Transparency needed to end debt sustainability fears

Over the past decade, OECD DAC members and multilateral banks eliminated a major part of the debt owed by sub-Saharan African nations as part of the Heavily Indebted Poor Countries (HIPC) initiative – launched by the International Monetary Fund (IMF) and World Bank in 1996 and reinforced in 1999 – and the Multilateral Debt Relief Initiative (MDRI) of the Group of Eight (G8) nations in 2005.

Several studies have highlighted, however, that even with these initiatives the causes of critical debt remain (Berthélemy, 2001; Easterly, 2002).

There have been fears that the emerging economic partners would again plunge borrower nations into a new debt vortex (World Bank & IMF, 2009). No general increase has been seen yet, but the risk remains, especially for the most fragile states.

It is very difficult to assess whether the African countries which have benefited from debt relief are falling into debt again. The action on debt was in most cases too recent and information coherent with data from the past is not yet available. Furthermore, the HIPC initiative is only partially reflected in the statistics. Debt reductions only show up when repayments are made by developed countries for debtor nations. The MDRI, on the other hand, is calculated as a debt reduction.

Many of the Chinese contracts in Africa lay down that repayments be made in natural resources, with complex institutional contracts that make repayments unpredictable in financial terms.²¹

The link between the expansion in the number of Africa’s economic partnerships and the continent’s debt is also complex. Reisen (2007 and 2008) argues that the emerging powers have had an impact on Africa’s debt sustainability in several ways:

• Financing can increase debt, but grants, which probably represent a substantial part of the total (see above), tend to lighten the burden by making repayments in currency easier.

• Loans, including those made at non-concessional terms, can have a positive impact if they finance productive projects that offer a return higher than the interest rate. This is the case in China’s loans to Africa, especially those by Exim Bank, and export credits. They are targeted at improving infrastructure and can strengthen long term growth prospects if properly maintained. Classical debt analysis often does not take into account the relationship between loans and future growth.

• The emerging countries also have an impact on resources making possible the repayment of external loans: increases in exports, higher prices for raw materials, lower costs of imported products and public works, grants etc.

With this in mind Figure 6.11 does not indicate any rapid increase in new debt since the reductions accorded by traditional partners in recent years. On the contrary, debt is continuing to fall for countries which have reached the HIPC completion point because they can then get relief under the MDRI. The biggest debt reduction comes after reaching the completion point.²² Combined with favourable economic circumstances, especially rising raw material prices before and after the 2008 financial and economic crisis, debt reductions have created an unprecedented situation for the financing of African countries. Reisen (ibid.) says that overall China barely contributes to Africa’s new debts inasmuch as the main beneficiaries of co-operation with China, such as Sudan and Angola, have rich natural resources and have not benefited from debt reductions.

Nevertheless it seems that some African countries that received large debt reductions still face significant risks. Chaponnière (2007) highlights how China's co-operation has spread to low-revenue countries such as Ethiopia, Mali and Tanzania and claims that even if the loans are smaller for countries which do not have raw materials, they can be large in relation to their resources, and also in debt terms if the concessional rates are inadequate.

Raffinot and Dahoun (forthcoming) use the example of Ethiopia to highlight how the emerging economies contribute to the running up of new debts by countries that have benefitted from major debt reduction. According to the published data reproduced in Figure 6.11, Ethiopia's new debt does not seem significant. Nevertheless the most recent figures from the IMF and Ministry of Finance still show that new debt increased quickly after it reached the HIPC completion point at which point Ethoipia also benefitted from the multilateral relief.

Ethiopia’s public sector debt has practically returned to pre-MDRI levels – it was USD 5.6 billion in 2009/10 against USD 6 billion in 2005/06. While most of the new debt was owed to international financial bodies and the sustainability level does not appear to be under threat, loans from countries that were not members of the Paris Club contributed to the phenomenon.²³ They accounted for 17.5% of total public debt in 2009/10. China's Exim Bank made loans of USD 349 million in November 2009 and USD 25 million²⁴ in January 2010.  China became Ethiopia's third biggest lender in 2009/10 with 11% of its new loans, behind the World Bank's IDA (34.3%) and the IMF on 11.5%. It was also the main bilateral lender ahead of India (4.8%).

The growth in financing from the emerging partners has been accompanied by a change in attitude, especially on the part of China, taking them closer to the lending policies of Africa's traditional partners. China's financing conditions now correspond to the concessionality norms of the traditional powers (Brautigam, 2010a). The two 20-year Chinese loans to Ethiopia had an interest rate of 2% with a grace period of seven and eight years respectively. According to available information, these conditions are in line with OECD DAC terms, say Raffinot and Dahoun (forthcoming). The concessionality rates, calculated with a standard discount rate of 10%, are approximately 58% and 59% respectively. This is part of a general trend to move closer to the practices of the traditional partners.

China has also granted large debt reductions and its increasingly assumes the role of a conventional lender. The emerging economies are seeking a bigger voice in international financial governance not only through their membership of the Group of 20 nations but also their strengthened representation on international bodies. The increase in IMF quota shares given to emerging countries will only heighten the trend.²⁵ This can be seen in their treatment of indebted African countries where China has announced several debt cancellation initiatives:

• More than USD 1 billion owed by Africa's poorest countries was cancelled at the first China-Africa Forum in October 2000. According to Wang & Bio-Tchané (2008), this effectively wiped out almost 10.5 billion Chinese yuan renminbi (CNY), or USD 1.3 billion, between 2000 and 2002.

• CNY 10 billion of debt owed by 33 HIPC and Least Developed Countries (LDC) in Africa that had diplomatic relations with China were written off in 2006. China cancelled outstanding debt for the same 33 on interest-bearing loans that became payable in 2009 as part of a three year plan unveiled at the Fourth China-Africa Forum in Sharm El-Sheikh, Egypt, in 2009. 

• Finally, at the 2010 Millennium Development Goals summit, Prime Minister Wen Jiabao announced the latest figures on China's accumulated debt cancellation so far: CNY 25.6 billion, about USD 3.8 billion, of debt owed by heavily indebted and least developed countries.

China’s position is increasingly like that of a traditional lender to Africa. For example, before 2000 Mali's debt to China was "dormant": it was recognised as being owed but in practice no repayment was ever asked for. This posed a technical problem in analysing Mali's debt sustainability as the nominal sum increased while there was no real impact on Mali's repayments. China later adopted a policy more in line with that of traditional creditors, cancelling part of the sum but asking for effective payment of the rest of the amount due.

So, rather paradoxically, the effective weight of debt owed by African countries to China has grown. Even if the terms and conditions for China's loans are different from traditional creditors' (Foster et al., 2008), their philosophies seem to be getting closer.

For all that, China has not openly adopted the standards set by Paris Club creditor nations, nor those of the HIPC initiatives and MDRI (Wang and Bio-Tchané, 2008). In particular it has granted debt reductions to countries, such as Zimbabwe, which are not considered eligible by the Bretton Woods institutions. Neither has China become a member of the Paris Club though it has taken part in meetings that the body has held with non-member creditors and the private sector.

In this context, the Bretton Woods institutions seek to keep Africa's new debts in check by supervising concessionality levels of loans to countries which receive financing from the international bodies. They also use the Debt Sustainability Framework (DSF), which seeks to stop lenders from lending more money to countries that have exceeded their debt ceilings (Box 6.6). This framework is not aimed at emerging partners' financing and but it has also constrained traditional lenders' activities and can potentially act as a brake on lending by emerging partners as well.

To work well, the DSF needs close co-ordination between all creditors. This is hard enough to do between public and private lenders from the traditional partners, but is even more difficult with the new lenders (Djoufelkit-Cottenet, 2006). Their commercial and diplomatic interests could encourage the emerging nations to get around the measures, in particular by hiding information (Reisen and Ndoye, 2008), the more so since the new emerging partners were not involved in drawing up the framework. They could seek clandestine means to be repaid – including through access to raw materials – by countries that would otherwise be in payment default.

The risk exists, then, that the fiscal space created by large-scale debt reductions granted by traditional partners will be used to repay new debts, especially on non-concessional terms, to the emerging partners. Ghana is a case in point. Following its MDRI, in 2007 Ghana managed to borrow on the international financial market at rates more than ten times higher than those of bodies such as the World Bank and African Development Bank. Another risk, just as big though less visible, concerns the development of internal public debt. This tends to grow, not only in the emerging countries, but also those with low revenues – such as the case of Ethiopia already highlighted – as internal financial systems strengthen. For most African nations, the Bretton Woods institutions and traditional lenders have little pressure to apply as nations which have reached the HIPC completion point and the end of the MDRI get unconditional debt reductions. Pressure can only be put on the very small number of countries which have not entered the HIPC system.

Tensions have surfaced when debt is reduced after a nation reaches the HIPC completion point. Conditions are applied according to each case. But the example of the Democratic Republic of Congo is among the best documented (Box 6.7).

To summarise, the impact of financing from the emerging partners is limited so far. In the short term it does not seem to be a threat to the debt sustainability of low-revenue African nations. In any event, China, the biggest creditor among the emerging partners, is adopting an attitude ever closer to that of the traditional creditors. There is still a risk, however, especially for the most fragile nations. Increased transparency in financial transactions between African economies and their partners would reassure Paris Club creditors and strengthen the credibility of the emerging partners as part of the international financial governance structure. Demands for transparency would have a greater chance of success if the African institutions showed greater transparency themselves.