Developing Countries: Challenges in Financing Poor Countries' Economic Growth and Debt Relief Targets
Published: 2004-04-20T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Heavily Indebted Poor Countries (HIPC) Initiative, established in 1996, is a bilateral and multilateral effort to provide debt relief to poor countries to help them achieve economic growth and debt sustainability. Multilateral creditors are having difficulty financing their share of the initiative, even with assistance from donors. Under the existing initiative, many countries are unlikely to achieve their debt relief targets, primarily because their export earnings are likely to be significantly less than projected by the World Bank and International Monetary Fund (IMF). In a recently issued report, GAO assessed (1) the projected multilateral development banks' funding shortfall for the existing initiative and (2) the amount of funding, including development assistance, needed to help countries achieve economic growth and debt relief targets. The Treasury, World Bank, and African Development Bank commented that historical export growth rates are not good predictors of the future because significant structural changes are under way in many countries that could lead to greater growth. We consider these historical rates to be a more realistic gauge of future growth because of these countries' reliance on highly volatile primary commodities and other vulnerabilities such as HIV/AIDS.
section_title: What GAO Found
paragraphs: The three key multilateral development banks we analyzed face a funding shortfall of $7.8 billion in 2003 present value terms, or 54 percent of their total commitment, under the existing HIPC Initiative. The World Bank has the most significant shortfall--$6 billion. The African Development Bank has a gap of about $1.2 billion. Neither has determined how it would close this gap. The Inter-American Development Bank is fully funding its HIPC obligation by reducing its future lending resources to poor countries by $600 million beginning in 2009. We estimate that the cost to the United States, based on its rate of contribution to these banks, could be an additional $1.8 billion. However, the total estimated funding gap is understated because (1) the World Bank does not include costs for four countries for which data are unreliable and (2) all three banks do not include estimates for additional relief that may be required because countries' economies deteriorated after they qualified for debt relief. Even if the $7.8 billion gap is fully financed, we estimate that the 27 countries that have qualified for debt relief may need an additional $375 billion to help them achieve their economic growth and debt relief targets by 2020. This $375 billion consists of $153 billion in expected development assistance, $215 billion to cover lower export earnings, and at least $8 billion in debt relief. Most countries are likely to experience higher debt burdens and lower export earnings than the World Bank and IMF project, leading to an estimated $215 billion shortfall over 18 years. To reach debt targets, we estimate that countries will need between $8 billion and $20 billion, depending on the strategy chosen. Under these strategies, multilateral creditors switch a portion of their loans to grants and/or donors pay countries' debt service that exceeds 5 percent of government revenue. Based on its historical share of donor assistance, the United States may be called upon to contribute about 14 percent of this $375 billion, or approximately $52 billion over 18 years.

section_title: Letter
paragraphs: I am pleased to be here today to discuss the funding of the existing Heavily  Indebted Poor Countries (HIPC) Initiative and the amount of further  assistance needed to help countries achieve economic growth and debt  targets.
The HIPC Initiative is a joint bilateral and multilateral effort to provide  debt relief to up to 42 poor countries to help them achieve long-term  economic growth and debt sustainability. The current cost for the  initiative is projected at about $41 billion in present value terms, funded  almost equally between bilateral and multilateral creditors. Although the  initiative was launched in 1996, multilateral creditors are still having  difficulty financing their share of the initiative, even with assistance from  donors. GAO and others have reported that the existing initiative is  unlikely to provide sufficient debt relief to achieve long-term debt  sustainability, primarily because export earnings are likely to be  significantly less than projected by the World Bank and the International  Monetary Fund (IMF).
My remarks will focus on two key areas, as discussed in our recently  released report: (1) the multilateral development banks’ (MDB) projected  funding shortfall for the existing HIPC Initiative and (2) the amount of  funding, including development assistance, needed to help countries  achieve economic growth and debt relief targets. I will highlight the key  financing challenges in these two areas.
Our analysis of the funding shortfall focused on the three key MDBs—the  World Bank/International Development Association (IDA), the African  Development Bank (AfDB)/African Development Fund (AfDF), and the  Inter-American Development Bank (IaDB)/Fund for Special Operations  (FSO)—because they account for about 70 percent of multilateral  creditors’ debt relief costs. To determine the amount and timing of funding  shortfalls, we analyzed the banks’ total and annual cost estimates and  funding sources for 34 countries. To determine the amount of funding  needed to achieve economic growth and debt relief targets, we analyzed  World Bank and IMF projections through 2020 for the 27 countries that  have qualified for debt relief thus far, focusing on estimates of key  economic variables including debt stock, debt service, donor assistance,  government revenue, and exports. In addition, we analyzed the impact of  fluctuations in export growth on the likelihood of these countries  achieving debt sustainability. We performed our work from June 2003 to  February 2004 in accordance with generally accepted government auditing  standards.
subsections: section_title: Background
paragraphs: The World Bank and IMF have classified 42 countries as heavily indebted  and poor; three quarters of these are in Africa. In 1996, creditors agreed to  create the HIPC Initiative to address concerns that some poor countries  would have debt burdens greater than their ability to pay, despite debt  relief from bilateral creditors. In 1999, in response to concerns about the  continuing vulnerability of these countries, the World Bank and the IMF  agreed to enhance the HIPC Initiative by more than doubling the estimated  amount of debt relief and increasing the number of potentially eligible  countries. A major goal of the HIPC Initiative is to provide recipient  countries with a permanent exit from unsustainable debt burdens. To date,  27 poor countries have reached their decision points, and 11 of these have  reached their completion points. In 1996, to help multilateral creditors  meet the cost of the HIPC Initiative, the World Bank established a HIPC  Trust Fund with contributions from member governments and some  multilateral creditors. The HIPC Trust Fund has received about $3.4 billion  (nominal) in bilateral pledges and contributions, including $750 million in  pledges from the U.S. government.
section_title: Key Multilateral Development Banks Face Significant Challenges to Financing the Existing Initiative
paragraphs: The World Bank, AfDB, and IaDB face a combined financing shortfall of  $7.8 billion in present value terms under the existing HIPC Initiative (see  table 1).
subsections: section_title: The World Bank Has An Estimated Financing Gap of $6 Billion
paragraphs: Financing the enhanced HIPC Initiative remains a major challenge for the  World Bank. The total cost of the enhanced HIPC Initiative to the World  Bank for 34 countries is estimated at $9.5 billion. As of June 30, 2003, the  World Bank had identified $3.5 billion in financing, resulting in a gap of  about $6 billion (see table 1). Donor countries will be reviewing the  financing gap during the IDA-14 replenishment discussions beginning in  spring 2004. If donor countries close the financing gap through future  replenishments, we estimate that the U.S. government could be asked to  contribute $1.2 billion, which is based on its historical replenishment rate  of 20 percent to IDA.
Over 70 percent of the funds IDA has identified thus far come from  transfers of IBRD’s net income to IDA. Although IBRD has not committed  any of its net income for HIPC debt relief beyond 2005, we estimate that  the financing gap of $6 billion could be reduced to about $3.5 billion, or by  about 42 percent, if the net income transfers from the IBRD continue.  Similarly, the U.S.’s potential share decreases by the same percentage,  from $1.2 billion to about $700 million. However, transferring more of  IBRD’s net income to HIPC debt relief could come at the expense of other  IBRD priorities.
section_title: AfDB Has a Financing Gap of at Least $1 Billion
paragraphs: The total cost of the enhanced HIPC Initiative to the AfDB for its 32  member countries is estimated at about $3.5 billion (see table 1). As of  September 2003, the AfDB has identified financing of approximately $2.3  billion, including $2 billion from the HIPC Trust Fund and about $300  million from its own resources. Thus, AfDB is faced with a financing  shortfall of about $1.2 billion in present value terms. We estimate that  AfDB will need about $400 million to cover its shortfall for its 23 eligible  countries, as well as about $800 million for its 9 potentially eligible  countries. In addition, we estimate that the U.S. share of the AfDB’s  financing shortfall is between $132 and $348 million, depending on the  method used to close the $1.2 billion shortfall.
section_title: IaDB Expects to Finance HIPC Commitments at the Expense of Future Lending
paragraphs: The IaDB expects to provide about $1.4 billion for HIPC debt relief to four  countries—Bolivia, Guyana, Honduras, and Nicaragua. Most of the relief is  for debt owed to the Fund for Special Operations (FSO), the concessional  lending arm of the IaDB that provides financing to the bank’s poorer  members. As of January 2004, the IaDB has identified financing for the full  $1.4 billion, about $200 million from donor contributions through the HIPC  Trust Fund and $1.2 billion through its own resources. Although the IaDB  is able to cover its full participation in the HIPC Initiative, the institution  faces about a $600 million reduction in the lending resources of its FSO  lending program from 2009 through 2019 as a direct consequence of  providing HIPC debt relief. According to IaDB officials, the FSO will not  have enough money to lend from 2009 through 2013. To eliminate this  shortfall, donor countries may be asked to provide the necessary funds  through a future replenishment contribution. Assuming that donor  countries agree to close the financing gap, we estimate that the U.S.  government could be asked to contribute about $300 million so that the  FSO can continue lending to poor countries after 2008. This estimate is  based on the 50-percent rate at which the United States historically  contributes to the FSO.
section_title: Financing Shortfall Is Understated
paragraphs: The $7.8 billion shortfall for the three MDBs is understated for two  reasons. First, the estimated financing shortfall for two institutions—IDA  and the AfDB—is understated because the data for four likely recipient  countries—Laos, Liberia, Somalia, and Sudan—are unreliable. The World  Bank considers existing estimates of the countries’ total debt and  outstanding arrears to be incomplete, subject to significant change, and it  is uncertain when the countries will reach their decision points. Similarly,  the estimated costs of debt relief for three of AfDB’s countries—Liberia,  Somalia, and Sudan—are likely understated due to data reliability  concerns.
Second, the financing shortfall does not include any additional relief that  may be provided to countries because their economies deteriorated since  they originally qualified for debt relief. Under the enhanced HIPC  Initiative, creditors and donors could provide countries with additional  debt relief above the amounts agreed to at their decision points, referred  to as “topping up.” This relief could be provided when external factors,  such as movements in currency exchange rates or declines in commodity  prices, cause countries’ economies to deteriorate, thereby affecting their  ability to achieve debt sustainability. The World Bank and IMF project that  seven to nine countries may be eligible for additional debt relief, and their  preliminary estimates range from $877 million to about $2.3 billion,  depending on whether additional bilateral relief is included or excluded  from the calculation. The additional cost to the U.S. government could  range from $106 million to $207 million for assistance to the World Bank  and AfDB, based on the U.S. historical replenishment rates to these  banks. Furthermore, the topping-up estimate considered only the 27  countries that have reached their decision or completion point; the  estimate may rise as additional countries reach their decision points.
section_title: Achieving Economic Growth and Debt Relief Targets Requires Substantial Financial Assistance
paragraphs: Even if the $7.8 billion shortfall is fully financed, we estimate that, if  exports grow slower than the World Bank and IMF project, the 27  countries that have qualified for debt relief may need more than $375  billion in additional assistance to help them achieve their economic  growth and debt relief targets through 2020. This $375 billion consists of  $153 billion in expected development assistance, $215 billion in assistance  to fund shortfalls from lower export earnings, and at least $8 billion for  debt relief (see fig. 1). If the United States decides to help fund the $375  billion, we estimate it would cost approximately $52 billion over 18 years.
subsections: section_title: Countries Projected to Receive Development Assistance through 2020
paragraphs: According to our analysis of World Bank and IMF projections, the  expected level of development assistance for the 27 countries is $153  billion through 2020. This estimate assumes that the countries will follow  their World Bank and IMF development programs, including undertaking  recommended reforms. It also assumes that countries achieve economic  growth rates consistent with reducing poverty and maintaining long-term  debt sustainability. These conditions will help countries meet their  development objectives, including the Millennium Development Goals that  world leaders committed to in 2000. These goals include reducing poverty,  hunger, illiteracy, gender inequality, child and maternal mortality, disease,  and environmental degradation. Another goal calls on rich countries to  build stronger partnerships for development and to relieve debt, increase  aid, and give poor countries fair access to their markets and technology.
section_title: Countries Face a Substantial Financial Shortfall in Export Earnings
paragraphs: We estimate that 23 of the 27 HIPC countries will earn about $215 billion  less from their exports than the World Bank and IMF project. The World  Bank and IMF project that all 27 HIPC countries will become debt  sustainable by 2020 because their exports are expected to grow at an  average of 7.7 percent per year. However, as we have previously reported,  the projected export growth rates are overly optimistic. We estimate that  export earnings are more likely to grow at the historical annual average of  3.1 percent per year—less than half the rate the World Bank and IMF  project. Under lower, historical export growth rates, countries are likely to  have lower export earnings and unsustainable debt levels (see table 2). We  estimate the total amount of the potential export earnings shortfall over  the 2003 to 2020 projection period to be $215 billion.
High export growth rates are unlikely because HIPC countries rely heavily  on primary commodities such as coffee, cotton, and copper for much of  their export revenue. Historically, the prices of these commodities have  fluctuated, often downward, resulting in lower export earnings and  worsening debt indicators. A 2003 World Bank report found that the World  Bank/IMF growth assumptions had been overly optimistic and  recommended more realistic economic forecasts when assessing debt  sustainability.
Since HIPC countries are assumed to follow their World Bank and IMF  reform programs, any export shortfalls are considered to be caused by  factors outside their control such as weather and natural disasters, lack of  access to foreign markets, or declining commodity prices. Although failure  to follow the reform program could result in the reduction or suspension  of development assistance, export shortfalls due to outside factors would  not be expected to have this result. Therefore, if countries are to achieve  economic growth rates consistent with their development goals, donors  would need to fund the $215 billion shortfall. Without this additional  assistance, countries would grow more slowly, resulting in reduced  imports, lower gross domestic product (GDP), and lower government  revenue. These conditions could undermine progress toward poverty  reduction and other goals.
section_title: Additional Assistance Will Lead to Debt Sustainability in Most Countries
paragraphs: Even if donors make up the export earnings shortfall, more than half of  the 27 countries will experience unsustainable debt levels. We estimate  that these countries will require $8.5 to $19.8 billion more to achieve debt  sustainability and debt-service goals. After examining 40 strategies for  providing debt relief, we narrowed our analysis to three specific strategies:  (1) switching the minimum percentage of loans to grants for future  multilateral development assistance for each country to achieve debt  sustainability, (2) paying debt service in excess of 5 percent of  government revenue, and (3) combining strategies (1) and (2). We chose  these strategies because they maximize the number of countries achieving  debt sustainability while minimizing costs to donors. We found that, with  this debt relief, as many as 25 countries could become debt sustainable  and all countries would achieve a debt service-to-revenue ratio below 5  percent over the entire 18-year projection period (see table 3).
In the first strategy, multilateral creditors switch the minimum percentage  of loans to grants for each country to achieve debt sustainability in 2020.  We estimate that the additional cost of this strategy would be $8.5 billion.  The average percentage of loans switched to grants for all countries under  this strategy would be 33.5 percent. Twelve countries are projected to be  debt sustainable with no further assistance. In addition, 13 countries  would achieve sustainability by switching between 2 percent (Benin) and  96 percent (São Tomé and Príncipe) of new loans to grants. A total of 25  countries could be debt sustainable by 2020, although only 2 countries  would achieve the 5-percent debt service-to-revenue target over the entire  period.
The second strategy is aimed at reducing each country’s debt-service  burden. Under this strategy, donors would provide assistance to cover  annual debt service above 5 percent of government revenue. We estimate  that this strategy would cost an additional $12.6 billion to achieve the goal  of 5-percent debt service to revenue for all countries throughout the  projection period. Under this strategy, no additional countries become  debt sustainable other than the 12 that are already projected to be debt  sustainable with no further assistance. While this strategy would free  significant resources for poverty reduction expenditures, it could provide  an incentive for countries to pursue irresponsible borrowing policies. By  guaranteeing that no country would have to pay more than 5 percent of its  revenue in debt service, this strategy would separate the amount of a  country’s borrowing from the amount of its debt repayment. Consequently,  it could encourage countries to borrow more than they are normally able  to repay, increasing the cost to donors and reducing the resources  available for other countries.
The third strategy combines strategies 1 and 2 to achieve both debt  sustainability and a lower debt-service burden. Under this strategy,  multilateral creditors would first switch the minimum percentage of loans  to grants to achieve debt sustainability, and then donors would pay debt  service in excess of 5 percent of government revenue. We estimate that  this strategy would cost an additional $19.8 billion, including $8.5 billion  for switching loans to grants, and $11.3 billion for reducing debt service to  5 percent of revenue. Under this strategy, 25 countries would achieve debt  sustainability in 2020—that is, 13 countries in addition to the 12 that are  projected to be debt sustainable with no further assistance. All 27  countries would reach the 5-percent debt-service goal for the duration of  the projection period. However, similar to the debt-service strategy above,  this strategy dissociates borrowing from repayment and could encourage  irresponsible borrowing policies.
If the United States decides to help fund the $375 billion, we estimate that  it could cost approximately $52 billion over 18 years, both in bilateral  grants and in contributions to multilateral development banks. This  amount consists of $24 billion, which represents the U.S. share of the $153  billion in expected development assistance projected by the World Bank  and IMF, as well as approximately $28 billion for the increased assistance  to the 27 countries. Historically, the United States has been the largest  contributor to the World Bank and IaDB, and the second largest  contributor to the AfDB, providing between 11 and 50 percent of their  funding. The U.S. share of bilateral assistance to the 27 countries we  examined has historically been about 12 percent.
subsections: section_title: Volatility in Export Earnings Likely to Further Increase the Cost of Achieving Debt Sustainability
paragraphs: We also analyzed the impact of fluctuations in export growth on the  likelihood of these countries achieving debt sustainability. The export  earnings of HIPC countries experience large year-to-year fluctuations due  to their heavy reliance on primary commodities, as well as weather  extremes, natural disasters, and other factors. We found that the higher a  country’s export volatility, the lower its likelihood of achieving debt  sustainability. For example, Honduras has low export volatility, resulting  in little impact on its debt sustainability. In contrast, Rwanda has very high  export volatility, which greatly lowers its probability of achieving debt  sustainability. Since volatility in export earnings reduces countries’  likelihood of achieving debt sustainability, it is also likely to further  increase donors’ cost as countries may require an even greater than  expected level of debt relief to achieve debt sustainability.
Mr. Chairman and Members of the Committee, this concludes my prepared  statement. I will be happy to answer any questions you may have.
section_title: Contacts and Acknowledgments
paragraphs: For additional information about this testimony, please contact Thomas  Melito, Acting Director, International Affairs and Trade, at (202) 512-9601  or Cheryl Goodman, Assistant Director, International Affairs and Trade, at  (202) 512-6571. Other individuals who made key contributions to this  testimony included Bruce Kutnick, Barbara Shields, R.G. Steinman, Ming  Chen, Robert Ball, and Lynn Cothern.
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