In difficult times, Strengthening the Lending Capacity of the Multilateral Development Banks
An important question
COVID-19 has shown, particularly in the emerging markets and developing world, a whole range of vulnerabilities in the economies of these countries. Public health systems have come under enormous strains, reflecting many decades of neglect. Budgets have been stretched, with very few countries having the fiscal space needed to respond to the crisis in a vigorous way, without imperiling the long-term health of public finances and/or without turning for immediate help from the international financial institutions.
We have known for a long time that fiscal policies in the great majority of countries in the world have exhibited a “deficit bias,” that is, a tendency, regardless of the business cycle or whether the economy in question is in a phase of expansion or downturn, to register a budget deficit. Looking at the data for 191 countries over the 41-year period 1980–2020, countries have run deficits 75 percent of the years (with many advanced economies registering deficits in every single year over this period) and this tendency has intensified over the past decade, following the 2008 global financial crisis. This deficit bias has led to the rapid build-up of public debt, a process that has picked up speed in 2020 as a result of the fiscal interventions necessitated by the pandemic.
Against this background, the role of the international financial institutions and multilateral development banks has acquired renewed relevance. In the aftermath of the pandemic some 80 countries have received support from the IMF’s Rapid Credit Facility and Rapid Financing Instrument (RFI), the latter a facility providing fast-disbursing support to countries experiencing commodity price shocks, natural disasters, and other fragility-related emergencies. Thus far, as of this writing, the IMF has approved some US$87.4 billion under the RCF and RFI and other facilities, against financing needs (conservatively estimated) in these countries likely in excess of US$2.5 trillion. (However, of the US$87.4 billion, a full US$45.7 billion correspond to three Flexible Credit Lines for Chile, Colombia and Peru; actual IMF disbursements thus far, therefore, account for no more than 1.7 percent of the IMF’s own estimates for the financing needs of emerging markets and developing countries). Other official lenders such as the World Bank and the regional development banks such as the IDB have also stepped in with emergency funding.
Given the volume of interventions announced thus far in the more advanced economies and given the present and prospective needs for financial support in coming years in the developing world, one can legitimately raise the question of whether the collective “firepower” of the international financial institutions and the multilateral development banks — meaning, the aggregate amount of financial resources available for assistance to their members — is adequate to the task at hand. And the task is not simply meeting the needs arising out of the dislocations provoked by COVID-19, enormous as they are, but also those that will emerge in coming years from multiple climate change-related disruptions, as well as the whole range of other development needs which remain, such as persistently high levels of poverty, widening income disparities, the need to rebuild dilapidated physical infrastructure, to improve the quality of educational systems as we rise to meet the challenges of technological change for the future of work and the job markets, among others. Our answer to this question is a resounding “no”.
This note will address the issue of boosting the lending capacity of multilateral lenders. The first part of what follows is focused on the development banks. A separate (shorter) section deals with the adequacy of IMF resources. The proposals presented here are offered in a spirit of constructive dialogue, mindful of something that Winston Churchill said in 1940 in the middle of World War II: “in this crisis we must not let ourselves be accused of lack of imagination.”
Mobilizing the private sector for development: A sponsored loans program
The intent of this proposal is to look beyond the conventional funding mechanisms of the multilateral development banks, which have historically consisted of periodic capital increases funded by member countries. This mechanism may continue to be used in the period ahead, but it has its own limitations. First, the amounts collected in recent rounds have not been especially large. To take an example: the IDB’s ninth general capital increase (GCI-9) went into effect in February of 2012 and consisted of $1.7 billion of paid-in capital, to be paid by members over a period of five years, as well as $68.3 billion of so-called “callable” capital. According to a Standard & Poor’s report on the IDB, payments of the annual instalments have often been late and “as we expect the IADB to continue distributing $200 million yearly in grants to Haiti until 2020, the gains from GCI-9 are largely offset.”1 Second, budgets everywhere are under pressure and there is every reason to expect that member countries will see such capital contributions competing with other urgent claims on scarce budgetary resources, against the background of rapidly rising public debt levels. Indeed, in some official circles, this funding model is seen as having been virtually exhausted.
This proposal starts by suggesting at the outset that the multilateral development banks should explore innovative mechanisms to mobilize private sector resources in support of social and economic development programs. The unusual low-interest-rate environment which has been a chief feature of the post-global financial crisis world has created a situation today where upwards of US$15 trillion of private sector wealth (equivalent to over 17 percent of world GDP) is earning negative yields. A broad range of institutional investors and some 2,800 billionaires keep, on average, some 22 percent of their asset holdings in cash. Many of the holders of private sector wealth might want to deploy some of their assets to finance promising development projects aimed at addressing some of the most urgent needs of our time, from the mitigation of climate change, to the persistence of poverty, the pervasive nature of gender discrimination and other problems which, if allowed to fester, could pose substantial risks to sustainable economic growth and undermine the social and institutional foundations for continued wealth creation.
The sponsored loans program is a scheme where a private sector investor expresses an interest in a particular development project, reflecting her/his own sense of social and economic priorities. We will call this investor the Guarantor. For example, the IDB could receive from the Guarantor an amount — say US$100 million — as an equity-like instrument, and these funds would be used exclusively to guarantee IDB loans for the duration of the time horizon. The IDB would raise money in the capital markets using its AAA rating and on-lend the resources to its members to finance the project in question under the traditional state guarantee. Because the Guarantor takes on the risk of the loan the IDB would have a lower capital charge allowing it to further expand its balance sheet. The investor maintains his cash position in the long run (assured of a non-negative yield) while supporting development goals in the short to medium-term.
By sponsoring the loans, the Guarantor would make available resources to tackle a range of development challenges around the world or, as in the case of the IDB, in the LAC region. The Guarantor’s money would be used only in the event of a government default, a highly unlikely occurrence given the bank’s distinguished loan repayment historical track record. Multinational corporations could become guarantors as part of their corporate social responsibility strategy. Loan sponsorships could be split between several Guarantors who might share a common interest in a particular project — viz. the promotion of gender equality. Annex I lays out a simple graphic representation of the sponsored loans program proposal.2
In the paragraphs that follow, we present three examples of the sorts of projects that might be funded under this program. The sponsored loans program could substantially enhance the lending capacity of the multilateral development banks. Indeed, in theory, the binding constraint would no longer be internal debt-to-equity ratios in lending operations or the fiscal situation of its official shareholders, but rather identifying worthy projects that might excite the imagination of private investors, who would be taking on all of the risk. This, in turn, might lead the financial institutions to modernize internal procedures and structures, so as to be able to take on a potentially much larger volume of projects, but also to examine whether they are appropriately staffed with respect to experience, talent and skills.
You can read on Augusto’s full article here four projects that he proposes to progress the global agenda:
Project I: Tackling persistent gender inequalities
Project II: Developing alternative metrics of human welfare
Project III: Supporting the environmental transition in agriculture
Boosting the IMF’s firepower