sustainability

:

: development

development

impact

impact

Debt overhang effects

Debt overhang effects

Possibility of adverse disincentive effects:

Possibility of adverse disincentive effects:

High debt

High debt

stocks

stocks

may increase fear of higher future taxation and/or

may increase fear of higher future taxation and/or

macro instability, thereby increasing uncertainty, which in turn

macro instability, thereby increasing uncertainty, which in turn

reduce the

reduce the

incentive

incentive

for private investment, with implications for

for private investment, with implications for

growth

growth

Empirical evidence inconclusive on ‘debt

Empirical evidence inconclusive on ‘debt

-

-

tax channel’ (narrow

tax channel’ (narrow

version), but

version), but

supportive of the ‘debt

supportive of the ‘debt

-

-

macro instability channel’ (extended version),

macro instability channel’ (extended version),

though only shown so far for SSA sample.

though only shown so far for SSA sample.

Sustainability

Sustainability

:

: development

development

impact

impact

Cash

Cash

-

-

flow effects

flow effects

Possibility of cash

Possibility of cash

-

-

flow effects (crowding out):

flow effects (crowding out):

Annual debt service

Annual debt service

payments

payments

squeeze public expenditures,

squeeze public expenditures,

whereby the

whereby the

complementarity

complementarity

effects of public spending on

effects of public spending on

private investment may be reduced, with implications for growth

private investment may be reduced, with implications for growth

and also reducing government resources for direct poverty

and also reducing government resources for direct poverty

reduction programmes.

reduction programmes.

Empirical evidence on cash

Empirical evidence on cash

-

-

flow squeeze fairly unanimous.

flow squeeze fairly unanimous.

Sustainability

Sustainability

:

: development

development

impact

impact

Ideally, analysis of sustainability and assessment of debt reli

Ideally, analysis of sustainability and assessment of debt reli

ef

ef

should integrate information about the extent to which debt

should integrate information about the extent to which debt

burdens affect growth and poverty reduction

burdens affect growth and poverty reduction

Traditionally, this is not the way sustainability analysis has

Traditionally, this is not the way sustainability analysis has

been

been

done

done

Rather, it has relied on a more narrowly defined concept of

Rather, it has relied on a more narrowly defined concept of

‘debt service capacity’

‘debt service capacity’

Sustainability

Sustainability

Debt service capacity

Debt service capacity

Original concern generating this type of analysis was the

Original concern generating this type of analysis was the

increase in debt problems in the 1970s and 1980s, and the

increase in debt problems in the 1970s and 1980s, and the

discussion about whether debtor countries were temporarily

discussion about whether debtor countries were temporarily

liquidity constrained or insolvent

liquidity constrained or insolvent

If insolvent, it became important to identify the economic (and

If insolvent, it became important to identify the economic (and

political) factors determining solvency, in order to reform

political) factors determining solvency, in order to reform

policies, borrowing decisions and debt management

policies, borrowing decisions and debt management

During the 1970s to mid

During the 1970s to mid

-

-

1990s, the debt strategy involved

1990s, the debt strategy involved

policy reforms to bring debtor countries on a solvent path,

policy reforms to bring debtor countries on a solvent path,

together with occasional relief of immediate problem debt.

together with occasional relief of immediate problem debt.

Sustainability

Sustainability

:

: debt

debt

service

service

capacity

capacity

The debt strategy was significantly informed by the following

The debt strategy was significantly informed by the following

three strands of literature:

three strands of literature:

Growth

Growth

-

-

with

with

-

-

debt literature

debt literature

Debt dynamics literature

Debt dynamics literature

Fiscal dimension literature

Fiscal dimension literature

Sustainability

Sustainability

:

: debt

debt

service

service

capacity

capacity

Growth

Growth

-

-

cum

cum

-

-

debt literature

debt literature

Analytical focus on the relationship between the rate of growth

Analytical focus on the relationship between the rate of growth

in income and the interest cost of foreign debt, measured by the

in income and the interest cost of foreign debt, measured by the

rate of interest

rate of interest

Debt burden may be untenable due to insufficient income

Debt burden may be untenable due to insufficient income

growth (i.e. g<r)

growth (i.e. g<r)

If externally borrowed funds do not lead to continuously

If externally borrowed funds do not lead to continuously

higher income growth, from which a part can annually be

higher income growth, from which a part can annually be

transferred abroad, then the debt regime is not sustainable.

transferred abroad, then the debt regime is not sustainable.

Sustainability

Sustainability

:

: debt

debt

service

service

capacity

capacity

Debt dynamics literature

Debt dynamics literature

Notion based on the requirement that borrowing hard

Notion based on the requirement that borrowing hard

currency abroad necessitates repayment in hard currency

currency abroad necessitates repayment in hard currency

(brought about through exports)

(brought about through exports)

Analytical focus on the relationship between the rate of growth

Analytical focus on the relationship between the rate of growth

of exports and the interest cost of foreign debt, measured by th

of exports and the interest cost of foreign debt, measured by th

e

e

rate of interest

rate of interest

Debt burden may be untenable due to insufficient export

Debt burden may be untenable due to insufficient export

growth (i.e. x<r)

growth (i.e. x<r)

If borrowed funds do not lead to continuous expansion of the

If borrowed funds do not lead to continuous expansion of the

export sector, from which a part can annually be transferred

export sector, from which a part can annually be transferred

abroad, then the debt regime is not sustainable.

abroad, then the debt regime is not sustainable.

Sustainability

Sustainability

:

: debt

debt

service

service

capacity

capacity

Fiscal dimension literature

Fiscal dimension literature

The bulk of developing country debt is a public sector liabilit

The bulk of developing country debt is a public sector liabilit

y

y

Analytical focus on the relationship between

Analytical focus on the relationship between

gov

gov

. revenue and

. revenue and

the interest cost of foreign (public) debt, measured by the rate

the interest cost of foreign (public) debt, measured by the rate

of

of

interest

interest

Debt burden may be untenable due to insufficient

Debt burden may be untenable due to insufficient

gov

gov

. revenue

. revenue

(i.e., t<r)

(i.e., t<r)

If borrowed funds do not lead to increased

If borrowed funds do not lead to increased

gov

gov

. revenue, from

. revenue, from

which a part can annually be transferred abroad, then the debt

which a part can annually be transferred abroad, then the debt

regime is not sustainable

regime is not sustainable

Limitations

Limitations

on revenue through higher taxes due to their

on revenue through higher taxes due to their

contractionary

contractionary

and

and

distortionary

distortionary

effects. Higher revenue should

effects. Higher revenue should

come through income growth and expanded tax base

come through income growth and expanded tax base

Sustainability

Sustainability

:

: debt

debt

service

service

capacity

capacity

These three analytical frameworks provide important insights

These three analytical frameworks provide important insights

about the long

about the long

-

-

term sustainability of particular debt situations

term sustainability of particular debt situations

They help explain the origins and causes of the debt crisis, an

They help explain the origins and causes of the debt crisis, an

d

d

they can inform future borrowing policies.

they can inform future borrowing policies.

Sustainability

Sustainability

:

: debt

debt

service

service

capacity

capacity

In terms of assessing the specific debt relief requirements of,

In terms of assessing the specific debt relief requirements of,

say, the

say, the

HIPCs

HIPCs

, these analytical models are less operational

, these analytical models are less operational

The three models show how key economic variables should

The three models show how key economic variables should

evolve together over time in order to avoid undermining long

evolve together over time in order to avoid undermining long

-

-

term solvency

term solvency

–

–

but they do not tell us the

but they do not tell us the

appropriate level

appropriate level

of

of

the debt stock in any given country, and by implication whether

the debt stock in any given country, and by implication whether

(and how much) debt relief is needed

(and how much) debt relief is needed

Sustainability

Sustainability

:

: debt

debt

service

service

capacity

capacity

So debt analysts went about issue

So debt analysts went about issue

‘

‘

indirectly

indirectly

’

’

, based on the fact

, based on the fact

that debt problems are more easily judged when there are

that debt problems are more easily judged when there are

tangible problems with debt service (for instance, payment

tangible problems with debt service (for instance, payment

arrears, debt

arrears, debt

reschedulings

reschedulings

or IMF stand

or IMF stand

-

-

by

by

-

-

arrangements)

arrangements)

To assess this, the economic literature has adopted the

To assess this, the economic literature has adopted the

‘

‘

debt

debt

indicator approach

indicator approach

’

’

to sustainability analysis, and u

to sustainability analysis, and u

se is made of

se is made of

various debt indicators and other economic variables to explain

various debt indicators and other economic variables to explain

failure to repay and predict future problems

failure to repay and predict future problems

Sustainability

Sustainability

:

: debt

debt

service

service

capacity

capacity

Debt indicator approach

Debt indicator approach

Since insolvency is typically first manifested by accumulation

Since insolvency is typically first manifested by accumulation

of payment arrears (on interest or principal), and then by debt

of payment arrears (on interest or principal), and then by debt

reschedulings

reschedulings

, analysts have examined data on debt service

, analysts have examined data on debt service

problems and debt burden indicators (e.g. the debt

problems and debt burden indicators (e.g. the debt

-

-

to

to

-

-

export

export

ratio)

ratio)

Thus, this literature searches for the level of debt at which

Thus, this literature searches for the level of debt at which

countries

countries

switch

switch

from performing to non

from performing to non

-

-

performing debtors in

performing debtors in

debt service terms

debt service terms

Sustainability

Sustainability

:

: debt

debt

service

service

capacity

capacity

:

:

debt

debt

indicator

indicator

approach

approach

This approach is the basis for WDT/GDF classification (into

This approach is the basis for WDT/GDF classification (into

SILICs

SILICs

,

,

MILICs

MILICs

etc.) since 1989

etc.) since 1989

Four indicators (later only two) were here used, of which three

Four indicators (later only two) were here used, of which three

had to be above critical values, to classify countries (see pape

had to be above critical values, to classify countries (see pape

r for

r for

details)

details)

This approach also resulted in an empirical literature on debt

This approach also resulted in an empirical literature on debt

sustainability threshold, notably Underwood (1990) and Cohen

sustainability threshold, notably Underwood (1990) and Cohen

(1998/1995), which feed directly into the HIPC mechanism (i.e.

(1998/1995), which feed directly into the HIPC mechanism (i.e.

the targets)

the targets)

Sustainability

Sustainability

:

: debt

debt

service

service

capacity

capacity

:

:

debt

debt

indicator

indicator

approach

approach

Main result of this literature: debt service problems begin to

Main result of this literature: debt service problems begin to

occur when the NPV debt

occur when the NPV debt

-

-

to

to

-

-

export ratio reaches about 200 per

export ratio reaches about 200 per

cent

cent

This result became the original HIPC benchmark for debt

This result became the original HIPC benchmark for debt

relief, in that the debt sustainability target, adopted during 1

relief, in that the debt sustainability target, adopted during 1

996

996

-

-

1999, was set at 200

1999, was set at 200

-

-

250% for the NPV debt

250% for the NPV debt

-

-

to

to

-

-

export ratio

export ratio

Due to public pressure, the target was lowered in 1999 to a

Due to public pressure, the target was lowered in 1999 to a

single threshold of 150% for the NPV debt

single threshold of 150% for the NPV debt

-

-

to

to

-

-

export ratio

export ratio

Sustainability

Sustainability

Problems with HIPC sustainability targets

Problems with HIPC sustainability targets

Problem 1

Problem 1

Specific amount of debt relief calculated on the basis of debt

Specific amount of debt relief calculated on the basis of debt

capacity considerations only, with development prospects being

capacity considerations only, with development prospects being

subsequently dealt with in the

subsequently dealt with in the

Debt Sustainability Analysis

Debt Sustainability Analysis

(DSA)

(DSA)

documents of each country

documents of each country

Debt relief not influenced by development prospects, but vice

Debt relief not influenced by development prospects, but vice

versa

versa

In this context, growth and export projections are deemed

In this context, growth and export projections are deemed

“

“

murky

murky

”

”

, lacking in realism and consistency

, lacking in realism and consistency

Sustainability

Sustainability

:

: problems with HIPC sustainability targets

problems with HIPC sustainability targets

Problem 2:

Problem 2:

Weak empirical evidence for the original 200

Weak empirical evidence for the original 200

-

-

250% NPV

250% NPV

target, as well as for the current target of 150%

target, as well as for the current target of 150%

The studies cited in official HIPC documents to support the

The studies cited in official HIPC documents to support the

targets are fraught with problems related to methodology and

targets are fraught with problems related to methodology and

data use (see paper for details)

data use (see paper for details)

Concern with unqualified adoption by the HIPC designers of

Concern with unqualified adoption by the HIPC designers of

weak and

weak and

‘

‘

rule

rule

-

-

of

of

-

-

thumb

thumb

’

’

evidence to govern resource allocation

evidence to govern resource allocation

to poor indebted countries

to poor indebted countries

Sustainability

Sustainability

:

: p

p

roblems

roblems

with HIPC sustainability targets

with HIPC sustainability targets

Problem 3:

Problem 3:

Adoption of single numerical threshold to separate sustainable

Adoption of single numerical threshold to separate sustainable

from unsustainable cases is tricky

from unsustainable cases is tricky

The average HIPC country may or may not become

The average HIPC country may or may not become

sustainable at the 150% target in a statistical sense

sustainable at the 150% target in a statistical sense

We are not dealing with average debt problems, but country

We are not dealing with average debt problems, but country

-

-

specific debt problems

specific debt problems

Uniform treatment may be politically desired by creditors (and

Uniform treatment may be politically desired by creditors (and

some debtors), but it results in debt relief being allocated

some debtors), but it results in debt relief being allocated

uninformed by country circumstances

uninformed by country circumstances

Sustainability

Sustainability

:

: p

p

roblems

roblems

with HIPC sustainability targets

with HIPC sustainability targets

Solutions (.)

Solutions (.)

An efficiency problem looms in the background here, but what

An efficiency problem looms in the background here, but what

are the alternatives.

are the alternatives.

Country

Country

-

-

specific targets. Alas, even though more efficient,

specific targets. Alas, even though more efficient,

“

“

we

we

do not live in an ideal world,

do not live in an ideal world,

”

”

to quote from an e

to quote from an e

-

-

mail from a

mail from a

World Bank staffer (2000)

World Bank staffer (2000)

Perhaps multiple targets, identified on the basis of a

Perhaps multiple targets, identified on the basis of a

classification of HIPC countries on some agreed criteria.

classification of HIPC countries on some agreed criteria.

Alas, it would properly involve a prolonged discussion (fight)

Alas, it would properly involve a prolonged discussion (fight)

over the appropriate criteria and their quantification, as well

over the appropriate criteria and their quantification, as well

as

as

being politically too sensitive

being politically too sensitive

Sustainability

Sustainability

:

: p

p

roblems

roblems

with HIPC sustainability targets:

with HIPC sustainability targets:

solutions (.)

solutions (.)

If single targets are politically expedient, but economically

If single targets are politically expedient, but economically

flawed, and country

flawed, and country

-

-

specific (or multiple) target are economically

specific (or multiple) target are economically

efficient, but politically impossible, why then not abandon thes

efficient, but politically impossible, why then not abandon thes

e

e

targets altogether.

targets altogether.

A central recommendation in the recent evaluation report of

A central recommendation in the recent evaluation report of

the HIPC initiative by the

the HIPC initiative by the

Operations Evaluation Department

Operations Evaluation Department

of the

of the

World Bank, is to make DSA projections of income and export

World Bank, is to make DSA projections of income and export

growth more transparent and, above all, consistent with the

growth more transparent and, above all, consistent with the

overall financial resource envelope of HIPC countries

overall financial resource envelope of HIPC countries

Sustainability

Sustainability

:

: p

p

roblems

roblems

with HIPC sustainability targets:

with HIPC sustainability targets:

solutions (.)

solutions (.)

If this is done, then the need to calculate debt relief in a

If this is done, then the need to calculate debt relief in a

separate analytical building block anchored around sustainabilit

separate analytical building block anchored around sustainabilit

y

y

targets is no longer there

targets is no longer there

Instead, for any specified (desired) growth rate and poverty

Instead, for any specified (desired) growth rate and poverty

reduction programme, the overall resource requirements will be

reduction programme, the overall resource requirements will be

spelt out within an integrated analytical framework, from which

spelt out within an integrated analytical framework, from which

ODA and debt relief needs can be identified and measured

ODA and debt relief needs can be identified and measured

against creditor/donor commitments

against creditor/donor commitments

H

ere

H

ere

endeth

endeth

the

the

lesson

lesson

!

!

Questions

Questions

.

.

Further reading

Further reading

*

* Birdsall

Birdsall

, N. and Williamson, J. (with B.

, N. and Williamson, J. (with B.

Deese

Deese

)

)

(2002)

(2002)

Delivering on Debt Relief: From

Delivering on Debt Relief: From

IMF Gold to a New Aid Architecture

IMF Gold to a New Aid Architecture

. Washington, D.C.:

. Washington, D.C.:

Center

Center

for Global Development

for Global Development

and Institute for International Economics

and Institute for International Economics

*

* Claessens

Claessens

, S.,

, S.,

Detragiache

Detragiache

, E.,

, E.,

Kanbur

Kanbur

, R. and

, R. and

Wickham

Wickham

, P.

, P.

(1997) ‘

(1997) ‘

HIPCs

HIPCs

’ Debt

’ Debt

Review of the Issues’,

Review of the Issues’,

Journal of African Economies

Journal of African Economies

6(2): 231

6(2): 231

-

-

54

54

*

* Cohen, D.

Cohen, D.

(2001) ‘The HIPC Initiative: True and False Promises’,

(2001) ‘The HIPC Initiative: True and False Promises’,

International Finance

International Finance

4(3): 363

4(3): 363

-

-

80

80

*

* GAO

GAO

(2000)

(2000)

Developing Countries: Debt Relief Initiative for Poor Countries

Developing Countries: Debt Relief Initiative for Poor Countries

Face

Face

Challenges

Challenges

. Washington, D.C.: US General Accounting Office

. Washington, D.C.: US General Accounting Office

*

* GAO

GAO

(1998)

(1998)

Developing Countries: Status of the Heavily Indebted Poor Countr

Developing Countries: Status of the Heavily Indebted Poor Countr

ies

ies

Initiative

Initiative

. Washington, D.C.: US General Accounting Office

. Washington, D.C.: US General Accounting Office

*

* Gautam

Gautam

, M.

, M.

(2003)

(2003)

Debt Relief for the Poorest: An OED Review of the HIPC Initiativ

Debt Relief for the Poorest: An OED Review of the HIPC Initiativ

e

e

.

.

Operations Evaluation Department. Washington, D.C.: World Bank

Operations Evaluation Department. Washington, D.C.: World Bank

*

* Gunter, B.G.

Gunter, B.G.

(2001)

(2001)

Does the HIPC Initiative Achieve its Goal of Debt Sustainability

Does the HIPC Initiative Achieve its Goal of Debt Sustainability

.

.

,

,

WIDER Discussion Paper 2001/100. Helsinki: World Institute for D

WIDER Discussion Paper 2001/100. Helsinki: World Institute for D

evelopment

evelopment

Economics Research

Economics Research

*

* Gunter, B.G.

Gunter, B.G.

(2002) ‘What’s Wrong with the HIPC Initiative and What’s Next.’

(2002) ‘What’s Wrong with the HIPC Initiative and What’s Next.’

,

,

Development Policy Review

Development Policy Review

20(1): 5

20(1): 5

-

-

25.

25.

See also:

See also:

www.worldbank/hipc

www.worldbank/hipc

www.imf.org/external/np/exr/facts/hipc.htm

www.imf.org/external/np/exr/facts/hipc.htm