What constitutes odious debt?

The United States is desperately trying to persuade all countries (including poor ones like Vietnam) to contribute something for the reconstruction of Iraq. This implies that much of Iraq’s old debt of $134 billion will be written off. Some analysts are justifying this on the basis of the theory of odious debt. (For a good exposition, read Kremer and Jayachandran in Finance and Development, June 2002).

Many countries have huge debt burdens because of loans taken by oppressive rulers who have misused or stolen the money. It is used to be said that the foreign debt of Zaire was exactly equal to General Mobutu’s Swiss bank account. Should the debt burden imposed on a country by such rulers be regarded as a commercial debt? No, say some economists, this constitutes odious debt as distinct from commercial debt, and commercial rules should not apply. This debt must be written off, since it would be unfair to insist that people who have already been oppressed by a tyrant should be doubly oppressed by asking to repay loans taken by the tyrant for his personal benefit.

This argument is not just a moral one, it has a legal basis. In many countries, an individual is not liable to repay loans that have been taken in his name by fraud or force, and corporations are not obliged to repay loans entered into by their CEOs without due authority. Hence, it can be argued that country debts incurred without the explicit sanction of citizens constitute odious debt and need not be repaid.

This has a righteous ring, yet is not well grounded in logic or practicalities. The west regards communist regimes as oppressive, yet lent money to them. Can the borrowers now default with impunity? The vast majority of Third World countries have been ruled by dictators. Would it be appropriate for every developing country to default without penalty every time a dictator is overthrown? And if the next regime starts off by looking democratic but degenerates into an autocracy (e.g., Mugabe’s regime in Zimbabwe), at which point precisely does commercial debt become odious?

Commercial lenders will say, rightly, that they are not and should not be moralists. Loans are either performing or non-performing, not virtuous or odious. If regimes can refuse to repay loans on the ground that the previous regime was odious, the rational reaction of lenders will be to stop lending to all developing countries. The risk will be too great.

Besides, it is just not true that odious dictators are always bad for the economy. Korea, Taiwan, Indonesia and Chile all became miracle economies under military dictators. On the other hand, virtuous rulers (like Nyrere) sometimes left their countries deep in debt through virtuous incompetence. Economic outcomes and debt viability have very little connection with whether regimes are virtuous or odious: the issue is far more complex.

Vietnam has a communist regime which could be denounced as oppressive. It went through a long period of poor policy and incurred heavy debts, and qualified (along with basket cases from Africa) for debt forgiveness under the Highly Indebted Poor Countries (HIPC) programme of the World Bank and IMF. But while African countries eagerly applied for forgiveness, Vietnam insisted on repaying everything, and has overcome its crisis through improved performance. The regime has not become less odious, it has become more efficient, and that is what matters.

If odious debts are to be cancelled, who will identify them? Kremer and Jayachandran propose an independent rating agency, a sort of Moody’s that rates countries on odium. A high odium ranking will be a warning to lenders that a future government may renege on loans, and be allowed to do so by the world community. I doubt very much that either lenders or borrowers will find such a mechanism either workable or credible. What constitutes odious rule is more a matter of opinion rather than fact. Many leftist intellectuals in western democracies considered their own rulers to be odious, and those of the Soviet Union to be great.

Nor do we need a new rating agency to gauge misgovernance. Transparency International already has a corruption index. The World Bank has an institutional index (CPIAL) measuring the quality of governance. The Fraser Institute has an index measuring the extent of freedom. Any lender wishing to assess the risk of rulers stealing or misusing loans already has many yardsticks to go by.

We do not need new lending based on odium. Countries raped by dictators will get fresh aid even if they default on past loans: that has long been global experience. The same thing will doubtless happen in Iraq.

What lessons flow for India? The most important is that we must not expect tinpot dictators in Africa or Central Asia to repay Indian credits. So the giving of credits must be kept firmly outside the purview of the ministry of external affairs (MEA). Indian ambassadors to all countries catch a disease called localitis: they think improving relations with the country they serve in is a must for India. And so they press for additional credits to promote economic relations. They never ask whether the regime is odious, or capable of repayment.

In practice, a huge number of countries have failed to service credits given by India. Even oil rich countries like Iraq and Libya have been major defaulters. India has given credits worth thousands of crores to various African countries at the behest of the MEA. Not only have defaults been common, the regimes cultivated have often been condemned as barbarous by successor regimes. Not even in the narrowest foreign policy terms have these loans been of the slightest value. This waste must stop.

If the MEA really believes that a poor country like India should be giving financial support to others in the national interest, let it persuade the finance ministry to provide an outright grant. But let not various financial institutions (like the Export Credit Guarantee Corporation or Exim Bank) be forced to lend to dud dictators through MEA pressure. That habit has proved unwise and unsuccessful for so long that it deserves to be called odious.

What do you think?