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NZ support for debt relief to poor countries

27 June 2005 Media Statement

New Zealand announces support for debt relief to poor countries

New Zealand will support debt relief initiatives by paying off a share of developing country debt held by the World Bank, Aid Minister Marian Hobbs announced today.

"Debt is a crippling issue for many poor nations. If the rich nations of the world fail to act, it is the poor who will suffer," Marian Hobbs said.

"New Zealand has agreed to support a G8 proposal to effectively cancel the debts to the World Bank's International Development Association for some of the world's poorest and indebted countries. This is an important step in the global effort to reduce poverty.

"Due to our size, New Zealand is a relatively small player, holding only a 0.12% share of donor funding in the Bank. But, if all players agree to the proposal and match our contribution we'll be helping to make a real difference.

"The proposal needs to be agreed formally by donor country members of the World Bank.

"NZAID, our international aid and development agency, will fund this proposal as part of our support to the global fight against poverty. The estimated cost of this initiative is under $1 million dollars this year, moving to nearly $3 million by 2015.

"Roughly US$55 billion of debt is potentially covered under the G8 proposal. This initiative is focused on helping those countries which have severe poverty and where debt relief can really make the difference to their future prospects.

"This initiative, plus a WTO trade round which delivers on the promise of the Doha Development Agenda, should free up resources for more crucial development investments by poor countries, and allow them to trade their way to more sustained economic growth.

"I welcome the dialogue between officials and Jubilee Aotearoa Debt Action Network, which has contributed to New Zealand's decision to participate in this initiative," Marian Hobbs said.

Debt Q & A

General

What countries have the biggest debt problem?

The focus of the G8 proposal is on the 38 Heavily Indebted Poor Countries (HIPCs). This is a group of the world's poorest countries (with average annual incomes of US$500 a year, or in many cases substantially less) with the most serious debt problems. These countries have run up large debts, have high levels of poverty and have limited financial resources with which to repay their debt. The cost of servicing excessive levels of debt affects their ability to provide urgently needed basic health, education and other services. Most of the worst affected countries are in sub-Saharan Africa.

Countries emerging from conflict often face particular difficulties. The debt continues to build up even if the country is in a state of civil war. So when there is a peace settlement one of the first things a new government has to deal with is a massive debt. This makes it difficult for them to afford the immediate expenditure needed to consolidate peace processes and show people that peace is worth it: ie to deliver the "the peace dividend". Examples include: Rwanda and Nicaragua.

How did these countries get into so much debt?

Their governments - and often different ones from the ones in power today - took out loans for big projects, often projects that have failed to deliver the benefits that were expected. Some people argue that they were actually encouraged to do this by some of the lending institutions themselves, and endorsed by their Boards - and that the appraisal processes applied by these institutions were not as good as they should have been. There has been criticism that too much focus was on signing the loans and not enough on the quality of the project. But it's a complex issue - these projects might have performed better if there had been better governance, for example. Even in cases where projects have been successful, overall growth in the economy might have been insufficient to generate enough income to pay for the loans. The fact remains that, for whatever reason, many governments have insufficient funds to provide adequate health and education services for significant numbers of the world's poorest people.

Who is owed all the money?

Mostly the international financial institutions: the World Bank, International Monetary Fund (IMF) and the regional development banks, like the African Development Bank. Many wealthy countries also run a variety of lending or credit operations too. For the poorest countries, private sector lending is generally much smaller by volume and significance, largely because these countries are not deemed "creditworthy" for regular commercial lending.

Do poor countries owe New Zealand money?

No, not directly. New Zealand's bilateral development assistance is made up entirely of grants not loans. New Zealand cancelled its last bilateral debt in 1999, and we are not a member of the Paris Club of bilateral creditor nations.

But as a member of international financial institutions like the World Bank, the Asian Development Bank and the IMF we have, with others, helped finance and endorsed many of the loans. NZAID, the government's international aid and development agency, contributes to the concessional lending pools, also known as soft loan facilities, of the World Bank and Asian Development Bank. These lending pools need periodic top-ups from donors because the lending is so highly subsidised that much less comes back into the pools on repayment than was originally lent. Under recent replenishment terms, the soft loan facilities can also disburse outright grants too, further necessitating new contributions from donors.

Hasn't a lot of debt already been cancelled?

The International Monetary Fund (IMF) and World Bank established the Heavily Indebted Poor Country (HIPC) initiative to reduce the debts of these countries. New Zealand contributed $6.4 million to HIPC, and a further contribution of $3.45 million to HIPC was recently agreed. HIPC has reduced debt stocks by two thirds in eligible countries, and has been accompanied by increased poverty reducing expenditure in these countries. In addition, a number of developed countries have forgiven bilateral debts owed to them by poor countries. But experience has shown that the HIPC debt relief and bilateral debt cancellation has not gone far enough - many poor countries still face an irreconcilable dilemma between helping meet the economic and social rights of their poor and servicing their debts.

Are poor countries still encouraged to borrow money?

Up to an affordable point, yes. Debt is in itself not necessarily a bad thing. Invested wisely, these loans can have a positive impact on growth and improve the living standards of the poor. The repayments on these loans are used to fund new loans to other poor countries. The difficulty arises when countries take on too much debt, or use loans to fund projects of questionable economic return or marginal benefits to their citizens. Recent discussions around the future lending programmes of the World Bank have agreed much lower thresholds for so-called affordable debt and have resulted in agreement to provide increased grant funding, instead of more loans, to countries which have already reached these thresholds. This is intended to be part of the solution to break the "lend and forgive" cycle.

Debt relief

What is debt relief?

Debt relief can take one of a number of forms.

- Debts can be rescheduled, for example by spreading the repayments over a longer time period. This has its pluses and minuses: just like extending the period of a mortgage on a house. Rescheduling can bring down the monthly payments, but the interest you pay over the life of the loan will increase, sometimes quite substantially.

- Donors can agree to help meet the debt servicing costs, for example by agreeing to pay some of the interest and loan repayments due for a period of time. The analogy would be someone saying to you that they will pay your monthly mortgage repayments for the next few years, but that after a certain time you'll be expected to start paying for them again yourself.

- Or donors and/or the lending institutions can agree to write off some or all of the amounts owed, which is called debt forgiveness or cancellation. This is like someone saying that they will pay off the rest of your mortgage either in a lump sum or by taking over the responsibility for meeting the loan repayments for the life of the loan.

The G8 is proposing to effectively cancel the multilateral debt stocks for countries (initially 18) that have completed the HIPC process. The proposal still needs to be agreed by member countries of the IMF, World Bank and African Development Bank. The eligible countries will no longer need to make repayments on their multilateral debts. Their future assistance from the international financial assistance will be adjusted to take into account the amount of debt stock cancelled, but an equivalent (to the amount of debt stock cancelled) amount in additional financing will be provided by donors for reallocation to these and other poor countries. Recipient countries will likely receive their future assistance mostly in grant form. This will help to break the "lend and forgive" cycle.

Why is debt relief important?

In 2000 New Zealand and the rest of the United Nations member states signed up to the Millennium Declaration. Amongst other promises, this underlined the global commitment to eradicate poverty, and set out a number of specific goals (the Millennium Development Goals) and related targets. These cover real life-and-death poverty indicators: the numbers of mothers dying in childbirth, the numbers of children under five years old who die each year, halting the spread of HIV/AIDs, and the like.

It's now becoming increasingly apparent that without additional resources, many developing countries - and particularly those in sub-Saharan Africa - will fail to reach the MDGs. These countries need additional help so that their people can access basic health, education and other services. However, at the same time the international community says that more needs to be spent on this international poverty reduction effort, some countries are having difficulty keeping up with all their debt repayments to the World Bank and other international financial institutions. The G8 proposal will entail additional net flows of financial resources to indebted countries and other poor countries. These resources will help these countries in terms of medicines available at the local health clinic, books and chalk in the schools, or even the maintenance of an important local road.

What can be done to ensure debt relief translates into actual poverty reduction?

Debt relief is being provided to countries where the international community has confidence in locally owned "poverty reduction strategies". These set out the way in which governments intend to prioritise their poverty reduction efforts, and this usually involves increasing - or at least protecting - the amount of the budget which goes to essential services used by the poor. Progress in implementing these strategies is usually monitored jointly by donors and the developing country concerned. And the strategies are frequently supported by other poverty reduction initiatives with additional monitoring and reporting arrangements.

The additional resources associated with the G8 debt relief proposal are to be reallocated to poor countries on the basis of their performance. Countries with institutions that govern well, with good policy settings, and a proven track record of using assistance effectively, will receive relatively more funding. This ensures that assistance is directed where it is used most effectively in reducing poverty. It also provides an incentive for countries to improve their performance and thereby increase the amount of assistance that they receive.

What mechanisms are in place to prevent corruption in countries that qualify for debt relief?

There's always a risk that some debt relief or other development assistance will be misused, whether it goes through government budgets or is delivered as discrete projects. Where governments are receiving debt relief or other forms of direct assistance to their budgets, the international financial institutions and bigger bilateral donor agencies always give special attention to reviewing local financial management systems. These reviews usually identify certain weaknesses, and then the donors and governments work together to address these areas. This can include, for example, strengthening auditing processes, or increasing public and parliamentary involvement in budgetary processes. The prospect of debt relief and other forms of direct budgetary support can actually act as an incentive for governments to strengthen such financial management systems, with benefits across the whole range of government expenditures, not just those being targeted by donor initiatives.

Will the G8 debt relief proposal guarantee that debt problems do not reoccur?

The G8 proposal is focussed on reducing existing debts for eligible countries. No amount of debt forgiveness can guarantee future financial solvency. Long-term debt sustainability depends on solid growth based on sound government policies, including prudent external borrowing and debt management. For many countries it may also be linked to the opening-up of increased trading opportunities.

What are New Zealand and other countries doing to support debt relief?

New Zealand and other countries have contributed significantly to the HIPC initiative. New Zealand has advocated for the causes of debt repayment problems to be better addressed. New Zealand advocated strongly for the new approach to concessional lending now agreed in the World Bank and IMF, where countries assessed as being "debt vulnerable" will receive grants instead of more concessional loans. New Zealand has argued for a prudent approach by international financial institutions to new lending, particularly in the Pacific. The decision to support the G8 initiative is in recognition of the fact that greater debt relief is needed to support the achievement of the MDGs. Importantly, it involves additional financial transfers to the countries that need it. It may turn out that more needs to be done to address debt burdens in other poor countries. New Zealand will continue to keep under review its options for addressing multilateral debt.

Is the New Zealand funding for this debt relief initiative "additional" to existing ODA?

The funding sought from donors for the G8 initiative is necessary in order for the effective cancellation of multilateral debt to be matched by additional financing for the poorest countries. New Zealand's contribution will be provided by the New Zealand Agency for International Development (NZAID). The New Zealand Government has committed to significant new funding for NZAID over the next three years. This new funding has enabled New Zealand to participate in the proposal.

ENDS

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