Debt relief is back. Again. The “once-in-a-generation” debt cancellation of 15 years ago has returned to the agenda as indebted countries struggle to finance their response to Covid-19. Suspending collection of debt repayments is one practical thing – among others – that rich countries can do relatively quickly to free up money for poor countries during this crisis.
Hidden away in the annex to the G20 and Paris Club's April communiqué (PDF) is a deal on the table similar to 15 years ago: a suspension of interest payments if the proceeds are spent on something ‘good’.
“Each [debt relief] beneficiary country will be required to commit…to use the created fiscal space to increase social, health or economic spending in response to the crisis. A monitoring system is expected to be put in place by the [International Financial Institutions].”
But this time around things are different – the International Financial Institutions (IFIs) have an opportunity to get the monitoring process right. They should put less emphasis on complex, intrusive expenditure tracking systems, and use the aligned incentives that a real crisis brings to help build trust between state and society.
How debt was cancelled in the past
We’ve been here before. Since the mid-1990s, over 35 Highly Indebted Poor Countries (HIPCs) have benefitted from the cancellation of debts of around $100 billion – with certain conditions. Beneficiaries were banned from taking on new unsustainable debt, and they had to spend the savings on ‘pro-poor’ or ‘poverty-reducing’ expenditures through a new inclusive ‘Poverty Reduction Strategy’ that involved a tight monitoring framework.
This is hardly new. Indeed, the concept of making finance conditional on certain kinds of spending has never really disappeared. For instance, budget support programmes often involve some form of spending conditionality; and International Monetary Fund (IMF) programmes often insist that countries ring-fence social expenditure to protect certain areas from cuts.
The challenge of tracking conditional debt relief
Do these expenditure tracking efforts actually work? Evidence suggests an answer that is far from clear. The idea that debt savings go to finance certain types of expenditure is difficult to prove. In the case of Covid-19, proving that money is being spent on the right things will be tricky for three reasons.
1. Defining the parameters is difficult
The G20 communiqué singles out ‘social, health, or economic spending’ as eligible. Health ministry budgets are relatively easy to track, but what about health-related issues like water and sanitation? Does financing the armed forces to distribute food aid count as ‘social’ spending? Adding ‘economic spending’ to this list makes the definition incredibly broad.
Defining what ‘increase’ means is also not simple. Should eligible budget lines increase as a share of government expenditure? Or is the increase in spending a nominal figure set against last year’s budget, or an average of the previous three years? The timescales also make it unworkable. If the Covid-19 crisis lasts say three years, by the time a monitoring framework has been agreed, audited and analysed for compliance year on year, we should be nearing the end of the crisis.
2. Conceptual issues make tracking expenditure hard
All money is fungible and intentions (good or bad) cannot be known. Governments may appear to use debt relief money to increase expenditure on health, while moving money it was going to spend on health anyway somewhere else. Or they may have been planning to increase ‘eligible’ spending all along. Knowing a government’s original intention is simply not possible. Estimating the increase that can genuinely be attributed to debt relief is therefore very difficult.
Countries are also different and have differing crisis responses. One country may favour food aid, another unconditional cash transfers. Global tracking systems risk pushing single solutions. Finally, allocation does not mean impact. Those providing debt relief should really be interested in whether their funding has delivered real gains to the economy and society, not simply that cheques have been printed and cashed.
3. Spending is not the only tool for responding to Covid-19
Governments are using a range of policy levers to respond to the crisis, not just public spending. They can offer tax cuts to achieve policy goals (e.g. temporarily exempting small traders from trading fees). State-owned enterprises may be the major vehicles for government policy in power, roads and water markets, but may operate entirely off-budget. Loans, credits, equity investments and financial guarantees matter. Keeping viable firms in business, and their employees in work, may be just as beneficial as spending money on public services. Focusing monitoring efforts on public spending risks overlooking major elements of the policy response.
Building trust, not tracking
Tracking frameworks are ultimately about trying to align the incentives of lenders and governments. However, outsiders will always play catch-up when it comes to monitoring what governments are actually doing. Freeing up fiscal space through debt relief increases a government’s financial power. It doesn’t necessary change the attitude of those who wield it. Providing additional finance in the absence of strict controls doesn’t matter if, broadly, donors and governments share the same objectives. No amount of conditionality can turn bad intentions good.
Ultimately then, the issue is about trust. In the case of Covid-19, the incentives of creditors and recipient governments are likely well-aligned. The threat from Covid-19 is clear and present. Debt suspension is not debt relief. Indeed, if the offer on the table is a payment holiday while interest accrues rather than genuine debt reduction, it is difficult to see why a tracking mechanism is needed at all.
Conditions and tracking systems can be less intrusive if ultimately the debt (or most of it) will be paid back anyway. Supporting governments to respond is more like a humanitarian intervention (with associated higher risk tolerance) than a long-term development intervention (where donors are more careful with their money). A failed Covid-19 response in debtor countries might blow back as negative effects for creditor countries (subscription required).
The trust between state and citizens is even more important. Governments need to act now to support economy and society, or face serious political, economic, social, and perhaps security repercussions. There is an opportunity, and indeed a necessity, to build trust between state and citizens if the crisis response is to be effective.
The IFIs and governments should avoid coming up with convoluted structures that aim to clearly link each dollar of additional fiscal space to certain types of ‘Covid-19 response spending’.
Instead IFIs and governments should be asking how communication of policy measures can help to build trust between state and citizens.
- Creditors and donors should be clear about the different types of financial assistance they are offering and where that money is coming from. They can also make resources available to governments (e.g. local data on crisis impacts, emerging lessons from other countries) that can help support effective policy-making.
- Governments should provide a summary of their Covid-19 policy responses and associated costs and give regular updates on changes to those plans given the fast-moving nature of the crisis. They should also go beyond simply providing aggregate information on fiscal costs of measures. Citizens and firms want to know how specific policies will affect them. This means making information about the design of different relief programmes freely available. Policy announcements will also inevitably differ from what is actually executed, so it is important that governments keep the receipts.
This more flexible approach comes with risks. But then so do tracking frameworks. The pressures of Covid-19 arguably align objectives far better than any political declaration, tracking system, or monitoring framework. Ultimately, building trust – not tracking – should be the cornerstone of debt relief packages.