tutor2u | External Debt Relief

Study Notes

External Debt Relief

Level:
A Level
Board:
AQA, Edexcel, OCR, IB

Last updated 22 Mar 2021

Many of the world’s poorest countries are saddled with high levels of external debt owed to other governments, institutions such as the IMF and foreign companies, banks and individuals

  • The near $5tn of external debts owed by developing countries costs them more than $1.5bn a day in repayments – and much of that comes from the poorest countries
  • Most of the world’s poorest countries have limited access to international capital markets – their sovereign debt does not have an official credit rating
  • Without conditional loans from the IMF, World Bank and others, they would have to pay interest rates many times higher on private sector loans
  • Some developing countries have chosen to borrow from other emerging economies such as China or Brazil as a way of avoiding conditional loans from international institutions
  • Countries with persistent trade deficits end up accumulating large external debts, so too a government where spending greatly exceeds annual tax revenue leading to high fiscal deficits
  • A country defaulting on loans will find it harder and more expensive to attract future loans.

External debts can act as a severe constraint on growth and development – often times, the interest payments on existing public sector debt takes up a large percentage of a nation’s export revenues or annual tax revenues.

These debt repayments have an opportunity cost, they might be better used in supporting development policies such as investment in health and education to boost the human capital of the population.

To what extent should richer nations be prepared to write-off external debts of poor countries?

The Jubilee Debt Campaign pushes for debt cancellation and debt relief avoiding where possible conditions built into debt reduction agreements that create further problems for vulnerable countries.

One option is to reschedule debt payments and change the nature of the interest rate paid on these loans.

In July 2012 a United Nations report made the case for introduced indexed loan repayments where the interest rate is tied to a country’s rates of economic and/or export growth. This would help balance the risk of loans more equally between lender and borrower. In good years when growth of GDP is strong, the borrower country would repay more of their debts. During hard times (i.e. a recession caused by a fall in export revenues), the rate of interest on debt would fall.

External Debt Data

The stock of developing countries’ external debt increased to $4.9 trillion at end 2011, but at an average of 22 percent, remained moderate in relation to Gross National Income (GNI), and to exports (69 percent).

High income countries have, on average, a much higher level of external debt: 126 percent of GDP for G7 countries in 2011 compared to 19 percent for the top ten developing countries. General government debt (external and domestic) is also much higher, with an average of 76 percent in Euro-zone (17) countries in 2011, more than twice the comparable ratio for the largest borrowers among developing countries.

Djibouti (East Africa)

The Djibouti government’s external debt has increased significantly over the last decade from 40 per cent of GDP in 2001 to 70 per cent in 2009, and now stands at $700 million. For 2012, the IMF predicts the government will spend 14 per cent of revenues on foreign debt payments. Since 2001, over 70 per cent of lending to the country has been from multilateral institutions such as the IMF, World Bank and African Development Bank. In May 2012 the IMF agreed to lend a further $10 million to help the country meet its debt and import payments. As part of the loan programme the Djibouti government has agreed to reform diesel fuel subsidies, freeze any hiring in the public sector, except for health and education and freeze public sector pay, except for the lowest salary band. Inflation is 4% this year.

Djibouti has not yet been considered eligible for the Heavily Indebted Poor Countries (HIPC) initiative, which allows countries to have some debts cancelled in return for following IMF and World Bank economic policy conditions.

Source: Jubilee Debt Campaign Website, accessed, August 2012

Brazil writes off debt of African nations

In May 2013, the Brazilian government announced that it plans to cancel or restructure almost $900m in debt owed by African countries. The move is designed mainly to expand Brazil's economic ties with Africa and fast forward the growth of trade and investment between emerging countries and regions. In the aftermath of this move, Brazil’s future aid assistance is likely to target infrastructure, agriculture and social programmes. Among the 12 countries set to benefit are Tanzania, which owes Brazil $237m, along with oil-producing Republic of Congo and copper-rich Zambia.

Source: Adapted from newspaper reports, May 2013

World Bank on Debt Relief for the world's poorest countries

Heavily Indebted Poor Countries Initiative (HIPCI)

This is an initiative to provide debt relief to heavily indebted low income countries. Under the initiative, the International Monetary Fund and World Bank calculate the proportionate reduction required in the country’s external debts in order to return them a level <150% of the value of the country’s annual exports – this is considered to be a sustainable level. All creditors – multilateral, bilateral and commercial – are expected to provide the proportionate reduction to achieve this. The Ivory Coast is an example of a country that has benefited from HIPCI – it has been granted external debt relief of $7.7bn. As a result the stock of Ivorian public debt decreased from 69% of GDP in 2011 to 40% of GDP in 2012.

African sovereign debt on the rise (Financial Times)

Debt Relief for the Comoros

The International Monetary Fund (IMF) has agreed to US$176 million in debt relief for the Comoros, representing a 59 percent reduction of its future external debt service over a period of 40 years. The requirements met by Comoros included the maintenance of macroeconomic stability, reforms on telecommunications and energy, a national measles vaccination campaign for children to achieve 90 percent coverage nation-wide, and improvements in debt management.

Source: International Monetary Fund, December 2012

Further reading and research

Guardian articles: http://www.theguardian.com/world/debt-relief

Jubilee Debt Campaign: http://jubileedebt.org.uk

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