Coming to Terms with Reality. Evaluation of the Belgian Debt Relief ...

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International debt relief initiatives and their effects
2.2.2.2 Determining the correct cash flow equivalence between debt relief and aid
Even if we have revealed the true nature of a particular debt relief intervention through its
equivalence with a particular traditional aid modality, say GBS, this does not necessarily
mean that the debt relief and GBS intervention have the same effect, as debt relief is not
necessarily equivalent to other aid inflows from a (net) cash flow perspective.
Indeed, a traditional aid intervention is always to be considered as an increase in
international purchasing power to the recipient country, as it involves an inflow of foreign
currency, at least in a ‘balance of payments’ sense, and, when it is granted to the public
sector, also in a fiscal sense. In principle, debt relief granted provides an equivalent net
foreign cash flow effect, as (foreign currency) outflows (debt service payments) do no
longer have to be made.
The nominal amount of debt cancelled is however not necessarily a good indicator to
measure the net cash flow effect of debt relief, and the equivalence to a new aid inflow, for
a number of reasons. In that way, it will in general not be a good indicator of say, the
amount of net additional resources that are now available in the recipient country
government budget (net fiscal space), that is the result of a new aid inflow in the budget.
First of all, (budgetary) net cash flow gains from debt relief only gradually materialise over
time, at the pace of the contractual debt service payments cancelled (the exact timing
depending on the specific repayment terms and schedule). In order to make debt relief and
aid inflows comparable to each other, one uses the concept of the (Net) Present Value (PV)
of the debt relief. This takes into account the time value of money, and discounts payments
that are due in future through using a discount rate, usually a market interest rate. The (N)
PV of debt relief is then the sum of all future contractual debt service payments cancelled
on the debt relieved, with each of them appropriately discounted using the market interest
discount rate. Whenever the debt carries a below market interest rate, and/or repayments
are only due in a distant future, the PV of the debt relief will be (sometimes considerably)
lower than the nominal value of the debt cancelled. And even a considerable debt relief in
PV terms, can only have modest debt service relief consequences in the short term, when
all the debt service payments were due in the more distant future.
Second, the PV of debt relief, and the short term debt service relief involved, again
implicitly assumes that debt would have been fully serviced in the absence of any debt
relief operation, which is also overly optimistic, especially for countries experiencing debt
service problems. If not all debt would have been serviced, the eventual resource effect of
debt reduction is (at least partly) fictitious, referring to a mere ‘accounting clean-up of
historical and future arrears accumulation’ (Cassimon and Vaessen 2007, 14). Only the
share of debt service that would have been actually paid up to the creditor in the absence of
debt relief generates real fiscal space, which is referred to as the economic value of debt
(service) relief. In more technical terms, this can be presented as
Coming to Terms with Reality
where:
n
S t ( 1-
d )
E V =
t
(1 + i )
t=0
EV: economic value of debt relief, representing the net direct benefit of debt
relief, comparable to a new (foreign currency) aid inflow;
S t : contractual debt service in year t (present = year 0, final year of
reimbursement =year n) related to the debt relieved in the operation;
d: percentage of future non-payment in the absence of the debt relief
operation, i.e. the percentage of defaulting by the debtor that would have
taken place in the absence of the present debt relief ;
i: the appropriate discount rate from the debtor country’s perspective.
The bottom line here is that, in order to equate the cash flow impact of aid with that of say
GBS, one has to take the economic value of debt relief.
Take the extreme case that the economic value of debt relief is zero, then even a debt relief
intervention that seems to look like say GBS from a conditionality perspective, may be
completely fictitious, purely wind, from a cash flow perspective 26 , as distinct from oil as
you can have.
Third, debt relief operations may lead to a crowding out of other, potentially more effective
aid interventions. All too often it is assumed that debt relief takes place in addition to all
other forms of donor support. However, full donor additionality cannot automatically be
taken as the default situation; substitution of donor effort can be at play. The degree of
additionality is indeed one of the crucial elements in assessing debt relief operations. As
such, one can also not automatically assume that debt relief leads to increased net
aggregate fiscal space.
Besides the three foregoing reservations, there are a number of other, more technical issues
that deserve our attention here. One is the observation that parameter ‘d’ in formula (1)
differs depending on whether large (comprehensive) or small (‘marginal’) debt relief
operations are considered for valuation. The reason is that for large operations, such as
HIPC/MDRI debt relief, ‘d’ can indeed be proxied by the average default rate, calculated
on the whole debt stock. As such, (1-d) denotes the average value of debt, or the average
debt price. This average value or price also appears as the price quotations for that debt on
the secondary market, in case such a market exists. However, the average value is not a
good indicator of the default rate on the last unit of debt service due, or the so-called
‘marginal’ default rate, i.e. the probability that the last unit of debt service due would not
have been paid.
26 Note that this does not automatically mean that the debt relief intervention has no value, as the
conditionalities attached may have very useful indirect effects; it only means that, unlike a traditional aid
inflow, the real resource transfer does not materialise.
(1)
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