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Report of G7 Finance Ministers on the Köln Debt Initiative to the Köln Economic Summit

Cologne, Germany, 18 - 20 June , 1999

1. Launched in 1996, the initiative to reduce the debt overhang of heavily-indebted poor countries (HIPC Initiative) has already yielded positive results, bringing together for the first time multilateral, Paris Club, and other official bilateral creditors in a comprehensive framework for debt relief. Nonetheless, recent developments and experience have highlighted the vulnerability of many HIPCs to exogenous shocks. At the threshold of a new millennium, it is now time to reinforce the initiative so as to enhance the prospects for a robust and lasting exit for qualifying countries from recurrent debt problems.

2. We therefore support faster, deeper and broader debt relief for the poorest countries that demonstrate a commitment to reform and poverty alleviation. If implemented, the debt stock of countries possibly qualifying under the HIPC Initiative would be reduced, from some $ 71 billion in Net Present Value (NPV) remaining after traditional debt relief, by an additional $ 27 billion. These measures, together with forgiveness of debts arising from Official Development Assistance (ODA), of which some $ 20 billion in nominal terms are owed to G 7 countries, would lower countries’ debt service burden significantly and free resources for priority social spending.

A Framework for Poverty Reduction

3. While enhanced debt relief will reinforce debtor countries’ scope for policy action, sound economic policies must continue to be pursued, and renewed unproductive expenditure must be avoided. At the same time, it is important that the benefits of debt relief are targeted to assist the most vulnerable segments of population. Hence, there will have to be a strong link between debt relief, continued adjustment, improved governance and poverty alleviation. Both better governance in budgetary matters and financial savings derived from debt relief should allow for targeted expenditure on basic social services.

4. The pursuit of sound social policies should be integrated with structural adjustment programs that debtor countries are expected to implement. The new HIPC initiative should be built on an enhanced framework for poverty reduction, developed by the International Financial Institutions (IFIs). This is critical to ensure that more resources are invested in health, education and other social needs, which are essential for development.

5. To that effect, the World Bank and the IMF should adapt their support under the "Policy Framework Papers" (PFP), in particular the IMF’s programs under the Enhanced Structural Adjustment Facility (ESAF). Integrating their efforts, the World Bank and IMF should help qualifying countries with the drafting and implementation of poverty reduction plans for the effective targeting of savings derived from debt relief, together with increased transparency of budgetary procedures to protect social expenditures. Throughout program design and implementation, there should be consultations with broader segments of the civil society. Such dialogue will be the basis for deepening the sense of "ownership" with governments and citizens in debtor countries when necessary adjustment programs are to be adopted.

6. We call upon the World Bank and the IMF to develop by the time of the Annual Meetings specific plans for such an enhanced framework for poverty reduction.

Faster Debt Relief

7. While implementation of debt relief must continue to be predicated on sound economic policies over two stages, debtor countries should be allowed to advance the "completion point" through improved performance. The second stage could thus be shortened significantly if a country meets ambitious policy targets early on ("floating completion point"). This mechanism should lay out specific priority steps needed to deepen structural reforms and enhance social sector investment, focusing in particular on poverty reduction.

8. In addition to addressing the debt overhang, the HIPC Initiative should focus more on significantly reducing the cash-flow burden of debt service payments, in order to release resources for poverty reduction. The debt service burden of qualifying countries should be alleviated more quickly through provision of "interim relief" by the IFIs even before debt reduction is implemented at the "completion point". This is already current practice in the Paris Club for bilateral debts, and the IFIs should provide comparable treatment. Furthermore, after the "completion point", the IFIs could frontload debt stock reduction in a way to reduce debt service payments more strongly in the early years.

9. In order both to make the HIPC process more predictable and to simplify the modalities of earlier cash-flow relief, the amount of debt reduction should be determined at the "decision point" on the basis of the situation prevailing at that time. This will provide greater certainty about the level of debt relief.

10. A number of the very poorest countries with heavy debt burden have not yet embarked on the HIPC process. We call on the IFIs and the Paris Club to make it a priority to assist them to begin the process.

Deeper and Broader Debt Relief

11. In order to achieve lasting debt workouts for qualifying HIPCs and to support their efforts to alleviate poverty, the international community should commit to new steps to free up resources. Target ratios indicating the level where debt sustainability can be assumed, should be reassessed and lowered. Thus, we support bringing down the debt/exports ratio from a current 200-250 percent range to 150 percent. In addition, the alternative debt/revenue ratio should be given more attention and be lowered from currently 280 percent to 250 percent. This suggests also a revision of the sub-criteria designed to avoid moral hazard under this alternative and describing the minimum GDP ratios of exports and tax revenues; these sub-criteria could be lowered from 40 percent and 20 percent, respectively, to 30 percent and 15 percent. These combined revisions would result in deeper debt forgiveness, take greater account of debtor countries’ fiscal positions and broaden the HIPC Initiative to more countries.

12. While bilateral creditors in the Paris Club currently grant countries qualifying for the HIPC Initiative debt forgiveness of up to 80 percent on commercial debt, we support an even deeper degree of cancellation. To achieve debt sustainability, we would be prepared to forgive up to 90 percent and more in individual cases if needed, in particular for the very poorest among these countries. For poor countries not qualifying under the HIPC Initiative, the Paris Club could consider a unified 67 percent reduction under Naples terms and, for other debtor countries, an increase of the existing limit on debt swap operations with due regard to appropriate transparency.

13. While many bilateral creditors have forgiven debt arising from Official Development Assistance and/or extend ODA to poor countries only in the form of grants, remaining ODA debt continues to be a source of the debt overhang in many countries. We therefore call on all creditor countries to forgive bilaterally, through a menu of options, all ODA debt of qualifying countries on top of the amounts required to achieve debt sustainability. We are aware that such forgiveness would present a special burden on some creditor countries. In order to help ensure that HIPCs do not face new debt problems in the future, new ODA should preferably be extended in the form of grants.

Financing

14. We recognise that these changes will entail significant costs, in particular arising from debt owed to the IFIs. However the final costs of the initiative are subject to many uncertainties, and actual outlays will be spread over a long period of time. We are prepared to support a number of mechanisms to meet these costs, recognising the importance of maintaining an adequate concessional lending capacity by the IFIs:

· To meet the IMF’s costs, the Fund should mobilise its resources, while maintaining an appropriate level of reserves, through: the use of premium interest income; possible use of reflows from the special contingency account or equivalent financing; and use of interest on the proceeds of a limited and cautiously-phased sale of up to 10 million ounces of the IMF’s gold reserves.

· The multilateral development banks should build on the work they have begun to identify and exploit innovative approaches which maximise the use of their own resources.

· The costs to the IFIs will also require bilateral contributions. We have pledged substantial contributions to the existing HIPC Trust Fund. We will consider in good faith contributions to an expanded HIPC Trust Fund.

· In meeting the costs, we call for appropriate burden sharing among donors taking into account all relevant aspects, including the magnitude and quality of ODA already extended and past ODA forgiveness, and recognising the contributions of countries with high ODA loans outstanding relative to GDP.

15. On the basis of this framework, we call upon the IFIs and the Paris Club to provide faster, deeper and broader debt relief. Concrete proposals should be agreed by the time of the next Annual Meetings of the IMF and World Bank.


Source: Released at the Köln 1999 Summit

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