By Raquel Thompson
13 July [MEDIAGLOBAL]: The World Bank and International Monetary Fund (IMF) have introduced a tool to determine just how much debt low-income countries (LICs) can take on before they will likely face repayment problems. This decision comes more than two decades after Mexico announced that it could no longer meet payments on its foreign debt, ushering in the Latin American debt crisis of the 1980s.
Launched in 2005, the Debt Sustainability Framework (DSF) classifies the world’s 70+ LICs into one of three groups. Where countries fall on this three-tier ranking system is determined by the quality of their policies and institutions, as assessed by the World Bank.
Countries that receive a “strong policy” assessment are said to be able to sustainably carry up to 50 percent of their GDP in debt. Countries that receive “medium policy” and “weak policy” assessments can carry up to 40 and 30 percent of their GDP in debt, respectively.
While acknowledging the laudable attempt to prevent another destabilizing debt crisis from rocking the world, many critics have nonetheless expressed concerns that the DSF is presently hurting the low-income countries.
“The Debt Sustainability Framework had very good intentions,” Bernhard Gunter, an economist, explained during a seminar at the United Nations today. “And it is still a big step forward from previous situations, but the problem is it has constrained some of the low-income countries and it traps them in a low-debt/low-growth scenario. They would like to borrow more but they cannot.”
And in fact, many of these countries do have the capacity to carry more debt, according to Gunter, who was commissioned by the United Nations Development Program (UNDP) to investigate this very question.
“Our work shows that making progress in achieving the Millennium Development Goals is equally important to determine a country’s capacity to carry debt as the quality of policies and institutions,” he told MediaGlobal.
So, without incorporating social progress in its evaluations, the current Debt Sustainability Framework sets the debt thresholds for many countries artificially low, argued Gunter.
The rationale, which was supported in Gunter’s econometric work, is that MDGs are “like an asset.”
“For example, if you have two countries which are otherwise the same, but one country has all the children in school and the other one has only 50 percent of the children in school, you would assume that the country with universal primary education will have a higher capacity to carry debt because the country and the economy is more productive, more flexible, and therefore can adjust better to shocks—shocks like the one we are in now,” Gunter explained.
If the Debt Sustainability Framework incorporated social progress, as defined by achievement of the MDGs, in its evaluation of debt capacity, many LICs would immediately have more access to loans to finance urgent development needs, said Gunter.
Specifically, “All countries that are considered to have bad policies and institutions but make progress with achieving the MDGs…could take on more loans,” Gunter said.
Low-income countries are presently especially wary of the limits placed on their abilities to access loans, as they desperately try to cope with the recent food, fuel, and financial crises.
Their growth rates have plummeted from the sharp drop in exports and foreign direct investment. With that, tax revenues are shrinking, leaving LICs with even less money to address, among other things, the plight of the one million more people going hungry each day, according to the Food and Agriculture Organization.
And while “many industrialized countries have put in place countercyclical stimulus packages that seek to protect their populations…many developing countries have not been in the same position to do this,” said Paul Ladd of UNDP, who chaired today’s seminar.
This fact was not lost on the world’s largest economies when the Group of 20 met in April. The Communiqué from the London Summit called on the World Bank and IMF to “review the Debt Sustainability Framework, seeking ways to increase its flexibility,” said Leonardo Hernandez, another panelist at the seminar.
Hernandez, who serves as the Lead Economist in the World Bank’s Debt Department, said he plans on taking a closer look at Gunter’s work to see if it indeed presents a legitimate way to achieve this flexibility.
Gunter, for his part, remains convinced. “I have not really heard an argument why you should not take this on in your search for improving the DSF,” he said. “The statistical evidence is equally strong that social development increases the capacity to carry debt as it is equally strong for the CPIA [Country Policy and Institutional Assessment].”
Ultimately, “what is important is to have a framework that determines accurately which countries can take on more loans and which countries cannot,” Gunter told MediaGlobal. “The current debt sustainability framework focuses exclusively on the at least partly subjective evaluation by World Bank economists if a country has good or bad policies and institutions.”
On the other hand, determining to what extent countries have achieved the MDGs is more objectively measureable, he said.
