World Bank Faces Crunch Time

At 61, the World Bank is facing a mid-life crisis. It’s fighting to reverse a huge drop in lending to Middle Income Countries (MICs) that is undermining its influence and role globally. Yet the battle to claw back lost ground has reignited a bitter debate that’s been rumbling for years. Is it still relevant in these countries and, if so, how should it stay involved?

The fall in lending to MICs has been large and swift. Between fiscal 1990-97, the International Bank for Reconstruction and Development (IBRD), the Bank’s hard lending window for MICs, lent some $15-18 billion. After a dramatic jump in the wake of the 1997-98 East Asian crisis, lending slumped to about $10-11 billion from 2000-2003. Some key clients, especially in Central Europe, have become prosperous enough to do without IBRD financing and have “graduated” from the facility permanently. Others, such as Kazakhstan and Russia, are temporarily flush with oil cash and don’t need the money, while yet others, such as Indonesia and Nigeria have slipped from middle to low income status. These are perhaps inevitable changes and the Bank could claim that for those countries graduating, it reflects well on Bank policies. But the fall in lending goes much deeper than that, affecting the Bank’s largest MIC clients such as China.

Soul Searching
The scale of the disengagement seems to have taken the Bank by surprise and has prompted soul searching and a vigorous response. Last year, the Bank published a new strategy on its relations with MICs, Enhancing World Bank Support to Middle Income Countries. The gist of this was unequivocal. The Bank must actively seek to reverse this trend in the MICs: “shareholders gave us one very strong message: that the Bank Group must remain engaged with these countries, individually and collectively.” New strategies were evolved: the IBRD saw its role tailored more towards lending to support structural reforms, especially in the banking sector, and knowledge transfer, says Manish Bapna, executive director of the Bank Information Center, in Washington. And in August the Bank announced that it was raising the amount it would lend to any one country (from $13.5 to $14.5 billion) and cut front-end fees by 25 basis points in a bid to make the IBRD a more attractive source of funds.

The new policies were adopted just as the conservative Paul Wolfowitz, George W Bush’s appointee as Bank president, came on board. Opponents of the new plan expected he would roll back the Bank’s involvement in MICs. So far, they have been proved wrong. Indeed, Wolfowitz has toed the Bank line. He says that he sees the role of the Bank in MICs as critical with involvement centred on knowledge transfer -- that is, using experience gained in these countries to shape policies in poorer countries -- and strategies to alleviate poverty in MICs.

The Bank’s supporters have been breathing a sigh of relief. They are ardent in their belief that the Bank must stick with the middle income countries. They argue that capital markets are not sufficiently developed and too unpredictable for MICs, that the Bank has unique expertise in these countries that can be transferred to poorer nations and that MICs continue to be home to the majority of the world’s poor.

The naysayers, predominantly US policy makers and economists, have long argued the Bank should butt out of MICs and focus on poverty alleviation in lower income countries. The drop in lending played into their hands and they were dismayed at the Bank’s robust reaction. In an interview with Emerging Markets Report, Allan Meltzer, Professor of Political Economy at Carnegie Mellon University in Pittsburgh, PA, and an adviser to the US government on the role of the multilaterals, says the Bank’s policy to re-engage is doomed to failure. He attributes much of the fall in lending to these countries to a progressive drop in Bank subsidies and points out that repayments to IBRD are outstripping borrowing. In fiscal 2004, the World Bank saw principal repayments of $18,479 million against gross disbursements of $10,109 million (or more than $8 billion in net repayment). The figure for fiscal 2005 is less extreme although still startling at just over $5 billion in net repayments.

Focus on the Poor Countries
Meltzer has long argued that as MICs have access to capital markets, they do not need to borrow through the IBRD. “Countries that can borrow in the capital markets with investment grade ratings should not receive subsidized loans. Those loans can be better used to provide potable water, sanitary sewers, disease control in the poorest countries, and to encourage countries to adopt institutional reforms that have been effective in spurring development.” And he reasons that the Bank prefers to lend to MICs, such as China, as they tend to follow the Bank’s policy prescriptions, something lower income countries all too often fail to do. “Lending to China improves the Bank’s performance record,” he says, a cynical take on why the Bank is so keen to lend to MICs.

For Meltzer, it’s time to think the unthinkable. Instead of choosing the easy path of MICs, the Bank should focus on countries where poverty is most intractable. It could keep its advisory function as Bank staff are highly competent and should work to share its expertise better with the regional multi-lateral banks. If the Bank’s advice is good, countries will take it, if not, the Bank would be better off not offering it. After all, the Bank has a reputation for being the only one that “pays clients to take its advice,” quips Melzter.

Recently, these critical conservative voices have been joined by NGOs. As part of its drive to be more middle income borrower-friendly, the Bank has said it will allow borrowers to use national social and environmental standards rather than tough Bank standards in pilot projects. The idea was to tackle its reputation for bureaucracy, paperwork and slow processing, the notorious Bank ‘hassle factor’. Shannon Lawrence, international policy analyst at Washington-based Environmental Defense, says NGOs were alarmed at the announcement, seeing it as an attempt to dilute environmental standards and the Bank’s accountability in a bid to push through more loans. The move to alter environmental policy is especially galling and sensitive for NGOs as the Bank only started to treat environmental concerns seriously in the last decade. They are determined not to allow that good work to be undone.

Worse, the policy seems to be unworkable, Lawrence argues. Instead of reducing costs and accelerating transaction times, the Bank has found that it needs to analyse a huge array of different standards from country to country and even differing standards within countries before approving loans. That makes the new policy more cumbersome than the previous approach and has apparently prevented the Bank from moving ahead with any new pilot schemes to date, she says.

The fiasco over the Bank’s tortured attempts to change the rules on environmental scrutiny highlights the biggest headache facing it as it struggles to make the IBRD appealing to middle income clients: dealing with competing interests. The NGOs are often in direct conflict with borrowing clients. Not surprisingly, the MICs do not want conditions attached to loans. They bemoan the spread of conditions that now cover everything from environmental issues and human and women’s rights to anti-corruption drives. They make the decision making process slow -- all that extra paperwork and scrutiny of policies -- and fiendishly difficult at best. At worst, it means borrowers run the risk of having their request turned down.

The lower income countries are probably going to have to lump the extra conditions, but the extra burden and scrutiny is anathema to MICs who are driven to look elsewhere. Increasingly, they find less particular lenders in the private sector. China, for example, has trimmed its use of the IBRD window to $1 billion a year, cherry picking which loans suit it and thumbing its nose at burdensome conditions. The amount the Bank lends there is paltry but with $700 billion in foreign exchange reserves and $50 billion in net foreign direct investment every year, China is hardly short of funding. That means that even if the Bank continues to lend to China and countries of its ilk, it will become increasingly marginalised there and in a host of other MICs. Meltzer notes that increasingly MICs are demanding sweeteners to sign up to the World Bank’s conditions or threaten to turn to the private sector to borrow money. The Bank baulked at funding the Yangtze dam, for example, and China went to the private sector.

Between a Rock and a Hard Place
The NGO-borrower conflict over loan conditionality clearly illustrates the Bank’s dilemma on how far it can engage with MICs. Rich country shareholders are at a loss on how to resolve these issues. On one hand, they have been behind moves to tighten up conditionality. Unhappy with what they say is a lack of surveillance at the Bank into the success of its loans and programmes, they were behind moves to insist on better monitoring. And they were also behind the Bank’s ratcheting up of conditions to loans based on environmental and human rights standards. After all, they are not immune to the zeitgeist – taxpayers don’t want their money supporting regimes that bulldoze those standards. But at the same time, they are keen supporters of the Bank’s desire to remain active in MICs.

This schizophrenia leaves the Bank between a rock and a hard place. It is working hard to steer a course that satisfies all parties: the rich shareholders that want to expand lending to MICs but insist on a raft of conditions; the NGOs, with whom it has promised to engage more fully; the critics who say the Bank has no business being spread across countries that can fend for themselves; and the MICs that are being courted ever more actively by a more flexible and less intrusive private sector. To reconcile them all is impossible.

For new, few dare to contemplate a scenario where the World Bank has exited MICs altogether. And yet if the middle income giants keep cutting back borrowing from the Bank, the idea will inevitably gain ground. The Bank’s geographical focus will become highly lopsided and make a mockery of its pretence to have global reach. That would be hard for an organization that has increased its remit and that has often been accused of mission creep. It would see most of its operations focused on Africa and a handful of small and uninfluential countries in Asia and the Americas, the world’s laggard economies, uncomfortable for an organisation used to playing a central role worldwide.

Conservatives are praying for just that, a complete exit from MICs. They are biding their time for now as they see the argument running against them. Yet they remain optimistic that their turn will come. They continue to hold out the hope that Wolfowitz is playing pat for now, but will start to steer the institution away from its involvement in middle income countries over time. They say that his moves to shake up the bureaucracy might herald a wider shift in mindset. If they’re right, the World Bank will be a shadow of itself ten years from now.

And yet for now, there’s little sign that is the inevitable outcome. Instead, the threat has shaken up the Bank which recognizes it needs to reinvigorate or see its role shrink. Its best bet to stave off irrelevance is to be innovative and try out new products in the MICs rather than sticking to plain vanilla loans. The modernising wing says the Bank has been too slow and cautious in sticking to vanilla loans to borrowers. At the very least, the Bank’s private-sector International Finance Corporation (IFC) and perhaps even the whole organisation should use new financial instruments to catalyze the private sector’s work. One of the favourites is collateralised debt obligations, where risk can be tranched and sold to investors with different risk appetites, allowing a host of different investors to become involved. This flexibility is likely to prove powerful in deciding whether the Bank can stay relevant to the needs of the MICs and fuse its role with the private sector.

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