In summary, there are a range of options for financing debt reduction. These should be ordered in terms of their effects on financial flows to developing (and particularly low-income) countries, and used in sequence until the point is reached where the costs to developing/low-income countries of reduced capital flows equal the benefits of debt reduction. Where exactly this point occurs requires further investigation.
The sequence implied by this approach is broadly as follows.
Loan loss provisions. While IDA has no such provisions, some $1-2bn of IMF and IBRD provisions could be released to support the HIPC Initiative, provided DR Congo, Liberia, Somalia and Sudan qualified for debt reduction, and some IMF members waived their rights to refunds of their contributions to Special Contingency Accounts 1 and 2.
The capital proceeds of sales of the IMF's gold reserves (with the largest volume of sales politically attainable). Even the 5m ounces whose sale is currently proposed could raise $1¼bn if used in this way; and in principle sales of ten times this amount should be feasible. This would provide around $12bn at the current world price. This could be used to cover other multilateral debts, prioritising those in the weakest financial position (notably the AfDB), as well as those owed to the IMF.
IBRD reserves released by relaxing the capital-plus-reserves constraint on lending. Allowing the Bank to lend 10% more than its capital and reserves could allow the Bank both to increase its lending by $15bn and to use $5bn of reserves to finance additional debt reduction60.
Taken together, these sources could provide around $18-19bn for the reduction of multilateral debts, at a minimal cost in terms of new finance; provided the political constraints could be overcome. The net effect of debt reduction financed in this way would be clearly positive. There may also be some other funds within the IFIs which would also fall into this category.
Using the following funding sources would imply a roughly one-for-one trade-off between aid and debt reduction. These could still provide net benefits, if $1 of debt-reduction is more beneficial than $1 of new financing from the source concerned (given its uses, terms, etc); but these will be more limited than the previous sources. These sources should be prioritised to the potential net benefits of the capital flows affected.
Bilateral contributions to multilateral debt reduction. These would be likely to come directly from aid budgets; but where aid budgets are poorly allocated, and the cost is borne by low priority uses (eg hidden trade subsidies and politically motivated support for countries with limited need for aid), there would be substantial benefits.
IDA reserves and reflows. These contribute directly to new IDA credits, which would therefore be reduced if these sources were used to finance debt reduction. In view of the highly concessional nature of these resources, this should probably be avoided. As with the ESAF, any argument for a reduction or reorientation of IDA credits would need to be justified on its own merits.
While the cost of using bilateral contributions to finance multilateral debt reduction is relatively high, this would not be the case if genuinely additional resources could be generated. One possibility for this would be to secure agreement from those bilateral donors which are not already doing so to meet their international commitment to provide development assistance of 0.7% of GNP for a single year, on a one-off basis, expressly for debt reduction, for example to mark the Millennium. This would generate additional resources of around $100bn (Woodward, 1998) - equivalent to about half of the total debt of all the HIPCS (in present value terms), even before taking account of the debt reduction likely under existing mechanisms.
If current efforts to provide adequate debt-reduction for low-income countries were to fail, other financing mechanisms might be feasible in the long term. These would include, for example, the proceeds of a "Tobin tax" - an internationally-applied tax levied at a very low rate (generally assumed to be a fraction of 1%) on all international currency transactions. The sheer volume of such transactions means that such a tax would raise very considerable sums (possibly hundreds of billions of dollars per year), which would provide plentiful resources for debt reduction and other priority development needs61.
However, the practical and legal problems of establishing such a tax, together with the considerable political resistance to its introduction, mean that this is only a possibility in the long term. To rely on this as a means of financing debt-reduction would mean seriously delaying the process, to the detriment of countries whose need for debt reduction is urgent.