Grants and Debt Forgiveness in Africa

Abstract

Bilateral and multilateral creditors have made a significant effort to increase financial resources flowing to low-income African countries, helping them expand their import capacity. But the increasing share of pure grants and debt relief from bilateral donors in recent years has not allowed these countries to reduce their total indebtedness and solve their debt-overhang problem. Debt relief from bilateral donors has been neutral regarding recipient countries' import capacity.

Hernandez and Katada analyze the effects of bilateral debt forgiveness (part of official development assistance) on 32 low-income countries in Africa (1984­93). Asking whether it makes a difference for recipient countries to receive pure grants rather than official development assistance (ODA) debt relief, they focus on how one form of aid or the other affects the countries' import capacity. They conclude that: Grants allowed recipient countries to significantly expand their import capacity for 1984­93 as grants and import capacity have been increasing since 1984. But the increasing share of concessional lending and debt relief in recent years has not allowed these countries to reduce their total indebtedness and solve their debt overhang problem. Their arrears increased significantly.

The biggest recipients of debt relief also received the lion's share of the increase in pure grants. Debt forgiveness and pure grants were allocated in a way not entirely consistent with standard economic hierarchies (such as poverty levels, indebtedness, and access to alternative sources of finance). Bilateral ODA debt forgiveness appears to be neutral in the sense of not having any significant impact on recipient countries' capacity to import. Bilateral ODA debt forgiveness has neither increased or curtailed the import capacity of the major recipient countries. During 1989-­93, multilateral lending replaced the decrease in bilateral lending that, in turn, was caused by an increase in grants. (Bilateral ODA debt relief implies smaller cash flows because it is pseudo or accounting money and because with it goes reduced new lending from bilateral sources.)

Private creditors have typically withdrawn money from the countries in the sample as grants increased. And debt relief has had a crowding-out effect on new lending. Bilateral donors are switching their development finance to Africa from concessional and nonconcessional lending to a combination of pure grants and ODA debt relief.

This paper - a product of the International Finance Division, International Economics Department - is part of a larger effort in the department to monitor developments in highly indebted low income countries.