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LECTURE SEVEN

whether official or private involves repayment obligations. All borrowing.    Developing countries do not only borrow from donor countries and multilateral agencies but also commercially from the international banking system. unless the loans are gifts or written off. . The loan has to be repaid over a certain number of years (amortization repayments) Interest payments will be charged on the loan.

Debt burden are measured by various indicators: Debt to export ratio Debt to national income ratio Debt-service ratio (the ratio of debt service payments to export earnings .      Amortization and interest payments constitute debt-service payment. All loans that have to be repaid with interest are debt-creating flows.

The accumulation of external debt is a common phenomenon of developing countries at the early stage of economic development where: -The supply of domestic savings is low -Current account payments deficits are high -Imports of capital are needed to augment domestic resources. the external debt of developing countries was relatively low and small. Prior to the early 1970s.  .

In recent years. when poorly managed. . it is a contractually fixed charged on domestic real income and savings.   Foreign borrowing can be highly beneficial providing the resources necessary to promote economic growth and development. these costs have greatly outweighed the benefits for many developing countries. it can be very costly. Debt service is the payment of amortization and accumulated interest. The main cost associated with the accumulation of a large external debt is debt service.

. Debt service charge must be made with foreign exchange. debt service charges increase.   As the size of the debt grows or as interest rises. curtailed imports or further external borrowing. debt service obligations are met by export earnings. In most LDCs. Therefore debt service obligations can be met only through export earnings.

The net capital inflow is the difference b/n the gross inflow and the amortization on past debt. The basic transfer is important because it represents the amount of foreign exchange that a particular LDC is gaining or losing each year from international capital flows. It is measured as the difference b/n the net capital inflows and interest payments on the existing accumulated debt.   The basic transfer of a country is defined as the net foreign-exchange inflow or outflow related to its international borrowing. .

let r =the average rate of interest so that rD measures total annual interest payments. BT is simply the net capital inflows minus interest payments BT = dD –rD = (d-r)D . Fn be expressed as the rate of increase of total debt. D is the total accumulated foreign debt and d is the % rate increase in the total debt. then Fn = dD Because interest must be paid each year on the accumulated debt.     Let the net capital inflow.

If r>d the basic transfer turns negative and the country losses foreign exchange. .    BT will be positive if d>r and the country will be gaining more foreign exchange. In the early stage of debt accumulation. Any prospects and challenges for LDC debt crisis requires an examination of the various factors that cause d and r to rise and fall. when LDC has a relatively small total debt. the rate of increase in d is likely to be high. D.

As long as this accumulating debt is being used for productive development projects with rates of return in excess of r.   Because most first stage debt accumulation comes from official sources in the form of bilateral foreign aid and WB lending. r is therefore quite low and in any event less than d. most of the debt is incurred on concessional terms. the additional foreign exchange and rising foreign debts represented by the positive basic transfers pose no problem for recipient countries. .

2. .1. variable-rate private bank loans at market rates that cause r to rise. d naturally begins to decline as amortization rises relative to rates of new gross inflows The sources of foreign capital switch from long-term “official flows” on fixed concessional terms to short-term. 3. When the accumulated debt becomes very large so that its rate of increase. The country begins to experience severe BOPs problems as commodity prices suddenly fall and the TOT rapidly deteriorate.

A global recession or some external shock. 6. A substantial flight of capital is precipitated by local residents who for political or economic reasons. 5. .S. A loss in confidence in an LDC’s ability to repay resulting of the preceding factors. sudden change in the value of the dollar in which must debts are denominated. a steep rise in U.4. interest rates on which loans are based. such as a jump in oil prices.

.  All these six factors can combine to lower d and raise r in the basic-transfer equation. with the net result that the overall basic transfer becomes highly negative and the capital flows from the underdeveloped to the developed world. The debt crisis then becomes a self-reinforcing phenomenon and heavily indebted developing countries are forced into a downward spiral of negative basic transfer dwindling foreign reserves and stalled development prospects.

 . To help restore economic growth in the debtor countries.Any solution to the debt problem must resolve around concerted efforts by:  The debtor countries  International organisations  Official creditors  The commercial banks.

  Policy changes have been introduced to improve public sector performance. provide adequate incentives for productive sectors and encourage small and medium-scale enterprises with the view to increasing the role of the private sector in economic development. . reorganise or close loss-making SOEs through privatisation and commercialization exercises. Efforts have also been geared towards the promotion of exports while liberalization of imports and price system now operates in many African countries.

   UNCTAD as far back as 1978 proposed the cancellation or conversion into grants of loans to LDCs. . charities. campaign groups has declared war against international financial institutions to force them to cancel Africa's debt and offer the continent a fresh start. G8 also agreed on measures to reduce the bilateral debt-service obligations of LDCs and also convert their ODA loans to grant Also actions by the DCN of the UK comprising more than 40 churches.

Establishment of large-scale debt-forgiveness programmes among bilateral donors . A debt-ridden country is a debtor country. therefore classification of African debtor countries into middle-and lowincome countries seems unnecessary and should be discontinued.   The various initiatives taken by the international community should be made applicable to all African debtor countries. Disbursement of funds under SAF should be accelerated.

heavily indebted countries. Helping countries exit from endless debt restructuring to lasting debt relief.  . Reducing multilateral debt 3.HIPC initiative is the first international response to provide comprehensive debt relief to the world’s poorest.  It was launched by the WB and IMF in 1996.  It aims at: 1. Removing the debt overhang for countries that pursue economic and social reform targeted at measurable poverty reduction 2.

WB provide debt relief beginning immediately or soon after the decision point Strange link b/n debt relief and poverty reduction-freed-up resources will be used to support poverty reduction strategies developed with civil society participation . 2. Deeper and broader debt relief under which external debt servicing will be out by about 50b dollars more than twice the initial framework Fast debt relief where most participating creditors including IMF. 3.1.