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Debt sustainability or defensive deterrence?

10 January 2007

One year after the Multilateral Debt Relief Initiative, and the G8 promise of contributing decisively to the achievement of the Millennium Development Goals, some impoverished countries face tough decisions. They have new sources of finance to turn to, but the World Bank plans to penalise them if they do so.

The Bank plans to curtail countries’ allocations under its low interest window, IDA, to any country that borrows at non-concessional terms from commercial or new sovereign lenders. These lenders are described by the Bank using the economists’ terminology of ‘free riders’. The Washington-based institutions argue that the new lenders are riding on the largesse of the Bank and Fund which has cancelled debts, and is threatening the previously indebted countries’ longer term debt sustainability. The Bank therefore wants to ‘incentivise’ low-income country governments by indicating that they will receive less from the Bank if they turn to these sources.

There is a danger that the Bank’s actions might make it harder for governments to meet the MDGs, and push them to take on even more expensive loans to replace these gaps. A counterproductive spiral for borrowers could be started, while lenders would be let off the hook.

It is in particular the actions of highly liquid emerging powers such as China that seem to be of great concern to the classical donor community. Long-standing creditor and donors correctly see the availability of large hard-currency reserves as both a threat to their monopolistic status in the development arena and to the capacity for low-income countries to maintain a sustainable debt situation after the cancellation rounds of the last decade. Unfortunately the rich countries do not recognize that impoverished countries’ interest in these new, more expensive financial flows is in large part a result of the insufficient amounts of concessional aid that they are providing. Not living up to their own word leaves some developing countries with an open dilemma: to develop risking renewed unsustainability, or to be stuck in underdevelopment because of a chronic shortage of available resources.

Moreover, these new resources may also be very interesting to recipient countries because they come without the heavy conditionalities that are all too often attached to World Bank and IMF loans. While the absence of economic conditionalities may be welcome, the new lenders also neglect other aspects, such as human and civil rights, as well as environmental safeguards. This can risk creating further illegitimate debt. The actions and policies of these new actors must be carefully scrutinized.

The possible implementation of punitive measures by the World Bank against low-income borrowing countries, and the total absence of any credible sanction toward lenders, also represents one more clear indication of the inequity and lack of effectiveness of the current international debt architecture. This new situation has again drawn attention to the absence of a transparent and equitable settlement mechanism that could effectively deter opportunistic behaviour and correctly evaluate the share of responsibility to be ascribed to the various parties. It presents an occasion to rethink the current system, by forcing the usual ‘club’ of creditor countries to acknowledge the insufficiency and the unfair state of the international debt architecture and consequently amend it.

The same rich countries need to realize that this situation comes about largely because they are not doing what they have solemnly pledged to do. Poor countries would gladly accept cheaper financing if more of it was made available; as promised at the Monterrey and other summits. Denouncing China – a growing but still relatively poor country – because it is providing more expensive funds to the developing world is not the answer. They must live up to their commitments. If rich countries finally put their money where their mouths are, there wouldn’t be anyone ‘riding free’ out there.

Full report : Kb