Debt relief

Background: Debt hinders development

High-voltage transmission line for the distribution of environmentally friendly geothermal energy near a geothermal park in Kenya

High levels of debt can become an obstacle to development if they limit the scope for poverty reduction. 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 basic services and infrastructure such as schools, hospitals, sanitation and power supplies. This affects the poorest of the poor most.

Borrowing can be necessary for a country from an economic policy point of view. It becomes a problem if debt service payments exceed the country's revenues. In developing countries in particular, there is a constant need to strike a balance between maintaining a sustainable level of debt on the one hand and having sufficient funding for development on the other.

The causes of indebtedness

There are various causes for the extreme indebtedness of developing countries in the last few decades. These include the following:

  • Donors have granted loans in the past irrespective of the debtors' creditworthiness, for example because of geostrategic reasons or economic considerations (such as securing access to mineral resources).
  • The loans were used not to finance investment but to meet current expenditure. Over-optimistic growth forecasts, poor debt management, economic mismanagement and corruption compounded the situation.
  • Export prices are increasingly subject to sharp fluctuations. This applies especially to commodities – and many developing countries are financially dependent on commodity exports.
  • The industrialised countries have put up trade barriers against products from developing countries. Subsidies for agricultural products and raw materials are an obstacle to fair trade and limit countries' scope for generating more foreign exchange revenue.

Working together to exit the debt trap

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. Debt relief is therefore a key instrument of development cooperation.

Since the mid-1950s, under agreements forged by the Paris Club (of major creditor countries), the industrialised countries have put together a series of rescheduling – and later debt relief – arrangements for heavily indebted poor countries (HIPC).

The HIPC Initiative and the Multilateral Debt Relief Initiative (MDRI) have meant that, for the first time ever, highly indebted countries could also be relieved of a large part of their debt vis-à-vis multilateral institutions.

The Paris Club

The Paris Club was founded in 1956 in order to find coordinated and sustainable solutions to the payment difficulties experienced by debtor countries. The Paris Club groups together the most important creditor countries. Mainly, these are countries that are members of the Organisation for Economic Co-operation and Development (OECD). Since 1997, Russia has also been a member of the Paris Club.

Paris Club negotiations with a given debtor country involve those creditor countries that have guaranteed commercial loans or granted development cooperation loans for the country in question. The debt rescheduling agreements concluded in such negotiations are binding under international law.

The German government's chief representative in the Paris Club is the Federal Ministry for Economic Affairs and Energy. Further representatives include the Federal Ministry for Economic Cooperation and Development, the Federal Foreign Office and the Federal Ministry of Finance.

Debt relief is in our common interest

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

Strict conditions are attached to debt relief. The funds released as a result of debt relief must be used to combat poverty and foster sustainable development.

Debt relief also brings benefits for the creditor countries, because economic crises aggravate political conflicts. Moreover, the collapse of entire economies in developing countries destroys markets, not least for companies in Germany and other European countries. And the pressure to generate foreign exchange for debt service payments leads to overexploitation of natural resources and environmental degradation in many countries, the consequences of which are felt worldwide.

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