Tuesday, 9 May 2017

Multilateral Development Banks: Policy Options for the Next German Government

This post first was published early May in German on request of Stephan Klingebiel for the German Development Institute: 
http://blogs.die-gdi.de/2017/05/02/die-zukunft-der-multilateralen-entwicklungsbanken/

2015 was the year of important summit promises made by the UN and heads of states that yielded some of the most ambitious global commitments ever made:
1.       The 3rd Conference on Financing for Development in Addis Ababa;
2.       The Summit in New York on Sustainable Development Goals (SDGs); and
3.       The 21st Climate Change Conference in Paris.
2016 followed to witness the delivery promise by ten multilateral development banks (MDBs) and the IMF:  We stand ready to support the realization of these ambitious UN summit promises into reality[1]. Table 1 presents those MDBs that committed to the delivery promise through their presidents´ signatures. The Table will help the next German government to monitor these institutions for the implementation of their promise and to take them to task. Talk is cheap, especially at UN summits, but implementation is critical to improving lives and protecting the planet.

Table 1: Multilateral Development Banks with SDG Delivery Commitments
Multilateral Development Banks
Accronym
African Development Bank
AfDB
Asian Development Bank
AsDB
Asian Infrastructure Investment Bank
AIIB
European Bank for Reconstruction and Develoment
EBRD
Europen Investment Bank
EIB
Inter-American Development Bank
IADB
International Finance Corporation
IFC
Islamic Development Bank
IsDB
New Development Bank (BRICS)
NDB
World Bank
IBRD/IDA

The MDB bosses declared that the can translate the SDGs into meaningful country-level targets, policies, programs, and projects needed to achieve them. They would provide not only the necessary financing—either directly or by helping to “unlock” and catalyze additional public and private resources—but also policy advice and technical assistance supporting countries to build domestic capacity and to identify needed priority investments with the right standards.  At the same time, the IMF and the World Bank would strengthen their debt sustainability assessment tools to ensure that investment scaling-up in the wake of the summit promises  do not threaten the sustainability of public finances. So much for self-promotion.
With respect to the summit and delivery promises and the MDBs, three central strategic questions will confront the next German government:
·         Which share of the aid budget is to be spent via multilateral rather than bilateral channels?
·         How to allocate German budget contributions across the MDBs?
·         Which priority will be given to poverty reduction in the poorest countries relative to financing global public goods?

Aid allocation: Bilateral or multilateral delivery channels?
Budget allocation between bilateral and multilateral delivery channels can be guided by two important criteria: 1) Who has the comparative advantage to deliver on specific SDGs effectively and efficiently? 2) Which channel helps better promote the priorities of partner country and donor country?
Usually, multilateral are preferred over bilateral agencies for some genuine advantages: Know How (to fight poverty and pandemics), basic research (for example on agricultural seeds), to combat global climate change, global terror, financial crises and shortages of water, food and energy. These are classic global public goods that constitute the case for the necessity of multilateral organizations also for aid delivery.
Where – unlike in Germany – national agencies of aid delivery are hardly present, a hard decision is often avoided via cherry picking multilateral organizations for earmarked (´bilateral`) purposes. By contrast, German contributions to multilateral institutions are mostly contributions to their core budget. The high share of core budget payments in German contributions to multilateral organizations is welcome and should not be reduced. Many international organizations, especially at the UN, suffer from eroded core budgets that leads either to their effective ´privatization´ (example: the World Health Organization budget financed by the Gates Foundation) or to mission creep, mandate encroachment and fund shopping by management. This leads to aid fragmentation, costly for poor countries with thin administrative capacities.
To be sure, the risk of aid fragmentation is much higher when aid is delivered via bilateral channels, given the multitude and competition of bilateral aid agencies and of private donors. However, the bilateral channel is tempting for an export oriented country such as Germany as it will serve as a door opener for good bilateral relations, which imply stronger trade relations.

Assigning Mandates across the MDB Space
In the past, the bulk of multilateral lending has been provided by institutions created and ruled by the west. The pressure for the BRICS to ‘exit’ had risen with past, present and expected failure for ‘voice’ reform in the established international financial institutions (IFIs). With the Asian Infrastructure Investment Bank (AIIB) and the New Development Bank (NDB), two multilateral banks created in 2014 outside the established Bretton Woods system, choice has increased for borrowers and capital donors alike as the new institutions led by China and the other BRICS help rebalance multilateral development finance away from western dominance[2]
To avoid the administrative burden on developing partners that may arise through fragmented MDB lending, it remains important to avoid mandate duplication and overlap, to reduce mission creep and to arrest multilateral fragmentation[3]. The fragmentation of multilateral development cooperation is not just a problem for developing countries, but equally for sponsors in donor countries. They have so far often fulfilled the task to direct and control the management of multilateral development banks by benign neglect.
A clear role assignment and coordination of the multilaterals will help reduce mandate shopping and hopefully raise their efficiency and effectiveness. This requires first and foremost to find out comparative advantage across the MDB space in supporting specific SDG goals (of which there are 17 with 169 targets between them). Because of ministerial patronage and conflict of interest the mapping of comparative advantage cannot be trusted upon specific ministries, let alone upon international organizations (nor upon academics that depend on them). The most promising procedure is to have the heads of states to entrust national audit agencies with mapping comparative advantages in the MDB space[4].

Which Role should MDBs have for the Bottom Billion?
The Communiqué released by G20 Finance Ministers and Central Bank Governors at their meeting in Baden-Baden over March 17-18, contained the following, less noted, declaration:
“Given scarce public resources and the key role of the private sector for sustainable economic development, we welcome the work by Multilateral Development Banks (MDBs) on mobilising private capital. We call on MDBs to finalise Joint Principles by our next meeting and develop Ambitions on Crowding-in Private Finance by the Leaders Summit in July 2017. We look forward to the joint MDBs’ reports on the implementation of the MDBs Balance Sheet Optimisation Action Plan…”
Following a decision made in 2015, The AsDB has become a pioneer of merging concessional and non-concessional balance sheets in order to raise leverage on MDB capital. Since the AsDB merger, the assets of the concessional loan window, named the Asian Development Fund (AsDF), have been treated as equity and brought onto the bank’s core balance sheet. The inclusion of AsDF equity, comprised of $30.8 billion in loans outstanding and $7.2 billion in liquidity/receivables, effectively tripled AsDB capital to $53 billion. The Washington-based Centre for Global Development (2016) estimates that the move increased the AsDB lending capacity by 50%. The new regulations for the AsDF were released by the AsDB on 1st January 2017.
Reforms are also ongoing in other international financial Institutions. The IDA, following its 18th Replenishment, plans to leverage its capital for non-concessional loans through a private-sector set-aside window. The African Development Bank (AfDB) is opening its non-concessional window to the poorest countries. Also IFAD – an MDB and a specialized UN agency – is exploring options for changing the financial architecture, so as to increase the size of the programme of loans and grants.
The AsDB merger has been described as “win-win-win”: AsDF countries see expanded access to lending; AsDB countries also see expanded access (on non-concessional terms); and AsDF donors see a 50 percent reduction in their contributions to the grant fund as a result of a smaller pool of eligible countries. Is this too good to be true – a free lunch?
We need to consult MDB balance sheets to see when the MDB windows merger will bring the advertised results:
  • On the liability side, the ratio of concessional to non-concessional equity determines lending potential of merged windows. The more concessional equity can be merged into non-concessional equity, the more bang for the buck can be expected.
  • On the asset side, composition of borrowers—those requiring concessional lending terms and their size relative to non-concessional borrowers – will define the leverage ratio as non-concessional lending raises the leverage ratio while concessional lending will reduce it toward 1.
Table 2: MDB Balance Sheet Ratios
MDB
AfDB
AsDB
IADB
IBRD
Equity ratio 
4.16
2.24
0.07
4.38
Leverage ratio
2.49
3.79
3.26
4.13
Sources: Moody´s; CDG (2016); MDB annual reports; own calculations.

The net result of window mergers on MDB lending capacity will depend on how much additional finance the balance-sheet reform produces, and how much of the additional resources is absorbed by a higher concentration of fragile and conflict affected countries in the remaining pool of IDA countries. The World Bank balance sheet lends itself to the optimization proposed by the G20: Both the equity ratio and the leverage are comparatively high, so that lending capacity can be increased significantly by the window merger. In contrast, the room for manoeuvre is quite limited for the AfDB. This kind of redirection of investment priorities away from social investments toward hard infrastructure investments could be fatal in Africa where fragile and conflict affected countries are plentiful, and where the majority of countries are still dependant on concessional lending[5]



[1] http://www.worldbank.org/en/news/press-release/2016/10/09/delivering-on-the-2030-agenda-statement
[2] Helmut Reisen (2015), “Will the AIIB and the NDB Help Reform Multilateral Development Banking?”, Global Policy, Vol. 6,  Issue 3, September, pp. 297–304.
[4] To entrust the national audit authority on evaluating engagement with multilaterals was pioneered in the UK. See National Audit Office (2005), Department for International Development: Engaging with Multilaterals, London: NAO.
[5] See more detail in Helmut Reisen (2017), On the G20 call for MDB Balance-Sheet ´Optimization´, T20 Germany Blog, German Development Institute, 11 April.

Monday, 20 March 2017

On MDB Balance-Sheet ´Optimization´

The Communiqué released by G20 Finance Ministers and Central Bank Governors Meeting[1] in Baden-Baden last weekend carries, beneath embarrassingly dropping their commitment to free global trade, a less noted declaration:
Given scarce public resources and the key role of the private sector for sustainable economic development, we welcome the work by Multilateral Development Banks (MDBs) on mobilising private capital. We call on MDBs to finalise Joint Principles by our next meeting and develop Ambitions on Crowding-in Private Finance by the Leaders Summit in July 2017. We look forward to the joint MDBs’ reports on the implementation of the MDBs Balance Sheet Optimisation Action Plan.”
What do they mean by MDBs Balance Sheet Optimisation and why does it matter?
Let´s quickly revisit MDB history. The IBRD (World Bank) was created as a sister organization to the IMF following the Bretton Woods conference of 1944. In 1960, in a period when many poor countries were shedding their colonial status to turn independent, the World Bank created a concessional window, the International Development Association (IDA). Other multilateral development banks (MDBs) were created, such as the African development bank (AfDB), Asian Development Bank (AsDB), and the Inter-American Development Bank (IADB), following the example set by the World Bank with two separate windows, a concessional and a non-concessional. Concessional windows act like trust funds and are regularly replenished by cash contributions from MDB member governments. Non-concessional windows, by contrast, are largely financed by MDBs issuing bonds at low interest cost.
MDBs enjoy developed-country guarantees, a preferred borrower status and consequently investment-grade ratings. The MDB core competence is the selection, monitoring and enforcement of loans and other financial investments that foster human and physical investment not reached by private finance because of high risk and weak or non-existent institutions for the enforcement of financing agreements. It has therefor been argued that financing global public goods may distract MDBs from their core competence  [2], including poverty reduction in low-income countries.
The legacy MDBs are still dominated by Western governments. Especially AsDB governance is skewed: Japan remains the largest shareholder and decision maker although China is by now the larger economy. As long as such governance issues are not seriously addressed by raising voices, votes and contributions by China (and India), uneven representation has a negative impact on capital resources (to which China could amply provide) and hence lending capacity. 

The inception and creation of the NDB and the AIIB, dominated by China (and other BRICS), this 2010s decade has - surely more than by pure coincidence - let to US Treasury-led efforts to merge concessional and non-concessional windows at the MDBs in order to uphold the lending capacity of Western-dominated MDBs despite their relatively weak equity endowment[3]. The pressure to close the concessional windows of MDBs is bound to rise with the announced cut of USAID money under the first Trump budget as this cut will translate into lower replenishment pledges by the US.

The AsDB 2015 decision to merge its concessional and non-concessional balance sheets pioneered the approach to raise leverage on MDB capital. Under the AsDB merger, the assets of the concessional loan window, the Asian Development Fund (AsDF), was treated as equity and brought onto the bank’s core balance sheet. The AsDF equity, comprised of $30.8 billion in loans outstanding and $7.2 billion in liquidity/receivables, effectively tripled AsDB capital to $53 billion. The Washington-based Centre for Global Development (2016) estimates that the move increased the AsDB lending capacity by 50%. AsDB has in January 2017 released the new regulations for the AsDF[4]. Likewise, the IADB merged its two windows at the beginning of 2017.

Reforms are also ongoing in other international financial Institutions. The IDA, following its 18th Replenishment, plans to leverage its capital for non-concessional loans through a private-sector set-aside window. The African Development Bank (AfDB) is opening its non-concessional window to the poorest countries. Also IFAD - an MDB and a spezialized UN agency -  is exploring options for changing the financial architecture, so as to increase the size of the programme of loans and grants.
The AsDB merger has been described as “win-win-win”[5]: AsDF countries see expanded access to lending; AsDB countries also see expanded access (on non-concessional terms); and  AsDF donors see a 50 percent reduction in their contributions to the grant fund as a result of a smaller pool of countries. Is this too good to be true - a free lunch?

To approach the answer, let us have a look at a simplified MDB balance sheet, with
(Assets) A= $ +γ(EC + ENC) + R = D + EC + ENC = L (Liabilities).
$ denotes cash, γ the leverage ratio of the loan stock to the sum of concessional equity EC and non-concessional equity ENC, and R reserves on the MDB asset side. The liability side consists of MDB debt D and equity E, which can be split into EC and ENC. Let´s denote the ratio EC/ ENC by ε.

Now we can see when the MDB windows merger will bring the advertised results:

·         On the supply side of the MDB balance sheet equation, the ratio of concessional to non-concessional equity ε determines the additional lending potential of the windows merger. The more concessional equity can be merged into non-concessional equity (a higher ε), the more bang for the buck can be expected.
·         On the demand side, composition of borrowers—those requiring concessional lending terms and their size relative to non-concessional borrowers – will define the leverage ratio γ as non-concessional lending raises the leverage ratio while concessional lending will reduce it toward 1.

Table 1: MDB Balance Sheet Ratios
MDB
AfDB
AsDB
IADB
IBRD
Equity ratio ε
4.16
2.24
0.07
4.38
Leverage ratio γ
2.49
3.79
3.26
4.13
Sources: Moody´s; CDG (2016); MDB annual reports; own calculations.

The net result on the MDB lending capacity will depend on how much additional finance the balance-sheet reform produces, and how much of the additional resources is absorbed by a higher concentration of fragile & conflict affected countries in the remaining pool of IDA countries. The World Bank balance sheet lends itself to the optimization proposed by the G20: Both the equity ratio and the leverage ratio are comparatively high, so that lending capacity can be increased significantly by the window merger. In contrast, the room for manoeuvre is quite limited for both the IADB and the AfDB, albeit for different reasons.
The IADB had, already before the 2017 merger, wound down the concessional window (FSO) to such an extent that the equity ratio tends toward 0, so there was virtually no concessional equity left to be merged into non-concessional equity. 
It has been argued by an AfDF working group that AsDB merger would result in “lower levels of concessional funding for Asian LICs, in particular on ´non-bankable´ social infrastructure spending. It is also likely to reinforce a pre-existing bias in the AsDB for ´bankable´ projects in the profitable energy, telecommunications and transport subsectors or in agroindustry”[6].

Table 2:  Eligibility to Access ADF Funding
- Number of countries (out of 54 total) -
                                       Creditworthiness to sustain ADB financing
Per capita income
above the ADF/IDA
operational cut-off

No
Yes
No
30 AfDF-only
3 blend-eligible
Yes
4 AfDF-Gap
3 AfDB-only

This would be fatal in Africa where fragile and conflict affected countries are plenty and where the majority of countries (Table 2) still depends on concessional lending.




[2] Buiter & Fries (2002), What should the multilateral development banks do?, EBRD Working Paper No. 74.
[3] Most publications in that direction have been published by the Centre for Global Development (CGD). See CGD (2016), Multilateral Development Banking for This Century’s Development Challenges. For an alternative view, see Reisen, H and C Garroway (2014). The Future of Multilateral Concessional Finance. Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ). 
[4] https://www.adb.org/sites/default/files/institutional-document/33454/regulations-adf-2017.pdf
[5] See CGD (2016), Multilateral Development Banking for This Century’s Development Challenges, op.cit., p.35.
[6] ADF Working Group (2014), ‘ADF-14 Innovative Financing Approaches’, Options Paper, Box 3.

Thursday, 16 February 2017

Compact with Africa or Deal for Allianz AG?

The renowned development economist Paul Collier has recently suggested[1] funding Africa´s infrastructure by deploying a part of the huge asset base of pension funds and life insurance companies. The idea sounds great but is all but new[2]. And Collier´s suggestion may downplay the barriers to private co-financing of infrastructure precisely in those countries where demographic trends will generate the highest migration pressures: in low-income Africa such as the Sahel Zone countries.
Nonetheless, Collier´s suggestion has been picked up with enthusiasm by Germany´s finance minister Schäuble. Unsurprisingly, as the often fatal privatization of basic public services and the balance-sheet contraction of the public sector are central guidelines of the Lord of the ´Black Zero´.
Prima facie, the idea to engage institutional investors in co-funding Africa´s infrastructure is quite beguiling. Pension funds, life insurers and also sovereign wealth funds can be patient investors, as their balance-sheet liabilities reflect long-term savings for old age or future generations. Patient investors are a good fit for infrastructure projects, which tend to have a long gestation period. Moreover, as infrastructure returns correlate little with returns from other assets, they can contribute to higher risk-adjusted returns of institutional portfolios.
According to the World Bank´s Africa Infrastructure Country Diagnostic (AICD), the infrastructure need of Sub-Saharan Africa exceeds US $93 billion annually over the next 10 years[3]. To date less than half that amount is being provided (mainly from domestic and foreign official sources, with about half from China), thus leaving an annual financing gap of more than US $50 billion to fill.

Table 1: Global Assets Managed by Long-Term Institutional Investors
Assets, $ trillion/Year
2012
2020
Pension funds
33.9
56.5
Insurance companies
24.1
35.1
Sovereign wealth funds
5.2
8.9
Total, long term institutions
62.2
100.5
Source: PwC Asset Management 2020: A Brave New World, New York 2016

Ignoring valuation changes, the rise projected for the three groups of institutional investors translates into annual asset additions worth $4.78 trillion per year on average. To fill Africa´s annual infrastructure funding gap of $50 billion, one percent of new institutional investment by pension funds, life insurance companies and sovereign wealth funds would need to be invested in Africa´s infrastructure every year[4]. These numbers suit wonderfully the Bella Figura that the German G20 Presidency wants play with respect to Africa.
Skepticism seems warranted, though:  Despite the longstanding policy focus of G8/20 leaders, private long-term investment in Africa´s infrastructure has remained deficient. As Africa´s infrastructure gap became officially recognized, the Infrastructure Consortium for Africa (ICA) was established in July 2005 as a recommendation to the G8 Summit in Gleneagles (UK) by the Commission for Africa. Subsequently, G20 leaders highlighted the importance of private long-term financing to foster long-term growth[5], in particular since 2012. The G20 Summit 2013 in Moscow saw the creation of a permanent working group to identify and remove barriers to private investment in African infrastructure.  G-20-OECD High-Level Principles of Long-Term Investment Financing by Institutional Investors were agreed. All these efforts have achieved little:
·         The index of Africa´s infrastructure (AIDI) stagnates since 2010, after rising for a decade thanks to Chinese cooperation.
·         Private finance still plays a minority role in funding Africa´s infrastructure. Its share recently dropped to 15% (2015) from 23% (2012).
·         In capital imports to low-income Africa (<$1.045/head/year), the share of blended finance (mobilized by development finance institutions) has remained at a one-digit percentage level.
The rational for private investment in Africa by long-term institutional is high, but so are the barriers.
On the supply side, regulatory supply-side barriers and past decent returns for life insurers and pension funds explain why they mostly have stayed in the comfort zone of liquid bond and equity markets. Despite widespread whining about low or negative interest rates (particularly in Germany´s conservative media), OECD surveys on pension funds and life insurers report annual average returns of 3-5% for recent years. Rising bond and equity markets have allowed long-term investors to leave assets in their comfort zone of highly liquid securities markets.  Ultimately, encouraging long-term investment of pension funds and life insurers in infrastructure - including in Africa - will need the G20 to engage in a coordinated dialogue with regulatory authorities (such as EIOPA, the European Insurance and Occupational Pensions Authority) and the Financial Stability Board (FSB)—the international body of finance ministers, central bankers, and other agencies established in 2009 after the global financial crisis.
On the demand side, African countries remain poor, have immature domestic financial markets, and have recently featured deteriorating scores of safety and rule of law. This holds particularly in those low-income countries, such as in the Sahel Zone, where present demographic and future migration pressures remain extremely high. Common infrastructure project risks (completion, performance, revenue, financing, maintenance and operation risks) weigh also particularly in low-income Africa. In low-income Africa, a prominent role of private institutional investors should be envisaged only once the discussed host-country barriers have been largely removed.
Despite policy efforts to mobilize private finance through official development finance interventions, they so far have represented a small fraction of the flows directed to low-income Africa. The central dilemma: Low domestic savings, weak government finances and a low debt tolerance militate against forcing foreign private debt and contingent fiscal liabilities upon low-income African countries where infrastructure deficits are most blatant. Grants, remittances and FDI equity finance should be preferred over debt-creating finance as IMF debt sustainability assessments have deteriorated in a number of Africa´s countries, not least due to public infrastructure commitments[6].
Despite those warnings and limited absorption capacities, development banks around the world have an incentive to do business. The International Finance Corporation (IFC), part of the World Bank Group, is showing particular ingenuity. Thanks to its Managed Co-Lending Portfolio Program (MCPP), the Allianz AG has now invested $500 million in emerging-country infrastructure[7]. The Allianz engagement carries relatively little risk as IFC (joint with SIDA, the Swedish aid agency) assumes the first-loss in the joint infrastructure fund. In turn, Allianz is guaranteed a return of 4-4.5% above LIBOR. Not a bad deal for Allianz AG. But who will pay for the implicit subsidy?




[1] Paul Collier, Afrika kann sich nur selbst retten, Die Zeit, 27.10.2016.
[2] I myself helped popularise the idea in several papers in the early 1990s. Find them in Helmut Reisen (2000), Pensions, Savings and Capital Flows: From Ageing to Emerging Markets, Edward Elgar Publishing Ltd in association with the OECD, Cheltenham (UK).
[3] Vivien  Foster and Cecilia Briceno-Garmendia (Eds.) 2009, Africa’s Infrastructure: A Time for Transformation, World Bank, Washington DC: 2009.
[4] R. Kappel, B. Pfeiffer & H. Reisen (2017), „ Compact with Africa: Fostering Private long-Term Capital“, forthcoming, DIE-GDI Discussion Paper.
[6] IMF (2016), Regional Economic Outlook: Sub-Saharan Africa, IMF: Washington DC, April.