The
shrinking client base of concessional finance
The post-2015 agenda offers a
transformative vision for ending extreme poverty by 2030 and shifting the world
to a carbon-free growth path. Some of the institutions best equipped to finance
this agenda, however, face pressure to downsize as borrower countries lose
eligibility for concessional finance, as they surpass income per capita and
creditworthiness eligibility criteria.
India, for example, is the largest
World Bank borrower by volume, and recently became a middle-income country,
with income per capita above the threshold for concessional finance
eligibility. Other large, fast growing middle-income countries, including
Vietnam and Nigeria, are already “blend” countries, receiving a mix of both
highly concessional credits from the World Bank’s soft window, the
International Development Association (IDA), as well as less concessional hard
loans from the World Bank’s lending arm for credit-worthy countries.
The graduation from
concessional finance of large middle-income countries raises a range of
conceptual, political and operational issues for multilateral donors. On the
conceptual side, the nature of global responsibility towards poor people living
in non-poor countries – particularly those that have only just become non-poor – may conflict with political considerations against providing
concessional finance to countries that have accumulated high reserves and are
turning into emerging donor countries themselves. This raises questions about
the future roles, mandates and instruments of IDA, but also African Development
Bank (AfDB), Asian Development Bank (ADB) and their respective soft windows
(which in the case of ADB is already in the process of being dissolved and
merged with ADB's "ordinary capital resources"), as well as the International
Monetary Fund (IMF) concessional instruments.
Prudence suggests approaching
reform of the concessional windows with a precautionary, rather than
deterministic, perspective to enable flexible institutional response. That
perspective should not only consider future graduation prospects, but also
prospects for reverse graduation, e.g., due to disasters, military conflict and
governance failures.
Shareholders should not let
multilateral soft windows blindly continue business as usual, but also must not
allow them to ignore the option value of preserving their financial and
institutional strength by “declaring success” and letting them shrink.
The changing geography of poverty
The geographic distribution of
people living in extreme poverty is changing due to the recent period of high growth.
A number of the largest, faster growing countries continue to have sizable
populations living in extreme poverty. In fact, three-quarters of the world’s
extreme poor today live in countries classified as middle-income countries
(MICs), which have limited access to soft finance. Only one-quarter of the
world’s extreme poor live in the remaining 35 low-income countries (LICs). Some believe that this will be a transitory
phenomenon and that by 2025 poverty will become concentrated in fragile and
conflict affected states. Others argue that a sizable share of world poverty
could remain in stable MICs, or be concentrated in fragile MICs, e.g., such as Pakistan
and Nigeria.
Many donors consider that middle-income
country status itself is a reason to be reducing or even ending aid. The belief
is that it is an affront to middle-income countries for donors to get too
involved in their own internal policies, with the justification that
distributional issues are fundamentally domestic in nature. A major political
decision facing the international finance institution (IFI) shareholders is
therefore whether the international aid community should target poor countries
or poor people.
Medium-term poverty reduction
scenarios published by the World Bank and others in recent years show that ending
extreme poverty by 2030 is possible. The ambition required shouldn’t be
underestimated, however. The release of the 2011 purchasing power parity (PPP)
exchange rates estimated by the International Comparison Program also has prompted
unsubstantiated claims that ending poverty may be easily accomplished, due to
much lower price levels in developing countries than previously thought. This
end-poverty euphoria and optimism is well intentioned, but misplaced. Jumping
to conclusions about global poverty based on the new 2011 PPPs is unwarranted
and potentially misleading. Leaving aside whether or not the new PPPs are
appropriate for measuring poverty, using new PPPs will require re-calculating
the poverty line itself to ensure it is the average of national poverty lines used
in the poorest countries. The most thorough attempt to do this so far suggests
a new global poverty line of $1.82 in 2011 PPPs, at which the world is still as
poor as we thought, and ending poverty remains as ambitious (Prydz and Joliffe,
2015).
Regardless which PPPs are used,
slow growth over the medium-term is the principal reason why ending poverty by
2030 remains highly ambitious. This is also why the high concentration of
extreme poverty in middle-income countries is unlikely to be transitory. A
study we conducted for BMZ (Garroway and Reisen, 2014) forecasts growth to
2025, measuring the impact on extreme poverty and on concessional finance graduation.
Our main result: more than half a billion people will
still live in extreme poverty in 2025, the majority in MICs ineligible for
concessional finance.
Redefining eligibility criteria
At present,
the multilateral soft-finance windows are all pegged to the IDA “operational
cutoff”, which refers to eligibility ceiling defined by a specific level of GNI
per capita (US$1,195 for FY13). This has been a malleable yardstick in the past;
IDA eligibility was initially based on the “historical cutoff” (US$ 1,945 for
FY13). High demand for limited IDA resources led shareholders to lower the cutoff
in the early 1980s. Most observers agree that the cut-off itself is arbitrary
and doesn’t reflect a salient distinction between countries at different levels
of development.
There are
possible avenues for redefining the present operational cutoff. IDA itself has
suggested looking at other criteria beyond income per capita. Possible
complements could be the UNDP Human Development Index, the UN Economic
Vulnerability Index, or a similar index. Another approach would be to re-instate
the original “historical” cutoff. The simple but elegant solution is not only
justified by the historical precedent, but also finds support in the ultimate
stated objective of concessional windows to provide a durable way out of
dependence on external resources for development finance needs. Our BMZ study
(Garroway and Reisen, 2014) point to the empirical fact that few countries with
income per capita below $2000 have non-poor populations that can afford
redistribution at the national level to cover the poverty gap. This capacity
for redistribution – proposed by Ravallion (2010) – is measured by the marginal
tax rate on the non-poor population necessary to close the poverty gap. It is
an independent, highly relevant justification for raising the IDA operational
cutoff back to its historical level.
Smoothening
transition periods
The multilateral concessional
windows can also soften the transition from soft financing by making “blend”
status a more explicit step in graduation. Smoothing already happens in
practice through the use of blended and hardened terms, but it is not part of
an explicit phased and transparent approach. A widened transitional window for concessional
resources could be made available to countries whose incomes fall between the
current threshold and a higher threshold, perhaps the historical cutoff. Again
this finds justification in the finding that roughly $2,000 per capita serves
as dividing line between countries that can feasibly reduce poverty through
redistribution and those that would face prohibitively high tax rates on the domestic
non-poor.
IDA itself has proposed three
criteria for access to transitional support: (a) GNI per capita below the
historical threshold; (b) a significant poverty agenda, as measured by poverty
levels and other social indicators; and (c) a significant prospective reduction
in available financing after graduation. Such support could be made available
for new graduates that meet these three criteria and would help smooth the
transition of graduating countries. Given the eventual objectives of mobilizing
domestic finance adequately, allocation under the transitional window might
also be earmarked toward public spending for social inclusion and
redistribution as well as improved fiscal federalism, i.e. through higher
fiscal transfers from rich to poor states.
Strengthening
sub-sovereign allocations
IFIs could also increase direct
funding in grants or credits to local governments or even nongovernmental
organizations in regions with per capita incomes below country-level
eligibility thresholds, even if the country’s average income level is above the
threshold. Apart from the rural-urban inequality in populous large emerging
countries, such as Brazil, China, India or Indonesia, new threats like disaster-related
impoverishment also have distinct within-country geography. Again, like the
earmarking of transitional resources, the sub-sovereign allocations could also
be aimed at cooperation on inclusive policy processes such as budget
allocations, and sustainable urbanization to improve prospects for more
inclusive development. Some MIC governments might interpret such cooperation as
excessive interference into domestic political processes. But such concerns
might be less for multilateral rather than bilateral donors. Within the
multilaterals space this type of cooperation is well-suited for agencies where
MICs have more voice in governance.
It also may be worthwhile to explore
to what extent the European Union (EU) experience can inform multilateral concessional
lending. EU Structural Funds and the Cohesion Fund are financial instruments
of EU regional policy, intended to narrow disparities among regions and Member
States. Since 2000, more than €500
billion in Structural Funds, mostly via the European
Regional Development Fund, have been channeled to local projects in EU countries
via national intermediary institutions.
Opening
the soft windows for global public goods
Another major political
decision relates to the role of multilateral concessional finance in
provisioning global public goods, especially related to climate change
adaptation and disaster management. An important side effect of mainstreaming
climate change into development cooperation will be the need for multilateral
donors to integrate vulnerability to environmental and global risks into their
allocation criteria of concessional flows. An alternative to withdrawing
concessional finance from MICs would be using the soft windows to co-finance
regional and global public goods. The mandate of the soft windows could be
adapted to focus explicitly on infrastructure with upfront cost but long-term
developmental benefits as a way to help sustain global economic growth and
human welfare. Tracer sectors could be climate change adaptation and disaster
risk prevention and management.
Indeed eleven of the
prospective 2025 IDA graduates we identified in our BMZ study already have greater
than $US 100 million prospective annual disaster damage costs (Garroway and
Reisen, 2014). Asian MICs, India and Bangladesh, top the list. Disaster risk
management should be integrated with poverty eradication efforts; otherwise,
ending poverty may not be within reach. The soft windows could thus contribute
to the SDG-agenda while maintaining their anti-poverty mandate.
The option value of waiting on soft window reform
The option value of preserving
the concessional windows is considerable in a world with global governance
failures that prevent first-best policy solutions. The provision of global
public goods requires the institutional infrastructure that these windows can
deliver. Shrinking the soft finance windows prematurely would mean losing the
considerable option value of waiting. It implies losing effective financial and
technical services and know-how on a scale and with a quality that matter
globally or regionally. It would also forego network externalities that
represent a valuable global asset. Shrinking the multilateral soft windows
would also imply – for better or for worse – that MICs would also need to speed
up the establishment of new development banks, such as New Development
(‘BRICS’) Bank and Asian Infrastructure Investment Bank, without benefiting
from knowledge and ´certification value´ that existing concessional windows
have acquired already (Reisen, 2015).
