Debt sustainability in HIPCs in a new age of choice

Working and discussion papers
June 2014

External debt in developing countries has nearly fallen off development practitioners and analysts’ radar, especially in countries that benefited from debt relief initiatives in the past decade. These initiatives have been effective in achieving some of their goals, such as debt reduction, fiscal space for poverty-reducing expenditure as well as poverty reduction, growth restoration and expansion of exports. Recent International Monetary Fund (IMF)/World Bank Debt Sustainability Analyses (DSAs) classified three-quarters of the heavily indebted poor countries (HIPCs)/Multilateral Debt Relief Initiative (MDRI) countries that had benefited from debt relief in the previous decade as being at a low or moderate risk of debt distress. As HIPC economies were largely resilient at least in the medium term, most of the warnings regarding the potentially grim outlook for debt sustainability in the aftermath of the financial and economic crisis did not fully materialise.

Is this good enough news, or are the debt forecasts we observe right now just hiding a time bomb? There are two important reasons for further analysis.

Firstly, the global landscape of development finance has been changing rapidly, with emergence of new providers and new (debt-creating) sources of development finance. This includes assistance on non-concessional terms from Development Finance Institutions (DFIs) and non-Development Assistance Committee (DAC) donors, blended and climate related finance as well as  greater access to international capital markets for developing countries. The latter phenomenon is best exemplified by recent Eurobond issuance in Rwanda and Zambia.

Secondly, current macroeconomic conditions resemble in part those prevailing in some developing countries before the debt crises of 1980s. There was a combination of sound economic performance, high commodity prices, optimistic growth forecasts in resource-rich countries, and low interest rates.

Against this backdrop, are HIPC/MDRI countries at risk of falling into a ‘debt trap’ again? If so, what should be the recommendations to multilateral development banks and partner countries to avert the risk of another debt crisis?

This paper reviews some of the achievements of the multilateral- and the highly indebted poor countries’ debt relief initiatives and reflects on the extent to which  ‘new’ debt-creating development finance flows – stemming from emerging lenders, Eurobonds, public-private partnerships, blended and climate-related finance as well as domestic debt – may jeopardise debt sustainability and the results these initiaties have achieved so far.