I Do What I Do

by Raghuram G. Rajan

Consider a poor country that has to repay $100 million to official creditors such as developed countries or international financial institutions in the current period. Assume it earns $50 million in foreign exchange in this period and has no other resources. Clearly, it cannot repay the debt fully out of its own resources. Now consider three alternative proposals. First, the creditors do not forgive the debt, but lend $120 million to the country. Second, creditors forgive the debt down to $50 million, but lend nothing. Third, creditors forgive the entire debt and lend nothing. Which alternative is best for the country? Assuming this country has no access to private capital markets, the answer seems obvious: full debt forgiveness, which would be twice as good as half debt forgiveness and surely better than a loan that is not much bigger than the full debt amount. Yet when viewed in terms of net resources available to the country during the period, under the first proposal these would amount to $70 million (the loan of $120 million plus inflows of $50 million, less the repayment of $100 million), under the second they would amount to nothing, while under the third they would amount to $50 million. Of immediate importance to a resource-starved poor country is the amount of additional resources it gets in the current period (termed ‘additionality’). The best proposal in terms of additionality is the first, which offers no debt relief.