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

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Debt relief policy and practice by Belgium
contribution by DGD with the level of the total compensation required for ONDD. 81
Inspired by the relevant scientific literature, in section 2.2.2.2 we have proposed that debt
relief should be assessed from an ‘economic value’ perspective, i.e. the concept that refers
to the debt (service) payments that would have been made by the debtor, in this case to
ONDD, in the absence of debt relief (formula 1 on p.21). We believe that this starting
point is uncontroversial and unassailable. In fact, what ONDD is requesting as total
compensation, and what determines the terms of the compensation agreements of 1991,
2001 and 2005, is based on the same underlying principles. The real question is how
exactly to apply this concept in practice. As we have already outlined in section 2.2.2.2, in
our understanding, four elements are crucial here: (1) whether we use nominal versus
NPV of debt, (2) the determination of ‘i’ (the discount rate in formula 1) when using NPV,
(3) the determination of ‘d’ (the default rate), and (4) the use of the default rate ‘d’ in
marginal versus comprehensive debt relief operations. We will turn to each of these
elements in more detail below, from the perspective of the concrete compensation
agreements.
(1) Nominal versus NPV of debt. It is widely accepted in the literature, and put in practice
in international debt rescheduling and relief initiatives (Paris Club, IMF/World Bank
HIPC), that the (N)PV is the correct approach to calculate the economic value of debt
relief, and to determine fair burden sharing. However, the debt base that is underlying
both the 1991 and 2001, 2005 agreements is the nominal stock of debt (relieved). Clearly,
this is also because current accounting standards at ONDD are based on nominal value.
However, the fact that they are, and that accounting losses of ONDD are based on nominal
value, and so required compensation by ONDD takes that same base, does not mean that
the validity of the NPV approach would collapse. If anything, the reverse is the case. In
fact, the accounting value of a financial asset should reflect its economic value, i.e. the
present value of its future income streams. This is indeed the case when assets earn a
market return, because then their nominal value is a good approximation of the present
value. However, for concessional claims this does not hold, suggesting that nominal
(accounting) values are not appropriate. Moreover, it is not only that nominal values fail to
express present values in this case, it is also that their use in compensation formulas can
easily lead to moral hazard. Take the case where nominal value exceeds NPV. A creditor
would then be tempted to keep the nominal value of its claims intact as long as possible,
e.g. by granting a required discount, expressed in NPV terms, by stretching out principal
repayments to the very distant future, even if this option is damaging to the recipient. In
NPV terms, the value’s claim would be reduced by the agreed upon discount, but at the
same time it would remain valued at 100% in nominal value. In other words, a credit
agency has an incentive to select an option that it knows is less favourable to the recipient,
but that maximises the compensation the agency hopes to receive. This is exactly what
Belgium (ONDD) did in the Cameroon case. A good valuation system and compensation
81 To the extent that full compensation is deemed legitimate, after compensation from DGD on the basis of
the principles that we have set out, the remaining financing gap should be filled by another government
budget; as export credits are typically a foreign trade policy instrument, the foreign trade budget is likely
to be the most natural candidate.
Coming to Terms with Reality
formula should be constructed so as to avoid such moral hazard behaviour up-front; this
can be done by explicitly using the NPV logic in the approach, similar to what is common
practice in debt relief burden sharing calculations in the IMF, World Bank and Paris Club.
To conclude, as such, to determine a fair compensation from a development perspective,
the value of debt relieved should be calculated at its PV.
(2) The determination of ‘i’ (the discount rate) when using NPV. Since we are using a PV
concept, we have to derive the appropriate discount rate. In section 2.2.2.2 we discussed
this in more detail, stating our preference-in-principle for a debtor-based recipient
country-specific discount rate, but accepting, in line with the concepts of measuring aid
efficiency (developed in table 2.11), and more specifically the ‘economic cost’ perspective
that we suggest here, the use of a creditor-specific discount rate. As such, in calculating
the economic value of debt relief from a development perspective, we could settle for the
CIRR being a relatively good proxy of a creditor-specific interest rate that is
internationally-agreed upon, to be used in the calculations, instead of a debtor-specific
domestic interest rate, which is most likely higher than the CIRR.
(3) The determination of ‘d’ (the default rate). Thirdly, as again stressed in section 2.2.2.2,
the PV of debt relief should be corrected to account for default risk, leading to the notion
of economic value as we have defined it. We also discussed that, in the absence of an
international benchmark scoring model to derive the default risk, an accepted creditorspecific
scoring model, such as the one used by ONDD, despite its lack of transparency,
could be a satisfactory proxy. It is important to stress here that both the agreements of
1991, and those of 2001 and 2005 do explicitly account for default risk, on the basis of
scoring model of ONDD exactly. This means that to derive an appropriate economic value
of debt relief from a development perspective, for debt relief granted through large scale,
comprehensive debt relief operations (only), default risk is appropriately proxied by the
default risk scores from ONDD’s internal scoring model. Consequently, the default risk
measure that is suggested in the 2001 and 2005 compensation agreements is identical to
the one appropriate from a development perspective.
(4) The use of ‘d’ in marginal versus comprehensive debt relief operations. Finally, the
discussion from section 2.2.2.2 also highlighted the inappropriateness of using the ‘d’ as
derived from scoring models such as the one used by ONDD, in the case of valuing debt
relief operations where the debt relief treats an amount of debt that is very small
(‘marginal’) compared to the total debt stock. The reason is that the ‘d’ derived in scoring
models denotes the ‘on average’ default rate, of the whole debt stock. For debt-ridden
countries, the average value is not a good indicator of the default rate on the last unit of
debt service that would have been paid (the marginal value). As the marginal value of debt
is always higher than the average value of debt, or in other words the average ‘d’ always
smaller than the marginal ´d´, basing a valuation or compensation formula for small
(‘marginal’) debt relief operations, say small buybacks, debt swaps, or debt flow
rescheduling as in the Paris Club, on this average ‘d’ as derived from such scoring models
(reflected in secondary market prices for debt) would overstate the value of the debt relief
and result in a requested compensation that is higher than what would be the value of debt
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