The debt problems of many of the world’s heavily indebted lowest income countries continue to be a challenge for the international community. Most of these countries’ debt is owed to official creditors consisting of other governments (bilateral) and international financial institutions (multilateral). Despite debt relief efforts undertaken largely by bilateral and commercial creditors since the 1980s, the overall debt burden of the poor countries has increased. The debt burdens are of concern for two reasons: they may hamper economic development in debtor countries and they involve the lenders and debtors in a time-consuming pattern of rescheduling debt, providing new loans, and supplying donor assistance. To address the growing debt burden, in September 1996 governments around the world agreed to the Heavily Indebted Poor Countries (HIPC) Debt Initiative developed by the World Bank and the International Monetary Fund (IMF). The initiative was intended to build on existing debt relief efforts and bring together all of a country’s creditors to provide debt relief in conjunction with policy reforms to allow countries to exit from the rescheduling process. Establishment of the HIPC initiative involved resolution of differences among creditors concerning the need for expanded debt relief. Despite repeated efforts to relieve the debt burden of developing countries, the total amount of money owed to external creditors by the 40 countries classified by the World Bank and the IMF as heavily indebted poor countries increased from an average of $122 billion for 1983-85 to $221 billion for 1993-95 (nominal value, in 1997 dollars). (See app. I for a list of countries.) Figure 1.1 shows the composition of this debt among three categories of medium- and long-term debt, as well as short-term debt. Although total external debt increased substantially between these periods, the amount of medium- and long-term debt owed to private financial institutions (commercial creditors) decreased. Because these countries are seen as high credit risks, they have had limited access to private sector financing. For 1993-95, 73 percent of total external debt was medium- and long-term debt owed to official creditors, with the majority of that amount owed to bilateral creditors. The remaining 27 percent was medium- and long-term debt owed to commercial creditors and short-term debt such as trade financing. Of the total debt, 45 percent was owed to governments (bilateral creditors) and 28 percent was owed to international financial institutions (multilateral creditors). According to the U.S. Treasury, as of August 1998, 31 of the 40 countries had outstanding debt of approximately $6.8 billion to the United States. (See app. II for the amount owed by each country.) By the mid-1990s, much of the debt owed by the 40 countries was not being paid. According to the World Bank, heavily indebted poor countries made roughly 50 percent of their scheduled debt payments during 1994. We estimated that, during 1993-95, HIPC countries paid about 41 percent of their debt service owed. Although the largest share of the debt during the later period was owed to bilateral creditors, a majority of the debt service paid was to multilateral institutions, due to these institutions’ requirement that countries fully service their debt before receiving new lending. Significantly, the share of long- and medium-term debt service paid to multilateral creditors increased from 29 percent to 52 percent of the total, while the share paid to commercial creditors decreased from 44 percent to 22 percent. (See fig. 1.2.) Addressing the debt burdens of very poor countries, in the context of the broad range of development needs they face, constitutes a substantial challenge. Thirty-two of the 40 countries classified by the World Bank and the IMF as heavily indebted poor countries are in sub-Saharan Africa. Eighty-three percent of these countries are classified by the United Nations as being in its lowest category of human development, based on life expectancy, literacy, and per capita national income. Most receive substantial amounts of development assistance from governments, multilateral organizations, and nongovernmental organizations (NGO). We estimated that in 1994 foreign assistance represented about 16 percent of national income, using a weighted average, for 36 of these countries for which data is available. Some of the 40 countries, moreover, have recently emerged from—or continue to be engaged in—conflict or civil unrest. Although countries may incur external debt as part of their development strategy, development experts, including officials from the World Bank, the United Nations, and NGOs, have cited several reasons why debt burdens of some poor countries are a concern. Some development experts believe that debt levels above a certain threshold amount relative to a country’s economic capacity may, in and of themselves, limit economic growth. This has been termed the “debt overhang effect.” This effect reflects the view that if a country has substantial debt obligations, the debt will discourage current investment in the debtor country, due to a concern that future income may be highly taxed to pay debt. Other experts question whether debt overhang constitutes a serious obstacle to investment in HIPC countries, in light of additional impediments to investment, such as weak financial institutions and inadequate physical infrastructure, these countries face. Nonetheless, many experts agree that high debt payments constitute a drain on a country’s budget, potentially lowering the amount of money available for health and education spending and, for many countries, requiring further loans or grants. For the poorest countries, this can mean an increasing percentage of new aid will go to service existing debt rather than to aid in development. Finally, rescheduling and financing debt payments have been time-consuming for both creditors and debtors. For example, according to Department of State data, potential recipients of HIPC debt relief have concluded about 100 debt negotiations with the Paris Club over the last 10 years. Debt relief efforts since the 1980s have been undertaken primarily by bilateral and commercial creditors. However, these prior efforts have not resulted in a substantial reduction in the overall debt owed by poor countries. Some efforts aimed at poor countries have actually increased debt levels by, for example, converting interest payment arrears into new debt. Other mechanisms have left the debt of poor countries largely unaffected, notably the Baker and Brady plans of the 1980s. These plans focused on resolving the commercial debt problems of middle-income countries by essentially providing funds for countries to buy back part of their commercial bank debt. Two instruments have been used to reduce the commercial bank debt of some heavily indebted poor countries. Sixteen countries have received $11.8 billion of debt reduction since 1989, although about one third of this reduction has been for one country, Côte d’Ivoire. These instruments are the Debt Reduction Facility of the International Development Association (IDA), the part of the World Bank that lends to poor countries on highly concessional terms, and, more recently, officially supported debt and debt service reduction programs (Brady operations). According to World Bank data, through the Debt Reduction Facility, 16 countries had retired about $4.2 billion of principal and interest arrears owed to commercial banks, as of December 1997. In May 1997, Côte d’Ivoire also received debt reduction through the second mechanism, when Côte d’Ivoire reached an agreement with commercial creditors that resulted in debt reduction of $4.1 billion. The restructuring agreement helped Côte d’Ivoire to clear unpaid interest owed to commercial creditors and ensure that commercial creditors would provide relief at least comparable to that offered by official creditors. Bilateral creditors have forgiven some debt and renegotiated debt payments by lowering interest rates or extending due dates. Some bilateral creditors have individually forgiven debt owed by poor countries, but these amounts have not been large relative to the total bilateral debt owed. For example, between 1990 and 1997, the United States forgave $2.3 billion, or 37 percent, of the $6.1 billion of debt we estimate was owed by the 40 HIPC countries as of the end of fiscal year 1989. According to an Organization for Economic Cooperation and Development report, since 1989 France has forgiven over $10 billion in official development assistance (ODA) debt owed by countries in sub-Saharan Africa. According to the German government, Germany has forgiven or pledged to forgive about $5 billion in ODA debt owed by poor countries. More often, bilateral creditors have worked together to offer debt relief to poor countries by rescheduling debt payments on concessional terms or reducing debt through the Paris Club. To qualify for Paris Club relief, countries must be in imminent default and reach an agreement with the IMF on a reform program. The Paris Club conditions its debt relief on countries’ implementation of economic and structural reforms under IMF-supported lending programs, such as the ESAF. Disbursement of relief is then conditioned on satisfactory implementation of the reform program, generally lasting 3 years. Since 1988, the Paris Club has treated debt owed by poor countries on increasingly concessional terms. In many cases these efforts did not significantly reduce debt but instead mainly focused on helping countries meet debt payments within the short term by altering payment due dates or interest rates, rather than on forgiving debt. Some debtors sought repeated rescheduling. In 1988, the Paris Club became the first group of creditors to offer countries the option of reducing the amount of debt. Under the most recent terms of the Paris Club adopted in 1994, called “Naples terms,” countries could receive up to a 67-percent reduction in eligible debt under a stock-of-debt operation. Naples terms broadened the range of eligible debt, elaborated procedures for reducing a country’s debt, allowed for a reduction in the amount of debt owed, and were intended to allow the countries to stop rescheduling debt in the future. Multilateral creditors generally have not rescheduled or reduced debt owed them because of their belief that forgiving or reducing debt would diminish assurances of repayment on new lending. Multilateral development banks were also concerned that forgiving debt would hurt their credit ratings. Instead, multilateral creditors have relied on increased concessional lending and relief from bilateral creditors to enable countries to continue servicing their multilateral debt. Since the 1990s, there has been growing recognition that some poor countries were having increasing difficulty servicing their multilateral debt. For example, during a Paris Club restructuring of Uganda’s debt in the mid-1990s, some creditors concluded that debt relief from bilateral creditors would not sufficiently ease the country’s debt burden because most of Uganda’s debt was owed to multilateral creditors. Moreover, creditors and others were concerned that a greater percentage of new lending was being used to service existing debt rather than for development purposes. These recognitions contributed to the industrialized nations’ call for a new approach to address the debt of heavily indebted poor countries, including that owed to multilateral creditors. The HIPC initiative is the first coordinated effort to include all creditors, most notably the multilaterals, in addressing the debt problems of heavily indebted poor countries. Participating creditors include bilateral governments; the major multilateral creditors such as the World Bank and the IMF; and over 20 other multilateral development institutions, including the African Development Bank, the Inter-American Development Bank, and the International Fund for Agricultural Development. (See app. III.) According to the World Bank, over the past 2 years the Boards of the World Bank and the IMF have met about 30 times each, and about 25 multilateral development banks have been meeting every 6 months under the chairmanship of the World Bank to coordinate the implementation of the HIPC initiative. In 1996, the World Bank and the IMF made a preliminary determination regarding which of the 40 countries might eventually receive relief based on the HIPC initiative’s specific criteria concerning income, indebtedness, and reform, and identified 20 countries as potential recipients. As of August 1998, the World Bank and the IMF estimated that the creditors would provide debt relief through the initiative to 20 countries, worth about $8.2 billion in 1996 present value terms. Specific eligibility decisions have been made for eight countries, with six countries deemed eligible for relief under the HIPC initiative. One country—Uganda—has completed the process. The HIPC initiative builds on prior debt relief efforts, most notably those of the Paris Club. The HIPC initiative’s goal is to bring countries’ debts to levels that are considered sustainable, meaning the countries can make debt payments without incurring loan arrears or requiring debt rescheduling. The basic HIPC framework establishes eligibility criteria based on a country’s per capita income, indebtedness, and track record of reform. As shown in figure 1.3, implementation of the initiative involves two stages. Each stage can last 3 years and can be shortened in some cases. Eligibility for HIPC debt relief is assessed at the end of stage one, following the successful completion of World Bank- and IMF-supported programs. At this point (termed the decision point), the Boards of Executive Directors of the World Bank and the IMF determine whether (1) existing debt relief mechanisms are sufficient to bring a country’s debt to a point considered sustainable or (2) the country requires additional debt relief. The determination of whether debt is sustainable is based mainly on a World Bank and IMF assessment of whether the projected ratio of a country’s debt (in present value terms) to the value of its exports will be greater than a target value that is set within the range of 200-250 percent. Lowering the target level increases the amount of debt relief required to reach the target. For example, lowering the ratio of a country’s debt to its exports from 300 percent to 200 percent requires more debt relief than lowering it from 300 percent to 250 percent. The target level is based on factors affecting the vulnerability of the country’s economy, such as the percentage of government revenue required for debt service and whether export earnings are generated by a few commodities. Under certain conditions, for countries with very open economies and strong efforts to generate fiscal revenues, the target may be based on the ratio of debt to government revenue. This fiscal indicator can allow debt-to-export targets below 200 percent. If the Boards determine that existing debt relief mechanisms are insufficient to make debt levels sustainable and other principal creditors agree, the country enters the second stage of the HIPC initiative. During this stage, the country receives some debt relief from bilateral and commercial creditors and financial support from multilateral institutions. Paris Club creditors have agreed to provide relief up to 80 percent of debt service during the second stage. Multilateral creditors may also provide relief as part of their total commitment under the HIPC initiative during this second stage. The country must agree to continue implementing economic reform programs supported by the IMF and the World Bank and social reforms agreed to with the World Bank. If countries are judged to have met the requirements of these programs, they receive the remaining relief at the end of this stage, called the completion point. Official creditors have agreed to share the costs of HIPC relief by providing equal percentage reductions of debt owed them after the full use of existing debt relief mechanisms, including those offered by the Paris Club. Paris Club creditors have said they will limit relief to up to 80 percent of a country’s eligible debt. In exceptional cases, they may negotiate expanded terms. Commercial creditors are expected to provide relief comparable to bilateral creditors. Creditors will each decide how they will provide their share of debt relief to specific countries and which debt will be eligible for relief. Creditors may choose to provide relief through various means, such as rescheduling debt payments at lower interest rates, making debt service payments for countries as they come due, converting loans into grants, reducing debt, and/or lending new funds on concessional terms to be used to make debt service payments. The international financial institutions have said that even under the HIPC initiative they will not forgive debt outright because to do so may endanger their preferred creditor status.Instead, they will use other means. (The HIPC framework is described in more detail in app. IV.) Establishing a comprehensive framework for debt relief required resolving fundamental differences among creditors. For example, prior to 1995, both the World Bank and the IMF maintained that extraordinary debt relief mechanisms, including debt relief by multilateral creditors, were not necessary except for a handful of countries. Some creditors were concerned about the cost of providing debt relief and about the issue of “moral hazard”—that the prospect of debt relief would discourage countries from undertaking needed reforms and maintaining or strengthening responsible borrowing policies. In June 1995, the leaders of the Group of Seven countries called for the IMF and the World Bank to develop a comprehensive approach to assist heavily indebted poor countries with multilateral debt burdens. Shortly thereafter, a World Bank task force report called for a facility to pay multilateral debt service for a select group of countries. The World Bank and the IMF prepared subsequent analyses, and NGOs worked to influence the terms of the evolving framework. Key issues being negotiated during the design process of the HIPC initiative included how unsustainable debt burdens would be determined (with implications for eligibility and relief amounts), the type and length of reforms, whether debt stocks would be reduced, and how creditors would share in providing debt relief. The resulting September 1996 framework reflects creditors’ compromise views. However, the use of a range of values of the primary debt sustainability indicator, as well as the announced intention to implement the framework flexibly, left many key decisions to be made during implementation of the initiative. And some aspects of design, most notably how the shares of debt relief would be divided among creditors, had not yet been decided. The introduction of the HIPC initiative has prompted suggestions for alternative approaches to address the debt burdens of poor countries. Alternatives include fairly straightforward modifications to the HIPC initiative, such as increasing levels of relief, expanding eligibility, and accelerating implementation. Some suggestions call for more fundamental modifications of the HIPC framework and even question the basic structure of the HIPC initiative. Our report does not address the viability of different alternatives or compare them to the HIPC initiative. According to creditors, debtors, and NGOs, negotiating the design of the HIPC initiative has been a very challenging process, and there is a reluctance to significantly modify the HIPC framework. The Chairman of the Subcommittee on International Economic Policy, Export and Trade Promotion, Senate Committee on Foreign Relations, asked us to review the HIPC initiative. Specifically, we focused our review on (1) the implementation of the HIPC initiative and (2) the initiative’s potential to achieve its stated goal. This goal is to reduce select poor countries’ debt to sustainable levels; that is, to allow certain poor countries to pay their international debts on time and without further rescheduling. To describe the implementation of the HIPC initiative, we met with and obtained information from government officials of the United States, HIPC recipient countries, and other creditor countries; and officials from multilateral organizations and NGOs. We met with officials at the Department of State, the U.S. Agency for International Development, the Department of the Treasury, the World Bank, and the IMF. As an agency of the United States, we have no direct authority to review the operations of multilateral institutions. However, we obtained access to World Bank and IMF officials and information through the staffs of the U.S. members of their Boards of Executive Directors. We also obtained information from and interviewed officials of other creditor organizations, such as the Paris Club secretariat, the African Development Bank, and the Inter-American Development Bank. To obtain the views of other creditor nations on the implementation of the HIPC initiative, we met with officials from France, Germany, and the United Kingdom, including their representatives to the World Bank and the IMF and officials from their finance ministries, development ministries, and other government organizations. We met with and obtained data on debt and development from representatives of the Organization for Economic Cooperation and Development; and U.N. organizations, including the U.N. Development Program, the U.N. Conference on Trade and Development (UNCTAD), and the U.N. Children’s Fund. We also met with and obtained information from academic experts and NGOs, including Oxfam, the European Network on Debt and Development, Debt Relief International, Jubilee 2000, the Center of Concern, the Catholic Fund for Overseas Development, and the Heritage Foundation. To obtain information from recipient countries about the implementation of the HIPC initiative, we interviewed officials in Burkina Faso, Côte d’Ivoire, and Uganda. We selected recipient countries likely to represent a range of experiences under the HIPC initiative. Within the recipient countries we visited, we discussed concerns about the HIPC initiative with officials of relevant government bodies (for example, the prime minister’s office and the ministries of finance, trade, and planning), World Bank and IMF field staff, U.S. embassy and aid officials, local representatives of other donor countries and the European Union, business representatives, and local academics. To assess the initiative’s potential to achieve its stated goal, we met with officials from the U.S. government, other creditor governments, recipient governments, multilateral organizations, and nongovernmental organizations. We examined analytical papers and studies of debt issues from the World Bank and the IMF. Based on information from these studies as well as other sources, we conducted analyses of the HIPC initiative’s economic underpinnings and issues that arose during implementation. Within the recipient countries we visited (Burkina Faso, Côte d’Ivoire, and Uganda), we discussed concerns about the HIPC initiative with officials of relevant national and local government bodies (for example, the prime minister’s office and the ministries of finance, trade, and agriculture), World Bank and IMF field staff, U.S. embassy and aid officials, local representatives of other donor countries and the European Union, nongovernmental organizations, business representatives, and local academics. We performed our review from July 1997 to August 1998 in accordance with generally accepted government auditing standards. The Department of the Treasury and the Department of State commented that the report should provide greater context concerning the extent of prior debt relief efforts, particularly the efforts of bilateral creditors through both the Paris Club process, and unilaterally. We have expanded the report’s discussion of the debt relief efforts of bilateral creditors. The implementation of the HIPC initiative has involved significant negotiation among the major creditors on issues such as the eligibility of a country, the amount of relief to be provided, and the way in which relief is to be shared among creditors. As of August 1998, the Boards of the World Bank and the IMF had determined that six countries are eligible for assistance under the HIPC initiative and have agreed upon the amount and timing of relief for these countries. For five of these six countries, the Boards agreed to provide relief at the upper end of what the negotiated framework allows. Bilateral and multilateral creditors have agreed to share the debt relief by providing an equal percentage reduction of the debt owed them (after the full use of existing debt relief mechanisms) and to individually determine how they will provide the relief. The total amount of relief to be provided depends on creditors’ decisions as they implement the HIPC initiative, such as the number of countries deemed eligible, as well as debtors’ actions to establish the necessary track record of reform. Since implementation began, creditors have made some modifications to the HIPC framework that have expanded eligibility and contributed to increased estimates of relief. The amount of HIPC debt relief could increase further if, for example, countries that were not included in previous estimates become eligible. Conversely, if countries included in the estimates do not undertake required reforms and thus do not receive relief under the HIPC initiative, the amount of relief provided could decrease. As of August 1998, the Boards of the World Bank and the IMF had determined that six countries (Bolivia, Burkina Faso, Côte d’Ivoire, Guyana, Mozambique, and Uganda) were eligible for assistance under the HIPC initiative and had agreed upon the amount and timing of debt relief for these countries. (See table 2.1.) One country—Uganda—has completed the process. Projected relief for the six countries represents about $3 billion, or about 36 percent of the total projected HIPC debt relief of $8.2 billion (in 1996 present value terms), as of August 1998. For two additional countries—Benin and Senegal—the Boards of the World Bank and the IMF determined that debt relief from bilateral creditors on Naples terms would be sufficient to bring their debt to sustainable levels. Thus, they were not deemed eligible for relief through the HIPC initiative. Despite considerable debate on the amount and timing of debt relief to be provided, the World Bank and IMF Boards, in conjunction with principal creditors, have generally implemented the HIPC initiative to provide debt relief at the upper bounds of the negotiated framework. According to HIPC initiative documents, this is in response to the vulnerabilities facing recipient countries. This is specifically evident in lower end debt-to-export targets, which increase the amount of relief provided. In recognition of countries’ track records of reforms, the Boards have also generally shortened the second stage of the HIPC initiative, which provides debt relief sooner and can increase relief amounts in some cases. For five of the six countries deemed eligible to date, the expected debt relief amount is at or near the upper levels agreed to under the HIPC framework (Bolivia has a debt-to-export target of 225 percent). Nonetheless, in several cases, the cost of providing debt relief under the HIPC initiative has been a factor in determining the amount of debt relief to be provided. For five of the six countries for which target debt-to-export levels have been set, the target debt-to-export ratios are near or below the lower end of the 200-250 percent range under the HIPC framework. Two countries have been deemed eligible with debt-to-export ratios substantially below 200 percent (Côte d’Ivoire and Guyana), based on fiscal criteria that compare debt to government revenue rather than exports. The highest debt-to-export ratio set to date is 225 percent for Bolivia. Some creditor countries have stated that the target should normally be at or near the bottom of the range; others have maintained that the full range should be used. The United States supports a target of 200 percent or lower. According to HIPC documents, for the countries deemed eligible to date, the lower ratios reflect concern about countries’ significant economic vulnerabilities, such as dependence on a small number of exports and the resulting potential for volatility in export earnings. World Bank and IMF staff expect country-specific targets to be clustered more toward the bottom half of the 200-250 percent range. In the case of Burkina Faso, some countries argued for a lower ratio because of the uncertainty of the economic projections, particularly of future export prices. Other countries supported a higher range, noting that worker remittances were large in Burkina Faso and provided a cushion against possible risks. For some countries deemed eligible, such as Bolivia and Uganda, the potential cost of debt relief appears to have influenced their target ratios. In the case of Bolivia, while countries ultimately agreed to a target debt-to-export ratio of 225 percent, several supported a target of 200 percent while others supported a target in, or possibly above, the upper end of the 215-235 percent range. The target agreed to—225 percent—reflects, in part, concern about staying within the Paris Club’s limit on the amount of debt the Paris Club will reduce as well as the decision to limit the cost that Bolivia’s largest multilateral creditor, the Inter-American Development Bank, might incur in providing HIPC debt relief. The target set for Bolivia also reflects that the country is one of the least vulnerable of the potential HIPC recipients. The target debt-to-export ratio of 202 percent set for Uganda reflects, in part, the decision to stay within the Paris Club’s limit and within the terms of the burden-sharing arrangement multilateral and bilateral creditors had agreed to. As previously mentioned, implementation of the HIPC initiative involves two stages, each of which generally lasts 3 years. The Boards have shortened the length of the second stage for five of the six countries for which completion dates have been set (Bolivia, Burkina Faso, Guyana, Mozambique, and Uganda); four of these countries (Bolivia, Guyana, Mozambique, and Uganda) were given about a 1-year period. The actual length of the second stage could be longer if, for example, countries do not satisfactorily complete the required reforms. Countries’ views have differed significantly regarding the appropriate length of the track record of reform required for gaining HIPC debt relief. Some countries—such as the United States and Germany—have generally stressed that a longer time frame is important for ensuring a country’s commitment to critical reforms but have agreed to shortened second stages in some cases. Others, such as the United Kingdom, have stated that an overall reform period of 6 years is generally too long; they have supported efforts to give some recipients credit for their track records by reducing the length of the second stage. According to HIPC documents, the five countries with shortened periods are among the strongest performers of the potential HIPC debt relief recipients, and the shortened period reflects these countries’ past track records of good policy performance, including completion of successive ESAF and World Bank programs, and receipt of Naples terms from the Paris Club. Nonetheless, members of the Boards have debated the length of the second stage for these countries. There was considerable discussion about whether Uganda should have a second stage at all. According to HIPC documents, the remaining countries will likely require a 3-year period between the two stages—the decision point and the completion point. A shorter period between the decision point and the completion point means that countries will receive final HIPC debt relief sooner and may get more relief under certain conditions. In the case of Guyana, the decision to set the completion point in 1998 rather than the year 2000 (which would have been 3 years between the two stages) resulted in a projected increase in HIPC assistance of about 68 percent, or $103 million in present value terms. Significant negotiations have occurred on the question of how creditors will share the amount of debt relief to be provided through the HIPC initiative. When the HIPC initiative was announced in September 1996, creditors had not agreed on their shares of HIPC assistance, but Paris Club creditors had agreed to reduce up to 80 percent of the remaining eligible debt. The World Bank and the IMF had proposed an approach under which bilateral creditors would give debt relief up to 90 percent of eligible debt to a country first, with multilateral creditors providing the remainder required for the country to reach debt sustainability. Multilateral creditors sought to limit the type and amount of debt reduction they would provide because they were concerned that it would endanger their financial integrity and preferred creditor status. Bilateral creditors rejected the approach proposed by the multilaterals. The Paris Club creditors committed to provide relief up to 80 percent of the eligible debt countries owed them, and stated that, in exceptional cases, they may negotiate terms that expand the amount of relief they are to provide. They stated that multilateral creditors should contribute simultaneously with the bilateral creditors and provide a greater share of the total HIPC relief because (1) bilateral creditors had already provided debt relief and (2) servicing multilateral debt was a key part of poor countries’ debt burdens. Furthermore, according to a U.S. government official’s summary of the Paris Club’s position, the preferred creditor status is essentially a political judgment; it does not imply that the multilateral creditors should not provide debt relief. Nonetheless, one of the tenets of the HIPC initiative is to ensure the preferred creditor status of multilateral creditors. After much negotiation, in July 1997 creditors endorsed a broad burden-sharing arrangement, termed the “proportional approach,” under which bilateral and multilateral creditors would provide debt relief together and provide equal percentage reductions of debt owed them after the full application of existing debt relief mechanisms, including Naples terms. Using the proportional burden-sharing approach, World Bank and IMF staff determine how much debt relief the bilateral and multilateral creditors, as a group, are to provide a particular country. Within the Paris Club, bilateral creditors determine how much of this amount they will individually provide. The World Bank and the IMF determine the share of the debt relief each multilateral creditor is to provide, based on the share of debt owed to them by the recipient. Applying the proportional burden-sharing approach continues to involve negotiation among the creditors when they determine the specific relief amount for each recipient. Although creditors agreed to provide the same percentage of debt reduction, the dollar amounts of this relief will vary by creditor because creditors are owed different amounts of debt. For example, in the case of Burkina Faso, bilateral and multilateral creditors agreed to provide debt relief valued at about 14 percent of what they are owed. For bilateral creditors, this amounted to about $21 million in debt relief. For multilateral creditors, the same percentage reduction amounted to about $94 million. In some cases, poor countries’ debt levels are so high that the burden-sharing terms agreed to under the HIPC framework will not provide enough relief to reach the target debt-to-export ratio. This was, for example, the case for Mozambique. To reach the 200-percent target debt-to-export ratio, under the terms of the HIPC initiative burden-sharing approach, bilateral creditors were to provide $916 million in debt relief to Mozambique. To provide this relief, bilateral creditors would have to exceed the cap they had agreed to—that they would provide relief equivalent to up to 80 percent of eligible debt. The 80-percent reduction of debt would have provided only $553 million in debt relief. To address the $363 million shortfall, bilateral creditors agreed to provide exceptional amounts of relief beyond those terms, which has been termed “deep relief.” However, even after Paris Club creditors agreed to extend their terms and provide relief equivalent to 86 percent of eligible debt, a financing gap of $116 million remained. Individual bilateral creditors and donors as well as the World Bank and the IMF subsequently agreed to use various mechanisms, such as increasing the amount of debt relief or contributing funds, to finance the remaining gap. The agreement for Mozambique entailed significant negotiations among creditors because of the amount of relief needed to bring the debt-to-export ratio to the target level of 200 percent—Mozambique alone represents approximately half of the debt relief promised thus far. Creditors each determine how they will provide their share of the relief. Creditors may choose to provide relief through several means, such as rescheduling debt payments at lower interest rates, buying back the debt, making debt service payments as they come due, converting loans into grants, reducing the debt, and/or lending new funds on concessional terms to make debt service payments. A creditor’s decision about how it will provide debt relief to a particular recipient may be influenced by many factors, such as the amount of outstanding debt, the impact of providing debt relief on the creditor’s future budgets, the financial policies governing the creditor institution, and the needs of the recipient country. Multilateral creditors have said that they will not forgive debt outright; rather, they intend to provide debt relief in ways that maintain their preferred creditor status. According to the World Bank and the IMF, most of the multilateral development banks have obtained the institutional approval to participate in the HIPC initiative and defined the means they will use to provide relief, such as buying back debt or paying debt service through the HIPC Trust Fund or similar self-administered trust funds, rescheduling current payments or arrears on concessional terms, and refinancing on grant terms. The World Bank’s participation in the HIPC initiative is to be funded solely from the Bank’s own resources. Debt relief provided by the World Bank under the HIPC initiative is taking place primarily through contributions to the HIPC Trust Fund from IBRD income. The Trust Fund provides relief on debt owed to IDA, either through buying back some of its concessional debt or providing an unconditional commitment to pay debt service owed to IDA as it becomes due. Some of this relief may be advanced during the second stage when the World Bank could provide part of its lending program in the form of IDA grants instead of IDA credits, which are funded through general IDA resources. The IBRD has contributed about $750 million from its income to the HIPC Trust Fund to buy back or repay debt owed to IDA. The executive directors have recommended the approval of another transfer of $100 million from IBRD income to the Trust Fund. The HIPC Trust Fund has been specifically set up to keep the IDA and IBRD aspects of the World Bank’s operation at arm’s length. The HIPC Trust Fund also receives contributions from other participating multilateral development banks and bilateral creditors that are to be used primarily to help other multilateral development banks, such as the African Development Bank, to finance their share of HIPC debt relief. The multilateral development banks have stressed that the means used to provide debt relief through the Trust Fund should accommodate constraints specific to these institutions, such as policies against debt restructuring or forgiveness. As of August 10, 1998, 16 governments had made pledges or contributions to the HIPC Trust Fund totaling about $204 million. Also, nine countries proposed additional contributions totaling $92 million to relieve multilateral debt through reallocation of their excess resources in the World Bank’s Interest Subsidy Fund, which was set up in 1975 with donor contributions to subsidize the interest rates on IBRD loans to the poorest IBRD borrowers. (See app. IV for a list of contributors to the HIPC Trust Fund.) The IMF is participating in the HIPC initiative through special ESAF grants at the completion point that are deposited into an escrow account to meet debt service payments owed to the IMF under a predetermined schedule. The IMF is funding its contribution through its own trust fund financed from bilateral (member) contributions and the ESAF reserve account. To finance these grants, several countries have contributed or made investments for the benefit of the ESAF-HIPC Trust totaling approximately $46.5 million, as of June 1998. In May 1998, the IMF transferred about $54.5 million to the ESAF-HIPC Trust for fiscal year 1998 and expects to make a similar payment on a quarterly basis to the ESAF-HIPC Trust for fiscal year 1999. The IMF Board has authorized the transfer of up to an additional $332.5 million from the ESAF Trust Reserve Account to meet the IMF’s commitments under the HIPC initiative. Although all creditors will forgo future revenue to provide debt relief, bilateral creditors use different methods to budget for the cost of debt relief. Some creditors, including the United States, adjust for the probability of debtor countries not fully repaying their debt in the budgeting process. The United States has a complex methodology of estimating the market value of outstanding debt owed to it. For U.S. budgetary purposes, the cost of debt relief reflects the difference between the estimated market value of the loan before reduction compared to the value afterwards. Other creditors value the loan at face value at the time of initial approval. Thus, providing debt relief means they must budget for the face value of the debt when the debt is relieved. Estimates of the amount of relief to be given to countries under the HIPC initiative will continue to be influenced by decisions creditors make as the HIPC initiative is implemented as well as actions taken by debtor countries to establish the necessary track records of reform. The $8.2 billion estimate (in 1996 present value terms) depends on decisions, such as how many recipient countries participate in the HIPC initiative, what debt-to-export targets are established, what amount of time participants have to establish their qualifications for HIPC debt relief, and countries’ economic conditions. Therefore, the actual amount of relief to be provided under the HIPC initiative may be higher or lower than estimated. For example, the actual relief provided could be lower if fewer countries participate than anticipated or if target debt-to-export ratios are set higher than the 200 percent assumed in the projections. On the other hand, slower than projected growth in a country’s exports could substantially increase the amount of relief provided by the HIPC initiative. World Bank and IMF staff estimated that weaker export growth (2 percentage points lower annually for each country from 1995 onward) could increase the amount of relief provided under the HIPC initiative by about $1 billion in 1996 present value terms. The amount of relief provided also could increase if more countries become eligible. For example, since implementation of the HIPC initiative began, the Boards have agreed to modifications to the HIPC framework that have increased the number of countries eligible to receive relief and may raise the amount of relief for other countries. The changes contributed to increases in the projected amount of relief from $5.6 billion in June 1996 to $8.2 billion in August 1998 in 1996 present value terms. According to HIPC documents, these changes reflect the desire of some countries to make the plan more inclusive, concerns about the quality of available data on worker remittances, and updated information. A World Bank official said modifications to the HIPC framework respond directly to concerns of debtor countries and help to mitigate the countries’ vulnerabilities. Some countries have expressed concern about increased costs and cautioned that eligibility decisions should not be made before the financial implications of the agreed-to modifications are assessed. For example, expanding the eligibility criteria to specifically take into account government spending (fiscal criteria) allowed countries such as Côte d’Ivoire and Guyana to become eligible for the HIPC initiative and raised projected HIPC relief by about $600 million in present value terms. Advocates for the expansion of the eligibility criteria were concerned that certain countries with very open economies, and thus relatively low debt-to-export ratios, were improperly characterized as having a sustainable debt burden under the HIPC initiative. According to a World Bank official, the fiscal criteria reflect the Boards’ desire to maintain the original framework while allowing some flexibility in addressing the debt problems of very open economies. Moreover, the fiscal criteria may increase further the number of countries eligible for assistance. Additionally, changes to country-specific analyses and an increase in the potential assistance offered by the HIPC initiative for post-conflict countries, particularly the Democratic Republic of Congo (formerly Zaire), contributed about $1 billion to increased estimates of HIPC debt relief. According to HIPC documents, the increase for the Democratic Republic of Congo is based primarily on new projections that include slower growth in the volume of mineral exports and lower world prices as well as increased debt due to a buildup of late interest and arrears. The World Bank and the IMF caution that any estimates for post-conflict countries are subject to significant change. Changes made in 1997 in the way the amount of exports is calculated also have increased the projected amount of HIPC relief. The first change involved agreement that exports would be calculated using an average of 3 years of data, rather than 1 year as assumed in the first cost estimates of the HIPC framework. According to HIPC documents, this change was a compromise between the desire to obtain a recent actual measure for a country’s export capacity and the desire to smooth out export fluctuations by providing a longer-term base. While this change in methodology may seem like a small refinement, it increased the total estimated amount of HIPC debt relief by about $1 billion, according to HIPC documents. A second change involved the evaluation of worker remittances. These were originally intended to be added to exports but are no longer included due to limited data quality and availability. When worker remittances are not included, the estimated amount of export earnings available for servicing the debt is lowered. Thus, the exclusion of worker remittances increases a country’s debt-to-export ratio. The resulting higher ratio allowed at least one country—Burkina Faso—to become eligible and increased projected relief by about $130 million, according to the World Bank and the IMF. The amount of HIPC debt relief provided will also be influenced by the actions taken by debtor countries to establish the necessary track record of reform. If countries included in the estimates do not undertake required reforms and thus do not receive HIPC relief, the amount of relief could decrease. On the other hand, the total projected amount of debt relief could increase if countries that were not included in the estimates—such as Liberia, Somalia, and Sudan—establish the necessary track records of reform and become eligible for relief through the HIPC initiative. At the end of 1996, in present value terms, Sudan had $15.6 billion of outstanding debt—one of the highest debt levels among potential HIPC recipients. According to preliminary estimates from the World Bank and the IMF, if Sudan qualifies for HIPC debt relief, reducing its debt-to-export ratio to 200 percent would require about $4.5 billion in HIPC debt relief. Providing debt relief to Sudan through the HIPC initiative could, thus, significantly increase the cost of the initiative relative to current estimates. Undertaking the steps necessary to qualify some countries—such as Liberia, Somalia, and Sudan—for the HIPC initiative will involve significant efforts and resources because they have not established the necessary 3-year track record of reform. Further, some of these countries have significant unpaid debt, including debt owed to official creditors. For example, clearing unpaid debt for Sudan, which had arrears of about $6 billion as of year-end 1996, will involve significant financial resources. The IMF reported that Sudan made scheduled payments to the IMF in 1997 and has begun to reduce its arrears to the IMF but has increased its unpaid debt owed to other external creditors. In agreeing to the HIPC initiative, the IMF and the World Bank Boards established a broad framework for debt relief but left many of the specifics regarding the extent of that relief and how it would be carried out still to be determined. Different creditor country perspectives on matters ranging from burden sharing to required reform track records have required extensive negotiation during the implementation phase. For the first six countries to qualify for relief, the Boards have decided on relief amounts at the upper end of the framework as agreed to, and with shortened reform periods for five countries. The extent to which those decisions establish a precedent for future relief remains to be seen, especially with respect to reform periods, since the early qualifiers have relatively strong reform records. The costs of debt relief have influenced design and implementation decisions. The amount of relief that will be provided through the HIPC initiative is not yet known and is dependent on eligibility, timing, and relief amount decisions still to be made. The World Bank commented that substantial effort was put forth by creditors in the design and implementation of the HIPC initiative and that an expanded discussion of how the initiative is being financed would be useful. We agree and have expanded our discussion of these issues, including how the HIPC Trust Fund is being financed, and included a listing of the multilateral institutions providing relief through the HIPC initiative (see app. III). The HIPC initiative will provide benefits to recipient countries; however, many will remain vulnerable to future debt problems, even with sound economic policies. In conjunction with existing debt relief mechanisms, such as relief from Paris Club creditors, the HIPC initiative will reduce countries’ debts by varying amounts, some substantially. Reductions in the amount of recipient country resources that are used for debt service will also vary and are difficult to determine due to prior arrears and the use of donor resources in some cases to help make debt payments. The limited evidence for the particular debt targets in the HIPC initiative suggests that reducing debt-to-export ratios to near 200 percent is not likely to provide countries with a “cushion” to protect against adverse economic events. Strong export growth and substantial donor assistance are important to the HIPC initiative’s projections of sustainable debt burdens. For some countries, those export growth projections may turn out to be overly optimistic. If export earnings are lower than expected, financial support from bilateral and multilateral donors is assumed to increase. This assumption has been questioned given the budgetary pressures of major donor countries. The HIPC initiative has also focused attention on the limited capacity of some countries to manage their debt. Improvements in debt management are considered necessary for them to avoid future debt problems. The HIPC initiative will reduce the total amount of debt owed, in present value terms, by varying amounts for the first six recipient countries. This is because their initial debt and export levels vary widely. The present value of debt relief for these countries due to the HIPC initiative ranges from a low of 6 percent of debt for Côte d’Ivoire to a high of 57 percent for Mozambique, with the average reduction 22 percent for the first six participants. (See table 3.1.) Our analysis indicates that the amount of projected reduction in countries’ debt burdens since 1995 attributable to the HIPC initiative relief—as measured by the debt-to-export ratio—and the amount attributable to other factors vary greatly across the first six HIPC qualifiers. For example, we estimated that, for Uganda, 77 percent of the reduction in this ratio between 1995 and April 1998 (Uganda’s completion point under the HIPC initiative) is due to export growth, with 18 percent attributable to the HIPC initiative debt relief and 5 percent attributable to a combination of other debt relief and net borrowing. In contrast, for Côte d’Ivoire, 58 percent of the reduction can be attributed to other debt relief and net borrowing combined, 39 percent to export growth, and 3 percent to the HIPC initiative. (See app. V for information on the determinants of debt reduction for the first six countries.) The HIPC initiative is expected to reduce debt service obligations by varying amounts for the countries for which preliminary projections are available, although the reduction in how much countries will actually pay to service their debt is difficult to determine. Table 3.1 shows estimated reductions in debt service owed by HIPC recipients, based on HIPC documents and our analysis. The effective reduction from the HIPC initiative on the debt service actually paid by participants is hard to gauge for several reasons. First, some countries experienced substantial arrears in servicing their debt prior to receiving debt relief. The IMF has estimated how Mozambique’s debt service payments will be affected by debt relief.The scheduled annual debt service payments are expected to be dramatically reduced by the combination of the HIPC initiative and existing Paris Club (Naples terms) debt relief. The HIPC initiative itself will reduce scheduled debt service payments in 2000-03 by 42 percent (from $170.5 million to $98.7 million per year) from the obligations remaining after the Paris Club relief. (See table 3.2.) However, Mozambique was paying only about 30 percent of its scheduled annual debt service in 1995-98 ($113.2 million of $375.3 million). Thus, the projection is that the scheduled debt service payment of $98.7 million in 2000-03 will only be about 13 percent less than the annual debt service of $113.2 million Mozambique was actually paying in 1995-98, prior to relief. A second complexity in assessing the effect of debt relief on a country’s finances is that a substantial portion of the debt service paid by these countries is financed through donor and creditor resources. Thus, it is very difficult to determine how a reduction in debt service owed—or even debt service paid—by HIPC recipients will affect the net flow of resources to a recipient country, and we were generally unable to make that determination. This is most clearly evident in Uganda’s recent experience. In 1995, Uganda established a Multilateral Debt Facility through which bilateral donors, primarily Denmark, the Netherlands, Norway, and Sweden, channeled resources directly to pay Uganda’s multilateral debt service. Payments to this facility averaged $45 million per year in 1996 and 1997. In contrast, HIPC initiative debt relief is reducing Uganda’s annual debt service burden by an average of around $30 million per year. (Because the relief is being “front loaded” at Uganda’s request, debt service in the first 5 years will be reduced by about $39 million annually and by about $20 million annually in subsequent years.) According to Ugandan officials, they would need to continue to receive $15 million per year in assistance from these bilateral donors, in addition to other aid flows that were being received, to be in as strong a position after the HIPC initiative relief as before. This assumes that the Facility would continue to be funded at the same level. Ugandan officials told us that they hoped some of the future assistance would be channeled into social sector aid, such as education, although an IMF official noted that these funds were approved by donor governments for debt relief and shifting them into other types of aid may not be straightforward. Countries receiving debt relief through the HIPC initiative will need to maintain strong economic performance and, in most cases, continue to receive large amounts of donor assistance in order to service their debt. The limited analytical evidence that exists for the debt targets used in the HIPC initiative suggests that countries with debt-to-export ratios near the bottom of the 200-250 percent range may still have unsustainable debt burdens. The HIPC initiative’s projections assume that, after completing the HIPC initiative, countries will maintain sustainable debt levels in part through strong export growth. In addition, for most countries, substantial donor assistance is expected to continue, including balance-of-payments support. Finally, the HIPC initiative analysis assumes that, if adverse economic events do occur, such as a significant decrease in the price of a key commodity, the countries’ needs for financing will be met with increased donor assistance. There is no strong analytical evidence supporting the decision concerning the HIPC initiative’s target range of the debt-to-export ratio. The World Bank and the IMF have provided limited support for the conclusion that debt at the 200-percent debt-to-export ratio was sustainable, and no analysis to support ratios in the upper end of the target range (250 percent). World Bank reports have suggested that debt-to-export ratios above 200 percent indicate potential debt problems in poor countries, and a 1996 World Bank document noted that a debt-to-export threshold of 200 percent indicates that at this level a country is likely to have difficulty servicing its debt. World Bank and IMF officials cite two internal World Bank studies as support for their stated debt-to-export ratios. We believe these studies have limited relevance for determining the HIPC initiative’s target ratios for two reasons. First, their analysis was based primarily on middle-income countries and, second, they examined debt levels at which countries began to experience debt servicing problems, not when they might emerge from such problems. One study, done in 1990, analyzed 1980-87 data on 111 countries to determine at what level of debt relative to exports countries began to experience problems servicing their debt. The study found that countries that did not experience debt servicing problems generally had debt-to-export ratios below 200 percent. However, 30 percent of the countries that did experience debt service problems had debt-to-export ratios below 200 percent throughout the period. The second study, dated in 1996, examined approaches for predicting when countries would have problems with debt service. It concluded, based on examining Mexico’s ability to service debt at the height of its 1984-89 debt crisis, that a debt-to-export ratio above 198 percent could yield debt servicing problems. Debt-to-export ratios at or slightly above 200 percent are in the upper part of the range the World Bank uses to classify countries as moderately indebted. Our analysis shows that a number of countries classified as moderately indebted have subsequently experienced debt servicing problems. Of the 11 countries classified by the World Bank in 1991 as moderately indebted low-income countries, four (Benin, Central African Republic, Mali, and Togo) have subsequently had their debt rescheduled through the Paris Club. In addition to the concerns over the particular levels of the debt sustainability indicators under the HIPC initiative, there is a concern that the indicators are narrow. A particular concern is that the focus on export-based indicators does not directly consider the overall economic capacity of a country or the particular level of demand for government expenditures. For example, critics have argued that the export-based indicators do not reflect the extent to which governments’ social spending needs vary across potential recipient countries. A related concern is that since export revenues generally accrue to the private sector, they are not necessarily indicative of resources available to these governments. A recent study commissioned by the IMF to evaluate its ESAF programs cited the above concerns in suggesting that, in general, a more appropriate measure of a country’s debt burden would be the ratio of debt to its overall national income. The addition of fiscal, or government spending, criteria for determining debt sustainability has done little to satisfy critics. To qualify for debt relief under the HIPC initiative’s fiscal criteria requires that three conditions be met: a country’s present value of debt-to-government revenue ratio must exceed 280 percent, a country’s exports-to-GDP ratio must exceed 40 percent, and a country’s government revenues-to-GDP ratio must exceed 20 percent. These conditions are likely to be met by just a few countries. The World Bank and the IMF have not provided any economic justification for these particular levels. They have stated that the 280 percent debt-to-government revenue ratio is somewhat arbitrary. The HIPC initiative documents note that if this ratio were set much lower than 280 percent, the overall cost of the HIPC initiative would rise substantially. Some debt experts have questioned the statement in HIPC documents that the HIPC initiative debt relief will reduce countries’ debts to a point that will significantly diminish any debt overhang effect. Whether debt overhang constitutes a serious obstacle to investment in HIPC countries has been debated during the HIPC initiative’s implementation, with some officials and analysts doubting its significance and others continuing to cite reduction of debt overhang as a primary benefit of the HIPC initiative. Several analysts maintain that high debt levels do deter investment in HIPC countries but some also question whether the levels of debt reduction under the initiative will significantly reduce that effect. Some experts have observed that the way debt burdens are measured under the HIPC initiative—in present value terms—may not correspond to investors’ perceptions about how high a country’s debt burden is. Although present value is a useful way of comparing different debt burdens when the degree of concessionality of the debt varies widely, investors are more likely to look at debt in nominal terms, according to one debt expert. He noted that, beyond the creditors, the concept of present value is not widely understood. Since the present value of concessional debt is generally lower than its nominal value, countries will generally be left with debts that are higher in nominal than in present value terms. The economic projections in HIPC initiative analyses generally assume a steady growth in export revenues for HIPC countries. This assumption is an important element in the initiative’s expectation that HIPC recipients will have a sustainable debt burden. As exports grow, the indicators of indebtedness steadily improve, for a given level of debt. Exports have grown for most of the HIPC recipient countries in recent years. However, projections in HIPC documents assume significantly greater export growth in the years ahead. The first six countries deemed eligible for debt relief under the HIPC initiative had annual average growth rates in exports of 4.5 percent between 1985 and 1995. (See table 3.3.) HIPC documents project that in years after they receive relief under the initiative, these same countries will achieve an average annual growth in exports of 7.8 percent, a 75-percent increase over the previous period. Most of the countries that have been approved for relief under the HIPC initiative are dependent on a few primary commodities for a majority of their export earnings. (See table 3.4.) For this reason, their export earnings are considered to be particularly vulnerable to adverse economic events. For example, a significant fall in the price or output of a country’s primary export could bring the debt ratios to levels that once again exceed the HIPC initiative’s target levels for debt sustainability. In the case of Uganda, approximately 66 percent of its export earnings in 1995 derived from one commodity, coffee, whose world price was near a 10-year high. According to HIPC documents, a 20-percent drop in the international price of coffee would raise Uganda’s debt-to-export ratio by 30-40 percentage points. (Figures 3.1 and 3.2 illustrate the historical volatility of the world prices of coffee beans and also of cocoa beans, which are the main export commodity of Côte d’Ivoire.) Moreover, Uganda’s recent experience illustrates the sensitivity of export earnings to variation in the amount produced. World Bank and IMF officials have cited increases in Uganda’s export earnings (1995/96 and 1996/97) as evidence that the HIPC initiative’s assumptions of countries’ increased exports are reasonable when countries undertake necessary reforms. However, Uganda’s most recent export data (1997/98) underlines concerns about the volatility of exports, with Uganda’s exports projected to decline about 23 percent. Poor weather conditions in 1997/98 and the resulting decline in coffee exports are cited in HIPC documents as the reason for projected increases in Uganda’s debt-to-export ratio in 1997/98 through 1999/2000. Similarly, a single commodity, cotton, accounts for 46 percent of Mali’s exports, and its top three commodities account for 76 percent. According to HIPC documents, any one of three events would put Mali’s debt ratios at unsustainable levels through the projection period (2017). These events include (1) a drought similar to that experienced by Mali in 1972-75 and 1983-85, (2) a 15-percent decline in gold prices, or (3) a 20-percent decline in cotton prices. In the case of Burkina Faso, an important element in its projected increase in exports is a steady 10-percent growth in gold exports. However, a recent sharp decline in the price of gold has substantially reduced investment in this sector and, according to a World Bank official, created considerable doubt regarding the likelihood that Burkina Faso will achieve the projected increases in gold production. A key element in the HIPC initiative’s projection of debt sustainability is that countries receiving debt relief will continue to get substantial foreign aid well into the future. This expected assistance includes not just aid to support development projects within countries but also concessional financing, including balance-of-payments support. For example, macroeconomic projections done by the World Bank and IMF staff at Uganda’s April 1998 completion point show that, with its HIPC initiative debt relief of $347 million in present value terms, Uganda will continue to require donor assistance to meet its external debt and balance-of-payments needs until 2006. The inclusion of balance-of-payment support by donors within the HIPC initiative complicates the definition of debt sustainability and the establishment of a proper target level, since any level of debt could be considered “sustainable,” given a sufficient amount of donor support. According to World Bank officials, if a HIPC recipient country that is adhering to agreed-on reforms experiences circumstances that result in debt servicing problems, increased donor flows to that country will be forthcoming. A World Bank official cited commitments by some governments, for example, to provide the assistance Uganda needs in order to meet debt servicing obligations after the HIPC initiative relief, provided reforms continue. Future donor flows to potential HIPC recipients depend, of course, on many factors. However, the assumption that donor support of HIPC recipients will continue at current levels and will, under adverse conditions, increase has been questioned, given that net concessional flows from governments and multilateral institutions to poor countries have declined since 1990. Moreover, the World Bank observed in 1998 that the future prospects for official concessional financing worldwide are bleak due to fiscal pressures in Europe and Japan, the largest donor by volume, and to continued public concern over spending on foreign aid in the United States. Additionally, officials from the U.S. Treasury, other governments, and NGOs have raised questions about whether governments will simultaneously provide debt relief, increased concessional financing, and substantial contributions to replenish the international financial institutions, particularly in light of their own budget constraints. Officials we spoke to from other governments, including France and Germany, noted that creditors are likely to continue financially supporting countries, but the amounts are uncertain due to costs and fiscal pressures. The HIPC initiative has focused international attention on the limited debt management capacity of many poor countries. This limitation is a potential hindrance to their ability to emerge from their debt problems and avoid future unsustainable debt levels. Many HIPC participants and debt experts have noted that assistance with debt management has been a significant benefit of the initiative, although some have expressed frustration that the pace of improvement is slow. HIPC countries vary greatly in the quality of their capabilities for tracking and managing debt. Few HIPC countries have the capacity to analyze debt in a broader economic context, according to developing country experts, which limits their ability to participate fully in the analysis of their debt relief requirements under the initiative and to avoid future debt problems. Even for countries with basic debt management systems in place, analyzing how debt and debt reduction can affect their overall macroeconomic situations poses a major challenge. According to the World Bank and the IMF, in recent years almost every country classified as a HIPC has received a substantial amount of technical assistance intended to improve its ability to manage debt. Most of this assistance has been concentrated on information management—on improving accounting systems for recording and tracking financial obligations. These efforts have resulted in significant improvements in many HIPC countries. They have been largely organized by UNCTAD and the Commonwealth Secretariat, both of which have developed and installed debt management software and provided extensive training. In addition, these countries have received significant support from several bilateral donors. However, countries that are candidates for debt relief under the HIPC initiative vary greatly in the degree to which they have in place the technical and governance requirements for effective debt management. Two early qualifiers for the initiative, Uganda and Bolivia, stand out as countries that have relatively well-developed capabilities for tracking and managing debt. Uganda, for example, has been using the UNCTAD debt data management software since 1985 and operating it independently since 1993. This capability constituted a major challenge for the country, according to government officials, due in part to destruction from 2 decades of civil war that included the burning of the Treasury building. In addition to increasing technical capacity, Uganda moved on the constitutional front, in 1994 giving its parliament all powers to contract new debt. Similarly, according to government officials, Burkina Faso established a centralized committee that would have to approve any new government borrowing. The capacity of some HIPC countries to accurately track their financial obligations is still weak, however. Many African countries, especially, lack the capacity to maintain accurate loan records and track the timing and amount of debt servicing obligations. This can result in situations where various agencies within a government engage in external borrowing with no central control over, or even complete knowledge of, total debt amounts, according to officials from countries we visited. For some HIPC countries, initial examination of debt data has revealed inconsistencies, according to an official from UNCTAD. In some countries, the division between different agencies of institutional responsibilities for debt management and the inability to retain skilled staff have created problems. Due in part to concern about countries’ ability to manage their debt, under IMF-supported programs, ceilings are to be negotiated on countries’ new borrowing on nonconcessional terms. According to an IMF official, for heavily indebted poor countries, the ceiling is generally understood to be a low amount. Following receipt of debt relief through the HIPC initiative, Uganda has agreed to limit its nonconcessional borrowing to $10 million annually for the next several years. Burkina Faso and Côte d’Ivoire are two HIPC countries that are in the earlier stages of receiving assistance with debt management. At the beginning of the HIPC initiative process, the government of Burkina Faso was unable to project the effect of new debt on future debt service. The government asked a private consultant for assistance in understanding and qualifying for the HIPC initiative. Now, with the support of the Swiss government, Burkina Faso is in the process of implementing the UNCTAD debt management system. However, according to donor and recipient officials, improvements in debt management in Burkina Faso are moving very slowly. The country needs to develop up-to-date and accurate debt data, install computer equipment and software to replace the manual records currently being used, and train staff to manage the financial management system before the country can move much further. In Côte d’Ivoire, manual records are generally still used due to budgetary constraints, and the government has yet to receive significant outside assistance on debt management. UNCTAD recently completed a needs assessment, and expectations are that Côte d’Ivoire will have the UNCTAD system by January 1999. In addition to computer hardware and software, training and other related technical support are needed. Even with a system of basic debt data management in place, analyzing how debt and debt reduction can affect a country’s overall macroeconomic situation poses a challenge most HIPC participants cannot meet, according to officials from the United Nations and recipient governments. This is due both to a lack of accessible modeling techniques and limited technical expertise. World Bank and IMF staff have developed very complex and nonuniform spreadsheets to conduct debt sustainability analyses for countries potentially receiving debt relief under the HIPC initiative. World Bank and IMF officials acknowledged early in the HIPC initiative process that the absence of a uniform, documented standard for simulating debt reduction exercises would make it difficult for countries to participate fully in analyzing their debt situations. The World Bank set as a priority the development of such a model to be made available to interested countries. According to World Bank and IMF documents, this software was to be designed to be easily linked to the debt data management software put in place by UNCTAD and the Commonwealth Secretariat. However, as of August 1998, this software was not generally available for countries’ use. According to officials at UNCTAD, restructuring and downsizing at the World Bank has resulted in loss of the expertise needed to complete the software and make it available. According to a Bank official, versions of the software are being tested in some countries. Other efforts to assist countries in developing the capacity to independently formulate their own debt strategy and debt sustainability analysis include the program undertaken by Debt Relief International, an NGO based in London, with funding from the governments of Austria, Denmark, Sweden, and Switzerland. The program also intends to help governments maximize their ownership and leadership of debt reduction and to demonstrate to the donor and creditor community a high level of debt management. The program is thus driven by recipient countries’ requests for it. According to Debt Relief International, it has received requests for assistance from 16 heavily indebted poor countries. The capacity and will to closely monitor future borrowing after completing the HIPC initiative is critical to avoiding further debt problems, according to debt experts and some recipient country officials. Despite receiving relief through the HIPC initiative and implementing strong economic policies, many recipient countries will remain vulnerable to future debt problems. Although the HIPC initiative has focused attention on the debt problems of poor countries and is substantially reducing the debt burdens of some, an expectation that all recipient countries that follow sound economic policies will avoid future debt problems is unrealistic. Projections that debt burdens are sustainable for HIPC recipients assume that economic conditions for these countries remain favorable and donors remain committed to assisting these countries in meeting their development goals and debt obligations. These assumptions may prove to be optimistic given the cyclical nature of many of these countries’ major exports and recent declines in donor assistance. Furthermore, the expectation that recipient countries will effectively track existing debt and ensure that new debt is affordable may also prove optimistic in some cases. The organizations commenting on our report emphasized that recipients of debt relief through the HIPC initiative are and will remain vulnerable to economic difficulties. The IMF stated in particular that the ESAF program, as well as other donor support, could be used to help recipients facing economic shocks. Our analysis points out, however, that these countries will generally depend on support from the IMF and other donors to service their debt and cover other external financing needs, even under the HIPC initiative’s assumption of favorable economic conditions. Their overall economic vulnerabilities suggest that some are likely to need increased levels of such external financing, even after debt relief. The World Bank stated that the HIPC initiative recognizes the vulnerability of recipient countries, and this is reflected in the initiative’s choice of debt relief targets near 200 percent. The World Bank also stated that the report’s conclusion that many countries remain vulnerable to debt problems could be viewed as an implicit recommendation for increasing relief amounts. Our assessment that countries remain vulnerable to future debt problems is based on our analysis of the relief targets used in the HIPC initiative, the high concentration of these countries’ exports, and the reliance of these countries on donor flows for continued debt support, separate from their development needs. While our analysis concludes that countries remain vulnerable to future debt problems, we are not recommending greater relief. We recognize that debt relief under the initiative will benefit participants, but conclude that some recipient countries may once again experience debt problems. This assessment highlights the limitations of the initiative and should prove useful in future discussion among those responsible for policy decision in this area. In addition, the World Bank said that the initiative’s export projections derive from estimates made by the World Bank, the IMF, and the recipient country and are higher than the historical average due to the positive effect of sustained policy reform. Our conclusion that the initiative’s export projections are optimistic is based on analysis of countries’ historical export growth rates and the concentration of these countries’ exports. The cyclical nature of the prices of some of the primary export commodities of HIPC recipient countries is not accounted for in the underlying analyses of the initiative. Although sustained policy reform could improve these countries’ export prospects, changes in commodity prices and outputs can be outside the influence of individual countries. Our report provides an example of this when poor weather conditions resulted in declining coffee exports and increases in Uganda’s debt-to-export ratio in 1997 and 1998.

Summary: Pursuant to a congressional request, GAO reviewed the: (1) implementation of the Heavily Indebted Poor Countries (HIPC) Debt Initiative; and (2) initiative's potential to achieve its stated goal of bringing poor countries' debts to sustainable levels. GAO noted that: (1) the HIPC initiative will help reduce participating poor countries' debt burdens, in some cases, substantially; however, many will remain vulnerable to future debt problems even with sound economic policies; (2) the implementation of the HIPC initiative reflects compromise among the major official creditors on issues such as countries' eligibility and the total amount of debt relief to be provided; (3) in recognition of countries' economic vulnerablities, creditors have generally agreed on relief amounts that are at or close to the upper bounds of what the negotiated framework allows; (4) nonetheless, in order to avoid further debt problems, countries receiving debt relief through the HIPC initiative are assumed to maintain strong economic performance and continue to receive large amounts of donor assistance; (5) in most cases this assistance includes balance-of-payments support; (6) the HIPC initiative projections assume that countries will maintain sustainable debt levels in part through strong export growth; (7) these export growth assumptions may be optimistic for some countries; and (8) since many HIPC recipients rely upon a few commodities for their export earnings, they are particularly vulnerable to economic events such as a decline in the price or output of a primary export.