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Promoting the Private Sector: How the Bank works with member countries toward this end

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
March 1988
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Mary Shirley

Since the early 1980s development strategies have been changing. During the 1960s and 1970s public policy in much of the developing world was characterized by a confidence in the capacity of government to act as the main spur to development, and to correct market failures. The underdeveloped state of indigenous private sectors and capital markets in many countries; a mistrust of the private sector, stemming partly from the experience of the depression of the 1930s; a fear of the power of multinational companies, and their identification with the colonial past in some cases; and the faith of some influential economists in central planning combined to convince many governments that only they had the resources and purpose to promote development.

In many countries, however, the expansion of the public sector has stretched managerial capacity to the point where serious inefficiencies result. Time and again bureaucratic failures have proved to be at least as costly and prevalent as market failures. For example, prices set low to benefit consumers have discouraged producers, creating scarcities and greater dependence on imports; credit allocation and subsidized interest rates have resulted in a bias toward capital-intensive industry; low-yielding public investments and inefficient public enterprises have slowed growth and contributed to expanding public debt; neglect of maintenance has led to a rapid deterioration of public assets; excessive and poorly designed and implemented regulations have contributed to growth in the underground economy. Furthermore, trained public servants are in short supply in most developing countries; by trying to do too much governments have spread this “scarce resource” thinly over many activities.

As a consequence, there has been a reexamination of the role of the state and a growing awareness of the need to reassess priorities, prune what has become unmanageable, and use all resources, including managerial resources, more effectively and efficiently. The emphasis has shifted toward tapping private skills and resources wherever possible and strengthening the state’s core responsibilities, such as providing adequate social and economic infrastructure and a supportive policy and regulatory environment.

Together with its affiliate the International Finance Corporation (IFC), the World Bank is an important source of foreign finance for private enterprise in the developing world, having provided about $28 billion over the last five years. The Bank helps countries to strengthen the private sector’s contribution to economic growth in several ways. The first is through its lending to assist private sector investments. Second, in its lending to public sector agencies the Bank normally looks beyond the immediate project to the long-range goal of enhancing the agencies’ efficiency and effectiveness. This improves the provision of public services that are needed by the private sector. Third, the Bank encourages countries to adopt a policy framework conducive to private risk-taking, innovation, and economically rational decision making and resource allocation. In addition, through its cofinancing activities the Bank not only brings additional private funds into developing economies, but also helps to build confidence on both sides for future cooperation.

With the expansion of policy-based lending, the Bank has increased its emphasis on policies designed to improve the efficiency and competitiveness of the private sector and the economy as a whole. This article describes the Bank’s activities in this area and the new initiatives now being planned.

The characteristics of the private sector vary widely among developing countries, and this must be taken into account in the Bank’s lending operations. At one extreme are the dynamic, well-established private sectors of newly industrializing countries with more developed capital markets, such as Brazil or the Republic of Korea, ranging from large modern firms active in international markets to the small, family-run businesses typical of all developing economies. At the other extreme are the nascent private sectors in, for example, much of Sub-Saharan Africa. Here private activity consists mostly of very small-scale businesses concentrated in subsistence agriculture and tertiary activities in the so-called informal sector. In between these two extremes are the private sectors of countries such as Côte d’Ivoire, Peru, or Tunisia, moving tentatively into large-scale modern activities, but still mainly in small-scale traditional agriculture, trading, and services.

A significant proportion of the private sector in developing countries is made up of subsistence farmers, informal sector businessmen, and small traders. Efforts to foster a vigorous private sector often benefit these groups directly—as with lending to small farmers and business people—and indirectly, for example by providing infrastructure, health services, and a more supportive regulatory environment. The promotion of the private sector can complement efforts to alleviate poverty by increasing the productivity of the poor, expanding their employment, and adding to their purchasing power.

Support for projects

Loans and credits from the Bank to agriculture and to development finance institutions, for use by small- and medium-sized enterprises, benefit the private sector directly, as do the operations of the IFC. Indirectly, the Bank affects the conditions for private business through its loans to public sector agencies that provide essential infrastructure and services.

Direct support. Over the past five years direct support to the private sector from the Bank has totaled about $26 billion, or 25 percent of the total lending (see table). This includes most of the lending to agriculture and lines of credit to financial intermediaries that were used to finance private investment. For example, agricultural credit projects in India financed over 250,000 loans to farmers by state and commercial banks. The loans increased production, expanded farm employment, and met or exceeded the rates of return estimated at project appraisal. An agricultural credit project in Morocco, for example, assisted some 350,000 farmers to increase their incomes through mechanization, purchases of equipment and livestock, and land improvements.

Bank support of the private Industrial Credit and Investment Corporation of India (ICICI) promoted private investment in chemicals, textiles, electrical machinery, automotive ancillaries, rubber products, mining, and the like, and also helped ICICI expand and diversify. ICICI is a profitable bank which is now able to mobilize resources both domestically and in international markets. Not all development finance institutions are as successful as ICICI, particularly those publicly owned development finance institutions which have been subject to government pressure to lend to certain sectors or projects. The Bank has been encouraging governments to pursue policies that assure the independence of DFIs, increase competition and financial discipline, expand domestic resource mobilization by providing a variety of depository and nondepository instruments that pay competitive returns, and generally support the development of resilient and robust financial structures.

Nature of World Bank and IDA lending, fiscal years 1981-87(In millions of US dollars)
1981198319851987Total

1981-87
Percent of total

lending 1981-87
Private sector orientation
Small- and medium-scale enterprises (through development finance institutions)1,3421,7691,1262,71911,68011.26
Agriculture and rural development12,3112,5701,7622,01414,62214.10
Subtotal3,6524,3392,8884,73326,30225.37
Infrastructure and services
Transport29771,5902,0351,66911,97611.55
Power1,3231,7682,2503,01715,92615.36
Telecommunications329571226821,8031.74
Water, sewerage, and urbanization1,0361,3651,1652,4399,6849.34
Agriculture31,4501,1071,2777418,2077.92
Subtotal5,1155,8886,8498,54847,59645.90
Policy-based lending41,1201,8481,0452,99113,76013.27
Other lending
Social sectors57486661,1194945,7755.57
Heavy industry, coal, oil, and gas1,5261,6832,3748049,5099.17
Technical assistance131531101047430.72
Subtotal2,4052,4023,6021,40216,02615.46
Total12,29214,47714,38417,674103,684100.00
Source: World Bank data.

For example, credit and area development, agroindustry, fisheries, forestry, livestock, and perennial crops.

Including roads, railways, ports, and airports.

For example, research, extension, and irrigation.

For example, structural adjustment and sector policy adjustment.

Education, training, population, health, and nutrition.

Source: World Bank data.

For example, credit and area development, agroindustry, fisheries, forestry, livestock, and perennial crops.

Including roads, railways, ports, and airports.

For example, research, extension, and irrigation.

For example, structural adjustment and sector policy adjustment.

Education, training, population, health, and nutrition.

IFC, the Bank’s affiliate, lends and makes equity investments directly in the private sector. Although small compared with the World Bank and many private banks (in June 1987 its portfolio of disbursed loans and equity was $1.9 billion, with investments in 404 companies in 77 countries), its activities have an important catalytic effect. Private financial institutions participate in many of IFC’s loans; during the last fiscal year IFC disbursed $165.5 million in funds from participating banks and other financial institutions, For example, IFC recently arranged for a $50 million syndicated loan with commercial banks to Morocco’s tourism and housing development bank, to finance private tourism projects in Morocco. IFC has supported growth-oriented investment funds in such countries as the Republic of Korea, Malaysia, and Thailand, which attract foreign equity and also serve to familiarize foreign investors with local securities and improve local companies’ access to world capital markets. IFC is working to promote the conversion of debt owned by developing countries into equity in local companies.

IFC also assists private development through advice, services, and guarantees. For example, through the Guaranteed Recovery of Investment Principal, IFC shares risks with foreign equity investors; the Africa Project Development Facility provides technical assistance to small- and medium-sized businesses in Africa; the African Management Services Company finds senior executives from around the world to work with African companies; the Foreign Investment Advisory Service assists governments to review and adjust policies, regulations, and institutions to facilitate direct foreign investment; while IFC’s capital markets department gives advice to governments on how to organize, modernize, and internationalize their financial markets.

Lending for infrastructure, services. Much Bank lending aims to accelerate economic growth by removing bottlenecks—whether caused by inadequate infrastructure, poor public services, lack of trained manpower, inefficient investments, or low worker productivity attributable to poor health or malnutrition. The resulting savings in the costs of doing business may be of greater benefit to the private sector than any direct lending.

Projects to expand and improve the reliability of, say, the electric power or the telephone system, to build and maintain roads, or to increase the capacity and efficiency of ports benefit the private sector. For example, a power project in Brazil helped to integrate the two most important service centers, the Southeast and the South, and upgraded the efficiency of the major industrial and commercial centers. Transport projects in Korea supported the transformation of the economy by linking major ports with the industrial complexes around Seoul and provincial capitals. Bank assistance to the Telephone Organization of Thailand improved local and long-distance service throughout the country.

Policy environment

Through its policy dialogues with client governments and increasingly through its structural adjustment and sectoral adjustment loans, the Bank works to promote economic policies that, among other things, support a competitive and efficient private sector. Over the last five years Bank policy-based lending has been 13 percent of total lending; in addition, a number of traditional projects contain conditions directed at policy reform. Often these loans assist the private sector by removing distortions and increasing access to markets. Examples of the types of measures supported are the replacement of controls with market prices, where appropriate; the pricing of public services to cover economic costs; reduction of trade barriers and the introduction of more realistic exchange rates; use of market-determined interest rates and the curtailment of credit allocation by governments. Increasingly, the Bank has been promoting measures that affect private sector development by encouraging foreign and domestic private investment, deregulating private activities, and streamlining and rationalizing regulations.

Promotion of new private investment. This has taken a variety of forms, including schemes to refund import taxes paid by exporters, improved private sector access to credit, removal of restrictions on investments, removal of tax disadvantages and selective introduction of tax incentives, security against expropriation without compensation, and the like. In Ghana, Kenya, Liberia, the Philippines, Papua New Guinea, Yemen Arab Republic, and Zambia, Bank-financed consultants are helping governments with the preparatory work necessary to attract foreign oil companies for exploration and petroleum development. In Mauritius the Bank supported the establishment of the Export Development and Investment Authority to attract new investment and increase exports.

The Bank has been instrumental in the creation of the Multilateral Investment Guarantee Agency (MIGA) (see “Increasing Private Capital Flows to LDCs,” by Ibrahim Shihata, Finance & Development, December 1984). This is an autonomous organization which insures investors against such risks as losses due to nationalization or loss of control, war, or civil disturbance, and restrictions on the exchange conversion or transfer of profits. In addition, MIGA will do research, provide information and policy advice to governments, and generally act to encourage the flow of direct investment to and among developing countries.

Deregulation. The Bank has given support for the rationalization or abolition of regulations affecting private enterprise in such countries as the Central African Republic, Indonesia, Mauritius, Mexico, Nigeria, and Pakistan. The Bank is supporting Indonesia’s efforts to promote foreign investment through changes in the regulatory environment, such as relaxing the requirements for local participation in joint ventures and extending the validity of investment licenses. A study of licensing restrictions on private investment is under way as the first step toward extensive deregulation. In Mauritania the Bank, in collaboration with the International Monetary Fund, is assisting in the revision of the investment code to stimulate private investment and in the abolition of import licensing. It will also help to improve assistance to local entrepreneurs for project promotion and management and expand the credit, training, and advice available to private business. The Bank has supported Pakistan’s efforts to introduce a range of incentives for private industry, improve the export credit guarantee scheme, and change the collateral practices of banks to help small exporters obtain credit.

The Bank also emphasizes improving governments’ capacity to manage their interactions with the private sector. Governments tend to overregulate, partly because they mistrust the market’s ability to curb private sector excesses. Paradoxically, particular interests in the private sector may welcome government regulation because they are able to manipulate the rules to serve their own ends. Bank-financed technical assistance is increasingly helping to strengthen the public institutions responsible for promoting private development, curbing monopoly practices, and regulating private activities.

Rationalizing public activities

The Bank has also supported programs to rationalize the public sector and reduce the “crowding out” of private activities (see “Privatization and the Public Sector” by Samuel Paul, Finance & Development, December 1985). Where appropriate, these programs eliminate public monopolies, privatize public activities, and redirect public expenditures.

The elimination of public monopolies has been an important stimulus to private activity in many cases. For example, in 1981 the Somalia Government with Bank support eliminated the monopoly power of the Agricultural Development Corporation in maize and sorghum marketing; by 1984 ADC’s share of total purchases of these crops had dropped to 1.6 percent while production had almost doubled. In Morocco an agricultural sector adjustment loan is supporting the Government’s efforts to put the public and private sectors on an equal footing in fertilizer marketing and to close 80 percent of the outlets of the public enterprise as its sales decline in the face of private competition. In Niger, when private traders were allowed to compete with the public food-importing enterprise, more foodstuffs became available, at lower prices, even in formerly neglected remote areas.

Divestiture has become increasingly widespread in the developing world. While the sale of enterprises is complex and politically difficult, more and more governments intent on stemming deficits, improving efficiency, and reducing the management burden are selling, leasing, or liquidating government assets. Some 41 of the projects approved by the Bank from 1980 to 1987 include elements supporting the divestiture of state-owned enterprises (SOEs), either through liquidation, sale, contracting out their management, or leasing. These elements include the conditions in structural adjustment or sectoral adjustment loans, studies to help identify divestiture candidates and to design sales programs, and financing for legal, accounting, or investment-banking advice.

Liquidation of nonviable enterprises has been a condition of structural adjustment lending in, for example, Burundi, Malawi, Panama, and Thailand. In Togo the Bank has supported privatization through policy-based lending and by funding technical assistance; IFC has assisted the Government to evaluate bids on its SOEs and has invested directly in one of the privatized enterprises. In countries as diverse as the Congo, Jamaica, the Philippines, and Turkey, the Bank is supporting the preparation of privatization programs, the identification of private buyers, and the negotiation of sales. In several African countries the Bank is promoting the creation of funds that will assist indigenous private buyers of state-owned enterprises with loans to rehabilitate their newly acquired enterprises.

The Bank also assists with reviews of public expenditures, designed to concentrate scarce funds on high priority activities and to assure that the public sector does not crowd out the private from access to labor, credit, or other resources (see “Reviewing Public Investment Programs” by Basil Kavalsky, Finance & Development, March 1986). Many of these reviews are undertaken in the context of structural and sectoral adjustment lending. In a similar vein, the Bank is supporting Pakistan’s move to restrict public industrial investment to the completion of ongoing projects in order to avoid crowding out private industry; the private sector’s share of total investment is expected to grow from 36 percent in 1986–87 to 50 percent in 1987–88. The Bank is supporting Senegal’s adjustment program, which aims progressively to withdraw the state from direct involvement in production and promote private sector initiative and investment, while achieving greater efficiency of public resource management and restoring internal and external creditworthiness.

Future Bank programs

The Bank plans to increase its support of a more efficient and competitive private sector both by strengthening ongoing lending and economic work and by developing new approaches. Country teams within the Bank will develop strategies appropriate to each country’s circumstances and coordinate the various actors in the Bank group. Coordination between the Bank and IFC has increased in recent years; IFC officers participate in Bank country strategy meetings and there are regular consultations between country managers in the Bank and IFC. The Bank has created a new division, the Public Sector Management and Private Sector Development Division, to enhance cooperation and devise new approaches.

The Bank will design private sector assessments for selected countries as a basis for developing strategies where knowledge of the private sector is limited. On the basis of these assessments, country teams will be better able to work with IFC colleagues, government officials, and private sector representatives to develop programs that encourage private sector development at the macro, sector, and enterprise level. For example, at the macro level, structural adjustment loans would more explicitly address reform of the investment code or the tax laws; at the sector level, adjustment loans would concentrate on changing regulations on private agriculture or industry, while projects would continue to provide credit to promote and rehabilitate private enterprises and assistance in marketing or manpower training.

The Bank’s planning of country strategies for its lending will also reveal new areas that need analytical work, followed up with practical advice. For example, besides continuing support for the sale and liquidation of SOEs, where appropriate, the Bank will explore opportunities for private delivery of public services and for management contracts, leases, and joint ventures. Indonesia’s experience in contracting a Swiss firm to run its customs service, or Thailand’s lease of passenger transport on certain rail lines to the private sector, could have wider applicability. Contracting out or leasing may be appealing in theory, but many government officials are wary about their capacity to negotiate and monitor agreements. While Bank studies will inform them about the experience of other countries, Bank projects will assist them to draw up and manage contractual agreements with the private sector, as well as to devise ways to assist the private sector to respond to the expanded demand.

Another area that is receiving increased attention is the development of capital markets. In even the relatively more developed countries, the limited size of capital markets is an important barrier to efficient development. Too frequently banks operate in segmented markets under heavy regulation and public borrowing crowds the private sector out of formal credit markets. Thirty-five developing countries have equity markets, but most of these are small, poorly regulated, and dominated by a few large traders. IFC provides advice and support for the development of stock markets; the Bank through its SALs and financial and industrial sector adjustment loans will increase its efforts to eliminate subsidized interest rates, credit rationing and centralized allocation, improve the capital markets, and create competitive, multipurpose banking systems.

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