```
                                                                 
Developing Countries: Switching Some Multilateral Loans to Grants
Would Lesson Poor Country Debt Burdens (02-MAY-02, GAO-02-698T). 
                                                                 
Last year, President Bush proposed that the World Bank and other 
development banks replace half of all future loans to the world's
poorest countries with grants. The goal of the proposal was to	 
relieve poor countries' long term debt burdens. The World Bank	 
estimates that the proposal would result in a financial loss of  
$100 billion dollars to it during the next 40 years. GAO found	 
that the proposal would help poor countries reduce their debt	 
burdens and that the World Bank would lose only $15.6 billion,	 
which could be financed through relatively small increases in	 
donor contributions. This testimony is based on an April report. 
(See GAO-02-593.)						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-02-698T					        
    ACCNO:   A03222						        
  TITLE:     Developing Countries: Switching Some Multilateral Loans  
to Grants Would Lesson Poor Country Debt Burdens		 
     DATE:   05/02/2002 
  SUBJECT:   Foreign loans					 
	     International economic relations			 
	     International organizations			 
	     Developing countries				 
	     Debt						 
	     Debt collection					 
	     Federal grants					 
	     Financial institutions				 
	     Economic policies					 
	     Foreign policies					 
	     Heavily Indebted Poor Countries Debt		 
	     Initiative 					 
                                                                 
	     International Monetary Fund			 

******************************************************************
** This file contains an ASCII representation of the text of a  **
** GAO Product.                                                 **
**                                                              **
** No attempt has been made to display graphic images, although **
** figure captions are reproduced.  Tables are included, but    **
** may not resemble those in the printed version.               **
**                                                              **
** Please see the PDF (Portable Document Format) file, when     **
** available, for a complete electronic file of the printed     **
** document's contents.                                         **
**                                                              **
******************************************************************
GAO-02-698T
     
Testimony Before the Subcommittee on International Monetary Policy and
Trade, Committee on Financial Services, House of Representatives

United States General Accounting Office

GAO For Release on Delivery Expected at 10 a. m., EDT Thursday May 2, 2002

DEVELOPING COUNTRIES

Switching Some Multilateral Loans to Grants Would Lessen Poor Country Debt
Burdens

Statement of Joseph A. Christoff, Director International Affairs and Trade

GAO- 02- 698T

Page 1 GAO- 02- 698T

Mr. Chairman and Members of the Subcommittee: I am pleased to be here today
to discuss the impact that switching some loans to grants would have on poor
countries? debt burdens.

In July 2001, President Bush proposed that the World Bank and other
development banks replace 50 percent of future loans to the world?s poorest
countries with grants. A goal of this proposal was to relieve poor
countries? long- term debt burdens. The president?s grants proposal would
mean a significant change for multilateral institutions such as the World
Bank, which traditionally use low- cost loans to deliver development
assistance. The World Bank estimates that this controversial proposal would
result in a financial loss of $100 billion over the next 40 years.

As discussed in our recent report, 1 we found that the proposal to shift
50percent of multilateral institutions? loans to grants (1) would help poor
countries reduce their debt burdens, and (2) would cost the World Bank $15.6
billion, which could be financed through relatively small increases in donor
contributions.

In conducting our work, we used World Bank and International Monetary Fund
(IMF) analyses that included detailed country- specific economic forecasts
and projections of the financial implications of switching from loans to
grants. However, we based our analysis on historical export growth rates for
10 poor countries, 2 in contrast to the highly optimistic rates assumed by
the World Bank and IMF. We also built on prior work that examined World Bank
and IMF 20- year projections on poor countries? debt burdens. The World Bank
and the IMF reviewed and provided detailed comments on this earlier
analysis. However, we were unable to discuss our new findings with World
Bank and IMF officials because the Department of the Treasury did not
approve our access to officials of those institutions. Treasury officials
were concerned that our work would interfere with ongoing negotiations to
refinance the World Bank?s International Development Agency (IDA).

1 See United States General Accounting Office, Developing Countries:
Switching Some Multilateral Loans to Grants Lessens Poor Country Debt
Burdens, GAO- 02- 593 (Washington, D. C.: April 19, 2002).

2 The 10 countries chosen- Benin, Bolivia, Burkina Faso, Ethiopia, Mali,
Mozambique, Nicaragua, Tanzania, Uganda, and Zambia- are geographically
dispersed, represent a wide range of economic conditions, and receive about
two thirds of internationally provided debt relief.

Page 2 GAO- 02- 698T

The Administration?s proposal to replace 50 percent of multilateral loans
with grants would lessen poor countries? debt burdens and increase their
ability to repay future debt. Our analysis found that under the grants
proposal 4 of the 10 countries we analyzed would be debt sustainable 3 for
20 years and 2 other countries would be debt sustainable for most of that
period. Furthermore, the grants proposal is more effective in promoting debt
sustainability than proposals to forgive 100- percent of old multilateral
debt. Any advantage of the 100- percent debt forgiveness proposal is
eliminated after 7 years because poor countries would accumulate new debt
that will become unsustainable.

We estimate that the financial loss of the 50- percent grants proposal is
$15.6 billion. Our estimate differs from the World Bank?s projected loss of
$100 billion over 40 years because we adjusted for the impact of inflation
and the investment income that could accrue over time. We found that the
World Bank could fully finance the grants proposal if donors increase their
contributions by 1. 6 percent a year, which is less than the expected rate
of inflation over the next 40 years.

During the 1970s and 1980s, many low- income countries sharply increased
their external borrowing, mostly from other governments or multilateral
institutions. During this period, the price of primary commodities tended to
be high, contributing to optimistic export growth projections on the part of
developing countries, which encouraged them to overborrow. By the end of
1997, the total external debt of the 42 countries classified as heavily
indebted poor countries had a face value of more than $200 billion. Much of
this debt was not being repaid or was repaid only with the support of
donors. In 1996, the Heavily Indebted Poor Countries (HIPC) initiative was
created to provide debt relief to these poor countries. 4 In 1999, the World
Bank and IMF agreed to enhance the HIPC initiative by doubling the estimated
amount of debt relief to over $28 billion for 32 of

3 The World Bank and International Monetary Fund consider a country to be
?debt

sustainable? if the ratio of a country?s debt (in present value terms) to
the value of its exports is 150 percent or less.

4 Efforts to relieve the debt burdens of poor countries have concentrated on
the external debt of these countries. Thus, debt sustainability is defined
in terms of repaying debt owed to external creditors, with export earnings
considered an important source of revenue for repaying this debt. Summary

Background

Page 3 GAO- 02- 698T

these countries. According to the World Bank and IMF, countries that receive
debt relief under the HIPC initiative are projected to be debt sustainable.
However, we found that the initiative is not likely to help recipients
achieve debt sustainability because the World Bank and IMF assume that these
countries will achieve export growth rates more than double their historical
levels. 5

Two key factors make it difficult for poor countries to achieve the high
export growth rates assumed by the World Bank and IMF. First, most of the 10
countries we analyzed rely on one or two primary agricultural and/ or
mineral commodities for a significant portion of their foreign exchange
earnings. However, the prices of these commodities have been on a downward
trend in recent years, which impairs these countries? ability to increase
their export income. Second, development professionals and multilateral aid
organizations recognize that the HIV/ AIDS pandemic is a major threat to the
growth rates of many poor countries. The governments of these countries will
need to divert funds from economic growth initiatives to cover dramatically
increasing health care costs, rising labor costs, and productivity losses in
key export sectors.

5 See GAO- 02- 593 and United States General Accounting Office, Developing
Countries: Debt Relief Initiative for Poor Countries Faces Challenges, GAO/
NSIAD- 00- 161 (Washington, D. C., June 29, 2000).

Page 4 GAO- 02- 698T

A shift from loans to grants would benefit all countries? ability to repay
their future debt. If grants were to replace 50 percent of loans, the debt-
toexport ratios of all 10 countries we analyzed would improve (see table 1).
Their debt- to- export ratios are projected to decline from an average of
432 percent under the historical baseline to an average of 235 percent under
the 50- percent proposal. Under the historical baseline, only two countries-
Mali and Mozambique- are debt sustainable. Two additional countries- Benin
and Uganda- would become debt sustainable over the 20- year period under the
50- percent grants proposal. In addition, Nicaragua and Tanzania are either
debt sustainable or nearly so for a considerable portion of the 20- year
period under the grants proposal.

Table 1: Projected 20- Year Debt- to- Export Ratios under Three Scenarios
Country Historical baseline

(percent) Impact of 50- percent

grant proposal (percent)

Impact of full forgiveness of old

multilateral debt (percent)

Benin 168 99 142

Bolivia 668 393 649 Burkina- Faso 713 377 648 Ethiopia 572 328 502 Mali 62
42 44

Mozambique 153 78 140

Nicaragua 377 210 358 Tanzania 434 239 429 Uganda 339 125 324 Zambia 837 457
784

Average 432 235 402

Note: Countries projected to be debt sustainable are in bold. That is, their
debt- to- export ratio is near or below 150 percent. Countries that are
nearly debt sustainable are in italics. GAO?s projections of debt
sustainability assume that countries receive debt relief under the HIPC
initiative and grow at historical export growth rates.

Source: GAO analysis.

Shifting Some Multilateral Loans to Grants Would Have a Positive Impact on
Debt Sustainability for Poor Countries

Grants Can Help Some Countries Reach Debt Sustainability

Page 5 GAO- 02- 698T

The 50- percent grants proposal does not help every country become debt
sustainable over the 20- year projection period, however. Based on our
analysis, Bolivia, Burkina Faso, Ethiopia, and Zambia will not be debt
sustainable at the end of the 20- year period, even if they receive 50
percent of their future assistance in the form of grants. The benefits from
50- percent grants are not sufficient to lessen the debt burdens of these
four countries because they are projected to borrow substantial additional
resources to compensate for insufficient revenue from exports.

The grants proposal is also more effective in promoting debt sustainability
than proposals to forgive 100- percent of old multilateral debt. Our
analysis shows that debt- to- export ratios decline from an average of 402
percent under the 100- percent debt forgiveness scenario to an average of
235 percent under the 50- percent grants proposal. Long- term debt
sustainability under 100- percent debt forgiveness is in fact only slightly
improved over the historical baseline. Forgiveness of old multilateral debt
would improve countries? debt ratios only for the first 7 years. After that,
the advantage of this plan is eliminated because these countries are
projected to accumulate a substantial amount of new debt that will quickly
become unsustainable (see fig. 1). Grants Proposal

Contributes More to Debt Sustainability Than Full Forgiveness of Old
Multilateral Debt

Page 6 GAO- 02- 698T

Figure 1: 20- Year Debt Sustainability Projections for 10 Poor Countries

Note: The lines for the three scenarios represent the annual average debt
ratios for the 10 countries. Source: GAO analysis.

The proposal to shift 50 percent of multilateral loans to grants would
result in a revenue loss to the World Bank. We estimate the present value of
foregone repayments from poor countries to the World Bank to be
approximately $9.73 billion over the next 40 years. The total financial loss
of the 50- percent grants proposal is approximately $15.6 billion, since the
$9.73 billion would have accrued an additional $5.82 billion in investment
income to the World Bank. This amount represents about 8 percent of the
$120.2 billion in present value terms that the World Bank expects to commit
to poor countries over this 40- year time frame. Grants Proposal Can

Be Financed through Relatively Small Increases in Donor Contributions

Shift to 50- Percent Grants Would Reduce World Bank Concessional Resources

Page 7 GAO- 02- 698T

The World Bank has reported that the grants proposal would result in a $100
billion loss to IDA over 40 years- about $59 billion of this loss stems from
foregone repayments, with the remaining $41 billion derived from foregone
interest earnings. However, the World Bank?s methodology assumes that the
value of a dollar received today is worth the same as a dollar received 40
years from now. This assumption does not properly account for the impact of
inflation and the investment income that could accrue over time.

Our analysis shows that the 50- percent grants proposal could be fully
financed through small increases in contributions from donor countries over
what is currently projected. If donor countries were to increase their
annual contribution to IDA by 1.6 percent over 40 years, they would fully
finance the 50- percent grants proposal. An annual increase in donor
contributions of 1.6 percent would be less than the expected rate of
inflation, which is projected to be 2.3 percent over this time period. Donor
contributions to IDA are expected to increase by 13.4 percent over the next
3 years, with U. S. contributions expected to grow by more than 18 percent.

Alternative options for making up the foregone revenue from the 50percent
grants proposal are fairly limited. The World Bank finances its concessional
loan program through International Bank for Reconstruction and Development
(IBRD) contributions, investment income, and loan repayments, in addition to
donor contributions. The World Bank is unlikely to recoup the lost revenue
from IBRD contributions because any increase in contributions to IDA from
IBRD would come at the expense of other priorities such as maintaining
sufficient reserves for lending to middle income countries. The World Bank
would have difficulty significantly increasing its investment income without
increasing the risk of its investments beyond what it considers prudent.
Furthermore, it cannot increase loan repayments from poor countries without
effectively nullifying any improvement to their debt sustainability that
would accrue from the 50- percent grants proposal.

Mr. Chairman and Members of the Subcommittee, this concludes my prepared
statement. I will be happy to answer any questions you or other Members may
have. Small Increases in Donor

Contributions Can Finance the Grants Proposal

Page 8 GAO- 02- 698T

For addition information about this testimony, please contact Joseph
Christoff at (202) 512- 8979. Individuals making key contributions to this
testimony included Thomas Melito, Anthony Moran, Bruce Kutnick, R. G.
Steinman, Ming Chen, Jeffery Goebel, and Lynn Cothern. Contacts and

Acknowledgments

(320118)
*** End of document. ***
```