Debt Sustainability, Non-Concessional Borrowing and the World Bank s Anti-Free Riding Policy

1. Debt Sustainability, Non-Concessional Borrowing and the World Bank’s Anti-Free Riding Policy By Economic Affairs Division, Commonwealth Secretariat, London.

2. Organisation of presentation Presentation is organised into 3 Sections: A Review of Non-Concessional Borrowing by and Debt Situation of LICS A Review of the World Bank’s Recent Proposed Policy on Anti-Free Riding Recommendations

3. 1. A Review of Non-Concessional Borrowing by and Debt Situation of LICS

4. 1.1 A review of the profiles and stylized facts on non-concessional borrowing in LICs Our review shows that natural resource rich countries and countries in conflicts (that are therefore in arrears with BWIs) account for the bulk of non-concessional debt stock and flows, particularly public and publicly guaranteed types.

5. But it would not be illogical to anticipate that post-MDRI countries too could soon start (or might have just started) contracting non-concessional debts in sizeable amounts.

6. We also highlight the geographical concentration of bilateral external credits that characterises many countries, with outstanding credits from emerging creditors like China, Kuwait and Saudi Arabia accounting for high percentage of GDP of the borrowing countries. We point out that this could make the borrowers more vulnerable.

7. In addition, we review the available descriptive and “qualitative” information about the activities of emerging creditors in LICs, with emphasis on the lending activities of China in Africa.

8. 1.2 A review of the likely reasons that could have made the countries resort to non-concessional borrowing. We identify a number of supply factors at the creditors’ end and demand factors in the borrowing LICs.

9. 1.3 Prospects and Possible Problems with Non-Concessional Borrowing by LICs

10. We identify a number of possible prospects and disadvantages associated with non-concessional borrowing by LICs. We similarly discuss possible dangers and disadvantages in doing so.

11. A conclusion from these is that the circumstances of each country would determine which of the prospects and problems would apply and to what extent.

12. 2. A Review of the World Bank’s Recent Proposed Policy on Anti-Free Riding

13. The World Bank staff recently produced, in June 2006, a policy document recommending series of measures to its Board in preventing what it refers to as “Free riding”. The latter and larger part of our paper is devoted to a review of the policy document.

14. 2.1 Summary of the Contents of the Policy Document We summarise the main contents of the document, including the peculiar concept of free riding adopted and the concessionality benchmark to be used. We point out that, instead of the DAC’s concessionality definition, it adopts wholesomely the very strict concessionality definition used by the IMF in its PRGF programme ceiling imposition on foreign borrowing.

15. We also summarise the World Bank’s proposed responses, including the use of DSF both as the coordinating tool for the creditors as well as the instrument for penalising borrowers deemed to be complicit in free riding through a combination of cuts in volume of IDA assistance and hardening of terms of IDA credits.

16. Specifically, the DSF is to be used as the tool for rallying and coordinating creditors. Borrowers are to be discouraged from being complicit in free riding through sanctions. But pragmatism and case-by-case treatment are emphasised as the underlying principle in applying the sanctions.

17. Grant eligible IDA-only LICs (including the post-MDRI ones) and, hence, those characterised as either “red light” or “yellow light” in the DSF debt distress risk classification: For this category of LICs, the sanction would be volume reduction of not less than 20% on the grants to be received – in addition to the standard 20% volume discount.

18. The “green light” post-MDRI LICs: These, on the other hand, would be subjected to hardening of terms of various degrees (depending on the severity of the breach), instead of volume reduction, for breaching the concessionality guidelines. Very serious breaches can attract both volume reduction and hardening of terms or even total disengagement of IDA from a country.

19. 2.2 Prospects and Benefits of Implementing the Policy These include the following: Reduction of the incidence of opportunistic creditors financing low-return projects. Guarding against moral hazard problem of reckless borrowing by LICs with a view to becoming (or continuing being) eligible for IDA grants.

20. Strengthening, through the use of DSF, of bargaining position of LICs in contracting foreign loans. Discouragement of LICs from embarking on large borrowing until they have put in place adequate debt management capacity and governance institutions.

21. 2.3 Possible Problems and Disadvantages of the Proposed Policy These include the following:

22. A problem is the the philosophy or fundamental objective, which seems to have prompted the World Bank proposal, that is routed in inappropriate perception by the World Bank of its role as a competitor with other creditors in provision of resources to LICs.

23. A related problem is the inappropriate sentiment that it is evil for it to cross-subsidise private investors, particularly emerging creditors, irrespective of the consequences on the LICs.

24. Discrimination against LICs by IDA in allocating its resources is identified as a part of the problem that drives LICs to contract non-concessional loans and the proposed policy document has nothing to offer in addressing this issue. The discrimination is through: Netting off mechanism in MDRI implementation Volume cuts on IDA grants Use of PBA mechanism that is regressive.

25. The policy would also hinder attainment of MDGs (as well as financing of growth-promoting infrastructural and other large expenditure projects) by the LICs by discouraging them from borrowing, just as the penalty of further reducing IDA grant allocation to them can make them resort further to non-concessional borrowing.

26. Another problem is the implied increased financial oversight of, and intrusion in, the affairs of government by the World Bank in implementing the policy. This would erode sovereignty of the countries, just as it would run counter to the much acclaimed principles of ownership and alignment that are a part of the Paris Declaration on Aid Effectiveness.

27. Also, the acceptance and legitimacy, in the eyes of LICs and creditor community, of DSF, on which the whole policy rests, are in doubt. In addition, the proposed policy may suffer from operational ineffectiveness as a result of exclusion of domestic borrowing, as efforts to curtail foreign borrowing may simply lead to a resort to domestic borrowing.

28. Besides, the proposed policy glosses over all other fundamentals that affect debt sustainability and focuses on only volume of loans. In addition, it is one sided and asymmetrical by penalising only borrowing LICs for breaching the concessionality guidelines while leaving the creditors untouched.

29. Finally, the policy may not be easy to enforce as LICs that breach the guidelines could easily hide this fact from IDA while, for many of them, even the maximum penalty (viz: disengagement from the “offending” country) at the disposal of IDA may be insufficient to deter some LICs, particularly resource rich countries.

30. 3. Recommendations

31. 3.1 Recommendations to Policy Makers in LICs

32. Policy makers should refrain from reckless and injudicious borrowing. They should strengthen debt management capacity as well as the legal framework for managing of debt and broader government finances, including enactment and forceful implementation of adequate fiscal responsibility laws.

33. They should diversify geographical sources of their foreign loans, without necessarily sacrificing the degree of concessionality. They should pay attention to the exchange rate and monetary management challenges posed by inflow of foreign resources, including foreign loans.

34. 3.2 Recommendations to International Creditor Community They should refrain from lending: (i) recklessly by giving loans to governments with doubtful future repayment capabilities. (ii) to governments whose intention to use the proceeds judiciously, as opposed to misappropriating the proceeds, are in doubt.

35. (iii) to odious regimes, which may be strengthened in their quest to oppress dissidents and abuse human rights, as in Sudan vis-à-vis its Darfur region. (iv) to finance activities whose social and environmental standards greatly fall short of the Equator Principles.

36. 3.3 Recommendations to the World Bank, in particular, and International Development Partners, in General

37. The World Bank should be at the forefront in providing and championing an initiative of a multilateral framework for promoting debt management capacity in LICs, similar to the IF network – that is for promoting technical assistance on trade-related matters. By this, the only need or justification for the IDA’s paternalism on and intrusion in the borrowing prerogatives of sovereign country governments would have been addressed and removed.

38. It should also do more in promoting exports in LICs, e.g. through its trade-related financial instruments and advocacy for trade concessionality for LICs in WTO and other trade negotiation arenas. It should refrain from perceiving itself as a rival to other creditors in the loan market for LICs and from seeing cross-subsidisation of emerging creditors as necessarily a bad thing.

39. It should liberalise or relax its conditionalities so as not to prompt borrowing governments to be resorting to less concessional sources with fewer attached strings. It should desist from the existing discrimination against LICs in allocating IDA resources by doing something to its netting off mechanism on MDRI relief; PBA mechanism and volume cuts on grants.

40. It should extend the proposed policy to cover the domestic debt also, for policy effectiveness. Finally, it should extend sanctions for breaching the concessionality guidelines in its proposal to creditors too, particularly by spearheading an adoption of international agreement whereby lending to LICs that flagrantly breach concessionality norms and/or social and environmental standards be treated as odious and illegitimate.

41. In this regard, an acclaimed proposal has been put forward in international debt debate for setting up internationally recognised independent body (e.g., under the UN auspices) to decide on whether internationally controversial regimes are odious or not, for the purpose of officially blacklisting such regimes so that all foreign loans granted to them would be deemed odious lending that successor regimes would not be bound to honour.

42. However, as countries under such odious regimes are not likely to be many from global perspective and would definitely not be an eligible member of the Commonwealth (under the existing rules of the Commonwealth), such a proposal may not be relevant to the Commonwealth, unless the criteria of odiousness of international lending is widened and appropriately modified.

43. Accordingly, what is being recommended here is for foreign lending, even to reputable and non-odious regimes, to be similarly regarded as odious if it breaches: (i) concessionality guidelines contained in a more universally owned and accepted DSF and/or (ii) prescribed social and environmental standards We suggest that the World Bank should be at the forefront in promoting this idea.

44. Chairperson, Honourable Ministers, Ladies & Gentlemen, thank you for listening!