World Bank Reprint Series: Number 378 Edward V.K. Jaycox, Ravi I. Gulhati, Sanjaya Lall, and Satya Yalamanchili .t e Nature of the Db Problem Om Eastern and Southern Africa Reprinted with the permission of the Institute for Intemational Economics, from African Debt and Financing, Special Reports number 5 (May 1986), pp. 47-62, edited by Carol Lancaster and John Williamson. 3 The Nature of the Debt Problem in Eastern and Southern Africa Edward V. K. Jaycox, Ravi I. Gulhati, Sanjaya Lall, and Satya Yalamanchili Difficulty in the servicing foreign debt is a relatively new problem for sub- Saharan Africa: in the Eastern and Southern Africa (ESA) region, in particular, it is barely a decade old. The first reschedulings began in late 1976, when Zaire could not meet its normal servicing obligations. By the 1980s, the pace of reschedulings had quickened, and by the end of 1985 several countries were facing severe debt problems. However, the impact of the problem was not uniform. Some countries were not seriously affected by the debt burden; they could pay debt service without difficulty, and a few could contemplate taking on more commercial debt. Others were very seriously affected, and could either not pay their scheduled debt service or could do so only at intolerable economic cost. This chapter focuses on the debt problems of these seriously affected countries in the ESA region. It classifies 15 countries accordirng to their debt burden and describes the structure of their debt (second section). It traces the genesis of their debt problems, showing the diversity of experience, and highlights the experience of Zambia (third section). It goes on to show (fourth section), again using the Zambian case, how the existing "rules of the game" were inadequate for dealing with the emerging crisis. The chapter closes with some conclusions. The authors are, respectively, Vice-President, Chief Economist, Senior Economist, and Research Assistant, Eastern and Southern Africa Regional Office, World Bank, Washington, DC. This paper was presented in conjunction with Edward V.K. Jaycox's contribution to the discussion of chapter 6. This explains the absence of comment by discussants. 47 48 AFRICAN DEBT AND FINANCING STRUCTURE OF THE DEBT BURDEN IN ESA While several factors determine the net economic burden represented by outstanding debt, the measure that best captures the various aspects (hardness of terms, maturity structure, and capacity to meet obligations in foreign exchange) is the ex ante debt-service ratios. This is the value of scheduled debt-service payments as a proportion of export earnings, before allowing for arrears or renegotiations. The actual debt-service ratio will differ from this, of course, if countries fall into arrears or reschedule their payments, and the two ratios do diverge for many countries in the region. Table 3.1 shows the structure of outstanding debt at end-1984 for 15 ESA countries, ranked according to their 1985 ex ante debt-service ratios. It also shows their actual debt-service ratios for 1984, the arrears accumulated, the reschedulings undertaken, and the average terms on which the debt was contracted. Note that the ex ante ratios for 1985 understate the debt burden, since they exclude (for lack of data) the servicing of arrears, short-term and private nonguaranteed debt, large items for some countries. Some 1984 data are estimates and need to be treated with caution. The countries are grouped into three categories. While the ex ante debt- service ratio has been used to classify them, the grouping also reflects our assessment of the future prospects of these countries. The seriously affected countries are those thought unlikely to be able to meet their debt obligations even if they undertook serious policy reforms and obtained generous (by current standards) rescheduling terms.' They already have high arrears, and nearly all have been involved in recent renegotiations. They are suffering from economic decline to a greater extent than other ESA countries. Their creditworthiness is very low, so that short-term credits are unlikely to be rolled over for them. The moderately affected countries (with the possible exception of Uganda) should be able to meet their obligations if unforeseen events do not disrupt their export capability or increase their import needs. However, this does not signify that the burden can be borne easily. The diversion of a quarter to over a third of total export earnings to servicing outstanding debt may squeeze commodity imports too hard to permit a satisfactory growth pelformance. By definition, the countries not affected by their debt burden should be able to service their debt without difficulty. The terms of debt do not, at first sight, appear to be worse for the seriously affected countries than for the others: the origins of the debt problem do not, in other words, seem to lie in the hardness of credit terms. This question is addressed in the next section. Table 3.2 shows the nature of the debt-service I Mozambique should be part of the "most seriously affected" group, but is excluded for lack of data. Uganda may also be shifted to this group from the "moderately affected" group because recent political and economic events may have reduced its debt servicing capacity. NATURE OF THE DEBT PROBLEM 49 burden for five of the most seriously affected countries: Zambia, Tanzania, Somalia, Sudan, and Zaire. The burden is calculated for 1985 through 1990, based on debt outstanding at end-1984, abstracting from further borrowing or rescheduling, and excluding the servicing of short-term and private nonguar- anteed debt. The total value of scheduled debt-service payments for 1985-90 calculated on this basis comes to $14.7 billion for the five countries. Multilateral institutions account for 30 percent of this, with the International Monetary Fund (IMF) taking up 18.5 percent of total payments due. The burden of multilateral debt servicing is particularly high for Somalia and Zambia (over 45 percent), and relatively low for Sudan and Zaire (below 25 percent). The IMF emerges as the single largest recipient of debt-service payments for the five countries. These are three times the payments due to the World Bank Group and over twice as much as payments due to the largest bilateral creditor, the United States. Suppliers' credits are significant for Zambia and Tanzania while financial institutions (n.ainly commercial banks) are important for Sudan and Zaire. The relative weight of concessional versus nonconcessional official debt varies: Tanzania and Somalia have to service a great deal of concessional debt, while Zaire and Sudan have to service predominantly nonconcessional debt. Space limitations prevent the presentation here of the underlying data, but four points should be noted about the pattern of financial flows: * Different donor and creditor countries concentrate on different recipients. Thus, the United States is very important for Zaire, less so for Zambia and Sudan, and not at all for Tanzania and Somalia. Saudi Arabia is significant for Sudan and Somalia; Italy has a significant presence in all countries but Zambia, and so on. * The source of credit also varies by creditor country. No Japanese financial institution has extended credit to these debtor countries, while financial institutions from the United Kingdom, United States, and France are relatively important for them. West Germany, Japan, and Italy, on the other hand, extend substantial amounts of supplier credits while other creditors do not. * An interesting fact is that the terms of suppliers' credits differ widely, depending on the recipient. For example, German supplier credits to Zambia carried a grant equivalent (calculated at a discount rate of 10 percent) of 10 percent but the corresponding figure for Zaire was -- 8 percent. This discrepancy is not easy to explain. Similarly, UK commercial banks extended loans to Zambia with a grant equivalent of 2 percent, but the corresponding figure for their loans to the Sudan was -21 percent. Since both debtors were crisis-ridden during the 1980s, it is not easy to explain these differentials. * Overall (including grants as well as public and private loans), the hardest 50 AFRICAN DEBT AND FINANCING TABLE 3.1 DEBT-SERVICE BURDEN, EASTERN AND SOUTHERN AFRICAN COUNTRIES (million dollars and percentage) Publicly guaranteed debt P Arrears PrivJate on Finan- non- long- Sun- cial in- guaran- Short term Total' Official Multi- plier stitu- teed term princi- Countries debt bilateral lateral credits tions debt debtb pal Not affected Rwanda 270 53.9 188.8 - - - 27 - Botswana 281, 81.5 157.9 7.2 29.5 - 5 - Burundi 346 101.5 209.0 0.0 23.9 - 12 - Moderately affected Zimbabwe 2,128 294.7 443.8 19.3 944.1 81.9 344 - Malawi 885 145.8 569.9 19.0 108.5 0.0 42 0.2 Ethiopia 1,527 680.8 596.6 57.0 124.4 0.0 67 0.8 Mauritius 560 89.4 312.6 0.5 105.9 12.7 39 - Kenya 3,805 897.6 1,621.4 62.6 421.9 428.3 369 4.0 Uganda 1,031 261.3 659.3 27.1 42.4 0.0 26 15.2 Most seriously affected Zaire 5,001 2,763.7 1,187.4 139.4 572.7 7.5 244 86.0 Tanzania 3,329 1,135.1 1,020.6 171.4 290.2 60.6 554 96.8 Somalia 1,429 742.2 533.2 0.0 59.2 0.( 49 45.8 Zambia 4,775 1,552.3 1,295.1 224.7 404.6 23.4 388 886.7 Madagascar 1,952 813.6 573.6 63.4 333.8 0.( 83 85.0 Sudan 7,201 3,764.7 1,546.5 40.3 905.4 0.0 404 539.6 Total 34,520 13,378.1 10,915.7 831.9 4,366.5 614.4 2,653.0 1,760.1 - Zero or negligible. NOTE: Based on value of total debt outstanding, end 1984. SOURCE: World Bank, Financing Adjustment with Growvth in Sub-S charan Africa, 1986-90 (Wash- ington, 1986); World Debt Tables: External Debt of Developing Countries, 1985-86 edition. a. Includes arrears on long-ternm principal payments and estimated private nonguaranteed and short- term debt. b. Estimated. c. Includes IMF repurchases and charges, interest on short-term debt and payment arrears. terms were offered by the USSR (grant element 20.9 percent) and France (36.1 percent), and the softest by the United Kingdom (68.2 percent), Saudi Arabia (62.8 percent), and the United States (60 percent). These points are important if solutions to the debt problem are to include measures to allocate among the bilaterals the burden of future grants and credits to debtors undertaking serious reform.2 2 See, for instance, our contribution to the discussion of chapter 6, this volumne. NATURE OF THE DEBT PROBLEM 51 Esti- Weightted average ternms of public debt pE x mated Dcommitments (1965-84) post- ex anLte Debt debt- debt- Nut. zer of service Interest Grant service serice Total arrears, (as debt rene- post- rate element ratio' ratiod percentage of gotiations' ponedr (percent- Maturity Grace (percent- (1984) (1985) debt outstt Wding) (1975-85) (1975-85) age) (years) (years) age) 5 2.4 0.5 (0.2) - - 1.3 39.8 9.0 73.0 4 5.1 - - - 6.3 22.8 5.8 27.9 19 17.2 - - - 2.6 30.5 7.5 57.6 26 25.6 - - - 8.8 13.5 4.1 12.0 34 28.5 0.6 - 3 113 4.5 28.9 6.8 46.0 18 28.5 0.8 (0.1) - - 2.9 28.2 6.9 53.8 32 30.9 - - - 7.9 16.2 4.8 16.7 37 32.6 4.0 (0.1) - - 5.8 24.4 5.8 32.4 36 45.0 63.0 (6.1) 2 78 4.3 24.3 5.6 41.4 25 47.0 1,720.0 (34.6) 7 4,270 5.7 18.2 5.0 28.3 35 58.2 356.3 (10.7) - - 3.7 27.7 6.9 48.0 42 61.2 185.7 (13.0) 1 142 2.7 23.1 6.8 50.2 77 65.4 1,159.4 (24.3) 3 523 6.6 18.2 5.0 23.7 64 82.3 85.0 (4.4) 7 799 4.6 22.6 5.5 37.8 24 123.9 1,424.8 (19.8) 6 1,866 5.3 19.4 5.6 32.7 3,452.1 (10.0) 28 7,791 d. Includes interest on total public and publicly guaranteed debt only; excludes interest on arrears, short-term debt and private nonguaranteed debt. e. Includes long- and short-term debt arrears on interest as well as principal. ' Under the auspices of the Paris Club and the London Club. The data cover debt arrangements "eypected to be signed by end-1985" plus commercial bank reschedulings agreed in principle until end-October 1985. g. Figures indicate postponed debt service as reported by countries as well as estimates by the World Bank- THE GENESIS OF THE DEBT PROBLEM The existence of a large amount of debt does not signify a "problem" for a debtor countrv that harnesses its borTowed resources effectively for purposes of development. Even a small amount of debt can, on the other hand, become a heavy burden on a country that fritters the money away on consumption or inefficient investments. The emergence of a debt "problem" is the result of a complex interplay of several economic factors, which reflect when and on what 52 AFRICAN DEBT AND FINANCING TABLE 3.2 DISTRIBUTION OF SCHEDULED DEBT-SERVICE PAYMENTS, SELECTED COUNTRIES, 1985-90' Total debt servc SBilateral official (percentage) sertvice Stupplier Financial Debtor (million Credits institutions Nonconces- country dollars) (percentage) (percentage) Total Concessional sional Zambia 3,096 8.0 14.6 30.9 10.6 20.3 Tanzania 1,496 9.2 14.0 45.0 24.2 20.8 Somalia 812 - 5.4 47.5 36.6 10.9 Sudan 4,833 0.5 24.1 51.8 20.3 31.5 Zaire 4,418 3.9 16.3 56.8 10.5 46.3 Total 14,655 4.0 17.7 47.9 16.6 31.3 - Zero or negligible. SOURCES: World Bank data files, IMF, OECD a. Publicly guaranteed debt only. b. "Concessional" IMF refers to servicing of Trust Fund loans. terms a country had to borrow abroad and how it used the borrowed resources. These factors can be grouped into five broad categories, each having elements that are exogenous and elements that are within the policy control of the debtor government:3 current trade balance; domestic savings, consumption, and fiscal performance; efficiency of investment; terms of borrowing; and the role of the creditors. Current Trade Balance The growth of exports, reliance on imports, and changes in terms of trade exert a direct impact on the need to borrow overseas. Endogenous influences include the exchange rate, expoit promotion and import-substitution policies, industrial policies, and the like, which affect export performance and import dependence. Exogenous factors are primarily changes in terms of trade and (for agricultural exports) weather conditions. I For a systematic analysis, see Ravi Gulhati. "The 'Need' for Foreign Resources, Absorptive Capacity and Debt Servicing Capacity," in J.H. Adler(ed.) ,CapitalMovements (London: Macmillan), 1967. NATURE OF THE DEBT PROBLEM 53 Multilateral institutions (percentage) IMF World Bank Others Conces- Nonconces- Conces- Noniconces- Conces- Nonconces- Bonds Total sionalb sional sional sional sional sional (percentage) 46.5 1.3 28.0 0.7 12.2 1.4 2.9 - 31.5 2.4 1.6 7.5 13.5 3.5 3.0 0.3 47.2 1.3 15.8 1.9 - 11.2 16.9 - 23.7 1.3 14.9 1.6 - 3.7 2.1 - 23.0 2.2 16.2 0.6 1.6 0.8 1.6 - 30.4 1.7 16.8 1.8 4.4 2.8 3.0 0.0 Domestic Savings, Con1sumption, ana ;'iscal Performance A country that borrows to sustain consumption (public or private) is much more likely to run into a debt problem than one that borrows for investment. While these factors are highly susceptible to policy influence, exogenous events like wars, droughts, and trade-related shocks can strongly affect savings perform- ance. Ef.ficiency of In-vestment The productive use of new and existing investments is a critical determinant of debt-servicing capacity via its effects on incomc growth and export performance (regardless of which particular project is financed from abroad). Investment and production efficiency are subject to various policy influences, although somc important variables, stuclh as the supply of managerial and technical manpower, are not amenable to short-term measures. Exogenous shocks like civil unrest, import cuts, an(I the like can seriotusly disrupt economic efficiency. Terms of Borrowing Different countries have borrowed on (lifferent terms, and changes in interna- tional interest rates have affected the burdeni of a given amount of debt over 54 AFRICAN DEBT AND FINANCIN;( time. While harder termns do, by definition, create a higher servicing burden, and debtor governments can make unwise borrowing choices, it was noted earlier that borrowing terms were not noticeably different for the seriously affected than for other countries. Countries with relatively low debt-service burdens, like Botswana, Zimbabwe, or Kenya, borrowed on fairly hard terms, while some, like Somalia, were in trouble even though their loans were on relatively soft terms (table 3. 1). Econometric analysis suggests that although the terms of borrowing do affect the debt-service ratio in the expected direction (i.e., harder terms lead to higher debt-service ratios), this impact is not large. Thus, the current debt problem in ESA owes more to other factors than to the hardness of the debt, and we shall not emphasize this factor in the following analysis. Role of Creditors The debtor country decides how to use borrowed resources, but creditors do have a strong impact on the choice of project and its precise form. Moreover, creditors can use "hard sell" tactics to persuade countries to overborrow, even when the debtors are clearly heading into servicing difficulties (e.g., commercial banks in Tanzania in 1978-81, or in Somalia since 1980). Export-credit agencies also often keep cover on countries that are already in difficulty, because of weaknesses in their country-risk assessment procedures or project- evaluation capabilities. The phenonmenon of external loans financing large, unviable "white elephants" is well known in the African context.5 Not even the World Bank is free of its share of bad projects. Some bilateral donors, pursuing their commercial interests, have pushed through projeets that were extremely costly to the recipient. One egregious example (one of many) is the Inga-Shaba hydroelectric project in Zaire. One of the largest projects of its kind in Africa, it was financed largely by the tJS Export-Import Bank (Eximbank), which started in the early 1970s and was completed by 1982. The plant at Inga cost about $84. million (at 1984 prices), a transmission line to Shaba $146 million, and a high-voltage network within Shaba another $253 million. Every part of this enormous investment has been underutilized (the power generating plant, for instance, reached only 30 percent capacity by 1984), with concomitant heavy running costs, yet its servicing constitutes a major part of Zaire's debt burden. The demand for power was greatly overestimated, while the generating facilities 4 See E. H. Brau and C. Puckahtikom, Export Credit Cozer Policies and Payment Difculties, IMF, 1985. ` See the W!orld Banik's Towards Sustained Derelopment in Sub-Saharan Africa, 1984, p. 24. NATURE OF THE I)EBT PR03LE.;M 55 suffered from problems in equipment design and inadequate technical support. To some extent, the creditors must share the responsibility for creating the problem of Zaire, since the debtor government lacked the capabilities to assess the project properly. In this case, a US agency was involved, but this does not mean that the United States was more to blame than other creditors. Examples of this sort can be found for many creditors in many debtor countries. The ESA countries with a debt problem show different combinations of the above factors. It is important to understand these differences when remedies are being formulated. To the exteiit that the causes are traced to- faulty government policy, the remedy requires policy changes and institutional reforms. To the extent that exogenous shocks are to blarne, remedies lie in adapting the economies to the new circumstances, smoothing out temporary setbacks, and providing sufficient exteinal assistance to achieve the structural changes needed. We cannot do justice to the intricacies of this subject here, but a sketch of the genesis of Zambia's debt problems and a comparisoni with other seriously affected countries would he instructive. Genesis of Zambia's Debt Problems An adverse current external balance has consistently been the most powerful exogenous factor propellinyg Zambia into higher levels of debt. Its terms of trade index (1980 = 100), dominated by a sustained fall in the price of its main export (copper), declined from 262 in 1970 to 82 in 1983. In 1983, imports were, despite a substantial increase in (debt, under a third of their 1974 real value. However, Zambian terms of trade improved sharply in 1972-74 and again in 1.976-77. The improvements encouraged more overs-a. ,.rrowing, especially from financial institutions (which showed large increases in lending in 1972-76), and in the form of suppliers' credits (1974-79). Noncopper exports did not rise, partly because of consistent overvaluation of the exchalnge rate and partly because of supply weaknessess in the productive sectors of the economy. However, neither the Zambian government nor the lenders (including the multilateral institutions) expected the copper price decline to be so (dramatic and sustained. Thus the government's efforts to sustain imports by borrowing did not appear so misguided in the mid-1970s. The major adjustment to the decline in terms of trade was made by reducing investment rather than consumption. (;ross investment fell by 12.9 percent and development expenditures by 70 percent a year, respectively, during 1979- 83, while private consumption rose in real terms, sustained by official subsidies and price controls on consumer goods. By 1984, net new investment in productive facilities was low, and existing industrial and mining facilities were suffering from extensive deterioration. At the same time, the investments which 56 AFRICAN DEBT AND FINANCING had been made during the 1970s had been poorly planned and executed. Industrialization had been inward-looking and highly protected, largely incap- able of generating new exports. Besides being progressively starved of imported inputs, the largely state-owned industrial sector lacked the basic technological capabilities to maintain or improve the facilities it built up. It certainly did not possess, and could not over time generate, the capabilities needed for entering competitive export markets. Agriculture was potentially much more productive and competitive, but was hit by adverse weather conditions and constrained by policies that gave little incentive to expand production. In sum, Zambia's debt problem arose from its unwillingness (or inability) to cut back consumption in response to exogenous falls in income; its inability (partly because of wrong policies) to expand agricultural production and exports; its inefficient use of investment resources in industry, which was greatly overextended in relation to its technological and managerial capabilities and oriented to a small, protected market; and its inability to devote enough resources even to maintain its productive facilities. To top it all, Zambia borrowed on fairly hard terms, and its massive arrears (24.3 percent of total debt) added to its current repayment problems. The debt problems of the other countries arose from factors both different from and similar to those in Zambia. THE DIFFERENCES First, let us consider the differences. The role of exogenous shocks varied widely across the six seriously affected countries. Zambia was at one extreme with a massive and sustained decline in the price of its major export, and a smaller adverse impact on its agriculture from inclement weather. At the other extreme was Madagascar, with stable terms of trade until 1976. then an improvement followed by some deterioration. The Sudan, the biggest debtor in the region, also suffered only a slight deterioration in its external terms of trade (a mere -0.8 percent a year over 1970-82) and from a few seasons of bad weather. Tanzania and Somalia suffered somewhat more from exogenous factors. Tanzania enjoyed two booms in coffee prices (1973-74 and 1976-77) before its terms of trade deteriorated by 12 percent of GDP in 1977-82; at the same time, drought and war increased pressures to borrow overseas. Somalia's exports rose steadily until 1980 and its foreign debt remained modest. However, in 1977, came war wit1h Ethiopia and in 1983 a Saudi ban on imports of Somalian livestock (the value of livestock exports fell from $106 million in 1982 to $32 million in 1984). By 1984, imports were seven times greater than exports. Zaire was the closest to Zambia-it suffered a large terms of trade decline (from 200 in 1970 to 100 in 1983). A temporary reversal in 1972 encouraged heavy borrowing. After the second oil shock, its export earnings fell 25 percent NATURE OF TlE [)EBT PROBLEM 57 in 1980-83. Thus, exogenous shocks had very different impacts on countries in this group. The patterins of doomestic savings and consumption in the six couintries were also quite different. Somalia was at one end, with consumption in excess of GDP in most years since 1978, and with foreign aid (and later debt) financing this excess as well as a reasonable level of investment. Zaire was at the other end, with gross domestic savings rates as high as 26 percent and gross dornestic investment rates ranging between 18 percent and 38 percent of GDP during 1972-82. Other countries lay between these two. The Sudani had a very high consumption rate, especially from aid proceeds; aid and debt also financed grandiose industrial and agricultural investments. Madagascar had low levels of savings and investment until 1978, when it decided to launch a mnassive industrialization program based on foreign resources; yet in this period, domestic savings fell steadily, and the investment boom ran out of steam in 1982 as debt problems mounted. Tanzania maintained a reasonable level of investment, about half of it financed by domestic resources, tihrough much of the 1970s. Zambia started with high levels of savings and investment, but its sustained decline in income and mounting debt problems led to verv low new investment and deterioration of existing facilities by the 1980s. THE SIMILARITIES Now let us consider the similarities. The policies and reactions of the six countries corresponded greatly in three broad areas. First, exchange rates in all countries became progressively overvalued over the 1970s and early 1980s. The extent of overvaluation varied, but the effect was uniform: everywhere import dependence was encouraged; traditional as well as new exports were discouraged. Second, there was a universal inability (or unwillingniess) to cut back consumption leviels reached in periods of high commodity prices and high incomes. Perhaps it is unrealistic to expect countries to be able to adjust consumption levels to declines in income of the severity expen-Lnce(l bv Zambia or Zaire, but not even the Sudan or Somalia, with relativelv modest declines, adjusted consumption levels as their abilitv to sustain th -m fell. This "ratchet effect" did not applv equally to investment. Most of these countries initially sustained unrealistically high levels of investment based on borrowing, but, as economic difficulties intensified, they all cut back much more on investment than on consumption. Not only were most new projects abandoned, but existing facilities were also starved of proper maintenance and inputs. This, in turn, fed back into the economic crisis, lowering export potential and the productive capability of the countries. Third, the most important factor as far as the debt problem is concerned is the universal inefficiency in the use of investible resources through poor investment 58 AFRICAN DEBT AND FINANCING decisions and the inability to use existing investments effectively. This general economic inefficiency had several causes. Too many resources were directed to industry rather than agriculture (which also faced adverse internal termns of trade because of pricing and exchange rate policies). Too many inherently uneconomic "white elephants" were set up, many in industiy but also in many other sectors. Industriai investments were fragmented, inward-looking, and verv expensive, and shortages of technological and managerial skills made even relatively simple activities uncompetitive. The protected environment did little to stimulate efficiency gains over time, and the debt crunch came too quickly to allow a proper "learning period" (even the advanced newly industrializing countries (NICs) needed two to three decades to master new manufacturing technologies). An emphasis on public-sector expansion worsened the problems created by skill shortages, while adding problems of its own (such as reserved markets, official subsidies, and political interference). Thus, the end result was an inefficient and inflexible production structure, highly dependent on imported inputs but unable to compete internationally. This structure could not service the debt that had been used to set it up. Once the external environment turned unfavorable for traditional exports and aid inlflows, this basic deficiency became painfully obvious. 'Fhis feature of African debt distinguished it most sharply from the crisis-ridden countries in Latin America. Brazil, for instance, was able in a very short time to reorient its production to generate the huge export surpluses needed to service its vast debt: the basic competitive capabilities were present. In the crisis-ridden countries in ESA, on the other hanid, the existing productive apparatus (apart from traditional exports) could not do this. Viabilitv of the productive structure, therefore, has to be an intrinsic part of any long-term solution to the Africani debt problem. The solution does not, in other words, lie in squeezing debt service out of existing structures, but in providing additional net resources to change, rehabilitate, and improve those structures. TLese features of the ESA debt problem seem obvious now, but the signs were apparent much earlier. Yet debtors and creditors could not mount an effective response. The resulting "muddling through" strategy cost the debtor countries dearly. The next section illustrates the inadequate international response to Zambia's debt crisis. INADEQUATE RESPONSE TO THE DEBT CRISIS: THE CASE OF ZAMBIA Zambia's debt problem was thus brewing since the early 1970s, when copper prices started a long and sharp decline. The Zambian government delayed coming to grips with the problem until the early 1980s, when its efforts to borrow its way out of the problem could no longer be sustained. Creditors should have anticipated the "crunch" much earlier but contirnued to increase NATUIRE OF THE DEBT PROBLEM 59 TABLE 3.3 ZAMBIA: SELECTEI) INDICATORS 1975-80 1980-85 1 982 1983 1984 19851 Annual growvth rate (constant prices) GI)P - 1.1 -0.3 -2.8 -2.0 -1.6 -- 1.5 Consumption 0.() -2.2 -8.8 -4.4 -- 1.0 n.a. Investment - 16.9 - 12.9 - 23.5 - 24.2 -1.2 n.a. Exports - 3.5 - 2.5 -15.7 -11.4 -13.0 -6.5 Imports -8.9 - 13.9 -22.() -17.2 -23.2 3.7 Foreign debt: gross disbursements (million dollars) Bilateral loans 163 76 66 75 MultilaLeral loanis 52 47 112 87 Suppliers cre(lits 35 6 3 3 Commercial banks 99 .19 68 45 Official grants 3(1 42 50 71 Disbursements from 1985 commitments - - - 58 IMF 46 201 152 0 Net resource transfjr zia loans" (million dollars) Multilateral :3 - 14 51 n.a. United States 55 2 42 n.a. Germany 5 1'9 5 n. a. United Kingdom 12 3 51 n.a. Japan 5 -9 -11 n.a. USSR - 11 -3 -3 n.a. - Not applicable. n.a. Not available. a. Estimated. b. Includes ODA loans (but not grants), supplier credits. other official anld commerical banks. TABLE 3.4 ZAMBIA: CHRONOLOGY OF RECENT EVENTITh July 1976 IMF standbv agreement April 1978 IMF standby agreement May 1981 IMF extended Fund facility agreement (36 months) July 1982 Cancellation of EFF April 1983 IMF standbv agreement (12 months) May 1983 Paris Club agreement on debt restructuring March 1984 World Bank export rehabilitation and diversification loan May 1984 Consultative Group agreement on external aid July 1984 IMF standby agreement (21 months) July 1984 Paris Club agreement on debt restructuring February 1985 Suspension of 1984 IMF standby March 1985 IDA/World Bank agricultural rehabilitation project June 1985 Consultative Group agreement on external aid October 1985 Government announcement of foreign exchanige auction and import liberalization December 1985 Consultative Group agreement on external aid December 1985 IDA industrial reorientation credit January 1986 Liquidation of arrears vis-a-vis the IMF 60 AFRICAN DEBT AND FINANCING lending to Zambia at a high rate until nearly 1980. In 1981, the first major effort at economic reform was launched, with advice and financial backing from the IMF. However, the reform package stressed demand contraction and short-term balance of payments improvement much more than Zambia's overall needs-structural adjustment, export diversification, and improved economic efficiency. While the extended Fund facility (EFF) did lead to some improve- ments, not enough emphasis was placed on longer term, supply-side measures. IMF credit on hard terms did little to alleviate Zambia's debt problem. The austerity of the first reform package exceeded the government's ability to manage, and the program was abandoned in 1982 (see table 3.3 for selected indicators and table 3.4 for a chronology of recent events). Zambia embarked on a new chapter in 1983, when it negotiated another standby with the IMF and engaged in discussions with the World Bank on wide-ranging economic reforms, culminating in the export rehabilitation and diversification loan of 1984. The government adopted a flexible exchange rate system, decontrolled most prices, and took strong measures (including a freeze of government salaries) to reduce the budget deficit. The first steps toward a plan for rationalizing the copper-mining sector were taken as part of the Bank loan, which emphasized the long-termn strategy of developing alternative exports as copper production gradually declined. This was followed up by the beginning of a program of agricultural reform, including increase in producer prices, reduction in tax rates on agricultural income, decontrol of wheat prices, and the opening up of maize marketing and fertilizer distribution to private traders. These actions were taken in the context of a Bank group agricultural rehabilitation project in early 1985. Later in the same year the government announced the establishment of a foreign exchange auction and import liberalization program as a prelude to International Development Association (IDA) industrial reorientation credit and the negotiation of another IMF standby. This series of reforms impressed the donors and the creditors who applauded the government's commitment to set its house in erder. The Consultative Group (CG) met in mid-1984 to discuss the magnitude of the foreign resources Zambia would need in support of its reform program. The World Bank proposed: * rescheduling 100 percent of principal and interest payments due to all bilaterals and 100 percent of the principal due to private creditors. This would yield 41 percent of the required cash flow, with the remaining 59 percent coming from new grants and loans. * quick disbursing assistance for half of the new grants and loans * import growth of only 1 percent a year in real terms, after sharp declines throughout the latter 1970s and early 1980s. This slight recovery in imports from a dangerously low level was necessary to permit any economic growth and to sustain copper exports (the copper mines needed imported inputs). NATURE OF THE DEBT PROBLEM 61 The response of CG members was very favorable, and there was general agreement on the requirements for external finance as proposed by the Bank. Nevertheless, decisions by the Paris Club a few weeks later were inconsistent with the agreed financial framework. While the terms given to Zambia were liberal by Paris Club standards, and were as favorable as those agreed in 1983, they required Zambia to pay SDR 80 million more during the following 12 months than the CG had envisaged. Furthermore, new loan commitments and disbursements fell far short of CG expectations in 1984. Owing to these factors and an unexpected fall in copper prices, Zambia could not honor debt- service commitments and began to accumulate arrears vis-a-vis the Paris Club, the IMF, and other multilateral institutions. Zambia experienced an acute scarcity of foreign exchange for critical imports of raw materials and spare parts as well as capital and essential consumer goods. This further reduced copper exports, while capacity utilization of manufacturing assets, trucks, and tractors fell to abysmnal levels. GDP, consumption, and investment continued to decline, and there were few visible rewards for Zambia's courageous reforms since 1983. Why was the gap so big between CG decisions and actual capital flows? Three factors should be emphasized. * CG decisions are not very "hard": they are frequently imprecise and subject to many qualifications. * Participants at CG meetings represent aid agencies, which supply only part of the external finance destined for Zambia. Decisions on debt relief are made in the Paris Club or the London Club, and decisions on new loans by export-credit agencies and commercial banks are beyond the purview of CG participants. * The CG does not deterniine how the burden of providing resources to Zambia is to be distributed among different countries or agencies. In the event, disbursement of multilateral loans rose sharply in 1984 but declined somewhat in 1985 (table 3.3). There was no corresponding effort on the official bilateral side. The gross flow of supplier credits and commercial bank loans fell steeply. Among the major creditors, the United Kingdomn and the United States succeeded in raising substantially the net transfer of resources by increasing concessional loans as well as new loans from commercial banks. Thi., move was offset in some measure by reductions of all types of flows from Gerrnany, Japan, and the USSR. Apart from the inability of the existing institutional machinery to provide a coherent response to Zambia's acknowledged financing needs, there were other problems.6 The debt-renegotiation process was time-consuming and costly in terms of high-level administrative manpower. Its results were unpredictable, t See discussion, chapter 6. this volume. 62 AFRICAN DEBT ANI) FINANCING and the process had to be repeated periodically for each creditor. The period of reseheduling was short, so that the debtor had no guarantee that its long- terrn adjustment programs woutd continue to receive externial support. All these factors contributed to the inadequate handlinig of Zambia's debt problem as it reached crisis proportions. Zambia's case is not unique, of course: the same syndronme beset otlher seriously affected countries. The final result was an inability of the creditor and donor community to comie squarely to grips with the debt problem in sub-Sahaaran Africa. C ONCLUT SIONS The origins of the debt crisis in Eastern andi Southeirn Africa are complex and varied. Factors outside the control of dlelbtor nations have often playe(I a powerful role in propelling them inito heavv borrowing abroad. However, shortcomings in (domestic policy and weaknesses in the productive structure have also exercised a significant influence. Thle most striking common element to emerge from the experience of the crisis-ridden debtor countries is the inability to utilize new an(l existing investment efficiently. Unless this problem is solved or relieved. there is little hope that the debtors can become viable and( creditworthv ini the long term. 'I'here is otne other possible lifeline-the revival of traditional exports. This would help greatly in the short to mediumn termni in the long tern, however, the nonitraditionial sectors would have to strengthen their performance. If no revival occurs, this long-term problem will have to be tackled imme(liatelv. The existing institutional framework for del)t relief anid fresh aidl and eredhits is not gearedl to solving structural problems of this sort. These problems are most evident in the sub-Saharani African debtor countries. 'Jo ad(dress these problems would( consequently require special measures lby the international community, as well as strenuous policy reforms on the part of the (lebtors. World Bank Reprint Series: Number 378 The following are the remarks made by Mr. Jaycox to a panel discussion, entitled "What Is To Be Done?' Reprinted with the permission of the Institute for International Economics, from African Debt and Financing, Special Reports number 5 (May 1986), pp. 178-184, edited by Carol Lancaster and John Williamson. 178 AFRICAN DEBT AND FINANCING Edward V.K. Jaycox The 15 countries of Eastern and Southern Africa (ESA) are classified in chapter 3 into 3 "not affected" by the debt problem, 6 "moderately affected," and the remaining 6 "most seriously affected." This paper is concerned with the last category, which consists of Zaire, Tanzania, Somalia, Zambia, Madagascar, and the Sudan. The debt problem in these "most seriously affected" countries is the result of their structural and policy weaknesses, often (but not always) accentuated by severe exogenous shocks and actions by their donors and creditors. These debtor economies have experienced prolonged economic decline, falling net investment, widespread damage to their physical assets, an erosion of their human capital stock, and a substantial compression of consumption levels. The sociopolitical fabric of many of these countries is threatened. It is not likely, given the prospects for their exports and their minimum import needs, that their economies can service their debt fully. Even if debt service is rescheduled on liberal terms, under the existing "rules of the game," and even if debtors initiate genuine reforms, we do not foresee a clear solution to the problems of these "most seriously affected" countries. Solutions that aim simply to overcome each debt "crunch" as it arises cannot provide solutions to the deep-rooted structural problems of the crisis-ridden debtor countries. Long-term solutions necessarily require rehabilitation and major policy reforms in these countries.' Such reforms need considerable time Developed countries can help lower the debt-service burden by reducing protectionist barriers A PANEL DISCUSSION 179 to take effect, particularly since increased production efficiency requires the acquisition of technological and managerial capabilities. Some per capita income' growth, even at a moderate level, is necessary if economic reform is to acquire an internal political constituency. Thus, a politically feasible solution must involve a transfer of resources of sufficient size and over a sufficient period to enable restructuring as well as some economic growth. The Zambian case illustrates various inadequacies in the present institutional framework for dealing with the debt problems of sub-Saharan Africa (chapter 3). Even when the debtor country commits itself to a serious economic reform program (which is approved by the multilateral institutions and accepted by the donor-c.editor community), it faces two soits of problems. First, the process of debt renegotiation is slow, costly in terms of administrative resources, limited in duration, and uncertain as to its long-term irnplications. Thus, the debtor has to renegotiate debts not only with bodies like the Paris Club but also individually with each creditor, a heavy demand on the limited administrative resources of the debtor government. The rescheduling is valid only for a year, so that the debtor does not receive a clear commitment that its long-term structural adjustment program will get the debt relief it needs in future years. In addition, since rescheduled debt generally bears commercial rates of interest, the exercise leads to a hardening in the average terms on which external resources are transferred. Such temporary relief then leads to a "ballooning" of debt-service payments in a relatively short (three to five year) period-too short for most countries in this region to achieve a significant economic turnabout. Second, the existence of a variety of forums that deal in an uncoordinated manner with different aspects of debt relief and new credits and grants means that it is practically impossible to achieve the target of transferring a given amount of net resources to the debtor. There is no institution or forum which currently has overall responsibility for ensuring that this sort of target is met. The debtor may be passed back and forth between Consultative Groups, the Paris Club, the London Club, and other such bodies without a clear assurance that the resources it needs to carry through its reform program will be committed. This uncertainty, and the real risk that the resource transfer realized will fall short of target, acts as a considerable disincentive to persisting in the painful and politically costly reform programs. What is required, therefore, is coordinated action by debtors, bilateral creditors and donors, and the multilateral institutions. Such a mutually reinforcing system would be very important, of course, for all developing countries, irrespective of how affected they are by the debt problem. It may be too much to hope that such a system could be established immediately for all developing countries, or even for all sub-Saharan countries. But a special to exports from developing countries and by reflating their economies. This set of issues is not explored in this paper. 180 AFRICAN DEBT AND FINANCING regime for the "most seriously affected" debtors which wish to undertake intensive reform may be easier to visualize. The characteristics of the special regimes are described below. THE DEBTOR COUNTRIES The first step for seriously affected debtor countries is to work out a credible package of policies that can lead to econoniic recovery and renewed credit- worthiness in a specified period. The World Bank and the International Monetary Fund can provide assistance in working out such a reform package, and act as monitors to evaluate the progress of the reforms for the creditor and donor community at large. While the diversity of debtor economies means that each package would have a different policy mix and emphasis, there will be some common elements. In a typical seriously-affected, low-income country, the package would consist of the following elements: o measures to correct exchange-rate distortions and to move toward a system in which exchange rates approximate more closely market-determined rates, so providing incentives to efficient export growth and import substitution * stricter demand management and budgetary policies in order to reduce excessive consumption to raise domestic savings and the productivity of public investments * incentives and measures for efficient development of agriculture and industry; these would include a more rational structure of price incentives (and removal of most price controls) and of protection against import competition; strong measures to provide necessary extension services and inputs to agriculture, and to improve parastatal performance in industry and trade; and liberalization of policies toward private enterprise (and perhaps foreign investors) * improved management and coordination of external aid and debt * measures to build the institutional strength and efficiency of core economic ministries and other public sector agencies, and to break the critical bottleneck of skilled manpower. Simple and obvious as these rm-easures sound, they arc not easy to design or implement. the move from the highly interventionist strategies pursued by many African countries to more outward-looking and market-oriented strategies can be painful. It could involve hurting entrenched elites as well as urban populations, although the overall redistributive effects would tend to be favorable (helping smallholder agriculture while reducing widespread rent-seeking activ- ities). The main problem in undertaking such structural reforms is that in present economic circumstances the costs appear to be much higher. Falling incomes, grossly underutilized capacities, real urban wages near sub-subsist- ence levels, mounting social unrest-these may not be the most propitious A PANEL DISCUSSION 181 circumstances in which to administer strong reform measures. However, it is precisely these adverse circumstances which have forced debtor countries to seek drastic solutions. What is important now is tihat the solutions be correctly perceived by debtors and creditors, and be properly implemented. BILATERAL DONORS AND CREDITORS The promotion of economic development has not figured prominently in the past actions of donors and creditors now caught in the debt crisis. It is becoming increasingly obvious, however, that the fundamental debt problem can be tackled only by supporting debtors that are willing to discipline themselves and to undertake the major structural reforms outlined above. Support in this context can have several components: o adherence by donors and creditors to the expenditure program set up by the government in conjunction with the World Bank and the IMF; this means forgoing the financing of projects or commodities that may appeal to the commercial interest of donors or creditors but which are considered unnecessary for the debtor * extension of quick-disbursing, program finance to the extent considered necessary by the World Bank and IMF to achieve structural adjustment * pledges to give finance in the framework of three-year, rolling expenditure programs, if the debtor is certified by the World Bank and the IMF to have adhered to its policy commitments * most importantly, the provision of sufficient external finance, in the form of grants, coneessional loans and debt relief, to support the debtors' policy reforms. The response of the donor and creditor community can be broken into a series of interconnected steps. The first is to agree on an estimate, prepared by the World Bank and the IMF, of the total net resource requirements over a specified period for a particular debtor country. These requirements take into account expected balance of payments developments consistent with reasonable economic growth (maintaining or modestly increasing real per capita constumption), assuming significant improvements in the debtor government's economic policies. The second step is to decide on the correct mix between debt relief and fresh financial resources to arrive at the required net inflow. Debt service to multilaterals as well as interest on rescheduled commercial debt is not reschedulable. As for the rest of the debt-service payments, various alternatives are possible. At one extreme, all the debt payments can be met as the obligations arise, to be offset by new loans or grants. At the other extreme, the debt can be entirely rescheduled, with a correspondinigly lower need for fresh capital inflows. Under present rules, the repayment of existing debt with fresh inflows is preferable to debtors, since the terms for fresh inflows tend to 182 AFRICAN DEBT AND FINANCING FIGURE 6.1 ZAMBIA: DEBT SERVICE ON NEW AND EXISTING DEBT AND BALANCE AVAILABLE FOR DEBT SERVICE Million dollars 1,100 1,000 - 800 - 700 - , ,........................... After rescheduling 5007 400 - 300 - Balance available -.' 200 -for debt service 200 - --- 100 - 0 -100 -200 . - 1985 86 87 88 89 90 91 92 93 94 95 Years be softer than those obtainable on rescheduled debt. The rescheduling of past debt on commercial terms leads to a ballooning of debt service, with the cost of rescheduled debt quickly exceeding the savings in the initial period. This ballooning effect is illustrated for Zambia in figure 6. 1. A debt-service profile of this sort can be sustained only by coum.ies that can provide a very rapid export supply response under the new policy package. However, for most countries in this region, the preponderance of primary commodity exports facing relatively stagnant markets renders such response unlikely. Thus, the appropriate mix between debt relief and fresh inflows is likely to be weighted toward the latter, unless debt relief can be given on very concessional terms. The third step is to allocate the financing burden between bilateral and multilateral donors and creditors. Since the multilaterals cannot grant debt relief, their contribution rests on the extent to which they can roll over existing credits (on similar or softer terms) and provide additional credits. Their status as preferred creditors entails an obligation to maintain, as far as possible, substantial net resource transfer to debtors undertaking serious reform. The fourth step is to agree on criteria for burden-sharing among the bilaterals. Different bilaterals are prominent in different debtor countries, reflecting historical and geopolitical considerations. This rules out the notion of universal criteria, but it may be important, say, for Saudi Arabia to know that the special A PANEL DISCUSSION 183 treatment it is expected to give to Somalia and the Sudan in support of their reform will be paralleled by what France is doing in Madagascar or the United Kingdom in Zambia. The existing major bilaterals in each case will have to bear most of the burden, unless they can persuade other aid-givers to join. Bilaterals that have extended finance on hard terms in the past, and which are correspondingly large recipients of future debt service, should make a partic- ularly large effort in support of the debtor's reform efforts. The fnfth step is to coordinate the aid and loan-granting agencies in each of the bilaterals. Many parties are involved in these bilateral relationships. For example, US relations with Zambia involve the US Agency for International Development (AID), the Export-Import Bank and commercial banks. At present, there is not nearly enough coordination among these parties. In the future, it is essential that each donor and creditor government take responsibility for the overall financial relationship with the debtor country engaged in a serious reform process. The target for net resource transfer and for the appropriate mix between new aid and debt relief can be met only in this way. Finally, there is the question of the present institutional machinery. The Consultative Groups discuss the economic situation of the debtor country in a comprehensive manner and consider medium-term scenarios, with an opera- tional focus on the balance of payments for the next year or two. Representatives of donor and creditor governments generally come from aid ministries and decisions by the Consultative Group are more or less confined to official concessional assistance. Export-credit agencies and private banks meanwhile make their own independent decisions on new loans. Action on debt restructuring is taken by the Paris Club for official debt and by the London Club for private debt. Responsibility is consequently very fragmented and diffused, and the cumbersome and uncertain nature of the process imposes additional costs on debtors. It is therefore imperative to improve existing organizations, strengthen the international machinery and generally become more business-like in tackling the debt problem. In particular, it is essential to have an authoritative donor- creditor forum for decision making. To this forum must come representatives of donor and creditor governments that have the authority, after taking account of actions by private donors and creditors, to contribute sufficient resources on appropriate terms in support of debtor governments engaged in serious reform. This role must be enacted with clarity and coherence at the authoritative forum proposed here. WORLD BANK AND IMF The two major multilateral institutions can play two crucial roles in dealing with sub-Saharan Africa's debt crisis: first, of a technical and advisory nature, and second, in their capacity as major creditors. On the technical and advisory side, the World Bank and the IMF can provide 184 AFRICAN DEBT AND FINANCING the link between debtors and the creditor-donor community, ensuring that both parties fulfill their obligations in implementing the reform program. In other words, they can play a key role in orchestrating the reform efforts of debtors and the support of donors and creditors. To this end, they have to devise principles and procedures for much closer interinstitutional collaboration than exists now. They also have to equip themselves, in terms of staff and expertise, to help debtor countries design appropriate policy packages; monitor their implementation in debtor countries; make specific recommendations to donors and creditors on support needed and the proper mix between debt relief and fresh loans and grants; and monitor the response of donors and creditors and, in case of shortfalls, take appropriate action. In their role as major creditors, the two major multilaterals must address the special needs of sub-Saharan Africa. They have operated with resources on a variety of terms: ordinary IMF drawings, Trust Fund money, World Bank loans and IDA credits. Most of the African debtors have relied mainly on concessional IDA funds and this should continue. Resources on near-commercial terms are not suitable for borrowers that cannot be expected to adjust speedily. This emphasizes the critical importance of securing the IDA VIII on a scale commensurate with the magnitude of Africa's economic problems. It also underscores the desirability of concentrating concessional Trust Fund reflows on African debtors engaged in serious reform. One aspect of the predicament of African debtors is that they have drawn heavily oni IMF ordinary resources on near commercial terms during recent years. Nearly 20 percent of projected service payments during 1985-90 of the most seriously affected debtors is to the IMF. This poses a dilemma. On the one hand, IMF resources have a revolving character but, on the other, many of these African debtors have not achieved the turnaround in their trade balance which would permit early net repayment of the dues to the IMF. It is important, therefore, to deal judiciously with this issue so that adequate support can be maintained for debtor governments undertaking serious reforms. In conclusion, the basic thrust of our analysis is that African debtors can grow out of their current debt problems, given sufficient time and financial support. The fact that a number of countries in the region have remained creditworthy debtors and have used debt productively gives grounds for hope that the ones in trouble today can be rescued with the right mix of reform and assistance. Reforms are already under way in a number of countries, but they need to be deepened and sustained. Donors and creditors must do their part in supporting this painful and often prolonged process. The existing institutional system needs to be improved in some ways. The Bretton Woods institutions can play a pivotal role at various stages of this process. The essential point is to adopt a positive approach to solving this difficult problem, rather than to muddle on from on-e set of ad hoc measures to another, while the debtors slide deeper into economic decline.