Gerald M. Alter
As a development institution, the Bank—the term here refers both to the International Bank for Reconstruction and Development (IBRD) and its affiliate, the International Development Association (IDA)—is concerned with assisting its member countries achieve sustained economic growth with a wide distribution of the benefits of that growth. Its function is to serve as an intermediary for the transfer of financial resources from the more developed to the less developed countries. The forms in which this transfer takes place and the rules governing such transfer are designed to promote the efficient use of capital for economic and social development, as well as to maintain the Bank’s access to the sources of capital.
However, the transfer of foreign exchange for the support of investment is only effective in accomplishing broader development objectives if there are genuine efforts on the part of the borrowing countries to augment productive investment, promote domestic savings, expand employment opportunities, diversify economic activities, balance external accounts, and, a more recent emphasis, to promote more equitable distribution of income and control population growth. These efforts may be reflected in institution building and policy improvements related to the sectors in which the Bank chooses to lend or in macroeconomic policy improvements, the implementation and monitoring of which can often be reinforced at the project level.
The Bank cannot dictate the economic and financial policies of its member governments. At the same time, however, there is broad agreement among the Bank’s member countries, developed and developing alike, on what the basic objectives of development are. This agreement enables the Bank to maintain a policy dialogue with each of the countries to which it is lending; in addition, the Bank regards it as one of its responsibilities to advise on ways to achieve mutually shared development objectives in a given set of circumstances. Loans and credits are extended by the Bank with these considerations in mind; they are intended to supplement the country’s domestic savings and the other external sources of finance, and to assist it in overcoming nonfinancial constraints on development. To the extent that a country is successful in removing these obstacles, it may also become more creditworthy for Bank and for other external financing; it may also have less need for concessional assistance.
The Bank’s lending program for a country is a plan of commitments covering a five-year period. The total volume of lending is determined in the light of a country’s overall investment and balance of payments financing requirements, as they emerge in a soundly conceived development perspective. These analyses are based upon the country’s own performance, the availability of suitable projects, country creditworthiness, per capita income level, external resource constraints and opportunities, and the competing requirements of other countries. The lending program is normally built up from projects selected in agreement with the member government.
An aggregate resource transfer of a specific magnitude to a given country over a period of years is one of the goals of the overall country lending program. However, the lending program may be reduced, and some loans dropped, if the country’s performance at the macro, sector, or project level falls significantly below reasonable standards, and it turns out that corrective action cannot be taken by the country. Thus, nonfinancial goals related to the country’s performance in economic management need to be considered along with the financial objective. This article will concern itself with how these nonfinancial goals are promoted through Bank lending and the manner in which a project loan and the lending program can be structured to reflect these goals.
Improving investment processes
The Bank’s nonfinancial goals for a country usually emerge out of a cooperative evaluation between the Bank and the country of the principal weaknesses of the past development effort and the sources of strength on which new programs can be built. Most often, measures are required to increase the capacity in critical sectors to absorb (additional) resources and to improve the allocation of investment within a sector or between sectors. In low-income countries with a relatively brief history of independent government, the improvement of absorptive capacity is frequently a key element in enlarging and making more effective the whole development effort. Even in more advanced countries with a better absorptive capacity in the aggregate, specific sectors with very limited absorptive capacity may be identified as areas where accelerated development is critical and the support of specific investment can become an effective instrument for improving absorptive capacity.
The Bank’s project appraisal tests, designed originally to ensure that Bank funds are used productively, can be extended within a single institution or sector, particularly in countries where there is evidence of a substantial misallocation of investment resources. Bank loans frequently make provision for financial and technical assistance for the preparation of future projects, and this leads naturally into the planning of investment programs for important institutions and for whole sectors. Similarly, steps which appear necessary to ensure the efficient execution and operation of Bank-financed projects lead to measures for improving the institution’s overall operations.
Thus, as lending within a sector grows, the Bank will normally pursue broader goals and attach performance conditions to loans which have wider application for the sector and the economy as a whole. This may involve encouraging a shift in investment to broaden the distribution of the benefits of economic progress, encouraging policies leading to expanded public and private savings, improving capital market mechanisms, and inducing modifications in government price, tariff, taxation, and exchange rate policies which have led to distortions in investment incentives.
If in any one country many such goals are ranked equally, there is the danger of uncritical support of unduly dispersed activities, leading to a permissive approach to performance assessment which makes it almost impossible to evaluate how successful the Bank has been, and why. While it is sometimes difficult to select a few objectives, and to rank them, it may be preferable to select a few important goals, with an emphasis perhaps on a selected number of measures which the country seems prepared to introduce and which the Bank can usefully support, thereby strengthening the country’s determination to do so.
The selection of Bank goals and the weight to be given to each in specific countries must also take account of the goals of other development assistance institutions. In some situations the Bank may rely mainly on other institutions to pursue certain goals. In other instances it may operate in a complementary fashion. Cooperation with the International Monetary Fund is particularly important.
Interrelationships among goals
Thus, project and sector goals are frequently closely related to Bank goals for the economy as a whole. Accordingly, lending programs are designed to reinforce the links and complementarities between sector and macro goals. For example, a key issue in deciding the size of a lending program is whether the country can provide its share of the financial resources. The Bank may proceed with a lending program on the understanding that measures will be taken to increase public savings, a shortage of which had been identified as a key development constraint. Decisions on whether to proceed with individual projects, which rely on the availability of domestic financing or budgetary funds, will be influenced by whether, in fact, such measures have been taken.
Projects can also be designed to make a direct contribution to public savings. In lending for a country’s railroads, for instance, the Bank can call for rate and cost recovery policies to help the railroad become financially viable, to generate resources for financing sector investments, and to make economic use of the resources at its disposal. In this process, it may be possible to reduce sharply government subsidies to rail services, thereby making a substantial contribution to the growth of public savings.
Bank project lending can also be used to support a country’s strategy for correcting imbalances in investment priorities. In recent years, great stress has been placed on redirecting investment resources toward the production of agricultural commodities and industrial goods. There has been a growing realization that direct investment in productive projects, together with help in solving related policy problems, may be necessary to overcome the bottlenecks to the realization of a country’s productive potential and in particular to encourage output of exports and import substitutes.
Often sectoral imbalance can be overcome only by creating adequate incentives for private investment needed to supplement direct government investment and technical assistance. For example, a project designed to raise the yields and output of agricultural products may only be able to succeed if the farmers, who are the primary beneficiaries, are given higher prices for their crops as an inducement to invest their own time and resources. Accordingly, a government decision to raise producer prices would be a precondition to making a Bank loan in this case.
Bank project lending is used to support a country wishing to give more emphasis to investment in projects which will promote employment and benefit low-income groups by raising their productivity. Employment and income distribution are influenced by a wide range of policies as well as by the composition of investment and the design of individual projects. A strategy to maximize employment and improve income distribution attempts to make the best use of these instruments of public policy by minimizing the need for difficult trade-offs between goals and emphasizing the complementary aspects. For example, lending for projects to promote agricultural production for either domestic consumption or export is also a way of raising rural incomes if the beneficiaries are low-income farmers in a backward region.
To some extent, project appraisal methodology which systematically corrects market prices by attaching weights (based on the fundamental economic priorities of the country) to project benefits and costs can assist in achieving employment and income distribution goals. The most significant impact can often be obtained, not at the stage of appraisal, but at the earlier stage of project preparation. Projects can be selected and designed which, for example, are labor-intensive in sectors where such a choice is appropriate—such as those financed by development finance company loans which might encourage small businesses, or in a field such as education where projects can be designed to use local labor and materials.
In the field of integrated rural and urban development, the Bank has recently encouraged projects which are important for both growth and equity. By stressing an integrated approach to area development, the Bank can contribute substantially to the efficiency of investment which a country allocates for such purposes. This may be done by one or a series of projects in an urban area in which, for example, the Bank finances a sites-and-services scheme for low-cost housing in conjunction with supporting public services and training, as well as the basic economic infrastructure required for the growth of production and employment.
These examples illustrate some of the major types of specific actions by borrowing countries whose adoption and implementation may be related to the achievement of mutually shared development objectives. Governmental initiatives designed to improve performance in the achievement of these objectives, and governmental responses to Bank suggestions are important in determining the extent of Bank support. At the same time, the modalities of project lending have been fashioned to complement this dialogue, to give concrete expression to the targets for change which appear feasible in a particular country situation, and to test the government’s willingness and ability to introduce the necessary supporting measures. Experience gained in lending for individual projects feeds back into the decisions on the appropriate degree of Bank involvement and on the urgency of the goals which the Bank has selected for emphasis in its lending to a particular country. These decisions in turn influence the degree to which the Bank urges policy and institutional improvements designed to realize the broader objectives of its lending for individual projects.
In almost all countries, some loans are viewed primarily as vehicles for giving support to specific investments, the Bank having adequately assured itself that the increment in resources will be effectively employed in that specific sector, and other goals are regarded as secondary. In loans to other sectors in the same country, institution building or policy improvements may in some instances be directly related to primary goals. Unless these are reached, little is accomplished and their achievement is not advanced simply by giving support to a specific high yielding project. In some countries, in order to assure the Bank that effective use will be made of any increment in resources which it provides, substantial institutional reforms and policy changes may be required.
The question of how much is enough will frequently arise. There may well be trade-offs between losses in economic benefits owing to delays in investment and losses owing to failure to advance institutional and other improvements. Finally, and most importantly, there are many situations in which actions to be taken by the borrowing country to assure a successful project will, if progressively pursued on a broader scale as lending proceeds for similar projects, contribute to broader primary goals.
Relation to program lending
One of the goals of project lending is to achieve resource transfers. However, the time intervals involved in the project cycle—including the disbursement period itself—impose limitations on the extent to which project loans can be adjusted in volume to help meet rapidly changing conditions. Accordingly, in “special circumstances” (Article III, Section 4 (vii) of the Bank’s Articles of Agreement and Article V, Section 1(b) of the IDA’s Articles of Agreement), and when a quick transfer of resources is required to help a country overcome unforeseen temporary difficulties, it may be appropriate for the Bank to offer a program loan. This is particularly justified if it contributes significantly to achieving what is regarded as a primary nonfinancial goal of the Bank in that country—such as putting in place a policy framework conducive to, say, the expansion of exports or the accelerated development of a problem sector. As program loans are made in circumstances where country officials attach great importance to rapidly disbursing and flexible assistance, a more effective dialogue on basic macro or sector policy issues is often facilitated, leading to a more precise definition of actions to be taken, and results to be achieved. Moreover, the dialogue can be directed to the policy measures which will reduce the continuing need for non-project assistance.
In practice, the Bank in recent years has found relatively few situations justifying the extension of program loans. Less than 5 per cent of Bank resources in the period 1974 to 1978 was made available in the form of program loans. The special circumstances justifying program loans according to present Bank policies include (1) reconstruction or rehabilitation; (2) a sudden fall in the export earnings of an important single export item; (3) a sharp deterioration of the terms of trade as a result of a rapid rise in import prices; and (4) structural imbalances. With respect to the second and third special circumstances, the Bank has taken the position that Fund facilities are most appropriate, since the introduction of an effective stabilization program is frequently a sine qua non. The Bank is usually in a supporting role. However, it is sometimes moved to act with a program loan on its own, particularly where basic structural adjustments which should be financed over the long term are required, or where the shortfall is so large that the need for quick disbursal of assistance is substantially in excess of the compensatory financing available on suitable terms.
The fourth special circumstance involves a variety of particular cases calling for the correction of structural imbalances that may or may not require the adoption of an effective stabilization program.
Bank program loans in the last three categories of special circumstances have supported country actions designed to shift investment priorities and policies in favor of agriculture and less import-intensive development, improve industrial and trade policies and procedures such as liberalization of licensing or increased incentives for industrial investment, carry out an action program in a major industrial sector such as jute and textiles, and increase public savings by tax measures and other revisions in the government budget. In most of these situations where quick disbursement of assistance was called for, stabilization measures were not enough. The same economic weaknesses or strengths which needed to be addressed in the context of the Bank’s program of lending for specific projects arose in situations calling for the quick disbursement of loans.
Thus, the more specific the Bank’s dialogue on macro and sector economic policies with the country in the context of the “program of project loans,” the better will the Bank be in a position to use the opportunity provided by the need to disburse assistance quickly in order to reinforce the impact of its project lending. By the same token, the continued relationship of the Bank with the borrowing country through project lending can reinforce the effectiveness of program lending. Many of the longer-term policy understandings that may be part of a program loan can be monitored during the economic surveys and sector work in connection with subsequent project loans, and Bank action on its project loans can be guided by performance in areas covered by its program loans.