27638 Précis WORLD BANK The HIPC Initiative: OPERATIONS EVALUATION DEPARTMENT WINTER 2003 NUMBER 230 Progress and Prospects T he Heavily Indebted Poor Countries (HIPC) Debt Initiative— designed to relieve the high external debt burdens of some of the poorest nations—was put in place by the World Bank and the IMF in 1996; an expanded, enhanced HIPC followed in 1999. With a more comprehensive approach to debt relief—including, for the first time, multilateral debt—the Initiative represents a major innovation in development finance. But is the Initiative likely to achieve all of its goals? A recent Operations Evaluation Department (OED) review assesses the progress and prospects of the Initiative, with a view to informing—and, where necessary, strengthening—its ongoing implementation. Background group was formed to develop new ways to In the mid-1990s, public concern with comprehensively deal with unsustainable excessive debt burdens (see table) together debt. When the group’s draft working with declining aid resources and a percep- paper was leaked to the press in 1995, it tion of development failure in many of the proved an unexpected catalyst. The devel- least-developed countries provided the opment community quickly embraced the impetus for debt relief. With the vocal sup- ideas outlined in the draft, and the HIPC port of advocacy nongovernmental organi- Initiative was launched in 1996. The Initia- zations (NGOs), these concerns came to be tive embodied the lessons of experience, shared by pragmatic policymakers in linking aid effectiveness with the policy donor governments and international financial External Debt as Percentage of GDP institutions. Within the (period average) World Bank, there was increasing recognition Country category 1980–84 1985–89 1990–94 1995–00 that the persistently rising debt burdens of HIPC 38 70 120 103 some of its poorest bor- Other International Development rowers reflected Association (IDA) countries 21 33 38 33 problems of insolvency Other lower-middle-income rather than illiquidity, countries 22 30 27 26 calling for a different response than attempted Source: Global Development Finance and World Development Indicators. in the past. A working 2 World Bank Operations Evaluation Department environment and aid coordination, conditionality with own- other poor countries. The countries that are past their deci- ership, and social impacts of macroeconomic policy with sion point are already benefiting from significantly lower public expenditure prioritization. debt service. OED also found that beneficiary countries are allocating The HIPC Mandate Broadens HIPC resources largely as anticipated in the decision point The goal of the original framework was to reduce the documents, and that budgetary resources for targeted sec- external debt of eligible countries as part of a strategy to tors have indeed increased appreciably. In many HIPCs, the achieve debt sustainability, thus eliminating the debt over- Initiative has increased national awareness of the external hang as a constraint to economic growth and poverty debt problem and is spurring efforts to improve debt man- reduction. But after 1996, the pressure continued to build agement. A number of efforts are also underway to for debt relief that was “broader, faster, deeper.” In improve the management of public expenditures. response, the enhanced HIPC Initiative (E-HIPC) was crafted and approved in 1999. The strong influence of But Expectations Exceed the Scope of the Program’s Design NGOs led to the creation of a direct link between debt While the Initiative’s objectives have expanded and become relief and poverty reduction in E-HIPC, which took the more ambitious, it remains a limited instrument. To fully form of targeting the anticipated debt service savings to achieve its current stated objectives, actions by develop- spending on the social sectors. The debtors had limited ment partners are needed that are beyond the Initiative’s influence on the design of the Initiative, even though they purview. Thus the Initiative faces the risk of promising out- are central to its implementation. The outcome of this comes—in particular, on the freeing up of resources for dynamic political process was that the original focus on increased social sector expenditures and “ensuring” debt removing the debt overhang—the key issue that the Initia- sustainability—that it cannot deliver by itself. The Initia- tive was created to address—was broadened. The E-HIPC tive’s design should have paid more attention to the partici- thus came to acquire a more ambitious set of objectives: (1) pation of all creditors, to ensure that the anticipated relief to provide a permanent exit from debt rescheduling, (2) to is delivered in full, and building HIPCs’ capacity for debt promote growth, and (3) to release resources for increased management, a long-standing constraint. social spending. The need to create the fiscal space for Additionality. A key assumption underlying the objec- increased social expenditures was a critical prerequisite for tive of freeing up resources for higher social spending is broad-based support from the donor community, and it has that past aid levels would be maintained, so that HIPC debt had a major impact on the Initiative’s design and imple- relief would translate into additional real resources. To mentation. accomplish this, without diverting aid resources from poor but not highly indebted countries, an overall increase in aid The Initiative is Likely to Achieve Its Original Goal resources is needed. But the Initiative’s design provides no The HIPC Initiative has been a catalyst for far-reaching mechanism to ensure this. Both global net resource trans- changes in the processes surrounding development assis- fers and those to the HIPCs in recent years show a sharp tance, reflecting the coming of age of a new authorizing environment with the active participation of civil society. It has made the processes of the sovereign debt regime more HIPCs’ Growing Share of Aggregate Net open and accountable and spurred development coopera- Resource Transfers Percent tion, including heightened coordination between the World 100 Bank and the IMF. It has also been the catalyst for the Poverty Reduction Strategy process, which aims to help 90 countries improve governance, transparency, and accounta- 80 bility, while promoting country ownership of poverty 70 reduction strategies. 60 OED found that the HIPC Initiative, as one instrument in the development assistance architecture, is highly rele- 50 vant in addressing a key obstacle to growth and poverty 40 reduction facing many poor countries. And one of the prin- 30 cipal findings of the review is that that the Initiative is 20 likely to achieve its original fundamental goal—to provide some of the poorest countries with much-needed relief by 10 reducing their debt stocks and debt service burdens. If the 0 expected debt relief is delivered, the Initiative will succeed 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 in reducing by half (on average) the HIPCs’ external debt Decision point HIPCs Remaining HIPCs Other developing countries stocks and their debt service, which will bring their debt Source: OECD, DAC database. burdens to levels comparable with, or lower than, those of Précis 230 3 decline, starting just about the time the Initiative was cre- challenge is to ensure that all new funds are invested pro- ated. HIPC countries are indeed receiving an increasing ductively and efficiently to promote repayment capacity. share of declining global aid resources relative to other The fiscal base in HIPCs is typically narrow, and exports poor countries (see figure), but they are not receiving addi- are concentrated in a few commodities subject to highly tional funds compared to what they were getting before the volatile markets. The HIPC countries need to remove fiscal creation of the Initiative (that is, before 1996). To the constraints and other policy obstacles to more rapid, extent that the Initiative has helped protect the share of the broad-based growth. They also need to diversify and HIPCs, it may be judged a limited success, but it appears enhance their export base, which would require trade facili- that the share of other poor countries has declined corre- tation and better access to developed country markets. spondingly. The resulting redistribution conflicts with the A key ingredient for debt sustainability and poverty principle of performance-based allocation and could reduce reduction is a credible strategy for growth. Here the link to the overall efficiency and effectiveness of aid. This outcome the Poverty Reduction Strategy Paper (PRSP) process holds is a direct consequence of limited aid resources, and it can- promise, but early evidence, including the World Bank’s not be overcome through design improvements in the Ini- own review of early PRSPs, indicates there is little emphasis tiative itself as currently conceived. on growth-related activities beyond the adoption of a Debt Sustainability. The objective related to debt sus- sound macroeconomic framework and investment in tainability has evolved to become more ambitious, fueling human capital. Factors such as investment climate, trade expectations of what the Initiative can deliver. The notion access, and infrastructure development are critical to pro- of debt sustainability has been contentious, with contro- mote growth but have received little attention so far. versy about how to measure it and how to “ensure” it. The A necessary condition for accelerated growth is the adop- review concludes that the main indicator used in the Initia- tion of sound policy frameworks that will foster economic tive, the net present value of debt-to-exports ratio, while stability, effective public expenditure management, and effi- not perfect, is operationally preferable to alternative indica- cient and non-distorting revenue generation. A track record tors for practical reasons. The current threshold is also rea- of strong policy performance has been a HIPC requirement sonable in comparison with the debt levels of non–highly from the outset. The specific requirements were progres- indebted poor countries. But does the Initiative deliver debt sively relaxed during the millennium rush—to reach the tar- sustainability? The main tool for assessing this is the debt get of getting at least 20 countries to decision point by sustainability analysis (DSA), the robustness of which has end-2000. Many of these countries have experienced subse- not yet been demonstrated convincingly. The DSA has two quent policy slippages and have yet to convincingly demon- components. One assesses current levels of debt using a strate an ability to put sound policy frameworks in place. new methodology that provides a sound basis for calculat- ing the amount of debt relief for each country. The other NGO and Donor Pressure has Increased Focus on the projects future debt indicators to assess each country’s like- Social Sectors lihood of achieving debt sustainability. The review finds The E-HIPC guidelines for increased public expenditures that the economic models and the methodological basis toward poverty reduction emphasize the social sectors— underlying these debt projections need to be made more primarily education and health—over others with the transparent, and the growth assumptions more realistic. potential to help reduce poverty through enhanced eco- To place the Initiative on a firmer footing, the DSA’s nomic growth. The performance criteria highlight expendi- also need to better capture the potential effects of volatility tures rather than outcomes or impacts, even though in export earnings—a key risk factor. Improved risk analy- increased expenditures may encounter diminishing returns sis would provide a better assessment of each country’s in the short and medium run. The capacity of many coun- likelihood of meeting the Initiative's debt sustainability tries’ education and health ministries to manage increased threshold. This by itself would not improve the prospects budget resources efficiently is weak. Moreover, a substan- for debt sustainability, which is influenced by other factors tial share of aid resources is already earmarked for social discussed below, but it would permit a more informed expenditures, and the World Bank’s public expenditure debate about the policy changes needed in donor and recip- reviews indicate that financing is not always the primary ient countries alike, as well as fostering greater realism in constraint to achieving outcomes. The need for investment setting objectives and funding arrangements. to promote growth may warrant a different balance between the social and other sectors, especially infrastruc- Growth and Policy Performance are Central to Achieving ture and rural development. the Initiative’s Objectives Debtor country representatives have expressed concern A one-time debt reduction is not sufficient to guarantee about the inflexibility in the allocation of HIPC resources, that a country will avoid future debt problems. The noting that external strictures on their resource allocation prospects for debt sustainability depend on a number of can weaken budget discipline and domestic ownership. They factors that affect a country’s repayment capacity, includ- criticized the over-emphasis on social sector expenditures as ing the amount and terms of new borrowings. The main potentially undermining the achievement of HIPC objectives 4 World Bank Operations Evaluation Department without increased economic growth. Perhaps reflecting these pressures, over half of HIPC governments’ revenues are Management Response expected to be earmarked for social expenditures in the Management is in broad agreement with OED’s recommenda- coming years. Most countries consider this imbalanced and tions. While agreeing that the objectives of the HIPC Initiative have grown in ambition over the years, the Management response inconsistent with their focus on broader development goals. noted that by reducing debt stocks, the Initiative was always And since most countries’ PRSPs are still being developed, meant to contribute toward a broader, more comprehensive these anticipated allocations are also inconsistent with the development architecture, but not to supplant it. Management intended role of the PRSPs to set priorities. also expressed support for OED’s emphasis that additionality is an important underlying principle of the Initiative, but contends Conclusions and Recommendations that it should be assessed on a country-by-country basis and that Excessive debt creates problems and must be effectively transfers of additional resources to support development pro- dealt with. But the HIPCs’ unmanageable debt burdens are grams should not come at the expense of debt sustainability. a symptom of deeper structural problems. While the HIPC Initiative appears likely to provide a much-needed respite from high debt service, debt relief is not a panacea for broader economic development problems, nor is a one-time Executive Directors’ Perspective debt reduction a guarantee that future debt will remain at The Committee on Development Effectiveness (CODE) com- mended OED for an excellent report, timed to inform manage- sustainable levels. The HIPC Initiative is thus an impor- ment’s annual update on HIPC planned for September 2003. The tant—but small—part of the overall development assistance members supported the thrust of the recommendations. CODE’s framework. Perhaps the greatest challenge facing the Initia- discussion emphasized several key points: (1) Debt relief is not a tive is the expectations of what it can achieve within financ- substitute for broader, growth-oriented development programs, ing limitations and policy and institutional constraints in the and the HIPC should be seen as one of several instruments to sup- HIPCs. Achieving its multiple objectives requires actions by port poverty reduction; (2) Additionality is an important part of HIPC governments to adopt sound policy frameworks and a the HIPC framework, but should not override performance-based balanced development strategy. It also requires actions by allocation of resources; and (3) The realism of debt sustainability the international community to assist the countries to analysis and a clear external communication supporting wider increase their exports and support necessary capacity build- public understanding of the report’s findings were also important. ing efforts. Donors face a further challenge to make ade- quate resources available to finance the development priorities of HIPCs and other poor countries, and ensure that HIPC debt relief is truly additional to other aid flows. Four actions are recommended to address the strategic Director-General, Operations Evaluation: Gregory K. Ingram issues facing the Initiative: Acting Director, Operations Evaluation Department: Nils Fostvedt • Clarify the purpose and objectives of the Initiative, Manager, Corporate Evaluation and Methods: Victoria Elliott ensure that its design is consistent with these objectives, Task Manager: Madhur Gautam and that both the objectives and how they are to be achieved are clearly communicated to the global "This Précis is based on “The Heavily Indebted Poor Countries (HIPC) Initiative: An OED Review,” by Madhur Gautam. community. • Improve the transparency of the methodology and economic models underlying the debt projections and "The complete study is available at: http://www.worldbank.org/oed/HIPC the realism of economic growth forecasts in the debt sustainability analyses. This would facilitate "Précis are available to Bank Executive Directors and staff from the decisionmaking by providing a better assessment of the Internal Documents Unit and from regional information service prospects and risks facing individual countries. centers, and to the public from the World Bank InfoShop. Précis are • Maintain the standards for policy performance. This also available at no charge by contacting the OED Help Desk: eline@worldbank.org or calling 1-202/458-4497. would help minimize the risks to achieving and maintaining the Initiative’s objectives. When the established policy performance criteria need to be relaxed, DISCLAIMER: The views in this there should be a clear and transparent rationale. paper are those of the Operations Evaluation staff and editors and • Increase the focus on pro-poor growth in the should not be attributed to the World Bank, its affiliated performance criteria. There should be a better balance organizations, or its Executive Directors. between growth-enhancing and social expenditures, Précis aussi disponible en français Series Editor: Caroline McEuen relative to the current emphasis on the latter. Précis en español tambien disponible @ http://www.worldbank.org/oed Précis 230 The HIPC Initiative: Progress and Prospects ISSN 1564-6297