Beyond Traditional World Bank Finance Presentation to the Finance Forum September 24, 2004

1. Banking and Debt Management Group Beyond Traditional World Bank Finance Presentation to the Finance ForumSeptember 24, 2004

2. Outline • Strategic Framework • Overview: IBRD Financial Products • How are IBRD clients using them? • How could FS clients use them?

3. Strategic Framework: Outline • Shifting the nature of the partnership • Shifting the way we deliver financing • Implementation at country/CAS level

4. A. Shifting the Nature of the Partnership IBRD: A provider of development assistance that also has a role as financial partner of MIC Lending instruments  Financial products

5. Evolution • Evolution in range and way IBRD delivers financing and financial advisory services. • Full range of financial products and services to support country’s program and overall sovereign debt/risk management needs. • True flexibility  at inception and over the life of the loan to manage financial risks related to liquidity, interest rate, currency and commodity.

6. Why financial choice matters Until 1999 choice to clients quite limited. “New” products introduced potential value added beyond the VOLUME of lending  financial mode of delivery of lending could now provide value in itself: • supporting Government’s policy goals in debt and risk management; • contributing to country dialogue by introducing the dimension of financial partnership; and • potentially, opportunities for new lending.

7. B. Shifting the Way we Deliver Financing • Integrating financial products into Bank country programs upstream and at a portfolio level. • Ensuring awareness of the full menu of financial products and services available. • Linking choice to overall sovereign debt/risk management.

8. Integration • Key strategic goal fully utilize untapped potential by shifting to an upstream, country-portfolio level integration of the most appropriate mix of available WBG financial products and services. • Culture change decisions on the portfolio and on each individual project to be supported by IBRD involve both development decisions and financial decisions.

9. Awareness • There is CLEARLY a disconnect between available financial products and knowledge of and use of these by both staff and clients. • Strategic Forum + MIC Task Force: Outreach is renewed priority • Intensify targeted training and outreach. • Improve/innovate financial products and services for clients. • Mainstream Financial Advisory Services on-going in 10 MICs.

10. Upstream Approach Need to shift: • Scope: from loan-by-loan  portfolio approach • Level of dialogue (with Staff):task managers  country directors/managers • Level of dialogue (in Countries):from line ministries  Finance Ministry and sovereign debt managers • Timing:from appraisal/negotiations  upstream and as part of CAS preparation and implementation

11. Outreach • Intensify targeted training and outreach. • Improve/innovate financial products and services for clients. • Mainstream Financial Advisory Services. on-going in 10 MIC countries

12. Debt Management: The context for decision-making Potential value added of using IBRD Financial Products can only be fully evaluated by looking ex-ante at the overall IBRD portfolio (existing and projected) within the framework of the sovereign debt/risk management strategy.

13. C. Implementation at Country/CAS Level • Understand the country’s sovereign debt management structure and strategy. • Present to country team and authorities how the IBRD financial products can help manage financial risks (FX, interest rate, commodity prices, etc.) at:  2 levels (country and projects) and  2 dimensions (existing IBRD portfolio and new lending) • Implementation + Implications: add value NOT create more unfunded mandates.  we work in parallel to task managers and  our support is centrally funded

14. Outline • Strategic Framework • Overview: IBRD Financial Products • How are IBRD clients using them? • How could FS clients use them?

15. The use of financial products in debt management • The framework for applying financial products is to design and implement a debt management strategy.  a critical step is to identify financial risks and plan on how to manage them. • Bank working in 12 pilot countries under the Bank/Fund Debt Reform and Capacity Building Program to support governments in developing a reform plan for debt management and domestic debt market.

16. Building Capacity in Debt Management • Establishing key objectives and priorities. • Establishing a prudent risk management strategy an strengthening middle office analytical capability. • Establishing an organizational structure that ensures clear accountability and transparency. • Establishing a clear legal framework. • Recruiting trained staff, and selecting and implementing effective management information systems.

17. Our Members’ Main Financial Risks Financial risks of the government balance sheet may arise from: • Foreign exchange rates (Currency risk) • Interest rates • Liquidity/Rollover risk • Credit • Commodity prices

18. IBRD can help manage risks • For new IBRD debt Offering a menu of flexible, competitive terms for clients to choose the most appropriate product. • For existing debt (= outstanding IBRD portfolio)  Offering products that allow clients to transform the financial characteristics as their needs change. IBRD can help clients reduce the risk on their debtportfolio

19. Using IBRD products to manage risks At the sovereign portfolio level: • Changing the currency and interest rate characteristics of existing IBRD debt. • Smoothing out the portfolio repayment profile. • Reducing vulnerability to commodity prices. • Lowering currency risk on government on-lending by swapping IBRD debt to local currency. • Managing the liquidity/rollover risk.

20. Using IBRD products to manage risks At the loan level: • Locking in fixed interest rates (e.g. on-lending…). • Tailoring FSL repayment terms to meet project needs. • Blending IBRD and donor funds to reduce the overall cost of a project.

21. Overview of IBRD Financial Products • Loans • Fixed Spread Loans (FSLs) • Variable Spread Loans (VSLs) • Specialized Financial Products • Deferred Drawdown Option (DDO) Loans • Special Structural Adjustment Loans (SSALs) • Hedging products • Embedded in FSLs • Free-standing for: • VSLs • Existing IBRD portfolio • Guarantees • Partial credit guarantees • Partial risk guarantees

22. Products for Standard New Loans Key Attributes • Competitive, market-based pricing. • Long maturities. • All major currencies + local currency possible. • Fixed or floating interest rate. • Flexibility to modify key financial characteristics over the life of their loan. • Same price for all borrowers.

23. Borrower chooses the currency Flexible repayment terms Principal repayment schedules based on the disbursed loan balances Loan agreement provides for conversion options for currency and interest rate risk management Hedges can be perfect Regular Financial Terms for new IBRD Loans Fixed-Spread Loan Variable Spread Loan • Borrower chooses the currency • “Standard” country repayment terms • Principal repayment schedules based on the committed loan amount • A separate legal agreement is necessary to access stand-alone currency and interest rate hedges • Currency and interest rate hedges cannot be perfect

24. Sample IBRD Pricing Sample IBRD pricing Cost of borrowings = LIBOR – 0.30% Lending spread = 0.75% Waiver = -0.25% Total lending rate = LIBOR + 0.20% Some pricing comparisons Mexico = LIBOR + 1.22 % China = LIBOR + 0.26% Turkey = LIBOR + 3.21% Philippines = LIBOR + 3.70%

25. Deferred Drawdown Option (DDO) Loans • No immediate need/interest in disbursing from the Bank (Standby Facility). • Access to a liquidity risk management tool. • Front-End-Fee paid by borrower only when disbursed. • Slightly higher commitment charges than regular loan.

26. Stand-alone Hedging Products • Interest rate swaps • Interest rate caps and collars • Currency swaps • into local currency where local currency swap markets exist • Commodity swaps (on a case-by-case basis)

27. Local Currency Financing Available as: • Currency conversion of current disbursements or disbursed and outstanding FSL amounts. • Currency swaps on disbursed and outstanding IBRD loan amounts (MDA is required). • Availability Subject to: • Liquid swap market in the local currency • Limited to the local expenditure component

28. Outline • Strategic Framework • Overview: IBRD Financial Products • How are IBRD clients using them? • How could FS clients use them?

29. How are IBRD clients using the products?

30. How are IBRD clients using the products? • Colombia • Uses FSL rate fixing, currency choices and repayment term flexibility to achieve the desired currency, interest rate and refinancing characteristics of its sovereign debt • Tunisia • Customizes repayment schedules to smooth out repayment flows to reduce rollover risk • Latvia and Chile • Used a DDO as “insurance” against a potential temporary financing shortfall

31. How are IBRD clients using the products? • Mexico • IBRD uses USD/MXN swap market to provide synthetic local currency loan in MXN • Government can eliminate currency risks in on-lending to states and other entities • Philippines • LGU Urban Water and Sanitation Project (APL2) • JPY-denominated FSL with ARF to lock in low JPY interest rates • Longer grace period • Cash flow considerations – preferred level principal repayments

32. How are IBRD clients using the IBRD financial products? • Bulgaria • Uses stand-alone hedging products to transform USD loans into EUR in preparation for EU accession • First IBRD currency swap with a client Original Obligations USD USD Bond Holders IBRD Bulgaria IBRD + Currency Swaps USD USD Swap IBRD Bulgaria Euro Euro Intermediary = Net Cash flows Euro Euro Bond +Swap Markets Bulgaria IBRD

33. How are IBRD clients using the IBRD financial products? • China • TB Control Project & Basic Education V Project • Used an FSL to blend IBRD and DFID funds to achieve concessionary funding and obtain longer grace period • Third Xinjiang Highway Project • FSL with a customized repayment schedule to match IBRD debt service with projected revenues • Papua New Guinea • Has selected FSLs because of flexibility to subsequently change currency and interest rates

34. Outline • Strategic Framework • Overview: IBRD Financial Products • How are other clients using them? • How could FS clients use them?

35. How could FS clients use them? Possible uses for FS projects: • Reduce the cost of debt within the agreed risk management strategy. • Reduce/enhance exposure to variable rates by converting variable rate debt to fixed interest rate or vice-versa. • Eliminating foreign exchange risk by lending in local currency or converting FX-denominated debt to local currency. • Reduce liquidity risk by tailoring repayment terms based on institution/project cash flow.

36. How could FS clients use them? Possible uses for FS projects: • DDO used as a standby facility in a reform program for the banking sector for example. • Reduce vulnerability to commodity price volatility. • Help develop or start a mortgage market???

37. How could FS clients use them? • Reduce the cost of debt. • IBRD loans can provide cost savings relative to other funding sources for some countries Indicative Market Spreads Over Libor for Selective Countries • The variable interest rate on existing IBRD Loans can be fixed to reduce interest rate risk in volatile markets, or to lock in historically low rates • Balances on loans that will not be disbursed could be cancelled, to reduce commitment fee expenses

38. How could FS clients use them? • Reduce/enhance exposure to variable rates by converting variable rate debt to fixed interest rate or vice-versa. • Tariffs tend to behave like fixed interest rate (regulated) • Allow on-lending in fixed interest rate

39. How could FS clients use them? • Eliminating foreign exchange risk by lending in local currency or converting FX-denominated debt to local currency.

40. How could FS clients use them? • Reduce vulnerability to commodity prices. • Through IBRD commodity swaps, transform existing or new USD loans into “financial oil” loans • IBRD debt service would be positively correlated to oil prices, reducing fiscal budget volatility Example of Transformed Loan Terms Currency denomination Final Maturity Grace Period Principal Amortization Interest Payments From USD 17 years 5 years 24 level principal installments LIBOR + 50 b.p. To Financial Oil (USDeq of x) barrels of oil 17 years 5 years [X 24] barrels per year [Y] barrels per year

41. How could FS clients use them? • Reduce liquidity risk by tailoring repayment termsor contracting a DDO. • Disbursement-linked FSL • May be better suited for local currency loans where available maturities are short • Loans where project revenues are tied to timing and volume of disbursements • Example: • China – lower initial repayments, higher later payments. The idea would be to wrap the IBRD loan around the shorter-term local bank loan to effectively create a single loan (but still legally two loans) with a longer repayment period.

42. For More Information http://treasury.worldbank.org/index.html http://www.worldbank.org/FPS • Financial products • IBRD lending rates • Public debt management • Training for clients and WB staff • Analytical tools • Other TRE products and services • Information for investors

43. Questions / comments?