Sudan - Technical Brief on the External Debt Situation

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Sudan - Technical Brief on the External Debt Situation Background Material for Sudan Roundtable This brief is a continuation of the flow of technical information from the World Bank to the authorities and creditors on the external debt situation. The update is timely given that the forthcoming referendum raises a number of questions related to the treatment of external debt in Sudan. While it is premature to attempt a thorough analysis of these issues before the outcome of the referendum is known, information on a number of technical issues that have been raised could be helpful to ongoing discussions on debt among the authorities and major creditors. The authorities may wish to consider these issues, open up a dialogue with their creditors and continue to build upon their track record under Fund programs by preparing and implementing a Poverty Reduction Strategy (PRS), a mandatory requirement for debt relief under the HIPC Initiative. Section 1: Context 1. Sudan has a large external debt burden and significant arrears to international creditors. Sudan has a severe external debt burden, with large and protracted arrears that limit international relations and integration into the world economy. The country has not serviced the majority of its external debt since the early 1990s, though some creditors, including some offering more recent financing, are receiving repayments. Total external debt in nominal terms stood at US$35.7 billion at end-2009, with over US$30 billion in arrears (Table 1). Debt to the World Bank is entirely owed to IDA and comprises about 4 percent of the country s total external obligations. As of September 2010, IDA arrears were US$600 million, which restricts access to Bank and IDA financing. 2. The forthcoming referendum raises a number of questions related to the treatment of external debt in Sudan. A popular referendum on self-determination for Southern Sudan is planned in early 2011, as agreed in the Comprehensive Peace Agreement of In the run up to this event, representatives of the National Congress Party (NCP, representing the North) and Sudan People s Liberation Movement (SPLM, representing the South) are discussing possible post-referendum arrangements. A June 2010 Memorandum of Understanding between the parties established a working group to discuss possible division of Sudan s assets and liabilities, with debt being a major liability. While it is premature to attempt a thorough analysis of debt issues before the outcome of the referendum is known, information on a number of technical issues that have been raised could be helpful to the ongoing discussions on debt among the authorities and major creditors. 3. This brief provides technical information that could inform discussions on Sudan s debt. Based on the types of issues raised in discussions with the authorities and also with creditors, the following three topics are explored: (i) information on the HIPC process and eligibility; (ii) information on past debt apportionment exercises that IBRD/IDA undertook in instances where member countries dissolved into two or more entities; and (iii) information on the IDA arrears clearance process. 1

2 Background Material for Sudan Roundtable Table 1: Composition of Sudan s Public and Publicly Guaranteed External Debt in Nominal and Present Value (PV) Terms, as of end-2009 Public and Publicly Guaranteed (PPG) External Debt PPG External Debt in Nominal Terms as of end-2009 Percent of Total Arrears as of end-2009 PV of PPG External Debt Before Traditional Debt Relief as of end Total (in billions US$) of which Multilateral Debt World Bank International Monetary Fund African Development Bank Arab Fund for Economic and Social Development Arab Monetary Fund European Investment Bank International Fund for Agricultural Development Islamic Development Bank OPEC fund for International Development Bilateral Debt Paris Club pre-cutoff post-cutoff Other official bilateral debt pre-cutoff post-cutoff Commercial debt pre-cutoff post-cutoff Source: Central Bank of Sudan annual debt bulletin and World Bank staff estimates. Section 2: Sudan and HIPC Eligibility 4. Given its inclusion in the list of grandfathered HIPCs, a unified Sudan would continue to remain eligible for HIPC debt relief as long as it remains eligible for IDA-only financing and Extended Credit Facility (ECF) financing from the IMF. In 2006, the Boards of the IDA and IMF closed the list of countries potentially eligible for HIPC relief. 1 Sudan was recognized as a country that was potentially eligible for HIPC and was grandfathered under this initiative, i.e. given reserved rights to be considered for the process at some future date. In order to qualify for HIPC relief, Sudan would need to meet the key HIPC criteria, specifically: (i) maintain a satisfactory track record of performance under an IMF program; (ii) have a Poverty Reduction Strategy Paper (PRSP), at least in the form of an interim-prsp in place; and (iii) have a debt burden that exceeds HIPC thresholds after full application of traditional debt relief from Paris Club creditors and other bilateral and commercial creditors. (Box 1 1 See Initiative for Heavily Indebted Poor Countries Issues Related to Sunset Clause Proposed Decision, IDA/R and SM/06/288 Supplement 2 (October 5, 2006). See also Heavily Indebted Poor Countries (HIPC) Initiative Issues Related to the Sunset Clause, IDA/R /1 (August 16, 2006) and SM/06/288 (August 17, 2006). 2

3 Background Material for Sudan Roundtable provides more details on the HIPC process). 2 Authorities have enquired whether Sudan s rising percapita income could make it ineligible for HIPC debt relief. At US$1,230, Sudan s 2009 income per capita is above the current IDA operational cutoff of US$1,165, but Sudan is classified as a Least Developed Country by the United Nations and remains eligible for IDA financing at standard terms. 3 For a country with per capita income above the IDA operational cutoff for two consecutive years, IDA would consider hardening lending terms for new loans and eventually graduate that country from IDA assistance. Graduation from IDA is not a mechanistic process triggered only by a country s GNI per capita, however. IDA graduation is usually a process that typically takes several years. 5. HIPC debt relief would not result in a total cancellation of Sudan s external debt. The objective of HIPC debt relief is to reduce a country s debt burden to a level deemed sustainable (e.g. 150 percent of the present value of exports). HIPC relief is provided after traditional debt relief from bilateral and commercial creditors. Since almost two-thirds of Sudan s debt is held by bilateral creditors, the bulk of Sudan s debt relief will likely come from the Paris Club and other bilateral creditors. Moreover, given the large volume of arrears, securing arrangements for clearance of arrears--a prerequisite for HIPC debt relief--would be a key challenge to securing debt relief. 6. Should the referendum result in secession, the issue of HIPC eligibility would need to be revisited. As the list of countries potentially eligible for HIPC is formally closed, the two new countries that could result as an outcome of secession would not be automatically eligible for HIPC debt relief. There is no precedent to guide how this scenario could play out. Both countries would need to be members of the IMF and IDA in order to be potentially eligible for HIPC debt relief. In addition, they would both need to meet the Initiative s income and eligibility criteria post any debt apportionment exercise that may result due to the division. HIPC eligibility would also depend on how separation takes place - whether there is a total dissolution of the current state of Sudan (as was the case with the Socialist Federal Republic of Yugoslavia (SFRY) in 1992) or whether Southern Sudan secedes from the current Sudan and Sudan (Khartoum) is considered the continuing state (as was the case in the separation of Serbia and Montenegro in 2006, Indonesia and Timor-Leste in 2002, and Ethiopia and Eritrea in the early 1990s). Sudan (Khartoum) could retain HIPC eligibility if it were to be legally classified as the continuing state. Under this scenario Executive Directors of the Bank and the Fund may accept that if Sudan (Khartoum) retains all the rights and the obligations of the former Sudan to IFIs, it would also retain the eligibility to the HIPC initiative. 7. HIPC eligibility could facilitate access to other IDA mechanisms. Countries eligible for the HIPC Initiative could also qualify to receive assistance via the IDA Debt Reduction Facility (DRF) as well as IDA s exceptional arrears clearance support framework. The DRF helps reforming HIPCs reduce their sovereign commercial external debt by providing grants that help eligible countries prepare and implement repurchase operations for their commercial debt at a deep discount, provided the client 2 Based on preliminary end-2009 data, it appears that Sudan would qualify for HIPC debt relief after a traditional relief is provided. However, qualification would need to be established based on full debt reconciliation on the most recently available calendar year data. Macro indicators that feed into debt relief calculations are typically volatile (e.g. exports), hence the 2009 results may not be indicative of future estimates. 3 Countries are eligible for IDA on the basis of (i) relative poverty and (ii) lack of creditworthiness. The operational cutoff for IDA eligibility for FY11 is a 2009 GNI per capita of US$1,165 using Atlas methodology. Countries classified as Least Developed by the United Nations are also eligible for IDA financing at standard terms (see OP 3.1 and Annex D). To receive IDA resources, countries must also meet tests of performance. An exception has been made for small island economies. In exceptional circumstances, IDA extends eligibility temporarily to countries that are above the operational cutoff and are undertaking major adjustment efforts but are not creditworthy for IBRD lending. 3

4 Background Material for Sudan Roundtable countries fulfill all the requirements for support from the DRF. 4 The IDA exceptional arrears clearance framework may be accessed in the context of the HIPC Initiative and is described in detail in Section 4. Box 1. The HIPC Initiative The HIPC Initiative was launched by the IMF and the World Bank in 1996 as the first comprehensive effort to eliminate unsustainable debt in the world's poorest, most heavily indebted countries. In October 1999, the international community agreed to enhance the Initiative by increasing the number of eligible countries, raising the amount of debt relief each eligible country will receive, and speeding up its delivery. The enhanced HIPC Initiative aims at reducing the present value (PV) of external debt at the decision point to a maximum of 150 percent of exports or 250 percent of government revenue. 5 HIPC debt relief is provided on top of traditional debt relief mechanisms (i.e. Paris Club debt rescheduling on Naples terms and assuming at least comparable action by other bilateral creditors). Eligible countries qualify for HIPC debt relief in two stages. In the first stage, the debtor country needs to demonstrate the capacity to prudently use the assistance granted by establishing a satisfactory track record, normally of three years, under IMF- and IDA-supported programs. In the second stage, after reaching the decision point under the Initiative, the country implements a full-fledged poverty reduction strategy, which has been prepared with broad participation of civil society, and an agreed set of measures aimed at enhancing economic growth. During this stage, the IMF and IDA grant interim relief, provided that the country stays on track with its IMF- and IDA-supported program. In addition, Paris Club creditors, and possibly others, are expected to grant debt relief on highly concessional terms. At the end of the second stage, when the floating completion point is reached, the IMF and IDA provide the remainder of the committed debt relief, while Paris Club creditors enter into a highly concessional stock-of-debt operation. Other multilateral and bilateral creditors are expected to contribute to the debt relief on comparable terms. Many Paris Club creditors go beyond HIPC relief to provide 100 percent debt relief on their claims. The MDRI launched in 2006 provides additional multilateral debt relief to countries once they reach the HIPC completion point. While HIPC and MDRI debt relief typically results in substantial reduction of a country s debt burden they do not amount to a 100 percent cancellation. Moreover, entering the HIPC process requires a country to clear its arrears in full and make regular payments on all remaining outstanding debt. Section 3. Precedents on Debt Apportionment 8. There are examples of World Bank member countries that split into two or more independent states. In 1947 India divided into the two independent states of India and Pakistan and then in 1971 East Pakistan became the independent state of Bangladesh. Egypt and Syria formed the United Arab Republic in 1958 but dissolved the union in In 1992 the SFRY broke up into five independent republics: Bosnia and Herzegovina, Croatia, the Federal Republic of Yugoslavia (FRY, comprising Serbia and Montenegro), Macedonia and Slovenia. 6 Subsequent to this, Montenegro broke away from Serbia in 2007 to become an independent republic, and the province of Kosovo did the same in The Czech and Slovak Federal Republic dissolved into the independent Czech and Slovak Republics in In 1993 Eritrea broke away from Ethiopia to become an independent republic and in 2002 the island of Timor-Leste became independent from Indonesia. 9. These political adjustments required the authorities and creditors to agree on the treatment of external debt. Apportionment of an IBRD portfolio was undertaken twice in the Bank s history: first in the case of Pakistan/Bangladesh in 1971 and next in the case of the SFRY in IDA has only 4 Sudan s estimated external commercial debt burden is about US$6 billion, almost 40 percent of the total estimated commercial debt of all HIPCs. Financing a buyback operation of this debt would require a significant mobilization of resources, from the Bank as well as from bilateral donors willing to participate in the financing modalities 5 Countries qualify for HIPC relief under exports or revenue ratios. Sudan qualifies under the former as its debt to revenues ratio is below the HIPC threshold of 250 percent. 6 In 2003 the Federal Republic of Yugoslavia formally changed its name to the Republic of Serbia and Montenegro. 4

5 Background Material for Sudan Roundtable apportioned a portfolio once, in Bangladesh. The Bank followed the same approach to apportioning IBRD and IDA claims between Pakistan- Bangladesh and between the successor republics of the SFRY. On both occasions the Bank established and followed the principle of final beneficiary to apportion debt that could largely be allocated to a particular region or benefiting party. There were also cases of secession where debt was not apportioned. For example, IDA had claims on Ethiopia and none were apportioned to Eritrea. Similarly, none of the IBRD and IDA claims on Indonesia were apportioned to Timor-Leste The experience of other countries may be relevant if Sudan s debt were to be apportioned in the context of state secession. For example, debt apportionment has often been implemented using the principle of final beneficiary which allocates debt to a particular territory (for example a World Bank investment project that benefited a particular region or province). In cases where debt is not readily allocable, for example budgetary or balance of payments support such as that made available under an IMF program, debt has been allocated based on a formula that accounts for economic weight, population, revenue share, etc. This was an important component of the framework used for the apportionment of debt for the SFRY. Debt apportionment usually takes place in close coordination and agreement with creditors. It is also typically done in parallel with the process of securing IFI membership for one or both of the new nations. Annex 1 provides more details on the Bank s experience with debt apportionment in the context of state seccession. While the above examples are instructive, there could be other reasonable approaches that can be used, as long as they are agreed to by all parties, including creditors. Section 4: Arrears Clearance 11. Financing assurances for arrears clearance would be the first step towards debt relief and normalization of creditor relations. Irrespective of the outcome of the referendum, Sudan would need to clear payments arrears to the World Bank and other IFIs before it can resume a program of regular financial support with them. Sudan s arrears to the IFIs as of end-2009 included about US$600 million to IDA, US$1.6 billion to the IMF and US$300 million to the AfDB. These arrears are exceptionally large and are currently a significant stumbling block in the path of debt relief and restructuring. Full arrears clearance to the IFIs is likely to be a complex process that will require coordinated and concerted action among the IFIs and possibly need the generous support of international donors. 12. Sudan could qualify for exceptional arrears clearance support from IDA. IDA has a systematic framework providing support for arrears clearance that was used recently in the cases of Cote d Ivoire, Liberia and Togo (Box 2). 8 Under this framework, IDA can support arrears clearance operations in eligible HIPCs. IDA also offers pre-arrears clearance grants in the period leading to the debt workout. Sudan s inclusion in the list of countries ring-fenced for HIPC eligibility makes it eligible for exceptional IDA support clearance of arrears owed to the Bank. Arrears clearance from IDA and the AfDB would be provided as part of the delivery of debt relief under the HIPC Initiative. IDA s own contribution to the arrears clearance will depend on an assessment of Sudan s capacity to pay performed prior to the arrears clearance. Under a secession scenario, if the two new countries are potentially eligible for HIPC, they would be eligible for exceptional IDA support but this will depend on whether or not the country(s) qualify for HIPC relief after traditional debt relief mechanisms and on the assessment of their payment capacity. Clearing arrears, or having in place, a plan for clearing arrears to IFIs is a necessary condition for reaching the HIPC decision point. 7 The IMF also did not apportion any part of the obligations owed by Ethiopia and Indonesia to Eritrea or Timor- Leste respectively. 8 IDA provided US$257 million in arrears clearance grants to Cote d'ivoire; US$394 million to Liberia; and US$98 million to Togo. 5

6 Background Material for Sudan Roundtable 13. Neither the World Bank nor other IFIs has mechanisms to directly support an arrears clearance process outside of the HIPC initiative. The country in question would have to finance the clearance of arrears from its own foreign exchange resources or with funds provided by donors. In 2002, Afghanistan cleared its arrears to IDA with the help of Italy, Japan, Norway, Sweden and the United Kingdom who contributed to a trust fund for that purpose. In 2004, Iraq cleared US$110 million in overdue obligations to IBRD from its own resources as part of the process of reengagement with the international community. Box 2. The World Bank s Policies on Arrears Clearance The Executive Directors of IBRD and IDA adopted a framework to facilitate the workout of arrears in Under this framework, the Bank works closely with borrowers with protracted and large arrears during a pre-arrears clearance performance period provided the borrowers meet certain eligibility conditions. The performance period serves to establish a track record on adjustment measures, allow the Bank to undertake an intense policy dialogue with the country, and develop new lending operations. However, consistent with previous Bank policies, no new regular financing agreements may be signed, declared effective or disbursed until all arrears have been cleared. To be eligible for treatment under this framework, a borrower needs to: (i) implement a medium term growthoriented structural reform program endorsed by the Bank; (ii) undertake, if needed, a stabilization program endorsed and monitored by the IMF or supported by a Fund arrangement; and (iii) agree to a financing plan which provides for full clearance of arrears to the Bank. When a borrower has arrears to several IFIs, the preferred approach is for those arrears to be cleared simultaneously. However, a sequential arrears clearance approach may be pursued on a pragmatic case-by-case basis by mutual agreement among IFIs. Financing for arrears clearance is first sought from the government and bilateral donors. But in view of important developments since this plan was adopted, such as the introduction of the HIPC and MDRI initiatives and the need to address the problems of a small group of countries with large and protracted arrears to the World Bank, it was agreed that if such financing is not forthcoming or sufficient, IDA can provide exceptional support for arrears clearance for eligible countries. Eligibility for such exceptional allocations is ring-fenced to countries with arrears as of end-december 2006, and that are (or could be) eligible for debt relief under the HIPC Initiative. It should be noted that at least pari passu treatment with other creditors is a requirement for exceptional arrears clearance support. In the period leading up to a debt workout, IDA may offer pre-arrears clearance grants to allow IDA to engage early with countries meeting the criteria for exceptional arrears clearance support. These grants may be used to develop new IDA operations, as well as finance emergency high priority expenditures. They are conditioned on inter alia country performance and pari passu treatment with other creditors. In order to qualify, the recipient country must demonstrate that it has taken convincing steps towards social and economic recovery, the arrears to the World Bank (IBRD and or IDA) must be large and protracted, a concerted international effort to provide positive financial flows and other assistance must be underway, other creditors should have agreed not to make net withdrawals of financial resources from the country; and alternative sources of financing for post-conflict recovery should be inadequate or available only on inappropriate terms. 10 The size of pre-arrears clearance grants depends on demonstrated need for resources, and has in previous cases ranged from US$l to a maximum level of US$10 per capita. Afghanistan, Congo Dem Rep, Cote d Ivoire, and Liberia have used this facility so far. 9 Report on Bank Policies and Practices with Respect to Countries in Arrears, Joint Audit Committee, R90-205, October 22, 1990, and Additional Support for Workout Programs in Countries with Protracted Arrears R91-70, April 11, The policy was reviewed and endorsed by the Joint Audit Committee in April For the criteria governing pre-arrears clearance grants see "Further Elaboration of a Systematic Approach to Arrears Clearance" (IDA/SecM , June 11, 2007). 6

7 ANNEX 1. SUMMARY OF THE BANK S EXPERIENCE WITH DEBT APPORTIONMENT IN THE CONTEXT OF STATE SUCCESSION September 2010 Example What happened The Bank s Decision Remarks Emerging Issues Pakistan Bangladesh Following its secession from Pakistan in 1971, Bangladesh became a new member of the Bank in August Pakistan took the view that its loss of control over Bangladesh, and its admission to Bank membership, entitled Pakistan to be relieved from liability for any outstanding debt with respect to Bangladesh. On its part, upon becoming a member, Bangladesh only accepted liability for uncompleted projects wholly located in Bangladesh and financed by IDA credits to Pakistan. Reactivation credits were made during FY1974 to complete the projects for which disbursement had been suspended at the outbreak of hostilities. A legal opinion concluded that Pakistan as the original guarantor remained liable until a satisfactory arrangement could be reached. Pakistan was notified accordingly. Further, IBRD and IDA could as a matter of policy insist on obtaining the agreement of Bangladesh that it assumes liability for those debts before providing additional financing. In June 1974, the Bank reached an agreement with Bangladesh that it would be liable for 84% of the total outlay of loans and credits. In January 1975, the Board took a decision to consolidate all 8 loans and credits into a new Bank loan for 30 years with a 10 year grace period at 6.15% interest. IDA credits assigned to Bangladesh were also consolidated into one new credit for 50 years with a 10 year grace period and a grant element of 86%. It is noteworthy that in this case that Bangladesh became a Bank member before the issue of its partial liability for Pakistan s debt to the Bank was completely settled. Between 1971 and 1975, Pakistan s debt was not put in non-accrual status as it continued to service its debt obligations. It was later reimbursed for payments made on accounts later assigned to Bangladesh. The decision taken by the Board to reschedule the debt amounted to a novation of Bangladesh s obligations and was unusual because the terms were longer than those of the original loans, with the justification being that Bangladesh was accepting new liability. In many occasions, the old State and the successor State reached an agreement regarding apportioning the commingled assets and liabilities of the pre-existing central government, especially those owed to external entities. In instances where the separation is acrimonious, as in this case, the view taken by the Bank was that external creditors cannot be left without a debtor because of a failure by the concerned States to reach an agreement. Hence, the fallback is for the creditors to stand on the strict legal position, which is that the original debtor remains liable. In this case, Pakistan therefore remained the debtor or guarantor of loans and credits made for the benefit of Bangladesh as a matter of law. 7

8 Dissolution of the Socialist Federal Republic of Yugoslavia In 1991, Slovenia and Croatia became the first of the six constituent republics of the former SFRY to secede. Macedonia followed later the same year, as well as Bosnia and Herzegovina the following year and the SFRY ceased to exist. In the aftermath, the Federal Republic of Yugoslavia (FRY) consisting only of Serbia and Montenegro took its place with a declaration to this effect on April 27, The Bank was faced with a complex set of questions dealing with the servicing of debt owed by the SFRY as well as membership of the five successor republics. First, the Bank determined that the SFRY had ceased to be a member. Further, as was done at the Fund, it was decided that the five successor republics would be allowed to succeed to its membership without new admission procedures upon satisfaction of a number of conditions. Among them; acceptance by all successor republics of the allocation of SFRY s shares in the Bank s capital among them; final agreement on the portion of the debt of the SFRY to the Bank allocated to the successor republic; and elimination of arrears of the republic concerned to the Bank or an acceptable plan for elimination of arrears of debt owed to the Bank. The case of the SFRY is unique in its complexity. It also stands out because nearly all the debts were apportioned through direct negotiations with the creditors including the Bank and the Fund. The successor republics reached agreement with their creditors to take over their respective shares of the former SFRY s debt. This case also stands out because of the acknowledged role played by the Fund and the Bank in influencing the way in which the assets and liabilities were divided as well as the nature and scope of the negotiations. In apportioning the loans, the Bank adopted the final beneficiary rule whereby a loan is deemed to be owed by the entity which actually benefited from it rather than by the entity which entered into the loan agreement. This approach was fundamental from an internal legal stand-point because confirmed the principle that localized debt passes to successor states. The Bank s decision was also momentous because by adopting the final beneficiary rule, it set a precedent for the apportionment of other such debts in the SFRY. 8

9 Serbia Montenegro Montenegro declared independence from the composite Serbia and Montenegro on June 3, Shortly after, Serbia declared itself successor to the former Republic of Serbia and Montenegro (SaM). In a joint letter the two republics notified the Bank that they had reached an agreement regarding both their membership in IFIs as well as in the apportionment of financial assets and liabilities between them. The issue was whether the Bank Group could continue activities in Montenegro during the transition period, before Montenegro became a member in its own right. Both republics agreed on their respective portions of the financial obligations undertaken by the former SaM and committed themselves to uninterrupted and timely service of all debt obligations owed to the Bank Group. It was also agreed that disbursements under loans and repayment of already disbursed loans for operations in both republics would be handled through Serbia until Montenegro acquired its membership status. During the transition period, and prior to membership the Bank management considered it important to continue activities with Montenegro under agreements entered into with the former Serbia and Montenegro. A proposal to this effect was approved by the Board on August 28, However, the Board also decided that no new financing would be approved or committed during the transition period. This represents the more common case in which the predecessor State (Serbia) and the successor State (Montenegro) reach an agreement on the apportionment of assets and liabilities without the involvement external creditors, including IFIs such as the Bank and the Fund. A notification served once agreement has been reached may influence the progress towards independent membership of the successor state, as well as its share allocation in that process. By accepting Serbia as the successor to composite SaM in the Bank, the Bank determined that Serbia had taken on all the rights and obligations of Serbia and Montenegro in IBRD, IDA, IFC and MIGA as it had done at the Fund. In general, this case demonstrates the Bank s approach as being that in cases where the Bank finances projects in territories which were not independent but were included in the membership of a member country, guarantees for servicing would be obtained from that member. Upon independence, the new member would be expected to continue observing its obligations to the Bank. With respect to loans made to identifiable entities in such territories, the guarantee given to the Bank by the member when the loan was made continues until the new state assumes all obligations arising under the guarantee agreement. In this case, legally, the rights and obligations of SaM that Serbia assumed as the successor to composite SaM include SaM s rights and obligations in respect of the Bank Group operations in the territory of Montenegro. Ethiopia Eritrea Formally, Eritrea became independent on May 24, On December 25, 1993 Ethiopia wrote a letter to the Bank confirming that it would honor all of its obligations to the Bank contracted until 31 May 1991, the date when Eritrea seceded after taking control over its present territory. In the letter, Ethiopia also asserted that its ownership rights to all assets and capital share holdings in the Bank Group will remain unchanged despite the secession of Eritrea. The question The Bank pointed out to Ethiopia that four credits had been extended to the country since the cut-off date of 31 May 1991, including a Recovery and Rehabilitation Credit for Eritrea (Credit No. 2478, ET). The Bank s understanding was therefore that Ethiopia would honor these latter credits as well, except to the extent that it was to be relieved from obligations regarding the credit for which Eritrea was direct beneficiary, once Eritrea became a member and assumed commensurate obligations in its own right. This encapsulation of the Bank s In many ways, this was an uncomplicated situation because of the agreements reached between Eritrea and Ethiopia. In addition to the issue of credits however, the Bank had to consider whether Eritrea could be assigned some of the shares of Ethiopia. Given that Ethiopia was going to retain its membership, this would have amounted to reducing its shares by a fraction equivalent to what would be taken over by Eritrea. The Bank ruled this out stating that its This example is apposite from a legal standpoint primarily for capturing the conditions under which the Bank may finance reconstruction and rehabilitation by a non-member in a post-conflict context. In this particular case, the conditions were: (a) a clear commitment from Ethiopia that it would be responsible for servicing the credit; (b) satisfactory assurances from Eritrea concerning implementation; and (c) guarantees that, in the event Eritrea became independent, it will take full responsibility for the IDA 9

10 was with regard to credit that had been given to Ethiopia after the cutoff date, one of which was for the reconstruction and rehabilitation of Eritrea. approach was not disputed by Ethiopia. The issue in this case was therefore not so much apportionment of the overall debt, but rather mechanisms for ensuring that Eritrea could access needed credit. approach was that a member s shares remain with that member even when its territory has been reduced due to secession or some other reason. credit. Ethiopia assumed the debt obligations on the condition that Eritrea would take them over once it was admitted to Bank membership as clarified in the exchange of letters. Serbia Kosovo Kosovo declared independence from the Republic of Serbia in February In July 2008, it applied for membership in the Bank. On June 3, 2009, the Board of IBRD adopted Resolution No. 597 approving the terms and conditions of Kosovo s membership. In addition, the Board of IDA adopted Resolution No. 221 also approving the terms and conditions of Kosovo s membership. Having duly met the terms and conditions laid out, Kosovo signed the Articles of Agreement of each institution on June 29, 2009 thereby becoming a member. In negotiations with the Bank, Kosovo agreed to assume legal responsibility for IBRD loans which had been provided by the Bank to the Republic of Serbia or its predecessor States for the benefit of Kosovo. As part of the succession of the FRY to the SFRY s membership in the Bank which had ceased upon disintegration in 1993 and the associated resolution of FRY s overdue payments to IBRD, the IBRD loans which SFRY had taken for the benefit of Serbia and Montenegro were extraordinarily restructured into six new Consolidation Loans (categorized as A to F) as authorized by the Board on May 8, The Consolidation Loans were negotiated in November, 2001 and became effective on January 8, This example is useful with regard to the actual apportionment of the loans. Loans A, B and C were consolidated loans taken for the benefit of Serbia (including Kosovo). Three of the six loans (D, E and F) consolidated existing Bank loans taken for the benefit of Montenegro, for which it assumed responsibility. All 18 loans taken between 1970 and 1983 for the benefit of Kosovo by Serbia and its predecessor state were consolidated into a single loan, C and apportioned to Kosovo. In this regard, the approach followed was similar to that applied on earlier exercises of apportioning external debt of the other ex-yugoslav republics, as had been negotiated with the Bank in the early 1990s. This example is useful first, because it hewed closely to the terms negotiated between the SFRY and the Bank hence enhancing the validity of the Bank s approach, and second, for capturing the key elements of the debt consolidation and apportionment process: (i) calculation of the principal outstanding for each existing loan to FRY; (ii) calculation of the capitalized value of interest arrears and overdue charges (to include also interest on overdue principal that was not yet billed) for each loan, which would be added to outstanding principal to determine an updated principal value of each loan to be consolidated; and (iii) apportionment of these existing loans across the six Consolidation Loans (categorized as A to F). 10

11 Czech Rep. Slovakia A month before Czechoslovakia was dissolved, the respective Ministers of Finance of Czech Republic and Slovakia wrote to the Bank and Fund requesting that the two states be allowed to succeed to the membership of Czechoslovakia. They also notified the Bank and Fund that the two states had agreed to divide the assets and liabilities consistent with the territoriality principle on debt apportionment and on the basis of the population ratio in each state (2:1) with regard to national debt. With regard to succession to membership, the Bank followed the Fund approach, which was that the states would succeed to membership of the former Czechoslovakia on the condition that each of them was willing and able to carry out the obligations of membership. This willing and able condition, though not provided in the Articles was normally made implicitly by the Fund in the context of applications for membership. In adopting the Fund s approach, the Bank noted that the conditions imposed not legally questionable as none of them would require judgments on the part of Bank Management or Executive Directors. The Board passed a resolution which provided that the membership of the Czech Republic and Slovakia was to be substituted for Czechoslovakia s membership of the Bank. In addition, the resolution also allocated the assets and liabilities of the former Czechoslovakia among the two successor states and provided that the membership would be subject to similar conditions as required by the Fund. It is noteworthy that this mention of conditions was merely procedural as both states had already complied with them by then. This example is noteworthy because it was the first time that the Bank and the Fund developed the conditional succession to membership approach for successor states. This approach has been criticized as adding political criteria to the extent that the conditions are not specifically provided for in the Fund s Articles of Agreement, and because it is for the Fund to determine if the state is capable of carrying out its rights and obligations. 11