Twenty years of debt relief: The debt spiral continues

In the absence of domestic savings, a poor country must finance its «catch-up development» with foreign capital. This will only be temporary, however, because with industrialization the country would soon be generating sufficient foreign currency to transition from being a capital importer to a capital exporter. This simple recipe, known as ‘growth-cum-debt’, was written after the Second World War. It is still being promoted today, though the ingredients have changed slightly. This is so despite the fact that some Asian countries have demonstrated that it is quite possible to mobilize domestic savings for development by means of a prudent financial market strategy.

Structural adjustment policies at a dead end

The first post-war debt crisis erupted in August 1982 in Latin American emerging countries. The spectre of a collapse of global capital markets haunted the world. Contrastingly, there is no universally perceived date for the debt crisis of the poorest countries, as those markets were too insignificant. Besides, the International Monetary Fund (IMF) and World Bank sprang into action to prevent the debt crisis from spreading. As an alternative to ‘growth-cum-debt’ they prescribed a stringent austerity policy for poor countries. Their aim was to ensure that those countries could continue to service their debt and promote their growth by means of «structural adjustments» (e.g. privatizations) rather than on credit.

The bitter medicine was ineffective. What little growth there was came at the cost of cuts in social services and even more poverty, and the debt problem was not defused. World Bank and IMF loans took the place of private obligations. In a growing number of countries in the South, debt service exceeded spending on education and health.

Switzerland’s pioneering role

Switzerland was one of the first creditor countries to take action. After a two-year campaign by development organizations, the Parliament in 1991 approved their principal demand: in the framework of Switzerland’s 700th anniversary celebrations, it made 500 million francs available for debt relief. The funds thus released in the South were to go directly towards poverty reduction. It was hoped at the same time that this would send a signal to other creditors. A mere drop in the ocean would not suffice.

That aim was achieved. Under World Bank leadership, creditor countries launched an international debt cancellation initiative (Heavily Indebted Poor Country Initiative) in the mid-1990s, which reduced the debt mountains of many poor countries and channelled the funds thus freed up towards social development. Yet a second initiative became necessary (Multilateral Debt Relief Initiative) in order to defuse the problem of debts owed to the IMF and World Bank as well. This made it possible to reduce the old debts (without new borrowing) of 32 of the poorest countries by up to 90 per cent.

Ostensibly the initiatives were a success – quantitatively, because the mountain of debt was reduced, and qualitatively, because social development was promoted. Yet one major question remains topical to this day: how big can the remaining debt be so as not to hamper development?

What are sustainable debts?

This has been the subject of disagreement since the end of the 1990s. The World Bank, which traditionally lays claim to the monopoly in matters of indebtedness, suggested a threshold of 150 per cent of expected export income for debt service and 250 per cent of public revenues for debt.

These formulas soon had to be adjusted to the country-specific conditions considering how widely economic power and the risk of over-indebtedness vary across the countries concerned. Non-governmental organizations suggested another denominator, which was that debts should be considered sustainable so long as they do not jeopardize the funding of the UN Millennium Development Goals (MDGs). Socially necessary government spending should therefore be one determinant, not just revenues.

The concept of debt sustainability serves to determine debt relief. If it is being taken seriously, however, it should also apply to new debts. What this would mean in reality is that after debt relief a country could no longer take out new loans, not even when state revenues declined rapidly as a result of global economic crises. No country, whether industrialized or poor, renounces additional borrowing to stimulate the economy in such a situation. The latest figures in fact show that the debt spiral is continuing unabated: according to the United Nations Conference on Trade and Development (UNCTAD), there were 49 poor countries in a critical situation in 2009.

Insolvency procedure making headway

The upshot is that the debt problem of the South cannot be solved by technical means alone and retrospectively. The global debt cancellation initiatives have focused only on eliminating old debts and symptoms. Without forward-looking policy solutions it will not be possible to prevent new debt spirals.

One promising potential solution is a regulated insolvency procedure for heavily indebted countries, as NGOs have been demanding for years now (see box). They are now hoping for support from the European Union, for which such a procedure no longer seems taboo when it comes to dealing with some of its own national bankruptcies.

Binding rules for dealing with national insolvencies that also safeguard the rights of debtors should send clear signals to creditors – for example that they can no longer simply pocket profits and cover losses with development funds. Government loans should be declared as illegitimate if their only purpose is to finance private instead of public interests. A regulated insolvency procedure could also put an end to the profitable business of «vulture funds», which buy up unserviced national debts at next to no cost and keep litigating against the debtor country until a considerable profit materializes.

But an insolvency procedure also means debtor government accountability. Not every ministry should be free to raise external funding for its prestige projects. State sovereignty cannot be used as a pretext for piling up debts behind closed doors. Borrowing must serve a country's development priorities and must be discussed publicly. But this presupposes the existence of an informed civil society or a budget policy that discloses not only all expenditures but also the origin of revenues. Only transparent and democratic debt management is effective.

Bruno Stöckli, Alliance Sud

Box

Campaign for insolvency procedure

At the World Social Forum in Dakar in early 2011, various organizations launched an international campaign entitled Defuse the debt crisis. It called on the international community and in particular the G20 to institute binding rules for national bankruptcies that do not take account merely of creditors’ interests. An arbitral court that is independent of debtors and creditors should ensure that debt reduction does not take place at the expense of the poorest. Besides, it should also examine the legitimacy of creditors’ claims. The initiators believe their campaign stands very good chances since countries in the South are far from being the only ones threatened by national bankruptcy.
Bruno Stöckli , Alliance Sud

Article published in Alliance Sud News no. 67, Spring 2011