Debt and Development in Poor Countries: Rethinking Policy Responses

The poorest countries face enormous challenges to development, with economic issues still presenting some of the greatest obstacles. High on the current public policy agenda, including in the U.S. Congress, is financing increased debt relief for the poorest countries. Indebtedness is not a new issue. In the 1980s, Latin American middle income countries became severely indebted to private banks, causing a financial crisis with prolonged economic and social consequences. Today, the Heavily Indebted Poor Countries (HIPCs), mostly located in Sub-Saharan Africa, face worse economic prospects and relatively large debt burdens to official creditors. For most developing countries, debt is a marginal issue and not the primary obstacle to growth and development. For the HIPC countries, however, debt may be a drag on economic growth and so debt forgiveness may afford an opportunity to boost the development process. Total HIPC country external debt amounts to $206 billion and current HIPC proposals anticipate total debt reduction costs for all creditors in 1999 net present value terms to be $28.2 billion, not large amounts by developed country or global standards, but as yet mostly unfunded. A decision on financing HIPC debt relief falls to Congress. If debt reduction is desired, experience argues that it be comprehensive and timely, but probably not unconditional, which could be counterproductive if it is a replacement for, or diminishes incentives to effect, broader economic, political, and social reform. For debt relief to support growth and development, it is arguably best used if supported by a well-managed, long-term investment strategy that ensures clearly productive public and private use of debt. This point speaks to the larger issue of addressing the need for improved social, political, and economic institutions to encourage political participation and entrepreneurial activity that will help create an environment conducive for attracting foreign and domestic capital investment. For their part, developed countries and international financial institutions might consider how best to support developing country attempts to reform and adapt to changing international economic trends. Solutions that prolong debt relief may delay development; this has led to recent changes to the HIPC initiative intended to quicken and deepen debt reduction. Also, foreign aid can be helpful at the margin and may be used to help with immediate social needs, but cannot finance all long-term development needs. Other policy support, such as removing trade barriers to developing country goods, would strongly complement debt relief. Diminishing poverty in poor countries has become a major new emphasis of the HIPC debt reduction initiative, yet debt relief is no guarantee of success. Debt does not necessarily cause poverty, so more than debt reduction many be needed. Also, because financial resources are largely fungible within government budgets, debt relief cannot assure that social program spending will be given priority. In summary, given the myriad factors that must work together for development to take place, the benefit of debt relief may be limited unless it becomes part of broader program for social, political, and economic change.