Is Debt Relief Possible to Poor Countries - Article Example

Is Debt Relief Possible to Poor Countries? There have been studies, discussions and debate on the economic advantages of giving debt relief to poor countries. Debt relief is a result in the reduction of of the present value of these debt obligations or deferral of payments thus providing smaller debt service obligations. Many believe that debt relief is an effective policy to relieve debt burdens of developing countries that it will bring in benefits that will encourage growth and development. But is it the real case? Does debt relief provide economic advantage to the poor developing countries? I believe that debt relief should not be given to all poor countries based on the following contents of an article. I will present the article from Stanford University done by Marguerite Religioso that goes to prove in her article… that debt relief is possible only for some poor nations. She cited that the International Monetary fund has been continuing its efforts to come up with an instrument that would help the poor countries who are heavily indebted. Her theory of “Is debt relief a viable solution to worldwide poverty or a waste of time and money” has pros and cons which she cited in the article. To evaluate the rationality of arguments, author cited the study done by Stanford graduate students Henry and Arslanalp who used the stock market as a reliable source of economic indicator. The significant result of the study proved that the stock market of the countries that obtained debt relief from the Brady plan (named after the U. S. Government Treasurer) showed 60% appreciation in 1989 to 1995 in real dollar terms even before debt relief was formally accepted. This is the period that debt relief is being studied for implementation in sixteen countries identified in Brady Plan. Study confirmed Henry’s theory that the behavior of the stock market is an accurate predictor of economic movement/ Henry says, “within a year of each country’s Brady agreement, foreign capital began flowing back in, and robust economic growth resumed” that only goes to show debt relief is beneficial. Regiglioso referred to the study of Henry that explains a debt relief situation that is usually happening when a country suffers temporary difficulty of debt servicing. Its creditors get to be apprehensive and quickly collect their loans all at once. Since no one could be paid at all, a complete economic standstill occurs. When some of the debts are relieved, new funds will come to stimulate growth and investment. While the basic objective of debt relief is supposed to be applied to all poor countries, Regiglioso reported that debt relief doesn’t work for the poorest of the poor. In contrast to the situation of the 16 Brady countries, study of Henry showed that debt relief will not benefit 45 poorest of the poor countries mostly found in Sub-Saharan Africa Reason is because of their structures. The Brady countries experienced only temporary difficulty of debt servicing, while the latter suffers from economic structural problem that cannot be solved by debt relief. These are lack of basic structural necessities of road, clean water, and hospital and property rights. The study contends that it is not economically feasible to lend to these poorest countries since capital inflows and investment will not come in to these countries The implication of this study, as interpreted by Regiglioso is that the poorest countries need aids and grants and not debt relief. .Direct aid would be most advantageous to governments in building social infrastructure. Henry believed that aid will transform the poorest countries into becoming attractive places for foreign and domestic investment. Henry in this study argued that to make debt relief more meaningful and work advantageously, the highly indebted but not-so-poor countries should be included in the program. These countries are Indonesia, Pakistan, Colombia, Jamaica, Malaysia and Turke. Henry believed that with their countries present level of infrastructure, the market economies will quickly respond to the debt relief. What the study implies is there is hope in debt relief, and underscores how, when and what could international financial resources be used effectively. Part B “The payment of debts is necessary for social order. The non-payment is quite equally necessary for social order. For centuries humanity has oscillated, serenely unaware, between these two contradictory necessities.” Simone Weil (1910- 1943) French Philosopher This quotation goes along with my argument that debt should be paid either thru a debt relief or forgiveness. Debt relief should be given to poor countries, among of them, the Brady Countries and those highly indebted (not so poor) countries because their economies have a possibility to recover. I agree with the results of study that not all poor countries can benefit from debt relief. Aids and grants on the other hand are recommended for the poorest of the poor, as their economic structure cannot sustain debt relief. I agree with the result of Henry’s research that the basic social infrastructure of poorest countries be developed first, and then capital inflows will follow next. Chart at left from World Bank show that exports of goods and services of poor countries cannot sustain external debt servicing. Debt relief for these countries will allow them to recover economically. The poor countries are stagnated by the heavy debt burdens making it impossible for them to escape poverty Regiglioso’ points out that there is hope for debt relief, but foreign sources should consider the ability of the developing and poor countries to pay debts, because debt relief is only a deferral of payment or reduction to make it easy for countries to pay. Reference Rigoglioso, Marguerite. (August 2003) “Debt Relief Works for some Poor Nations” Retrieved October 17, 2009 from http://www.gsb.stanford.edu/news/bmag/sbsm0308/research_henry_debt_relief.shtm Debt Relief Works for Some Poor Nations August, 2003 What do Jesse Helms, the Pope, and rock star Bono have in common? In recent years, they have all been calling on the wealthy nations of the world to relieve the debt of developing countries. The International Monetary Fund also has been working to garner support for a mechanism that would assist countries drowning in debt. Is debt relief a viable solution to worldwide poverty or a waste of time and money? Arguments on both sides of the coin have appeared to be theoretically plausible and persuasive, making the debate particularly prolonged and acrimonious. "The problem," says Peter Henry, associate professor of economics, "is that both sides hold strong views but have not bothered to look at the facts." In a recent study titled "Debt Relief: What Do the Markets Think?" funded by the National Science Foundation and the Stanford Institute for Economic Policy Research, Henry and Stanford graduate student Serkan Arslanalp analyze data that may finally settle the question. To evaluate the pros and cons of debt relief, Henry and Arslanalp employed a traditionally reliable source of economic information: the stock market. They examined how the stock markets of the 16 developing countries that reached debt relief agreements under the Brady Plan (named after former U.S. Treasury Secretary Nicholas Brady) between 1989 and 1995 responded to news of their own Brady agreement. The researchers found that the local stock markets of these countries appreciated by an average of 60 percent in real dollar terms in the year prior to the announcement—the period in which each country was outlining its debt relief strategy with the anticipation of acceptance under the Brady Plan. The evidence thus shows that debt relief was beneficial because market participants expected it to have a positive economic effect on the Brady countries. To determine whether the stock market reaction was a reliable predictor of real economic improvement or merely short-lived "irrational exuberance," the study also considers whether the market increase accurately predicted a greater influx of foreign investment capital and higher levels of economic growth in these countries. "It turns out that the stock market was almost always right," says Henry. "Within a year of each country's Brady agreement, foreign capital began flowing back in, and robust economic growth resumed. "The major problem for the Brady countries was that they ran into temporary difficulty servicing their debt," Henry explains. "Creditors got worried and rushed to collect on their loans all at once. This meant that no one could be paid at all, which caused a complete economic standstill. Once some of the debt was relieved, it cleared the way for new funds to come from other sources. This provided the impetus the countries needed to stimulate investment and growth." Doesn't Work for the Poorest of the Poor While Henry's research confirms the benefits of debt relief for the Brady countries, it reveals, surprisingly, that debt relief is not the best use of funds across the board. The study finds, in particular, that debt relief for what has been referred to as the "highly indebted poor countries"—a group of 42 of the world's poorest countries, mostly in sub-Saharan Africa—will not produce the salutary effects that it did for the Brady countries. "The reason," says Henry, "is that these latter countries are very different patients, if you will. Whereas the Brady countries were suffering from a temporary inability to service their debt, exacerbated by creditors demanding payment all at once, the poorest debt-ridden countries suffer from a more fundamental problem. They lack much of the basic social infrastructure that forms the basis for profitable economic activity—things like well-defined property rights, roads, schools, hospitals, and clean water." To compare the social infrastructure of the typical Brady and highly indebted poor countries, Henry used a measure constructed by Stanford economist Robert Hall and Berkeley economist Charles Jones. According to the index, which ranks 127 countries, the United States has the best social infrastructure; the median Brady country ranks 63rd, while the median highly indebted poor country ranks a low 102nd. "Since the principal problem of this latter group is a lack of social infrastructure, there is little to no scope for profitable lending to them in the first place," explains Henry. "Hence, there is no reason to believe that debt relief there will stimulate a sudden rush of foreign capital that leads to higher investment and growth." Aid, Not Debt Relief What the study implies, then, is that highly indebted poor countries should be targeted not for debt relief but for direct aid that would assist such governments in building social infrastructure. "This is what would eventually make them attractive places for both domestic and foreign investment," Henry says. Moreover, the study indicates that debt relief would be most efficient in a number of countries that are not being considered for such programs at all. These include highly indebted (but not so poor) countries—such as Indonesia, Pakistan, Colombia, Jamaica, Malaysia, and Turkey—whose economic profiles resemble those of the Brady countries. "Given their level of infrastructure, it is much more reasonable to expect that economies such as these would respond positively to debt reduction," Henry maintains. "The message of the study is ultimately a hopeful one," he concludes. "It indicates where and how international resources can best be used to help developing countries." MARGARET REGIGLIOSO "Debt Relief: What Do the Markets Think?" Serkan Arslanalp and Peter Blair Henry, 2002. NBER Working Paper No. 9369, National Bureau of Economic Research, Cambridge, Mass. Debt Relief Works for Some Poor Nations Hailing Outside Prophets Can Threaten Inside Profits Committing Altruism Cloaked in Self-Interest Queuing Theory Meets Your Morning Latte More Ideas from the Business School's Faculty Faculty Publications Further Reading Birdsall, Nancy, and John Williamson. 2002. Delivering on Debt Relief: From IMF Gold to a New Aid Architecture. Washington, D.C: Institute for International Economics. Easterly, William. 2001. Debt Relief. Foreign Policy (November/December): 20-26. Jochnick, Chris, and Fraser A. Preston, editors. 2004. Sovereign Debt at the Crossroads. Oxford University Press, forthcoming. O'Neill, Paul. 2002. Caring Greatly and Succeeding Greatly: Producing Results in Africa, Remarks at Georgetown University in Washington, D.C. June 5, 2002. [Details] Thomas, Melissa A. 2001. "Getting Debt Relief Right." Foreign Affairs. (September/October): XX-XX.       Read More