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Newsletter:  May 2002/ Issue 2
Debt-for-Nonproliferation: The Next Step in Threat Reduction

by Jim Fuller, Director of the Pacific Northwest Center for Global Security
this article originally appeared in Arms Control Today

Debt restructuring and reduction, whereby the terms of a loan are changed or part of a loan is forgiven, are common tools used by creditors for a variety of purposes. Wealthier creditor nations, such as the United States, often restructure and reduce debt owed by developing nations in order to bring about positive economic change in a debtor country. Similarly, the private financial sector restructures private debt owed by nations when it makes financial sense to do so. International nongovernmental organizations (NGOs) and others have also worked with government and private creditors to use debt reduction to accomplish more philanthropic goals that can benefit both public and private creditors in less tangible ways.

Indeed, “debt swaps”—a term used loosely here to denote a creditor forgiving monetary debt in exchange for specific actions by a debtor—have been an effective tool for improving global conditions in a number of ways. The international environmental community, in particular, has been very effective in encouraging and leveraging debt conversion to help meet global environmental objectives since 1984, when the World Wildlife Fund conceived of “debt-for-nature” swaps. In these exchanges, a portion of a country’s restructured debt—either commercial debt or official debt owed another country—is forgiven in return for the debtor dedicating an agreed-upon amount of local currency to an environmental project. Over the last two decades, nearly $1 billion in debt-for-nature swaps have been implemented.

Another important area that would benefit from this relatively new and innovative funding mechanism is nuclear, chemical, and biological weapons proliferation prevention. Since 1992, the United States has directly underwritten about $10 billion in threat reduction activities in Russia and the former Soviet Union, but the situation in Russia demands even greater investment. Russia’s financial problems and security needs both argue for increased involvement by other industrialized nations and the private sector. “Debt-for nonproliferation” swaps are potentially powerful tools that could leverage current conditions to reduce further the security threat from Russia’s weapons infrastructure.

Currently, there are more than 30 US-Russian threat reduction programs administrated by three different US departments, with a budget that totaled $750 million in fiscal year 2001. But the September 11 terrorist attacks on the United States, the ensuing revelations as the war on terrorism progresses, and the use of anthrax in the US mail system have called into question the pace with which threat reduction work in Russia is being completed. The human losses endured and the costs to the US economy as a result of the September 11 terrorist attacks would likely pale in comparison to a successful attack using a weapon of mass destruction.

In January 2001, a bipartisan task force co-chaired by Howard Baker and Lloyd Cutler strongly recommended that investments in US Energy Department nonproliferation activities be increased to roughly 1 percent of the annual US defense budget over the next 10 years. Energy Department (Continued on page 6)

nonproliferation programs help Russia dispose of weapons plutonium; protect, control, and account for nuclear weapons material; stabilize the economic situation in Russia’s “nuclear cities;” and promote nuclear warhead safety and security. The importance of these programs cannot be overstated, and the Baker-Cutler report indicated that its 1 percent recommendation would total about $3 billion per year, or $30 billion over the ensuing decade.

However, neither the departing Clinton administration, the incoming Bush administration, nor the Congress has supported appropriations anywhere close to this level. Clearly, another funding mechanism is needed that will provide a substantial and immediate infusion of cash into Russia’s nonproliferation efforts. But the funding needs to minimize the characteristics of an international welfare program in order to promote a long-term, sustainable Russian proliferation prevention enterprise that will last after direct aid stops. A process is needed to ensure that once the acute proliferation issues are successfully addressed, the people whose livelihood depended on the production of nuclear, chemical, or biological weapons have an alternative future. Further funding should be aimed at spurring Russian private-sector interest in the business of preventing proliferation.

A well-implemented debt-for-nonproliferation swap would have all these advantages. The processes that may be used to effect a debt swap can be grouped into four categories:

By promoting self-investment, debt-for-nonproliferation swaps would encourage infrastructure building and therefore help to generate a sustainable Russian effort to prevent proliferation. A swap could also involve industrialized countries besides the United States, providing broader international participation in preventing proliferation from Russia than currently exists. The establishment of a fund would also probably be the most effective way to involve private and NGO stakeholders in forging public-private partnerships for nonproliferation. Such partnerships would have multiple benefits, such as promoting confidence in the accountability of funds and helping to establish a private-sector component in a long-term nonproliferation effort. Last, but certainly not least, a swap would reduce Russian external debt without forcing Moscow to spend hard currency and draw down its Central Bank foreign reserves, thus serving the long-term goal of promoting economic stability in Russia.

In addition to process-related advantages, it makes extremely good political sense for the West to help Russia while it struggles in its quest for a market-based economy because Moscow has offered strong support for the US war on terrorism and has held the Organization of the Petroleum Exporting Countries at arm’s length in its quest to control worldwide oil prices more strongly.

A wide variety of programs could benefit from a viable debt-for-nonproliferation program. Cleaning up cold war nuclear waste could provide an extensive jobs program for former weapons specialists and would make Russian nuclear cities more attractive for outside investment. The long-term sustainability of the US effort in Russian nuclear material protection, control, and accounting is another effort that would benefit from additional funding and greater commitment by Russia’s private sector. The evolving European Nuclear Cities Initiative is in need of the innovative financing that a successful debt-for-nonproliferation enterprise would offer. The decontamination of Russian nuclear-powered multi-purpose submarines is another activity that has yet to be underwritten by the West or the Russians.

Of course, despite these benefits the idea of a swap would be less tenable if there were no financial basis for debt forgiveness. But Russia’s economic situation offers some genuine opportunities for constructive debt reduction. The collapse of the ruble in 1998, coupled with the size of Russian federal debt, has severely hampered Russia’s transition to a viable free-market economy, its capacity for making social-service and infrastructure improvements, and its ability to fund proliferation prevention and other security endeavors. Russian external debt totals $147 billion, nearly $71 billion of which is from the Soviet era. Approximately $2.7 billion of this Soviet-era debt is owed to the United States. This debt amounts to almost 140 percent of projected revenue from exports and is roughly 42 percent of projected 2002 gross domestic product.

Sizable amounts of Russian external debt are held by the Paris Club and the London Club, two separate ad hoc groups of creditors that meet with representatives of nations about to default on their debt. The Paris Club is currently comprised of 18 creditor nations (including all members of the G-8) and deals with official, bilateral debt instruments. The London Club is comprised of commercial banks. Both organizations meet with debtor nations in order to agree on the best terms for any debt restructuring. Although the United States could theoretically effect a debt swap itself, in reality a swap would involve these forums because unilateral US action could harm the economic interests of other creditors left holding Russian debt.

There is some precedent for Russian debt forgiveness among these creditors, which have provided some debt relief to Russia. In August 1999, the Paris Club provided a framework agreement that postponed payment of debt principal under their auspices until after the 2001 Russian presidential election but continued interest obligations. In February 2000, the London Club agreed to forgive some of the Russian debt to commercial lenders. In this agreement, $31.8 billion in claims held by commercial creditors were exchanged for $21 billion in new Eurobonds. When combined with an eight-year grace period on payment of principal, plus a lower interest rate, total debt forgiveness amounted to 52 percent in present-value terms.

The economic straits brought on by the collapse of the ruble have, until recently, been somewhat offset by the strong price of oil, which has bolstered Russian revenues. This improvement has somewhat weakened the financial case for debt relief because Russia is better able to service its debt obligations. However, the ruble appropriations required for servicing the debt will likely squeeze budgets for reform: revenues from oil and gas sales account for about one-half of the federal budget, and gas and oil prices tend to go together.

Despite this uncertain economic future, securing Paris Club participation in a debt swap would likely be a challenge. For instance, Germany will chair an upcoming Paris Club meeting and therefore have substantial influence on the outcome and the current German position does not acknowledge the benefits of a more liberal debt-relief agreement.

Because of potential Paris Club reticence in writing off Russian debt, it is critical that the United States take a lead role in implementing a debt-for-nonproliferation swap—a role that makes particular sense because of extant US involvement in Russian threat reduction efforts. The precedent for the United States using its financial leverage to effect positive change in other countries is well established, though traditionally the goals of such actions have been developmental rather than security-oriented.

In three exceptional cases, the United States has reduced the debt of severely indebted lower-middle-income countries to promote not only economic reform but also US national security interests.

Each of these three special debt reduction cases required special legislation, and although in Russia’s case existing US legislation does, technically speaking, contain authority for debt swaps for various purposes, the chances of a debt swap succeeding would be enhanced by obtaining the positive congressional endorsement that would be represented by new legislation targeted specifically at swapping Russian debt-for-nonproliferation commitments.

Fortunately, Congress has expressed considerable interest toward debt-for-nonproliferation in recent months. On December 20, the Senate passed by unanimous consent the Security Assistance Act, which contained the Debt Reduction for Nonproliferation Act of 2001 (DRNA). It sets forth US security interests in preventing proliferation and reducing weapon stockpiles, especially in Russia, and it recognizes that existing nonproliferation programs have made substantial progress but that the threat remains urgent.

More specifically, the DNRA states that new nonproliferation funding streams—such as debt reductions and exchanges—are needed and that the burden will have to be shared by Russia, the United States, and other debt-holding governments. It further (Continued on next page) states that Russia’s substantial Soviet-era debt burden severely stresses its budget, will do so even more in 2003 and thereafter, and is among the factors that have led Russian officials to recognize that its future lies with the West.

If enacted in its current form, the DRNA would authorize the president to establish an office at the Treasury Department to administer the debt reduction and authorize $300 million in appropriations in fiscal years 2002 and 2003 to offset the cost of the debt reduction to the US Treasury. It would authorize the president to reduce the Lend Lease and agricultural portions of the Soviet-era debt and replace those obligations with new obligations defined in a “Russian Nonproliferation