Debt Sustainability Framework
The World Bank/ IMF's Debt Sustainability Framework is being adopted by an ever growing number of lenders. Concerns about this approach include the fact that the Framework does not promote a human-needs approach to sustainable debt levels, does not share responsibility for lending decisions equally between creditors and debtors, and it does not provide an answer to the call for much broader responsible lending standards.
What is a "sustainable" debt level?
Since the early 1980s, poor countries have been facing unsustainable debt levels which mean they are paying more to service their debts than in efforts to tackle poverty and provide essential services for their citizens. Debt levels in poor countries reached such crisis levels that rich countries and the international financial institutions were forced to act.
Paris Club and other ad hoc debt restructurings from the 1980s and the HIPC and MDRI debt relief schemes from the mid-1990s did reduce some countries' debt levels to some creditors, but they do not go anywhere near far enough. A fundamental flaw of all of these approaches was in their understanding of sustainability.
In calculating a "sustainable" level of debt, the international financial institutions and rich creditors assess poor countries in purely fiscal terms, with the aim of reducing or maintaining debts at a level that each country can just afford to repay. This takes no account of other demands on public funds, or of the poverty of the people. The aim is to protect the creditors, and to maintain some participation of the country within the global economy, such as providing an opportunity for international investment and trade.
Civil society groups have argued for years for a different measure of sustainability to be used, allowing a population's human rights and basic needs - such as food, shelter, health and education - to be protected, and not undermined by their country's debt payments. The human development approach to debt sustainability starts by looking at the funds a government needs to provide basic services to its people. The cost of these is then calculated, only after which can there be any assessment of how much a government may (or may not) be able to pay in external debt service.
Why the DSF?
As a result of the international community's failure to properly address the debt crisis, many poor countries are still facing huge debt burdens which siphon off finance that could otherwise be used to tackle poverty. While not acknowledging this failure, Northern country and multilateral creditors have become concerned about the re-accumulation of debt in low income countries, particularly through borrowing at non-concessional terms from commercial or new sovereign lenders. They accuse these lenders of "free-riding" on traditional lenders' generous debt cancellation schemes. Many in civil society suspect that a key issue is also that these creditors fear emerging lenders, and particularly China, challenging their monopoly in the development arena.
The World Bank/ IMF's Debt Sustainability Framework (DSF) was thus launched in 2005 to assess low-income countries risks of debt distress, and based on this risk assessment, whether its finance should come in the form of grants or loans. The DSF provides the basis of allocation for the IDA (the World Bank's concessional lending arm) and is now accepted practice across the Bank, such as in the new Climate Investment Funds, and increasingly by other groups of lenders such as the OECD's Export Credit Agency working group. However, the DSF marks no fundamental shift from an understanding of debt sustainability merely in terms of what a country can afford to repay, rather than the required human-needs based approach.
The DSF is constructed around the Country Institutional and Policy Assessment (CPIA), a widely criticised World Bank measure of the economic, institutional and governance framework, which classifies countries in "poor", "medium" or "strong" categories of performance. Debt distress thresholds are set at different levels for each category, according to ranges of debt and debt-service thresholds, using the net present value (NPV) of debt to exports ratio, NPV of debt to GDP ratio and the debt service to exports ratio. If countries' indicators are below these thresholds, they will receive a 'green light', meaning that they are able to take on further concessional loans; if the ratios are at the limit of the thresholds ('yellow light'), they are deemed able to take on board a mix of concessional loans and grants; if they find themselves above the thresholds ('red light'), financing will have to be provided exclusively through grants. However the reality is that there are not enough grants to go around which means that countries' may be forced into non-concessional borrowing even when they are aware of the risks. Moreover, the World Bank's new policy on non-concessional borrowing states that countries which do take on what it considers as excessive levels of new unconcessional debt may be punished by having their IDA allocations reduced or the terms of IDA loans hardened. No punishments on lenders for lending "imprudently" are forseen.
Other issues
A radically different approach to sustainability is urgently needed. Debt sustainability needs to be defined in terms of human need, not simply ability to repay. Poor countries should only have to service debts after they have met other essential demands on the public purse. However, there are a range of other problems with the Framework which need to be highlighted:
- The debt overhang
One central criticism of the Framework is that it fails to reduce countries' existing debt burdens, being a solely forward-looking tool for assessing new finance. This ignores the importance of debt reduction in freeing up resources to tackle poverty and fuel economic growth.
- Lack of country ownership
Debt Sustainability Analyses (DSA) are conducted by the International Financial Institutions (IFIs) with little input or ownership from the debtor nation who are bystanders in the process. This has led some countries - e.g. Bolivia - to conduct their own alternative DSA.
- Creditor co-responsibility
The DSF continues to focus exclusively on the behaviour of borrowing countries rather than accepting the shared responsibility of lenders. While poor countries are limited in accessing finance from certain sources, there are no sanctions at all for the creditor who lends irresponsibly. The use of the DSF also fails to recognise that poor countries' decision to turn to new, non-concessional lenders is often determined by lack of available development finance, including the failure of the IFIs and traditional donor community to provide enough grant aid. The other incentive for borrowing from these emerging lenders is that they do not attach the kind of harsh, undemocratic policy conditions that have characterised IMF and World Bank lending.
- Responsible as well as sustainable
Not only is the DSF wrongly structured to reduce poor country debt to truly, humanly, sustainable levels, it also makes no effort to address the quality of new lending needed to avoid the re-accumulation of unmanageable debts. It is therefore particularly concerning when creditors use their adherence to the DSF to answer the growing call for responsible lending. A much broader approach is required for genuinely responsible creditor behaviour, which would see the introduction of binding standards to address a range of issues including the legal and financial terms of the loan, transparency and public scrutiny, and adherence to social, environmental and human rights standards. Given that one of the root causes of the current debt crisis is unquestionably poor quality finance, often extended for geopolitical strategic purposes, poorly invested by the borrower (or not invested at all), this framework would seem ill-equipped to deal with these challenges.
- A new debt architecture
The current situation highlights the absence of a set of rules that could prevent the accumulation of unpayable debts, and a fair, transparent mechanism that could effectively determine the shared responsibility of borrower and lender, and resolve debt disputes. A new international debt architecture is urgently needed.
References:
Much of the material for this briefing note is taken from Eurodad, the European Debt and Development Network, www.eurodad.org, including:
Gail Hurley, Are lenders serious about the 2015 debt crisis? May 2008
Charter on Responsible Financing, January 2008
Francesco Oddone, Debt sustainability or defensive deterrence? The rise of new lenders and the response of the old, January 2007
To Pay or To Develop - Debt Sustainability Handbook, April 2006
There is more detail on the technical workings of the DSF on the websites of the World Bank and IMF: