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Debt relief

Background:
Debt holds back development


A girl writes on the blackboard at her classroom in Narok, Kenya.

Over-indebtedness can become an obstacle to de­vel­op­ment if it restricts the scope for reducing poverty. If the debt burden is so large that even with above-average economic growth a country is barely able to meet its interest and redemption payments, then there is no money left for urgently needed investments in the provision of basic services and infrastructure, that is, in schools, hospitals, sanitation and power supplies. It is the poorest of the poor who are hardest hit.

The debt crisis in a number of European states shows that problems of indebtedness are not only restricted to developing countries, but also increasingly pose a problem for the industrialised world. However, it is the least developed countries in particular that are affected by over-indebtedness. In developing countries, there is a constant balance to be struck between maintaining a sustainable level of debt on the one hand and having sufficient finance for de­vel­op­ment on the other. As a result, Germany now supports the poorest countries only in the form of non-repayable grants.

The causes of indebtedness

There are many causes of the extreme indebtedness of developing countries over the past few decades. These include the following:

  • Donors have granted loans in the past, and continue to do so irrespective of the debtors’ creditworthiness; for example, due to geostrategic reasons or economic considerations (such as to secure access to mineral deposits).

  • The loans were used not to finance investment but to meet current expenditure. Consequently, investments failed to deliver the hoped for productivity. Over-optimistic growth forecasts by the donor countries, poor debt management, economic mismanagement and corruption compounded the situation.

  • Export prices had initially declined steadily over a long period and are now increasingly subject to sharp fluctuations. This applies especially to prices for raw materials exports on which many developing countries depend.

  • The industrial countries put up trade barriers against products from developing countries. Subsidies for agricultural products and raw materials are an obstacle to fair trade and limit the scope for generating more income through foreign exchange.

  • The economic output of developing countries has slumped as a result of the global financial crisis. They require more money in order to be able to meet their payment obligations.

The collective way out of the debt trap

Over-indebtedness is like a trap from which a country is no longer able to escape without resorting to help. The collective way out of this trap is through debt relief. Debt relief aims to help poor countries scale down their debt burden to an economically sustainable level so that their economies can make a fresh start.

Strict conditions are attached to debt relief. In its Coalition Agreement, the German government stipulated that debt relief is only to be granted to a recipient country on the condition that its budget is managed transparently, efforts are made to combat corruption and economic mismanagement and that a solid economic structure is set up.

The funds released as a result of debt relief must be used to combat poverty and promote sustainable de­vel­op­ment, i.e. they must be spent on education, health care, infrastructure or on forestry and agricultural programmes. Debt relief is therefore a key instrument of German de­vel­op­ment co­op­er­a­tion.

Debt relief also brings benefits for the economies of creditor countries. Economic shocks aggravate political conflict. The collapse of entire economies in developing countries destroys markets, not least for companies in Germany and the rest of Europe. And the pressure to generate foreign exchange for debt service payments leads to overexploitation of natural resources and destruction of the environment in many countries, the consequences of which are felt worldwide.

Historical responsibility

The London Debt Agreement of February 1953 essentially liberated Germany from its pre- and post-war debt burden. Half of all the country’s debt was cancelled and the rest rescheduled, giving Germany more time to repay at more favourable rates. Any obligation to repay all of its debts would have made Germany’s economic recovery at the time much more difficult.

Implications of the global financial crisis

Debt cancellation, increases in the prices of raw materials and economic prosperity have all led to a sharp reduction in debt in many poor countries over recent years. However, the global financial crisis has severely affected developing countries and is threatening to wipe out the successes achieved as a result of debt relief. The average economic growth of all developing and emerging countries fell from 7.3 per cent in 2010 to 6.2 percent in 2011. The In­ter­na­ti­o­nal Monetary Fund (IMF) has cut its growth forecasts for 2012 and 2013 by 0.7 per cent and continues to envisage risks for economic de­vel­op­ment in developing and emerging countries.

During the years prior to the crisis, between 2000 and 2008, developing and emerging countries saw an impressive reduction in their NPV debt-to-export ratio, from 128.5 to 59.3 per cent, while their NPV debt to gross national income ratio also fell markedly, from 37.8 to 22 per cent. Following a sharp decline in exports (20 per cent between 2008 and 2009), the NPV debt-to-export ratio rose once again to 77 per cent, its highest level since 2005. The NPV of debt in relation to gross national income also increased once more.

A noticeable recovery is now underway. In 2010, the NPV debt-to-export ratio and the NPV debt to gross national income ratio both improved, to 69 per cent and 21 per cent respectively. The situation in heavily indebted poor countries (HIPC) was even more positive. In 1999, the NPV debt-to-export ratio of these countries averaged 457 per cent, whereas by 2011 this figure had fallen to 80 per cent. The NPV of debt in relation to gross national income for these countries stood at 114 per cent in 1999, but had been reduced to 19 per cent by 2011.

Yet this trend is unstable and depends greatly on global economic de­vel­op­ment. Moreover, the World Bank warns that the long-term effects of the crisis on poorer countries are not yet foreseeable. For example, the successes achieved to date in terms of reducing poverty might be jeopardised.

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