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Africa: Debt Relief Is Just a Start

Despite short-term benefits, the July 7 pledge by finance ministers of the group of eight industrialized nations to write off $40 billion in debt owed by 18 mainly African governments is likely to have a limited impact on their long-term prosperity, according to Standard & Poor's Ratings Services.

S&P points out that the debt write-off will free up cash for the affected governments to offset external shocks such as high commodity prices and enable African governments to maintain poverty-reduction and development activities. In the longer term, it will allow governments with a good track record of structural reforms and prudent fiscal policies to accelerate these programs, stimulate private-sector development -- and bolster their creditworthiness.

But for the majority of indebted African governments covered by the pledge, which don't enjoy such a track record, the effects are likely to be short-lived.

FUNDAMENTAL FLAWS. "Debt relief isn't a panacea for these governments," says S&P credit analyst Konrad Reuss. He notes that the correlation between debt reduction and economic growth is vague, and capacity constraints will limit the effective use of any additional money released by the G8 ministers' pledge. "Even if all debt were forgiven, most of these governments would still require significant levels of external donor assistance in the medium term," he says.

The G8 finance ministers' decision applies to African governments eligible for debt relief under the Heavily Indebted Poor Countries (HIPC) initiative. These include a number of sovereign government issuers rated by S&P, all of which are assigned speculative-grade credit ratings.

The actual debt-raising and debt-carrying capacity of HIPC governments is severely restricted because of their respective countries' structural economic weaknesses. Consequently, the actual fiscal impact of debt relief is critically linked to the government's ability and capacity to effectively use funds for non-debt-related outlays. This includes expenditures on education, health care, and infrastructure -- essential spending that has a significant influence on fostering economic development and reducing poverty.

BACK TO BASICS. Notwithstanding debt relief, the fiscal flexibility available to HIPC governments will continue to be limited on the revenue side by their inability to create a stable and broad tax base. This is mainly because of their insufficient tax-administration capacity, narrow economies, and low levels of income.

On the expenditure side, limitations arise through the enormous additional development needs created by years of inefficient or insufficient investment in infrastructure and fast-growing populations. Decreasing the debt burden will do little unless these underlying problems are addressed.

For African HIPC countries to take full advantage of the debt-reduction initiatives, their efforts should be focused on structural reforms on the expenditure side, according to Reuss. "The reforms should aim to address the reasons why the governments accumulated such levels of debt in the first place," he adds.

If they're done right, notes Reuss, these moves would enable Africa's heavily indebted countries to increase long-term growth -- and reduce the crushing poverty faced by their populations. From Standard & Poor's Ratings Services

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