Document Library

Debt Relief Effectiveness and Institution Building

Author: Andrea Presbitero
Date: 2009
Size: 31 pages (681 KB)

Access full text: available online

Summary

What effects have recent debt-relief programmes had? Does debt relief promote institutional change? This article from the Development Policy Review provides new evidence on debt-relief programmes in Heavily Indebted Poor Countries (HIPCs). It shows that debt relief is only weakly associated with subsequent improvements in economic performance and is correlated with increasing domestic debt. But donors are moving towards a more sensible allocation of debt forgiveness, rewarding countries that have better policies and institutions.

The debt crisis in HIPCs started in the 1970s with increasing bilateral loans, concessional lending and a lack of macroeconomic adjustments and structural reforms in poor countries. NGOs and some governments put pressure on multilateral institutions and Western donors to increase debt-relief efforts. The International Monetary Fund (IMF) and World Bank were initially reluctant, but in 1996 launched the HIPC Initiative. This was enhanced to provide faster debt relief to more countries, and donors made further pledges to cancel debt in 2005. Thanks to these efforts, ratios of external debt to GDP started to fall.

Apart from the decline in debt ratios, evidence on the effectiveness of debt relief in enhancing economic growth and reducing poverty is broadly inconclusive. This analysis provides evidence on the consequences of debt forgiveness in terms of macroeconomic indicators and institutional quality.

• Since the start of the HIPC Initiative, donors seem to target debt-relief efforts on countries with better institutions and policies, thus promoting institutional reforms. Debt-relief is providing the right incentives to limit the negative effects of aid dependence on the quality of institutions and efficiency of the public sector.  
• Results do not show any influence on increases in economic growth and investment once country-specific effects are taken into account. This could be because debt relief is concerned with a large share of debt which is not likely to be paid anyway. Debt-relief agreements do not free many resources for investment or change incentives for investors.  
• There is evidence of a shift from external to internal financing in HIPCs since the launch of the Initative. Rising domestic debt is an unintended consequence and undermines overall debt sustainability and pro-poor spending.

These findings raise concerns in relation to the overall effectiveness of recent debt-relief initiatives in achieving their targets.

• Advocates of debt relief assume that large external debts inhibit domestic and foreign investment and economic growth, leaving indebted countries in a poverty trap. This study does not find strong evidence that debt relief triggers investment and economic growth.
• The amount of resources freed by debt forgiveness is far less than that required for achieving the Millennium Development Goals. Expectations need to be scaled down to a more realistic level.
• More time might be needed to reap the benefits of debt forgiveness. If effectiveness depends on institutional improvements, current debt relief may achieve better results in the near future.

For author details, see utenti.dea.univpm.it/presbitero

Access full text: available online

Source: Presbitero A., 2009, 'Debt Relief Effectiveness and Institution Building', Development Policy Review, vol. 27, no. 5, 529-559
Author: Andrea Presbitero , a.presbitero[at]univpm.it