Debt Relief

The ODA-loan debt relief trick

Some loans will go bad and require relief. In a grant-equivalent system, one can either score the relief, or score extra upfront for the risk that relief will be required, but not both!

In 2014, the DAC decided to score risk upfront by adding “risk margins” when calculating loans’ grant equivalents. The margins were 1% for upper-middle income countries, 2% for lower-middle income countries, and 4% for low-income and “least-developed” countries – all on top of a “base rate” of 5%.

Here is an example to show how those risk margins boost loans’ grant equivalents. Imagine a million-dollar loan, at zero interest, extended in 2020 and repayable in 2030, to a low-income country. Its grant equivalent is its disbursement minus the 2020 value of the repayment. The table shows how the extra 4% risk margin reduces the repayment’s assessed value and thus increases the loan’s “grant equivalent” from about $386K (which would be below the threshold to score as ODA) to $578K (all of which would score as ODA).

So the risk margin massively increases the loan’s reportable ODA. But what if that risk materialises, and the lender forgives the loan? The DAC promised in 2014 that given that the new system would value upfront the risk of default on ODA loans, the eventual forgiveness of these loans would no longer be reportable as a new aid effort.

However, the DAC broke this promise in 2020, allowing additional scoring of debt forgiveness up to the full value of the initial loan. To be sure, in our example, the borrower received the full loan and never paid it back. But the lender also scored risk on many other loans where it did get its money back, yet it will never recalculate their grant equivalents omitting the risk margin.

Some years ago, a perceptive critic likened this set-up to a fortune-teller who offered a money-back guarantee. In fact, the good lady had no predictive powers, and she often had to return her fee. But she still kept all the money from the customers for whom, by chance, her worthless divinations proved correct.

Maintaining prospective-risk scoring on all loans while scoring extra for realised risk is a similar trick, and it is the fundamental error in the DAC’s rules on ODA-loan relief. But those rules contain several other major anomalies, discussed in detail here.

Inventing ODA for relieving non-ODA loans

Many loans to developing countries that are either directly provided by, or guaranteed or insured by governments are at commercial interest rates and support free-market purchases. These loans are mainly extended to enable developing countries to buy goods or services provided by the lender’s/guarantor’s domestic exporters: they are not extended primarily to promote economic development in the recipient countries.

Such official “export credits” are required under international law (as codified in the WTO Subsidies Code) to be unsubsidised, to prevent spoiling markets and ensure that competition is focused on the price and quality of the services offered rather than which government provides the biggest subsidy. This means that loan terms are required to build in premia or higher interest rates that are adequate to insure against the risk of non-repayment. These premium fees are often either paid directly by developing country governments, or indirectly in the prices of the goods or services they are buying.

And this in turn means that when loans go bad, the insurance premiums banked against risk on all loans are expected to cover the losses – just as an insurance company meets the costs of some houses that burn down from the premia it has collected from all its policy-holders.

The upshot of this is that debt relief on non-aid loans should be self-financing and require no “donor effort”.

There is therefore no justification for calculating the “grant equivalent” of individual acts of debt relief on commercial lending. Yet the DAC does exactly this, happily pretending that ODA is being given when there is no donor effort and no cost to the taxpayer. As a result, tens of billions of dollars may soon be scored as ODA for debt relief to Sudan. Not only will this effectively cost creditor countries nothing; the vast majority of the debt consists of exorbitant interest and late-interest charges that have been piling up for decades, without any expectation that repayment would ever occur. While final bilateral agreements on Sudanese debt relief have been delayed, it is already clear that this “phantom aid” will eat into some donors’ real aid budgets.

Why This Matters

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