Public debt relief can benefit private-sector creditors

In April, a court in London ruled that Zambia has to pay approximately $ 15.5 million to a fund called Donegal International for debts incurred from old loans. Donegal was claiming $55 million, but the court rejected this sum, accusing the fund’s representative of “serious dishonesty” during the proceedings.

The debt in question arises from loans Romania gave Zambia in the late 1970s. Donegal bought that debt from Romania at the hugely discounted price of approximately $ 3.3 million in 1999. Next, it demanded that the full debt be paid. In 2003, Zambia and Donegal agreed to payments of $ 15 million. Zambia transferred $ 2.5 million, but then stopped payments. In February 2007, the fund sued Zambia in London, demanding $55 million, including interest and administrative costs. The Zambian government, however, asked for the debt to be annulled, arguing that the agreement to sell the debt had come about by corrupt means in 1999. The court did not follow this argument, and decided that the agreement with Donegal was valid. In a second step, however, the court rejected the fund’s claims as excessive.

The case highlights a gap in the debt-relief process for poor countries. Creditor countries represented in the Paris Club have now forgiven 29 heavily-indebted poor countries (HIPC) over 90 % of their debts. For example, 94 % of Zambia’s debt was cancelled in 2005. As a rule, debtors are supposed to ask for reductions on a similar scale from other creditors (excluding multinationals like the World Bank and IMF), but many creditors do not comply with this approach, and the debtor countries cannot force them to.

The litigation against Zambia is not an isolated case. In August 2006, the World Bank recorded 44 cases in which private creditors sued heavily-indebted poor countries for claims, and two actions from state creditors. It is not known precisely how many private claimants are so-called vulture funds, which buy debts cheaply and then claim the nominal value like Donegal did.

Large-scale debt relief improves a country’s solvency, and therefore increases the likeliness of other creditors suing. Accordingly, there is a risk that some of the debt relief funded by development assistance may end up in the pockets of private creditors or even vulture funds. According to the daily Frankfurter Allgemeine Zeitung, Germany’s Development Minister Heidemarie Wieczorek-Zeul has called such funds’ actions “cynical and morally flawed”, and demanded that legal loopholes be closed as fast as possible. At their meeting near Potsdam in May, the G8 finance ministers, too, said they were “concerned about the actions of some litigating creditors against heavily-indebted poor countries”. They agreed “to identify measures to tackle this problem”. According to experts, this will only succeed if all creditors – not only those in the Paris Club – participate in debt-relief processes. An international insolvency procedure for countries would be the fairest solution. (bl)