What is a Debt forgiveness?

Welcome to the Investors Trading Academy talking glossary of financial terms and events.
Our word of the day is “Debt forgiveness”
Cancelling or rescheduling a borrower’s debts to lessen the pain of the debt burden. Debt forgiveness is increasingly viewed as the best way to relieve the financial problems facing poorer countries. Some of these countries have to pay so much in interest each year to foreign lenders that they have little money left to spend on the long-term solutions to their poverty, such as educating their workers and building a modern infrastructure. In 1998 the world bank calculated that around 40 of the world’s poorest countries had an ‘unsustainably high’ debt burden: the present value of their total debts was more than 220% of their exports.
Debt forgiveness has potential drawbacks. For instance, there is a risk of moral hazard. If countries that borrow too much are let off their financial obligations, poor countries may feel they have nothing to lose by borrowing as much as they can. This is why policymakers often argue that debt forgiveness should come with a conditionality clause, for instance, a requirement that countries have a track record of implementing economic reforms designed to prevent a repeat of the errors that first created the need for debt forgiveness. This is the approach taken by the world bank’s highly indebted poor country initiative, launched in 1996 and expanded in 1999. However, by 2003, only eight of the 38 poor countries eligible under the program had made enough progress in reform to have some debt forgiven.

By Barry Norman, Investors Trading Academy – ITA

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