A millenium debt swap?

Following the debt relief extended to highly indebted poor countries, it's the turn of the middle income countries: Philippine president Gloria Macapagal-Arroyo has proposed a debt swap to support the Millenium Development Goals (MDGs). According to her statement: In their case we propose a large-scale 50% conversion of debt for Millennium Development Goals financing programs. We are not asking for debt forgiveness or debt cancellation. What we propose is that the debt service or principal amount should be converted into equities in new projects of at least equal value and with their own potential earnings.

How does this work? Well suppose the Philippines needs to pay debt servicing of 1 billion dollars in 2006. The debt swap proposal means it will only pay 500 million; the remainder will be invested as equity in new projects that contribute towards the MDGs. Presumably, the project earns income, part of which goes to the participating creditor as dividend. After all, the main proponent (the Congressional House Speaker Jose de Venecia) claims that “the proposal does not call for new monies from the parliaments and governments of rich countries and participation by creditors in the debt-for-equity program would be voluntary. He said the proposal would not reduce the value of the creditor's financial assets. “They would have the option of choosing which profitable or allied MDG projects to support in specific debtor-country,” he said.

Essentially, the foregone debt payment is replaced by project earnings. Earnings can come from user fees (e.g. from irrigation and potable water schemes), product sales (e.g. from an agroforestry program), and the like. Alternatively, project earnings could have instead been collected for debt servicing. What difference would the debt swap then make? I can see four:

First, creditors would now presumably assume part of the risks in obtaining earnings from a project. These risks include: collection problems, poor project design, faulty implementation, economic and natural shocks. I see this as the major sticking point: if project earnings are backed by guarantee by the domestic government, then I really don't see the advantage of the swap.

Second, the swap would force both borrower and creditor to design projects with a serious income generating component. Very often projects are implemented without this component, leaving only the general tax fund as the source of debt repayment.

Third, half of the debt service bill is precommitted to MDG projects. The precommitment serves as a guarantee that the borrowing government will invest in MDG projects; moreover, the borrowing country is assured of a floor commitment for donor funding (indirectly, that is) in the medium term.

Fourth, a debt swap will be seen favorably by private lenders as a reduction in the effective debt burden of a borrowing government (if does not extend dividend guarantees.) This may widen the borrower's access to private funds for development.

The President's wish is that this debt for MDG proposal will find its way into the Summit declaration and that the Paris Club, the G-8 governments, the IMF and the World Bank, the regional development banks, and the world's large commercial banks will approve this proposal.

However the Outcome statement from the Summit says: We further stress the need to consider additional measures and initiatives aimed at ensuring long-term debt sustainability through increased grantbased financing, cancellation of 100 per cent of the official multilateral and bilateral debt of heavily indebted poor countries and, where appropriate, and on a case-by-case basis, to consider significant debt relief or restructuring for low- and middle-income developing countries with an unsustainable debt burden that are not part of the Heavily Indebted Poor Countries Initiative, as well as the exploration of mechanisms to comprehensively address the debt problems of those countries. Such mechanisms may include debt for sustainable development swaps or multicreditor debt swap arrangements, as appropriate. These initiatives could include further efforts by the International Monetary Fund and the World Bank to develop the debt sustainability framework for low-income countries. This should be achieved in a fashion that does not detract from official development assistance resources, while maintaining the financial integrity of the multilateral financial institutions.

In short, sympathetic but non-commital. Problems abound where the devil is, so instead of a blanket endorsement, the statement just refers to some "case to case" assessment. However there are other forums and meetings where the proposal can be taken up. Let's see whether there will be a millenium debt swap, after all.