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The World Bank’s comeback
– by Qays Hamad
After the Asian crisis ended, the World Bank’s net disbursements were in steady decline. (“World Bank” here refers only to the IBRD, the group’s main branch, not its sister institutions such as IDA, MIGA, and IFC). Recent years have even shown negative net disbursements, as loan repayments exceeded new loan disbursements.
There are many reasons for the decline, but it was primarily driven by high liquidity in the international capital markets, low interest rates, and generally improved refinancing options for middle-income countries (MICs). The World Bank and regional development banks have attempted to remain attractive to MICs with new concepts and innovative loan “products” (see box).
Critics of all stripes argued that the World Bank has become superfluous. World Bank critics led by Meltzer and Lerrick held that the institution had outlived its usefulness, and that private banks had long ago left it behind in financing developing countries. The IBRD had a relatively high equity to loan ratio, which of course grew steadily as its loan portfolio decreased. This led to a heated discussion about “alternative”, supposedly more developmentally effective, uses for IBRD’s share capital – specifically, the paid-in portion and accrued reserves in the amount of about US$ 37 billion . The shareholders eventually decided to invest part of the share capital in more promising ventures, producing higher returns that could then be used to subsidise programmes unsuited to traditional credit funding (combating climate change , for instance).
Some non-governmental organisations even suggested liquidating and disbursing parts of IBRD’s share capital – either using the money for debt cancellation or to expand IDA, the World Bank agency that grants subsidised loans to the poorest developing countries. Others proposed doing away with the IBRD completely and converting its share capital into an endowment fund for the poorest countries. The World Bank would thus have discontinued all lending to MICs, expecting private-sector institutions to take its place.
The situation has changed radically due to the 2007/2008 financial crisis, which drastically reduced MIC access to private capital markets. Initially, it appeared that developing countries would not be hit very hard by the American sub-prime crisis because they had not invested in the highly speculative and inadequately collateralised asset-backed securities. That assumption, however, proved false.
As banks lost confidence in each other and investors suddenly became very risk-averse, interest rates surged and bond spreads skyrocketed. In the end, the crisis spilled over into the real sector.
Spreads for inter-bank loans also increased. At times, inter-bank lending virtually ground to a halt. To cope with the liquidity crisis and losses sustained, investors began liquidating assets on a large scale and transferring them abroad – mainly to the USA. That trend contributed substantially to the developments in countries like Hungary.
In addition, hedge funds closed and major investment banks suffered massive losses. On a large scale, banks were forced to write off asset-backed securities that were now potentially valueless, and branded as “toxic assets”. Private and institutional investors rapidly became less willing to assume risk. They quickly withdrew substantial sums from emerging markets and avoided new investments in risky assets. This risk aversion was immediately reflected in the spreads for MIC’s sovereign bonds , which almost tripled within a few weeks.
Hungary provides a good example of this development: trading in Hungarian government bonds collapsed almost entirely. There simply weren’t any investors willing to buy securities from the Hungarian government, even with a “guaranteed” interest rate of more than 10 %. Although the Hungarian banking sector had not invested directly in sub-prime assets, it was nevertheless hit heavily by the sudden reassessment of investment risks that led to higher financing costs and shorter credit terms. In addition, fleeing investors caused share prices to plummet in several developing countries.
Last Exit World Bank
These developments led to a resurgence in demand for IBRD loans among member countries. In the first half of the financial year 2009, the credit pipeline nearly tripled compared to previous years. New IBRD loan commitments are now estimated at around $ 35 billion for financial year 2009, compared with around $ 13 billion each in 2007 and 2008. Several countries greatly increased their IBRD loans; some investment-grade countries (for instance, Hungary and Latvia) even returned as borrowers after having previously graduated from IBRD to become donors.
Requests for loans fall into several categories:
- immediate funding requirements (Hungary, Ukraine, Latvia),
- precautionary funding (mainly Latin America),
- funding to protect the poorest sectors of the population (safety nets), and
- funding for infrastructure projects affected by the withdrawal of private capital (India and South Africa).
World Bank President Robert Zoellick explained that the Bank will assist its member countries to the extent possible within its framework. He announced the mobilisation of a further $ 100 billion over the next three years. Based on IBRD’s solid capital base, it is completely feasible for the current loan portfolio to be doubled from $ 100 billion to $ 200 billion. Beyond that, however, the institution’s capital would have to be increased if additional loans are to be granted – a process likely to be protracted and controversial.
For the first time, the finite nature of IBRD’s lending capacity is becoming the focus of discussion. In the past, it seemed inconceivable that the IBRD might reach the limit of its financial capabilities, but now that seems near at hand. In reaction to the crisis, countries are clambering to borrow more from the World Bank, often exceeding previously agreed-upon volumes . Some major newly industrialising countries are even approaching the total upper borrowing limit of $ 15.5 billion.
High demand for fresh credit leads to the risk that it will not be possible to serve member states down the line. If certain countries react more quickly than their peers and borrow more than was anticipated before the crisis, the pool of available funds may dry up too fast. To reduce that risk, the World Bank is now working on an allocation formula. It should ensure that all countries are treated appropriately when fresh requests for credit are considered, not simply on a “first come, first serve” basis.
To this end, the usual range of allocation criteria, like the size of the country, economic performance, population, and credit risk, need to be complemented. For obvious reasons, other criteria must be taken into account as well , for instance, the actual financing requirements, the poverty impact of the measures, and quality of national crisis policies.
Moreover, the Bank is looking closer into which countries actually notify the IBRD of their requirements and which do not. Doing so would help to make funds allocated for certain countries temporarily available to others, provided the criteria are fulfilled. Typically oil-exporting countries and countries with alternative sources of finance (Middle Eastern countries, for example) have tended to use the IBRD less. In the uncertain times ahead, that may change, however.
The borrowing needs of MICs are substantial, with estimates ranging from $ 900 billion to $ 1.2 trillion for 2009 alone. Accordingly, World Bank loans can comprise only part of the often complex aid packages these countries receive. Nevertheless, as shown by Hungary and Poland, World Bank support not only eases strain on national budgets, but also helps to fund reform programmes that restore investor confidence. World Bank loans can also help countries increase their appeal in private capital markets.
Furthermore, it remains to be seen how the returnof middle-income countries to the World Bank affects the Bank’s MIC strategy. For the moment, the aim of winning back or keeping these countries as customers has been achieved, but primarily as a result of the crisis.
It is certainly true that the current financial crisis has stimulated international cooperation ¬– particularly in the G-20 process – and brought about consensus on measures to prevent any similar market destabilisation in the future. The fear remains, however, that these lessons will merely complement those of the previous Tequila, Asia and Ruble crises.
If, as many critics had demanded, the World Bank’s capital had been reduced when times were good, it could not afford to provide the kind of counter-cyclical support that is currently in high demand. Let’s hope that this lesson won’t be forgotten when the dust settles and demand for IBRD loans may drop again.