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Heavily indebted poor countries (HIPC) initiative

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Heavily indebted poor countries (HIPC) initiative

The Heavily Indebted Poor Countries (HIPC) Initiative is an international debt relief mechanism that provides special assistance to the world's poorest countries. It was launched at the G7 summit in Lyon, France in 1996 following a proposal from the World Bank and the International Monetary Fund (IMF). It is fully supported by the European Union and its Member States. The initiative was revised and strengthened in 1999 following the G7 summit in Cologne, Germany and has become known as the 'Enhanced HIPC Initiative'. It was originally planned to last two years, but has now been extended four times (in 1998, 2000, 2002 and 2004). The latest extension will possibly raise the number of eligible countries to around fifty.

Objective The principal objective of the initiative is to reduce the debt burden of poor countries to sustainable levels in order to ensure that no country faces a debt burden that it cannot manage. It represents a significant step forward, as it places debt relief in the framework of poverty reduction by aiming to ensure that essential restructuring and the development of a country is not compromised by servicing unsustainable debt burdens. The HIPC are also required to embark on clearly defined poverty reduction strategies. The initiative is made up of several dimensions: debt relief/cancellation and structural and social policy reform concentrating particularly on basic health and education provision. For the first time it now involves all types of creditors, i.e. bilateral, multilateral and commercial.

Financing the HIPC Initiative The total amount of aid provided to the 28 countries that have reached the "decision point" (see below) and the 13 countries that could benefit from debt relief under the enhanced HIPC initiative is estimated to be at around USD 61 billion in net present value for 2004. The funding is almost equally divided between two main types of creditors:

  • Bilateral and commercial creditorsThis category includes individual national governments as well as private enterprises;
  • Multilateral creditorsThese are multilateral banks such as the World Bank and the IMF and regional financial institutions such as the African Development Bank.

Debt relief from multilateral financial institutions is generally dealt with in the framework of the HIPC Trust Fund, which is managed by the World Bank. The Fund is made up of donations from a variety of multilateral and bilateral actors. The European Union is a major contributor to the Fund.

Eligible countries The initiative is designed to help those countries that cannot reach a sustainable debt burden through traditional mechanisms of rescheduling and debt reduction alone. These countries must follow IMF and World Bank-supported adjustment programmes and must implement a poverty reduction strategy in order to ensure that the benefits brought about by the special assistance awarded through the HIPC Initiative are used to further their development. The exact conditions they must meet to qualify are described below.

As of November 2001 over 40 countries, which include a number of ACP countries, were classified as heavily indebted poor countries although not all have yet qualified for assistance under the HIPC Initiative, nor will they do so automatically.

The stages of the HIPC Initiative There are two main stages to the HIPC Initiative. During the first stage the countries must adopt a number of measures in order to be considered for interim debt service relief (decision point). Once accepted, they qualify for some interim debt relief and must implement certain policies and meet certain conditions in order to qualify for full assistance (completion point). The process is very flexible, as there is no fixed timetable for the completion of the two stages.

Stage one: leading to decision point

Prior to qualifying for aid under the HIPC Initiative, the countries must normalise their relations with multilateral institutions and reach an agreement about discharging possible arrears. They must subsequently adopt adjustment and reform programmes supported by the IMF and the World Bank and establish a proven track record in implementing them. They must also adopt a special Poverty Reduction Strategy Paper (PRSP). During this first phase the applicant countries continue to benefit from "traditional" debt relief, laid down in agreements with bilateral creditors in the Paris Club.

Once this has been achieved, the remaining debt is analysed to determine whether a country's external debt stock is sustainable and whether it is eligible for aid under the HIPC Initiative. This is known as the 'decision point'. The decision is not based on the face value of a country's external debt but on its 'net present value' (NPV), which takes into account other important factors so as to arrive at the real debt burden. Debt is considered unsustainable when debt-to-export levels exceed a fixed ratio of 150%. In the special cases of very open economies, where external factors alone may not adequately reflect the fiscal burden of external debt, the ratio can be set below 150% provided the country meets certain conditions.

During this period bilateral and commercial creditors are generally expected to reschedule obligations coming due, achieving a 90% reduction in NPV of the debt owed to these two types of creditors. The World Bank and the IMF provide some 'interim relief' and other multilateral creditors are considering doing the same.

Stage two: leading to completion point Once a country is eligible for support under the initiative, it is entitled to extra debt relief above and beyond that provided by traditional mechanisms. In order to reach 'completion point' and benefit from full assistance, the country must establish a further track record of good performance under IMF/World Bank supported programmes as well as meeting other requirements. There is no deadline imposed for the completion of this second stage, however qualification for full assistance under the initiative is dependent on 3 main factors:

  • the satisfactory implementation of key structural policy reforms agreed at the decision point;
  • the maintenance of macroeconomic stability;
  • the adoption and implementation of the Poverty Reduction Strategy for at least one year.

Once a country has fulfilled these criteria it reaches 'completion point' and qualifies for the remaining assistance in order to reach a sustainable debt level, which implies the following:

  • Bilateral and commercial creditors: a reduction in the net present value of the stock of debt, proportional to their overall exposure to the HIPC. Many have announced that they will provide debt forgiveness over and above that envisaged by the HIPC Initiative. The Paris Club, an informal grouping of creditor countries, has indicated that it could reduce the stock of eligible debt by up to 90% in present value terms;
  • Multilateral creditors: a (further) reduction to reach sustainable debt levels.

Role of the European Union The EU and its Member States are important players in this initiative, reflecting their importance as development partners on the international scene. In a communication to the Council in 1999, the European Commission outlined its approach to the initiative and pledged donations to the ACP countries, Latin American countries and some countries in Asia. The biggest share of its support to the HIPC Initiative goes to the ACP countries. The Union plays a dual role, participating both as creditor and donor, providing debt relief as well as direct donations to certain HIPC countries and to the HIPC Trust Fund. The European Commission, which manages the EU's financial contribution to the initiative, signed two Financing Agreements in July 2000 governing the EU's contribution to the Trust Fund (EU as a donor) and to the European Investment Bank (EU as a creditor). At the present time, the total EU contribution to the HIPC Initiative is over EUR 1 billion.

Progress The HIPC Initiative has already had a positive impact on heavily indebted poor countries. To date 28 countries have reached the decision point and can benefit from interim debt relief. Of those 28, 18 have reached the completion point. The majority of these countries are in sub-Saharan Africa.

The HIPC Initiative alone is not a panacea and the initiative still attracts criticism from academic circles, NGOs and civil society groups. HIPC funding, use of HIPC resources, eligibility of middle income countries with a high percentage of people in poverty, debt sustainability, poverty reduction and the issue of additionality are among the key issues currently being debated.

Last updated: 14.12.2005