Introduction

Many of the poorest heavily indebted countries are continually shifting resources away from priority social sectors, such as education and health, to debt servicing because of their onerous debt burdens. The G-7 is therefore proposing that those countries demonstrating a commitment to reform, good governance and poverty alleviation be given faster, deeper and broader debt relief. The new initiative will more than double the amount of debt relief under the current Heavily Indebted Poor Countries (HIPC) Initiative to over $27 billion in 1998 net present value (NPV) terms. In nominal terms, this amounts to about $50 billion. We expect that the G-7 initiative, combined with existing debt relief mechanisms, will reduce eligible countries' debt by more than 50 per cent.

The HIPC Initiative, first put forward at the Halifax Summit in 1995, has already provided benefits by bringing together for the first time multilateral, Paris Club and other official and bilateral creditors to work co-operatively to reduce the debts of the poorest. Nonetheless, recent events have shown the extreme vulnerability of the HIPCs to external shocks and the need to provide them with a more lasting exit from unsustainable debt burdens.

The G-7 Debt Initiative reflects many elements of the Canadian Debt Initiative announced by Prime Minister Chrétien on March 25^th, including enhanced relief on Official Development Assistance (ODA) debt and greater attention to social factors and poverty reduction. As proposed in the Canadian initiative, it would provide more generous and more timely debt relief to more countries. For example, Honduras would become eligible to receive debt relief and Haiti, not currently considered an HIPC, may also qualify.

What Has Canada Already Done?

An Enhanced Framework for Poverty Reduction

Poverty reduction is a focal point of the enhanced G-7 Debt Initiative. The benefits of debt relief must be targeted to assist the most vulnerable sectors of the population and should therefore concentrate on providing resources to basic social services such as health and education.

The G-7 is calling on the International Financial Institutions (IFIs) to help develop an enhanced framework for poverty reduction to support the new initiative. This framework will emphasize the importance of participation of broader segments of civil society in the design and implementation of reform programs that are aimed at reducing poverty and promoting sustainable development.

Highlights of the G-7 Proposals for Debt Relief

Enhanced HIPC Initiative

The enhanced HIPC Initiative will provide debt relief that is faster, deeper and broader. This section of the backgrounder explains how these objectives will be achieved.

Faster debt relief for qualifying countries will be achieved by:

• providing greater interim relief. This would significantly reduce the cash-flow burden of debt service payments and would release resources for poverty reduction;
• shortening the track record. Countries could accelerate debt reduction if they make faster progress in implementing policies to reduce poverty and embark on a sustainable development path. This would essentially shorten the second performance period; and
• calculating debt relief at the decision point. This would increase predictability and augment the amount of debt relief provided.

Deeper and broader debt relief will be achieved by lowering both the export and fiscal sustainability targets. Specifically, it is proposed that:

• the NPV debt-to-fiscal revenue target be lowered from 280 per cent to 250 per cent to ensure more robust fiscal sustainability;
• the fiscal thresholds be lowered to allow more countries to benefit. Fiscal thresholds have been introduced to identify countries that are relatively open and are already making sufficient efforts to generate domestic revenues, but whose export bases may exaggerate their capacity to service the external debt. The export threshold (i.e. exports-to-GDP) will be reduced from the current 40 per cent to 30 per cent, and fiscal revenue in relation to GDP will be lowered from 20 per cent to 15 per cent. The fiscal revenue-to-GDP threshold is retained to avoid disincentives to maintaining or increasing the revenue effort with important resource implications for social and poverty reduction programs;
• G-7 countries be prepared to lower the debt-to-exports ratio from 200-250 per cent to 150 per cent. Combined with changes to the fiscal criteria, lowering the export target to 150 per cent would increase the amount of relief to US$27.4 billion and extend relief to 7 more countries among the 41 HIPCs; and
• additional countries outside of the 41 HIPCs, including Haiti, become eligible under an enhanced HIPC Initiative.

Paris Club Debt Rescheduling

The Paris Club is part of the HIPC Initiative through its work in restructuring the commercial debt of developing countries. It consists of an informal group of creditor governments, mainly from industrial countries (i.e., the Organization for Economic Co-operation and Development), that has met on a regular basis in Paris since 1956.

Currently, when countries are declared eligible for HIPC treatment, they can receive up to 80-per-cent debt relief on commercial debt service payments. After an additional three years of good economic performance, the Paris Club then provides up to 80-per-cent debt relief on the principal.

The new debt initiative calls for debt relief on the part of Paris Club (and other bilateral) creditors of up to 90-per-cent debt relief and even more, if necessary, to achieve debt sustainability. This will serve to avoid bilateral financing gaps similar to Mozambique's and therefore delays in the provision of debt relief.

Financing

The G-7 recognizes that making the HIPC Initiative more generous and timely costs money. We will therefore act responsibly and work in co-operation with other donors and the international institutions to determine how additional costs can best be financed.

To support the full participation of IFIs in an enhanced HIPC Initiative, Canada and the other G-7 countries are calling for:

• a limited and cautiously phased sale of the IMF's gold reserves, and possible use of refunds from the Second Special Contingent Account and premium interest income, to finance the International Monetary Fund's (IMF's) share of the cost;

• innovative approaches by the multilateral development banks to maximize the use of their own resources; and

• additional contributions to the HIPC trust funds based on appropriate burden sharing to further support the IFIs, including the IMF.

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Annex

What is the HIPC Debt Initiative?

In June 1995, at the Halifax Summit, the G-7 countries urged the Bretton Woods institutions to develop a comprehensive approach to address the special problems of the poorest heavily indebted countries through the flexible application of existing instruments and the creation of new mechanisms for debt relief. At the 1996 IMF/World Bank Annual Meetings, a new debt initiative for HIPCs was endorsed by the Governors of the two institutions. The purpose of the initiative is to help those poorest heavily indebted countries that have demonstrated a track record of sustained good policy performance to reduce their debt to sustainable levels and to allow for a permanent exit from debt rescheduling.

An initial list of 41 HIPCs was developed by the World Bank and the IMF in 1996. Countries in this list are subjected to a debt sustainability analysis by the World Bank and the IMF to determine which of the original 41 countries are "HIPC-eligible," i.e. have unsustainable debt burdens.

Results So Far

In the more than two years since its inception, 12 countries have been considered for debt relief with 7 being assessed as HIPC-eligible – Bolivia, Guyana, Burkina Faso, Côte d'Ivoire, Mali, Mozambique and Uganda – for a reduction in debt service of over US$6 billion. Uganda, Bolivia, and Guyana have completed the HIPC process, receiving more than US$1.8 billion in debt service relief.

Reduction of HIPC Debt (Estimated) Under Debt Reduction Mechanisms

(nominal, in billions of US dollars)

Outstanding HIPC-eligible debt	130 (71 NPV)
Debt relief under the enhanced HIPC debt initiative	50 (27 NPV)
ODA cancellation by G-7 for HIPC-eligible countries	20
Total debt relief delivered	70
Outstanding debt after enhanced debt relief	60
Maximum additional potential ODA cancellation by other donors	20
Maximum potential debt relief	90
Outstanding amount	40

Represents 33 countries expected to qualify for HIPC assistance. Excludes Liberia, Somalia and Sudan since it is difficult to assess their debt outstanding in their current situation.

Glossary of Terms

Eligible country: An eligible country must be an International Development Association (IDA)-only country, meeting the debt sustainability criterion, with an IDA or Enhanced Structural Adjustment Facility reform program in place.

Enhanced Structural Adjustment Facility (ESAF): Established in 1987 and extended and enlarged in 1993, the ESAF is the concessional loan window of the International Monetary Fund to provide assistance to low-income member countries.

Export criterion: Currently, the export criterion assumes that sustainability is achieved with a net present value of debt-to-export outcomes of not more than 200-250 per cent and debt service-to-exports of not more than 20-25 per cent.

Fiscal criterion: In the special case of very open economies with a high fiscal debt burden despite strong revenue generation, the net present value (NPV) of the debt-to-exports target may be set below 200 per cent to achieve an NPV of debt-to-revenue ratio of 280 per cent.

Fiscal thresholds: To qualify for consideration under the fiscal criterion, countries must have minimum thresholds of 40 per cent for the exports-to-GDP ratio and 20 per cent for the fiscal revenue-to-GDP ratio. The exports-to-GDP sub-criterion enables the identification of countries for which the export criteria may exaggerate their capacity to service their external debt. The revenue-to-GDP threshold was introduced to minimize the disincentive of increasing revenue since this could reduce heavily indebted poor country assistance, and also to protect government revenue for social programs and other development needs.

International Development Association (IDA): IDA is the concessional lending arm of the World Bank Group. IDA assistance is available to low-income member countries.

Net present value (NPV): The NPV is used to determine what the future stream of debt payments would be worth today discounting at the market rate of interest. Because loans to the heavily indebted poor countries (HIPCs) are on a variety of lending terms, often concessional, this also allows for comparability of outstanding debt among the HIPCs.

Nominal value: The nominal value of outstanding debt is the actual value of debt outstanding – i.e. what the HIPCs currently owe, regardless of the interest rate charged. Therefore, nominal values are higher than net present values.

Track record: In principle, there are two 3-year track records of good performance.
The decision point comes after the first 3-year track record of good performance; it is the point at which eligibility for debt relief is determined. The completion point comes after the second 3-year period of good performance; it is the point at which debt relief is provided.

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Source: Department of Finance, Canada.