Developing Countries: Switching Some Multilateral Loans to Grants
Lessens Poor Country Debt Burdens (19-APR-02, GAO-02-593).	 
                                                                 
Last year the United States proposed that the World Bank and	 
other development banks distribute more grants to the world's	 
poorest countries to help ease their long-term debt burdens. The 
United States recommended that grants replace up to half of all  
future lending. The proposal has been controversial because of	 
its potential impact on the resources available to poor 	 
countries. The World Bank estimates that the proposal could	 
reduce its resources by $100 billion during the next 40 years. A 
shift of multilateral loans to grants would reduce poor 	 
countries' debt burdens and increase their ability to repay	 
future debt. The total financial loss to the World Bank of a	 
50-percent shift from loans to grants during the next 40 years	 
would be $15.6 billion in present value terms. Financing the	 
proposal through harder terms on the remaining loans to poor	 
countries would reduce and potentially nullify any improvement to
their debt sustainability arising from the 50-percent grants	 
proposal. However, if donor contributions to the World Bank were 
to increase by 1.6 percent a year, which is less than the	 
projected rate of inflation during the next 40 years, the World  
Bank could fully finance the 50-percent grants. GAO's projections
on poor countries' future debt sustainability and the financial  
loss to the World Bank of the 50-percent grants proposal differ  
substantially from World Bank and International Monetary Fund	 
(IMF) projections. First, the World Bank and IMF project that all
10 countries will attain debt sustainability under the current	 
debt relief initiative by assuming that the countries' future	 
export growth rates will greatly exceed those achieved in the	 
past. However, high export growth rates are unlikely because	 
these countries rely on primary commodities, such as coffee and  
cotton, for a significant proportion of their export revenue and 
the prices of these commodities have trended downward. In	 
addition, AIDS is expected to reduce the overall productivity of 
these countries. Second, the World Bank' methodology assumes that
the value of a dollar received today will maintain the same value
40 years from now. However, after including the expected impact  
of inflation and the investment income that could accrue over	 
time, GAO estimates the financial loss of the grants proposal to 
the World Bank is only $15.6 billion in present value terms.	 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-02-593 					        
    ACCNO:   A03090						        
  TITLE:     Developing Countries: Switching Some Multilateral Loans  
to Grants Lessens Poor Country Debt Burdens			 
     DATE:   04/19/2002 
  SUBJECT:   Debt						 
	     Debt collection					 
	     Developing countries				 
	     Federal aid to foreign countries			 
	     Financial institutions				 
	     Foreign loans					 
	     Grants						 
	     International economic relations			 
	     Heavily Indebted Poor Countries Debt		 
	     Initiative 					 
                                                                 
	     International Monetary Fund			 

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GAO-02-593
     
A

Report to Congressional Requesters

April 2002 DEVELOPING COUNTRIES Switching Some Multilateral Loans to Grants
Lessens Poor Country Debt Burdens

GAO- 02- 593

Letter 1 Results in Brief 2 Background 3 Shifting Loans to Grants Would Have
a Positive Impact on Debt Sustainability for Poor Countries 5

Grants Proposal Can Be Financed through Relatively Small Increases in Donor
Contributions 8 GAO?s Projections Differ Substantially from World Bank and
IMF

Estimates 13 Observations 18 Agency Comments 18

Appendixes

Appendix I: Objectives, Scope, and Methodology 19

Appendix II: Economic Assumptions Used to Analyze Debt Sustainability 22
World Bank and IMF 20- year Economic Projections Provided Basis

for Analysis 22 Impact of Using Historical Export Growth Rates 22 Impact of
100- percent Forgiveness of Old Multilateral Debt 23

Appendix III: Assumptions Used to Analyze the Financial Impact of the 50-
Percent Grants Proposal on the World Bank 25 World Bank?s Assumptions Key in
Its Projection of Large Financial Losses 25

Harder Loan Terms on Borrowing Countries Is an Unrealistic Option for
Replacing Foregone Revenues due to Grants 26

Appendix IV: Optimistic Export Growth Assumptions Underlie World Bank/ IMF
Debt Sustainability Analysis 28 World Bank/ IMF Projected Export Growth
Rates Greatly Exceed

Historical Levels 28 HIV/ AIDS Expected to Have a Significant Long- term
Negative

Impact 33

Appendix V: Comments from the Department of the Treasury 35

Appendix VI: GAO Contact and Staff Acknowledgments 37 GAO Contact 37
Acknowledgments 37

Tables Table 1: Projected 20- Year Debt- to- Export Ratios under Three
Scenarios 6 Table 2: Required Multilateral Grants as a Share of Multilateral
Assistance to Achieve Debt Sustainability 7 Table 3: Estimated Sources of
IDA Resources for IDA- 12, FY

2000- 02 a 10 Table 4: Export Growth Rates and Debt/ Export Ratios for 10
Poor Countries 14

Table 5: Assumptions Used by the World Bank for Its IDA Financial
Projections 25 Table 6: Examples of Harder Loan Terms on IDA Countries to

Finance 50- Percent Grants Proposal 27 Table 7: 20- Year Historical and DSA
Export Growth Rates for 27 HIPCs 28

Table 8: Primary and Secondary Commodity Exports 30 Figures Figure 1: 20-
Year Debt Sustainability Projections for 10 Poor

Countries 8 Figure 2: Estimates for the Financing of IDA, FY 2003- 05 and FY

2042- 44 12 Figure 3: Cotton, Coffee, and Copper Indexes (1995- 2001) 16
Figure 4: Global Indexes for Cotton, Copper, and Coffee,

1980- 2001 32 Figure 5: Adult Prevalence of HIV/ AIDS among Adults Aged 15-
49, 2000 34

Abbreviations

DSA debt sustainability analysis FY fiscal year GDP gross domestic project
HIPC Heavily Indebted Poor Country HIV/ AIDS Human Immunodeficiency Virus/
Acquired Immunodeficiency

Syndrome IBRD International Bank for Reconstruction and Development IDA
International Development Agency IMF International Monetary Fund UNAIDS
Joint United Nations Programme on HIV/ AIDS

Lett er

April 19, 2002 The Honorable Jesse Helms Ranking Minority Member, Committee
on Foreign Relations United States Senate

The Honorable Douglas Bereuter Chairman, Subcommittee on International
Monetary Policy and Trade Committee on Financial Services House of
Representatives

In July 2001, President Bush proposed that the World Bank and other
development banks dramatically increase the distribution of grants to the
world?s poorest countries, recommending that grants replace up to 50 percent
of future lending. This proposal was motivated, in part, by concerns
regarding poor countries? long- term debt burdens and the adequacy of recent
initiatives to provide debt relief for the world?s poorest countries. The
president?s grants proposal would mean a significant

change for multilateral institutions such as the World Bank, which
traditionally use low- cost loans to deliver development assistance. The
proposal has been controversial, in part due to concerns about the impact of
the proposal on the amount of resources that will be available for poor
countries. The World Bank estimates that the president?s proposal could
reduce its resources by about $100 billion over the next 40 years. 1
Recognizing that previous assistance efforts have not resolved the debt
problems of poor countries, you asked us to review the proposal to shift a

portion of multilateral institutions? loans to grants. In response, we
assessed (1) how the loans- to- grants proposal would affect poor countries?
ability to repay their debt, (2) how it would affect the resources available
to the World Bank for poor countries, and (3) how our projections for
countries? debt sustainability 2 and the financial loss to the World Bank
from

1 The World Bank reports in Grants in IDA13, Summarizing the Options (March
2002) that the 50- percent grants proposal would result in $59 billion in
lost repayments over 40 years. This $59 billion loss in debt repayments
would result in an additional $41 billion loss in investment income to the
World Bank. 2 The World Bank and International Monetary Fund consider a
country to be ?debt sustainable? if the ratio of a country?s debt (in
present value terms) to the value of its exports is 150 percent or less,
which they believe allows countries to make their future debt payments on
time and without further debt relief.

the grants proposal compare with World Bank and International Monetary Fund
(IMF) estimates. In conducting our analyses, we built on prior work that
examined World Bank and IMF 20- year projections on poor countries? debt
burdens. The World Bank and the IMF reviewed and provided detailed comments
on this earlier analysis. We also used World Bank and IMF analyses that
included

detailed country- specific economic forecasts and projections of the
financial implications of switching from loans to grants. However, we were
unable to discuss our new findings with World Bank and IMF officials because
the Department of the Treasury did not approve our access to

officials of those institutions. 3 Treasury officials denied our requests
for access to officials of the multilateral institutions because they were
concerned that our engagement would interfere with ongoing negotiations to
refinance the World Bank?s International Development Agency. (See app. I for
an expanded discussion of our scope and methodology.)

Results in Brief A shift of multilateral loans to grants would lessen poor
countries? debt burdens, increasing their ability to repay future debt. If
grants were to replace 50 percent of future multilateral loans (assuming
historical export growth rates), 4 of the 10 countries analyzed would be
debt sustainable for 20 years and 2 other countries would be debt
sustainable for most of the 20 years. However, the 4 remaining countries
analyzed would not become debt sustainable even if grants replace 50 percent
of their future multilateral loans. Furthermore, the grants proposal is more
effective in promoting debt sustainability than proposals to forgive old
multilateral

debt. The total financial loss to the World Bank of a 50- percent shift from
loans to grants over the next 40 years would be $15. 6 billion in present
value terms. The options for making up the foregone revenue from the 50-
percent grants proposal are fairly limited. Financing the president?s
proposal through harder terms on the remaining loans to poor countries would
reduce and

potentially nullify any improvement to their debt sustainability arising
from the 50- percent grants proposal. However, if donor contributions to the
World Bank were to increase by 1.6 percent a year, which is less than the 3
The articles of agreement for the World Bank and the IMF require the United
States to deal with these organizations only through the Department of the
Treasury.

projected rate of inflation over the next 40 years, the World Bank could
fully finance the 50- percent grants proposal.

GAO?s projections on poor countries? future debt sustainability and the
financial loss to the World Bank of the 50- percent grants proposal differ
substantially from World Bank and IMF projections. First, the World Bank and
IMF project that all 10 countries will attain debt sustainability under the
current debt relief initiative by assuming that the countries? future export
growth rates will greatly exceed those achieved in the past. However, high
export growth rates are unlikely because these countries rely on primary
commodities, such as coffee and cotton, for a significant

proportion of their export revenue; since 1995, the prices of these
commodities have moved in a downward trend. In addition, HIV/ AIDS is
expected to reduce the overall productivity of these countries. Second,

GAO characterizes the financial loss of the 50- percent grants proposal
differently than the World Bank. While the World Bank estimates that the
financial loss from the proposal would reach $100 billion in nominal dollars
over 40 years, its methodology assumes that the value of a dollar received
today is worth the same as a dollar received 40 years from now. However,
after including the expected impact of inflation and the investment income
that could accrue over time, GAO estimates the financial loss of the grants
proposal to the World Bank is only $15.6 billion in present value terms.

GAO provided a copy of the draft report to the Department of the Treasury
for review and comment. Treasury agreed with the report?s findings.

Background The World Bank and the IMF have classified 42 countries as
heavily indebted and poor; three quarters of these are in sub- Saharan
Africa. Most of these countries receive substantial amounts of development
assistance

from governments, multilateral organizations, and nongovernmental
organizations. During the 1970s and 1980s, many low- income countries
sharply increased their external borrowing, mostly from other governments or
multilateral institutions. During this period, the price of primary
commodities tended to be high, contributing to optimistic export growth
projections on the part of developing countries, which encouraged them to
overborrow. By the end of 1997, the total external debt of these 42
countries had a face value of more than $200 billion. Much of this debt was
not being repaid or was repaid only with the support of donors.

In 1996, creditors agreed to create the Heavily Indebted Poor Countries
(HIPC) initiative to address concerns that some poor countries would have
debt burdens greater than their ability to pay, despite debt relief from
bilateral creditors. 4 In 1999, in response to concerns about the continuing
vulnerability of these countries, the World Bank and the IMF agreed to
enhance the HIPC initiative, which more than doubled the estimated amount of
debt relief to over $28 billion for 32 countries. Under the enhanced HIPC
initiative, countries seeking debt relief must first carry out economic and
social reforms under specified programs, at which point their eligibility is
assessed at what is called the ?decision point.? The World

Bank and IMF then determine what assistance is required to achieve the
country?s debt sustainability. The World Bank and IMF prepare detailed
economic analyses for this purpose, including economic projections covering
20 years. To date, 27 poor countries have reached their decision points.

In June 2000, GAO reported that, although the enhanced HIPC initiative will
provide significant debt relief to recipient countries, the initiative alone
is not likely to provide recipients with lasting relief from their debt
problems unless they achieve strong, sustained economic growth. 5 GAO?s
analysis indicated that World Bank and IMF assumptions about the growth of
countries? export earnings may be optimistic for a variety of reasons, and
failure to achieve the projected levels of growth could lead to recurring
difficulties in repaying debt.

4 Efforts to relieve the debt burdens of poor countries have concentrated on
the external debt of these countries. Thus, debt sustainability is defined
in terms of repaying debt owed to external creditors, with export earnings
considered an important source of revenue for repaying this debt. 5 See
United States General Accounting Office, Developing Countries: Debt Relief
Initiative for Poor Countries Faces Challenges, GAO/ NSIAD- 00- 161
(Washington, D. C.: June 29, 2000).

Shifting Loans to A shift from loans to grants would benefit all countries?
ability to repay Grants Would Have a their future debt. However, we found
that a shift to grants across all the

multilateral institutions would help some, though not all, of the 10
Positive Impact on countries we analyzed to become debt sustainable. Under
the 50- percent Debt Sustainability for grants proposal, 4 of the 10
countries would be debt sustainable under their historical growth rates over
the 20- year projection period, 6 and 2 would be

Poor Countries debt sustainable for most of this period. However, the 4
remaining

countries we analyzed would not achieve debt sustainability at historical
export growth rates. We also found that the 50- percent grants proposal
would promote greater opportunity to achieve debt sustainability than
100percent debt forgiveness on old multilateral debt. (See app. II for an
explanation of the assumptions used for these findings.) Grants Can Help
Some

According to the World Bank and IMF, countries are debt sustainable when
Countries Reach Debt

the present value of their future debt divided by their future exports is
Sustainability below 150 percent. As shown in table 1, under the current
debt relief initiative, but assuming the historical export growth rates of
each country,

only Mali and Mozambique are projected to be at or near debt sustainable
thresholds in the future, with most countries? debt- to- export ratios
substantially above those thresholds. However, if 50 percent of the
projected lending from multilateral institutions to these 10 countries were
to be provided by grants, then 2 additional countries- Benin and Uganda-

would become debt sustainable over the 20- year period. In addition,
although they are considered unsustainable at the 20- year point, two other
countries, Nicaragua and Tanzania, are either debt sustainable or nearly so
for a considerable portion of the 20- year period.

6 Our analysis of debt sustainability differs from the World Bank and IMF
analysis in that we assume future export growth will be similar to
historical levels, whereas the World Bank and IMF assume that future export
growth rates will average more than double historical levels. We discuss
this issue in greater detail later in the report.

Table 1: Projected 20- Year Debt- to- Export Ratios under Three Scenarios
Impact of full Impact of grants

forgiveness of old Historical

proposal multilateral debt

Country baseline (percent) (percent)

(percent)

Benin 168 99 142 Bolivia a 668 393 649 Burkina- Faso 713 377 648 Ethiopia
572 328 502 Mali 62 42 44 Mozambique 153 78 140 Nicaragua 377 210 358
Tanzania 434 239 429 Uganda 339 125 324 Zambia 837 457 784

Average 432 235 402

a Bolivia is considered eligible for both concessional and nonconcessional
resources from the World Bank. As such, it may not be eligible for grants.
Note: Countries projected to be debt sustainable are in italics. That is,
their debt- to- export ratio is near or below 150 percent.

GAO?s projections of debt sustainability assume countries received debt
relief under the enhanced HIPC initiative and grow at historical export
growth rates. In addition, we assume that countries receive additional
bilateral and multilateral assistance to replace foreign exchange shortfalls
due to lower export earnings.

Source: GAO analysis.

The 50- percent grants proposal has beneficial effects on the debt- to-
export ratios of all 10 countries we analyzed. Their debt- to- export ratios
are projected to decline from an average of 432 percent under the historical
baseline to an average 235 percent if they were to receive 50- percent of
their future multilateral lending in the form of grants. However, the
50percent

grants proposal does not help every country become debt sustainable over the
20- year projection period. Based on our analysis, Bolivia, Burkina- Faso,
Ethiopia, and Zambia will not be debt sustainable at the end of the 20- year
period, even if they receive 50 percent of their future assistance from
multilateral institutions in the form of grants. The benefits

from 50- percent grants are not sufficient to achieve debt sustainability
because these 4 countries are projected to borrow a substantial amount of
additional resources in the future to help compensate for the insufficient
export revenue generated under historical growth rates.

In addition, we found that if the grants proposal were increased to an
average of about 67 percent for the 10 countries analyzed, all would become
debt sustainable by the end of the 20- year period. As table 2 shows,
Bolivia would require the greatest proportion of grants, needing 90. 8
percent of its future multilateral assistance in the form of grants to

achieve debt sustainability.

Table 2: Required Multilateral Grants as a Share of Multilateral Assistance
to Achieve Debt Sustainability Required multilateral grant level Country
(percent)

Benin 11. 1 Bolivia 90. 8 Burkina- Faso 79. 7 Ethiopia 79. 3 Mali 0
Mozambique 1.3 Nicaragua 61. 2 Tanzania 68. 7 Uganda 38. 3 Zambia 83. 7

Average 67.2 a

a Weighted average. Source: GAO analysis.

Grants Proposal The grants proposal is also more effective in promoting debt
sustainability

Contributes More to Debt than proposals to forgive old multilateral debt, as
shown in table 1. Many Sustainability Than Full nongovernmental
organizations and debt relief advocates have Forgiveness of Old

recommended that multilateral organizations follow the course taken by some
countries and forgive 100 percent of the old debt owed by poor Multilateral
Debt nations. However, our analysis shows that the debt ratios are
considerably higher under the 100- percent debt forgiveness scenario than
under the grants proposal. While 100- percent forgiveness of existing
multilateral debt would dramatically improve countries? debt ratios
immediately following forgiveness, the advantage of this plan over the 50-
percent grants proposal is eliminated after 7 years (see fig. 1). This is
because, following

HIPC debt relief, countries are projected to accumulate a substantial

amount of new debt that will quickly become unsustainable. The 50- percent
grants proposal mitigates half of the impact of this new debt as it
accumulates. Figure 1: 20- Year Debt Sustainability Projections for 10 Poor
Countries

Note: The lines for the three scenarios represent the annual average debt
ratios for the 10 countries. Source: GAO analysis.

Grants Proposal Can President Bush?s proposal to shift 50 percent of
multilateral loans to grants Be Financed through

would reduce the amount of future resources available to the World Bank, but
donor countries could finance this deficit with relatively small Relatively
Small

increases in their contributions. We estimate that it would require $9. 7
Increases in Donor billion in present value terms to replace the World
Bank?s projected lost Contributions

revenue over the next 40 years. This amount represents about 8 percent of
the $120.2 billion in present value terms that the World Bank expects to
disburse to poor countries over this 40- year time frame. Efforts to
eliminate this shortfall by levying harder loan terms on poor countries are
impractical, given their already difficult debt burdens. However, donors
could fully finance the 50- percent grants proposal if they increase their

contribution to the World Bank?s International Development Association (IDA)
7 by 1. 6 percent each year- less than the expected rate of inflation. (See
app. III for an explanation of the assumptions used for these findings.)

Shift to 50- Percent Grants The proposal to shift 50 percent of multilateral
loans to grants would result Would Reduce World Bank in a revenue loss to
the World Bank. 8 Since grants reduce the amount of Concessional Resources
loans made, future repayments would be reduced proportionate to the amount
of grants provided. We estimate the present value of total foregone
repayments from poor countries to the World Bank to be approximately $9. 73
billion over the next 40 years. The total financial loss of the 50-

percent grants proposal is approximately $15. 6 billion, since the $9. 73
billion would have accrued an additional $5.82 billion in investment income
to the World Bank. This amount represents about 8 percent of the $120.2
billion in present value terms that the World Bank expects to commit to poor
countries over this 40- year time frame. Furthermore, the financial

loss of a switch from loans to grants would not begin until the end of the
10- year repayment grace period of IDA loans. At that time, the lost
repayments and investment income from the grants proposal would begin

to accumulate. Our analysis shows that the present value of foregone revenue
of the 50- percent grants proposal would increase from nearly zero after the
first 10 years to $2.4 billion after 20 years and then to $15.6 billion
after 40 years. Lost Revenue Unlikely to Be

Based on our analysis, the options for making up the foregone revenue
Recouped from IBRD

from the 50- percent grants proposal are fairly limited. As shown in table
3, Contributions or Internal the World Bank finances its concessional loan
program through Resources

International Bank for Reconstruction and Development (IBRD) contributions,
internal resources, and donor contributions. 7 IDA provides concessional
financing to the World Bank?s poorest member countries.

8 The financial loss of the 50- percent grants proposal is limited to 40
percent of IDA?s future commitments, since grants would only be made
available to IDA?s poorest members who are not eligible to also borrow from
the World Bank?s nonconcessional resources.

Table 3: Estimated Sources of IDA Resources for IDA- 12, FY 2000- 02 a
Amount

Share of total Source (billions of dollars) (percent)

IBRD contributions 0. 9 4 Internal resources b 7.9 39 Donor contributions
11.4 57 a Donor countries normally contribute to IDA on 3- year cycles,
called replenishments. IDA is currently funded through its 12th
replenishment cycle (referred to as IDA- 12), which covers fiscal years
2000- 02. The next replenishment cycle (IDA- 13) is scheduled to commence in
fiscal year 2003.

b Internal resources are made up of loan repayments (both principal and
service charges) and investment income. The World Bank does not separately
report the totals of these subcategories. Source: GAO analysis of World Bank
data.

The World Bank would have difficulty substantially increasing revenue from
IBRD contributions. IBRD contributions derive from a portion of the profits
that the World Bank realizes from loans it makes to middle- income
countries. Profits from these loans are primarily used to maintain the World
Bank?s reserves on middle- income lending, provide contributions to

the HIPC initiative, and reduce the interest and fees charged to those
countries. Thus, any increase in contributions to IDA from IBRD would come
at the expense of those other priorities.

Similarly, the World Bank would have difficulty increasing contributions
through its internal resources, which include investment income and loan
repayments. Investment income derives from the returns accruing from
invested IDA resources that have yet to be disbursed. As of fiscal year
2001, investments were about $11.7 billion, contributing $680 million to
IDA. Increased revenue from this source could only be realized by raising
the capital stock (for example, by reduced lending), or by increasing the
risk of investments (and correspondingly, their expected return) beyond what
the World Bank considers prudent.

It would also be unrealistic for the World Bank to significantly increase
the amount of income it receives from loan repayments, given the existing
debt burdens of many of its poorest members. Increased loan repayments could

be accomplished by increasing the interest rate of the loan, shortening the
grace period, reducing the repayment period, or some combination of these
changes. For example, our analysis found that the current 0- percent
interest charge on IDA loans would need to be increased to 2.83 percent for
all borrowing countries, to raise sufficient funds to finance the grants

proposal. Changes of this magnitude would represent a doubling of the cost
of IDA lending to borrowing countries, effectively nullifying any
improvement to their debt sustainability that would accrue from the
50percent grants proposal.

Small Increases in Donor Our analysis shows that the 50- percent grants
proposal could be fully Contributions Can Make Up financed through small
increases in contributions from donor countries the Lost Revenue over what
is currently projected. The amount of repayments required to make up the
loss due to grants is estimated to be $9. 73 billion in present

value terms. 9 If donor countries were to increase their annual contribution
to IDA by 1.6 percent over 40 years, the World Bank would receive an
additional $9. 06 billion in present value terms. Combined with an
additional $. 67 billion accruing from investment income on the net
contributions, the total would fully finance the 50- percent grants
proposal. Furthermore, this additional $9. 73 billion would itself generate
sufficient investment income to erase the remainder of the projected $15.6
billion revenue shortfall. An

annual increase in donor contributions of 1.6 percent over the next 40 years
would be less than the expected rate of inflation, which is projected to be
2.3 percent over this time period.

The 1.6 percent annual increase would be consistent with donors maintaining
their long- term commitment to the IDA program, as indicated by recent
discussions among the donors. Donor contributions to IDA are expected to
increase by 13. 4 percent over the next 3 years, with the U. S.
contributions expected to grow by more than 18 percent. However, the World
Bank?s baseline projections assume that donor involvement with IDA

will decline over time. This is because the World Bank assumes that donor
and IBRD contributions will stay constant in nominal terms for the next 40
years, while IDA?s future lending commitments to poor countries will
increase at the annual inflation rate. The long- term implication of these

assumptions is that the World Bank projects that future IDA resources will
increasingly depend on loan repayments from poor countries to make new
loans, as the proportion of IDA resources contributed by donors steadily
declines. We consider this an unlikely outcome, especially considering the
debt burdens of many of these poor countries. As shown in figure 2, under

9 The projected financial loss is based on estimates of the impact of the
grants proposal on expected loan repayments. This estimate does not include
repayments from additional multilateral loans necessary to maintain debt
sustainability at historical export growth levels.

World Bank projections, donor resources as a share of future lending
commitments will fall from 56 percent during IDA- 13 (FY 2003- 05) to only
23 percent in IDA- 26 (FY 2042- 44). However, if donor contributions were to
increase by 1.6 percent a year, the donor share would instead rise to 43

percent in IDA- 26.

Figure 2: Estimates for the Financing of IDA, FY 2003- 05 and FY 2042- 44

Note: Internal resources include repayments and investment income.
Percentages exceed 100 percent due to rounding.

Source: GAO analysis.

GAO?s Projections Our projections on countries? future debt sustainability
and the financial Differ Substantially

loss of the 50- percent grants proposal differ substantially from the
estimates of the World Bank and the IMF. While the World Bank and IMF from
World Bank and estimate that countries will be debt sustainable under the
current debt IMF Estimates

relief initiative, these projections are based on highly optimistic
assumptions about these countries? export growth rates. Furthermore, our
characterization of the financial loss of the 50- percent grants proposal
differs from the World Bank?s because our estimate includes the expected
impact of inflation and the investment income that could accrue over time.

GAO Disagrees with World The World Bank and IMF rely on overly optimistic
export growth

Bank and IMF Projections projections to achieve debt sustainability. As
shown in table 4, the World That the Current Debt Relief Bank and IMF
project that the 10 countries we analyzed will all have debtto-

Initiative Will Lead to Debt export ratios near or below 150 percent during
the 20- year period. To demonstrate debt sustainability, these projections
assume that these

Sustainability countries will have very high export growth rates, with rates
averaging more than double what they have experienced over the previous 20
years. However, if these countries? exports were to grow at rates consistent
with historical levels, only 2 of the 10 countries would be debt
sustainable, with 3 countries having debt ratios in excess of 650 percent.

Table 4: Export Growth Rates and Debt/ Export Ratios for 10 Poor Countries
Projected 20- year

Projected 20- year World Bank/ IMF

debt/ export ratios using Historical export growth

debt/ export ratios using projected export growth

World Bank/ IMF export rates

historical export growth Country

rates (percent) growth rates (percent)

(percent) rates (percent)

Benin 8. 1 59 5.2 168 Bolivia 7.1 153 3.1 668 Burkina- Faso 8.7 114 1.8 713
Ethiopia 8.9 79 2. 5 572 Mali 5.9 101 6.7 62 Mozambique 7.3 48 4. 6 153
Nicaragua 8. 5 60 4. 1 377 Tanzania 8. 9 132 5. 1 434 Uganda 9. 1 32 3.7 339
Zambia 6.7 101 .5 837

Average 7. 9 88 3.7 432

Source: GAO analysis.

The World Bank and the IMF assert that under their new approach to
development, countries can achieve higher economic growth rates, including
export growth, because their emerging development plans will be ?country
owned,? representing buy- ins from both the government and civil society.
This country ownership is expected to build a stronger base for the economic
and structural reforms needed to enhance productivity. However, we recently
reported that achieving this change in approach would be difficult to
accomplish. The preparation of these development strategies is complicated,
taking a significant amount of time to complete and straining already
limited government resources. 10 We also found that

civil society ownership of the countries? development priorities is
especially difficult to accomplish. 10 See GAO/ NSIAD- 00- 161 and U. S.
General Accounting Office, International Monetary Fund: Few Changes Evident
in Design of New Lending Program for Poor Countries, GAO01- 581 (Washington,
D. C.: May 8, 2001).

Uncontrollable External Two key factors make it difficult for poor countries
to achieve the high

Factors Limit Opportunities export growth rates assumed by the World Bank
and IMF. These factors

for Strong Economic are the countries? continued reliance on a few primary
commodities for Growth

much of their export revenue and the growing impact of HIV/ AIDS on economic
growth. (See app. IV for more detail on the potential vulnerabilities of
these poor countries to external shocks.) Reliance on primary

Most of the 10 countries we analyzed rely on one or two primary commodities

agricultural and/ or mineral commodities for a significant portion of their
foreign exchange earnings. For example, between 1995 and 1997, Zambia relied
on copper for 56 percent of its export revenue, and Uganda relied on coffee
for 56 percent of its export revenue. The price of these and other
commodities has fluctuated over time, usually due to factors outside the
control of these countries. As figure 3 shows, the trend in recent years for
many of these commodities has been downward, impairing countries? ability to
increase their export income. Environmental factors such as

floods and drought can also impact export income. For example, Mozambique
suffered heavy rains that damaged their agricultural production in 2000, and
despite reconstruction efforts, its growth rate in national income fell from
7. 5 percent in 1999 to 1. 6 percent in 2000.

Figure 3: Cotton, Coffee, and Copper Indexes (1995- 2001)

Source: IMF, International Financial Statistics, February 2002.

The recent global economic downturn has exacerbated the problem. According
to the United Nations, the 2001- 02 global recession is expected to have a
severe impact on developing countries. The IMF projects that global prices
for nonfuel commodities, such as those produced by our case study countries,
will fall by 3.8 percentage points between 2000 and 2002. According to the
World Bank and the IMF, recovery in the commodities markets may not occur
until 2003, provided there are no additional shocks to global markets.

Impact of HIV/ AIDS on economic The HIV/ AIDS pandemic also serves as a
significant restraint on export growth

growth among poor countries. HIV/ AIDS is widely recognized by development
professionals and multilateral aid organizations as a major threat to the
growth rates of many poor countries, because the

governments of these countries will need to divert funds from economic
growth initiatives to cover dramatically increasing health care costs,
rising labor costs, and productivity losses in key export sectors. According
to the

World Bank, studies in several sub- Saharan countries have found that the
effects of the disease could reduce the rate of economic growth by as much
as 25 percent over the next 20 years. In all but 2 of our 10 case- study
countries, the rate of HIV/ AIDS among adults aged 15 to 49 is above the
global average for this age group of 1. 07 percent. In Zambia, which has the
highest HIV prevalence of our case- study countries, an estimated 19.95
percent of working adults ages 15 to 49 years have HIV or AIDS.

World Bank Estimate of the The World Bank has reported that the grants
proposal would result in a

Financial Loss of the 50- $100 billion loss to IDA over 40 years, but this
estimate does not account Percent Grants Proposal for the time value of
money. According to the World Bank, about $59

Overstated billion of this loss stems from foregone repayments, with the
remaining $41

billion derived from foregone interest earnings. The World Bank?s
methodology assumes that the value of a dollar received today is worth the
same as a dollar received 40 years from now. This assumption ignores the
impact of inflation or the potential investment income that could accrue
over time. In present value terms, the financial loss from the proposal
would be $15.6 billion, and $9.73 billion in present value terms would be

required to replace the loss. In contrast to its estimate that the financial
loss from the grants proposal will be about $100 billion, the World Bank
reported in March 2002 that if donors were to increase their annual
contributions to IDA by an average of 2 percent a year, it would fully
finance the 50- percent grants proposal. This 2- percent estimate is 25-
percent higher than our estimate of an increase of 1.6 percent a year. We
identified two reasons that the World Bank estimate differs from ours.
First, the World Bank assumes that if donors were to increase their annual
contributions to IDA, such contributions would

accelerate over time; that is the annual donor increases would be higher in
later years than in earlier years. In contrast, we assume the increases in
donor contributions would be constant over the entire 40- year period. The
advantage of assuming a constant increase is that contributions made in
earlier years will have more time to earn investment income, thus lowering
the need for future contributions. Second, the World Bank added the cost of
fully financing its contribution to the HIPC debt relief initiative within
the grants proposal, while excluding the cost of HIPC from its projections
of donor contributions without grants. Our analysis excludes the costs of
HIPC from both estimates. We believe excluding the costs of HIPC debt relief
gives a fairer estimate of the true financial loss of the grants proposal.

Observations Despite the efforts of the HIPC initiative, our analysis
demonstrates that without grants, most of the 10 countries analyzed will
experience difficulties repaying their debt. The 50- percent grants proposal
substantially lessens the long- term debt burdens of the countries we
analyzed and is affordable as long as donors remain committed to financing a
significant portion of the IDA program. However, the debt problems of these
countries may not be resolved unless the grant component is raised to a
level higher than 50 percent across all the multilateral institutions.

Agency Comments We provided a draft of this report to the secretary of the
treasury for review and comment. The Department of the Treasury agrees with
the report?s

primary findings that President Bush?s proposal to increase the use of
grants at the multilateral development banks is affordable and would lower
poor countries? debt burdens more effectively than 100 percent forgiveness
of multilateral development bank debt. See appendix V for Treasury?s
comments.

We are sending copies of this report to appropriate congressional committees
and to the Honorable Paul O?Neill, secretary of the treasury. We are also
sending copies to the World Bank and the IMF. Copies will be made available
to others upon request. If you or your staff has any questions about this
report, please contact me

on (202) 512- 8979. Another GAO contact and staff acknowledgments are listed
in appendix VI.

Joseph A. Christoff, Director International Affairs and Trade

Appendi Appendi xes x I

Objectives, Scope, and Methodology The ranking minority member of the Senate
Foreign Relations Committee and the chairman of the House Subcommittee on
International Monetary Policy and Trade, Committee on Financial Services,
asked us to review the proposal to shift a portion of multilateral
institutions? loans for poor countries to grants. In response, we assessed
(1) how the loans- to- grants proposal would affect poor countries? ability
to repay their debt, (2) how it would affect the resources available to the
World Bank for poor countries,

and (3) how GAO?s projections for countries? debt sustainability and the
financial loss to the World Bank from the grants proposal compare with World
Bank and International Monetary Fund (IMF) estimates.

We did not discuss our results with the World Bank and the IMF because we
were unable to meet with officials from these multilateral institutions in
the course of this engagement. GAO has an agreement with the IMF, World
Bank, the Department of the Treasury, and the U. S. Executive Directors at
the IMF and the World Bank that Treasury must approve our access to
officials of those institutions. 11 For this engagement, Treasury officials
denied our requests for access to officials of the multilateral institutions
because they were concerned that our engagement would interfere with ongoing
negotiations to refinance the World Bank?s International Development Agency.

To assess how the loans- to- grants proposal would affect poor countries?
ability to repay their debt, we built on prior work that examined the World
Bank and IMF?s debt sustainability model, including their export growth
projections. The World Bank and the IMF reviewed and provided detailed
comments on that earlier analysis. We supplemented this work with additional
data from the IMF and the World Bank. First, we examined the World Bank?s
and IMF?s debt sustainability analyses for 10 of the 27 countries in the
Heavily Indebted Poor Countries (HIPC) initiative that have reached a
decision point- Benin, Bolivia, Burkina Faso, Ethiopia,

Mali, Mozambique, Nicaragua, Tanzania, Uganda, and Zambia. 12 These
countries are geographically dispersed, represent a wide range of 11 The
articles of agreement establishing the World Bank and the IMF require the
United States to deal with these organizations only through the Department
of the Treasury. 12 Under the current debt relief initiative, countries
seeking debt relief must first carry out economic and social reforms under
specified programs, at which point their eligibility is assessed at what is
called the ?decision point.? The World Bank and IMF then determine what
assistance is required to maintain debt sustainability and prepare detailed
analyses for this purpose.

economic conditions, and receive about two- thirds of
internationallyprovided debt relief. Our evaluation of the World Bank and
IMF analyses focused on projections for key economic variables including
debt stock, debt service, donor assistance, and exports. 13 Second, we
projected these countries? debt ratios over a 20- year period, examining the
impact of both

historic export growth rates and the 50- percent grants proposal on
countries? debt sustainability. 14 Third, we calculated the impact of both
historic export growth rates and the 50- percent grants proposal on
multilateral receipts and required donor assistance. Finally, we compared
the effect of the grants proposal in promoting debt sustainability to other
proposals calling for forgiveness of all old multilateral debt.

To assess how the loans to grants proposal would affect the resources
available to the World Bank for poor countries, we analyzed the implications
of a shift to grants on the World Bank?s medium- and long- term cash flows.
We did so by applying the same assumptions used by the World Bank in its
financial projections model (see app. III for more detail on these
assumptions). Specifically, we analyzed how much revenue would be forgone by
the World Bank over a 40- year period as the flow of repayments of loans
diminished over time, in both nominal and present value terms.

We then analyzed several options to make up the shortfall in repayments over
the 40- year period through both internal and external resources available
to the World Bank. These included making the terms of remaining loans
harder, such as decreasing the period for repayment or raising the interest
rate. We also analyzed the effect of increasing donor

contributions over their current levels by calculating the average percent
increase in donor contributions necessary to offset the forgone resources.
For our third objective, we first compared how GAO?s projections for
countries? debt sustainability differ from World Bank and IMF estimates. Our
analysis of country- specific economic conditions was primarily based

on information from IMF/ World Bank Decision- Point Documents, World Bank/
IMF Poverty Reduction Strategy Papers, Interim Poverty Reduction 13 In some
cases, we replaced gaps in data through interpolation.

14 To estimate the effects of lower export growth rates, we replaced the
annual shortfall in foreign exchange earnings with increased donor
assistance in the same annual proportions of grants and concessional loans
as indicated in each country?s debt sustainability analysis. We assumed that
these additional loans were provided at the same level of concessionality

as IDA- 40- year maturity, 10- year grace period, 0- percent interest and 0.
75 percent service charge.

Strategy Papers, the CIA World Fact Book (2001), and other case- study
papers by the IMF and the World Bank. In addition, the primary sources of
data pertaining to price fluctuations of commodities and export data were

IMF financial statistics and the United Nations Statistics Division COMTRADE
database. With regard to HIV/ AIDS and its impact on economic development,
data came from the above sources, plus reports obtained from the Joint
United Nations Programme on HIV/ AIDS, reports prepared directly by or under
contract to the World Bank and IMF, and

reports by the World Health Organization. Finally, we prepared a direct
comparison of GAO?s projections for the financial impact of the grants
proposal to World Bank and IMF estimates. We conducted our work from
September 2001 through April 2002 in accordance with generally accepted
government auditing standards.

Economic Assumptions Used to Analyze Debt

Appendi x II

Sustainability World Bank and IMF Once a country is deemed eligible to enter
the HIPC initiative, World Bank 20- year Economic and IMF staff prepare a
debt sustainability analysis (DSA). The DSA details 20- year economic
projections for a country?s exports, national income, Projections Provided
government revenue, debt stock, debt service, foreign assistance, and other
Basis for Analysis

economic indicators. The analysis also discusses the amount of debt relief
the country must receive to become debt sustainable and how this debt relief
would be distributed among creditors. World Bank and IMF projections for
these variables provided GAO with the basis for assessing the impact of
changing key assumptions, including substituting 50 percent of future
multilateral lending with grants.

Impact of Using As discussed in the report, the World Bank and IMF DSAs
assume that HIPC countries? future export growth rates, on average, will be
more than Historical Export

double historical levels. 15 An approach consistent with the historical
Growth Rates record is more conservative. Therefore, to evaluate the impact
of this conservative approach, we replaced the World Bank and IMF export

growth rates with each country?s historical export growth rate over the
previous 20 years, while maintaining all the other assumptions implicit in
the DSA. We refer to this as the historical baseline. Under the historical
baseline, most countries are expected to experience shortfalls in their
balance of payments revenue as exports grow slower than World Bank and IMF
projections. Since these countries are assumed

within the DSAs to follow their development programs, 16 including achieving
the growth rates necessary to reach their 2015 development goals, any
shortfalls in their export growth are assumed to be due to factors

outside of their control. Accordingly, we assumed that, for these countries
to achieve the gross domestic product (GDP) growth rate projected in their
DSAs, they will have to receive increased bilateral and multilateral
economic assistance to close this emerging balance of payments deficit.

The total assistance required to erase the deficit for the 10 countries
analyzed more than doubles during the 20- year projection period, from $73.5
billion in present value under the World Bank and IMF export 15 Average
export growth rates (both projected and historical) are the average
annualized growth rates calculated using ordinary least squares regression.

16 Countries are expected, for example, to achieve their goals of good
governance, anticorruption, transparent budget processes, and poverty
reduction as described in each country?s poverty reduction strategy papers.

assumptions to $153.2 billion, using the historical baseline. We also assume
that this new assistance will be in the form of both loans and grants, with
the annual proportions equivalent to those embedded within each country?s
DSA baseline projections. 17 Closing the balance of payments deficits allows
each of the 10 countries to continue to achieve the same GDP

growth rates as projected by the World Bank and IMF. If these countries do
not receive the necessary additional financing, then economic growth,
income, and imports would decline to close the balance of payments deficit.
While this economic contraction would somewhat lessen the

countries? future debt burdens, it could also adversely affect their
progress in reducing poverty. Impact of 100- percent

To analyze the impact of 100- percent cancellation of old multilateral debt,
Forgiveness of Old

we reduced the debt of the 10 countries by their total stock of existing
multilateral debt. We made this adjustment as of the beginning of the 20year
Multilateral Debt

projection period, coinciding with these countries? receipt of HIPC debt
relief. While substantial, this debt stock reduction does not entirely
eliminate the debt burdens of these countries because the countries retain

the portion of their pre- existing bilateral debt that was not included
under the HIPC program. Although HIPC reduces bilateral debt substantially,
debt that accrued after the date that countries first received debt relief
under the Paris Club process is not considered eligible for debt relief. 18
Under the historical exports scenario, the average debt- to- export ratio
for the 10 countries declines from the initial value of 161 percent before
the

elimination of their multilateral debt stock to 78 percent afterward.
However, due to the steady accumulation of a substantial amount of new debt,
the average debt- to- export ratio for the 10 countries rises to 402 by the
end of the 20- year projection period, nearly as high as the projected 17
The DSA baseline assumes that most of the future bilateral assistance
received by these countries will be in the form of grants, while
multilateral assistance is in the form of loans.

18 The Paris Club is an informal group of bilateral creditors that meets, on
an as- needed basis, to negotiate debt relief on sovereign debt. Over the
past 14 years, the Paris Club has undertaken actions to reduce or cancel
public debt owed to them by heavily indebted poor countries. Prior to 1988,
the Paris Club generally engaged in rescheduling, but not reducing, debt.
This solved immediate debt- servicing crises but offered no permanent
relief. The Paris Club generally limits the debt that is eligible to be
rescheduled to market- based debt, such as loans to support exports from the
lending country and loans that were incurred before an agreed- upon cutoff
date. This date corresponds to the first time that a country requests debt
rescheduling/ relief from the Paris Club. For many potential HIPC
recipients, this date occurred in the 1980s, and thus eligible debt was
contracted before this time.

debt ratio under the historical baseline with no multilateral debt
forgiveness (432).

Assumptions Used to Analyze the Financial Impact of the 50- Percent Grants
Proposal on

Appendi x II I the World Bank World Bank?s To analyze the financial impact
of the 50- percent grants proposal, we relied Assumptions Key in Its

on World Bank documents that listed the assumptions the World Bank used to
make its projections and the details of those projections. As discussed
Projection of Large in appendix 1, GAO did not have access to World Bank
staff on this Financial Losses

assignment. Therefore, our approach was to use information in the World
Bank?s documents to duplicate the World Bank?s own projections and analyze
the implications of changing some of the World Bank?s underlying
assumptions.

In projecting the financial impact of the 50- percent grants proposal, the
World Bank used two sets of assumptions: core assumptions for the
International Development Agency?s (IDA) financial situation, and
assumptions relevant to the 50- percent grants proposal (see table 5). The
World Bank?s projections take into account all of IDA?s expected cash
inflows (donor contributions, principal repayments, service charges,
investment income, and International Bank for Reconstruction and

Development [IBRD] contributions from its net income) and cash outflows
(disbursements of assistance, administrative expenses, and HIPC debt relief
payments). Table 5: Assumptions Used by the World Bank for Its IDA Financial
Projections Additional assumptions used to analyze IDA?s financial Core
assumptions used in financial projections model projections when grants are
included

 Future IDA assistance program remains level in real terms.

 IDA- only countries account for 80 percent of IDA assistance.

 Donor contributions remain level in nominal terms.

 Grants are provided to IDA- only countries. (50 percent grants  Donor
encashments match disbursements. means 40 percent of total IDA assistance
are grants.)

 Loan and grant disbursement profiles are based on a projected

 Lending terms for IDA- only are 10- year grace period and 40- year mix of
investment and programmatic assistance.

maturity.

 Future nominal investment income is based on expected returns  Lending
terms for ?blend? countries are 10- year grace period and of 5 percent per
year.

35- year maturity.

 Principal repayments assume a 5- percent noncollection rate,  Grants have
a 0. 5 percent annual commitment charge that will be based on historic
pattern. paid as a flat fee for 6 years.

 IBRD net income transfers to IDA remain level in nominal terms  Future
inflation rate is 2.3 percent per year. at $300 million per year.

 The discount rate over the 40- year period is 6. 3 percent.

 No change in IDA lending terms (0. 75 percent service charge on

 Programmatic adjustment lending represents 30 percent of IDA net
disbursements, no loan commitment fee). assistance for IDA- 13 and 35
percent for subsequent years.

 Costs of HIPC debt service forgiveness are fully covered by IBRD net
income pledge and subsequently by additional donor contributions.

 IDA?s share of the World Bank?s administrative expenses remains level in
real terms.

 IDA is broadly immunized against currency risk. Source: World Bank, IDA
Funding Scheme and Financial Projections, 2001.

We found that two of the World Bank?s core assumptions were critical in
generating the Bank?s projected $100 billion loss over 40 years due to the
50- percent grants proposal. First, the World Bank assumes projected future
lending will grow at the rate of inflation. Second, the World Bank assumes
donor contributions will remain fixed in nominal terms. The assumption that
IDA lending will increase at the annual inflation rate is reasonably
consistent with the World Bank?s recent experience. Over the

last decade (FY 1991- 2001), the World Bank estimates that IDA lending grew
at an annual rate of about 4 percent, while the U. S. inflation rate was
somewhat less than 3 percent annually over the same period. Similarly, the

assumption that donor resources will remain constant in nominal terms is
close to the World Bank?s experience over the last 10 years. During this
period, donor replenishment contributions rose from $12.4 billion (IDA- 8 FY
1988- 90) to $18.0 billion (IDA- 10 FY 1994- 96) and then declined to $11. 6
billion (IDA- 12 FY 2000- 02).

However, taken together, the long- term implication of these two assumptions
is that donor resources as a percentage of total commitments are projected
to steadily decline over time, falling from 56 percent of lending
commitments during IDA- 13, to only 23 percent during FY 2042- 44 (IDA- 26).
To compensate for a reduction in donor resources, the World

Bank assumes that internally generated resources, especially loan
repayments, will grow over time. The assumption that future lending will be
increasingly dependent on loan repayments greatly increases the financial
impact of the 50- percent grants proposal. Since the poorest

countries are projected to receive 80 percent of all IDA assistance and
account for 80 percent of all future repayments, the 50- percent grants
proposal would reduce IDA internally generated resources by about 40
percent. Harder Loan Terms on We found that it would be unrealistic for the
World Bank to significantly

Borrowing Countries Is increase the amount of income it receives from loan
repayments, given the existing debt burdens of many of its poorest members.
Lending under the an Unrealistic Option IDA program is considered
?concessional? in that its loan terms are for Replacing Foregone
considerably softer than market- based terms. The World Bank estimates

Revenues due to that loans under IDA have a ?grant element? of 64 percent.
That is, from the

perspective of recipient countries, a $1 million IDA loan is equivalent to
Grants receiving the combination of a grant worth $640,000 and a market-
based loan of $360,000. Our analysis shows that to finance the 50- percent
grants proposal through a hardening of IDA loan terms, the grant element of
the remaining loans would have to be reduced to 32 percent.

Table 6: Examples of Harder Loan Terms on IDA Countries to Finance 50-
Percent Grants Proposal

Current IDA Option

Option Option

Option Option terms 1 2 3 4 5

Interest rate 0% 2. 83% 2. 0% 2. 2% 1% 0% Grace period, years 10 10 10 5 5 5
Maturity, years 40 40 18 30 15 11 Service charge 0.75% 0. 75% 0. 75% 0.75%
0. 75% 0. 75% Total charges 0. 75% 3. 58% 2. 75% 2.95% 1. 75% 0. 75% Grant
element 64% 32% 32% 32% 32% 32% Note: For each option we assume equal annual
principal repayments after the grace period. Source: GAO analysis.

The reduction in the grant element could be accomplished by hardening loan
terms several ways: by increasing the interest rate of the loan, shortening
the grace period, reducing the repayment period, or some

combination of these changes. For example, the current 0- percent interest
charge on IDA loans could be increased to 2.83 percent, resulting in a total
annual charge of 3.58 percent (see table 6). Alternatively, the grace period
could be reduced to 5 years, with a total maturity of 11 years. However,
changes of this magnitude to the grant element would represent almost a
doubling of the cost of IDA lending to borrowing countries and effectively
nullify any improvements to their debt sustainability that would accrue from
the 50- percent grants proposal.

Optimistic Export Growth Assumptions Underlie World Bank/ IMF Debt
Sustainability

Appendi x I V

Analysis World Bank/ IMF The World Bank and IMF project that the average
annual export growth Projected Export

rate for the 10 countries we analyzed to be 7.9 percent over the next 20
years (see table 7). However, the historical export growth rate over the
Growth Rates Greatly past 20 years for these 10 countries- 3. 7 percent
annually- is less than half Exceed Historical

that amount. Similarly, for the 27 countries for which data were available,
Levels the World Bank/ IMF projects that the average annual export growth
rate will be 7.4 percent, compared to the historical average of 3.3 percent
annually. A comparison of the World Bank/ IMF projections with the
historical values for individual countries reveals some important features.
The World Bank/ IMF projected export growth rates for 4 of the 27 countries
(Chad, The Gambia, Guyana, and Mali) are lower than their historical levels
and thus may not require any grants to replace future lending to attain debt
sustainability. Alternatively, 5 countries have 20- year historical export
growth rates of zero or less (Cameroon, Niger, Rwanda,

Sao Tome & Principe, and Sierra Leone) and may not be able to attain debt
sustainability with less than 100- percent grants.

Table 7: 20- Year Historical and DSA Export Growth Rates for 27 HIPCs World
Bank/ IMF Historical export

export growth growth rate,

rate projections, 1980- 1999

2001- 2020 27 HIPC countries

(percent) (percent)

Benin a 5.2 8. 1 Bolivia a 3.1 7. 1 Burkina Faso a 1.8 8. 7 Cameroon 0.0 6.
7 Chad 9.0 5. 6 Cote d?Ivoire 3.1 7. 2 Ethiopia a 2.5 8. 9 The Gambia 8.3 5.
9 Ghana 6.7 6. 8 Guinea 2.1 7. 1 Guinea- Bissau 7.1 9. 2 Guyana?? 7.1 4. 1
Honduras 6.4 9. 5 Madagascar 4.9 8. 0 Malawi 4.4 4. 9

(Continued From Previous Page)

World Bank/ IMF Historical export

export growth growth rate,

rate projections, 1980- 1999

2001- 2020 27 HIPC countries

(percent) (percent)

Mali a 6.7 5. 9 Mauritania 1.9 5. 9 Mozambique a 4.6 7. 3 Nicaragua a 4.1 8.
5 Niger -2. 5 7. 6 Rwanda -4. 2 10. 5 Sao Tome & Principe -1. 7 6. 9 Senegal
3.0 6. 3 Sierra Leone -3. 7 7. 0 Tanzania ab 5.1 8. 9 Uganda a 3.7 9. 1
Zambia a 0.5 6. 7

Average - 10 countries analyzed 3. 7 7. 9 Average - All 27 countries 3. 3 7.
4

a Included in our analysis of 10 countries. b Historical GDP is from 1988-
1999.

Source: Data on historical exports of goods and services from the World Bank
Global Development Finance 2001 CD- ROM, series (XGS) (US$), 1980- 1999. DSA
export growth rate data from GAO analysis of IMF/ World Bank Decision- Point
Documents for HIPC countries.

Continued Reliance on The 10 countries in our study face increased economic
risk because they Primary Commodities rely heavily on only a few primary
agricultural and/ or mineral commodities

Limits Export Growth for a significant amount of their foreign exchange
earnings (see table 8).

Table 8: Primary and Secondary Commodity Exports Primary commodity Secondary
commodities

Benin Cotton Palm products Fruit/ nuts Tobacco Crude Oil

Bolivia Zinc Soybean Products Hydrocarbons/ natural gas Gold Silver

Burkina Faso Cotton Livestock/ meat Gold Leather/ hides

Ethiopia Coffee Vegetable products Leather Palm products Gold

Mali Cotton Gold Livestock

Mozambique Shellfish Electricity Cashews Cotton

Nicaragua Coffee Shellfish Sugar Meat

Tanzania Coffee Cashews Fish Tobacco Cotton Tea

Uganda Coffee Gold Fish/ fish products Tobacco Cotton Tea

Zambia Copper Cobalt Tobacco Electricity

Source: Data for all but 2 countries are from the United Nations HS
Merchandise Trade Statistics (1997- 2000, latest available). Data for
Burkina Faso and Zambia are from the World Bank ?Country- ata- Glance?
(2001) and the CIA World Fact Book (2001).

Global prices for commodities can fluctuate from year to year and thus
diminish the ability to accurately predict export earnings and growth rates.
Global price fluctuations or a regional environmental shock, such as flood

or drought, could cause export earnings to decline. Figure 4 shows the
historical volatility of coffee, cotton, and copper- three commodities
important to the 10 countries we analyzed.

Figure 4: Global Indexes for Cotton, Copper, and Coffee, 1980- 2001

Source: IMF, International Financial Statistics, February 2002.

The 20- year price trend for cotton and coffee has been downward, and the
trend for all three commodities has been downward over the last 6 years. The
volatility and negative trends in the prices of these commodities will make
it difficult for many countries to realize large increases in export revenue
growth. Zambia, for example, is heavily dependent on export earnings from
copper and other metals. The IMF anticipates the export growth rate for
Zambia to be 6.7 percent per year over the next 20 years. Historically,
however, Zambia?s growth rate has averaged 0.53 percent per

year over the last 20 years. Despite recognition of the volatility of
copper, the IMF anticipated optimistic export projections for Zambia- in
part due to the privatization of Zambia Consolidated Copper Mines, the
primary state- owned copper producer. However, the recent slump in copper
prices, coupled with the withdrawal of the primary foreign investor in this
operation, in January 2002, have adversely affected Zambia?s copper mining.
The long- term prospects for the copper industry in Zambia remain

uncertain. HIV/ AIDS Expected to

Development professionals and multilateral aid organizations widely Have a
Significant recognize that the HIV/ AIDS pandemic is a major threat to the
growth rates of many affected countries. The average global percentage among
adults Long- term Negative

aged 15- 49 living with HIV/ AIDS is 1. 07 percent. However, conditions
Impact

appear to be worsening in most of our case study countries. According to an
IMF report referring to research done in southern Africa, once the rate of
HIV prevalence exceeds 5 percent (as it has in 6 of our 10 case study

countries), it soars rapidly (see figure 5).

Figure 5: Adult Prevalence of HIV/ AIDS among Adults Aged 15- 49, 2000

22 Percentage

20 20.0

18 16 14

13.2 12

10.6 10

8.1 8.3 8

6.4 6

4 2.5

2.0 2

0.1 0.2

0 Benin

Bolivia Faso

Ethiopia Mali

Mozambique Nicaragua

Tanzania Uganda

Zambia Burkina Country

Global adult rate 1.07 percent

Source: UNAIDS.

The increasing prevalence of HIV/ AIDS raises several challenges for many
HIPC nations. According to the IMF and World Bank, HIV/ AIDS will have
substantial effects on a broad range of economic variables, including GDP

growth, poverty and income inequality, labor supply, domestic savings, and
productivity. AIDS primarily affects people in the most productive age group
(ages 15 to 49). On a household level, families may face a loss of income at
the same time other expenses, such as health care, are rising.

Producers? labor costs rise and productivity declines as a result of HIV/
AIDS. The disease is especially problematic for the agricultural and mining
sectors, which are critical for achieving export growth. On a national
scale, governments are forced to divert funds from economic growth
initiatives to cover dramatically rising health care costs and higher public
sector pension fund expenditures.

Comments from the Department of the

Appendi x V Treasury

Appendi x VI

GAO Contact and Staff Acknowledgments GAO Contact Thomas Melito (202) 512-
9601 Acknowledgments In addition to the individual named above, Anthony
Moran, Bruce Kutnick,

R. G. Steinman, Ming Chen, Jeffery Goebel, and Lynn Cothern made key
contributions to this report.

(320080)

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a

GAO United States General Accounting Office

Why GAO Did This Study

Under current debt relief efforts, the World Bank and International Monetary
Fund project that all countries will become debt sustainable (with a debt-
toexport ratio near or below 150 percent) in 20 years. However, GAO and
others have questioned whether current debt relief efforts will provide
sufficient relief. In July 2001, President Bush proposed that the World Bank
and other multilateral development banks replace up to 50 percent of future
lending to the world?s poorest countries with grants. This proposal was
motivated, in part, by concerns about poor countries? long- term debt
burdens. The World Bank has estimated that the cost of the 50- percent
grants proposal would reach $100 billion over the next 40 years. GAO (1)
assessed the effect of the loans- to- grants proposal on 10 poor countries'
ability to repay their debt, and (2) estimated the loss in revenue that the
World Bank would incur from the grants proposal.

April 2002 DEVELOPING COUNTRIES Switching Some Multilateral Loans to Grants
Lessens Poor Country Debt Burdens

This is a test for developing highlights for a GAO report. The full report,
including GAO's objectives, scope, methodology, and analysis is available at
www. gao. gov/ cgi- bin/ getrpt? GAO- 02- 593. For additional information
about the report, contact Joseph A. Christoff at (202) 512- 8979. To provide
comments on this test highlights, contact Keith Fultz (202- 512- 3200) or e-
mail HighlightsTest@ gao. gov.

Highlights of GAO- 02- 593, a report to the Ranking Minority Member of the
Senate Foreign Relations Committee and the Chairman of the House
Subcommittee on International Monetary Policy and Trade, Committee on
Financial Services. United States General Accounting Office

What GAO Found

A shift from loans to grants would lessen poor countries? debt burdens,
increasing their ability to repay future debt. The World Bank and
International Monetary Fund projections assume that poor countries? future
export growth rates will be approximately double historical rates. As a
result, they project that all 10 countries GAO analyzed will be debt
sustainable under current debt relief efforts (see column 2). GAO believes
such high export growth rates are unlikely due to these countries? reliance
on volatile primary commodities and the impact of HIV/ AIDS. Using
historical export growth rates, GAO found that, under the current debt
relief efforts, only 2 of the 10 countries it analyzed would be debt
sustainable over the next 20 years (see column 3). However, if grants were
to replace 50 percent of future multilateral loans, 4 of the 10 countries
analyzed would be debt sustainable for 20 years and 2 other countries would
be debt sustainable for most of the period (see column 4). GAO also found
that 50- percent grants would promote debt sustainability better than 100-
percent debt forgiveness of old multilateral debt (see column 5).

GAO estimates that the financial loss of the 50- percent grants proposal is
$15.6 billion in present value terms. The World Bank estimated the financial
loss of the proposal would reach $100 billion in nominal dollars over 40
years. However, the World Bank?s estimate does not include the impact of
inflation and the investment income that is expected to accrue over time.
Furthermore, GAO found that if donor contributions to the World Bank were to
increase by 1.6 percent a year, which is less than the expected rate of
inflation over the next 40 years, the World Bank could fully finance the 50-
percent grants proposal.

The Department of the Treasury agreed with the report?s findings. Projected
20- Year Debt- to- Export Ratios under Four Scenarios (percent)

Assuming historical export growth rates Country World Bank/IMF projections -
current debt relief efforts Current debt

relief efforts 50-percent grant proposal Full forgiveness of old

multilateral debt

Benin 59 168 99 142 Bolivia 153 668 393 649 Burki na-Faso 114 713 377 648
Ethiopia 79 572 328 502 Mali 101 62 42 44 Mozambique 48 153 78 140 Nicaragua
60 377 210 358 Tanzania 132 434 239 429 Uganda 32 339 125 324 Zambia 101 837
457 784

Average 88 432 235 402

Note: According to the World Bank and International Monetary Fund, countries
are projected to be debt sustainable if their debt- to- export ratio is near
or below 150 percent. The 10 countries chosen will receive about two- thirds
of debt relief under current efforts. G A O Accountability Integrity
Reliability

Highlights

Page i GAO- 02- 593 Developing Countries

Contents

Contents

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Appendix I

Appendix I Objectives, Scope, and Methodology

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Appendix I Objectives, Scope, and Methodology

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Appendix II

Appendix II Economic Assumptions Used to Analyze Debt Sustainability

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Appendix II Economic Assumptions Used to Analyze Debt Sustainability

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Appendix III

Appendix III Assumptions Used to Analyze the Financial Impact of the 50-
Percent Grants Proposal on the World Bank

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Appendix III Assumptions Used to Analyze the Financial Impact of the 50-
Percent Grants Proposal on the World Bank

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Appendix IV

Appendix IV Optimistic Export Growth Assumptions Underlie World Bank/ IMF
Debt Sustainability Analysis

Page 29 GAO- 02- 593 Developing Countries

Appendix IV Optimistic Export Growth Assumptions Underlie World Bank/ IMF
Debt Sustainability Analysis

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Appendix IV Optimistic Export Growth Assumptions Underlie World Bank/ IMF
Debt Sustainability Analysis

Page 31 GAO- 02- 593 Developing Countries

Appendix IV Optimistic Export Growth Assumptions Underlie World Bank/ IMF
Debt Sustainability Analysis

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Appendix IV Optimistic Export Growth Assumptions Underlie World Bank/ IMF
Debt Sustainability Analysis

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Appendix IV Optimistic Export Growth Assumptions Underlie World Bank/ IMF
Debt Sustainability Analysis

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Appendix V

Appendix V Comments from the Department of the Treasury

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Page 37 GAO-??-?? Document Name

Appendix VI

United States General Accounting Office Washington, D. C. 20548- 0001

Official Business Penalty for Private Use $300

Address Correction Requested Presorted Standard

Postage & Fees Paid GAO Permit No. GI00
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