Developing Countries: Challenges Confronting Debt Relief and IMF 
Lending to Poor Countries (15-MAY-01, GAO-01-745T).		 
								 
The Heavily Indebted Poor Countries (HIPC) Initiative and the	 
International Monetary Fund's concessional (below-market terms)  
lending facility--the Poverty Reduction and Growth Facility--are 
two multilateral programs intended to help spur economic growth  
and reduce poverty in low-income countries, most notably	 
countries in sub-Saharan Africa. The HIPC Initiative represents a
step forward in the international community's efforts to relieve 
poor countries of their heavy debt burdens. It does so by seeking
to include all creditors and by providing significant debt relief
to recipient countries. Unless strong, sustained economic growth 
is achieved, however the initiative will not likely provide	 
recipient countries with a lasting exit from their debt problems.
Furthermore, as long as the initiative links debt relief to	 
poverty reduction strategies, the tension between quick debt	 
relief and comprehensive country-owned strategies is likely to	 
persist. These issues should not be seen, however, as a reason to
abandon efforts to provide debt relief to eligible countries.	 
Heavily indebted poor countries continue to carry unsustainable  
debt burdens that are unlikely to be lessened without debt	 
relief, but participants and observers need to be more realistic 
about what the initiative may ultimately achieve. This testimony 
summarizes two GAO reports--NSIAD-00-161 and GAO-01-581.	 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-01-745T					        
    ACCNO:   A01007						        
  TITLE:     Developing Countries: Challenges Confronting Debt Relief 
             and IMF Lending to Poor Countries                                
     DATE:   05/15/2001 
  SUBJECT:   Economic growth					 
	     Federal aid to foreign countries			 
	     Foreign economic assistance			 
	     International economic relations			 
	     Foreign loans					 
	     Developing countries				 
	     Heavily Indebted Poor Countries Debt		 
	     Initiative 					 
								 
	     Honduras						 
	     IMF Poverty Reduction and Growth			 
	     Facility Program					 
								 
	     International Monetary Fund			 
	     Nicaragua						 
	     Tanzania						 
	     Uganda						 

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GAO-01-745T
     
DEVELOPING COUNTRIES

Challenges Confronting Debt Relief and IMF Lending to Poor Countries

Statement of Susan S. Westin, Managing Director International Affairs and
Trade

United States General Accounting Office

GAO Testimony Before the Subcommittee on International Monetary Policy

and Trade, Committee on Financial Services, House of Representatives

For Release on Delivery Expected at 2: 00 p. m., EDT Tuesday, May 15, 2001

GAO/ GAO- 01- 745T

Page GAO- 01- 745T 1 Mr. Chairman and Members of the Subcommittee:

I am pleased to have the opportunity today to discuss our assessments of two
important programs that are intended to help increase economic growth and
reduce poverty in lowincome countries, most notably countries in sub-
Saharan Africa. These multilateral programs are the Heavily Indebted Poor
Countries (HIPC) Initiative and the International Monetary Fund?s (IMF)
concessional (below- market terms) lending facility- the Poverty Reduction
and Growth Facility. The HIPC Initiative, the first comprehensive debt
relief effort to include all creditors (multilateral as well as bilateral),
is projected to provide about $29 billion in debt relief to 32 potential
recipients, 24 of which are in sub- Saharan Africa. The initiative is
intended to provide recipients with sufficient debt relief to resolve their
debt problems and free up resources that will be spent for poverty
reduction. The purpose of the IMF?s concessional lending facility is to
strengthen countries? balance- of- payments positions and foster lasting
economic growth, leading to higher living standards and a reduction in
poverty. Both programs require recipient countries to prepare ?country-
owned? poverty reduction strategies. These strategies are to be developed
with the participation of civil society, are to address a broad array of
policies aimed at reducing poverty, and are to reflect each country?s unique
circumstances.

Today I will highlight challenges confronting these programs as discussed in
two reports we prepared. 1 We reported that, even with debt relief and
continued concesssional lending, many low- income countries (1) need to
achieve strong, sustained economic growth in excess of historical growth
rates to resolve their debt problems and to graduate from eligibility for
concessional lending; and (2) face challenges in preparing comprehensive,
country- owned poverty reduction strategies, including macroeconomic

1 See Developing Countries: Debt Relief Initiative for Poor Countries Faces
Challenges (GAO/ NSIAD- 00- 161, June 29, 2000) and International Monetary
Fund: Few Changes Evident in Design of New Lending Program for Poor
Countries (GAO- 01- 581, May 8, 2001).

Page GAO- 01- 745T 2 policies, within the programs? timeframes. Before I get
into the specifics of these topics,

let me provide a brief summary of our assessments. SUMMARY In our review of
the HIPC Initiative, we found that the initiative provides significant debt
relief. However, it is not likely to provide a lasting exit from debt
problems unless countries achieve strong, sustained growth far greater than
what they have achieved in the past. For example, exports for most of the
seven countries we analyzed are projected by the World Bank and the IMF to
grow at rates significantly in excess of historical averages. 2 We believe
such growth rates are overly optimistic, since these countries rely on
primary commodities, such as coffee, for much of their export revenue. Past
experience has shown that the prices of these commodities tend to fluctuate
over time and, in fact, decline in certain years. Failure to achieve the
projected levels of economic growth could lead, once again, to these
countries having difficulty repaying their debt. Similarly, we found that
most of the current recipients of the IMF?s concessional assistance will
require high, continuous economic growth to reach the point of graduation
from concessional IMF assistance. To reach this point within 15 years, the
32 countries that borrowed from the IMF?s concessional facility in 2000 must
average a real per capita income growth in excess of 6 percent annually
during the entire period. This growth rate significantly exceeds the
countries? average growth rate of negative 1 percent over the last 15 years.

In both reports that we prepared, we found that governments face challenges
in preparing ?country- owned? poverty reduction strategies. According to our
analysis, by linking debt relief and poverty reduction, the HIPC Initiative
has created tension between the desire for countries to receive quick debt
relief and the time required to create such comprehensive strategies.
Preparing the strategies is complicated and can tax already limited
government resources by seeking to address the high incidence and diverse

2 Our analysis focused on seven of the eight countries in which a debt
sustainability analysis from the World Bank and the IMF was available at the
time of our study. These seven countries are Bolivia, Honduras, Mauritania,
Mozambique, Nicaragua, Tanzania, and Uganda.

Page GAO- 01- 745T 3 causes of poverty. For this and other reasons, country
ownership of the strategy can be

difficult to achieve. In particular, the development of a country- owned
macroeconomic framework- which is included in a country?s poverty reduction
strategy- is hard to accomplish. Many recipient governments have limited
technical capacity to independently analyze and effectively negotiate
macroeconomic policies. Also, the challenges to effectively engaging civil
society in a dialogue on these very complex matters are significant.
Furthermore, even if these challenges were overcome, a national dialogue on
the choice of effective policies is constrained by the limited knowledge
within the economics profession about how different policies actually affect
elements of the macroeconomic framework.

BACKGROUND In 1996, at the urging of the Group of Seven (G- 7)
industrialized countries, the World Bank and the IMF agreed to undertake a
comprehensive approach, called the Heavily Indebted Poor Countries
Initiative, for providing debt relief to the poorest and most indebted
countries in the world. In 1999, in response to the G- 7?s concerns about
the continuing vulnerability of these countries, the creditors agreed to
enhance the initiative by providing increased debt relief more quickly to
more eligible countries. Under the enhanced initiative, the debt levels of
eligible countries are expected to be lowered to a point that is considered
sustainable; that is, countries will continue to be able to meet their
future debt obligations on time without the need for further debt relief.
The Bank and Fund staffs assume that donor assistance will be an important
source of external flows for these countries and may help finance any future
gaps that countries experience in meeting their debt obligations. Creditors
also called for a strong link between debt relief and poverty alleviation
and said that debt relief should free resources for spending on priority
poverty reduction areas.

In order to strengthen countries? balance- of- payments positions, support
their reform programs, and foster their economic growth, the IMF has
provided loans on concessional

Page GAO- 01- 745T 4 terms to eligible low- income members. 3 In order to
receive loans, countries agree to

implement macroeconomic and structural reforms. Eligibility for these
concessional loans has been based mainly on a country?s per capita income
and eligibility for World Bank concessional lending. 4 The IMF provides
advice on macroeconomic issues such as achieving and maintaining stability.
At the same time, the IMF seeks to integrate social policies into its
programs and advice, with the World Bank taking the lead on these issues. As
part of a concerted international effort in 1999 to reduce poverty, the IMF
expanded the goals of its concessional lending program to include an
explicit focus on poverty reduction. To emphasize this focus, the IMF
renamed its lending program from the Enhanced Structural Adjustment Facility
to the Poverty Reduction and Growth Facility. As of May 4, 2001, 38 of the
77 countries eligible for the Poverty Reduction and Growth Facility had
current loan commitments totaling about $4.5 billion. Twenty- four of the 38
countries are in sub- Saharan Africa.

Countries eligible for HIPC debt relief and IMF concessional loans are among
the poorest in the world, with many classified by the United Nations as
being in its lowest category of human development, based on life expectancy,
literacy, and annual per capita income. Many depend on development
assistance from governments, multilateral organizations, and nongovernmental
organizations and have significant development needs.

3 The lending terms include a 5-ï¿½ year grace period, 10- year maturity, and
annual interest rate of 0.5 percent. A country?s balance- of- payments
accounts summarize its financial dealings with the outside world.

4 This threshold was based on a 1998 per capita income of $895 or less. The
World Bank provides concessional lending through the International
Development Association.

Page GAO- 01- 745T 5 OPTIMISTIC ECONOMIC GROWTH REQUIRED TO ACHIEVE A
LASTING EXIT FROM

DEBT PROBLEMS OR GRADUATE FROM CONCESSIONAL BORROWING Countries? Ability to
Repay Debt Requires Strong Economic Growth Last June, we reported that the
HIPC Initiative will provide significant debt relief to recipient countries.
5 Our analysis showed that for the seven countries we analyzed the total
amount of debt was expected to initially fall by more than a third in most
cases, with debt service also expected to decline considerably. However, our
analysis showed that the debt levels of the seven countries will resume
rising following the receipt of debt relief under the initiative. This will
occur because in order to have the funds that are expected to be spent on
poverty reduction- the so called ?freed- up resources? from debt relief-
these countries must continue to borrow at the same level as in the years
prior to qualifying for debt relief. Countries previously borrowed for
several reasons, including debt payments, and they will need to continue
borrowing after receiving debt relief in order to meet their remaining debt
payments and increase spending on poverty reduction. Thus, these countries
cannot both increase their spending on poverty reduction and reduce their
annual borrowing by the amount their debt service was lowered.

Countries? ability to repay their future debt depends on the assumption that
countries will achieve strong, sustained economic growth. Most recipient
countries that we analyzed are projected by World Bank and Fund staffs to
have robust growth in income and export earnings, with the projected export
growth of four of these countries- Honduras, Nicaragua, Tanzania, and
Uganda-- expected to average at least 9.1 percent a year over 20 years.
These growth levels are presumed to contribute considerably to these
countries? ability to meet their future debt obligations. Sustaining such
levels over a 20- year period will be difficult. These countries rely on a
small number of primary commodities, such as coffee, for a majority of their
export earnings, and the price of these commodities tend to fluctuate over
time, with export earnings in fact declining in

5 See Developing Countries: Debt Relief Initiative for Poor Countries Faces
Challenges.

Page GAO- 01- 745T 6 certain years. At an April 11, 2001, IMF Executive
Board meeting, several Directors

expressed concern that some countries' debt might not be sustainable if the
projected output and export growth rates do not materialize.

Shortfalls in these growth projections will lower the amount of revenue
these countries will be able to contribute toward their future debt service.
If these countries are to remain debt sustainable (that is, be able to make
their debt payments on time without the need for future debt relief), this
shortfall will need to be made up through increased donor assistance.
Without such assistance, countries will no longer be debt sustainable and
will require additional debt relief, or they will accumulate arrears. For
example, in the case of Tanzania, if actual export growth is 20 percent less
than projected, Tanzania will not be able to repay its debt obligations
unless donor flows (both loans and grants) increase by more than 30 percent.
Such an increase in lending could more than double Tanzania?s total debt
over what was originally forecast for the projection period.

Strong, Sustained Economic Growth Essential to Reach Consideration for
Graduation As we reported last week, most of the 32 countries that borrowed
concessional resources from the IMF in 2000 will need to achieve strong,
sustained economic growth to reach eligibility for graduation within the
next 15 years. 6 These countries would have to achieve an annual average
growth rate of 6 percent, which is substantially greater than the negative 1
percent growth rate the countries averaged over the previous 15 years.
Standard & Poor?s DRI projected the countries to have an average of 2.5
percent growth over the next 15 years. 7 Based on these projected growth
rates, as shown in figure 1, most countries need considerably more than 15
years to reach the graduation threshold.

6 See International Monetary Fund: Few Changes Evident in Design of New
Lending Program for Poor Countries. 7 DRI is a unit of Standard & Poor?s,
which is a division of The McGraw Hill Companies. It is a leading provider
of industry and economic data, forecasting, and consulting services. Its
World Forecast Database includes historical and forecast data for 170
countries.

Page GAO- 01- 745T 7 Figure 1: Number of Years Until Countries Reach
Eligibility to Graduate From Concessional

Borrowing

4 8

7 4

2 5

0 1

2 3

4 5

6 7

8

Number of Countries

0-15 16-30 31-45 46-60 61-75 More than 75

Years

Note: The median number of years to reach the graduation income level is 34
years; the average is 59 years. These values include two countries (Bolivia
and Macedonia) whose income levels already exceed the eligibility threshold.

Source: GAO analysis using data from the World Bank and Standard & Poor?s
DRI. Given that the current annual per capita income levels of these
countries is generally quite low (an average of $427), the median length of
time required for these countries to reach the graduation threshold at their
projected per- capita income growth rates is 34 years, with five countries
requiring more than 75 years.

If the changes announced by the IMF for its lending program to its poorest
members, particularly country ownership of the macroeconomic framework,
improve the overall effectiveness of a country?s development program, the
likelihood of earlier graduation from the IMF?s program could increase.
However, the actual impact of these changes on

Page GAO- 01- 745T 8 economic growth is unknown at this time. Moreover, as
discussed below, there are

many challenges and obstacles to establishing country ownership. COUNTRIES
FACE CHALLENGES IN PREPARING POVERTY REDUCTION STRATEGIES

Linking Debt Relief and Poverty Reduction Creates Tension Between Quick Debt
Relief and Comprehensive Strategies

Last year we reported that linking HIPC debt relief and poverty reduction
creates tension between quick debt relief and comprehensive strategies. 8
Preparing a comprehensive,

?country- owned? poverty reduction strategy can be complicated and resource
intensive, with success dependent on countries reaching widespread agreement
on sensitive and complex issues. Given the high incidence and the numerous
and diverse causes of poverty, the donors have called for a multifaceted
approach to reduce poverty. This approach is to include rapid economic
growth, civil society participation, good governance, and measures targeted
at the specific causes of poverty. However, coordinating so many actions can
tax already limited government resources. Moreover, while the World Bank and
the IMF call on governments to describe how their actions will reduce
poverty, there is limited evidence showing which actions have the greatest
impact on reducing poverty. Moreover, weaknesses in recipient countries?
capacity to collect and analyze data on the nature, extent, and major causes
of poverty may limit efforts to develop baseline data against which future
progress can be measured.

Finally, country ownership and donor support of the poverty reduction
strategy can be difficult to achieve. While having countries (government and
civil society) take ownership of their strategies is increasingly seen as
important for greater effectiveness, operational issues take time to
resolve. For example, it is not clear how to define ownership at the country
level or determine who will represent civil society. Nongovernmental
organizations and some donor governments raised the concern that in

8 See Developing Countries: Debt Relief Initiative for Poor Countries Faces
Challenges.

Page GAO- 01- 745T 9 order to receive HIPC debt relief quickly and
irrevocably, recipients may ?shortcut the

quality? of their strategies and limit the extent of civil society
participation. They therefore suggested separating the link between the
timing of debt relief and the preparation of poverty reduction strategies,
recognizing that recipient countries are likely to be monitored under World
Bank and IMF programs for many years. However, the World Bank, the IMF, and
the U. S. Treasury argued that the link should remain, since some countries
do not have to prepare a full poverty reduction strategy in order to begin
receiving debt relief, and the link is needed to ensure that governments
undertake reforms and use resources effectively.

Developing a Country- owned Macroeconomic Framework Is Difficult Last week
we reported that there are few differences between the IMF?s new lending
program for poor countries and its previous program. 9 The one major design
change, getting countries to take ownership of their macroeconomic policies-
which are to be included in their poverty reduction strategies- is difficult
to achieve. This is true for three reasons. First, many recipient
governments have limited technical capacity relative to the substantial
complexities inherent in establishing macroeconomic policies and targets.
Governments? limited ability to independently analyze and effectively
negotiate the macroeconomic framework reduces the opportunity for country-
specific elements to be addressed. Second, the challenges to effectively
engaging civil society in a dialogue on these very complex matters are
significant. For example, while the government of Benin has begun a dialogue
with civil society, many people told us that they were unsure how to use
this dialogue to address the country?s complex macroeconomic policies and
targets, other than the composition and level of spending. Moreover,
although there is ample donor assistance in Benin, we were not told of any
research organizations that are assisting Benin in the development of its
macroeconomic framework. Finally, a national dialogue on the choice of
effective policies is hampered by the limited knowledge of all parties about
how different policies actually affect elements of the macroeconomic
framework. Even if country ownership increases, given the need for poor
countries to

Page GAO- 01- 745T 10 maintain macroeconomic stability, which is essential
for economic growth and poverty

reduction, the actual policies and targets within the macroeconomic
framework are not likely to be altered substantially from the past.

OBSERVATIONS Last year we made the following observations on the HIPC
Initiative. We believe they still hold true. The HIPC Initiative represents
a step forward in the international community?s efforts to relieve poor
countries of their heavy debt burdens, and it does so by seeking to include
all creditors and providing significant debt relief to recipient countries.
However, unless strong, sustained economic growth is achieved, the
initiative will not likely provide recipient countries with a lasting exit
from their debt problems. Furthermore, as long as the initiative links debt
relief to poverty reduction strategies, the tension between quick debt
relief and comprehensive country- owned strategies is likely to continue.
These issues should not be seen, however, as a reason to abandon efforts to
provide debt relief to eligible countries. Heavily indebted poor countries
continue to carry unsustainable debt burdens that are unlikely to be
lessened without debt relief, but participants and observers need to have a
more realistic expectation of what the initiative may ultimately achieve.

While countries face difficulties in achieving ownership of their
macroeconomic frameworks, efforts to involve civil society have potential
benefit. Although civil society may not be able to influence the
macroeconomic framework through the initial poverty reduction strategy,
civil society may help improve the allocation of resources and increase the
amount of resources donors are willing to provide by helping establish
priorities for poverty reduction.

- - - - 9 See International Monetary Fund: Few Changes Evident in Design of
New Lending Program for Poor Countries.

Page GAO- 01- 745T 11 Mr. Chairman and Members of the Subcommittee, this
concludes my prepared statement.

I will be happy to answer any questions you or other Members may have.
CONTACTS AND ACKNOWLEDGMENTS For future contacts regarding this testimony,
please call Susan Westin or Tom Melito at (202) 512- 4128. Individuals
making key contributions to this testimony included Cheryl Goodman and R. G.
Steinman.

(320059)

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