Debt Relief Incentives in Highly Indebted Poor Countries (HIPC): An Empirical Assessment

Article excerpt

Abstract For more than two decades, the majority of countries in the African continent have experienced repeated episodes of rising external debt and debt service, which has led to numerous efforts of external debt relief. This paper provides new evidence on the effects of the Heavily Indebted Poor Countries (HIPC) Initiative on different economic and social indicators in 60 low income countries (LICs). Results show that LICs that were included in the HIPC Initiative marginally performed better than non-HIPC countries. There is evidence that countries that have reached the completion point of the HIPC Initiative by 2005 have experienced an average improvement in investment, health care, gross secondary education enrollment, and GDP per capita growth.

Keywords HIPC initiative * Debt relief incentive * Economic performance

JEL * F34 * H63 * O11

Introduction

For more than two decades, many developing countries have experienced repeated episodes of rising external debt and debt service burdens that have been accompanied by low investment and slower economic growth. The lack of economic progress experienced by the debt ridden developing countries has led to calls for measures to alleviate some of their debt burden. Advocates for debt cancellation have argued that most of the debt are odious (Adams 2004) and unjustified. Others considered the debt to be immoral, unethical and illegitimate (Tegucigalpa Declaration in 1999 at the Launching of Jubilee 2000).

The economic argument made for debt forgiveness is based on the Debt Overhang hypothesis. Debt overhang occurs if the stock of external debt in a country exceeds a country's repayment ability with some future probability, such that expected debt service increasingly depends on a country's output level. This means that some of the returns from investment are being used for debt service. Debt service is therefore considered as an implicit tax, thereby discouraging investment (Domar 1944; Krugman 1988; Sachs 1989), and stifling economic growth which makes it virtually impossible for highly indebted countries to escape poverty (Clements et al. 2005). Thus, it is believed that cancellation of external debts will encourage investment, economic growth and improve standard of living (Rajan and Subramanian 2005). This belief led to the adoption of the Heavily Indebted Poor Countries (HIPC) Initiative in 1996 which was subsequently enhanced in 1999 by the IMF and World Bank.

This paper aims at investigating the incentive effects of the HIPC Initiative on investment and economic growth of recipient countries. The paper is structured as follows: In "The HIPCs and Debt Relief Initiatives", a definition of HIPCs and a brief review of the history of debt relief initiatives are presented. "The HIPC Initiative: a Literature Review" summarizes the incentive framework of debt relief in a country that exhibits bad behavior. The data used in the study is discussed in the "Data" section. Empirical evidence of the effects of HIPC Initiative is reported in "Descriptive Statistics on the Effect of HIPC Initiative." The final section concludes.

The HIPCs and Debt Relief Initiatives

The HIPCs are a group of poor countries that were identified in the early 1990s as having excessive levels of external debt (for a listing of HIPCs see Table 7). These countries were jointly considered for debt relief under the HIPC Initiative which was instituted by the World Bank and IMF in 1996 and enhanced (1) in 1999. The HIPC Initiative is designed as an agreement among the major players in international finance with the objective of easing the debt burden of some of the world's poorest countries. It calls for the voluntary provision of debt relief by all creditors (multilateral, bilateral, or commercial debt) with the goal of providing a permanent exit from repeated debt rescheduling (Gunter 2003) and for long term debt sustainability (Arnone et al. …