Chapter

Financing for Developing Countries and the Debt Situation

Author(s):
International Monetary Fund
Published Date:
January 1995
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During 1994/95, the Board met several times to discuss issues related to commercial and official financing flows to developing countries and economies in transition, and to the debt situation confronting these countries, including the sustainability of the multilateral debt of the heavily indebted poor countries in the context of overall debt burdens. Board members noted that considerable progress had been made in resolving the debt problems faced by middle-income developing countries. Owing to their adoption of strong economic policy programs, most of these countries either had graduated from the Paris Club rescheduling process or were expected to do so shortly. Low-income developing countries, however, continued to face difficult debt problems. For these countries, sound economic policies Would require adequate financial support. The multilateral institutions, especially the fund and the World Bank, would be called on to play a large role through their financial facilities in supporting the reform efforts of developing and transition countries. The Board also explored ways to allow the Fund to continue providing financial resources on highly concessional terms to low-income countries through the ESAF.

Commercial and Official Bilateral Debt

In September 1994, during a discussion of the debt situation, Directors noted that substantial progress had been made in resolving both the commercial and official debt problems of the middle-income developing countries in the year since the Board’s last comprehensive review of the debt strategy. Owing to their strong economic policy programs, a number of countries had been able to conclude restructuring agreements with their commercial creditors; a flexible approach with a menu of options made it possible to tailor bank packages to the specific needs of individual countries. Most middle-income countries had graduated from the Paris Club rescheduling process, or were expected to do so at the end of their current consolidation periods. Directors observed that progress in this area for the few middle-income countries with unresolved commercial debt problems would require the implementation of strong economic policies by debtor countries and flexibility on the part of creditors.

Many middle-income countries had begun to enjoy renewed access to spontaneous private financing since-resolving their debt problems. Directors observed that the middle-income developing countries had been the major beneficiaries of the sharp increase in private financing between 1990 and 1993. Despite a severe market correction in early 1994, Directors saw recent developments as providing grounds for optimism with respect to the sustainability of substantial capital inflows, but they noted that continued access to international financial markets would depend on countries’ maintaining strong policy stances.

Low-income countries, in contrast, continued to confront difficult debt problems. Many had large debts to official creditors, and some had sizable commercial bank debts that needed to be restructured. Access to private sources of financing had not improved for low-income developing countries as a group. Directors emphasized that these countries would need to establish sound, stable, and sustainable economic policies and would also require supportive actions on a number of fronts.

Directors observed, for example, that, through the Paris Club’s phased approach to debt rescheduling—involving the rescheduling of debt-service flows on enhanced concessional terms—official creditors had provided substantial assistance in meeting the external financing needs of a number of low-income countries. Nevertheless, they noted that many low-income countries still faced large debt overhangs to official bilateral creditors that could be removed only by the implementation of stock-of-debt operations, as envisaged under the menu of enhanced concessions agreed by the Paris Club in 1991. In this context, at a subsequent discussion in February 1995, Directors welcomed the Naples terms—which provide for an increase in the level of concessionality for most low-income rescheduling countries from 50 to 67 percent—agreed by Paris Club creditors in December 1994. Directors welcomed in particular the first stock-of-debt operation under these terms in February 1995, for Uganda.

Directors felt that commercial bank creditors would need to show more flexibility in dealing with low-income developing countries with especially severe private debt burdens. Because of their limited resources, many of these countries were likely to be unable to finance the cost of simple debt buybacks. Directors considered that creditors should be willing to accept terms more explicitly tied to assessments of the low-income developing countries’ limited ability to service their debt, which might not be reflected in secondary-market prices for the debt. Sufficient resources would need to be made available on appropriate terms to support hank-debt operations.

Directors expressed concern about the decline in net bilateral aid flows recorded in 1994 and emphasized that the targeting of aid to the poorest countries could be considerably improved—for example, by reducing the use of aid as an instrument of export competition. Many Directors also felt that recipient countries needed to make more effective use of bilateral aid.

Directors noted that officially supported export credits remained a key source of official bilateral assistance, particularly for certain developing and transition countries. They agreed that access to export credits could help developing countries to establish credit-worthiness but should not be used as a substitute for general balance of payments support, especially in the medium term. Developing countries would thus need to carefully manage their outstanding debt to export credit agencies. Directors also encouraged export credit agencies to make more use of recent innovations in risk management, to coordinate their lending more closely with other agencies and multilateral institutions, and to hold more frequent discussions on the effective use of export credits with recipient countries. They considered that the potential benefits of escrow accounts should be weighed against the danger of the proliferation of such arrangements and of reduced access to nonseuritized lending.

Multilateral Financing and Debt

Directors observed that the multilateral institutions had played a central role in supporting the economic adjustment of developing countries. In particular, the fund, through the continued operation of its FSAF, and the World Bank, had made major contributions to lending on highly concessional terms to low-income countries. In the Directors’ view, in the future the multilateral institutions, especially the Fund and the World Bank, would be called to play an even greater role in providing financing to developing and transition countries. These institutions would establish the framework for support from other creditors and donors—in part by improving the availability and understanding of information on trends in financing flows.

In their September 1994 discussion, Directors stressed that debt forgiveness by the multilateral institutions, in light of their role in mobilizing resources for the developing and transition countries, was not desirable and should not be considered. Debt forgiveness would impair the effectiveness of the Fund by undermining its preferred creditor status and the revolving nature of its resources. At the same time. Directors emphasized the importance of highly concessional lending by the multilateral institutions—especially the regional development banks—in support of economic policy programs in the low -income developing countries. Multilateral institutions should also work with member countries whose payments were in arrears to help them overcome these problems.

During the February and April 1995 meetings, discussions centered on the magnitude and sustainability of the multilateral debt of the heavily indebted poor countries. On the basis of debt-service analysis presented in papers jointly prepared by Fund and World Bank staff, at the April meeting most Directors agreed with the conclusion that, for the majority of heavily indebted poor countries, debt service to multilateral institutions should be manageable, provided that concessional bilateral flows were maintained and that new multilateral lending was on appropriately concessional terms and supported a policy framework that generated at least modest real export growth. Some countries would, however, face heavy burdens of both debt service and the overhang of debt that would clearly impede development prospects in the future; for these cases, it was decided that further country-specific analysis would be undertaken.

At the February meeting, Directors agreed broadly that all new multilateral and bilateral lending to the heavily indebted poor countries should be on concessional terms. Directors agreed that there should be a reassessment of the means available to the Fund for dealing with countries with protracted arrears to the Fund and for assuring the viability of some additional countries with prospective heavy debt burdens by complementing the mechanisms put in place by other creditors, such as the Naples terms agreed by Paris Club creditors in December 1994.

Continued Fund Assistance Through the ESAF

Directors noted that most but not all heavily indebted countries would experience a decline in their debt service to the Fund over the next decade, mainly because of the introduction of highly concessional lending through the SAF and the FSAF. There was broad agreement that ESAF terms were consistent with sustainable debt-service burdens for most heavily indebted countries and that it would be appropriate to continue to provide assistance through the FSAF, provided that the revolving nature of the Fund’s resources and the institution’s monetary mandate were respected. Some Directors were of the view that the Fund would need to do more.

In April, Directors considered possible modalities for continued Fund involvement in low-income countries, including the most heavily indebted ones, through the ESAF. Directors broadly agreed that there would be a need for a continuation of ESAF-type concessional operations; most also were ready to explore the possibility of a self-sustained ESAF financed through resources expected to reflow to the Special Disbursement Account (SDA) from the ESAF Trust Reserve Account beginning in the year 2004, according to current projections.

Most Directors welcomed early consideration of possible ways to finance ESAF-type concessional operations in the interim period between the end of 1996, when full commitment of ESAF Trust resources is expected, and 2004, when resources from the SDA would become available. It was noted that some uncertainty attached to the likely timing of full commitment of existing ESAF Trust resources, and consideration was given to the usefulness of exploring with present FSAF Trust creditors the possibility of an earlier transfer of resources to the SDA by reducing the coverage of claims on the ESAF Trust Loan Account.

Directors also explored modalities for funding the loan component of ESAF assistance; most supported giving further consideration to combining various funding alternatives, including the use of the General Resources Account (GRA), although some did not favor this approach. Suggestions were made on possible sources of funding for the subsidy component, including transfers by members of resources refunded from the second Special Contingent Account (SCA-2), bilateral funding, and the investment income from the profits of the sale of some of the Fund’s gold. Some Directors were firmly opposed to gold sales, but interest was expressed in further discussion of the role of gold in the Fund.

Directors discussed several options for dealing with the problems of countries with a heavy debt overhang, including the possibility of extending maturities for ESAF loans for a category of countries eligible for ESAF assistance. However, most Directors considered that the Fund could best assist those countries facing continuing heavy debt burdens and balance of payments problems by ensuring that ESAF resources continued to be available on present terms. This would enable the Fund to tailor its financing to the situation of individual members while maintaining conditionality and continuing to monitor members’ policies over what might be prolonged periods. Nevertheless, a few Directors felt that this approach would not adequately address the problems related to debt overhangs and the need of members for assurances that debt service to the Fund would be kept at manageable levels. In the view of these Directors, further consideration should be given to the possibility of an extension of maturities.

In its April 1995 communiqué, the Interim Committee took note of the Board’s discussion of the multilateral debt of heavily indebted poor countries and stressed that multilateral lending to these countries should be on appropriately concessional terms. The Committee agreed that continued Fund support for the poorest developing countries on ESAF terms would be desirable, and it requested the Board to examine the options for continued financing and adapting of the ESAF.

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