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Finance & Development, September 1980
Article

World Bank lending for structural adjustment: A new type of lending evolved by the Bank to help member countries make structural changes in their economies

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
September 1980
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E. Peter Wright

The problems which developing countries face in adapting their economies to recent changes in the international environment vary greatly from country to country. All are adversely affected in some degree by the recessionary conditions prevailing over much of the industrialized world, by the persistence of worldwide inflation, by exchange rate instability, and by widespread political turbulence. But the effect of these conditions has varied widely in different groups of countries. The impact of the abrupt rise in energy prices in real terms, for instance, has been particularly hard for those developing countries which are net importers of oil, and which would have to pay US$34 billion more this year to import the same volume of oil as they did in 1978. This is the main reason, along with higher interest payments, why their combined current account deficits are expected to rise from an estimated US$27 billion in 1978 to US$61 billion in 1980 (Table 1). Yet within this group there are countries like Argentina which are largely self-sufficient in energy and have at present no serious balance of payments (BOP) problems to contend with. Still better placed are the countries which are major exporters of oil and gas: Algeria, Mexico, and Venezuela are outstanding examples. Their economies also are undergoing important structural changes, but they are not handicapped by any immediate shortage of external resources.

Table 1Current account deficits of oil-importing developing countries, 1970-801(In billions of U.S. dollars)
19701973197519781980
Current account deficit at current prices
Low-income1.22.35.45.710.0
Middle-income7.14.434.221.451.0
Total8.36.739.627.161.0
Current account deficit at constant 1977 prices
Low-income2.23.26.15.07.1
Middle-income13.26.038.318.536.1
Total15.49.244.423.543.2
Current account deficit as percentage of GNP
Low-income1.62.23.82.73.6
Middle-income2.50.95.32.24.0
Total2.31.15.12.33.9
Source: World Bank data.

The oil-importing developing countries most seriously affected by the persistent upward trend in energy prices and the recession in world trade fall into two main groups: the low-income countries of South Asia and sub-Saharan Africa where output per head has on average grown very little over the past two decades (1.4 per cent and 0.9 per cent a year respectively); and the middle-income countries, including a few in Africa, whose economies have been growing much faster (around 3.5 per cent a year on a per capita basis). The first group has little capacity to borrow abroad on commercial terms and must rely mainly on concessional aid to finance its external deficits. For the second group, commercial borrowing is much the most important source of external capital. Neither group has any choice but to adjust to the new situation. (Middle-income developing countries are defined here as those with a per capita gross national product (GNP) of over US$360 in 1978. The classification is the same as that used in World Development Report, 1980, with roughly 50 countries (combined population 900 million) falling into this group and just under 40 (population 1.3 billion) into the low-income group.)

As in the 1974-79 period, the adjustment is likely to take place in two phases: first, external deficits—and borrowing—will rise to permit a minimum level of imports to be maintained; and second, adjustments must be made to the patterns of production and trade so as to reduce the deficits to sustainable levels within 3-4 years. Since energy prices are likely to rise in real terms in the 1980s, rather than fall as they did from 1974 to 1978, the adjustment this time will involve real sacrifices. Constraints on consumption are inevitable in a situation like this if development is not to suffer.

Taking all developing countries together, lending by private banks and direct private investment accounted for nearly two thirds of their net imports of capital in 1979. Concessional aid and lending by international financial institutions, some of it on near-commercial terms, supplied most of the rest. Private bank lending to the middle-income developing countries is an important element in the process of recycling the surpluses of the members of the Organization of Petroleum Exporting Countries which are now running at over US$100 billion a year. However, the cost of borrowing on commercial terms has risen sharply, and some of the middle-income countries may be approaching their borrowing limits, at least as the lenders perceive them. No major difficulties are expected in financing their deficits this year, but there will be less and less room for maneuver thereafter, and deficits will have to be cut. Nor is the outlook for a real increase in concessional aid at all promising when the donor countries are preoccupied with so many other pressing national and international concerns.

Broad objectives

It was against this background that the World Bank’s proposals for structural adjustment lending were first outlined at its Annual Meeting in Belgrade, Yugoslavia in October 1979. The objective is to provide support for member countries already in serious BOP difficulties, or faced in the years ahead with the prospect of unmanageable deficits arising from external factors which are not likely to be easily or quickly reversed. (This sort of lending complements assistance by the International Monetary Fund—a topic to be discussed later.) To qualify for such lending, a country must be willing to adopt appropriate changes in its policies and programs to enable its economy to adapt over a reasonable period to the changes in the international environment without sacrificing its long-term growth objectives. This means reducing the current account deficit to a level commensurate with the amount of external capital to which the country can expect to have access on a regular basis, without straining its debt servicing capacity. The scope and complexity of structural adjustment programs formulated with this end in view will usually be such that they will require support over a number of years, and a series of loans may therefore be called for.

It is, of course, for each government to decide how best to approach the problems it faces and whether to seek the Bank’s advice and support. Circumstances will vary widely from country to country, and no two programs of structural adjustment will be exactly alike. There will be a general need to improve agricultural and industrial efficiency, to promote the expansion and diversification of exports on the basis of comparative advantage, to develop domestic energy resources more vigorously and improve the efficiency of their use, to restrain consumption, and to raise domestic savings rates. The composition of the public investment program may have to be altered to give more emphasis to quick-yielding investments and to encourage more effective use of existing capacity. Important changes may be required in agricultural pricing to stimulate domestic production. Tariffs may need to be restructured and import controls dismantled as part of a long-term program for making industries more competitive. Special incentives, or the removal of existing disincentives, may be necessary to stimulate exports or, in some cases, to substitute for imports. Public enterprises may have to be reorganized and their managements strengthened to reduce waste and inefficiency.

Whatever the program, difficult political decisions are likely to be involved, and its implementation will test the government’s administrative capabilities. Continuity in economic management is very important from this point of view. Preparatory studies will often be needed to provide a basis for action, and if institutional changes are called for, they must be carefully planned in advance. The Bank is ready to work closely with governments in formulating their programs and to provide any technical assistance that may be requested.

Extension of program lending

Loans for structural adjustment will be used to pay for general imports and will therefore be quickly disbursed—usually within 12-18 months of loan signing, as against more than 5 years for a typical project loan. In this respect, lending for structural adjustment will be similar to past program lending by the Bank.

In the early years of the World Bank’s operations, when much of its lending was to developed countries for postwar reconstruction, program loans accounted for a high proportion of its total commitments (see Table 2). However, there is a provision in the Bank’s Articles of Agreement—and a similar provision for the International Development Association (IDA)—which requires that, “except in special circumstances,” its loans be for the purpose of specific projects of reconstruction and development. Accordingly, since the mid-1950s, the Bank has concentrated mainly on project lending, including loans to development finance companies and rural credit institutions as well as the financing of national or regional investment programs in such sectors as agriculture and irrigation, small-scale industry, transport, communications, and water supply.

Table 2Program lending by the World Bank and IDA, 1946-801(In millions of U.S. dollars)
1946-501951-551956-601961-651966-701971-751976-80
Total Bank/IDA commitments8161,5082,8574,8617,17719,08943,603
Program lending by Bank/IDA5972991252254651,2541,962
Program lending as a percentage of total commitments73.219.94.44.66.56.64.5

In fact, program lending has accounted for only 5 per cent of the total commitments made by the Bank and the IDA together during the past 25 years, and the greater part of this has been to South Asia. Underutilization of industrial capacity in India in the early 1960s prompted a succession of industrial import credits designed to provide foreign exchange to pay for imports of materials, components, and spare parts. Similar loans were subsequently extended to the neighboring countries of Pakistan and then Bangladesh, as well as to Egypt. Otherwise, program lending in recent years has been confined to special circumstances created by war or natural disaster, by a sudden fall in export earnings in economies critically dependent on a single export item, or by a deterioration in the terms of trade resulting from a sharp rise in import prices.

If the fiscal years 1976-79 are taken for purposes of illustration, program loans were made to 14 countries during this period, and 3 of these were qualified solely by reason of war or natural disaster—Guatemala (earthquake), Lebanon (civil war), and Romania (floods in 1976 and an earthquake in 1978 (fiscal years)). During the past 12 months, loans in this category have also been made to the Dominican Republic to repair hurricane damage and to Nicaragua and Uganda for postwar reconstruction. Countries receiving program loans because of a sharp fall in export earnings have included Guyana (sugar), Jamaica (bauxite), Peru (copper, fishmeal, and sugar), and Zambia (copper). Higher oil prices were an important reason for program lending to Korea in 1976 and to Tanzania in 1977.

Lending for structural adjustment is thus a natural extension of program lending. It will not replace the types of emergency lending described above, but it will open up new opportunities for member countries to obtain the Bank’s assistance in introducing important policy changes and carrying out difficult economic reforms.

By itself, of course, structural adjustment lending cannot do much to cover the BOP gaps which the oil-importing developing countries face. Total disbursements of the World Bank and the IDA together in the fiscal year ending June 1980 were about US$5.8 billion, and if loan repayments are deducted, the amount comes close to US$4.6 billion—which represents 8 per cent of the current account deficits which these countries have to finance this year. However, middle-income developing countries which are seen to be making serious efforts to address their economic problems will find it easier to attract capital from private sources, and the Bank’s support for structural adjustment in a country should help to catalyze other sources of external financing. Moreover, to the extent that structural adjustment loans are substituted for project loans, the fact that disbursements will be made more quickly may be of some significance for individual countries.

In the long term, the scope for structural adjustment lending will depend on the rate of growth of Bank and IDA lending as a whole and therefore on the actions taken to increase the total resources at the Bank’s disposal. A proposal for doubling the World Bank’s capital to US$80 billion has already been approved by the Board of Governors and awaits legislative approval in various member countries. The Sixth Replenishment of the IDA, covering the three years between July 1980 and June 1983, will come into effect as soon as the necessary action is taken by the 33 contributing governments; the agreement has still to be ratified by the United States, which is the largest subscriber. These measures alone, however, will permit no more than a modest real increase in the level of Bank and IDA lending over the next three years—of perhaps about 5 per cent a year. This increase will have to include some provision for lending to China and other new members such as Zimbabwe. Meanwhile, the Independent Commission on International Development Issues (the Brandt Commission) has urged the Bank’s member governments to amend the Bank’s Articles of Agreement to change its present 1:1 “gearing ratio,” so that a larger amount of borrowing and lending could be supported by any given capital base.

Relations with the IMF

The International Monetary Fund provides substantial financial support for BOP adjustment through the extended Fund facility, as well as through its regular standby arrangements and other forms of assistance. In general, the operations of the two institutions complement each other, but each of them retains its distinctive character and functions. The IMF focuses primarily on BOP management, the Bank on the longer-term development of the economy. Their staffs are in close and regular consultation, and care is taken to ensure coordinated action between them and to avoid conflicting advice to member governments. The Fund pays particular attention to monetary and fiscal policies, foreign borrowing, and exchange rate management. The Bank is concerned with a country’s development priorities, the size and composition of its investment program, the efficiency with which it uses its resources, its employment objectives, and the ways in which the benefits of economic growth are distributed. The Fund is guided by the Bank on development matters; the Bank is guided by the Fund on BOP adjustment.

Prior recourse to the Fund’s facilities is not a prerequisite for structural adjustment lending, but countries in difficulty will frequently wish to take advantage of the assistance available from both institutions. Indeed, the size of the current account deficits which some of the developing countries face over the next few years, and the time required to effect the necessary structural changes, suggest that all available sources of external capital will need to be tapped if the momentum of world economic development is to be maintained.

Three loans made

The first three loans for structural adjustment made by the Bank—a loan of US$200 million to Turkey signed in March 1980, an IDA credit of US$55 million to Kenya in April, and a loan of US$50 million to Bolivia in June—illustrate the way in which the new policy is intended to work. All were preceded by extensive policy discussions between government officials and Bank staff. All were accompanied by a letter from the government setting out the policies which it was following, and specific measures that it had taken, or would be taking, to overcome its immediate financial and economic difficulties and to restructure the economy with a view to achieving longer-term development objectives. However, in no case were quantitative performance targets included among the loan conditions. Each loan is envisaged as the first of a series of operations that may extend over several years if the need is there, and if the adjustment program proceeds satisfactorily. The first loans are to be released in “tranches”—subject to a review of progress.

Bolivia, Kenya, and Turkey have all drawn on the Fund’s resources under recent stand-by arrangements, supplemented in the cases of Kenya and Turkey by purchases under the compensatory financing facility. While the Fund and the Bank programs are mutually reinforcing, the two institutions are emphasizing rather different aspects of economic policy. The Turkish program which the Bank is supporting is aimed at reducing state intervention in the management of the economy, providing greater incentives for export industries, mobilizing additional domestic savings, and increasing the efficiency of those public enterprises which have long been a serious drag on the economy. In Kenya, the Government attaches particular importance to restructuring the public investment program, standardizing and reducing the level of industrial protection, overhauling its system of export subsidies, and improving the management of its external debt. The Bolivian Government, with the support of the Fund, has already taken a series of stabilization measures aimed at reducing its immediate fiscal and BOP deficits, and the main thrust of the structural adjustment program is on strengthening the export sector through the reform of mining taxation, improved agricultural pricing and marketing policies, and the development of natural gas reserves. Steps are also being taken to improve the finances of state enterprises and to tighten control over their expenditures and foreign borrowing.

There is no way of forecasting with any precision the amount of structural adjustment lending which the Bank will undertake in the years ahead, since this will depend on world economic conditions, on the resources at the Bank’s disposal, on the interest of individual countries in approaching the Bank for assistance, and on the detailed programs which can be worked out as a basis for such lending. However, a tentative estimate of US$600-800 million for the year beginning July 1980 has been put forward by the Bank’s management, with the Philippines and several countries in Africa among the likely borrowers. The middle of this range would place the amount of such lending during the year at about 5 per cent of expected World Bank commitments. If other forms of program lending were to account for the same share of these commitments as the average for the past five years, program lending as a whole would rise to around 10 per cent of the total.

Structural adjustment lending will, for the most part, substitute for sector and project lending and not constitute additional flows of external assistance. However, it may be associated with some marginal reallocation of the Bank’s resources in favor of countries that have been particularly badly hit by the rise in oil prices or the contraction of export markets. There is, however, relatively little scope for the redistribution of IDA lending which is already largely directed toward seriously affected low-income countries. For the middle-income countries, the perceptions of their creditworthiness will continue in some cases to limit the amounts which the Bank can lend them without exposing itself to undue risks. This will be particularly true of countries which have failed to adjust satisfactorily to the problems of the 1970s and are still handicapped by inefficient industries, sluggish export growth, low rates of investment, and high energy use. However, in spite of the dramatic rise in commercial bank lending to the developing countries over the past six years the total external public indebtedness of the oil-importing developing countries at the end of 1979 was only moderately higher as a proportion of their national product than it was in 1973 (19 per cent in 1979, 15 per cent in 1973). Many of these countries therefore will be able to go on borrowing on commercial terms, although probably on a somewhat reduced scale, with the rise in interest rates adding substantially to their debt servicing charges.

In conclusion, structural adjustment lending by the World Bank should be seen as a constructive response to the difficult situation created for many developing countries by what looks like a lasting deterioration in their terms of trade and the growing problems associated with the recycling of OPEC surpluses. By the end of June 1980 three such loans had already been made to Bolivia, Kenya, and Turkey, and a number of others were at various stages of processing. The Bank’s Board of Executive Directors has agreed to consider such loans on a case-by-case basis, and it will be for member governments themselves to decide what use they wish to make of the new facility.

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