Oxfam International Policy Paper - Oct 98

Debt Relief for Nicaragua: breaking out of the poverty trap

1. Executive Summary

Nicaragua is Latin America’s poorest country, with some of the worst indicators for human welfare. It also has the world’s highest level of per capita debt, at around US$1,300 per capita, and one of the highest ratios of debt to GDP. Even though Nicaragua consistently fails to service its debt in full, actual debt repayments are two and a half times spending in health and education combined. This diversion of resources is taking place in a situation characterised by extreme poverty, for example:

• Over half of the population live below the poverty line
• Two fifths of poor children are malnourished
• Three quarters of the poor live in rural areas, and half of these are extremely poor, unable to meet their daily food needs

Poverty translates into chronic problems in health and education. Infant and maternal mortality is high, with the maternal mortality rate over three times higher in rural areas than the national average. Almost two fifths of the population do not have access to safe drinking water, and almost three quarters of the population are without sanitation services. Although gross enrolment in primary school is high, Nicaragua has the lowest primary school completion rate in the region and more than a third of poor children do not even have access to textbooks.

These abysmal human development indicators reveal problems that are further compounded by the pressures placed on the economy and government resource base by the extremely large foreign debt. In 1997, over half of government revenue went into servicing the US$6 billion debt. The effects on social sector spending have been disastrous, with per capita spending in the social sector now at levels lower than in the 1980s.

In 1997 spending on debt servicing was:

• Over half of government revenue
• Two and a half times recurrent health and education expenditure combined, and 11 times recurrent spending on primary health care

Social investments have been ‘crowded out’ by diverting limited government revenues to foreign creditors. The effect has been to exclude the poor from the benefits of growth. At the same time growth has suffered since the poor, over half of the population, are denied access to the social and economic infrastructure through which they can participate more effectively and more equitably in economic life. The barriers to growth and poverty reduction caused by debt have grave consequences now, and will continue to do so into the future.

Debt reduction is vitally needed to help Nicaragua break out of the poverty trap. The dimensions of the debt problem speak for themselves:

• The ratio of debt stock to exports is 689 per cent or over three times the lower limit set under the Heavily Indebted Poor Country (HIPC) initiative.
• The debt service ratio is 51 per cent for debt service due, compared to the HIPC range of 20-25 per cent.
• Net Present Value (NPV) debt stock to revenue is 934 per cent, compared to the 280 per cent sustainability threshold under HIPC.

These hard facts underline the damaging impact of debt on Nicaragua’s economic reform efforts and investments in the social sector. However, HIPC itself will do little to address these problems.

Debt relief prospects under the Heavily Indebted Poor Country (HIPC) initiative

While Nicaragua is eligible for debt relief under HIPC, on the basis of the debt sustainability criteria, the country may not actually receive any debt relief under HIPC until the year 2002 or later. According to the August 1998 IMF/World Bank review of HIPC, fewer than a quarter of HIPC countries will actually receive HIPC relief before the year 2000. At the same time, if Nicaragua receives HIPC debt relief in 2002, the debt relief provided will not be enough to reduce the debt to a sustainable level, because the debt sustainability thresholds in HIPC are inappropriate. As for many other HIPC countries, the framework delivers too little debt relief, too late. This is for a number of reasons:

• Timeframe.
  Nicaragua might not receive HIPC relief until 2002 or later. Because HIPC countries must undergo two successive IMF programmes, lasting a total of six years. This time period can be reduced if the IMF agrees that performance under the Enhanced Structural Adjustment Facility (ESAF) has been strong enough. In Nicaragua’s case, performance under ESAF has been interrupted. A strict interpretation would mean that the Decision Point for Nicaragua would be delayed until 2001, three years after signing of the present ESAF in March 1998. While we acknowledge that ESAF has been interrupted, the overall reform programme has been strong, if not the equivalent of ‘shock treatment’, and Nicaragua’s track record should be interpreted more flexibly. It appears that this has been agreed, and in the August 1998 IMF/World Bank paper which reviewed the progress of HIPC, Nicaragua’s earliest Decision Point has been proposed to be set at 1999. However, Nicaragua will then have to undergo another three-year ESAF programme before actually receiving debt relief under HIPC.

• Other problems with ESAF.
  The case for flexible interpretation of Nicaragua’s track record is also rooted in recent findings concerning the efficacy of ESAF. Recent external and internal reviews of ESAF, have observed that almost three-quarters of ESAF agreements are delayed or not completed, mainly due to policy disagreements between the government partner and the IMF. Delays in HIPC implementation therefore will be inevitable. The IMF itself has noted that for such programmes to be implemented consistently, governments must own the programmes, and be in a position to build consensus within government, and beyond. The Reviews have also recommended that such programmes must pay better attention to the effects of policies on the poor and vulnerable, and to integrate appropriate compensatory actions at the outset.

• Inappropriate debt sustainability thresholds.
  The World Bank and the IMF acknowledge that debt sustainability ratios are extremely difficult to define, and that the present ratios were derived using a ‘rule of thumb’. The ratios were derived mainly from Latin American experience of the 1980s, and relate to better developed economies, with more extensive levels of infrastructure, higher income levels and generally better social indicators. They are not valid or appropriate for the nature of Nicaragua and of other HIPC countries, which generally have extremely weak and vulnerable economies, often highly dependent on primary commodity exports. We propose more appropriate indicators in the ranges of: 150-200% NPV debt stock to exports; 15-20% debt servicing to exports and 200% NPV debt stock to revenue.

• Cost of HIPC.
  Because of concerns with the cost of HIPC, creditors are trying to limit its benefits. A shorter time frame and lower debt sustainability thresholds could make the cost of debt relief for Nicaragua much higher. Deeper and earlier debt relief for Nicaragua and other countries will receive considerable opposition on purely on the grounds of cost. Once again, this undermines the ability of the HIPC framework to reach its potential as an exit for poor countries to reach debt sustainability. The human development needs of such countries as Nicaragua demand extraordinary measures and efforts for debt relief, and cannot be left to debates on cost grounds alone. The total projected cost of HIPC is $8.2 billion, this is less than the $11 billion Europeans spend annually on ice cream or the $17 billion Europeans and Americans spend annually on pet food.

This Paper presents the case for Nicaragua receiving earlier and deeper debt relief based on a more flexible interpretation of its track record. Credit should be given for the achievements of the past, and the timetable for debt relief should be accelerated.

Breaking out of the poverty trap: a human development window

We support a proposal made by Oxfam International to accelerate HIPC, by developing a ‘human development window’ within the initiative. Under this approach, if Nicaragua agreed to commit 85-100% of debt relief resources to poverty reduction initiatives, the country would be given improved incentives in the form of even deeper debt relief by a Completion Point of March 2000, one year from the proposed Decision Point. This approach could be a major opportunity to re-energise HIPC, and contribute to achieving the targets set at various UN summits, and recently incorporated by the OECD as 2015 targets for reducing poverty and improving health and education. In Nicaragua’s case, through this approach, HIPC can become an important additional tool for achieving human development.

For illustrative purposes we look at the potential human development benefits to Nicaragua if debt service was reduced to 10% of exports under the ‘human development window’ in HIPC. We have calculated that over US$500 million could be made available between 2000 and 2002, if Nicaragua was to receive relief at a March Completion Point, which we propose. The finance that could be made available has then been compared with broad government development plans, contained in ‘Preparing for the next Millennium’, submitted to the Consultative Group in early 1998, and with UNICEF unit costings for social sector provision. The results are striking, with this finance, Nicaragua could, for instance:

• provide free universal primary education each year
• construct 1,500 pre-school classrooms, and rehabilitate 500 schools
• improve the primary level completion rate to from 34% to 70%
• improve access to primary health services for 1.2 million poor people
• improve water supplies to 600,000 people in rural areas
• provide complete sanitation coverage to the rural population

For such achievements to be made, it is vital that action is taken quickly. We propose the following measures:

• Government and creditors should commit themselves to the implementation of a ‘Debt for Human Development Window’ within HIPC.
• Government, donors and civil society should work together to develop agreed national development plans within a Poverty Action Framework, and mechanisms for converting debt relief into human development within these plans, from now until late 1999.
• A Debt Sustainability Analysis (DSA) should be carried out in early 1999, before the March 1999 Decision Point, and that civil society are involved.
• Nicaragua should receive deeper debt relief, via the ‘Human Development Window’, at a Completion Point of March 2000.
• A committee of government, donors and civil society representatives should oversee the implementation of the Poverty Action Framework, and the use of debt relief resources. Civil society should also be able to help government monitor the use to which future lending is put, to ensure that the country does not become seriously indebted again, and to ensure that lending is used for productive purposes.

This approach could be an opportunity to develop a new partnership between Nicaragua and its creditors. Such a partnership is very similar to that recently proposed in the World Bank discussion paper. This paper proposes a range of approaches to improve ownership and success of national development strategies. Some of these approaches include: that governments should develop strategies with civil society and the private sector; that support is sought for these strategies and partners identified; that donors should be involved in the design of strategies to help with quality and future collaboration, and that donors should then agree to fund aspects of the programme. This kind of approach is compatible with the ‘debt for human development window’ for improving HIPC.

The ‘human development window’ approach for Nicaragua could become an important catalyst in a range of ways. Firstly, this is an opportunity to accelerate the flagging HIPC initiative, without re-negotiating the framework, through developing a system of incentives by developing a window for countries which are serious about poverty reduction. Secondly, this is an opportunity for Nicaragua to use the additional resources from debt relief, coupled with other instruments such as a strong policy environment, investment, and aid and lending support, to make progress on achieving the UN human development targets agreed at a range of UN summits. Thirdly, for creditor governments it is an opportunity for them to make progress on 2015 targets that they have adopted in the OECD document, Shaping the 21st Century. Debt relief for Nicaragua, linked to human development targets, could help to strengthen the linkage between growth and poverty reduction and higher levels of human development. This could be a real chance for Nicaragua to break out of the poverty trap.

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