Trade, debt and development: Does reform pay off?

Trade Directorate

The reform-for-debt relief formula is an exercise not only in global co-operation, but also in self-reform. For developing countries it is a necessary first step. 

During the early 1990s, the least developed countries accounted for a paltry 0.5% of world trade, while carrying a burden of total external debt that in some countries, such as Guinea-Bissau, Mozambique and Uganda, amounted to more than ten times their export earnings. This meant that, at times, a third or more of their export revenues went towards servicing financial obligations. And as their debt was denoted in hard currency, it could not be paid for with earnings made in the domestic economy, where weak currencies or barter predominated.

This put a severe strain on the countries’ economic prospects by drawing money away from much needed imports of machinery and equipment, and infrastructure investments.

Several attempts have been made to alleviate the problems of indebtedness, but few have attracted attention as much as the so-called Heavily Indebted Poor Country initiative (known by its acronym, HIPC, pronounced hipic) which the IMF and the World Bank launched in September 1996. It offered debt relief to eligible countries that were pursuing sound economic policies. Following a major review, the initiative was significantly enhanced in 1999 to enable more countries to qualify for deeper and broader debt relief, on condition that they showed commitment to poverty reduction.

By 2002, some 42 countries had been identified by the IMF and World Bank as being HIPCs, based on their indebtedness relative to exports and government revenues (see list). Of these countries, six had implemented a poverty reduction strategy involving successful economic reform and macroeconomic stability, and had received debt relief; these are called “completion point countries”.

For another 20 countries, debt relief had been approved, but was pending while they established a sufficient record in implementing their poverty reduction strategies; these are the “decision point countries”.

And 12 countries had no reform plans in place yet and so had not satisfied the criteria for eligibility; these countries can be called “pre-decision point countries”. Four HIPCs have been characterised as having potentially sustainable debt levels and so were not in need of special assistance.

The question both debtors and debtees will ask is, has this reform-for-debt relief approach paid off? Probably yes, though it is early days. In practice, the economic and trade performance of HIPCs has varied according to individual circumstances. Some countries have experienced significant economic growth, while others have slumped. Other factors apart from domestic policy reforms can affect performance too, such as a fall in commodity prices, the prevalence of HIV/AIDS, or armed conflict. Nevertheless, a comparison of economic indicators across the different groups of HIPC countries from 1997, the year when the first countries reached decision point under the original HIPC initiative, to 2001, the latest year for which data are available, suggests that the reforms-for-debt relief initiative may work.

In particular, those countries that have reached economic stability and started to implement policy reforms in the context of their poverty reduction strategies have performed better than countries that are less advanced in their reform programmes. Those that had not yet started with domestic reforms performed worst of all. In fact, in the six countries that had reached completion point, GDP in 2001 was higher than it was in 1997, whereas it fell over time in the other two groups.

The increase was particularly marked for investment, which for “completion point countries” was more than 30% higher in 2001 than in 1997, while it increased by less than 10% in “decision point countries”, where more progress was needed, and fell in the lagging “pre-decision point HIPCs”.

A similar pattern is seen for exports and imports. As for foreign direct investment, all three country groups increased their stock during the late 1990s, but the largest inflows once again went to “completion point HIPCs”.

Obviously, these results are preliminary, since the HIPC initiative in its enhanced form was launched less than four years ago and the first country to reach completion point was Uganda, as recently as May 2000.

The direction of causality lends itself to questioning, too. For instance, did “completion point countries” perform well because of recent reforms associated with debt relief, or because earlier policies and relatively good economic performances in the past have made it easier for them to qualify for debt relief? Looked at another way, what prevented the poorer performers from engaging in reform?

While the available evidence suggests that reform policies do make a difference in terms of economic and trade performance, perhaps some of the very poorest countries find it particularly difficult, say, because of disease, conflict or the resistance of vested interests, to lift themselves out of the poverty quagmire.

More time is needed to understand these possibilities more clearly, as the HIPC initiative is still evolving. For instance, it seems likely that trade reforms have helped some countries augment their export and import performance and, in turn, attack their debt levels. Yet, some of the early poverty reduction strategy programmes gave little consideration to trade and trade-related policies, concentrating instead on issues such as containment of inflation and government budgets, and investment in agricultural and social infrastructure.

Integrating trade policy reform into HIPC reform programmes is now being encouraged by the IMF and the World Bank, with a particular focus, for example, on customs reform and governance, and attention to the impact of textiles trade liberalisation on HIPC economies.

Trade policy programmes in OECD countries, such as the EU’s “Everything But Arms Initiative” or the US’s “African Growth and Opportunities Act”, which grant preferential market access to exporters from low-income countries, can play a complementary role in improving the prospects for exports from the world’s poorest countries.

Yet, what makes HIPC interesting is that it challenges poor countries to take action themselves, and to reap the benefit, while helping international policy to focus more attention on the problems of the weakest economies.

References

Bird, G. and A. Milne (2003), “Debt relief for low income countries: is it effective and efficient?”, World Economy 26(1): 43-59.

Daseking, C. and R. Powell (1999), “From Toronto terms to the HIPC Initiative: a brief history of debt relief for low income countries”, IMF Working Paper WP/99/142, Washington DC.

OECD (2003), “HIPC and trade policy reform: some early observations”, Unclassified document TD/TC/WP(2003)4/FINAL, Paris.

©OECD Observer No 237, May 2003




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