Ms Hilde F. Johnson, Minister of International Development

The Challenges of Debt Relief

Speech given at a seminar on development at the University of Oslo, 21 October 2003

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Dear friends,

Thank you for this opportunity to speak today on a topic of great importance - the question of debt relief to struggling countries around the world. Debt relief is as complicated as it is crucial, and I commend the organizers of today’s seminar for putting the spotlight on a topic we all need to focus on. We have seen many poor countries caught in a "debt trap", where they have to spend 4-5 times more on servicing debt than on education and health care.

If applied constructively and comprehensively, debt reduction can be a powerful weapon in the fight we all know is so urgent: the fight against poverty. Because this is the ultimate goal of debt reduction: to create a better future for the poorest.

Unmanageable debt has proven to be a heavy burden for many low- and middle-income countries around the world. Debt can be a serious impediment to development in many poor countries - an impediment often caused by external factors like unstable commodity markets or natural disasters. Although the developing countries themselves must bear the primary responsibility for creating a sustainable debt situation, the international community needs to be involved.

Giving debt relief, bilaterally or multilaterally, is a way to help. Let us take a look at some countries where it has worked well. In the early 1990s, Tanzania and Mozambique spent 30-40% of their export revenue on debt servicing - money that could have been spent on building the countries. Massive international debt relief measures have rectified this situation, and those two countries are now able to spend a larger share of their export revenue on education and health services, to the benefit of the poor. Currently, Tanzania spends only 6-7% of their export revenue on debt servicing. The corresponding number for Mozambique is 3-4%.

Allow me to focus on a few basic points before we move on. This may be well-known facts to many of you, but they still bear repeating and remembering whenever we talk about debt relief.

Why do poor countries need loans - and where can they get them?

Development costs money. To build roads and bridges and schools and hospitals, the developing world needs resources. Some resources can be found within the country itself, but much of it needs to come from the outside - given the limitations within most poor countries. Foreign currency is necessary to buy much of what they need to make progress. Foreign currency could come from international donors, from remittances sent from workers abroad, from exports - or from international loans. The reality is that loans are badly needed - and that most of the poor countries lack the creditworthiness needed to borrow from private banks. This means that the only loans available to them are those given through international lending institutions like the World Bank. If those institutions do not have sufficient funds for new loans, it will affect the poor countries.

Why is debt relief so important to the developing countries - and how should it work?

Debt in itself is not necessarily a problem. In fact, for a poor country, where the need for investment is enormous, it is perfectly normal to have a certain level of debt. Those loans can be spent on health care, on education - on a number of things that directly benefit the poor. However, the problem occurs when the country no longer is able to service those loans without making sacrifices in areas crucial to the population’s well-being. Unsustainable debt can propel the country into an evil cycle: not only does the debt drain national budgets and limit spending, it also further deteriorates the international creditworthiness of the country - making it even more difficult to access new funding.

Debt relief is not an end in itself, but one of several instruments in the fight against poverty. Used effectively, it could be a very powerful tool. Debt relief must be implemented in a way that maximizes its contribution to poverty reduction: as much development, education and health as possible for each debt relief dollar.

Unsustainable debt leads to balance-of-payment problems, creates an uncertain and unattractive investment climate, and makes it even harder to find the necessary resources to run the country. And who suffer the most when this happens? The poorest and the weakest in society. This is why we have to use debt relief in the fight against poverty - and we have to do it right.

But - debt relief must be paid for

Doing it right requires attention to the international system and the total funding of debt relief operations. Because the world, unfortunately, is not a place where we can wave a magic wand and make debts disappear without a trace. Debt means money owed to somebody - and debt relief most often means money taken out of one part of the aid budget, which equals less in another. Creditor nations will usually forgive debt only to recoup the loss in other parts of their ODA budgets. Norway is the exception here, in that we do not finance debt relief on our ODA budget. Most others do - which means that what you squeeze out of the balloon in one end, will doubly inflate the other. Total world ODA sums are fairly stable - which means we must think long and hard about the best possible ways to spend the money. Debt reduction will be the best way to fight poverty in some developing countries - but not in all.

Norway’s efforts

Debt relief has been, and remains, a key component in Norway’s development policy. Here, as in our other development initiatives, our focus is on improving conditions for the poorest. Norway was the first country in the world to forgive the total amount of debt owed to us by the poorest countries. The debt forgiveness is not part of the ODA budget - it is built on export credits. We do not collect one single dollar from the very poorest countries, such as Senegal, Ghana, Sierra Leone and Gambia.

In 1998, Norway created a comprehensive debt strategy, in which we also allow for debt relief to middle-income countries. This can take the form of debt-for-development swaps, where debt is reduced provided that the resources gained are used for poverty reduction.

In addition to canceling our own debt, we have provided more than 3,2 billion Norwegian kroner to cover debt payments from developing countries to multilateral creditors like the World Bank and to compensate these institutions for the debt relief they themselves provide. Such compensation is crucial in order to enable the institutions to continue to assist poor countries in fighting poverty. Debt relief would rapidly deplete the resources of these institutions, there would be less to borrow - and it is highly unlikely that rich countries would compensate for the shortfall. If the World Bank and similar institutions lack sufficient funds for lending, the poor will suffer.

This must remain our guiding principle: to use debt relief for the benefit of the poor. To maximize resources for poverty reduction.

International initiatives

Debt relief is also a priority issue internationally.

The Norwegian debt strategy is closely linked to the international debt relief initiative for the poorest countries – the HIPC initiative (Heavily Indebted Poor Countries Initiative), established in 1996. The HIPC mechanism was the first ever to involve all creditors in a joint effort and to link debt relief explicitly to poverty reduction - a break-through in international debt relief. Norway worked actively for its establishment and for enhancing the initiative significantly in 1999 - for deeper, faster and broader debt relief. The HIPC initiative is expected to provide 45-50 billion dollars in debt relief to nearly 40 of the poorest countries in the world, reducing their debts by two-thirds. Currently, 27 countries are receiving debt relief under HIPC.

The result is a substantially reduced debt burden, and a release of huge sums for health, education and other poverty reduction. After receiving full debt relief, HIPC countries are expected to spend only 2 % of GDP on debt servicing, and four times more on social sectors. These numbers are still not a reality - but they need to be. We have along way to go. We are working to get there.

For Norway, it is of the utmost importance that we give debt relief in close cooperation and in participation with other creditors. We must forgive debt in a way that benefits the recipient country - not debt relief where the primary benefit goes to other creditors.

Even under the current HIPC, compensating debt relief provided by the World Bank and other institutions is a huge challenge. In fact, the total HIPC costs for the World Bank amount to more than 10 billion dollars. From 2006 the Bank will lose about 600 million dollars a year unless additional resources are provided – that is 600 million dollars less each year for poverty reduction. Therefore, it will be necessary to mobilize substantial additional donor resources. Norway is working actively to ensure that this pressing issue is being addressed and that donor countries make funds available as soon as possible. If we fail here, the poorest will again suffer the most - given that the lack of resources would force the World Bank to cut back assistance to those without alternative financing sources. In other words, we could find ourselves in a situation where Bangladesh is paying the debt relief for Nicaragua. This is not what anybody wants.

Full cancellation of debt?

Some have voiced a demand for full debt cancellation - immediately and unconditionally. However, debt relief on such terms may not be the best strategy if the ultimate goal is to fight poverty. We should keep in mind that many of the countries in question have limited capacity to make effective use of large assistance inflows, including those from debt relief. The necessary systems to deal with large sums of new development assistance are simply not in place - they are under construction, so to speak. Administrative structures may be incomplete, checks and balances may be few and fragile, corruption and human rights violations could be frequent. Democratic institutions may be present, but not sufficiently powerful. In such an environment, resources freed up by debt relief might well end up in the pockets of the powerful rather than with the poor. Not what they want - not what we want.

PRSPs

In order for debt relief to benefit the poorest, the countries themselves must implement homegrown, comprehensive development strategies – as expressed in the PRSPs (Poverty Reduction Strategy Papers).

The PRSP process serves a double purpose:

First, to establish mechanisms which ensure that resources freed up by debt relief are spent on development and poverty eradication, for the benefit of the poor.

Second, to put in place policies that reduce the risk of renewed accumulation of unsustainable debt.

Active participation by civil society and democratically elected bodies is indispensable in this process: to ensure preparation of credible strategies and to make sure that scarce resources are not wasted on corruption, military expenditures or prestige projects.

All of us want debt relief as soon as possible. That is a given. But we have to realize that the creation of a comprehensive poverty strategy, developing a broadly accepted PRSP, requires patience - to make sure it is not just done, but done right. Nobody, least of all the poor, will benefit from a PRSP process without satisfactory popular participation. The PRSP process should guarantee such participation.

Sacrificing quality for quick results might satisfy some donors, but would not serve the poor. Debt relief is about more than economic and social development, it is about human rights, democracy and holding governments accountable. This takes time - this takes effort - this takes patience.

The PRSP process needs improvement. The strategies should not be just "new wine in old wine skins". There should be a difference!

In the initial phase, PRSPs have often been heavily influenced by external partners such as the World Bank and IMF. However, it is important to keep the strategies as "living documents" - to allow for continuous updates as lessons are learned. Eventually the strategies will be genuinely "owned" and honoured by the population itself.

Some have also criticized the HIPC tempo. My answer here relates to what I just said: we need to ensure – through a country-owned PRSP process – that debt relief really contributes to reducing poverty. We also need to consider the fragile macro-economic situation in many HIPC countries. This must be strengthened in order to create a basis for sound economic and social development.

In other words: We are talking about assurance of poverty focus. The "time loss" we criticize today may prove to be a valuable investment in the future.

A number of HIPC candidates have yet to start receiving debt relief. This is unfortunate, and due to the fact that virtually all of these countries are more or less devastated by armed conflict. Ten of the 11 remaining HIPC countries are affected by armed conflict . (The 11 ^th> country, Togo, suffers from a poor macro-economic environment and a weak public expenditure system that must be strengthened before debt relief can benefit the poor.)

It would be irresponsible to provide debt relief to countries at war. The new resources would in those cases most likely go straight into arms purchases rather than health clinics and schools. It is, however, extremely important that the international community stands ready to assist these countries once prospects for lasting peace appear on the horizon.

An example: the Democratic Republic of Congo, ravaged by war for several years. Creditors have committed to giving debt relief to the tune of 6 billion dollar, meaning that 80 % of Congo’s debt is cancelled. Support to countries emerging from conflict is, and must remain, a top priority in our debt relief strategy.

Illegitimate debt

"Illegitimate debt" has become a catchphrase in recent years. Let me share with you some of my thoughts around this call for action.

Some NGOs have suggested that debt considered by them to be "illegitimate" should be cancelled immediately. Although backed by the best of intentions, this approach could prove unproductive. The first and most important question is how to define such debt. So far, the definitions of "illegitimate debt" have been rather vague - which means that just about any kind of debt might qualify. Unless we can agree on an operational definition, the illegitimacy approach will be difficult to implement.

Let me elaborate on that by giving you a few examples.

What is "illegitimate debt" - is it debt which finances human rights violations? Debt by undemocratic regimes? Debt that is not sustainable? Debt by dictators? Other kinds of debt?

If "illegitimacy" is our starting point, who should receive debt relief? What criteria should we use?

Should countries that are not democracies, yet have made enormous economic progress, in part due to external borrowing – have their debt cancelled when governments change and a true democracy is established? My answer is "no". If loans retroactively can be defined as "illegitimate", this could mean that very few creditors would be willing to lend to developing countries, dramatically reducing access to financing for development. Who would suffer? The poorest.

Or take Zimbabwe - should Zimbabwe’s debt be divided into one "legitimate" and one "illegitimate" part, depending on the health of the democracy at the moment the loan was decided?

Or South Africa. Neither multilateral finance institutions nor western countries lent money to the apartheid regime. The apartheid debt is almost exclusively owed to private banks. Should we, from our limited development budgets, sacrifice the poorest in order to buy back private bank debt for a relatively resource-rich country as South Africa? In the case of the debt incurred by Mobutu in former Zaire, as well as in other HIPC countries, most of what is considered "illegitimate debt" will be cancelled under HIPC in any case.

Massive cancellation of "illegitimate debt" in the case of middle-income countries would mean a significant reallocation of overall assistance at the expense of the poorest countries - because debt relief funds must come from somewhere, usually aid budgets. A corresponding global increase in development assistance budgets is unfortunately far from realistic. Again; the poorest will lose.

The "illegitimate debt" approach may have some merit if it is more precisely defined. It could make creditors more careful about ensuring that future financing goes to countries that conduct policies conducive to poverty reduction, without hitting countries that both need and deserve fresh resources. Therefore, we are willing to examine constructive proposals to give the term "illegitimate debt" a more meaningful and acceptable definition.

Future

While I completely disagree with those proclaiming HIPC a failure, I do agree that there is potential for improvement. A number of countries struggling to achieve debt sustainability may under HIPC receive additional relief ("topping up") - if they face problems due to external shocks rather than domestic policy. This provision must be forcefully implemented. Debt relief strategies must be expanded and upgraded.

Norway has advocated increased flexibility in the conditions for debt relief and better alignment of the conditions to the countries’ own development strategies. The conditionality does in some cases need examination. It is crucial that reforms are based on priorities identified in these strategies if they are to be successfully implemented. Support from donors, including the World Bank and IMF, has not always paid sufficient attention to this.

Our focus on the HIPC countries and my concerns about the "illegitimate debt"- approach do not mean that we turn a blind eye to the debt problems of middle-income developing countries. I mentioned before that in our debt relief strategy, we are considering so called debt-for-development swaps as one way to reduce the debt of these non-HIPC countries. Just like the case for HIPCs, debt forgiveness vis-à-vis non-HIPCs should aim at contributing to poverty reduction. Simply put; such swaps mean that we forgive debt, while the debtor country commits itself to spend the money they gain on poverty reduction. In order to make these operations as effective as possible, we advocate multilaterally coordinated swaps. We are also working to eliminate the volume limitations for such swaps currently in force in the Paris Club, the forum where industrialized countries coordinate their bilateral debt relief operations.

The G8 summit in Evian, France last summer encouraged the Paris Club to further explore possibilities for debt reduction for middle-income countries. The aim is to find flexible solutions based on longer-term debt analyses. Norway has expressed clear support for what has been termed "The Evian approach". Since this initiative is of recent date, it is premature to speculate on what it will mean in concrete terms. However, the very fact that the debt problems of the middle-income countries have been elevated on the Paris Club agenda is most welcome.

Despite the important contribution of debt relief to our common goal of reducing poverty, let me in conclusion emphasize that we need to focus more explicitly on issues beyond debt relief in order to assist poor countries in maintaining longer-term debt sustainability. Unmanageable debt is a symptom of deep structural problems and no amount of debt forgiveness can guarantee a sustainable debt situation in the longer run. Debt relief is not a "quick fix". This is well known, but it bears repeating.

Debt relief is not a panacea for poverty reduction. Each country must be considered on its own merit - there is no "one-size-fits-all" here.

We need to continue our focus on solving the debt problems of the poorest countries. Norway has done quite a bit already - but we must do more. The international community has contributed - but not enough. We need to do more - and we need to do it right.

Debt relief is a powerful tool. It must be used - and used right. And the fundamental question must remain: Will it benefit the poor? That is our test.

Any new idea must pass this test: Will it benefit those we are trying to reach? Because our ultimate goal is not to please governments or placate our guilt - it is this: to contribute to a better future for the poorest.

Thank you.