Contributions from
the Column
Focus

Germany’s DC: a foot in the door of crucial partners

World Bank: in search of strategy

Cooperation challenges

Economic development needs capacity building

What China’s success means for other countries


10/2005 		 

World Bank works
on strategy

Over the past ten years, there has been a marked decline in the volume of World Bank lending to middle-income countries (MICs). However, operations in emerging economies are important for the multilateral institution’s refinancing. While the World Bank can provide continued assistance to help address the specific problems of MICs, the Bank does not yet have a comprehensive and consistent strategy for such activities.


[ By Qays Hamad ]

In view of the economic achievements of MICs, many donors are questioning whether it still makes sense to engage in development cooperation with these countries and which role such cooperation should play. Some MICs are characterised by enormous export volumes, huge foreign exchange reserves, growing technological and scientific competency, and in-creased foreign policy ambitions. Thus, it is currently debated whether donor support for MICs is still appropriate. But this is not an open question for the World Bank, because in accordance with its Articles of Agreement, MICs are entitled to support simply by virtue of their being member countries. However, the World Bank needs to redefine its strategy for the cooperation with those countries.


Common misunderstandings

First, some misunderstandings need to be clarified. The complaint that the World Bank feeds rich emerging markets instead of addressing poverty is simply wrong. Loans to MICs are not dispersed at the expense of least developed countries. The opposite is true: The World Bank, in its capacity as the International Bank for Reconstruction and Development (IBRD), borrows on the capital market at extremely favourable terms, lends the funds to MICs with an interest premium and thus generates net income. Without that income, it would not be able to provide continued financial contributions to the World Bank’s soft loan window IDA (credits for the poorest countries) or the HIPC Trust Fund. This is why the decline of lending to MICs by four billion dollars over the past ten years is in fact problematic from a development perspective.

Yet the United States, the World Bank’s largest shareholder, likes to raise the “crowding out” argument. As early as 2000, the influential Meltzer Report suggested that the Bank should withdraw from MICs altogether because the private sector was more efficient at financing them (which turned out to be a misjudgement). Furthermore, conservative US policymakers worry in public that World Bank loans give China, for example, additional financial scope for spending on armaments or for buying American companies.

Another popular argument is that MICs have “grown out” of development cooperation because of their economic and technological achievements. This is equally unconvincing. The notion is based on an extremely narrow definition of development cooperation. In fact, many MICs continue to require support with regard to the very problems that emerge from economic success: environmental and resource protection, social security, the provision of public goods, et cetera.


Dwindling lending volumes

There are several reasons why the volume of World Bank lending to MICs has been on the decline. First, the MICs’ development goals did not match the priority that poverty reduction enjoyed under President James Wolfensohn, and which in many ways relied on Poverty Reduction Strategy Papers as a basis for World Bank support. Furthermore, MICs typically have strived to catch up with rich nations, rather than focusing on reaching the UN Millennium Development Goals (MDGs) – in many cases in spite of persistent poverty problems in those countries.

Moreover, many MICs are able to borrow at favourable terms on private capital markets, due to their good credit rating. As a consequence, their governments have been avoiding World Bank conditionality. This trend has grown stronger in recent years because the World Bank often has been unable to offer the expert advice MICs were looking for. Over the past few years, the World Bank has tended to expand its competency in the field of economic advice at the expense of its technical advice capacity, which matters to MICs.

Moreover, specific national issues have played a role in a number of countries. For instance, Indonesia had to switch from IBRD to its softloan subsidiary IDA in the course of the Asian crisis because it lacked creditworthiness. Russia’s borrowing needs have declined because of growing oil revenues. China has reached the Bank’s borrowing limit. These countries alone represent 60 % of the decline in IBRD’s lending volume.

Another aspect that must not be neglected in this context is the fact that the World Bank (more specifically, the IBRD) has apparently lost some of its competitiveness vis-à-vis other multilateral development banks. Even though its lending interest rates have been significantly lower in some cases, it has lost market shares to other development banks. MICs often find the economic policy reform conditions attached to IBRD project loans too burdensome. Undoubtedly, the high cost which they need to shoulder in order to meet the Bank’s fiduciary guidelines and safeguard policies have also contributed to some MICs turning their back at the World Bank.


An action plan

In order to reverse this trend, the Bank’s management has proposed to align instruments and products more with MICs’ needs. The action plan Enhancing World Bank Support to Middle-Income Countries (2004) should be regarded as a framework which is geared towards respective changes in the Bank’s instruments. The following are the core elements of the Action plan:
– In countries with advanced legal standards (e.g. environmental or social standards) that meet the requirements of the World Bank, the Bank should no longer rely on its own safeguards for project implementation but rather use country systems instead (Hamad 2004). This would reduce costs for borrowers. Sector policy conditions (such as user tariffs in water supply projects) should be implemented within the framework of country dialogue and not at the project level.
– The Bank wants to offer products which better reflect the fact that even though MICs have access to capital markets, they are still very vulnerable to capital fluctuation and volatility. This is why the World Bank has begun to offer its clients hedging products to hedge loans (even other banks’ loans). There is also a related debate on increased local-currency lending, which would eliminate the exchange risk for borrowers altogether.
– The World Bank should offer stand-alone technical assistance as a product, because many MICs are primarily interested in such technical cooperation. Some countries are even more interested in the free technical assistance that comes with the loan and not so much in the World Bank loan as such.

However, involvement in technical assistance outside lending operations touches upon the Bank’s mandate and raises the question of the division of labour between multilateral organisations. All the same, the in-terest of MICs should not be underestimated. China – having reached the Bank’s single country borrowing limit – has placed own funds as a bond with the World Bank in order to secure a new loan. Obviously, what the government really wanted was just the technical advice that came with the loan.

The Bank’s management supports its Action Plan with the following arguments:
– While MICs generate almost 90% of the gross national product of all developing countries, they are also home to about 80% of the developing countries’ population and to more than 70% of the worldwide poor.
– The 2006 World Development Report highlights social inequity as a central impediment to development. But it is in MICs in particular that inequity is often very high: Ten of the twenty countries with the most unequal income distribution are MICs.
– If a country has achieved MIC status, that status is not necessarily stable. Over the past twenty years, 38 countries have lost their MIC status becoming a LIC, while only ten of them have succeeded in reacquiring it.
– MICs often play an important role as anchor countries, which have an influence on other countries in their respective regions but also on the global economy as a whole.
– The World Bank can play an important role in these countries, and this includes the area of poverty reduction, through which it can make a major contribution towards achieving the MDGs. In large MICs, this is mainly feasible through supporting social security systems or through fostering broad-based growth.

At the same time, continued World Bank activity in MICs of course also has institutional implications for the Bank itself. The World Bank can only act as a global institution if it continues to work with advanced countries and puts the experience gained there to beneficial use elsewhere. Otherwise it would lose its function as a “knowledge bank.”


Conclusion

In principle, it is a useful and welcome idea for the World Bank to develop a MIC strategy. However, the fact that MICs have interests that differ explicitly from those of poorer countries is a potential source of conflict. Infrastructure financing is of much greater importance to MICs, as they wish to address impediments to palpable growth. Moreover, MICs regularly criticise the use of IBRD net income to subsidise IDA in the Bank’s Executive Board, as they would prefer to see that money going towards reducing their own borrowing costs.

If the World Bank wants to stay in business in MICs, its deliberations must start from the following idea: As their income grows, MICs are increasingly able to rely on private capital markets for refinancing. This “graduation” process, i.e. leaving the status of development-bank borrowers behind, is a desired outcome. If the World Bank, however, wants to stay in business and play a continued role in MICs, IBRD must offer attractive services, keep transaction costs as low as possible and better respond to clients’ specific needs.

However, staying in business should not be an end in itself. After all, the World Bank is a “development bank” and must do justice to both aspects of that notion. In creditworthy MICs, the primary goal of cooperation with the World Bank is the transfer of expertise and knowledge. Therefore, the Bank must develop and offer further instruments for that purpose.

Just like most strategic issues, the Bank’s MIC Action Plan has been put on ice after the change in the institution’s leadership. While new World Bank President Wolfowitz quickly adopted the well-known US positions on the World Bank after his appointment, he will not be able to ignore institutional constraints. Moreover, he cannot determine the Bank’s course by himself, and some shareholders, for example the Europeans, do not share the view of the US government in this question.

The discussion about the World Bank’s role in MICs is closely related to the question of its future as a finan-cially sound development institution that is largely independent of donor contributions. For some time now, the United States has been advocating for a shift towards more Bank operations on the basis of grants which in turn would come with much stronger conditionalities for recipient countries. Deprived of loan repayments and interest income such a World Bank would of course depend massively on donor funding and would thus be much more easily controlled and exploited for specific inter-ests. If one takes a look at the United Nations system, which has to make bids for donors’ voluntary contributions on a regular basis (involving what are often far-reaching compromises in terms of substance and human resources), one gains an idea of just how “toothless” such a World Bank might look like.


Qays Hamad
is Assistant Head of the Division “World Bank, IMF and Debt Issues” in the German Federal Development Ministry. This article reflects his personal view.
Hamad@bmz.bund.de