Monday, 3 August 2020

The New DAC Method of Reporting Debt Relief as ODA: HIPC Redux?

Donors have agreed on a new accounting method aid treatment of debt relief on 24/07/2020. At first glance, these are good news for Covid-stricken poor countries. Debt write-offs have helped in the past stimulate new investment and lower funding cost as a debt overhang has been removed, most notably via the HIPC and MDRI initiatives[1]. But to what extent does the new DAC method of reporting debt relief as aid improve funding prospects for the poorest countries?

To help alleviate funding shortfalls among the world’s poorest economies, many of which are in sub-Saharan Africa (SSA), international organisations and the G20[2] had called on bilateral creditors to suspend debt payments from fiscally constrained countries. A debt service relief package has been approved by some of the world’s biggest lenders for more than 25 African countries, including the World Bank, the International Monetary Fund, the G20, the African Development Bank, and all Paris Club creditors.

So debt service payments to official multi- and bilateral creditors have been effectively halted since the Covid pandemic. However, neither China nor private creditors seem to have bought into a formal debt relief deal orchestrated by official efforts[3]. These creditors might be free riders of official debt relief as their claims could gain in market value.

End July 2020, members of the OECD Development Assistance Committee (DAC), comprised of 29 donor countries and the EU, have agreed on a method for reporting debt relief as grant-equivalent ODA. Alongside reporting on a grant-equivalent basis, ODA figures will continue to be calculated, reported and published on the previous cash-flow system[4]. The DAC Chair, Susanna Moorehead, hailed the new accounting method on Twitter (30/07/2020): “Really important milestone! This collective decision by the DAC will generate much-needed support and development impact. It responds to developing countries' calls for increased debt relief by increasing incentives for donors to issue debt relief whilst protecting #ODA integrity”.

Oil exporting countries and Heavily Indebted Poor Countries (HIPC) have been the main drivers for the rapid accumulation of public debt in SSA). Fitch Ratings forecasts the median government debt/GDP ratio for the 19 Fitch-rated SSA sovereigns to reach 71% at end-2020, from 57% at end-2019 and 26% in 2012[5]. With an average SSA export/GDP ratio (2018) of 25% according to the World Bank WITS, the prospective end-2020 median SSA debt/export ratio can be quickly approximated at 280%. To be sure, post Covid debt ratios can´t be estimated with any precision as foreign exports as well as domestic currencies and GDPs have tumbled, leading to inflate debt ratios through a multitude of channels.

 As we learned 20ys ago (HIPC), however, the amount of *true debt relief* implied by the new DAC method will depend on how far the market value of debt forgiven was below its face value. Relief is zero if discount is at 100% and even negative if other ODA is lowered[6]. Again today, the new DAC method seems distorted by a lack of perspective on the ‘market value’ of the debt which is ´reliefed´. Understandable, because SSA official debt is not quoted on secondary markets. But it can be simulated, as Cohen (2000) did twenty years ago (see Table).

Table: Cohen´s Price Estimates

D/X, %

D, Secondary Market Price

D, Marginal Price

150

61

30

200

46

10

250

36

 2

300

23

-3

D/X= debt-export ratio, %.

The appropriate ‘market value’ takes account of the risk of non‐payment: arrears, rescheduling and ‘constrained’ refinancing of various sorts. Building on econometric evidence that relied on middle income debtors in the 1980s, the Cohen had argued that the HIPC initiative was about ten times less generous than face value accounting had suggested. With a prospective end-2020 median SSA debt/export ratio approximated at 280% (see above), imputed secondary market prices are below 30% and marginal debt prices at zero.

One can certainly argue with the numbers but not with the principles: DAC donors are granting relief on debt that was almost worthless anyhow. While thus probably helping DAC donors to overstate ODA numbers via debt relief along the grant-equivalent method, the new method of accounting for debt relief might also crowd out traditional aid flows. The new DAC accounting method would free few ressources in itself while the reduction of traditional aid flows would be a net loss for aid recipients.

It is important, therefore, to resuscitate a former ODA concept: Country Programmable Aid (CPA) reflects the amount of aid that can be programmed by the recipient at partner country level[7]. CPA is necessary to reestablish DAC donors´ balance sheet truth and clarity. Otherwise, the new DAC method of debt relief will allow DAC agencies to brag big ODA numbers that do not reach needy low-income country budgets.

 



[1] HIPC (Highly Indebted Poor Country) coordinated debt relief was provided by bilateral Paris Club creditors from 1996 and was reinforced by the MDRI (Multilateral Debt Relief Initiative) in 2005 to allow for the cancellation of claims on HIPC completion point countries by the IMF, WBG and the AfDB.

[4] The new methodology for reporting on debt relief in the grant equivalent system is complicated. It takes 26 (!) pages of description; see OECD (2020), Reporting on Debt Relief in the Grant Equivalent System, DAC, 30/07/2020.

[5] Fitch Ratings (2020), Rising Debt Distress in Sub-Saharan Africa, Special Report, London, 30/06/2020.

[6] Daniel Cohen (2000), The Hipc Initiative: True and False Promises, OECD Development Centre Working Paper No. 166, October. Also published as Cohen (2003), International Finance, Vol. 4.3., Winter 2001, pp. 363-380.

[7] CPA is defined through exclusions, by subtracting from gross ODA aid that is unpredictable by nature (humanitarian aid and debt forgiveness and reorganisation), entails no cross-border flows (development research in donor country, promotion of development awareness, imputed student costs, refugees in donor country and administrative costs), does not form part of co-operation agreements between governments (food aid and aid extended by local governments in donor countries), is not country programmable by the donor (core funding to national NGOs and International NGOs), or is not susceptible for programming at country level (e.g. contributions to Public Private Partnerships, for some donors aid extended by other agencies than the main aid agency). See DAC Glossary of Key Terms and Concepts.


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