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Four ways to improve the World Bank’s proposal for a Sustainable Development Finance Policy

Written by Annalisa Prizzon

International Development Association (IDA) deputies are gathering in Washington DC this month for the World Bank Group’s 2019 Annual Meetings. On the agenda – among other items – is the proposal for a World Bank Sustainable Development Finance Policy.

The draft proposal, which will support borrowing countries to boost their ability and capacity to avoid future debt crises, is certainly heading in the right direction. But IDA deputies need to reconsider some of its dimensions to make it work – and need a reality check of its implications. 

The challenges ahead

On average, only half of the actual developing countries’ lending volume are captured by World Bank databases, with loan transparency a major challenge. Furthermore, debt ratios are rising in many African countries, increasing vulnerability to macroeconomic shocks.

In 2017, 15 countries were either already in debt distress or classified as high risk , a number that has nearly doubled since 2012. Effective debt management is critical to ensure future sustainability, however many African countries’ capacity to tackle this remains weak and has deteriorated in some of them.

What is the Sustainable Development Finance Policy?

Earlier this year, World Bank shareholders proposed that the revised Non-Concessional Borrowing Policy – due for review this year – should also help countries’ efforts to manage their debt, given the scale of the problem and its potential consequences. The result is an updated approach: the Sustainable Development Finance Policy (SDFP).

The IDA is the World Bank’s lending arm for poorer countries that disburses and lends funds at far more favourable terms and conditions than market rates. In a nutshell, the SDFP aims to prevent the IDA from subsidising large commercial loans to prevent debt build up, especially when debt management capacity is low.

The incentive mechanism for borrowing countries outlined in the new policy is expected to be simple and based on rewards. Essentially, if a country doesn’t improve its debt management performance, fiscal sustainability, or coverage and timeliness of debt reporting, a percentage of its allocation from the IDA will be ‘set-aside’ rather than disbursed. This currently stands at 10% for countries at high risk of debt distress and at 20% for those already in debt distress.

There are a number of ways the SDFP is a step up from the Non-Concessional Borrowing Policy. First, it has a clearer recognition of the linkages between sustainable financing, economic growth and fiscal policy to improve debt sustainability.

Second, the SDFP is broader in terms of country coverage and eligibility. It includes not just grant-only IDA countries that benefitted from debt relief, but also those that are in the process of graduating from IDA. And third, it represents a shift towards a portfolio approach to evaluating debt management capacity on external borrowing, rather than a project-by-project assessment.

Having said that, a few areas need to be re-considered to make the incentives of the SDFP work.

Effective debt management, fiscal policy and debt reporting: four ways to improve the policy

1. More transparency on assessment criteria and indicators

Within the three main areas reviewed yearly (debt management, fiscal policy, and debt transparency), primary indicators should be defined, and benchmarks should be set. These indicators should both target and measure actual improvement in each function.

While the challenges each country faces varies, assessments on the amount of funding they receive should be as transparent as possible – or at least as well-argued as possible. Improvements in debt management take time; the effects of the policy could take time to materialise, and data collection for evidence-based decisions could prolong it even further. Indicators should reflect this reality.

2. Greater clarity on the financial implications

The SDFP proposal states that ‘set-asides’ which are not disbursed – which happens when a country fails to meet the policy requirements – are expected to be redistributed across IDA countries based on the standard World Bank performance allocation rule.

But when the country allocation is increased, would new projects be approved or would existing projects be expanded? And would the country failing to meet the criteria be able to benefit from the reallocation, albeit marginally? The SDFP should illustrate potential scenarios of the implications of this outcome and how to manage them.

3. Support from the Debt Management Facility

The current proposal suggests that resources for debt management improvements could come from the IDA allocation too. This could strengthen the ownership of the programmes but could also crowd out resources for other projects within the IDA allocation. So, programmes boosting debt management capacity should be supported by the Debt Management Facility – a multi-donor fund co-administered by the World Bank and the International Monetary Fund (IMF).

4. Coordination between creditors

The success of the SDFP requires all official creditors – both bilateral and multilateral, and not only the World Bank – to have a similar approach and does not lie solely on the World Bank. Coordination is essential for any incentive to work, and should not be limited to a creditor outreach programme.

For example, all official creditors need to exert pressure on private lenders to make these incentives for effective debt management credible. ‘Set-asides’ of either 10% or 20% of the IDA allocation could be ineffective, as the prospective ‘penalty’ is lower than what countries could receive from other creditors.

The next 10 years will be crucial to make progress and meet the ambitious Sustainable Development Goals. However, borrowing to implement national development plans remains one of the few ways to make this happen. This is because aid flows from donors have been stable and tax revenues have expanded slowly in most developing countries. Effective debt management is crucial – now more than ever.