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Evaluation of Canada’s International Debt Relief Initiatives

Internal Audit and Evaluation Department of Finance Canada

Approved by the Departmental
Audit and Evaluation Committee
on March 25, 2010

Executive Summary

Annex E: Management Response And Action Plan

Executive Summary

This report presents the results of the Evaluation of the Canada’s International Debt Relief Initiatives. International debt treatments were established in the 1950s as part of a coordinated international effort providing methods of repayment for heavily-indebted middle-income and lower-income countries. Canada has been an active participant in these efforts since inception. The scope of this evaluation covers the initiatives from 1996 onwards, when they were modified to focus on heavily indebted poor countries (HIPCs) and the process of debt relief, or systematic cancellation of the debt stock, was started for those HIPCs that qualified for the debt relief. The intent of this new program was to reduce the debt burden of the HIPCs, and enable them to implement programs directed towards growth, poverty reduction and other social measures. The Department of Finance represents Canada in the institutions responsible for developing and implementing debt-relief related policies and initiatives, such as the World Bank, the International Monetary Fund, the Paris Club and other regional financial institutions.

3. Background

The definition of debt relief in the literature is broad and refers to the partial or total cancellation of debt, including debt rescheduling, the slowing or stopping of the accumulation of the debt owed by developing countries to richer developed countries. However, it is important to note that prior to the 1996 initiatives, the primary focus of the debt-related initiatives was debt rescheduling, or changing the terms and conditions of the debts, for example, reducing interest rates or increasing the payment period with the aim of maximizing returns to the creditor nations. Since 1996, the main feature of the debt related initiatives established in this period has been to provide partial or complete cancellation of both the interest and principal. Much of the contention surrounding debt relief in the literature was directed towards the pre-1996 debt rescheduling offered repeatedly to these indebted countries. Debt rescheduling is often referred to as “traditional debt relief” in the World Bank literature.  For the sake of clarity, the definition of debt relief in this report refers to the partial or complete cancellation of debt stock.

To understand the recent origin of the debt relief initiatives, it is necessary to review the political, historical and international context that exacerbated the debt acquirements by the developing countries and the subsequent international efforts to address it. Annex A provides detailed information; however, a summary is presented below to provide the general context.

The debt crisis for developing countries was found to originate from both the demand side (debtor countries) as well as the supply side (creditor countries). The debt was first incurred by developing nations at a time of generally favourable conditions, for example, strong economic growth, low real interest rates and a depreciating United States (US) dollar. The practice of borrowing vast sums was encouraged by leading economists at the time (in support of import substitution industrialization), to enable investment in industry and infrastructure, through borrowing from creditor countries. Subsequently, however, a series of events occurred that significantly changed the relationship between the debtor and the creditor nations.

An increase in the money supply in the West during the 1970s (to offset the increasing unemployment rate), and an unexpected shock in the price of oil increased the costs of production and led to an inflationary spiral. Oil-rich countries deposited their newly acquired wealth with banks in the West, causing surplus liquidity in the banks. Consequently, international interest rates continued to be low and the banks lent out with a low risk-premium and high concentrations of loans in specific countries. Concurrently, large sums of money were loaned out to countries that would not normally be able to repay it. Developing nations also took advantage of the low interest rates and borrowed heavily.

Eventually, though, in order to control the increasing domestic inflation, the governments of the creditor banks implemented contractionary policies. As a result, the conditions of the lenders had now changed, with much higher real interest rates, a high US dollar and slow growth. With compounding interest, the debt service for some of the impoverished nations rapidly grew to double, or more, the original value of the loan and, for some of these countries, exceeded the value of their total exports (their income in foreign currency), considerably impeding or even preventing their ability to repay the interest payments. Adding to the problem was the decreased foreign currency income from the lower terms of trade and recessionary conditions in the West.  As a result, the nominal value of these debts increased so that many developing countries were required to spend more money on interest payments than on investments to benefit their own country and potentially lift their populations out of poverty.

The Mexico debt-crisis in 1982 was a signal that many developing countries would not be able to repay their entire debt burden. It was also recognized that any type of debt treatment would require a collaborative international effort in order to succeed. Therefore, through international institutions, such as the Paris Club, International Monetary Fund (IMF), World Bank (WB) and African Development Fund (AfDB), various debt treatments were established, including the HIPC debt relief initiatives with the intent to lessen the burden of debt payments for the debtor countries and better enable them to foster growth.

3.1 Canada’s Involvement in International Debt Relief

Canada’s involvement in the various debt initiatives goes back to 1956 with the establishment of the Paris Club, an informal group of official creditors whose role is to find coordinated and sustainable solutions to the payment difficulties experienced by debtor countries. Since then, Canada has been actively involved in discussions regarding the provision of debt treatment and debt sustainability policies within the context of various international organizations/institutions, including the Paris Club, Commonwealth of Nations, G7/G8 Summits, IMF and World Bank. To reach its objectives, Canada has been participating in the following interrelated initiatives:

• Bilateral Debt Treatments Through the Paris Club;
• The Heavily Indebted Poor Countries Initiative (HIPC);
• The Multilateral Debt Relief Initiative (MDRI); and,
• The Canadian Debt Initiative (CDI).

Bilateral Debt Treatments Through the Paris Club: Canada is one of the original members of the Paris Club (the Club has 19 permanent members, including Canada). Since its inception in 1956, Paris Club creditor countries have reached over 380 debt agreements with almost 80 debtor nations. Over the past two decades the total amount covered by these agreements has exceeded US$425 billion. Through the Paris Club, Canada has provided debt relief to countries that have demonstrated an unsustainable debt burden3 and have official bilateral debts owed to Canada. In total, Canada has provided debt treatment (including debt relief) to 48 countries - for many of these countries, on multiple occasions. Prior to 1996, the bilateral debt treatment was the primary vehicle through which debts were processed, with the rescheduling of the payments stretching out the time of maturity and reducing the debt service payments in most cases. Eventually, this method was recognized to be problematic, since many countries were still not able to pay their regular debt service payments. The Heavily Indebted Poor Countries Initiative (HIPC): Since rescheduling the debt did not seem to be fruitful, the HIPC Initiative was launched in 1996 by the IMF and the World Bank with the aim of comprehensively reducing the external debt burdens of the world’s poorest and most indebted countries. Comprehensive reduction involved engaging the international financial community, including multilateral organizations, commercial lenders and governments to work together to reduce the external debt burdens of the most heavily indebted poor countries4 to sustainable levels. The HIPC Initiative was enhanced in 1999, in order to provide faster, deeper and broader debt relief and to further strengthen the links between debt relief, poverty reduction, and social development. The HIPC initiatives involve participation from both the bilateral and multilateral debt relief processes. An illustration and detailed description of the HIPC process follows on the next page. The Canadian Debt Initiative (CDI): The Canadian Debt Initiative was established in 1999, under which Canada promised to cancel 100% of the debt it was owed by a number of countries once they completed the HIPC process. In 2000, the program was expanded to include all countries which completed the HIPC process. In 2001, Canada also put in place a moratorium on all debt payments from eligible HIPCs, including those in the interim period (this was only for debt incurred under bilateral agreements). In 2009, it was estimated that the total eventual cost of the CDI would be$1.3 billion.5 There are two steps involved in receiving debt relief under the Canadian Debt Initiative:

1. Once a CDI country demonstrates the ability to use resources effectively for poverty reduction and has fulfilled the first set of conditions in the HIPC process, it receives an immediate moratorium on debt payments.

2. Once the CDI eligible country completes the HIPC process, it receives 100% debt cancellation.

The Multilateral Debt Relief Initiative (MDRI): Between 1956 and 2005, multilateral organizations such as IMF and World Bank had priority with respect to debt payments.  Therefore debtor countries would pay these financial institutions first before any other bilateral payments. There was no question of cancellation of the payments required, because these institutions were always paid.

The Multilateral Debt Relief Initiative was established following the G8's Gleneagles Summit in 2005 as an extension of the HIPC Initiative. It was recognized that completion of the enhanced HIPC process was insufficient for substantially reducing the debt burdens. The next objective was to help accelerate progress toward the United Nations’ Millennium Development Goals.6 All countries that completed the HIPC process under the enhanced HIPC Initiative and those HIPCs with per capita annual income below US$380 and outstanding debt to the Fund at end of 2004 were considerable eligible for the MDRI. Under the MDRI, 100% relief has been provided on eligible multilateral debts resulting from loans held by the IMF, the World Bank and the African Development Fund (AfDB) and Inter-American Development Bank (IaDB). This is paid for by a pool of funding provided by donor countries, the majority of which are members of the G8. To date, at least 26 countries that have completed the HIPC process have benefited from the MDRI. There are still 14 countries remaining in the HIPC process that may benefit from this initiative. MDRI is expected to eliminate a total of US$50 billion in debts owed by the world’s poorest countries.7

Under the recently adopted Multilateral Debt Relief Initiative (MDRI), Canada has committed to make payments to the IMF, the World Bank and the African Development Fund over the next 45 years to compensate these institutions for cancelling debts owed to them by heavily-indebted poor countries. The payments are pooled with those of other creditors; therefore, tracking the impact of Canada’s individual contribution would not be possible.

Detailed Description of the HIPC Process:8

Phase 1 - Pre-decision point: A country can only be considered for HIPC assistance if it meets specific criteria, faces an unsustainable debt burden, has already implemented acceptable policies through IMF and World Bank, and has developed a plan to pull the country out of poverty. At this point, the Executive Boards of the IMF and World Bank (Canada is a member of these Boards), decide whether the country has sufficiently satisfied the conditions, and then the international community (countries supporting HIPC) commits to reducing the country’s debt. This is called the decision point.

Phase 2 - Interim Period: The country may immediately receive interim debt relief, but will only receive the full amount under the HIPC if it continues to fulfill further conditions of the IMF, and shows a track record of what is considered good performance. The Paris Club provides the interim relief, on a case-by-case basis, reducing debt payments after the country reaches its decision point. The Canadian Debt Initiative provides a moratorium on debt payments for countries at this stage. This will be followed by the provision of debt relief for the flow of debt payments that a country is required to make. The interim period could last for some time, possibly three or more years, depending upon when the key policy reforms identified in Phase 1 are implemented, including elements such as: maintaining macroeconomic stability and implementing an agreed-upon poverty reduction strategy plan for one year. At this point, the country would reach Completion Point.

Phase 3 - Completion Point: The lenders provide the full relief promised at the decision point. The Paris Club reduces the debt owed by up to 90% or more if required (on bilateral debt). The Canadian Debt Initiative provides 100% debt relief at this point (on bilateral debt). MDRI was established in 2005 and also provides 100% relief on debt stock owed by HIPCs at end-2004. Therefore, at this stage, the debt relief is provided to reduce the stock of debt owed by the country.

By March 31, 2008, Canada provided more that $965 million in debt relief under the HIPC Initiative. As of 2009, 35 out of the 41 HIPCs have reached the decision point. The total cost of HIPC initiative debt relief to creditors is estimated at US$74 billion in end-2008 Net Present Value (NPV) terms. Multilateral and Paris Club creditors bear the largest shares of the total cost of the Enhanced HIPC initiative. Amongst multilateral creditors, the World Bank, International Development Association (IDA), IMF and AfDB Group share the greatest cost. The cost to MDRI is estimated at US $29 billion in end-2008 NPV terms. About 85% of this has already been delivered to the 26 countries that have reached completion point. The committed assistance to the 35 post-decision point HIPCs totals 40% of the GDP of these countries. After full delivery of the debt relief, it is expected that the debt load of these 35 countries will reduce by 80%.9 The debtor and creditor entities and the types of international debt payment arrangements are fairly complex. Table 1 illustrates, for example, the types of sovereign debt that are treated in the Paris Club, London Club10 or in an “ad-hoc” manner. Table 1 Creditor and Debtor Categories and the Restructuring Forums Debtors Creditors IMF Multilateral development banks Bilateral agencies Commercial banks Bond investors Suppliers Sovereigns Preferential treatment Preferential treatment Paris Club London Club No Formal System Ad-hoc Public sector enterprise No such debt exists Special treatment Paris Club London Club No Formal System Ad-hoc Banks No such debt exists Special treatment No such debt exists Special treatment No Formal System No such debt exists Private Companies No such debt exists National corporate bankruptcy regime National corporate bankruptcy regime National corporate bankruptcy regime National corporate bankruptcy regime National corporate bankruptcy regime Source: Rieffel, 2003 3.2. Debt Relief Structure and Partners The structure of debt relief in Canada is complex and requires interaction and communication amongst several players: the Paris Club, IMF, World Bank, African Development Bank, other regional banks, the Department of Finance, Canadian International Development Agency (CIDA), Department of Foreign Affairs and International Trade (DFAIT), Export Development Canada (EDC), Canadian Wheat Board (CWB) and some non-governmental organizations (NGO), such as the North-South Institute. In most cases, the IMF and World Bank, based on information gathered about the debtor country, decide whether or not a specific country should receive debt relief and the terms and conditions under which the relief would be granted. Canada, through its representatives at the IMF, World Bank and Paris Club, takes part in these negotiations and provides its input on the issues discussed at these institutions. Once overall agreements are reached and decisions are finalized, they are passed on to the creditor agencies within Canada, primarily the Canadian Wheat Board and Export Development Canada. CIDA has also been involved in older loans classified under Official Development Assistance (ODA). Within the context of those overall agreements, the officials from these agencies negotiate the terms of the debt relief with the debtor countries. See Annex B for a brief description of the roles and responsibilities of different Canadian players in the provision of debt relief. 3.3 Funding Structure and Amount At the Department of Finance, the debt relief payments consist of compensation payments for bilateral debt relief, and the share of costs incurred for MDRI. Both are categorized as “Grants and Contributions”, and are listed as part of Vote 5 in the Main Estimates.11 The compensation payments for bilateral debt relief may vary considerably from year to year, since in any given year, the full amount may not be disbursed to the debtor countries. For example, a country that is going through the enhanced HIPC process and is anticipated to reach the completion point in a certain year may experience some delays, and therefore, may not be qualified to receive debt relief in that particular year. Furthermore, the agreements between Canada and the IMF establish the amount that Canada will make available for debt relief. Accordingly, each year, the IMF provides an estimate of the expected share of Canadian lending. The actual amount lent will vary due to changes in exchange rates, fluctuations in demand by borrowers, and planning decisions between the IMF and other lenders. For the multilateral debt relief, the payments for compensation are based on a contractual agreement over a period of several years and are not linked to the performance of any one country. As a result, there is more certainty in the exact amount of funding required by the Department each year. The amount allocated for the debt relief (combined bilateral and multilateral programs) in the 2008-09 Main Estimates is$370 million. This amount for 2009-10 is $199 million. Information on debt relief provided by Canada for bilateral agreements and multilateral payments are given below in Table 2 and 3.12 Table 2 Canadian Bilateral Debt Relief January 1, 2000 – December 31, 2007 (Thousands of Dollars) Country 2000 2001 2002 2003 2004 2005 2006 2007 Total Total for HIPC Benin 211 191 402 402 Bolivia 1,417 9,650 11,067 11,067 Cameroon 266 2,776 121,920 21,285 46,418 29,345 226,729 448,738 448,738 Congo 25,135 2,378 870 28,383 28,383 DRC 74,465 2,075 1,509 1,032 79,080 79,080 Ethiopia 31 17 13 385 447 447 Ghana 5,225 5,609 8,280 19,113 19,113 Guyana 1,113 66 44 1,872 3,095 3,095 Haiti 152 152 Honduras 3,447 1,800 20,931 26,178 26,178 Iraq 427,948 427,948 Ivory Coast 116,491 12,011 128,503 128,503 Madagascar 2,967 4,725 4,107 2,406 21,471 35,676 35,676 Poland 169,652 105,208 81,326 63,638 65,669 70,236 54,912 610,640 Rwanda 265 732 437 66 53 3,084 4,637 4,637 Senegal 445 691 289 3,968 5,392 5,392 Tanzania 8,110 59,033 137 12,842 80,122 80,122 Yugoslavia 158,356 47,272 205,628 Zambia 7,090 9,917 10,708 11,713 11,743 43,022 94,192 94,192 Total 18,696 258,723 529,777 222,069 159,903 616,642 347,648 55,933 2,209,391 965,024 Table 3 Canadian Multilateral Debt Relief January 1, 2006 – December 31, 2009 (Thousands of Dollars) Institution 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010p IMF 0 0 0 0 0 0 16,600 0 0 0 0 AfDF 0 0 0 0 0 0 10,400 6,900 107,900 0 IDA 0 0 0 0 0 0 0 15,400 20,500 41,400 51,200 Total 0 0 0 0 0 0 16,600 25,800 27,400 149,300 51,200 Cumulative nominal Total 270,300 Source: International Trade and Development Division, International Trade and Policy Branch, Finance Canada. 4. Evaluation Approach and Methodology As stated earlier, the purpose of this evaluation study is to assess the relevance and performance of Canada’s participation in the International Debt Relief Initiatives for which the Department of Finance is responsible. Debt Relief Initiatives (both bilateral and multilateral) are pursued in cooperation with international organizations. As with most programs that have an international scope, Canada is only one player amongst many, albeit an influential one.13 The evaluation study assesses Canada’s participation in the debt relief initiatives. Canada participates in the policy-making and program implementation decisions at the IMF and World Bank that results in Canadian funds being transferred in compliance with those policies. Therefore, for the sake of transparency, the relevance and performance of the initiatives as a whole have been assessed; however the focus of the proposed recommendations is on activities for which the Department of Finance is directly responsible. To answer the evaluation questions four lines of evidence were employed: key informant interviews; a review of existing IMF/World Bank Audit, Evaluation and Monitoring Studies; a third party literature review; and a review of internal documents and reports. The literature review, including the third party document review was primarily conducted by external consultants, while the review of implementation documentation and the key informant interviews were conducted by the Finance evaluation team. The final evaluation report was also prepared in-house by Finance evaluation analysts. 4.1 Existing IMF/World Bank Audit andEvaluation Studies The IMF and World Bank are responsible for monitoring, assessing and reporting on the performance of the Debt Relief Initiatives. Evaluation studies are carried out on a regular basis by the evaluation divisions of the World Bank and the IMF. These evaluation reports provide an in-depth look at the impact of the initiatives on a country-by-country basis, and are consequently detailed and informative. The IMF and the World Bank evaluation divisions report directly to the Executive Committee of each institution and are therefore considered to be independent. It should also be noted that a majority of the staff in the evaluation division of the IMF are recruited from outside of the IMF.14 In addition, the IMF and World Bank produce an annual monitoring report entitled “The Status of Implementation Report.” These documents contain detailed reporting on the progress of the initiatives and some discussion of the growth patterns of developing countries. The information collected through the Status of Implementation reports and IMF/World Bank evaluation studies were used to inform the evaluation questions in this study.15 4.2 Third Party Literature Review Finance evaluators conducted a detailed literature review of “third party studies” by academics and/or NGOs who are not affiliated to any of the participating governments or international institutions. The objective of this literature review was to collect background and performance information on the debt relief initiatives from a range of perspectives. Several research methods were employed to identify these studies. They included an Internet search as well as a search of several electronic catalogues/databases available at the Department of Finance library. These were supplemented by use of a “snowball” method, whereby the cited references in relevant books and articles were scanned to identify other relevant studies. Although a third party study on the Canadian initiatives was not found, 26 studies on the debt relief initiatives as a whole were available for review. Eighteen of these studies addressed issues related to either relevance or performance or both and were incorporated into this evaluation. 4.3 Key Informant Interviews A total of 13 knowledgeable experts were interviewed to obtain detailed information, on the implementation, performance and impact of the debt relief related initiatives. The information collected served to fill in gaps as well as to complement and substantiate findings determined through other methods. The interviewees were selected in order to obtain the maximum information possible from the different perspectives on this topic: Table 4 Evaluation Interviews Category Number Government of Canada representatives, including officials from the Department of Finance and CIDA 4 Representatives from the Canadian Wheat Board and Export Development Canada 3 Representatives from the World Bank and IMF 2 Non-government organizations 2 Established academic experts in debt relief 2 4.4 File and Internal Documents Review This line of evidence included reviews of Treasury Board Submissions, memoranda to senior management and other correspondence, as well as financial transaction records. The Department of Finance Reports on Planning and Priorities (RPPs), the Departmental Performance Reports (DPRs) and the Bretton Woods reports submitted to Parliament were also reviewed. 5.Evaluation Questions/Issues The evaluation questions are based on the requirements of the Treasury Board 2009 Evaluation Policy, and address, in some detail, the issues of relevance and performance. The chart below lists the lines of evidence that were used to address each evaluation issue—the chart clearly illustrates how the evaluation incorporates the results of more than one line of evidence for each issue. Table 5 Evaluation Matrix Evaluation Question Source IMF & World Bank Literature Review Third Party Literature Review Interviews File and Internal Document Review Relevance Issue # 1(a): What is the theoretical and strategic basis for the provision of debt relief? X X X X Issue # 1(b): Are the mandate and strategic objectives of Canada’s participation in the debt relief initiatives still relevant? X X X X Issue # 1(c): Is there still a need to compensate Canadian agencies (i.e., EDC and CWB) for provision of debt relief services? X X Alignment With Government Priorities Issue # 2: Is Canada’s participation in the debt relief initiatives still consistent with Government priorities? X X Issue # 3: Is Canada’s participation in the debt relief initiatives still consistent with federal roles and responsibilities? X X Performance: Achievement of Expected Outcomes Issue # 4(a): Are the debt relief initiatives achieving their objectives? X X X Issue #4(b) Has the provision of debt relief improved economic and financial conditions of recipient countries? X X X Performance: Program Design, Delivery and Improvement Issue #4(c): Have the initiatives been implemented according to their original design? X X Issue #4(d): Are there design or implementation problems that may hinder Canada’s ability to achieve its debt relief objectives? X X Performance: Efficiency and Economy Issue # 5(a) Do the benefits of debt relief outweigh the costs? X X X Issue #5(b): Is the funding structure of the debt relief the most appropriate mechanism for achieving its objectives? X X X = Lines of evidence used 6. Limitations of the Study As with most evaluation studies there are limitations to this study due to resource and time constraints. However, they are expected to have a minimal impact on the conclusions and recommendations of this evaluation. The evaluation information extracted from the international reports is based on non-direct, non-experimental analysis. The impact analysis that has been conducted has been primarily a “before” and “after” study of the program within the same country since meaningful benchmarking or finding adequately comparable countries is difficult. Due to the nature of the analysis (comparative analysis of nations), this limitation could not be rectified without considerable expense in terms of time and resources.16 A few external studies do attempt to isolate the program impacts and these are included in the literature review. The majority of the evaluation reports in the literature review are prepared by entities that are affiliated with either the World Bank or the IMF. Although they are considered independent organizations, still and perhaps because of their affiliations, they may be perceived as somewhat biased. It should be noted again, however, that the IMF Evaluation Group hires the majority of its staff from external sources. Both the IMF and World Bank Evaluation Groups report directly to their Executive Board. The small number of the interviewees could be considered a limitation as well. However, very few independent experts were found who were familiar with the details of the functioning and operation of the Canadian Initiatives as well as the performance of the Department of Finance in this regard. In the end, we were satisfied that the interviews with NGOs and other experts were structured to cover all the key concerns regarding this program, including the various viewpoints. The information gathered as a result of these interviews has been complemented and supported by the third-party literature reviews. 7. Evaluation Results This section triangulates the evidence obtained from the various lines of evidence on the relevance and performance of the Canadian Debt Relief Initiatives used to formulate the conclusions and recommendations. 7.1Relevance Key Findings 1(a): What is the theoretical and strategic basis for the provision of debt relief? The primary basis is the debt overhang theory, or the theory that the level of debt stock was so high for some HIPCs that repayment in the future was unlikely because of the financial, economic and political situation of the country. This situation would reduce substantially the potential for funds from new investors and hence hinder the growth of the debtor country. The majority of the interviewees and much of the literature concurred that the basic premise of this theory was valid, particularly in the case of the HIPCs. 1(b): Are the mandate and strategic objectives of Canada’s participation in the debt relief initiatives still relevant? Evidence from all sources indicated that the mandate and strategic objectives of Canada’s participation continue to be relevant. For example, there are still 14 countries remaining in the HIPC process that have not proceeded to the completion point. In addition, with the current global financial situation, there may be more countries that fall into financial difficulties and require debt cancellation. Our overall conclusion is that Canada should continue participating in the bilateral and multilateral International Debt Relief Initiatives. 1(c): Is there still a need to compensate Canadian agencies (i.e., EDC and CWB) for provision of debt relief services? Some of the interviewees questioned the need to continue making such payments to EDC, given its current strong financial situation, and the political/economic situation of several of the remaining debtor countries. Many of these countries are recognized to be in a weak political and economic state, and are not expected to stabilize soon. Our review of the internal documents indicate that their penalties and arrears would continue to accumulate with interest which, based on the existing arrangement, would then continue to be paid by the Government of Canada to EDC. If this pattern of increasing accumulation persists, it is reasonable to conclude that the current arrangement would be difficult to sustain over time. As such, the evaluation is recommending a re-examination of this arrangement. Recommendation 1: The Department of Finance should consider discussing this arrangement with EDC to re-examine the need for compensating EDC for losses incurred through debt relief. The stated objective of the debt relief initiatives (both bilateral and multilateral initiatives) is “to reduce the debt burden on heavily indebted countries so that they can pursue policies of growth and development.”17Overall, the evidence indicates that the mandate and strategic objectives of Canada’s participation in the debt relief initiatives were relevant to start and are still relevant today. The general consensus is that there is still a need for a full debt relief program and there is still a role for Canada with respect to debt relief. A few informants pointed out that as there is no international bankruptcy court for national governments, the Paris Club and HIPC initiatives are performing that function. The argument is that there would always be a need for programs and an international forum such as this for settling differences and mitigating problems related to debt relief. The number of countries requesting and qualifying for debt relief is now decreasing. Consequently, the mandates of these programs will be modified to focus more on debt management as opposed to debt relief. Theoretical and Strategic Basis The driving theory behind the provision of debt relief is the debt overhang hypothesis that refers to “a situation where the debt stock of a country exceeds the country's future capacity to repay it.”18 This was the case for many HIPC countries who found themselves unable to pay the debt stock, and in many cases, the debt service payments, simply because of the financial and/or political circumstances of the country. In this situation potential investors became wary of providing new financial resources to these countries which, in turn, limited the countries’ abilities to spend on education, health, and infrastructure and had resulted in putting them in even worse economic shape. Cancellation of the debt stock was meant to free up resources and create additional fiscal space which recipient countries could use for development purposes rather than for making interest payments to wealthier nations. It is important to note that recipient countries have been required, in return, to implement programs and policies considered beneficial for development purposes. In countries where debt service payments were being made, high interest payments would also tend to “crowd out” the potential expenditures that could be better spent on development. The debt relief or cancellation of the debt stock creates additional fiscal space so that countries can use their funds for development purposes. The majority of the expert interviews concurred with the basic premise of the theory, particularly those associated with the program itself, and the government documents and the literature reviews were also found to be supportive. As mentioned above, for the HIPC debt relief initiatives, a number of IMF conditions must be met by the debtor country, primarily related to implementing macroeconomic, structural and social programs and preparing poverty reduction strategies. This in turn may help to establish conditions for long-term growth. Some interviewees, however, have stated that the conditions in place are too many and often not relevant to growth. Summarizing the results from the interviews and the literature review, the fiscal space that is created by the debt relief for the debtor country encompasses two components. The first is the reduced debt service payments required for the debtor country, which frees up sums that could be directed to social and economic programs. If the country is not making the debt service payments, because of an inability to do so, the debt relief would not be of any immediate financial benefit. Secondly, debt cancellation rather than debt rescheduling, reduces the debt stock of the country, as well as the debt service payments. This would allow the country to be considered for credit on the regular market, a desirable outcome, which may not have been possible before because of the debt overhang. The 2006 World Bank Evaluation Report found that in some cases debt relief may replace existing financial grants from other international programs, such as International Development Association (IDA). It is generally agreed that the benefit of debt relief can only be realized if the debt relief is granted in addition to other financial grants for development programs. Both the interviewees and third-party literature expressed concern about this issue and maintaining the continuity of debt relief and development programs in light of the current global economic downturn. Relevance of the Mandate and Strategic Objectives The severity of the debt problem for developing nations has been outlined in several third-party, IMF and World Bank documents as well as in the Government of Canada parliamentary document, the Report on Bretton Woods and Related Agreements Act. The increasing debt burden leading up to the crisis in the 1980s (for the most part) had become overwhelming for many impoverished nations, with debt payments often exceeding the total income generated by foreign exports. For the group of countries classified by the World Bank as low income19 outstanding debts had been estimated by external sources to have risen 430% since 198020 and by 2005, it had amounted to US$523 billion. Debt owed to multilateral institutions was estimated to have increased even faster, by 793% to US$154 billion. Debt payments (net present value) to annual export revenue ratios exceeded 150% for those countries that expected to qualify for HIPC consideration.21 By 2003, 41 countries were expected to qualify as HIPC participants. These countries accounted for 14% of developing countries, and for 5% of the developing world’s Gross National Income. 22 By 2009, twenty-six countries had reached their completion point in the HIPC process, which means that they satisfied all of the IMF conditions on social programs and governance. These countries then obtained a total irrevocable debt relief amount of close to US$39 billion.23 In October 2009, sixteen countries out of the 41 eligible HIPC countries continue to have remaining debts.24

Considering the gravity of the debt situation, the majority of the interviewees agreed that it seemed appropriate that the debt be reduced or eliminated, particularly given that much of the debt originated to pay for Western capital goods and services in order to facilitate developmental needs for the poorer nations. The evidence for justifying the continued relevance of this program was also found in published evaluation and monitoring reports of the IMF and World Bank. Although some HIPC countries have successfully completed the program and are improving their prospects, there are many others that have not yet reached completion point. In particular, there are still 14 countries that are heavily indebted and have yet to receive full debt relief.

Key informants and some of the third-party literature noted that there is a substantial risk that some of the HIPC countries that are emerging from the "impoverished nation" status may, once again, fall back into large debts. With the current global financial crisis, there is recognition by some that HIPC countries that have reached completion point may find themselves with high levels of debt yet again. Accordingly, as the external environment changes (i.e., economic recession, emerging creditors), the program may need to be modified; however, the need for debt relief still exists.

The main concern expressed is that once the individual debtor country has been relieved of its debt and it regains its credit worthiness, it may yet again amass an unsustainable level of debt this time, by borrowing from countries or private creditors that have no incentive to follow the HIPC policies. This could initiate a debt relief and debt compounding cycle that may be difficult and expensive to end.

Since debt relief is an international commitment made by the Government within the context of the G8 summits and other international fora, many interviewees consider it an obligation which would last for the next 50 years. For many of these interviewees, the main question was not whether Canada should participate in the program, but rather how Canada could use its position and influence on the world stage to coordinate international efforts for convincing non-Paris Club creditor countries to provide debt relief. All informants have underlined the importance of Canada's approach, its active participation in international debt relief, and its active encouragement of the more reluctant members of the IMF, World Bank and G8 to do the same.

Accordingly, the relevance of Canada continuing the debt relief seems well-supported by the evidence. The shift in focus for future efforts towards ensuring that new unsustainable debt is not accumulated again appears to be justified as well.

Compensation to EDC and CWB

Interviews with representatives from Finance Canada, CWB and EDC were conducted regarding this issue. In addition, a 2007 review of the transfers of the funds was examined as well as several other internal documents. In general, the transfers of funds and processes were found to be timely and accurate, both by the review as well as the interviews.

However, some of the interviewees questioned the continued relevance of the Government of Canada’s ongoing payments to EDC in compensation for the loss that it incurred as a result of Canada’s participation in the debt relief initiatives. Several reasons were given in support of this argument.

The Government originally agreed to compensate EDC on its loss (both interest and principal), as it was unsure at the time as to whether EDC would be able to acquire the capital base necessary to fulfill its mandate. Now, EDC generates substantial annual net incomes, with a significant profit margin, independently of the compensation payments

Furthermore, based on the existing arrangement, as the developing countries delay in completing the HIPC initiative, the Government’s compensation payments to EDC also increase over time, as the amount legally-owed to EDC continues to increase with the accumulation of late interest charges. Considering the fact that many of the remaining countries are in a weak political and economic state and that their situations are not expected to improve in the near future, this would mean that the Government of Canada would be obliged to compensate EDC for progressively larger and larger accumulated sums. An example of this is the case of Côte d’Ivoire; its delay in graduating from the HIPC Initiative is expected to increase the Department of Finance (Government of Canada)’s compensation payments to EDC by millions of dollars. On March 1, 2007, the total amount (debt stock, including arrears and late interests) that was owed by Côte d’Ivoire to EDC was US$146.4 million. By January 1, 2009, the amount of this debt had increased to US$166.2 million through penalties and interest payments.25

Some of the interviewees pointed out that the debt legally-owed by HIPCs to EDC has decreased from C$1.1 billion in March 1999 to C$247.7 million by 2008. This has made EDC considerably less exposed to default risk than before. Numerous private sector financial institutions with exposure to highly indebted countries have agreed to abide by the debt relief terms included in Paris Club agreements and absorb the cost of these debts within their corporations. Consequently, EDC will be one of the few remaining creditors to receive full repayment, including post-maturity interest, on the loans it provided to these countries prior to March 2001.

As a Crown Corporation, EDC is required to make dividend payments to the Government of Canada whenever its capital exceeds its forecasted needs. During the past few years EDC has become profitable, and as such, it has been paying the Government of Canada dividends equal and sometimes exceeding the compensation amounts given to EDC.  It has been argued that this by itself could signify that compensation to EDC may no longer be necessary.

The number of countries involved in the HIPC process owing debts to CWB has decreased significantly, so the concern may be similar but is not considered as significant. In addition, the structure of the compensation to CWB is not the same as EDC; for example, CWB is not obliged to return the payments to the Government of Canada if it becomes profitable.

Considering all of this evidence, the evaluation proposes a re-examination of the existing compensation arrangement between Finance and EDC.

Recommendation 1:  The Department of Finance should consider discussing this arrangement with EDC to re-examine the need for compensating EDC for losses incurred through debt relief.

7.2 Alignment with Government Priorities

Key Findings

2. Is the transfer program consistent with Government priorities?

The evaluation found the Debt Relief Initiatives to be consistent with Government Priorities. In particular, it is in line with the Priority 4, listed as Effective International Presence, in the Department of Finance’s Report on Plans and Priorities.

3. Is it consistent with federal roles and responsibilities?

Debt relief requires international collaboration of creditor and debtor countries. This is a government to government affair, which falls under the federal government’s jurisdiction.

Consistency with Government Priorities and Federal Roles and Responsibilities

The Debt Relief Initiatives were found to be consistent with federal government priorities as they are stated in official government publications, budget documents and documents related to Canada’s global obligations. For example, the Department of Finance’s Report on Plans and Priorities lists Effective International Presence as Priority 4. In much of the literature and all of the interviews, debt relief has been argued to help promote development targeting the reduction of global poverty. Some interviewees suggested that debt relief is an international commitment made by the federal government that will be carried out over the next 50 years. Canada is fulfilling its international obligations with the G8, IMF and World Bank.

Debt relief requires international collaboration of creditor and debtor countries. As such, it is a government to government affair. Although other levels of government can contribute to these efforts, it is ultimately the responsibility of the federal government to lead this type of initiative in Canada. Considering the clarity of these jurisdictional divisions, the evaluation did not find any duplication of efforts in this area between the federal government and any other levels of government.

The G8 countries are leading the largest international collaboration on debt relief in history. Some informants stated that this program is in line with Canada's international reputation as an active participant for establishing ethically, morally based policies. Informants and literature reviews demonstrated that debt relief is considered an effective aid transfer. Accordingly, no other levels of government or institution are as well placed to play this role as the federal government.

Some informants and third-party studies noted that since the world is globally more interconnected, the impacts of mass poverty and despair on other continents can come to Canadian borders in the form of illegal activities, such as drug trafficking, terrorist activities, economic refugees and so forth. It is argued that the federal government’s involvement in the debt relief can provide some assistance to improve conditions in these impoverished nations and reduce that probability.

Some of the interviewees also pointed out that the socio-economic plans for improving the debtor country's situation sometimes require addressing mundane, but necessary needs, such as funding electricity for hospitals, rather than high profile assistance, such as providing vaccinations for polio. It has been argued that the private donors, for various reasons, would prefer to get involved in the high profile activities. Federal governments’ involvement would better ensure that these so-called “mundane” needs were addressed as well.

Potential Alternatives and Complementary Measures

All evidence seems to suggest that the existing initiatives are a reasonable approach. There does not seem to be any viable and widely accepted alternative to the existing debt relief programs.

One complementary mechanism suggested was the Debt Reduction Facility at the World Bank.26 Private creditors would sometimes sell HIPC sovereign debt for cents on the dollar in the secondary market in order to generate some liquidity. The Facility gives grants to eligible governments to buy up their sovereign debts on the secondary market.  In the interviews, it was noted that Canada and other developed nations could also buy up the debt of highly indebted countries and then give them back to the debtor countries conditional on establishing specific development projects. There was some concern that this approach was not often used and would not be favoured by some policy makers, since there may be a perception that the government is rewarding private creditors with tax-payers funds. Although this could be one interpretation, by returning the sovereign debt to the original debtor country, the government would be able to reduce the proportion of commercial debts (high-interest debts) owed by these poor nations. This method would also reduce the possibility of vulture funds, which have the potential to be very expensive to creditors. Vulture funds are private creditors who purchase the poor country’s debt in the secondary market, just as described above, but then initiate a lawsuit against the poor country to force it to pay the full debt amount, with penalties and arrears. Canada, with the World Bank and IMF have provided financial support to developing countries with respect to this type of litigation, and are also convincing private creditors and other sovereigns to support the HIPC process.

Alternatives to debt relief such as debt swaps have also been mentioned, however they did not receive good reviews by most of the interviewees or by the literature, as they seem to be much more complex in design and more difficult to implement. We have been unable to locate sufficient literature on the full impact of debt swaps that have been carried out in the past—and as they often involve trading off the debtor country’s utilities or infrastructure for the debt, the potential impact of the “swap”, should be well understood before considering this as a serious alternative.

Program Focus

Both the interviews and the literature reviewed generally agreed that the issues of debt relief are also complicated by subsequent debt management issues. Research into this has been initiated by international institutions to better understand the negative outcomes of the HIPC initiatives, including the fact that some countries have used the additional fiscal space to incur further and deeper debt with private creditors, many of which do not offer concessional loans. The situation is further complicated by some non-member countries that do not abide by the debt sustainability framework, incorporated into the Paris Club rules, and are willing to lend recklessly to HIPC countries, pushing them back to dangerous levels of debt. Because of this concern, and since there are fewer and fewer countries with heavy debt burdens, there has been a shift in focus internationally from the provision of debt relief to debt management programs and consequently, there is a shift in focus at Finance Canada as well.

There have been instances of “Odious Loans” (defined as those that are given to governments that implement policies harmful to their own people, for example, for civil war campaigns and general oppression) that have been provided to HIPC countries.  Research into identifying characteristics of odious loans is being conducted by international organizations, including the World Bank and NGOs.

7.3Performance:  Achievement of Expected Outcomes

The original stated objective of debt relief has been described in many documents, but is most clearly enunciated in a World Bank report entitled “Debt Relief for the Poorest:  An Evaluation Update of the HIPC Initiative”.27 The objective is to reduce the debt burden of relatively poor countries, so that their governments can pursue policies of economic growth and development. The original objective was to reduce the debt owed by the HIPCs; however, the objective was expanded in 1999 to include economic development, growth, poverty reduction and a permanent exit from debt rescheduling.

Since 1999, the IMF imposed conditions prior to the provision of the debt relief have included the preparation by the debtor countries of detailed plans outlining their respective social and health program improvements as well as poverty reduction mechanisms. It should be noted, however, that the evaluators were not able to find a direct causal link between debt relief and debt reduction and improvement in social outcomes, including poverty reduction.

Key Findings

4(a and b) Are the debt relief initiatives achieving their objectives? Has the provision of debt relief improved economic and financial conditions of the recipient countries?

Objective 1: The debt burden of the debtor countries will be reduced.

The evidence suggests that substantial progress has been made towards this goal. Twenty-six out of 41 eligible countries have reached completion point and have received irrevocable debt relief under HIPC and MDRI. In the short term, the primary goal of reducing debt owed by HIPC countries has been achieved for countries that have reached completion point and for some that are in the interim stage. Whether the reduced debt burden is sustainable in the long-run has been debated at length in the literature and among the interviewees.

Expanded Objective 2: Policies of economic development and growth will be implemented in the debtor countries.

Policies of economic development have been implemented in the debtor countries, many of these policies are necessary conditions that HIPCs must satisfy prior to receiving debt relief. It was noted that Poverty Reduction Strategy Papers (PRSP) developed under the supervision of the IMF and World Bank representatives for the HIPC process often do not consider the pre-existing social and economic plans in the debtor country. This could lead to inefficient solutions for the debtor government. Evidence from the literature review and key informants also suggest that too many conditions are placed on some of these countries, impairing their ability to achieve full debt relief.

Recommendation 2: Finance should advocate the importance of incorporating the existing economic and development plans of the debtor governments into the economic and financial conditions required by the HIPC agreements.

Expanded Objective 3:  Spending on education and poverty reduction measures will increase after receiving debt relief.

In the post-decision point HIPCs, there is some evidence that spending on poverty-reducing measures and social programs, such as education and health have increased over time in the post-decision point HIPCs. It is not clear whether the spending for these countries is any greater than it would have been without the HIPC measures. There is little evidence to indicate that the increased social expenditures have led to direct improvements in education, health, increases in school enrolment rates or decreases in mortality rates.

Expanded Objective 4: Increased growth, measured through a rise in GDP, and other indicators will begin to be evident.

HIPCs have experienced some growth post completion point. Countries with more stable governments have often exhibited some improved growth. However, it is difficult to determine whether the increased growth is due to the debt relief programs or favourable political conditions within the debtor countries. It is also not clear whether the policy conditions of reducing poverty and improving education have led to improvements in growth and development.

The evidence suggests that substantial progress has been made towards the primary goal, (objective 1). Twenty-six out of 41 eligible countries have reached completion point and have received irrevocable debt relief under HIPC and MDRI. Thirty-five out of the 41 have reached the decision point and qualified for HIPC Initiative Assistance. The remaining countries are, in general, making progress. Some countries that have not made substantial progress generally have significant obstacles (primarily related to security or political reasons) that have prevented their progression. Therefore, in the short term, the primary goal of reducing debt owed by HIPC countries has been achieved for countries that have reached the completion point and by some that are in the interim stage. This has reduced the financial burden on these countries and increased their overall fiscal space. Whether the reduced debt burden is sustainable in the long-run has been debated at length in the literature and by the interviewees. This issue is, in fact, the primary criticism of the debt relief programs, as many countries have borrowed again heavily from non-HIPC countries. To address this rising problem, the World Bank has initiated programs for debt management and debt sustainability. Finance Canada is also involved in these programs.

Debt Reduction

The objective of debt reduction appears to have been achieved in the short run, though this may not persist in the long run.28 By June 2009, the Enhanced HIPC Initiative and the MDRI reduced US$29 billion of debt in 26 countries.29 The 2009 World Bank series of reports reveals that debt stock for those countries reaching completion point has dropped from US$138 billion at the end-2008 NPV to US24 billion. Status of Implementation and Evaluation Reports reveal that for the 35 HIPCs that have reached the decision point by 2008, debt service was reduced from 16.6% of exports in 2000 to 4.1% in 2008. From 1999 to 2008, for the 35 countries that passed the decision point, and qualified for debt relief, average debt service payments were reduced from 4.6% of GDP to 1.1% of GDP, which is by about 3.5 percentage points. Figure 2, taken from the 2009 IMF Status of Implementation Report, illustrates the drop in external debt stock for the HIPCs at the different stages of the regime. It should be noted that this table does not indicate the levels of domestic debt for the country. Source: IMF Status of Implementation Report 2009 Figures 3a and 3b show the debt service payments of countries that have had or still have bilateral debt with Canada. Debt as a percentage of GDP has declined over time for those countries that passed the decision point. Most of the interviews and evaluation findings provided the context for the decline in debt service payments or debt. Accordingly, countries that were servicing their debt prior to the HIPC implementation, did perceive the debt relief as providing financial relief, particularly when they reached the completion point. Developing countries that were not servicing the debt at all, did not view the debt relief as particularly helpful, as in their case it did not free up any financial resources. However, the additional fiscal space placed these countries in a better position to acquire additional credit, relaxed their overall budget constraint and increased their ability to acquire tools to establish and grow their economy through improved access to international markets. A successful example of the HIPC process is that of the Central African Republic. Following the conclusion of an appropriate arrangement with the IMF, Paris Club creditors on April 20, 2007, signed an agreement with the Central African Republic to restructure its external debt, allowing a reduction of the debt service of the country to zero for the next three years.30 Third party documents also indicate an improvement in net present value (NPV) of debt to export ratio. HIPC debt cancellations are expected to bring the NPV of debt to export ratio of participating countries to 140%, lower than the official threshold for HIPC at 150%. With the full 2005 G-8 proposal on multilateral debt, or international financial institution (IFI) debt, the proposed implementation was expected to bring this ratio significantly down to 52%. For many countries the ratio was reduced and remained low for some time. Meanwhile, for others, the ratio was reduced, but has shown some signs of increasing. Source: IMF Status of Implementation Report 2009 Source: IMF Status of Implementation Report 2009 Poverty Reduction and Social Measures Whether the additional fiscal space from the debt reduction has improved poverty reduction and development measures is not clearly evident from either the literature review or the interviews. Figures 4a, 4b, 4c and 4d show some interesting trends for countries that have bilateral debt with Canada. Figure 4a shows minimal change in poverty reducing expenditures as a portion of GDP for some countries, while Figures 4b and 4c show positive trends for some of the other countries. Most key informants claimed that improvements were evident both in the planning of socio-economic developments as well as in their implementation. Some have stated that the poverty-reduction conditions imposed by the IMF and World Bank were not well aligned with the country’s priorities, particularly when the country had already formulated its own plan before entering into HIPC agreements. IMF monitoring reports and international evaluation reports (IMF and World Bank) have been tracking Poverty Reduction Expenditures (PRE). These reports indicate an increase in social expenditures. According to IMF reports, debt relief preceded increased spending in Poverty Reduction Expenditures by about 2% of GDP during the early 1990s to 2008. Total social programs expenditures and PRE increased from 6.7% of GDP to 8.8% of GDP between 2001 and 2007. This study only maps trends over time from data taken from IMF reports, and therefore, cannot directly attribute the patterns of social program expenditure on the debt relief program itself. In order to show causality, some type of comparative analysis across countries would be required to isolate the impact of the debt relief from other confounding factors, such as economic environment, internal political improvements or lack thereof, as well as other types of coordinated aid efforts across the globe. This would be a challenging task, and is undertaken by few international studies. One such study did attempt to do this -- Chauvin and Kray (2005) concluded that there was no clear significant effect of debt relief on expenditures on health and education. In addition, the evaluation report by the World Bank (2006) suggests that a balance between growth recovery and social/ poverty reduction expenditures is required. Currently, there is somewhat less emphasis on improving growth in the initiatives. Evidence of improvement in social conditions is mixed. For example, these efforts seem to have produced only moderate improvements in actual poverty levels. Some reports attribute improved growth to the conditions imposed during the HIPC process and prior to completion of the process. However, the impacts of these expenditures are not clearly understood. For example, increases in health expenditures have been accompanied by decreases in child mortality rates. Meanwhile, spending on education has not been found to be accompanied by higher levels of school enrolment or educational attainment. The World Bank (2009) series of studies also examined a number of indicators, such as rates of immunization, infant mortality, and changes in access to clean water and sanitation. The results showed that a positive relationship, somewhat indicative of causality, does exist for infant mortality and the amount of debt service reduction when HIPC and non-HIPC completers are compared. However, such a positive relationship for other factors, such as levels of immunization and changes in access to clean water and sanitation are not observed, since the data show that overall both HIPCs and non-HIPC developing countries have improved in these areas. It is important to bear in mind that the HIPC initiatives are in the early stages of the process—the earliest completers of the HIPC process were in 2002; therefore, it is possible that the full impact of these increased expenditures on social programs may only be observed after a lag of a few more years. Source: Status of Implementation Report, IMF, 2009 Source: Status of Implementation Report, IMF, 2009 Source: Status of Implementation Report, IMF, 2009 Growth As the debt relief itself has preceded considerable economic growth in most countries, there appears to be a correlation between growth rates and completion of the HIPC initiative. World Bank 2006 numbers reveal that real GDP growth rates have averaged about 4.3% in the post-completion countries over the period 1999-2004. The growth rates are similar to the growth rates in the early period between 1994 and 1998 but much higher than the 1980-93 period of 1.7%. This is also higher than more recent growth rates of decision point HIPCs, at 2.7%.31 Post-completion point countries have not shown improvement in their revenues or export performance. Various studies have monitored all low-income countries, HIPCs and others, and found that they have improved their economic management, and overall general governance. HIPC countries started out as somewhat better, and improved the most after the HIPC process. However, whether the provision of debt relief has improved economic and financial conditions of the recipient countries in the short term or long term is not conclusive. A report in the third party documents suggest that debt relief is directly linked to long-term improvements of economic and financial conditions of HIPC countries. Accordingly, without the debt relief, HIPC countries would not be able to expand their production possibilities. However, another report emphasizes that debt relief has no impact on participating countries, since IDA reduces flow of aid by the amount of debt relief attained by these countries, resulting in zero financial gain. It was noted that the poverty reduction plans developed under the supervision by the IMF and World Bank representatives for the HIPC process are often developed without full consideration of pre-existing social and economic plans in the debtor country. This could lead to inefficient solutions for the debtor government. It has also been suggested that one set of existing policies may have been simply replaced by another similar set of policies to address slightly different issues in order to fulfil the conditions. Consequently, some informants and recent 3rd party analysis suggested that rather than imposing conditions on the poor countries, it would be more productive to work together in conjunction with the debtor government. In addition, “buy-in” from the participating nation allows the country the opportunity to build on pre-existing poverty reduction strategies, likely leading to more effective results. At the same time, a more collaborative approach would also necessarily require more effort and resources on the part of the IMF and World Bank members. Recommendation 2: Finance should advocate the importance of incorporating the existing economic and development plans of the debtor governments into the economic and financial conditions required by the HIPC agreements. Source: Status of Implementation Report, IMF, 2009 Measures of Canada’s Contribution The consensus of the interviewees is that Canada would be unable to achieve any significant results by itself. International efforts, both through the bilateral and multilateral programs, have made it effective. Due to the free rider problem32—cooperation amongst all the creditor nations is imperative. Nevertheless, since it is of interest to observe Canada’s contribution, this report makes an attempt to isolate Canada’s efforts. The above charts attest to the pattern of debt and poverty reducing expenditures for those countries to which Canada has directly provided debt relief of US1 million or more through bilateral agreements. These trend lines are similar to those for most HIPC countries.

The 2008 World Bank Evaluation study examines four countries in some depth that have been debtors to Canada. Only one, Honduras substantially decreased its poverty levels, while the three others (Ghana, Senegal and Tanzania) demonstrated only mixed progress. In the September 2008 Status of Implementation report, the World Bank reported on the progress of countries in meeting their Millennium Goals. The report demonstrates that of eight debtors to Canada, the majority could attain at least one goal; three countries might attain 3 goals, while two of the other countries could attain the majority of their goals. Meanwhile, two of these countries were likely not to attain a majority of their goals.

In 2009, the total debt of impoverished countries already cancelled by Canada comes to US $965-million, including debt owed by Latin American and Caribbean nations. Haiti is the latest, 13th country, to meet the requirements of the Canadian Debt Initiative (CDI). The CDI is designated to cancel$1.3-billion in debt in total.33 The cost to Canada through the Paris Club agreements is US $209 million for these countries. Canada is committed to provide IMF, World Bank and African Development Fund with US$2.5 billion over the next 40 years to compensate them for the losses incurred through international debt relief.

Debt Sustainability

Since 2002, some HIPC countries that have reached the completion point have maintained sustained debt levels. The debt relief provided in the HIPC initiative framework seemed to show a tangible effect on debt sustainability of debtor countries concerned. For example, for 32 of the HIPCs that have reached the decision point, debt service was 5% of exports in 2007, compared to 16.6% of exports in 2000. The debt service payment also decreased from US $651millions in 2000 to US$236 millions in 2007.34

The impact cannot be generalized as it is acknowledged that the extent to which the debtor countries have been able to maintain a low debt burden upon the completion of the program is not fully known at this point. Since full debt relief was only achieved after 2002, insufficient time has passed to determine whether the countries passing the completion point will be able to manage their debt levels appropriately. Experts in the program area as well as external organizations have agreed that it is too early to tell.

For example, the 2006 World Bank evaluation report states that 18 countries were reported to have their debt ratios reduced by 50%. However, eleven of the 13 that reached the completion point subsequently experienced a deterioration of this debt ratio and eight of the 13 again exceeded HIPC thresholds (150% of exports). Much of this is due to new borrowing, although exchange rates may also have worsened the ratio.

An IMF study35 using computer simulations indicate that if patterns of growth and borrowing are assumed to remain unchanged, pre- and post-MDRI debt ratios tend to converge in the long term. For example, MDRI debt relief reduces the NPV of debt-to-export ratio on average by 40 percent over 2006-10, but by 2025 the difference between pre- and post-MDRI debt ratios declines to just over 10 percentage points. The simulation assumes there is accumulated debt from new borrowing. These results agree with the Easterly (2001) study on past borrowing/debt reduction patterns of HIPCs and creditor countries. However, the initial assumption - that neither the growth patterns nor the borrowing patterns would change once the debt overhang of these countries had been significantly reduced - seems somewhat rigid.

Most observers feel that it is too early to determine debt sustainability, and that a longer time horizon, such as 20 years, is needed. Others believe that the best available predictor of debt sustainability is the IMF debt sustainability analysis conducted prior to helping the country through the HIPC initiative. Achieving debt sustainability remains a challenge for the HIPCs—both because they are likely to continue to borrow to meet their developmental needs and because their export base is narrow and their earnings too volatile. In addition to this, the recent international economic turmoil in 2007-09 may have some impact on both the goals of the developing countries, as well as the creditor nations.

Finance Canada has expanded the focus of its programs from providing debt relief to pursuing collaborative policies with the IMF and World Bank on establishing debt management/sustainability initiatives for these countries. Most of the interviewees agreed with this approach. The general consensus was that this change in focus should be given a high priority. Otherwise, the potential consequences would likely include a much higher debt burden and prove to be much more expensive for creditor countries such as Canada.

Unintended effects

A number of unexpected and unintended effects have occurred since the implementation of the debt relief, some of which are positive and others, somewhat negative.

The evidence of the impact on the domestic tax revenue generation is not clear, however some of the interviewees as well as the literature36 suggest that debt relief may in fact have a negative impact on generating tax revenue; the availability of HIPC money may tempt government leaders to hesitate raising taxes, as they may feel political pressure to lower them.

Key informant interviews and some of the evaluation studies indicate that poor, non-HIPC countries do not have the same access to concessional resources37 as HIPC countries. Countries that have managed themselves well and are paying their debts are not considered to be in the HIPC category, and at the end of the HIPC process are, in a sense, penalized for their good management. It is suggested that donors should ensure that HIPC countries are not favoured at the expense of low-income countries that are good performers. Bangladesh is an example of a poor country with large outstanding debts, but since it had been continuously making its debt payments, it was deemed ineligible to receive HIPC assistance. In 1999, Canada, outside the HIPC process, unilaterally decided to cancel all of its outstanding loans to Bangladesh because of of its good record of economic reform.

The conditions required to obtain HIPC assistance are often many and difficult to fulfill for some countries. The number and severity of the conditions also vary from country to country, although the end goals appear to be the same. The conditions may cause long delays and numerous obstacles in attaining the needed debt relief, leading to concerns from interviewees and some literature that qualifying for debt relief is not an objective process as it may be subject to bias.38

Other third party literature39 and key informants have pointed out that the money provided by IMF and World Bank for debt relief may not result in more money put towards growth prospects. There is a moral hazard associated with providing this debt relief. These countries could formally agree to poverty reduction measures to obtain considerable reductions in debt load and grants from member creditor countries and after obtaining the funds, these same countries could then revert to practices generating unsustainable debt loads with the assumption that more relief would be provided if needed.

On the other hand, for leaders to plan to use the debt relief funds inappropriately, the government of the debtor country must make its choices rationally with long-term planning in mind, since obtaining the funds from debt relief is often a lengthy process through the HIPC initiative. It is argued that this is not likely to occur as most political leaders have timeframes limited to the next election.

Many interviewees and some of the literature note that the problem of moral hazard exists in theory, but in practice countries are required to show some evidence of implementation of growth and poverty reduction policies prior to receiving any debt relief. Although there are some countries that, at various stages of the HIPC process, still regress to policies that are wasteful40, this could be expected of any program or policy that gives grants or some form of financial assistance. A certain proportion of recipients could be expected to react in this way.  Some also suggest that this is why debt relief cannot be considered in isolation, but rather should be incorporated as part of a framework of aid, macroeconomic policies and capacity building within the country, that is put together to manage debt appropriately.

Another issue attracting attention is the free rider problem. This problem arises when participating creditor countries (those involved in the HIPC initiative and Paris Club) provide debt relief to improve the financial situation of the developing countries, while other potential creditors outside these organizations, such as China and India, take advantage of the fiscal space created by providing unsustainable loans to these countries.

As mentioned in a previous section, the problem of vulture funds has recently been observed. In this case, a private firm may buy up the developing countries’ debt from private creditors at a relatively cheap rate, and then, when the country is more financially sound (through the HIPC process), it may launch a lawsuit against the developing country to force it to pay back the debt. A number of lawsuits against Sierra Leone, Zambia and the Democratic Republic of Congo were initiated in 2008. Some creditor countries have now begun to introduce legislation to limit the scope of litigation against HIPCs.

Yet another unintended effect of the debt relief is the adverse selection problem by the creditors.41 Countries under the HIPC process are much more likely to obtain non-debt related assistance in addition to debt relief than those that are not undergoing any kind of debt rescheduling or cancellation. Therefore, the impact of the debt relief is magnified by the additional assistance. For those donor countries that have a fixed budget for international assistance, this implies that non-HIPC countries (possibly better managed, poor countries) would receive less assistance than HIPC countries. Chauvin and Kray (2006) found that countries with poor government policies received more aid, and more debt relief in the first few years (1989-1993), but this was reversed in later years, 1999-2003, indicating that the selectivity problem diminished in later years.

The majority of key informants acknowledge that these issues exist and require consideration, but an alternative solution to debt relief that is equally transparent, and minimizes distortions is not evident.

7.4 Performance: Program Design and Delivery

4(c) Have the initiatives been implemented according to their original design?

The principal goal and overall design of the Initiatives have generally remained the same, although the mandate and the scope have been expanded over time. These changes were made to improve flexibility and to allow the debtor countries to be more involved in the design of the debt relief.

4(d) Are there design or implementation problems that may hinder Canada’s ability to achieve its debt relief objectives?

It was noted that the channels of communication between different partners in Canada, particularly between the Department of Finance and CIDA would need to be strong, particularly now, as there is a shift in the direction of policy (internationally) towards debt management and some debt management related services are being provided by both departments.

Some interviewees pointed out that the Government of Canada does not communicate clearly to the public its contributions with respect to debt relief and the role it has had internationally in the progress of this initiative, particularly with respect to the Canadian Debt Initiative. For example, the website on debt relief initiatives has not been updated since 2005.

Recommendation 3: The Department of Finance should improve the provision of information on the debt relief initiatives, so that the information presented to Canadians  is current and clearly describes Canada’s role, the contributions to bilateral and multilateral debt relief, and the performance of the debt relief initiatives.

IMF imposed conditions are found to be inappropriate by some of the interviewees and in a study by the independent IMF Evaluation Group. The conditions are externally imposed, often too many and not directly related to encouraging growth, and reducing debt. Most agreed, however, that the establishment of some conditions were necessary to facilitate growth.

Recommendation 4: The Department of Finance should ensure a mechanism is in place for revisiting on a regular basis both the HIPC process for establishing conditions and for reviewing the conditions periodically that they are achievable and critical for the recipient country’s growth and development.

Program design and delivery were addressed primarily through interviews and internal documentation, although there was some literature discussing elements of the program design internationally.

The ultimate goal of debt relief has not changed in principle, and the overall design has remained consistent. Adjustments have been made over time to fix or reduce problems in the program design and delivery as these were revealed. Some interviewees stated that the rules and conditions have been relaxed steadily, and are now more focused on poverty reduction strategies. Also at the operational level, the system is considered to be more flexible now, as the debtor country is involved in developing and implementing its own strategies. The design is now being modified to incorporate debt management strategies with the debtor countries.

There are now few HIPC countries left with high levels of debt stock remaining and the policy work on multilateral debt initiatives in the Department of Finance is being expanded to include establishing programs to help HIPCs develop sustainable debt management policy frameworks, and effective governance tools, such as budget formulation, etc. The Department of Finance and CIDA, in conjunction with the World Bank and NGOs, are investigating and developing various strategies and programs focused on this goal.

IMF also is implementing a number of pre-conditions during the HIPC process. As part of this, IMF has placed a more rigorous assessment of the debtor country regarding its future debt sustainability, which is meant to provide some insight into whether or not a debtor country would be able to maintain debt at a sustainable level. It should be noted that the analysis is based on predictions with very fixed assumptions about the future growth of the country; therefore, it provides at best a rough estimate of sustainability. Other conditions include monitoring the budget of the recipient country to check for unexpected, frivolous expenses.

Considerable policy and program development has occurred on debt relief, and more recently, on debt sustainability/management independently at both Finance Canada and at CIDA. It is imperative that the communication between the departments be regular and informed because the work at Finance is shifting towards debt management and the issue of debt sustainability, which have long been an important part of CIDA’s development work. The Department of Finance can be expected to expand its efforts in this area, given that the current focus of the World Bank and other international organizations.

Some interviewees pointed out that the Government of Canada does not communicate in any detail its contributions with respect to debt relief and the role it has had internationally in the progress of this initiative. In particular, there is little information about the Canadian Debt Initiative, although the Bretton Woods Report is tabled regularly in Parliament. Meanwhile, the US Government Office of Accounts, for example, regularly reports on the specific payments—bilateral and multilateral to date, for debt relief. The information would inform and update the public and parliament on the progress to date, and allow for discussion and further analysis of the extent of Canada’s international participation. In the literature reviewed for this evaluation, there was a scarcity of public documents summarizing Canada’s current specific contribution towards the bilateral and multilateral initiatives, or on the performance of the HIPC initiatives, such as successful reduction of debt, and so forth. For example, the Finance website describing the Debt Relief program was last updated in 2005, and has minimal information available about Canada’s contributions.

Recommendation 3: The Department of Finance should improve the provision of information on the debt relief initiatives, so that the information presented to Canadians  is current and clearly describes Canada’s role, the contributions to bilateral and multilateral debt relief, and the performance of the debt relief initiatives.

Evidence from the interviews indicate that maintaining clear diplomatic channels and regular communications is an ongoing challenge to encourage public creditors to continue to co-operate in funding concessional loans and grants to HIPC countries. In particular, there is a concern with emerging markets who also want to foster growth within their countries by providing credit to low income countries. These creditors are not a part of the original HIPC creditors and represent about 7% of the total HIPC Initiative’s cost. Twenty of these creditors have agreed to participate in the HIPC Initiative, while the other eight creditors have not agreed as yet.  Communications with private creditors have resulted in some of them agreeing to align with the HIPC process and offer concessional loans to the HIPCs.

As the global economy has worsened over the last year, it may also be a challenge to ensure funding for the HIPC initiative and MDRI. Considering the new global economic climate and the Government’s fiscal situation, some interviewees raised some concern that the Government may be tempted to move away from its debt relief related commitments. It seems that the European partners are unlikely to change course, since they are more closely tied to the debtor countries through history, financial ties as well as geography. The majority of the interviewees hoped that Canada will stay the course, like its European partners.

Although many interviewees agreed that imposed conditions for HIPCs were necessary, some suggested that rather than imposing these conditions from above, it would be more appropriate to work directly with the country to establish the most appropriate mechanisms for successful growth. The 2009 World Bank release, states that in many of these countries, the basic conditions which prompted the accumulation of debt, such as narrow production and export bases, are still prevalent. This finding suggests it may be necessary to work directly with the debtor government would be necessary to improve these base conditions. Other interviewees were of the opinion that the IMF conditions were inappropriate as they did not consider or attempt to incorporate the country’s pre-HIPC economic growth plan. This view is supported by the 2007 study conducted by the Independent Evaluation Group at the IMF,42 which suggested that the number of IMF conditions was excessive and the conditions were not always focused on the intended goal of establishing an independently functioning healthy economy.

Finally, some interviewees suggested that the key to the success of the program was that the recipient country felt some ownership of the reform program. While some informants agreed with this finding, others stated that the IMF seemed to be pursuing ideological objectives rather than implementing a practical approach. In particular, there was some criticism of the push for privatization of natural resources, such as water or natural gas. Overall, however, there was a unilateral consensus that some conditions were necessary, at the very least to ensure the money was not being used by corrupt leaders for inappropriate purposes (odious debt relief).

Recommendation 4: The Department of Finance should ensure a mechanism is in place for revisiting on a regular basis both the HIPC process for establishing conditions and for reviewing the conditions periodically that they are achievable and critical for the recipient country’s growth and development.

7.5 Performance: Program Efficiency and Economy

Key Findings

5(a) Do the benefits of debt relief outweigh the costs?

Across all the interviewees, the consensus was that the benefits of debt relief initiatives do outweigh its costs. The dollar amount of the total cost for the debt relief, including the administrative costs, is relatively very small. In addition, many of the recipient countries were unlikely to be able to ever repay Canada. The benefits of debt relief include fiscal flexibility for the recipient countries. Additional benefits have been outlined in the section on “relevance” above, including the importance of cooperating with G8 partners in a large-scale international program

The program administration is found to be effective, with few staff involved, resulting in fairly low costs.

5(b) Is the funding structure of the debt relief the most appropriate mechanism for achieving its objectives?

The evaluation found that the current funding structure under Vote 5 may not be the most appropriate mechanism, as it is not flexible enough to allow the program administrators to adjust the amounts as needed.

Recommendation 5: The Department of Finance should review the funding structure of the multilateral debt relief to identify the most appropriate and efficient funding mechanism that would enable program managers the flexibility to respond in a timely manner to the changes in needs, which are mostly externally driven.

Costs of Debt Relief Initiatives relative to the Benefits

Across all the interviewees, including the NGOs, IMF and World Bank representatives, the consensus was that benefits of the debt relief do outweigh the costs. The dollar amount of the total cost to Canada for the debt relief, including the administrative costs, is small relative to the Canada's federal budget on an annual basis. In addition, several informants noted that Canada would not experience any actual reduction in income by providing debt relief, since many of the HIPCs did not make debt service payments in any case.

In essence, the majority agreed that debt cancellation was simply a formalization of the existing situation. All but one informant maintained this position. This conclusion is considered by many an argument to stay the course, but others, particularly academic studies or research conducted by NGOs, suggested that Canada could do more towards debt relief. For example, it was suggested that relaxing the conditions for eligibility during the HIPC process would likely help more nations.

The program administration and the use of the transfer payment system for the international debt relief are found to be efficient with little duplication, resulting in fairly low costs. A small number of people in the department are managing and processing rather large sums of funding, with no significant problems indicated in the process.

A review was conducted internally by Audit and Evaluation in 2007 on the process of the transfer payments, timeliness and accuracy of payments between the Department of Finance and EDC, CWB, IMF and the World Bank. The 2007 study found that the payments are calculated accurately and provided in a timely manner. The interviews in this evaluation from program area as well as EDC and CWB support this finding. It was also noted, however, that no formal audit of the controls and processes of the Debt Relief Initiatives within the Department of Finance have been conducted. The adequacy of controls and processes may need to be periodically audited, given the amount of the transfer payments.

Funding Structure

At the Department of Finance, debt relief initiatives are classified as grants and contributions, and are listed as part of Vote 5 in the 2009-10 Main Estimates.43 The bilateral debt relief is compensation paid to the Canadian Wheat Board and Export Development Canada for their losses due to the cancellation of the debt to HIPC countries. The multilateral debt relief is compensation paid to International Financial Institutions, such as the World Bank and IMF for the losses incurred when they have cancelled the debt owed to them by these HIPCs. The sources of funds for bilateral and multilateral debts should be clearly distinguished. Multilateral debt relief is fully funded out of the International Assistance Envelope (IAE)44 and therefore must be established as new payments on an annual basis. Bilateral debt relief is not funded out of the IAE, but is paid through a source of provisional funds, "contingent reserves" set aside in 1990 to protect against Canada’s international debt exposures.

Interviewees stated that the current funding structure under Vote 5 may not be the most appropriate, as it has not been flexible enough to adjust the amounts as needed. In addition, it does not guarantee that the funding will be available when needed. For the MDRI, timely alignment of payments with the decisions made at international institutions such as the IMF and World Bank is desirable. It was suggested that changing the funding to a statutory payment, under “other transfer payments”, particularly with respect to MDRI, would be preferable for easy adjustment. According to some of the interviewees, it does not seem appropriate for the Canadian Government to be forced to delay funding on international commitments simply because of administrative issues.45

The bilateral payments can vary from year to year. As such, it is difficult to predict the exact amount needed, since the decision to cancel the debt depends on the country’s ability to meet the established conditions, in addition to meeting the approval of the IMF and World Bank board members.

Recommendation 5: The Department of Finance should review the funding structure of the multilateral debt relief to identify the most appropriate and efficient funding mechanism that would enable program managers the flexibility to respond in a timely manner to the changes in needs, which are mostly externally driven.

8. Conclusions

Overall the evidence indicates that debt relief initiatives are achieving (at least in the short-run) their original objective. The debt relief initiatives have helped recipient countries reduce their debt burden considerably, particularly for those 26 countries that have past the completion point, such as Cameroon. Debt relief is considered the simplest, most pure form of aid. Any other alternative, such as debt swaps and other mechanisms are generally more complex and difficult for the debtor nation to implement. In addition, the potential impacts of other mechanisms are not always well understood.

There are a number of opportunities for improvement associated with the debt relief programs that have been highlighted in this evaluation report. They include ensuring a mechanism exists to review of the number and type of conditions imposed on the HIPC countries in order to establish good governance; reviewing the fund structure of the multilateral debt relief payments to find a more flexible system; and improving the provision of information to the public regarding the initiatives.

It has been argued that debt relief should not be viewed as a panacea for all ills of the debtor country, but rather one tool among many aid tools that can be used to alleviate poverty and to improve social conditions in these countries. The only way debt relief can be implemented effectively within a multilateral context is with the maximum cooperation of creditor and debtor countries. Although the level of cooperation that exists at present among multilateral creditors is very good, there is still some room for improvement. In addition, some of the new and emerging creditor countries, such as China and India, as well as private creditors have to be involved to prevent the “free rider” problems and to maximize benefits. The effectiveness of the debt relief also depends largely on the type of governance found in the debtor countries. If the governance is weak, there is a greater probability that the debt relief will not be effective. Where governance is strong, positive results have been observed.

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AnnexA: Context of Debt Relief

What is Debt Relief? Debt relief refers to the partial or total forgiveness of debt, or the slowing or stopping of debt growth, owed by eligible poorer developing countries to richer developed countries. To understand the recent origin of the debt relief initiatives, it is necessary to review the political, historical and international context that exacerbated the debt acquirements by the developing countries and the subsequent international efforts to address it.

The origin of some of external indebtedness for, at least, some of the developing countries, can be traced back to before their independence, when they were colonies of a European nation. However, most academics agree that much of the current levels of debt were accumulated following the 1973 oil crisis. According to experts in development economics, the degree of external debt accumulation of these countries and the financial requirements of the debtor countries have been intertwined with the financial conditions of the advanced (creditor) nations. Prior to the 1970s, the external debt of developing countries was relatively small. Over the years 1970-2000, the debt grew from $68 billion to over$2 trillion.46 Import-substitution industrialization policies prior to and during the 1970s were the approaches advocated by leading economists, and developing nations borrowed from western countries for their developmental purposes. At the time, the terms and conditions for the loans were good, and there was a reasonable expectation of high returns on their investments. There were a number of events that escalated the debt problem. One interviewee summarized the situation by stating that developing countries faced a series of inter-related problems in the 1970s: The United States (US) was a key importer of goods from the developing world. The US was engaged in the Vietnam War, but tried to insulate its economy from the impacts of the war by increasing the money supply. During the same time, the price of oil increased sharply, so much so that, oil importing countries, including European and Japan had to pay five to six times more than what they had paid before for the same barrel of oil. The majority of the funds generated as a result of high oil prices went to a few oil producing countries who translated their new liquid assets into primarily financial investments in the US. This combined with excess liquidity generated as a result of printing money by the US Treasury created a situation in which the banks had liquidity and were willing to lend.

Meanwhile the investment strategies had been successfully implemented by many of the developing nations, and many of these countries were able to increase their exports.  With the excess liquidity the buyers (developed nations) were better able to import these products. This encouraged these growth strategies for these developing nations, despite the increased cost of production from the higher oil prices. To deal with the impact of this increase in oil prices, to purchase essential items and to fund infrastructure and economic development programs, many of the developing countries found themselves having no choice but to borrow heavily, with the anticipation that the returns generated from the produced goods would pay for this extra cost.  In addition to this, some of the countries that had borrowed heavily had corrupt leadership, so though the leadership may have benefited, the country itself did not gain much from these loans. Banks and other financial institutions started lending openly to these countries without carefully examining their credit worthiness (one can find some parallels in this with the approach of some of the financial institutions and events that precipitated the current financial crisis in the US and elsewhere).

As would be expected now, the excessive liquidity led to high inflation. In the late 1970s and early1980s, the prime rate was increased to control inflation, which, in turn, resulted in an increase in the value of the US dollar. Tight monetary policies were subsequently implemented to control inflation and forced banks into contractionary policies, including requesting the repayment of their loans at higher interest rates. The developing countries now had to pay back more and faster on their loans. Though the value of the income generated from their exports also increased with the higher US dollar, it was offset by a decrease in their terms of trade (the downward trend had started globally for raw materials and basic manufactured goods, the exports of the more impoverished developing nations). Further appreciation of the US dollar increased the debt burden on the loans dramatically.

Canadian Debt Relief Initiatives

1) Bilateral debt relief: Canada provides bilateral debt relief to indebted countries in line with debt relief agreements signed at the Paris Club and with commitments made under the Heavily Indebted Poor Country (HIPC) Initiative and the Canadian Debt Initiative (CDI). The Department of Finance implements the bilateral debt relief required under these international initiatives by reducing the debtor countries’ scheduled payments to official creditor agencies, such as the Canadian Wheat Board (CWB) and Export Development Canada (EDC). The Government has a statutory obligation to compensate the CWB for losses on sovereign loans, while its compensation to EDC is the result of a 2001 Cabinet decision.

2) Multilateral debt relief: Multilateral debt relief (i.e. forgiveness of debt owed by poor countries to international financial institutions) has an objective that is similar to bilateral debt relief. Under the recently adopted Multilateral Debt Relief Initiative (MDRI), Canada has committed to make payments to the IMF, the World Bank and the African Development Fund over the next 45 years to compensate these institutions for cancelling debt owed to them by heavily-indebted poor countries.

AnnexB: Description of the roles and responsibilities of Debt Relief Partners

Department of Finance Canada

The Minister of Finance is responsible for both bilateral and multilateral debt relief. As such, the Department of Finance coordinates Canada’s debt relief efforts, including the provision of policy advice and policy implementation. The Department consults closely with its partners, including the the Canadian International Development Agency and the Department of Foreign Affairs and International Trade. The Minister of Finance is also Canada’s Governor at the IMF and the World Bank Board of Governors.47

Within Finance Canada, the International Trade and Finance Branch is responsible for the coordination and administration of Canada’s international commitments. The International Finance and Development Division manages Canada’s relations with the IMF, the World Bank and the Paris Club, providing comments on both general policy matters as well as the financial assistance programs that these organizations provide to individual countries. It also coordinates the Department’s interests in export finance, including oversight of the financing activities of the federal Export Development Corporation and the Canadian Wheat Board. The Division leads Canada’s participation at the Paris Club and maintains liaison with commercial banks on developing country debt issues.

Export Development Canada (EDC) and Canadian Wheat Board (CWB)

Export Development Canada and Canadian Wheat Board are agencies that provide Canadian loans to various countries, when they are required. EDC is a crown corporation; therefore, EDC is part of the consolidated public accounts, and compensation to EDC is not legislated. Meanwhile, by an act of legislation, there is a legal requirement for compensation, if CWB loses money on external loans, the Minister of Finance must compensate. The Canadian Wheat Board provides credits and loans primarily to sovereign states that want to import Canadian wheat. EDC does the same both to sovereign states as well as to foreign companies to finance the purchase of Canadian exports. As participants in the Canadian debt relief initiatives, EDC and CWB have agreed to write off all loans granted prior to 2001 to the eligible debt relief receiving countries. In return, the Government of Canada compensates CWB and EDC for these and any other losses incurred by these institutions. Note that for any new loans, CWB and EDC must first get approval from the Department of Finance to ensure that the loan would be guaranteed. Normally, once the countries have received debt relief, they become creditworthy and could seek loans from EDC and CWB on their own. In these cases, however, the loans would not be guaranteed by the government. It is anticipated that EDC and CWB will be less and less involved in the debt initiatives as these outstanding loans are paid off.

Canadian International Development Agency (CIDA)

CIDA’s involvement in the debt relief is two fold. It manages the so-called old Official Development Assistance (ODA) loans on behalf of the Government of Canada. CIDA provided loans for debts acquired by poor debtor countries until 1986. CIDA is also involved in various projects related to debt relief. One particularly relevant project has the objective of building debt management capacity. As part of this, CIDA works with NGOs, including the Debt Relief International (DRI), a UK-based NGO that operates through 4 regional organizations, to assist the debtor countries to improve their understanding of and to develop the capacity for debt management. DRI works with at least 33 HIPC countries to provide them with a better grasp of HIPC and other debt relief options that might be available to them. They also help these countries with developing debt management strategies and/or frameworks as well as other tools and institutional capacity for budget developments and fiscal projections. This initiative started in 1997 by DRI. CIDA (Canada) got involved in 2002.

CIDA attends the Paris Club and IMF meetings as an observer and to ensure that ground level information is provided to these institutions and incorporated in their debt relief related policy and other decision-makings.

Department of Foreign Affairs and International Trade (DFAIT)

DFAIT’s role is primarily to provide information and advice on the Canada’s foreign policy, including the state of Canada’s diplomatic relations with or commercial interests in the countries that are being discussed at the Paris Club or other forums. DFAIT officials working in embassies in the countries under consideration also provide information at the “ground level” about the progress of the country. This helps to verify the general assessments that are provided by the IMF/WB and facilitates the decision-making.

Non-Governmental Organizations (NGO)

Non-governmental organizations play an important role in the debt relief. Some of them work closely with the Canadian agencies in the provision of the relief itself and others through creating awareness and influencing policy making. NGOs usually make their concerns heard through CIDA and/or through other existing formal and informal mechanisms, such as the G7/G8 Summits. The Department of Finance Canada, used to have a biannual consultation in place through which the Minister of Finance and several NGOs would exchange information and discuss debt relief related issues. As of this year (2009), the Department has begun a web consultation process. The objective is to create an online forum where interested NGOs and the general public can express concerns regarding Canada’s delivery of foreign aid in general and debt relief in particular. Included in this is an online survey that will be conducted on annual basis to receive feedback.

Grants & Contributions – Also known as “Vote 5” is used when grants and/or contributions expenditures equal or exceed $5 million. It should be noted that the inclusion of a grant, contribution or other transfer payment item in the Estimates imposes no requirement to make a payment, nor does it give a prospective recipient any right to the funds. Contributions: These are conditional transfer payments to an individual or organization for a specified purpose pursuant to a contribution agreement that is subject to being accounted for and audited. Should the individual or organization use the transfer payment in the manner specified by the contribution agreement, the government does not expect to receive any goods or services directly in return, to be repaid or to receive a financial return. Grant: This is a transfer payment subject to pre-established eligibility and other entitlement criteria. A grant is not subject to being accounted for or audited by the department. The recipient may be required to report on results achieved. Debt overhang: Debt overhang occurs when creditors anticipate that the debt will not be repaid in full. The expected debt payments will be lower than the nominal present value of the debt. This stock of unpaid foreign debt could potentially be a major economic impediment even when the debtor is not repaying it. The theory states that the stock of debt must be reduced to sustainable levels before growth and development can resume. A ‘Vulture Fund’ is any private financial organization that specializes in buying up the debts in a distressed economy environment. These securities could be high yield debts where debtors are struggling to pay. The goal of the vulture fund is to make profit by buying cheap debts of heavily indebted third world countries facing debt repayment difficulties. These organizations are depicted as circling vultures that patiently wait to pick up the remains of a rapidly weakening debtor and later claim huge interest repayments through litigation. Currently, there are at least 40 lawsuits by ‘Vulture Funds’ against poor countries. Free Rider Problem: If one creditor country provides debt relief to a debtor country, another creditor country may take advantage of that and increase the debt load of the debtor country by increasing its interest rate, or giving out more loans. In this way, some creditor countries could benefit at the expense of others and the poor country would be no better off, or may be in a worse position, defeating the original purpose of the debt relief. For example, members of the Paris Club follow the guidelines provided by the IMF in giving grants and concessional loans to HIPCs. Non-members, however are not required to follow the guidelines, and could, again, give out unsustainable loans to HIPCs. Types of Debt Incurred: The types of debt typically incurred by a country are given in the following 48 list: 1. Official development assistance, or official aid, can be a grant or a loan with at least a 25-percent grant element, for the promotion of economic development or basic human needs. The loan portion is offered at a low interest rate and over a long repayment period. 2. Other concessional debt has a below market interest rate. 3. Loans from other multilateral financial institutions (non-concessional). 4. Export credits - Loans for the purpose of trade that may be extended by the government or the private sector. If extended by the private sector, they may be supported by government guarantees. For example, the Export Development Canada finances the exports of Canadian manufactured goods through buyers’ credits, project finance, suppliers’ credit, and small business credits. 5. Commercial loans - loans offered by the private sector (e.g., banks) at market rates. 6. Short-term credit - trade financing with a maturity of 1 year or less. Difference between Multilateral Debt and Bilateral Debt: Multilateral debt is almost always serviced because the international financial institutions enjoy “preferred creditor” status. A default on a multilateral debt obligation is likely to result in a country being cut off completely from international credit from any official or private source. Meanwhile, debt owed to bilateral and private sector creditors are not so critical, hence significant proportions are often in arrears. Cancellation of bilateral and private sector debt may therefore represent simply a paper transaction involving the cancellation of debt that was not being repaid in the first place. Such a transaction, while effective in reducing the overall debt overhang, may not actually free up any resources for investments in poverty reduction and infrastructure in a country. Most HIPC debt stock reduction to date has come in the form of writing off debt already in arrears. The cancellation of multilateral debt on the other hand, almost always means that money that would otherwise have gone into servicing debt becomes available to spend instead on development. It also reduces debt overhang at the same time. Research has shown that it is also the most efficient form of resource delivery to countries in need.49 Moral hazard: One formal definition is thatThe risk that a party to a transaction has not entered into the contract in good faith. For example, the party has provided misleading information about its assets, liabilities or credit capacity, or has an incentive to take unusual risks in a desperate attempt to earn a profit before the contract settles. Moral hazard can be present any time two parties come into agreement with one another. Each party in a contract may have the opportunity to gain from acting contrary to the principles laid out by the agreement. Moral hazard can be somewhat reduced by the placing of responsibilities on both parties of a contract”.50 A definition of moral hazard used in the literature is that when debtor countries receive debt relief, it provides them with some financial relief, but also gives them the opportunity to borrow more funds irresponsibly, leading to more loans, and unsustainable debt, yet again. This behaviour of the debtor nations would stem from the belief that they would have access to debt relief again in the future when needed. Litigation against HIPCs: Commercial creditors’ lawsuits against HIPCs present a growing challenge to the implementation of the HIPC Initiative. In response to these problems, the international community has intensified its efforts to discourage litigation against HIPCs, and the World Bank and the IMF have continued their intense efforts to encourage broad and equitable participation by all creditors in the HIPC Initiative.51 Odious debt is debt taken on by a country that serves the interests of the ruler or the ruling regime (typically a nondemocratic one) rather than the country as a whole and its people. If the ruler or regime that incurred the debt is overthrown or otherwise replaced, the question immediately arises as to whether the country should be held liable for that debt from which it received no benefit. The other question raised by NGOs and academics is whether creditors should bear some of the responsibility for screening and resisting such loans in the first place. AnnexD: World Bank, IMF, Finance Canada & CIDA Chart AppendixE: Management Response and Action Plan Evaluation of Canada’s International Debt RELIEF Initiatives Management Response and Action Plan March 25, 2010 Recommendation Management Response Planned Action Lead Target Date # 1: The Department of Finance should consider discussing this arrangement with EDC to re-examine the need for compensating EDC for losses incurred through debt relief. We agree. Discussions on the appropriateness of the arrangement to compensate EDC for losses resulting from Canada’s participation in debt relief initiatives, which was approved by Cabinet in June 2001, have already been held. Such discussions confirmed that the current agreement remains adequate. This agreement ensures that EDC takes greater responsibility for the risks involved in Corporate Account loans to heavily-indebted countries by not compensating the Corporation for multilaterally-agreed debt relief on loans contracted after March 2001. We will continue to compensate EDC for losses resulting from Canada’s participation in debt relief initiatives on loans contracted before March 2001. International Finance and Development Division (IFDD) Completed (on February 22, 2010) # 2: The Department of Finance should advocate the importance of incorporating the existing economic and development plans of the debtor governments into the economic and financial conditions required by the HIPC agreements. We agree. The evaluation could, however, have noted that the Department of Finance already advocates for the inclusion of debtor governments’ existing economic and development plans in HIPC agreements through its support of the IMF and World Bank’s Poverty Reduction Strategy (PRS) approach. This approach encourages debtor countries to develop credible country-owned Poverty Reductions Strategy Papers (PRSPs) through a participatory process involving domestic stakeholders. The Department of Finance will continue to support efforts to improve the IMF and World Bank PRS approach through the work of our Executive Directors at these institutions. International Finance and Development Division (IFDD) Ongoing Comments: Of note, the debtor governments’ preparation and successful implementation of priorities identified in their PRSP are actually defined as a prerequisite to receiving debt relief under the HIPC initiative. # 3: The Department of Finance should improve the provision of information on the debt relief initiatives, so that the information presented to Canadians is current and clearly describes Canada’s role, the contributions to bilateral and multilateral debt relief, and the performance of the debt relief initiatives. We agree. The evaluation could have noted that the Department of Finance provides information on Canada’s contributions to bilateral and multilateral debt relief initiatives through the following channels: • The Government’s Annual Report to Parliament on Official Development Assistance; • CIDA’s Annual Statistical Report on International Assistance; • Finance Canada’s Annual Report on Operations under the Bretton Woods and Related Agreements Act. • Annual Main Estimates and Departmental Performance Reports We do agree, however, that the debt relief section of the Department of Finance’s website should be updated. The Department of Finance will update the section of its website on debt relief, with a view to providing a more up-to-date description of Canada’s contributions to bilateral and multilateral debt relief initiatives. We will also continue to provide annual updates on Canada’s contributions through existing channels. International Finance and Development Division (IFDD) By Q3 of FY2010-11 (December 2010) #4: The Department of Finance should ensure a mechanism is in place for revisiting on a regular basis both the HIPC process for establishing conditions and for reviewing the conditions periodically that they are achievable and critical for the recipient country’s growth and development. We agree. The evaluation could, however, have noted that mechanisms to review the selection and appropriateness of conditions defined by international financial institutions are already in place. Both the IMF and the World Bank regularly undergo reviews of the conditions that are included in their operations. The Department of Finance does not, by itself, set the conditions attached to the country operations of various international financial institutions’. The Department of Finance does, however, review the conditionality frameworks of these institutions through the interventions of our Executive Directors at these institutions. The Department of Finance will continue to participate, through our Executive Directors at the IMF and the World Bank, in these institutions’ recurring conditionality framework reviews. International Finance and Development Division (IFDD) International Policy and Analysis Division (IPAD) Ongoing #5: The Department of Finance should review the funding structure of the multilateral debt relief to identify the most appropriate and efficient funding mechanism that would enable program managers the flexibility to respond in a timely manner to the changes in needs, which are mostly externally driven. We agree. The Department of Finance has already modified the payment mechanism for Canada’s contributions to the Multilateral Debt Relief Initiative (MDRI) to provide such flexibility. This was achieved by making Canada’s payments to the MDRI statutory rather than an item in the Department’s Vote 5 (Grants and Contributions) in The Main Estimates. Such changes were legislated by section 18(1) of the Economic Recovery Act (which received Royal Assent on December 15, 2009). No additional action necessary. International Finance and Development Division (IFDD) Completed (on December 15, 2009) 1 Please note that an assessment of Canada’s participation in the Evian Approach was not within the scope of this evaluation as this initiative was only recently implemented and there is little information on its performance. Introduced at the G8 summit in 2003 and implemented through the Paris Club, the Evian Approach is meant to provide indebted countries, which are not classified as Heavily-Indebted Poor Countries, with a debt treatment that would allow them to achieve debt sustainability. It should be noted that the Evian approach may encompass debt rescheduling and/or debt relief. October 5, 2009, (http://www.g8.fr/evian/extras/498.pdf 2 Subsequent to the introduction of the Federal Accountability Act, TBS has introduced new policies on Evaluation and Transfer Payments, requiring departments to evaluate 100% of their direct program spending, Grants and Contributions and Transfer Payments at least once every five years. 3 A country's debt level is considered unsustainable if debt-to-export levels are above a fixed ratio of 150 percent. For countries that have very open economies and where the exclusive reliance on external indicators may not adequately reflect the fiscal burden of external debt, it is considered unsustainable if the debt-to-government revenues are above 250 percent. 4 IMF, 2008 5 and 8 Finance Canada, 2009. 6 Established in 2001, the Millennium Development Goals (MDGs) refer to eight international development goals that 192 United Nations member states and at least 23 international organizations have agreed to achieve by the year 2015. They include reducing extreme poverty, reducing child mortality rates, fighting disease epidemics such as AIDS, and developing a global partnership for development. 7 Finance, Canada, 2009. 8 Finance Canada, 2005. 9 IMF, Status of Implementation Report, 2009. 10 The London Club is group of commercial banks working together to develop strategies for managing exposure to third world debts. There is no formal framework for restructuring commercial bank loans, and there is no formal group with a fixed membership. 11 Please see Annex C for a definition of grants and contributions. 12 Note that the information in Table 2 and 3 are for general information purposes only. They contain data on actual figures (as yet unpublished) for the debt relief already provided to debtor countries, obtained directly from the International Finance and Development Division at Finance Canada. 13 This point was raised several times by various Canadian and international key informants and experts during their interviews. 14 Independent Evaluation Office, IMF, http://ieo-imf.org/about/management.html 15 Conducting first-hand detailed performance assessments of the international debt relief initiatives would require extensive resources. By incorporating this information into the evaluation study, an attempt was made to reduce duplication as well as take advantage of the efforts already expended by the implicated international institutions. 16 With additional time and significantly more resources, it may have been possible to factor out the potential common impacts across various countries, and then check their progress. For example, if we compare two similar countries over the same time frame, this should remove much of the impact from the business cycle. By comparing countries similar in governance and social structure, it may be possible to get a more informed sense of whether the initiatives were beneficial. Note that this would still not prove causality. 17 World Bank , 2006. 19 There are 61 countries with a Gross National Income (GNI) per capita less than$765. For a full list, see:

http://www.worldbank.org/data/countryclass/classgroups.htm#Low_income

20 European Network on Debt and Development, 2005.

21 World Bank, 2006.

22 World Bank, 2003. Percentages reflect the year 2000.

23 IMF, 2009.

24 Ibid.

25 Information was obtained from EDC documents, and verified by Finance Canada.

26 Debt Reduction Facility (DRF) was launched by the Boards of IBRD and IDA in July 1989. The DRF has supported 18 HIPCs to reduce their commercial debt in this way.

27 World Bank, 2006.

28 The evidence for the extent of real financial relief on the participating HIPCs (medium-term) is derived from: third-party literature review, external evaluation reports, the Status of Implementation Reports, and from the general impressions of the impact as obtained from the key informant interviews.

29 World Bank, 2009

30 Paris Club Annual Report, 2007

31 World Bank, 2006.

32 If one creditor country provides debt relief to a debtor country, another creditor country may take advantage of that and increase the debt load of the debtor country by increasing its interest rate, or giving out more loans.  In this way, some creditor countries could benefit at the expense of others and the poor country would be no better off, or may be in a worse position, defeating the original purpose of the debt relief.

34 IMF, 2008.

35 IMF 2006, p.17.

36 Burnside and Fanizza, 2005

37 Concessional resources are grants, or loans that have relatively lower interest rates, or the loan period is extended to maintain lower debt service payments.  Usually, these are generated by sovereign creditors rather than private institutions.

38 A recent Evaluation report prepared by the IMF’s independent evaluation team showed that there are often many IMF conditions that are not directly related to growth: IMF, 2007.

39 Examples include: Thomas, 2001 and Easterly, 2001.

40 Some debtor HIPC governments have been spending on luxury items, while their citizens are still impoverished, but these countries have usually been denied full debt relief. A recent example is of an African country which followed all the rules, until recently, when its ruler purchased a jet for ease of their own travel while the country remained impoverished.

41 Dijkstra, 2008.

42 IMF, 2007.

43 For a definition of grants and contributions, please see Annex C.

44 The International Assistance Envelope (IAE) includes the budgetary allocations by the federal government to programs for international assistance. The IAE includes allocations to CIDA, Foreign Affairs Canada, the Department of Finance and other departments.

This has recently been addressed by senior management.

46 Krugman & Obstfeld, 2003, International economics: theory and policy

47 For more information regarding Canada’s contributions and operations at the IMF and World Bank, please see the Report on “Canada at the IMF and World Bank 2007: Operations under the Bretton Woods and Related Agreements Act”, March 2008, June 10, 2009, http://www.fin.gc.ca/purl/bretwd-eng.asp.

48 Report to Congressional commission, June 2000:  Debt Relief for poor Countries faces Challenges

49 European Network on Debt and Development, January 2005.

51 2007 Status of Implementation Report, IMF