(2) Project Cost Over-Runs
Since the completion of a project involves several phases and a lengthy period of construction, the total project cost for which the loan is committed should be determined with the expectation that the prices of goods and services will rise every year up to completion (price escalation), and that adequate emergency funds (contingency) should be set aside. If, however, project implementation is delayed for some reason or if there is an abnormal rise in costs, the initially committed amount may be insufficient to complete the project. This shortage of funds is known as a cost over-run.
Before approving a supplementary loan to cover a cost over-run, the following procedure is adopted. The Japanese government may (i) ask the recipient country to make its own efforts to address the problem (e.g., from its own funds or by raising funds from third countries) or review the project by reducing its scale or specifications; or (ii) investigate the possibility of providing a supplementary loan to cover the cost over-run in cases where such a loan is deemed necessary when the project review process and self-help endeavors fail to secure funds needed to cover the shortfall.
(3) Conditions for Procurement with Funds Furnished by ODA Loans
Classified according to the nature of the procurement source for goods and services, there are three types of ODA loan: (i) tied loans, in which goods and services are procured from Japan only, (ii) partially untied loans, in which goods and services may be procured from Japan and the developing country (DAC list countries), or (iii) untied loans, in which goods and services may be procured from any source country.
Prior to January 1, 1975, Japan's position vis a vis ODA loans was that they should essentially be tied loans. After that date, however, it adopted the general principle that they should be partially untied. In fiscal 1978, the Japanese government adopted a basic policy stance whereby it would move toward offering more untied money in newly pledged loans, with the aim of qualitatively improving ODA loans. Meanwhile, bettering the quality of aid also demands that the technology and expertise possessed by Japan be fully utilized. In fiscal 1997, untied loans accounted for 99% of all ODA loans, and partially untied loans for the remaining 1% (calculated on an E/N basis).
(4) Methods of Disbursement of Loan Funds
Broadly speaking, loan funds may be disbursed by either of two methods, (i) the letter of credit (L/C) switch method, and (ii) the reimbursement method. These are explained diagrammatically in Chart 23 and 24.
(5) Exchange of Notes (E/N)
The contents of the E/N will differ to some extent, depending upon the type of loan, but there is a basic format for a project loan that includes the following matters.
| (i) | The amount of the loan ceiling, the identities of the lending and borrowing parties, and the project itself |
| (ii) | The signing of the loan contract and the conditions of the loan |
(iii) The method of use and object of the loan
ODA loans are made available to pay suppliers, contractors or consultants from eligible source countries for the purchase of products and services from eligible source countries that are required for the implementation of the project.
Eligible source countries for procurement are subject to agreement between the governments of both countries, but in the case of general untied loans, they are all OECD member countries and all developing countries on the DAC's LDC list. For partially untied loans, the eligible source countries are developing countries on the DAC's LDC list and Japan. When financing is to be provided in the local currency, that fact shall be stipulated in the E/N.
(iv) Tax exemption for the loan and interest
When negotiating the E/N, the Japanese government requests its counterpart in the recipient country to grant tax-exempt status to the principal and interest of the loan and any income derived by Japanese people or corporate entities from the implementation of the project, and to exempt from customs duties and other charges, materials and equipment brought into the country by Japanese corporate bodies for the implementation of the project. Any exemption from such taxes and charges is to be stipulated in the E/N.
(v) Government guarantees for the loan
It should be stipulated in the E/N that when the borrowing party in the recipient country is the central bank or other government-affiliated institution, rather than the government itself, the recipient country government will guarantee the repayment obligations of the borrower.
(vi) Provision of certain facilities
The E/N typically states that the borrowing country will provide all necessary facilities for Japanese individuals and corporate entities entering and residing in the country for the purpose of implementing the project.
(vii) Shipping of goods
The E/N will stipulate that free international competition should not be hindered in relation to the oceangoing transport of materials and equipment used in the implementation of the project.
(viii) Appropriate use
The E/N should state that the government of the borrowing country will guarantee that the loan and facilities to be constructed with loan funds will be used in an appropriate manner.
(ix) Consultation
The document should stipulate that both governments will consult with each other in regard to their understanding of the E/N and any other related matters.
(2) Eligible Source Countries for Commodity Loan Purchases
Japan decided in 1978 to adopt a basic policy of providing untied ODA loans. This means that all OECD member countries and developing countries qualify as eligible source countries.
(3) Counterpart Funds
In the case of the traditional single commodity loan, the local currency funds (counterpart funds) generated by the sale of goods furnished under the loan are used to fund economic and social development projects in the recipient country, or as the local currency component in ODA loan projects.
(4) Exchange of Notes
The following nine matters must essentially be agreed by the two parties in drawing up an E/N for a commodity loan.
| (i) | The loan amount, and the identities of the lending and borrowing parties |
| (ii) | Conclusion of the loan agreement and the terms and conditions of the loan |
| (iii) | Products eligible for purchase under the commodity loan agreement |
(iv) Procurement methods
To ensure the effective and correct utilization of the loan funds, the document should stipulate that goods will be procured in accordance with OECF guidelines.
(v) Shipping of goods and marine insurance coverage
The agreement should stipulate that the recipient country will endeavor to guarantee that the principles of free competition are applicable to the shipment and that marine insurance coverage will be obtained for goods purchased with funds provided by a commodity loan.
(vi) Tax exemption for the loan and interest
The agreement should specify that tax exemption measures for the implementing institution will be put in place by the recipient country government.
(vii) Government guarantees for the loan
It should be stipulated that when the borrowing party in the recipient country is the central bank or other government-affiliated institution, rather than the government itself, the recipient country government will guarantee the repayment obligations of the borrower.
(viii) Appropriate use
The exchange of notes document should note that the commodity loan will be used appropriately and solely to purchase products and services specified on the agreed list.
(ix) Consultation
The agreement should state that the governments of both countries will consult with each other as required on any matters relating to the agreement.
(i) Recycling of Funds
In order to guarantee the inflow of new money into debtor countries, the Japanese government announced in May 1987 an emergency economic measure in which more than $20 billion of completely untied new funds would be returned over a three-year period to developing countries, with a particular focus on debtor countries. This measure was expanded in an announcement made at the Arch Summit in July 1989. As a result, in excess of $65 billion was made available over the five-year period from 1987 to 1992 to developing countries struggling under the weight of their foreign debt. A sum of $12.5 billion of this total was earmarked as ODA loans, and of this, a decision was taken to extend more than $2 billion in co-financing arrangements with the World Bank to eligible countries under the new debt strategy program.
This facility made it possible to flexibly provide non-project loan funds to countries with severe balance of payments problems, and combined with reductions in ODA loan interest rates, provided another source of soft new money, contributing substantially to the alleviation of the debt burden in developing countries.
(ii) Grant Aid for Debt Relief
Japan's grant aid for debt relief program has expanded to provide relief for ODA loan debts incurred through E/Ns signed by LLDCs between 1978 and fiscal 1987.
(iii) Grant Aid to Support Heavily Indebted Poor Countries
This form of aid is designed to relieve debt in heavily indebted poor countries, chiefly in Africa. When it is agreed that supplementary relief measures will be adopted and ODA loan obligations be rolled over under an international framework for heavily indebted poor countries that lack the capacity to meet their debt obligations, despite sustained efforts at economic reform, an amount equivalent to the interest repayment is furnished in the grace period and an amount equivalent to 80% of the total principal to be repaid is extended after the grace period.
(iv) Rescheduling and the Toronto Scheme
Rescheduling of public debt is undertaken via the Paris Club, further details of which are provided below.
The Poorest Countries were the subject of the Toronto Summit Economic Declaration of June 1988. In October the same year, agreement was reached on a special measure known as the Toronto Scheme, and in December 1991, the New Toronto Scheme, representing an enhanced set of measures, was adopted by the Paris Club. An economic declaration was made in July 1990 at the Houston Summit on the so-called Low and Middle Income Countries, and special measures were agreed in September the same year.
(2) Implementation of Debt Relief
When suffering economic hardship and confronted with balance of payments problems, and unable to meet their repayment obligations when they become due, debtor countries have no option but to seek relief from those debts. To address the problem of public-sector debt (government loans and guaranteed commercial debts), creditor governments established the Paris Club, a group with the aim of adopting coordinated action in debt relief measures. The French Ministry of Finance is the Paris Club's Secretariat. Receipt of approval for a standby credit facility or SAF (ESAF) arrangements between the affected country and the IMF is a prerequisite for a meeting of the Paris Club.
(3) Debt Relief Measures
Debt relief is normally provided in the form of a deferral of the debt obligation (rescheduling). When balance of payments problems result in a developing country becoming unable to pay for its imports or make repayments on a loan furnished by a donor country, or when it will be unable to meet its repayment obligations in the near future, the repayment period may be extended in order to provide relief from the debts associated with the imports or loan. The debt (OECF or JEXIM) to be rescheduled is the principal and interest for which the repayment deadline is approaching in the applicable rescheduling period (normally, the same as the applicable period for an IMF standby credit facility or SAF (ESAF)).
The statutory provisions concerned with debt rescheduling are those contained in the Export-Import Bank of Japan Law and the OECF Law. However, rescheduling the repayment period for JEXIM or OECF debts represents nothing more than a renewal of a contract, and such a renewal itself may take place as a matter of course, without any regulatory requirements.
(4) Implementation Process for Debt Relief
The procedure for debt rescheduling undertaken via the Paris Club, which accounts for most recent debt rescheduling initiatives under international agreement, can be described as follows.
When the government of a developing country experiences balance of payments problems, as evidenced by lateness in meeting its loan repayment obligations or in paying foreign exporters for goods supplied, or if it is certain that this will be the case in the near future, the Paris Club Secretariat may convene a meeting of the Paris Club in response to an appropriate request by the government of the developing country.
At the Paris Club meeting, the parties discuss the debt position of the affected country and the progress of negotiations (e.g., for a supplementary loan, or for a program of economic reform) with the IMF and the country concerned, and reach an agreement on the framework for the rescheduling. While this agreement does not have the coercive force of a treaty, the creditor countries are required to implement bilateral legislative measures (e.g., amendment to the loan agreement) to achieve the rescheduling objective, in accordance with the agreed framework.
Agreements struck by the Paris Club normally include two elements: matters concerning the debt obligation (whether it is a government loan or a government-guaranteed commercial debt, the date of signing of the loan agreement concerned (cutoff date), and the original repayment period of the debt concerned), and the rescheduling conditions (new repayment schedule). The deferred interest is normally determined on a bilateral basis between the creditor and debtor countries.
In Japan's case, the OECF or other implementing institution concludes a rescheduling agreement (in the form of an amendment to the original loan agreement) through a process which involves an exchange of notes between governments with the approval of the Paris Club.
Flowchart for ODA Loans: Exchange of Notes, Preparation of Loan Agreement, and Procurement