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Abbate Francesco, Tran-Nguyen Anh-Nga - 9 luglio 1991
Official debt reductlon: a comparatlve analysis of the Toronto
optlons, the UK Proposal and the Netherlands lnitiative*

by

Francesco Abbate and Anh Nga Tran-Nguyen**

(* A preliminary version of this paper was presented at the joint symposium of the Association of African Central Banks and the International Monetary Fund on "Structural Adjustment, External Debt and Growth in Africa", held in Gaborone, Botswana on 25-27 February 1991.

** The authors are, respectively, Chief and Economic Affairs Officier, Development Finance programme, UNCTAD. This Paper was prepared with the assistance of Anne Miroux, Cape Kasahara and Lucette Fagedet.)

The settinq

In 1988. Paris Club creditors introduced the Toronto options, a major policy advance in the rescheduling of official bilateral debt owed by low income countries. However, the implementation of the Toronto options has resulted in an amount of debt relief which is not commensurate with the weak debt serviclng capacity of most low lncome African countries.

Recognlzing the inadequacy of the Toronto measures. the Governments of the Unlted Klngdom and the Netherlands have recently put forward proposals entailing masslve debt reduction. The UK proposal consists of reducing by two-thirds the stock of Paris Club debt (contracted before the cut off date) and rescheduling the remaining one third over 25 years, with interest payments being capitalized during the five year grace period: debt service would then grow as a functlon of debtor's export capacity.(1) The Netherlands proposal calls for full forgiveness of bilateral official debt owed by the least developed and other low income countries which face severe debt problems and are implementing sound economic policies.

The following chart shows the debt servlce profiles resulting from the implementation of the Toronto options and the UK proposal(2) (the latter with two different rates of growth of debt service payments: 5 per cent and 8 per cent). The debt service reduction obtained with the UK proposal is quite substantial, when compared with the Toronto options. In fact, the UK proposal implies high concessionality, as the resulting grant element would amount to about 67 per cent, while the combined grant element of the three Toronto options is only 20 per cent. Moreover, in the case oE the Toronto scheme, debt service obligations generally need to be rescheduled repeatedly, sometimes every year (the assumption used in the chart); the resulting debt servlce would sharply increase after the flrst 8 years of grace and would peak in the 14th year, reaching a level which is slightly below the debt service scheduled for the first year in the absence of debt relief.

ln the case of the UK proposal, there would be no debt service payments in the flrst 5 years. This inltiative also allows a debt service profile whlch could be adapted to the export capacity of debtor countrles. Moreover, by reduclng ln one stroke two thirds of the stock of debt, it would avoid the cumbersome procedure of repeated reschedulings of debt service, thus saving administrative costs for debtor countries. Another advantage of the reduction of the stock of debt ls that by lifting the debt overhang, it would create stable incentives for adjustment as well as for domestic and foreign investment. The Dutch proposal would be even more favourable as, where applied, it would involve the cancellation of all bilateral official debt.

The impact of alternative debt relief measures on SPA countries as a whole

In order to evaluate the adequacy of the three alternative debt relief measures (Toronto options. UK proposal, and Dutch initiative) in relation with the debt servicing cspacity of debtor countries, the impact of these schemes on the scheduled debt service of selected low income African countries will be assessed. These are the countries benefiting from the World Bank's Special Programme of Assistance (SPA). The analysis is first carried out for the SPA countries as a whole and then individually.

In a first step, export earnings of SPA countries are projected from 1990 to 1997, on the basis of two different annual average rates of growth, 5 per cent and 8 per cent (item 1 in table 1). The rate of 5 per cent might look quite modest but, in reality, somewhat optimistic when compared with the average rate of growth of 3 per cent registered during the last decade. In comparison, the export growth rate of 8 per cent might be considered too optimistic.

In order to determine the amount of debt service which the debtor countries would be able to pay, a "normative" debt service to export ratio needs to be applied to these projected export earnings. A debt service ratio of 20 per cent has been proposed here on the basis of a number of observations. During the past decade, actual debt service payments of severely lndebted low income countries were equivalent on average to 25 per cent of their exports of goods and services (after debt reschedulings and accumulation of large arrears). However, despite significant capital inflows, these countries as a group (and especially SPA countries) experienced negative GDP growth rates in per capita terms. A debt service ratio of 20 per cent would allow these countries to release additional resources to finance some per capita GDP growth, especially if the export growth rate is weak and if external capital inflows are not buoyant, as expected. It should be noted that a debt service ratio of 20 per cent is still quite hi

gh, if compared with an actual debt service ratio of 12 per cent which the low income African countries registered in 1980 81.

To evaluate the various schemes, a normative debt service derived from a debt service ratio of 20 per cent (item 2 in table 1) may be compared with the amount of scheduled debt service that debtor countries would have to pay after repeated reschedulings of Paris Club debt service under the Toronto options, or alternatively, after the implementation of the UK or the Dutch proposals (item 4). This amount of "post debt relief" debt service ls obtained from applylng the three alternative Paris Club debt relief measures on the amount of scheduled debt service, as projected by the World Bank on the basis of the existing (end 1988) stock of debt, disbursements from existing commitments, and new commitments which were foreseen as of 1990. The World Bank projectlons might therefore underestimate the amount of debt service which debtor countries would have to pay in 1997.

------------------------------------------------------------------

Table 1

Alternative debt service Profiles of SPA countries

(in millions of US dollars)

Year 1 Y e a r 8

(1990) (1997)

Average export

growth rate of

5% 8%

__________________________________________________________________

1.Exports of goods and services 12011 16901 20585

2.Total debt service

- Scheduled, before rescheduling 6383 4590 4590

-"Normative" derived from a debt 2402 3380 4117

service ratio of 20%

3. Debt service on eligible

Paris Club debt (1)

- Before rescheduling 1855 1136 1136

After repeated reschedulings

on Toronto terms (2) 282 990 990

After implementation of UK proposal 0 338 282

4. Total scheduled debt service (3),

after implementation of:

- Toronto terms 4566 4442 4442

- UK proposal 4284 3790 3734

- Dutch proposal 4284 3452 3452

__________________________________________________________________

Source: UNCTAD calculations based on World Bank report "Special

Programme of Assistance: Proposal for the Second Phase",

1990, annex D.4.

(1) Excludes debt contracted after the cutoff date. The stock of

eligible Paris Club debt amounted to about $ 10 billion in

1989.

(2) On the assumption that the debt service on eligible Paris

Club debt is rescheduled each year, starting from 1989.

(3) Net of expected rescheduling of non Paris Club debt on

current rules.

------------------------------------------------------------------

A number of observations can be made on the basis of the data shown in Table 1.

If the scheduled debt service exceeds the "normative" debt service, this means that additional debt relief measures are needed in order to brinq the debt service into line with the debt servicing capacity of debtor countrles. Table 2 shows the amount of additional debt service reduction that would be necessary under different hypotheses. This table also shows the ratios of total scheduled debt service to exports, after implementation of the three alternative debt relief measures.

The Toronto scheme appears to be inadequate under both export growth assumptions, as large amounts of additional debt service reduction are required to bring the debt service to a level compatible with debtor's servicing capacity. The needed additional debt service reduction would amount to about 24 per cent of total scheduled debt service when the export growth rate is 5 per cent, and to about 7 per cent when the export growth rate is 8 per cent.

------------------------------------------------------------------

Table 2

Impact of different debt relief measures on debt service of SPA countries

_________________________________________________________________

Y e a r 8

(1997)

Average export growth rate of

5% 8%

__________________________________________________________________

Additional debt service reduction

(US $ million) needed to reach

a 20% debt service ratio after

implementation of:

- Toronto terms - 1062 325

UK proposal - 410 --

Dutch proposal - 72 --

Ratio of total scheduled debt service

to exports, after implementation of:

- Toronto terms - 26.3 % 21.6 %

UK proposal - 22.4 % 18.1%

Dutch proposal - 20.4 % 16.8 %

__________________________________________________________________

Source: See table 1.

------------------------------------------------------------------

When the export growth rate is high. both the UK proposal and the Dutch initiative would release enough resources to service the remaining debt service. However. when the export growth rate is low both proposals would require addltional debt service reductions equivalent to about 11 per cent of total scheduled debt service in the case of the UK proposal and to about 2 per cent in the case of the Dutch proposal.

It should be noted that the Toronto options and the UK proposal exclude from rescheduling an important part of debt which is the post cutoff date debt. For SPA countries as a whole, such debt represents about 11% of total non concessional bilateral debt owed to Paris Club creditors; but for some individual countries this share is much higher. In the case of Uganda, for example, it is about 50 per cent. Moreover, debt owed to non Paris Club creditors accounting for 25 per cent of total bilateral non concessional debt is not subject to the same debt relief measures. Thus, the amount of required additional debt service reduction under the UK proposal could be met at an aggregate level by eliminating the cutoff date rule and by extending the scheme to debt owed to non Paris Club creditors.

To be sure, the maintenance of the cutoff date is central to the Paris Club policy of protecting new export credits from rescheduling. However, the increase in concessional debt relief that would result from bringing forward the cutoff date would by far outweigh any possible adverse impact on new export credits. In any case, most low income African countries will be able to attract and afford only highly concessional flows for many years to come. Alternatively, if the cutoff date policy is not changed, even greater aid flows will be required in some cases to compensate for the servicing of post cutoff date debt.

The impact of the UK Proposal on individual SPA countries

The results shown above concern SPA countries as a whole.

To be sure, individual countries' debt burden and need for debt relief differ significantly. In order to highlight the varying country situations. an estimate of the possible impact of the UK proposal on the debt service ratios of each of 18 SPA countries (out of a total of 23) has been undertaken (see annex table). (3) These estimates have been made on the assumption that the proposal would have been applied in 1990 on the overall debt (including post cutoff date debt) owed to Paris Club creditors by each of these countries (after taking into account ODA debt cancellations which were granted by donor countries in 1989 and 1990). Exports are assumed to grow by 5 per cent annually. After five years of grace and interest capitalization, debt service payments are projected to increase by 5 per cent a year, following the suggestion contained in the UK proposal of adjusting payments growth to export growth.

It should be noted that the debt service ratios have been calculated on the basis of World Bank projections of debt service payments on the existing (end 1989) pipeline of long term debt. This tends to underestimate future debt service obligations, as new commitments, as well as short term debt and IMF credit, are not taken into account. Despite these shortcomings, the estimates of the impact of the UK proposal on debt service ratios of individual countries have produced some interesting results.

First, for a group of countries (Benin, Central African Republic, Chad, Malawi, and Togo) whose debt service ratios originally do not exceed 20 per cent, the UK proposal would result in a small reduction of their debt service ratios of few percentage points. For these countries, an overwhelming part of their debt is on concessional terms.

For a second group of countries (Guinea, Niger, Senegal, Zaire), the UK proposal would have a rather significant immediate impact as it would lower their debt servlce ratios to less than 20 per cent by the second year of the scheme, from levels which were originally in the 25 35 per cent range.

For a third group of countries (Madagascar, Mali, Mauritania, Tanzania and Uganda), the debt service ratios after the implementation of the UK scheme would decline below 20 per cent from years 6 8 onwards. Therefore, over the medium term these countries would continue to be afflicted by the debt overhang, although in some cases (Madagascar and Tanzania) the immediate debt service reduction would be considerable. In this group. about 40 per cent of total debt is owed to Paris Club creditors.

Finally, the fourth group includes those countries which would maintain high, sometimes extremely high, debt service ratios (Guinea Blssau, Mozamblque, Sao Tomé and Principe, Somalia). For most of these countrles, the UK proposal would have a significant impact on debt service ratios; nevertheless, their debt service ratio would still remain far above 20 per cent. For instance, in the eighth year of the scheme, debt service ratios in Gulnea Bissau and Mozambique would be about 60 per cent and 30 per cent respectively. In Sao Tomé and Principe and Somalia these ratios would be in the 30 40 per cent range. In all countries belonging to this group, a large part of the debt is owed either to non Paris Club bilateral creditors or to multilateral institutions. In the case of Guinea Bissau, for example, about three quarters of official bilateral debt is to non Paris Club creditors, and about half of its total debt is to multilateral institutions.

The above analysis leads to the following conclusions:

(a) If the UK proposal is implemented, half of the SPA countries

(i.e. the 9 countries belonging to the first and second

group), would register debt service ratios lower than the

"normative" level of 20 per cent withln two years. But for the

remaining countries, this initiative is not enough. This

conclusion is reinforced by the fact that debt service

projections do not include debt contracted after 1989 and

assume that debt reduction would also apply to post cutoff

date debt. There is, therefore, a need for additional

measures, such as higher percentage of debt reductlon, as

advocated by the Dutch proposal, inclusion of post cutoff date

debt, equivalent measures to be taken by non Parls Club

creditors, rescheduling of multilateral debt, commercial bank

debt reduction. and increased ODA flows.

(b) It is necessary to tailor debt relief measures to the specific

needs of individual debtor countries. For the

severely indebted low income countries, the writing off of

two-thlrds of Paris Club debt, as proposed by the UK, should

be treated as a benchmark. Creditor countries should consider

granting additional concessional debt relief where it is

needed in order to contribute to the removal of the debt

overhang.

Footnotes

(1) The following repayment formula underlies the UK proposal:

Let D1 be the debt outstanding at the beginning of period 1

(i.e. after the grace period), P1 be the initial payment,

r the interest rate (and also the discount rate), g the rate

of growth of payments (which can be made equal to the

projected rate of growth of export earnings) and N the

remaining maturity of the loan after the grace period (20

years).

If all payments are made at the end of each period, then:

t-1

N P1 (1+g)

D1 = > ------------

t=1 (1+r) t

At

Dt =(l+r) Dt-1

Pt = r Dt-1 + At

where At equals the amortization payment in each period.

From the above, the value of P1 is given by:

D1 (r g)

P1 _______________

(1=g) N

1- ________

(1=r)

(2) In the UK proposal, the debt service profile varies with the

growth rate of payments (g, as in footnote 1). The chart on

p.3 shows the debt service profiles on the basis of two

hypothetical values of g: 5 per cent and 8 per cent. Given

the same repayment period of 20 years applied to all cases,

the lower is g, the higher are the payments during the first

few years. If g is made equal to the export growth rate, a

paradoxical situation might occur: the lower is the export

growth rate, i.e. the lower the debtor's servicing capacity,

the higher are the initial payments. If the same maturity is

applied to all rescheduling countries, it could be suggested

that, instead of making g equal to export growth rates, an

alternative proposal could be applied, which would allow a

debtor country with a slow growth in export earnings to make

smaller payments in the earlier part of the repayment period

(for example, by allowing g to be higher than the export

growth rate). Another possibility would be to lengthen the

maturity, in accordance with difficulties in debt servicing.

(3) Burundi, Gambia, Ghana, and Kenya have been excluded from

this exercise because they are not likely to require Paris

Club rescheduling in the foreseeable future. 2ambia has been

also excluded because it was not covered in the World Bank

report mentioned in table 1.

 
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