Avoiding Indebtedness and Underdevelopment: Lessons for Timor-Leste

12 December 2004 by Ben Moxham


Unlike nearly any other nation in the underdeveloped world, Timor-Leste has refused to borrow money from the international community. At this year’s donors meeting in May, the Prime Minister, Mari Alkatiri, spelled out his Government’s position: “We are not ideologically opposed to borrowing money. But we are opposed to unsustainable borrowing”. These are wise words.

Despite the nations of the South having abundant natural and human resources, the burden of debt for larger developing nations has restricted their development, for smaller nations, it has suffocated it altogether. In 2000, the UNDP UNDP
United Nations Development Programme
The UNDP, founded in 1965 and based in New York, is the UN’s main agency of technical assistance. It helps the DC, without any political restrictions, to set up basic administrative and technical services, trains managerial staff, tries to respond to some of the essential needs of populations, takes the initiative in regional co-operation programmes and co-ordinates, theoretically at least, the local activities of all the UN operations. The UNDP generally relies on Western expertise and techniques, but a third of its contingent of experts come from the Third World. The UNDP publishes an annual Human Development Report which, among other things, classifies countries by their Human Development Rating (HDR).

and UNICEF calculated that $80 billion a year for ten years would be enough to ensure that the entire population of the world had basic services such as decent food, access to drinking-water, primary education and access to basic health care. [1] Yet in 2001 alone, developing countries spent $382 billion on debt repayments. [2]

In general, indebtedness remains one of the biggest barriers to developing countries’ effort to build strong domestic economies and improve the living standards of their citizens. For every $1 owed in 1980, developing countries have since repaid $7.50 but still owe $4. [3] This is a massive transfer of resources from the South to the North that renders international institutions’ talk about “poverty reduction” and achieving “Millennium Development Goals” meaningless.

Yet the spectre of debt is just one concern governments must consider. Borrowing money to fund development can be a viable option, if Timor has the resources to pay it back but more importantly, if the reasons for borrowing are clear and justified. Without a clear purpose determined by the borrowers themselves, such loans will not significantly meet real needs, and instead, place a country at the mercy of the lenders and the conditionality they place on such loans. Experience shows that countries with weak negotiating positions are reduced to implementing economic packages prescribed and enforced by lenders such as the Asian Development Bank (ADB) and the World Bank World Bank
WB
The World Bank was founded as part of the new international monetary system set up at Bretton Woods in 1944. Its capital is provided by member states’ contributions and loans on the international money markets. It financed public and private projects in Third World and East European countries.

It consists of several closely associated institutions, among which :

1. The International Bank for Reconstruction and Development (IBRD, 189 members in 2017), which provides loans in productive sectors such as farming or energy ;

2. The International Development Association (IDA, 159 members in 1997), which provides less advanced countries with long-term loans (35-40 years) at very low interest (1%) ;

3. The International Finance Corporation (IFC), which provides both loan and equity finance for business ventures in developing countries.

As Third World Debt gets worse, the World Bank (along with the IMF) tends to adopt a macro-economic perspective. For instance, it enforces adjustment policies that are intended to balance heavily indebted countries’ payments. The World Bank advises those countries that have to undergo the IMF’s therapy on such matters as how to reduce budget deficits, round up savings, enduce foreign investors to settle within their borders, or free prices and exchange rates.

as a condition on the loans. These economic packages are imposed with little understanding of the local political and economic dynamics, and generally serve the interests of the lenders and their business elites better than those of the borrowing nations’. Indeed, the “concessions” a government may be forced to make can be a larger burden than the repayment of the loan itself.

What is a Concessional Loan?

The basic economic logic behind taking out a loan is that if it is used sensibly, it can play a useful role in unlocking the economic potential of a particular sector, spurring on production that otherwise could not have occurred, especially if money generated through such production can meet and exceed the cost of repaying the loan. Yet many developing countries have difficultly accessing credit on affordable terms because international lenders are nervous of the uncertain returns in investing in a developing country.

To overcome this problem, bilateral and multilateral lending institutions such as the ADB, the Japan Bank for International Cooperation (JBIC) and the World Bank, each offer “concessional” loans - low interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. loans with long pay back periods - to help poorer countries finance their development. The World Bank for example, offers concessional loans through its lending arm, the International Development Association (IDA). Loans to poorer countries like Timor-Leste are repaid over 40 years and carry an annual 0.75% ‘service’ charge. Similarly, ADB concessional loans are taken out over a 24 or 32 year period with an initial eight year ‘grace’ period. A 1% service charge is payable Payable A sum of money that one person (debtor) or group of people owes to another (creditor). during this period which rises to 1.5% per year after that.

Loan Conditionality: A Loss of Sovereignty

Aside from having longer pay back periods and lower interest rates Interest rates When A lends money to B, B repays the amount lent by A (the capital) as well as a supplementary sum known as interest, so that A has an interest in agreeing to this financial operation. The interest is determined by the interest rate, which may be high or low. To take a very simple example: if A borrows 100 million dollars for 10 years at a fixed interest rate of 5%, the first year he will repay a tenth of the capital initially borrowed (10 million dollars) plus 5% of the capital owed, i.e. 5 million dollars, that is a total of 15 million dollars. In the second year, he will again repay 10% of the capital borrowed, but the 5% now only applies to the remaining 90 million dollars still due, i.e. 4.5 million dollars, or a total of 14.5 million dollars. And so on, until the tenth year when he will repay the last 10 million dollars, plus 5% of that remaining 10 million dollars, i.e. 0.5 million dollars, giving a total of 10.5 million dollars. Over 10 years, the total amount repaid will come to 127.5 million dollars. The repayment of the capital is not usually made in equal instalments. In the initial years, the repayment concerns mainly the interest, and the proportion of capital repaid increases over the years. In this case, if repayments are stopped, the capital still due is higher…

The nominal interest rate is the rate at which the loan is contracted. The real interest rate is the nominal rate reduced by the rate of inflation.
, concessional loans differ from non-concessional loans in a major way - they are contingent upon the implementation of conditions set by the creditors. The specifics of these conditions may vary across debtor countries, but the basic framework involves the restructuring of economic and even political policies to ensure an environment acceptable to creditors. In most cases, these conditions constitute the main elements of comprehensive reform packages that need to be approved and are monitored by international financial institutions (IFIs) like the World Bank, the International Monetary Fund IMF
International Monetary Fund
Along with the World Bank, the IMF was founded on the day the Bretton Woods Agreements were signed. Its first mission was to support the new system of standard exchange rates.

When the Bretton Wood fixed rates system came to an end in 1971, the main function of the IMF became that of being both policeman and fireman for global capital: it acts as policeman when it enforces its Structural Adjustment Policies and as fireman when it steps in to help out governments in risk of defaulting on debt repayments.

As for the World Bank, a weighted voting system operates: depending on the amount paid as contribution by each member state. 85% of the votes is required to modify the IMF Charter (which means that the USA with 17,68% % of the votes has a de facto veto on any change).

The institution is dominated by five countries: the United States (16,74%), Japan (6,23%), Germany (5,81%), France (4,29%) and the UK (4,29%).
The other 183 member countries are divided into groups led by one country. The most important one (6,57% of the votes) is led by Belgium. The least important group of countries (1,55% of the votes) is led by Gabon and brings together African countries.

http://imf.org
(IMF) and the ADB. In the 1980s and most of the 1990s these conditions came in the form of Structural Adjustment Structural Adjustment Economic policies imposed by the IMF in exchange of new loans or the rescheduling of old loans.

Structural Adjustments policies were enforced in the early 1980 to qualify countries for new loans or for debt rescheduling by the IMF and the World Bank. The requested kind of adjustment aims at ensuring that the country can again service its external debt. Structural adjustment usually combines the following elements : devaluation of the national currency (in order to bring down the prices of exported goods and attract strong currencies), rise in interest rates (in order to attract international capital), reduction of public expenditure (’streamlining’ of public services staff, reduction of budgets devoted to education and the health sector, etc.), massive privatisations, reduction of public subsidies to some companies or products, freezing of salaries (to avoid inflation as a consequence of deflation). These SAPs have not only substantially contributed to higher and higher levels of indebtedness in the affected countries ; they have simultaneously led to higher prices (because of a high VAT rate and of the free market prices) and to a dramatic fall in the income of local populations (as a consequence of rising unemployment and of the dismantling of public services, among other factors).

IMF : http://www.worldbank.org/
Programmes (SAPs), which have since been repackaged into the Poverty Reduction Strategy Papers (PRSPs).

To be eligible for a World Bank IDA or IMF concessional loan, a country must first prepare a PRSP Poverty Reduction Strategy Paper
PRSP
Set up by the World Bank and the IMF in 1999, the PRSP was officially designed to fight poverty. In fact, it turns out to be an even more virulent version of the structural adjustment policies in disguise, to try and win the approval and legitimation of the social participants.
. This document is prepared by a country government under the supervision of Bank-IMF teams. It is a ‘blueprint’ for how the government can direct development loans and assistance. One study found the following policy features common in PRSPs:

- The removal of barriers to trade and a greater commitment to integration into the world economy.
- The removal of price controls on basic commodities Commodities The goods exchanged on the commodities market, traditionally raw materials such as metals and fuels, and cereals. such as gas, electricity, water, transport, etc
- User-fees to recover costs in the provision of health and water services, as well as increased reliance of private sector provision of these services
- Privatisation of state owned enterprises and industries
- Fiscal restraint to achieve macro-economic stability
- ‘Good Governance” reforms, including measures to stamp out corruption, maintain a smaller public service, decentralise government services and implement a legislative ‘enabling environment’ to assist the private sector. [4]

Critics of the PRSP argue that country governments have little control over the structure, content and policy prescriptions in their PRSPs. [5] Experience shows that these conditions often prove to be more powerful than national laws since deeply indebted and cash strapped governments do not usually have access to alternative sources of development finance. Because there is so little variation in these macro policies across an extremely broad range of countries, and because governments need IFI endorsement before qualifying for new lending, critics argue that this “strongly suggests that governments were not empowered to any great degree in policy making”. [6]

As well as being implemented in an undemocratic fashion, such policies have proven to be damaging. In Zambia, just one example among dozens [7]8), the IMF recently forced the government to sell the State-owned Zambia National Commercial Bank (ZNCB) in face of enormous public, parliamentary and Presidential resistance. Heavily indebted, Zambia would not receive debt relief from the IFIs unless it privatised. “If they don’t sell, they will not get the money” said a blunt Mark Ellyne, the IMF’s resident representative. [8] Yet the ZNCB was a successful enterprise and one of the few sources of credit for Zambian people. Its privatisation continues an IFI-authored reform program that a recent World Development Movement report on Zambia argues has resulted in thousands of people becoming unemployed, the destruction of key industries, social unrest and increased poverty. [9] As Zambia illustrates, the interests of creditors rarely coincide with the peoples of the underdeveloped world.

Grants and Technical Assistance: Policy Overhaul Minus the Debt

For Timor-Leste, most of the policies common in PRSPs already apply; they have been written into the development agenda of the country by the many World Bank and donor consultants working on the National Development Plan (NDP), the Transitional Support Program (TSP) and now, the Sector Investment Program (SIP) process.

Even without applying the pressure of debt, the World Bank still has enormous power over the policies of the world’s newest nation. It has fundamentally shaped government policy by providing technical assistance in key government ministries, managing the bulk of international assistance through the Trust Fund for East Timor (TFET) and drawing up the Transitional Support Program (TSP) - the list of policy actions government must complete as a condition for receiving donor funds for direct budgetary support. It is little wonder that the policy landscape in Timor looks similar to heavily indebted countries, even without a formal PRSP.

Policy conditions apply not only to loans, but also to grants and technical assistance. Grants are funds transferred by a bilateral or multilateral body to a government without need of repayment. They can be given as a general grant, which are funds available for any type of expenditures (as in most grants channeled through the TFET), or selective grants tied to specific uses (like when donors choose what to fund in the TSP).

Technical assistance is usually funded by grants, and either covers activities that are in preparation for bigger grants or loans, or have to do with direct drafting and implementation of policy. Technical assistance grants cover the deployment of consultants, the preparation of feasibility studies, and capacity building activities like trainings and seminars. As such, they are a powerful way of changing policy without needing the leverage Leverage This is the ratio between funds borrowed for investment and the personal funds or equity that backs them up. A company may have borrowed much more than its capitalized value, in which case it is said to be ’highly leveraged’. The more highly a company is leveraged, the higher the risk associated with lending to the company; but higher also are the possible profits that it may realise as compared with its own value. of debt.

Concessional borrowing is typically the lure the World Bank uses to bring in nervous foreign direct investment, for example, by financing the government share Share A unit of ownership interest in a corporation or financial asset, representing one part of the total capital stock. Its owner (a shareholder) is entitled to receive an equal distribution of any profits distributed (a dividend) and to attend shareholder meetings. of a public-private venture. While the Timorese Government has so far refused to borrow, the World Bank and the ADB have not been idle. They have provided technical advice and research in key sectors such as water and electricity, laying the groundwork for extensive private sector participation in anticipation of the government shifting its position. The World Bank for example, is providing $500,000 to fund a study on “Private Participation in Infrastructure. [10] It will examine what economic infrastructure will be needed to support proposed “business parks, industrial parks, export processing zones and tourism resorts.” The research proposal is clear about its purpose: “The ultimate beneficiaries of this project are the private sector investors, both domestic and foreign.

Most of the policy framework for East Timor was developed with little informed participation of the Timorese themselves. For instance, while the NDP was supposedly mainstreamed in a national consultation process, it is questionable how many of the macroeconomic prescriptions in the NDP were discussed in those consultations. These are the same policies that have been applied throughout the developing world to damaging effect. So why does Timor - a new country with a unique history - apply, and seemingly uncritically so, these same policies that have failed to reduced poverty or inequality?

The Dangers of Externally Determined Policy

Even without having to borrow money, Timor’s policy regime is already captured by the donors through their use of economic power. “Put bluntly”, says a US Congress memo reporting on World Bank activities in Timor, “it seems likely that assistance levels will decline if East Timor government pursues economic or budgetary policies which were unacceptable to donors”. [11] And because the policies now in effect weren’t developed with an understanding of Timorese reality, they have already begun to cause problems.

Attempts to develop sustainable livelihoods are undermined by the current policy regime. For example, a poultry factory was set up in Hera, on the outskirts of the nation’s capital - a modest attempt at improving production efficiency. However, it was forced to shut down after only a few months due to cheaper imports of Brazilian chickens. Local chickens sell for $2 to $3 in the Comorro market while the Brazilian imports sell for only $1.50. These are the predictable effects of a trade liberalization policy applied so uncritically.

The government is also involved in several key policy struggles with the IFIs over whether a minimum wage policy should be implemented and whether tariffs should be used to protect the domestic rice industry. In both cases, the World Bank predictably opposes any government intervention that interferes with market forces. While the government has stood firm, if it borrows from the IFIs, its position on these important policies and social safeguards will be weakened.

Private Sector Fundamentalism

A key assumption of the IFIs is that the development of a strong private sector will alleviate poverty. What effectively transpires however, is not the development of the capital-strapped domestic private sector but the promotion of the foreign private sector to come and take advantage of what Timor has to offer. However, a healthy foreign private sector does not mean that poverty will necessarily be alleviated. Indeed, this logic ignores that, privatization often aggravates poverty. For much of the developing world, privatized public services have become inaccessible and unaffordable as private providers have implemented restrictive user pays principles or abandoned services in non-profitable areas.

Much of the discussion around economic development in Timor today also stresses the need to develop an export economy. The logic here, as pursued in so many other countries, is that export earnings can both pay back the original loan and fund national development. For Timor, the World Bank and other agencies want to see the government borrow money to invest in areas for export development such as like coffee, vanilla, or palm oil - primary commodities.

While such a strategy can be an option for the country, it is not the only option, nor is it the most important. Indeed, many underdeveloped nations can attest to the pitfalls of depending on the export market, especially for primary commodities. The export prices for raw materials have been steadily declining, to the point that they are currently below the levels of the Great Depression in the 1932. [12] It was this decline, in combination with rising interest rates, that tripled repayment rates on Third World debt overnight, triggering the debt crisis of the early 1980s that many nations have still not escaped from.

Depending on the export of primary commodities is becoming less and less a viable economic option for developing countries. Manufacturing and now technology has reduced the relevance of primary products in the global economy. Today, the amount of raw material per industrial unit is only 40 per cent of what it was in 1930 during the Great Depression. [13] Developing countries are also heavily dependent on earnings from exports of primary goods, especially needed to repay debt, leading to an oversupply in the market that ironically, further drives down prices. The deregulation or abolition of many global commodity pricing and quota systems - a condition of many IMF and World Bank SAPs - has accelerated this oversupply. Coffee, Timor’s principal export, for instance, has been hard hit by the market deregulation of 1989. In 1980, one kilo of Arabica coffee was worth $3.47, today it is only worth $1.47. Similarly, rice from e.g. Thailand, now exports for half the price it did in 1980. [14] Predictably, Timorese farmers have argued that, without restrictions on the import of this cheap rice, they cannot compete.

There are also the environment and social effects of building a commercial export industry. The main legacy of transnational agribusiness in the developing world is of destroyed environments and the expropriation of land and natural resources from communities. All the while, the alleviation of poverty continues to be an illusion.

Timor’s biggest export potential is and will remain oil and gas. Used intelligently, it is this substantial revenue that can fuel an infant domestic economy, in dire need of assistance to develop and integrate nationally. Timor doesn’t need to gamble away borrowed money on setting up immiserating and risky export industries.

Conclusion

If the policies now in place in Timor have proved to be problematic for other countries, why then are they not being challenged? The answer lies in the manner by which IFIs have elevated these policies to ideology and rich donors find such ideology a convenient justification for the pursuit of their interests (e.g. creating a market for their own business sectors, sourcing cheap inputs for their industries, etc.). What aggravates matters is the dearth of funds available for development financing for poor countries like Timor (at least until oil and gas revenues materialize) which are then compelled to borrow or accept grant money that comes with restrictive packages of conditionality. Sadly, a flawed ideology with economic power behind it is enough to silence sensible development alternatives.

Even putting aside the motives of the IFIs, their own lending programs are riddled with problems . The undemocratic and questionable focus of much development lending, has resulted in a history of project failure, corruption, inefficiency and low social access. In a review of all publicly available ADB project audit reports from Indonesia, Sri Lanka and Pakistan, the NGO Environmental Defense Fund, concludes that, “over 70 percent of ADB projects in these countries are unlikely to provide long-term social and economic benefits. [15] Yet the government is left to pay back the loans.

Consider the example of the World Bank’s Community Empowerment Project (CEP) in Timor which concluded this year. There, only 30 to 40% of the loans made under the micro credit component of the project were ever paid back. The World Bank conceded they designed and ran this project poorly, especially the micro-credit component. Yet they had already learned these lessons from the Indonesia version of the CEP, the Kecamatan Development Project and dozens of other countries subject to the same program. Luckily for Timor, the project was grant funded. For the Indonesians, in exchange for an unsuccessful project, they are left with a $200 million debt.

These, and various other experiences, are now available for the Timorese Government and people to scrutinize and consider carefully. Because it owes nothing, Timor-Leste has a rare opportunity to avoid the trap of debt and the pressure to maintain damaging policies that comes with it.

With wise use of its oil resources, Timor can invest in meaningful development projects, avoiding an over-reliance on the policies of the IFIs and rich bilateral donors that have demonstrably failed. Most importantly, because Timor is debt-free, it has greater room to negotiate its own course of development and to set the discussion on its own terms. Harnessing the international goodwill Goodwill The difference between the assets on a company’s balance-sheet and the sum of its tangible and intangible assets. When one company takes control of another company, the acquiring company generally pays a price that is higher than the value of the net assets. Goodwill generally consists of intangible elements, such as brands, which are evaluated subjectively. that comes with being the youngest in the community of nations, and with a population well attuned to striving for true self-determination, Timor will do well to resist subjugation by richer nations and institutions through the system of indebtedness and grant making.



This background paper was originally published in Indonesian in Jurnal Libertasaun, (Sa’he Institute for Liberation, East Timor, 2004). The author works for Focus on the Global South (http://www.focusweb.org), a research and advocacy organisation based in Bangkok, Thailand. Email: ben at focusweb.org.

Footnotes

[1UNDP, Global Human Development Report, 2000. This amount has been the subject of various negotiations for economic packages, official aid and loans, as though developing countries have no capacity to meet such responsibility.

[2Drawn from the World Bank, Global Development Finance 2002. Quoted in, Eric Toussaint and Damien Millet, The Debt Scam, Vak Publications, India, 2003. p. 14

[3Ibid. The Debt Scam, p. 68

[4Frances Stewart and Michael Wang ‘Do PRSPs Empower Poor Countries and Disempower the World Bank, or is it the other way around?’ QEH, Working Paper Series No. 108,

[5For a comprehensive critique of the PRSP and PRGF, see, Charles Abugre, Still Sapping the Poor: A critique of IMF Poverty Reduction Strategies, ISODEC, June 2000

[6Above n. (5) ‘Do PRSPs Empower Poor Countries?’, p. 20

[7For elaboration on the other countries, see, The Structural Adjustment Participatory Review International Network (SAPRIN), Structural Adjustment: The Policy Roots of Economic Crisis, Poverty and Inequality , Zed Books, 2004; Michel Chossudovsky, The Globalization of Poverty and the New World Order, 2nd Edition Global Outlook, 2003.

[8Quoted in Zambia: Condemned to Debt, How the IMF and World Bank have undermined development World Development Movement, April 2004. ) Page 10. Available at www.wdm.org.

[9Ibid, Zambia: Condemned to Debt

[10Private Sector Investment Program Draft, Democratic Republic of Timor-Leste, (March 2004)

[11Memorandum Congressional Research Service, United States March 27, 2002

[12Rivero p. 118

[13Oswaldo de Rivero, The Myth of Development: The Non-Viable Economies of the 21st Century, Zed Books, 2001. p. 7

[14Global Development Finance Report 2004, World Bank p. 187

[15The Asian Development Bank: In Its Own Words - An Analysis of Project Audit Reports for Indonesia, Pakistan, and Sri Lanka, July 24th 2003, Available from www.environmentaldenfense.org.

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Ben Moxham

Ben Moxham is a volunteer with Focus on the Global South, based in East Timor. He worked with a joint government-civil society Timorese research and evaluation team looking into the Community Empowerment and Local Governance Project (CEP).

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