Debt forgiveness is a programme to cancel or reduce the amount of debt a person, or usually country, has.
Debt forgiveness is an emotive issue because many feel it is wrong that low income developing countries suffer from high debt burdens when they really need the money to invest in improving economic welfare. Many developing countries spend a high % of GDP on servicing the debt burdens.
For example, it has been estimated that for some sub-Saharan African Countries the interest on their debt burden is over 200% of their total export value.
Therefore, in the West, there has been much pressure for the government to write off Third World Debt.
In 2005 Live 8, raised the issue again, with Governments taking some steps to cancel Third World Debt. However, critics argue this debt was cancelled by merely using existing Aid money. Therefore, in practice little was done to improve the Third World Development
Problems of Cancelling Third World Debt
An economist would argue that cancelling bad debts can cause the problem of moral hazard. This is the argument that cancelling debts encourages people to create bad loans.
To combat this problem the World Bank tried to tie debt cancellation to structural changes in the economy. (i.e. to get debt cancelled – countries had to prove that they no longer had the same circumstances which created the debt in the first place.)
However, even this World Bank approach has been highly controversial. It is argued that the free-market reforms they advocate are not necessarily good for developing countries. By 2003 only 8 out of 38 HIPC (Highly Indebted Poor Country) and been able to meet the criteria.
Readers Question Least developed countries are not benefited by the foreign loan. However, the amount of the best stock is increasing in these countries. What would be the measures to control foreign debt? and why such countries are not benefited from foreign debt?
Foreign loans could be beneficial if targeted at useful infrastructure improvements. However, often foreign loans are misspent, they may be siphoned off due to corruption. Also, another problem with foreign capital flows is that they tend to be highly cyclical so that they come in boom times but leave in downturns. This exacerbates the problem of boom and bust economic cycles.
Foreign debt can be debilitating for an economy Because a high % of income goes on servicing the debt. e.g in 2002, 75% of Moldavian income went on servicing debt.
Dealing With Foreign Debt
Debt cancellation. There is much pressure being put on developed countries to write off third world debt. Many countries have, in principle, signed up to this. However, there is concern that debt relief is leading to lower levels of aid.
Reform of Tax Collecting
Many developing countries suffer from an inability to collect taxes, especially off the wealthy. Raising tax rates and also enforcing taxes would help to boost their income to pay off debt.