The World Bank and IMF have classified 42 countries as heavily indebted and poor; three quarters of these are in subSaharan 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. Under the enhanced HIPC Initiative, countries seeking debt relief must first carry out economic and social reforms under specified programs. At a country’s decision point, the World Bank and the IMF assess the country’s eligibility to receive debt relief under the initiative. At the completion point, the World Bank and the IMF assess whether the country has continued to implement sound economic policies and is eligible to receive full debt relief. To determine the amount of assistance that is required for each country to achieve debt sustainability, the World Bank and the IMF prepare detailed economic analyses called debt sustainability analyses (DSA), which include economic projections covering 20 years. To date, 27 poor countries have reached their decision points, and 10 of these have reached completion points. (See app. II for the status of each country.) 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. The United States has already paid $600 million of this total. 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.) The World Bank’s share of the shortfall is $6 billion, which it will begin addressing in spring 2004. The AfDB needs to secure at least $1.2 billion in additional funding. The IaDB expects to finance its $600 million shortfall by reducing future lending to poor countries. Bilateral donors may be asked to contribute additional funds under the existing initiative; the United States may be called on to contribute an additional $1.8 billion. However, the total projected funding gap of $7.8 billion is understated because the World Bank estimate does not include the costs for four countries that are eligible for debt relief but for which data are unreliable. In addition, the estimates of all three banks do not account for any additional relief that may be provided to countries because their economies deteriorated since they qualified for debt relief. 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. About $8.8 billion of this debt relief cost is for the highly concessional loans made by IDA, which provides financing to the World Bank’s poorest member countries. The remaining $700 million in debt relief is for loans made by the International Bank for Reconstruction and Development (IBRD), which provides market-based loans to the World Bank’s middle-income member countries. 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.) To cover this gap, we estimate that IDA’s financing needs beginning in 2006 for 34 HIPCs will be about $584 million on average per year through 2020. In 2002, donor countries agreed to review 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. For example, a portion of its net income is retained annually to ensure IBRD’s financial integrity. IBRD has also provided substantial resources to IDA for its new lending, representing about 24 percent of its net income over the last 5 years. Moreover, countries that borrow from IBRD have also benefited because this net income provides partial waivers of the interest and commitment fees IBRD charges on its loans. The total cost of debt relief 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. Taking into account the total funds the AfDB has identified thus far from the HIPC Trust Fund, its internal resources, and its annual cash flow projections, AfDB estimates that it would have sufficient funds to cover its share of HIPC commitment to its 23 current decision and completion point countries up to 2007. 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. 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. First, assuming that the United States contributes at its historical replenishment rate of 11 percent, we estimate the U.S. share of AfDB’s financing shortfall could be at least $132 million. However, as of October 2002, the United States had contributed or pledged approximately 29 percent of the bilateral donors’ resources committed to the HIPC Trust Fund. Under that contribution rate, the U.S. share of the AfDB’s financing shortfall would be about $348 million. 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 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 lending resources in its FSO lending program for the years 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 for the years 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 U.S. historically contributes to the FSO. The $7.8 billion shortfall for the three MDBs is understated for two reasons. First, data for four eligible countries are unreliable. 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. The World Bank and IMF estimate that this additional relief could range from $877 million to $2.3 billion. 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. 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. Our estimate of the likely funding shortfalls confronting the MDBs, discussed above, does not account for this potential additional debt relief. The World Bank and IMF made a preliminary estimate that this additional relief could cost from $877 million to about $2.3 billion, depending on whether additional bilateral relief is included or excluded from the calculation. (See fig. 1.) 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. Donor countries currently disagree on whether bilateral debt relief provided outside the HIPC framework should be counted as part of the debt relief needed for countries to achieve their debt sustainability targets. Donors that support including additional bilateral relief in topping-up calculations would benefit through lower additional costs. For instance, most Paris Club countries would not have additional costs for relieving their bilateral debt because they have already pledged 100-percent debt relief, but they could be asked to fund the multilateral creditors’ debt relief. In contrast, if additional bilateral relief were excluded from topping- up calculations, creditors’ HIPC costs would increase substantially. In this case, Paris Club creditors would be faced with higher HIPC bilateral costs, as well as potential contributions to cover higher multilateral creditors’ costs. Donors that support this method intend to provide HIPCs with a cushion against external shocks by ensuring that additional bilateral relief results in debt ratios below the targets. Using the lower cost methodology and limiting the analysis to the countries that have qualified but have yet to receive final debt relief, the World Bank and the IMF project that at their completion points seven countries would exceed the debt-to-export ratio calculated at their decision points. In addition, if the lower cost methodology were to consider countries that have already reached their completion points and received topping up, the total estimate would increase to about $877 million. The World Bank’s share would be $459 million, and the AfDB’s share would be $127 million. (See fig. 1.) If the additional bilateral relief is excluded from the topping up calculation, as some donor countries advocate, the amount of additional debt relief increases from $877 million to $2.3 billion, including the cost for countries that have already reached their completion points. Under this methodology, the cost to the World Bank and AfDB for topping-up would approximately double. (See fig. 1.) Depending on the method used to calculate topping up, 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. 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. 2). If the United States decides to help fund the $375 billion, we estimate it would cost approximately $52 billion over 18 years. According to our analysis of World Bank and IMF projections, bilateral donors and multilateral creditors are expected to provide $153 billion in development assistance to 27 HIPCs from 2003 to 2020. These estimates assume that the countries will follow their World Bank and IMF development programs, including undertaking recommended reforms and achieving 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. 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 if their exports grow at an average of 7.7 percent each year, they receive debt relief under the HIPC Initiative, and donors provide their expected assistance. 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—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. For countries to achieve the economic growth rates consistent with their development goals, donors would need to fund the $215 billion shortfall. Without this additional assistance, countries would grow slower, resulting in reduced imports, lower gross domestic product (GDP), and lower government revenue. These conditions could undermine progress toward poverty reduction and other goals. 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. In considering strategies for future debt relief, we examined (1) switching various percentages of multilateral loans to grants and (2) paying each country’s debt service-to-fiscal revenue ratio in excess of 5 percent of government revenue. A country’s debt service-to-fiscal revenue ratio more closely links the country’s debt burden to the ability of the public sector to generate income. Many HIPC countries are suffering public health crises, most notably HIV/AIDS, which could put an additional burden on government revenue. 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 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 (see table 4). 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 5- percent debt service-to-revenue goal 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 billon 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. The export earnings of HIPC countries experience large year-to-year fluctuations due to their heavy reliance on primary commodities, 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. See appendix VI for a detailed discussion of the impact of fluctuations in export earnings on debt sustainability. We received written comments on a draft of this report from the Department of the Treasury, the World Bank, AfDB, and IaDB. These comments and our evaluation of them are reprinted in appendixes VI, VII, VIII, and IX. The organizations also provided technical comments that we discussed with relevant officials and have included in this report where appropriate. The Treasury stated that the report leaves the impression that very large amounts of money will be needed in the future; the HIPC Trust Fund has a financing gap; and the HIPC Initiative was never intended to ensure an exit from unsustainable debt burdens. We agree that the challenge of achieving high economic growth rates, while maintaining debt sustainability, will likely require a substantial commitment of resources from the donors beyond what the World Bank and IMF project. Our report refers to financing challenges over the life of the initiative, not specifically to the HIPC Trust Fund at this point in time. Under the current pay-as-you-go approach, we did not identify a gap in the HIPC Trust Fund. However, as Treasury recognized in its letter, there are several factors that are likely to result in the need for additional resources in the future. Our report provides estimates of those and other emerging costs. Numerous official World Bank and IMF documents, as recent as 2003, affirm that a permanent, lasting, or durable exit from unsustainable debt remains a central objective of the HIPC Initiative. While the Treasury may have retreated from this objective, the World Bank and IMF have not. The World Bank disagreed with the assumption that deviations from projected debt profiles would be offset only through additional debt relief or compensatory financing, and not through other forms of adjustments. We disagree with this characterization. The report explicitly states that donors have the option of not financing the export shortfalls, however, this will reduce the funds available for poverty reduction and hamper countries’ economic growth. The World Bank concurred with our finding that long- term projections of export growth rates need to be more realistic and the report’s emphasis on pursuing a sustainable development finance strategy for countries that have received debt relief. AfDB said that our estimate of the financing shortfall for the 23 countries that have already qualified for debt relief is overstated. We disagree with this assessment. We consider our estimate to be more accurate because it accounts for the actual amount of resources the AfDB has identified to contribute to the initiative and converts the estimate into 2003 dollars. The AfDB also said that our finding that countries are likely to need considerable assistance in the future to meet their debt relief and economic growth targets is likely to be correct. All three institutions said that our use of historical export growth rates are not good predictors of the future because significant structural changes are underway 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. IaDB agreed with our report. As agreed with your office, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days from the report date. At that time, we will send copies of this report to the Honorable John Snow, Secretary of the Treasury, and to appropriate congressional committees. We are also sending copies to the World Bank, AfDB, IaDB, and IMF. Copies will be made available to others upon request and at no charge on the GAO Web site at http://www.gao.gov. If you or your staff have any questions regarding this report, please contact me on (202) 512-8979. Other GAO contacts and staff are acknowledged in appendix X. The Chairman and Ranking Member of the House Financial Services Committee and the Chairman and Ranking Member of the Subcommittee on Domestic and International Monetary Policy, Trade, and Technology of the House Financial Services Committee asked us to conduct a review of the Heavily Indebted Poor Countries (HIPC) Initiative. In response, we assessed (1) the multilateral development banks’ 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. The scope of our work involved three key multilateral development banks (MDB)—the World Bank/International Development Association (IDA), African Development Bank (AfDB)/African Development Fund (AfDF), and the Inter-American Development Bank (IaDB)/Fund for Special Operations (FSO), as well as the 42 potentially eligible HIPCs. (See app. II for the status of the 42 countries potentially eligible for HIPC and their membership in the MDBs.) To determine the MDBs’ financing shortfall in present value terms, we analyzed each bank’s cost and the total funding each institution has identified. This analysis covered 34 countries for the World Bank, 32 for the AfDB, and 4 for the IaDB. To determine the amount of debt relief each bank has committed to under the initiative, we reviewed documents prepared by the World Bank, AfDB, IaDB, and the International Monetary Fund (IMF). To determine the amount of internal and external resources available for each bank, we reviewed their implementation status reports and financial statements. This information included the amount of money that each MDB has already received or expects to receive from the HIPC Trust Fund. We also determined the amount of funds each bank currently has and expects to receive annually to calculate the present value of these commitments. This analysis also enabled us to determine the magnitude and timing of financing shortfalls for the three banks. To determine the amount of financing the U.S. government may be asked to pay for the MDBs’ financing shortfall, we obtained and reviewed information from U.S. Treasury officials regarding the U.S.’s historical rates of replenishment for each MDB, as well as the amount of funds the U.S. government has provided and plans to provide to each bank through the HIPC Trust Fund. We discussed our analysis with officials from the three banks and the U.S. Treasury. We analyzed World Bank and IMF staff projections contained within the debt sustainability analyses (DSA) to assess the impact of historical export growth rates on countries’ debt burdens and the funding needed to achieve economic growth and debt relief targets for the 27 countries that have reached their decision or completion points. According to our analysis of the DSAs, the World Bank and IMF project these countries will receive $153 billion in development assistance through 2020. Our analysis builds on prior work that examined the HIPC Initiative, including the World Bank and IMF DSAs. The DSAs contain 20-year economic projections for each country’s exports, national income, government revenue, debt stock, debt service, and other economic variables. Most countries’ DSAs also provide projections of expected future loans, grants, and balance of payment gaps. These projections provided us with the basis for creating a database to assess the impact of changing key assumptions such as export growth rates, percentage of multilateral assistance in the form of grants, and debt service assistance payments on countries’ debt targets. While the countries’ DSAs are publicly available, data inconsistencies among countries, gaps in information, and missing variables presented challenges in constructing a database for our analyses. Since few DSAs provided annual data for the entire 20-year projection period, and several DSAs were missing key economic variables, we used a variety of methodologies and statistical techniques to interpolate these missing data and compute missing variables. Consistent with the World Bank and IMF estimates, our analysis used the December 2002 Commercial Interest Reference Rate (CIRR) for the Special Drawing Rights (SDR). We reviewed the underlying methodology of the DSAs, vetted key assumptions, and discussed country-specific questions with IMF staff. We supplemented our analysis with additional information from IMF, World Bank, AfDB, and IaDB officials. To illustrate the impact of lower export growth on the cost to donors and on countries’ debt burdens, we substituted each country’s DSA export growth rate with its historical growth rate. The difference between the export earnings projected in the DSA and the export earnings projected using the historical rates is defined as the export earnings shortfall. In order to keep countries on their projected gross domestic product growth paths, we assume that donors will need to make up this shortfall. The present value of this shortfall for these 27 countries is $215 billion. We also analyzed how the form of financing the shortfall impacts countries’ debt burdens. If the shortfall is made up by grants only, each country’s debt remains the same. However, the countries’ debt-to-export ratios will increase due to lower export earnings. If the shortfall is made up by a mix of grants and loans, countries’ debt will increase. To determine the countries’ new debt burden, we calculated the debt service and the net present value of the debt from these new loans. To determine the amount of funding needed to achieve debt relief targets under projected and historical growth rates, we analyzed 40 different strategies for providing debt relief. These strategies included financing the export earnings shortfalls with grants only or a combination of loans and grants, switching the minimal percentage of loans to grants for each country to achieve debt targets, switching a constant percentage of loans to grants for all countries, and paying debt service in excess of 5 percent of government revenue. For each of these strategies, we calculated the potential costs to donors to help countries achieve the debt targets. These costs include foregone MDB loan receipts from switching baseline DSA loans to grants and the debt service assistance needed to achieve the 5 percent debt service-to-revenue target. Finally, we compared the results of the various strategies, highlighting those strategies that maximized the number of countries achieving debt targets while minimizing costs to donors. To assess how export volatility would affect the likelihood of achieving debt sustainability we used a Monte Carlo process that randomly drew 18,000 export growth rates (for each of 1,000 runs, 18 simultaneous draws, one for each year) from a distribution that reflects the historic growth volatility of each country. The distribution was based on the annual export growth rates from 1981 to 2000 for each country. In our Monte Carlo process, the 18 growth intervals of each country were assigned an equal probability of reoccurrence in the future. Projected export levels were then extrapolated with the growth rates randomly drawn from the country’s export growth distribution. To ensure that positive and negative growth rates were treated the same (or with equal weight) we incorporated growth rates into our model in a multiplicative fashion rather than in an additive form. The probability of achieving debt sustainability in 2020 was determined by the percentage of outcomes in 2020 with a debt-to-export ratio below 150 percent. We used three key variables—debt stock, historical rates of export growth, and MDBs funding sources—to assess both objectives. To assess the reliability of the debt stock data, we (1) discussed the data with the IMF and (2) reviewed their accounting process to determine outstanding country debt. Every alleged debt is vetted by both the country and the creditor and then independently reviewed by the IMF and the World Bank on behalf of the Paris Club. As we found this process to be rigorous, we determined that the debt stock data are sufficiently reliable for the purposes of our engagement. To assess the reliability of the historical rates of export growth, we reviewed the IMF and World Bank’s published documentation and records from our prior work that utilized these data. While these data have a number of limitations due to differences in data collection procedures in the 27 countries we reviewed, they are (1) used by the IMF to determine debt relief; (2) widely used by other acknowledged experts in this area; and (3) the only source of available data. Therefore, we determined that they are sufficiently reliable to use for examining the impact of debt relief on countries’ debt sustainability. To assess the reliability of the internal and external funding sources of the three MDBs, we (1) reviewed their debt relief financing plans; (2) reviewed the audited financial statements of the HIPC Trust Fund; and (3) corroborated the funding sources through interviews with knowledgeable MDB staff in budget, accounting, and finance. We determined the funding sources were sufficiently reliable for the purposes of this review. We performed our work from June 2003 to February 2004 in accordance with generally accepted government auditing standards. Forty-two countries are potentially eligible to receive debt relief under the existing enhanced HIPC Initiative. Since the enhanced initiative was launched in 1999, 10 countries have reached their completion points, meaning that the World Bank and IMF have determined that the countries have completed HIPC and are eligible to receive full debt relief. Seventeen are currently at their decision points, meaning the World Bank and IMF have determined they are eligible to receive debt relief under the initiative (see table 5). We analyzed 40 strategies for providing debt relief to poor countries. We highlighted three of these strategies in this report because we found they were the most cost effective. This appendix discusses some of the other strategies we analyzed and shows why they are less cost effective. These strategies included using a combination of multilateral loans and bilateral grants to fill the export shortfall and switching a constant percentage of loans to grants for all countries. In each case, donors face a series of costs, including $153 billion in expected development assistance, $215 billion to cover lower export earnings, and between $0 and $29.1 billion in debt relief. If donors choose to fill the $215 billion export shortfall with a combination of loans and grants, rather than grants alone, we found that countries will need $15.3 billion to $27.8 billion to achieve debt sustainability and debt- service goals (see table 6). If donors provide grants alone, we estimate that 12 of 27 countries would achieve debt sustainability, while only 6 would achieve sustainability if donors used a combination of loans and grants. We also found that the optimal percentage of loans switched to grants necessary for each country to achieve debt sustainability increases from 33.5 percent when grants fill the shortfall to 55.6 percent when loans and grants fill the shortfall, thus increasing the cost to donors. Providing grants alone is more cost effective because it avoids the build up of debt, improving countries’ likelihood of achieving debt sustainability and reducing the need for more debt relief in the future. The range in total cost of debt relief reflects the variation in additional costs, from $8.5 billion to $27.8 billion, in addition to the $153 billion in expected baseline development assistance donors provide and the $215 billion needed to cover the shortfall in countries’ export earnings. The strategies we examined in this report determined the minimum percentage of grants necessary for each country to achieve debt sustainability and resulted in a different percentage of grants for each country. While the provision of a consistent percentage of grants to each country may be the most equitable, we found that it would not be as cost effective as tailoring the percentage of grants to each country since some countries would not receive enough grants to achieve debt sustainability, while others would receive more than was required. For example, we estimate that switching 50 percent of new loans to grants would result in seven fewer countries achieving debt sustainability than would providing the minimum percentage of grants. Switching 50 percent of new loans to grants would cost over $6 billion more (see table 7). These options, therefore, are not the most cost-effective means of maximizing debt sustainability. In addition to the strategies mentioned in the report, you asked us to analyze the cost and impact of four specific options for increasing debt relief to poor countries. These options included switching 20 or 50 percent of loans to grants and reducing each country’s debt-service burden to 5 or 10 percent of revenue. With 20-percent grants, we estimate that 14 countries would achieve debt sustainability, while 18 would do so with 50- percent grants (see table 8). In each option, all countries would also reach the 5- or 10-percent debt service goal, as specified. The cost of these options ranges from $7.6 billion to $24.5 billion, in addition to assistance to fund the export shortfall. Consistent with the previous analysis, these options resulted in higher costs and/or fewer countries achieving debt sustainability. As described earlier in this report, we focused our analysis on three specific strategies for providing debt relief. The cost of these three strategies varies by country, as does their impact. Tables 9 to 11 below summarize these results. While the analysis in this report assumed constant export growth rates, consistent with the projections of the World Bank and IMF, the export earnings of HIPC countries are, in fact, highly volatile. The export earnings of these countries experience large year-to-year fluctuations due to their heavy reliance on primary commodities, weather extremes, natural disasters, and other factors. We found that higher export volatility, along with lower average growth rates, lowers a country’s likelihood of achieving debt sustainability. For example, under the World Bank and IMF export growth assumptions, which are usually higher than historical growth rates, all 27 HIPC countries are projected to be debt sustainable in 2020. However, we found that negative shocks tend to have greater impact on debt sustainability than positive shocks. After factoring in the impact of export growth volatility, we found that countries will not consistently achieve debt sustainability, with the average likelihood of achieving sustainability at 84 percent, despite the assumption of high export growth. We estimate that 10 countries have less than an 80-percent likelihood of achieving debt sustainability due to export volatility, with Rwanda having the lowest probability at 57 percent (see table 12). Countries with low export volatility, such as Honduras, tend to have a high likelihood of achieving debt sustainability under the high World Bank and IMF growth rates. Under historical export growth rates, which are usually lower than assumed in the World Bank and IMF projection, volatility reduces these countries’ likelihood of achieving debt sustainability even further. On average, we estimate that the likelihood of achieving debt sustainability is only 45 percent for the 27 HIPC countries, under historical export growth rates. Five countries, all of which had on average negative historic growth, are estimated to have less than a 10-percent likelihood 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 will require an even greater than expected level of debt relief to achieve debt sustainability. The following are GAO’s comments on the Department of the Treasury letter, dated April 2, 2004. 1. Treasury said the report leaves the impression that very large amounts of money, substantially above previously projected costs, will be required to be paid in substantial part by American taxpayers in future years. We agree that the challenge of achieving high economic growth rates, while maintaining debt sustainability, will likely require a substantial commitment of resources from the donors, including the United States, beyond what is currently projected by the World Bank and IMF. 2. Treasury said the report should have clearly reported the existence of international agreements for financing HIPC as they relate to the multilateral development banks and that contributions have thus far largely met commitments. We recognized throughout the report the donor community’s commitment to financing HIPC. However, under the agreed upon pay-as-you-go financing arrangement, funding has not been identified for large emerging financing shortfalls. We consider it to be fiscally prudent to estimate the full magnitude of the donor’s financial commitment. 3. Treasury said there has been no indication since October 2002 of any further financing gap in the HIPC Trust Fund. Our report refers to financing challenges over the life of the initiative, not specifically to the HIPC Trust Fund at this point in time, as reflected by the donor’s pay-as- you-go approach. Under the current pay-as-you-go approach, we did not identify a gap in the HIPC Trust Fund. However, as Treasury recognizes in its letter, there are several factors that are likely to result in the need for additional resources in the future. Our report provides estimates of those and other emerging additional costs. 4. Treasury said it is not convinced that our cost estimates for the AfDB are correct. We consider our estimate to be more accurate because it accounts for the actual amount of resources the AfDB has identified to contribute to the initiative and converts the estimate into 2003 dollars. For example, although the AfDB expects to provide $662 million (nominal) as it share of the HIPC Initiative it has only identified $370 million (nominal) thus far. 5. Treasury disagrees with the assertion that the enhanced HIPC Initiative was intended to ensure an exit from unsustainable debt burdens. We disagree. Numerous official World Bank and IMF documents as recent as 2003 affirm that a permanent, lasting, or durable exit from unsustainable debt remains a central objective of the HIPC Initiative. While the Treasury may have retreated from this objective, the World Bank and IMF have not. 6. Treasury also said achieving the aspiration of debt sustainability for poor countries requires a combination of elements. The report states that our estimates assume that the countries will follow their World Bank and IMF development programs, including undertaking recommended reforms and achieving economic growth rates consistent with reducing poverty and maintaining long-term debt sustainability 7. The Treasury said the report contains various cost projections largely unrelated to the current Enhanced HIPC Initiative. We disagree. At least 95 percent of our cost projections directly pertain to achieving the goals of the initiative—helping countries achieve economic growth and maintain long-term debt sustainability. The remaining amount is our estimate of the cost of achieving a second debt target—a debt service- to-government revenue of less than 5 percent—requested by the committee. 8. Treasury said that a recent World Bank/IMF study demonstrates that, while overall the projections were optimistic, almost half the countries have exceeded their original export projections. We do not believe that strong short-term (2 to 3 years) export growth necessarily constitutes a long-term trend. HIPC countries have historically experienced great volatility in their export earnings. It is not uncommon to see substantial increases in their export earnings for a few years followed by substantial declines. Although some countries have experienced high growth in recent years, sustaining that growth over 20 years or more is a difficult challenge. 9. Treasury said that it remains unconvinced that using an export growth average for the past 20 years is the best way to project future export growth. As noted in our previous reports, World Bank/IMF projected export growth rates have been optimistic—overall, more than double historical rates. We consider historical export growth rates to be more realistic, given these countries’ reliance on highly volatile commodities and other vulnerabilities. For example, the increasing prevalence of HIV/AIDS in many poor countries will likely have substantial negative effects on a broad range of economic variables, including export growth. The following are GAO’s comments on the World Bank letter, dated March 31, 2004. 1. The World Bank disagreed with the assumption that any deviation from a projected debt profile would be offset only by additional debt relief or compensatory financing. We disagree with the Bank’s characterization of the report. The report explicitly states that donors have the option of not financing the export shortfalls; however, this will hamper countries’ economic growth and reduce the funds available for poverty reduction. We assume, consistent with World Bank and IMF projections, that countries are following their reform and development programs. Hence we assumed that the other key elements of an effective development strategy are in place. 2. The World Bank said that the HIPC Initiative has never committed to debt relief targets in 2020. While we agree with this technical distinction, we note that debt sustainability analyses project all HIPC countries to have net present value debt-to-export ratios at or below 150 percent in 2020. Therefore, we chose 2020 because it represented the final year in World Bank and IMF projections. 3. The World Bank said that our methodology to assess the financing needs of HIPCs can be improved to recognize the very important efforts made by these countries themselves. As the report states, our analysis assumes that government revenue and GDP will grow at the optimistic rates projected by the World Bank and IMF because countries are expected to be undertaking recommended structural and policy reforms. 4. The World Bank said that we make an arbitrary assumption that historical growth rates are a good guide to future performance. As noted in our previous reports, World Bank/IMF projected export growth rates have been optimistic—overall, more than double historical rates. We consider historical export growth rates to be more realistic, given these countries’ reliance on highly volatile commodities and other vulnerabilities. While policy reforms may improve export growth, other factors may hinder growth. For example, the increasing prevalence of HIV/AIDS in many poor countries will likely have substantial negative effects on a broad range of economic variables, including export growth. 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. The following are GAO’s comments on the African Development Bank letter, dated April 2, 2004. 1. The AfDB said its current shortfall for the 23 African countries that have qualified to date is $130 million. We consider our estimate of about $400 million to be more accurate because it accounts for the actual amount of resources the AfDB has identified to contribute to the initiative and converts the estimate into 2003 dollars. For example, although the AfDB expects to provide $662 million (nominal) as it share of the HIPC Initiative, it has only identified $370 million (nominal) thus far. 2. The AfDB said the use of historical export data would imply limited progress in the future. As noted in our previous reports, World Bank/IMF projected export growth rates have been optimistic—overall, more than double historical rates. We consider historical export growth rates to be more realistic, given these countries’ reliance on highly volatile commodities and other vulnerabilities. For example, the increasing prevalence of HIV/AIDS in many poor countries will likely have substantial negative effects on a broad range of economic variables, including export growth. 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Summary: 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). 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. 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 more than $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 12 percent of this $375 billion, or approximately $52 billion over 18 years.