What are Debt for Education Swaps?

What are Debt for Education Swaps? - WORKING PAPER - To be distributed to the Working Group on Debt Swaps for Education, UNESCO Buenos Aires, Argentina, November, 2006

INTRODUCTION... 3 1. WHY INVEST IN EDUCATION?... 4 2. WHAT IS THE STATE OF EDUCATION IN DEVELOPING COUNTRIES?... 6 3. WHAT IS THE NATURE OF THE DEBT PROBLEM?... 8 4. WHAT ARE THE MAIN INITIATIVES AIMED AT DEBT RELIEF?... 10 5. WHAT ARE DEBT FOR EDUCATION SWAPS?... 12 6. WHAT ARE THE MECHANISMS FOR DEBT FOR EDUCATION SWAPS?... 14 7. WHAT SUCCESSFUL EXAMPLES ARE THERE OF DEBT FOR EDUCATION SWAPS?... 16 8. WHAT ARE THE POTENTIAL BENEFITS OF DEBT FOR EDUCATION SWAPS?... 18 9. WHAT ARE THE POTENTIAL COSTS OF DEBT FOR EDUCATION SWAPS?... 20 10. WHAT IS NEEDED TO DEVELOP AN INTERNATIONAL CONSENSUS?... 22 CONCLUSIONS... 24 SOURCES... 25 2

INTRODUCTION Substantial and long-term increases in resources for basic education will be needed. The world community, including intergovernmental agencies and institutions, has an urgent responsibility to alleviate the constraints that prevent some countries from achieving the goal of education for all. It will mean the adoption of measures that augment the national budgets of the poorest countries or serve to relieve heavy debt burdens. Creditors and debtors must seek innovative and equitable formulae to resolve these burdens, since the capacity of many developing countries to respond effectively to education and other basic needs will be greatly helped by finding solutions to the debt problem. 1 World Declaration on Education for All Jomtien, Thailand, 1990 After more than a decade of international declarations promoting debt for education swaps, three years ago a global movement began to emerge. In 2003, during the 32 nd session of the General Conference of UNESCO, the Ministers of Education of Argentina, Brazil, and Venezuela and the President of Peru encouraged initiatives to swap debt for education and requested UNESCO take a lead role. Consequently, the 33 rd session of the General Conference of UNESCO passed a resolution which led to the creation of a Working Group for the purpose of assessing the educational implications of debt swaps and other innovative financing mechanisms. The purpose of this document is to provide the tools for discussing and promoting debt for education swaps within the context of the international commitment to Education For All. Although an extensive history of debt swaps already exists, the major innovation which has been produced is the link between debt swaps and raising funds for education projects. It will be demonstrated that while debt for education swaps do not yet offer the most important solution to the debt and education problems, they do offer an innovative and vital source of funding for education. Specifically, this paper will present the following through a question-and-answer format: the centrality of education to promoting development, the crisis of the education sector across the developing world, the burden of the debt, and finally, how debt for education swaps offer a viable alternative to the funding strategies already being pursued within developing countries. 3

WHY INVEST IN EDUCATION? Investment in education is perhaps the most egalitarian and effective investment a government can make. The benefits of investing in education are supported by ethical, economic, social, and political arguments which are increasingly recognized in global forums. i Arguments for investing in education 2 From an ethical perspective, education is a fundamental human right. According to the Universal Declaration of Human Rights: Everyone has the right to education. Education shall be free, at least in the elementary and fundamental stages... Education shall be directed to the full development of the human personality and to the strengthening of respect for human rights and fundamental freedoms. From an economic perspective, investment in education leads to greater employment, higher wages, higher productivity, and greater economic growth for both society and individuals. The importance of education is evident in both the creation and distribution of wealth. Education provides the conditions in which new forms of income can be developed. The more equal the access to education, the more equal the distribution of income. From a social perspective, education serves a broad range of social justice goals, from saving lives to empowering vulnerable populations, such as women, the poor and indigenous populations. Empirical evidence demonstrates that universal access to education contributes to eliminating social barriers, such as gender, class, race, religion and cultural discrimination, as well as economic obstacles. Education is also a means for saving lives. Education allows for the early detection of symptoms of illnesses and for providing treatment. Education also affects the quality of nutrition, diet variety, as well as fertility and reproductive health. For every year of schooling, a future mother reduces the probability of her child dying prematurely by 8%. From a political perspective, investment in education means having a stronger foundation for democracy. An educated population is more capable of deciding its future, its government, and the decisions which are adopted. An educated society is more capable of holding its government accountable and ensuring transparency. History has demonstrated that during dictatorships, the strongest opposition groups are generally formed in the sectors with greatest access to education and culture. 4

ii International consensus on education as a priority investment 3 Internationally, various United Nations conferences have underlined the centrality of education to development: World Conference on Education for All, Jomtien, Thailand, 1990, Delegates from 155 countries unanimously recognized the role of education as a pillar in the fight against poverty and underdevelopment. The Conference promised to universalize primary education and massively reduce illiteracy before 2000. World Summit for Social Development, Copenhagen, Denmark, 1995 Heads of State from 117 countries reviewed the goals set in Jomtien and recognized that due to slow progress they were unattainable. The Summit recognized that at least 15 more years were needed to reach the goal of universal primary education. World Education Forum, Dakar, Senegal, 2000 Some 1,100 participants from 164 countries reviewed the Education for All objectives and cautioned that too much focus on the quantitative gains made in the 1990s ignores the qualitative aspects of education. The Forum committed to achieving quality basic education for all by 2015. United Nations Millennium Development Goals, New York, USA, 2000 All 191 UN Member States committed themselves to an expanded vision of development which places education at its core: Education is development. It creates choices and opportunities for people, reduces the twin burdens of poverty and diseases, and gives a stronger voice in society. The second of eight development goals calls for achieving universal primary education by 2015. World Summit, New York, USA, 2005 At the largest gathering of world leaders in history, over 100 heads of state emphasized the critical role of both formal and informal education in the achievement of poverty eradication and other development goals as envisaged in the Millennium Declaration EFA Goals 1 Expanding and improving comprehensive early childhood care and education, especially for the most vulnerable and disadvantaged children 2 Ensuring that by 2015 all children, particularly girls, children in difficult circumstances and those belonging to ethnic minorities, have access to, and complete, free and compulsory primary education of good quality. 3 Ensuring that the learning needs of all young people and adults are met through equitable access to appropriate learning and life-skills programmes 4 Achieving a 50 per cent improvement in levels of adult literacy by 2015, especially for women, and equitable access to basic and continuing education for all adults. 5 Eliminating gender disparities in primary and secondary education by 2005, and achieving gender equality in education by 2015, with a focus on ensuring girls full and equal access to and achievement in basic education of good quality. 6 Improving all aspects of the quality of education and ensuring excellence of all so that recognized and measurable learning outcomes are achieved by all, especially in literacy, numeracy and essential life skills. There is overwhelming evidence that education should be placed at the center of national development strategies. Since 1990, there has been a growing international consensus that universal access to quality education must be a priority. As the next section will demonstrate, much more needs to be done to convert these declarations into concrete action. 5

WHAT IS THE STATE OF EDUCATION IN DEVELOPING COUNTRIES? According to the Education For All Monitoring Report, steady progress has been made, especially towards universal primary education (UPE) and gender parity among the poorest countries, but the pace is insufficient for the goals to be met in the remaining ten years to 2015. iii State of Education: General Overview 4 Among the encouraging trends representing considerable achievements in many low-income countries, it is worth mentioning: Globally, 47 countries have achieved UPE (out of 163 with data available). Projections show that 20 additional countries (out of 90 with the relevant data) are on track to achieve UPE by 2015; 44 countries are making good progress but are unlikely to achieve the goal by 2015. Primary-school enrolments are up sharply in both sub-saharan Africa and South and West Asia, with nearly 20 million new students in each region. Girls primary enrolments have also risen rapidly, especially in some of the lowest-income countries of sub-saharan Africa, and South and West Asia. Among the major Education for All challenges which remain, several can be highlighted: UPE is not assured About 100 million children are still not enrolled in primary school, 55% of them girls 23 countries are at risk of not achieving UPE by 2015, as their net enrolment ratios are declining. Primary-school fees, a major barrier to access, are still collected in 89 countries (out of 103 surveyed). High fertility rates, HIV/AIDS and armed conflict continue to exert pressure on education systems in the regions with the greatest EFA challenges. Quality is too low: Enrolments in early childhood care and education programmes have remained static. Less than two-thirds of primary school pupils reach the last grade in 41 countries (out of 133 with data). In many countries, primary teacher numbers would have to increase by 20% a year to reduce pupil/teacher ratios to 40:1 and to achieve UPE by 2015. Many primary-school teachers lack adequate qualifications. The 2005 gender parity target has been missed by 94 countries out of 149 with data. 86 countries are at risk of not achieving gender parity even by 2015. 6

iv Funding of the Education Sector 5 Among the encouraging trends regarding the funding of education it is worth noting: Public spending on education has increased as a share of national income in about 70 countries (out of 110 with data). Aid for basic education more than doubled between 1999 and 2003 and, following the G8 summit, could rise to US$3.3 billion per year by 2010 The main problems regarding the funding of education are: Public funding for education is still inadequate: Public spending on education represents a higher proportion of GDP in rich countries that have already achieved EFA goals (regional average: 5.7% in North America and Western Europe) than in poorer countries. These need to sharply expand already under-resourced school systems whose coverage is insufficient (regional averages: 3.3% in South and West Asia; 4.6% in sub- Saharan Africa; 4.8% in Latin America and the Caribbean; and 4.9% in East Asia and the Pacific) Aid for basic education is still inadequate: At US$4.7 billion in 2003, bilateral aid to education 60% of which still goes to post-secondary education has increased since 1998 but remains well below the 1990 high of US$5.7 billion. Total aid to basic education accounts for only 2.6% of Official Development Assistance. While aid to basic education will likely increase in line with overall aid, its share would have to double to reach the estimated US$7 billion a year necessary just to achieve UPE and gender parity. Disproportionate volumes of bilateral aid go to middle-income countries with relatively high primary enrolments. By mid-2005, the Fast Track Initiative had resulted in pledges of only US$298 million. The persisting problems with regards to reaching the EFA are all the more salient when considering this statement from the Education for All Declaration signed in Jomtien more than fifteen years ago: Substantial and long-term increases in resources for basic education will be needed. The world community, including intergovernmental agencies and institutions, has an urgent responsibility to alleviate the constraints that prevent some countries from achieving the goal of education for all. It will mean the adoption of measures that augment the national budgets of the poorest countries or serve to relieve heavy debt burdens. Creditors and debtors must seek innovative and equitable formulae to resolve these burdens, since the capacity of many developing countries to respond effectively to education and other basic needs will be greatly helped by finding solutions to the debt problem. In order for many developing countries to deliver on their promises to improve their education systems, they will have to develop solutions that can simultaneously inject greater investments into education while addressing their enormous debts. The nature of the burden is discussed in the next section. 7

2. WHAT IS THE NATURE OF THE DEBT PROBLEM? Given that the problems of low quality education and over-indebtedness are mutually reinforcing, many developing countries are caught in a vicious cycle. The burden of the debt is so great that some governments spend more on servicing their debt than on education or health, and in some cases the two combined. i Size and Impact of the Debt 6 The first table compares regional public education spending and total debt service as percentages of GDP, as well as total debt service as a percentage of total exports. The total developing world debt is US$2,800.4 billion This figure should be contrasted with: Official Development Assistance (ODA) to developing countries at US$ 106.5 billion in 2005 reached its highest level ever. Global military spending and the arms trade totaled over $975 billion in 2004. REGION Education Spending (% of GDP) Total Debt Service (% of GDP) Total Debt Service (% of total exports) World 4.8 - - North America and Western 5.7 - - Europe Latin America and the 4.8 8.6 30.7 Caribbean Central and Eastern Europe 4.6 7.7 17.3 East Asia and the Pacific 4.9 3.2 10.5 Arab States - 2.5 15.5 South and West Asia 3.3 2.9 13.5 Sub-Saharan Africa 4.6 2.9 9.6 The second table compares spending in education, health, and debt servicing as percentages of GDP, as well as total exports, in the countries belonging to the UNESCO Working Group In 5 of the 8 developing countries debt servicing surpasses education spending. In four countries, the cost of servicing the debt surpasses the combined cost of education and health spending. COUNTRY Education Spending (% of GDP) Health Spending (% of GDP) Total Debt Service (% of GDP) Total Debt Service (% of total exports) Argentina 4.0 4.5 10.8 34.7 Brazil 4.2 3.6 11.5 38.6 Costa Rica 5.1 6.1 4.8 8.9 Egypt - 1.8 3.4 - France 5.6 7.4 - - Germany 4.6 8.6 - - Indonesia 1.2 1.2 8.9 12.8 Japan 3.6 6.5 - - Morocco 6.5 1.5 9.8 25.7 Norway 7.6 8.0 - - Philippines 3.1 1.1 12.8 13.8 Senegal 3.6 2.3 3.8 23.4 Spain 4.5 5.4 - - South Africa 5.3 3.5 2.7 4.3 United Kingdom 5.3 6.4 - - 8

ii Nature of the Creditors 7 In order to tackle the debt problem it is essential to understand the nature of the creditors. This entails recognizing to whom the developing world debt is owed and the political nature of these debts: There are three major categories of creditors: 1. Private/Commercial debt: owed to private sector creditors, including commercial banks, bond holders, and export and trading companies. Includes bonds, loans and promissory notes. 2. Multilateral debt: owed to international financial institutions, such as the World Bank, International Monetary Fund, and regional development banks, such as the Inter-American Development Bank. 3. Bilateral debt: owed to governments. Official Development Assistance (ODA) loans are typically owed to government aid agencies. Publicly guaranteed loans (mostly export credits) are owed to export credit agencies. These categories are important to take into account because developing countries are most successful in receiving debt relief and debt swaps from bilateral creditors than from other types of creditors. Breakdown of Developing Countries Debt by type of Creditor A major proportion of the long term debt (representing 78% of the total debt) of developing countries is in private hands. This is important to note in the context of debt relief, because debt for development swaps are generally carried out in bilateral debt programs. The implication of this reality is that even if countries did hypothetically manage to cancel, or swap, the debt owed to bilateral creditors, it would have a minor impact on the overall debt problem. Bilateral Debt 18% Multilateral Debt 17% Private Debt 65% Governments often have to make the difficult choice between social spending and meeting pressing debt obligations. Escaping this trap requires finding creative solutions backed by both the debtor governments and creditor organizations. 9

3. WHAT ARE THE MAIN INITIATIVES AIMED AT DEBT RELIEF? National attempts to resolve the debt crisis have had a relatively small effect. Moreover, international and multilateral efforts to resolve the global debt problem have been marginally successful. i Legitimacy of the Debt 8 The debate surrounding the legitimacy of the debt is generally divided among three positions: 1. Repudiation of the debt: the debt is illegitimate; it should not be paid. 2. Annulment of the debt: the debt is recognized but is declared unpayable; it should be annulled. 3. Conversion of the debt for development: the debt is recognized; its cancellation should be negotiated through swaps or other mechanisms. This last position, which is based on the co-responsibility of both debtor and creditor countries, reaches a middle ground between the repudiation and payment of the debt. This posture promotes debt swaps not only as a legitimate transaction, but as a solidarity pact with developing nations. ii Relief of Debt Owed to Private Creditors 9 Reduction Process: All private debts can, in principle, be reduced or restructured, if the creditor and debtor agree. As soon as the private creditor realizes that it cannot expect to recover a debt, it may be willing to sell it below face value, restructure the terms, or exchange it for another debt instrument. There is a secondary market for private debts, which functions more or less to market principles, in which discounted debts are traded. Under the London Club, procedures for restructuring commercial bank debt, a Bank Advisory Committee representing the major creditors is set up, usually chaired by the largest creditor. The committee reaches an agreement in principle with the debtor country, which then must be approved and subsequently signed by the participating creditors. The Brady Plan, introduced in 1989, stimulated growth in the secondary market as less liquid bank loans were exchanged for marketable securities called Brady Bonds. Trading in debt increased substantially in 1986-87 after several Latin American countries introduced debt-equity swap programs (discussed in the next section) as part of their London Club debt restructuring packages. Reduction Impact: At their peak, debt conversion transactions involving commercial debt reached US$28 billion in 1990. By 1996, the last year for which complete statistics on debt conversion are available, only US$900 million in commercial debt was converted. Despite these attempts, the private debt in developing countries, at around 65% of the total debt, remains overwhelming. 10

iii Relief of Debt Owed to Public Creditors 10 Multilateral Debt: Reduction Process: Traditionally, multilateral debt has not been available for debt relief. The status of preferred creditors enjoyed by the World Bank, the International Monetary Fund and by regional development banks used to preclude the possibility of writing off such a debt. However in 1996, the World Bank and IMF launched the Heavily Indebted Poor Countries Initiative (HIPC) to help poor countries to escape from unsustainable debt burdens by providing comprehensive debt relief provided they meet certain criteria. The enhanced HIPC initiative, created in 1999, lowered the qualifying criteria, speeded up the delivery process and created an explicit link to poverty reduction. Reduction Impact: Debt reduction packages have been approved for 29 countries, 25 of them in Africa, providing around $40 billion in debt service relief. In July 2005 at the G8 Summit, developed nations committed to canceling the debt of 18 countries belonging the HIPC initiative. Despite these advances, the initiative has been heavily criticized for not canceling large enough amounts of debt, placing unfair conditionality, for being slow in their implementation, and for not including highly indebted, middle income countries that have a large proportion of their populations living in poverty. Bilateral Debt Reduction Method: All bilateral debts can be subject to relief or conversion, with certain restrictions. Bilateral debt reduction is generally conducted through the Paris Club, an informal group of 19 government creditors whose role is to find coordinated and sustainable solutions to the payment difficulties experienced by debtor nations. Of particular importance to this document is the Paris Club debt swap clause: a clause that has been included in most Paris Club framework agreements since 1991. The clause currently allows for conversion on a voluntary basis of 100% of ODA loans and up to the higher of 30% or 40 million for non-concessional loans (on an exceptional basis). Reduction Impact: Since 1983, the total amount of debt treated worldwide in Paris Club agreements has been $509 billion. It is the official development assistance nature of most bilateral loans that makes them most likely to canceled, restructured, and swapped. Comprehensive debt reduction strategies are inadequate at both national and international levels. As bilateral debts are the most pertinent to the discussion of debt relief and debt conversion, the nature and effect of the bilateral loans is emphasized in the rest of this paper. 11

4. WHAT ARE DEBT FOR EDUCATION SWAPS? A debt for education swap is the cancellation of debt in exchange for funding in education. Debt swaps have been around for a couple of decades, and have evolved from purely commercial transactions to innovative methods to raise development funds while reducing the external debt. i Definition and Types of Swaps 11 A debt swap is the cancellation of external debt in exchange for the debtor government s commitment to mobilize domestic resources for an agreed purpose. The terms conversion, exchange, and swap are often used interchangeably. Just as there are various types of debts, there are also various types of debt swaps that can be placed into two main categories: 1) Commercial Swaps and 2) Development Swaps, the latter being the main focus of this document. 1. Commercial Swaps Definition: The cancellation of external debt in exchange for equity investment in a domestic company or privatized public enterprise in the debtor country. The dual purpose of a debt-forequity swap is to 1) reduce the external debt 2) promote investment, generally through privatization programs. History: During its peak period, 1985 to 1996, debt-for-equity swaps totaled US$38 billion. During this period much of the secondary market was dominated by trading in debt owed by Latin American countries until privatizations programs lost popularity. Evaluation: Debt-for-equity swaps have been heavily criticized for promoting a loss of sovereignty in the developing world as key industries that were once under public control ended up in the hands of foreign investors. 2. Development Swaps Definition: The cancellation of external debt in exchange for investment in a debtor s country development oriented sector (e.g. education or health). The dual purpose of debt for developments swap is to 1) mobilize additional resources for a development related sector and 2) reduce the external debt. History: The first debt for development swaps were the debt-for-nature swaps that gained popularity in the late 1980s, and which are still carried out in a number of countries. Stimulated by the apparent success of environmental organizations in mobilizing additional resources through debt for nature swaps, a large number of governments and NGOs became actively involved in debt for development swaps under different names: debt for education, debt-forhealth, debt-for-child-survival etc. Evaluation: although debt for development swaps have provided far less debt relief than commercial swaps, these transactions have provided much needed funding for many development projects 12

ii Support for Debt for education Swaps 12 After a decade of international calls for debt for education swaps, a global movement began to emerge three years ago: April, 1996: the International Commission on Education for the Twenty-first Century develops a report to UNESCO, which declares: Debt swaps should be encouraged in order to offset the adverse effect of adjustment policies and policies for the reduction of domestic and foreign deficits on educational spending. June, 1996: the Amman Affirmation on Education for All calls upon debt swaps to help resolve the education financial crisis. August 2003: a Latin American movement in favor of debt for education swaps begins to take hold when 20 civil society organizations sign a declaration expressing that Ministers of Education in the region develop a proposal to swap IMF debt for investment in education. September, 2003: at the XIII Iberoamerican Conference on Education, the Ministers of Education call upon regional Heads of States to analyze the possibility of converting a percentage of regional debt into education funding. October, 2003: at the 32nd session of UNESCO's General Conference, the Argentine, Brazilian and Venezuelan Ministers of Education, and the President of Peru, propose that UNESCO lead a global initiative to swap debt for education funding, citing support from Uruguay, as well as from UNICEF. November, 2003: at the XIII Iberoamerican Summit of Heads of States and Governments, leaders respond to the Minister of Educations proposal by promising to explore the idea of swapping debt for education. Early 2005: the Iberoamerican Working Group (GTI), coordinated by Spain s Ministry of Education, with representatives from Argentina, Brazil, Costa Rica, Ecuador and Mexico, promotes an Iberoamerican Pact for Education with the goal of advancing the definition of strategies, contents and instruments for the design of an Iberoamerican plan to support debt for education swaps. January, 2005: a few months after declaring debt for education swaps as a cornerstone of his foreign policy, the Spanish President, Jose Luis Zapatero, begins to negotiate debt for education swaps with several Iberoamerican countries. October, 2005: at the 33 rd session of UNESCO s General Conference, a resolution calls upon the establishment of a working group to be composed of representatives designated by interested Member States to assess the educational implications of debt swaps and other innovative financing mechanisms March, 2006, UNESCO announces the creation of the Working Group on Debt Swaps for Education. April/May 2006: the Euro-Latin American-Caribbean Civil Society Forum and the Vienna Summit for Presidents of the European Union, Latin America and the Caribbean, express support for debt for education swaps. November 2006, at the XVI Iberoamerican Summit of Heads of States and Governments, leaders call upon the Iberoamerican General Secretariat to further promote debt for education swaps. A decade ago, the idea of swapping debt for education was no more than a couple of statements made in international forums. Since then, the idea has attained official support from various international organizations, creditor and debtor governments, and from multiple civil society organizations, and most importantly, several important swaps are already being negotiated. 13

5. WHAT ARE THE MECHANISMS FOR DEBT FOR EDUCATION SWAPS? Reflecting the innovative and progressive nature of the initiative, debt swap models are generally dynamic, ad hoc, and participatory, ensuring more transparency and accountability than most institutional structures which already exist in developing world governments. Debt for education swaps can be broken down into two main types of models: bilateral swaps and triangular swaps. The major difference between these two models usually, although not always, depends upon the type of debt being swapped (private or public): i Bilateral Swaps 13 In a typical bilateral swap the creditor government agrees to reduce a developing country s ODA debt in exchange for debtor government investment in education. The creditor and debtor governments directly negotiate the terms of the debt reduction and the debtor government s commitment to set aside funds for education. The phases of a bilateral swap (as per the swap conducted between Spain and El Salvador during 2005/2006) are: I. The Swap Set the amount of convertible debt. Advance payment of the debt by the debtor country in case the current debt service would have a negligible effect on the education system of the beneficiary country. Sign swap agreement and define the educational areas to be financed (normally negotiated by both Ministries of Economy with constant participation of the Ministry of Education of the debtor country) II. Activating the Fund Create mechanisms for coordination and management: Binational Committee and Technical Committee (with the incorporation of Civil Society Organizations) Create the Debtor-Creditor Fund Activate the counterpart fund Transfer the maturities to the bilateral fund account If necessary, the creditor country transfers the advanced payment. III. Implementing the Fund Annual meetings of the Binational Committee, according to the established rules in the Regulation of operation and implementation. Presentation of projects to the Technical and Binational Committees Approval of the projects by the Binational Committee Selection of the implementing party via public acquisition protocol. Implementation, follow-up and evaluation of the projects. 14

ii Triangular Swaps 14 A typical triangular swap is an agreement made between at least three parties: 1. Creditor (usually a foreign bank), 2. Debtor country government and 3. Not-for-profit investor (an international development organization, which can be an NGO or a UN agency). A fourth party that may be involved is a developed country government or international organization providing funds. Two levels of negotiations usually take place simultaneously: The not-for-profit investor and the creditor resulting in a debt purchase agreement in which the not-for-profit purchases the debt from the creditor at a discount from face value. The not-for-profit investor and the debtor government resulting in a debt swap agreement. The debt is canceled at a redemption price paid by the debtor government to the non-profit, the proceeds of which are used by the not-for-profit for an agreed purpose. In contrast to the bilateral model, the non-governmental organization or United Nations agency may acquire commercial debt or official bilateral debt, usually from an export credit agency. There have been more triangular swaps over the years than bilateral swaps, while bilateral swaps tend to involve much greater investments in development. The following table summarizes the two main models of debt for development swaps: Type of Swap Bilateral Triangular Parties to Transaction Eligible Debt Source of Funds Amount of Debt Converted 1. Debtor Government 2. Creditor Government 1. Debtor Government 2. Not-for-profit investor 3. Creditor 1. Official Development Assistance (ODA) 2. Publicly guaranteed debt 1. Commercial debt 2. Bilateral publicly guaranteed debt (small amounts) Budget of creditor country Funds raised either by creditor country NGO or donation by commercial creditor Generally much larger Generally small Recipient of Funds Counter-part fund or public institution (e.g. Ministry of Education) NGO or counterpart/trust fund iii Administration of the Counterpart Fund (CPF) 15 Regardless of the type of CPF developed, the following criteria have been proposed for designing projects or programs: An adequate institutional capacity to manage the project. A cost-benefit analysis with regards to viability and efficiency. A clear identification of objectives. An approach which is sustainable over time. Definition of follow-up and impact assessment indicators. Criteria on the levels and procedures for civil society participation. It is important to stress that a debt for education swap is far more than a cash transaction; it is also a move towards participation, transparency and accountability. The design and implementation of the counterpart fund is critical in order to take advantage of this innovative mechanism to fuel development efforts. 15

6. WHAT SUCCESSFUL EXAMPLES ARE THERE OF DEBT FOR EDUCATION SWAPS? Debt for development swaps have been conducted for almost two decades in over 50 countries. However, there is no comprehensive data on the amount of debt swapped through these transactions. Nevertheless, there are numerous documented experiences which provide important lessons for future debt for education swap initiatives. i Bilateral Debt for development Swaps 16 Switzerland and Spain have developed two of the most important debt swap programs: The Swiss Debt Reduction Facility, created in 1991, is the most successful debt reduction program: The Facility provided funding for bilateral, commercial, and multilateral debt relief operations in exchange for debtor governments agreement to pay a certain percentage of the cancelled debt into a counterpart fund to be used for development projects and programs that benefit the poor. During ten years of operation, the Swiss government canceled over CHF 2 billion, or US$1.6 billion, debt in 19 countries. In 12 countries SDRF debt relief was linked to the creation of counterpart funds worth a total of CHF 267 million, or US$219 million, used for poverty reduction, income generation, and environmental projects. Currently, Spain is the leader among creditor countries carrying out debt for education swaps: In 2004, Spanish President, José Luis Zapatero, announced Spain will be actively involved in debt swap operations for social development, especially in the area of primary education. After initiating talks with Argentina, Spain began negotiating with other regional countries: Ecuador (US$50 million), Nicaragua ($38.9 m), Honduras ($138.3 m) y El Salvador ($10 m). In 2006, Bolivia, Guatemala, Peru and Paraguay were added to the list of beneficiaries of Spanish debt swaps which are estimated to amount a total of US $436 million. In all of these cases and those to come, the Spanish government will cancel debts in exchange for programs which consists of the construction of education facilities, the opening of new institutes, providing materials, and other investments within the sector. 2005 June July Aug Sept Nov 2006 Jan Feb Mar Case Study: Bilateral Swap between Spain and El Salvador, 2005 El Salvador President Tony Saca proposes swap to Spain President Jose Luis Zapatero El Salvador Ministry of Education begins formulating the project El Salvador Ministry of Finance contacts Director of International Finance (Spain) to define the servicing of the debt and the nature of the swap Swap is set at US $10 million, with $6.3 million paid in advance for 2006, to be deposited in a special account Swap agreement is signed in San Salvador. The administration and operational mechanisms are approved. Project profiles and an annual payment plan are presented. Law proposal is presented to El Salvador legislature Project profiles are presented to the Binational and Technical Committees Payment of resources for carrying out Project: construction and renovation of education facilities and educational materials for the most marginalized regions of El Salvador 16

ii Multilateral Debt Swaps for Development 17 The EcoFund experience in Poland is a unique case which could serve as a model for future debt for education swaps. In 1992, Poland developed the largest counterpart fund in the history of debt for development swaps. The country agreed to a 50% reduction of its debt with the Paris Club, and proposed an additional 10% reduction in exchange for a deposit of the equivalent funds in the EcoFund. With the support of the five creditors behind this swap (France, Italy, Sweden, Switzerland and the United States), it is estimated that $545 million will be invested in environmental projects until 2010. iii Triangular Debt for development Swaps 18 According to the UNDP, three organizations: Finance for Development, New York Bay and UNICEF have been the main participants in triangular debt for development swaps. Finance for Development and New York Bay have swapped $566.7 million since 1992. The funds have been invested in various sectors, including health, population, agriculture, eco-tourism and lowincome housing. From 1989 to 1995 UNICEF, a pioneer in debt for development swaps, had completed 21 transactions, generating $52.9 million for programs in support of child and maternal development while helping participating countries reduce their external debt stock by $199.3 million. Using debt donations and contributions from UNICEF committees to purchase debt, UNICEF came close to doubling its development funds through debt swap transactions. S p a i n - I n t e r m Case Study: Triangular Swap between UNICEF, Senegal and Argentina, 1993 UNICEF Dutch Committee STEP 1 Government of Argentina STEP 2 Government of Senegal STEP 3 UNICEF Senegal Development Projects Steps: 1. o UNICEF s Dutch Committee purchased US$24 million from the Government of Argentina face value of debt n from the Government of Argentina (a creditor of Senegal) for US$6 million (25% of the purchase price) 2. UNICEF transferred the US$24 million debt to the Government of Senegal for cancellation. - 3. Government of Senegal paid the equivalent of US$11 million (46% of the redemption price) in CFA francs M over three years in support of UNICEF-Senegal projects for women and children. There are various successful models for conducting debt for education swaps. Given the growing interest in debt swaps, it is necessary to systematically evaluate their costs and benefits. 17

7. WHAT ARE THE POTENTIAL BENEFITS OF DEBT FOR EDUCATION SWAPS? There are numerous quantitative and qualitative benefits associated with debt for development swaps in general, and education swaps in particular. i Potential Benefits for the Debtor country 19 1. Support for Development Programs 2. Debt Reduction 3. Impact on Balance of Payments 4. Civil Society Participation Increased Funding for Education Programs The most obvious benefit of a debt swap is the resources which are generated for the education sector. The rewards from swaps can be maximized if they are directly passed onto the most vulnerable populations in the debtor country, with the objective of achieving quality education for all. Debt Reduction Although debt swaps are not capable of solving the debt problem on their own, they can make a positive impact on the overall debt situation in a developing in a country. Furthermore, it should be noted that debt swaps offer a stronger argument than debt cancellation or payment default when discussing the debt problem. A debt for education swap ensures that the proceeds from the conversion benefit marginalized populations, while cancellation and default do not necessarily guarantee an investment in human development. Positive Impact on the Balance of Payments By reducing debt service payments in foreign currency, since payment into the counterpart fund is usually in domestic currency, debt swaps can have a positive impact on a country s balance of payments. Greater Civil Society Participation The qualitative benefits of debt for education swaps cannot be overlooked. Both triangular and bilateral debt swaps generally lead to greater participation by civil society, including NGOs, in designing and implementing development projects. Swaps can also generate positive publicity that raises the profile of development projects in the debtor country. 18

ii Potential Benefits for the Creditors 20 1. Support for development policies 2. ODA increase 3. Recovery of some of the debt 4. Civil society participation Support for development policies If the creditor is a government, or multilateral bank, debt swaps can help ensure that the resources made available to the debtor country from debt relief are used for activities that are important to the creditor, such as education funding. A swap is thus one way to make debt relief marketable from a political perspective to creditor country constituencies while at the same time achieving international development objectives. Official Development Assistance increase Debt relief, however granted, never represents an actual transfer of funds to the debtor country. Aid agencies in developed countries can use debt relief to increase their spending on official development assistance (ODA) without any immediate cost to the state budget. ODA to developing countries increased to US$106.5 billion in 2005, its highest level ever. The total represents 0.33% of the developed countries gross national income (GNI), up from 0.26% in 2004. Despite this advance, the developed world is far below the 0.7 percent target adopted by the United Nations more than 30 years ago. Moreover, total aid to basic education accounts for only 2.6% of global ODA. Recovery of some of the debt If the creditor is a commercial firm, selling the debt to an international agency or NGO at a discount from face value, or allowing it to be bought back directly by the debtor country, is a way of recovering at least some value of the debt. Greater civil society participation The qualitative benefits of debt for education swaps cannot be overlooked. Both triangular and bilateral debt swaps generally lead to greater participation by civil society, including NGOs, in designing and implementing development projects. Swaps can also generate positive publicity that raises the profile of development projects in the creditor country. There are numerous benefits of debt for education swaps for both debtors and creditors. In order for debt for education swaps to grow in size and popularity, it is essential that parties to the transaction ensure that the rewards of the swap be directly transferred to the most vulnerable populations in the debtor country in the most transparent and accountable manner possible. 19

8. WHAT ARE THE POTENTIAL COSTS OF DEBT FOR EDUCATION SWAPS? In order ensure the success of debt for education swaps it is necessary to plan and prepare for several potential costs. What appears to be a straightforward transaction on paper is a complex process in reality. i Potential costs for the debtor country 21 1. Internal Debt Increase 2. Problem with Additionality 3. Policy Conditionality 4. Transaction Costs Domestic debt increase A debt swap is essentially the reduction of external debt at the expense of increased expenditure in domestic currency, which could lead to a rise in domestic debt. The budgetary impact of debt swaps can be better dampened if payments are made over time. Problem with additionality Debt swap funds may replace debtor country government social spending, rather than adding to it. Ensuring additionality is thus an important consideration. Since it is nearly impossible to prove that any one project would not have been financed in the absence of the counterpart fund, additionality is often measured against a historical spending baseline. Policy conditionality Many debtor countries prefer debt cancellation over debt for development swaps because they view swaps as essentially debt relief with conditionality. However, no-strings-attached debt relief does not guarantee that the sectors most heavily burdened by the debt will benefit from its cancellation. Swaps not only provide the injection of new resources into the education sector, but also create the opportunity to create transparent and efficient institutions. Transaction costs Since debt swap transactions are complex and often time-consuming, government officials may need to devote significant resources to negotiating, documenting, and monitoring transactions. In order to cover some of their costs, many debtor countries have charged a transaction commission to the creditor. Institutionalizing swaps at the multilateral level could provide a systematic mechanism which facilitates negotiations and makes monitoring more effective and efficient. 20

ii Potential costs for creditors 22 1. Cost of Debt Cancellation 2. Lack of Control over Funds 3. Greater Responsibility 4. Transaction Costs Cost of debt cancellation Debt swaps involve at least some debt cancellation. Government creditors are not likely to support debt swaps if they do not wish to provide debt relief, and commercial creditors will refuse to sell if they believe that the market value of the debt they hold is higher than what they are being offered for it. It is thus essential to mobilize developed countries civil societies in order to lobby and pressure their governments and financial institutions into promoting debt for development swaps. Lack of control over funds To the extent that public debt swaps are simply another vehicle for providing foreign assistance, creditors might feel that they do not have sufficient control over the domestic currency fund created by the swap, and thus prefer more traditional forms of foreign assistance. This concern can be addressed by creating a counterpart which is regulated by creditor and debtor government representatives. Counterpart fund responsibilities Ensuring proper use of the counterpart fund created by a debt swap generally requires ongoing involvement by the creditor country. If there are problems administering the fund, the creditor country government might also be criticized for its role. There is thus some risk for the creditor that might not exist were the debt to be cancelled without conditions or sold on the secondary market. This risk can be offset be creating a counterpart fund governing body which is transparent, accountable and representative of the stakeholders involved in the debt for development swap. Transaction costs Since debt swap transactions are complex and often time-consuming, government officials may need to devote significant resources to negotiating, documenting, and monitoring transactions. In order to cover some of their costs, many debtor countries have charged a transaction commission to the creditor. Institutionalizing swaps at the multilateral level could provide a systematic mechanism which facilitates negotiations and makes monitoring more effective and efficient. When conducting debt for education swaps governments must conduct a cost-benefit analysis. Despite the above mentioned potential costs, international experience has demonstrated that debt for development swaps have been essential to raising additional funds for development projects, and a testament to these successes is the recent surge in calls for debt for education swaps. 21

9. WHAT IS NEEDED TO DEVELOP AN INTERNATIONAL CONSENSUS? In recent years a growing consensus supporting debt for education swaps has developed. Political will needs to be mobilized in order to convert declarations into concrete action towards achieving the Education For All goals. i Actions Recommended at the National Level 23 It is essential that the projects carried out with the debt swap be part of the debtor country s national education strategy, particularly for its most vulnerable population. Similarly, debt for education swaps should be incorporated into part of the debtor country s overall debt management strategy, as well as part of the creditor government s official development aid strategy. The counterpart fund is likely to generate greater benefits and awareness if its activities are focused on a focused set of critical issues, rather than on the education sector as a whole. For example, focusing debt swaps on universal access to quality primary education allows for the development of expertise and experience in maximizing the use of the funds, as well making it possible to define indicators against which progress on the issues can be evaluated. Governance of the counterpart fund is of critical importance to its credibility, survival, and performance. In general, debt swap experience suggests that models in which both governments have representatives on the governing committee(s), with local NGO presence, have the greatest chances for success. ii Actions Recommended at the Regional Level 24 The Iberoamerican Pact for Education (PIPE) can serve as a model for other regional/global agreements. The central goal of the PIPE is an overarching multilateral agreement which frames bilateral operations. The Iberoamerican Working Group (GTI) works towards an institutional scheme based on several principles: Ensure centrality of education in the negotiations and set priorities. Coherence among development policies. Coordination mechanisms and strategic supervision. Coordination of swap funds with other sources of financing. Networks for diffusing best practices and successful cases. Evaluation systems and publication of results (accountability mechanism) Statistical information and comparable data bases Mixed monitoring group. The PIPE agreement faces several obstacles: Requires inter-institutional agreements among different ministries within each country: economy/finance, education, development assistance, and social development. Easier to establish general criteria but more difficult to prescribe precise action guidelines (different national situations and priorities) As of now, only one creditor is participating, Spain, greatly limiting the multilateral nature of the agreement. The participation of Iberoamerican creditor countries with neighboring debtor countries would give the initiative a true regional dimension. 22