Journal Issue

IFC and Development

International Monetary Fund. External Relations Dept.
Published Date:
January 1989
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Direct and indirect benefits of IFC projects have had a measurable development impact beyond the immediate firms

The ultimate purpose of all IFC investments in developing countries is development. Therefore, IFC insists that all its investments must be viable both financially and in economic terms. To this end, IFC staff perform financial analysis to determine whether a project will produce a satisfactory financial rate of return (FRR). But such analysis alone may not be enough to assess the development benefits of an investment to an economy because market prices are often distorted in developing countries. Moreover, benefits and costs outside a firm’s operations are not captured by its financial accounts. For example, when a firm requires the government to build a new road, the costs of the road may not always be captured in the enterprise’s financial data. This provokes the need for assessing a project’s potential economic rate of return (ERR). A recent internal study has confirmed that IFC projects have indeed yielded relatively high ERRs, and therefore had broad economic benefits.

What is an ERR?

While the financial impact of a project on a company is based on market prices, the economic impact of the project on the country is based on opportunity costs, which are often different from market prices. Price distortions generally arise because of the effects of protection, subsidies, taxes, price controls, and other forms of state intervention in the marketplace.

The mechanics of economic and financial analysis are broadly similar, and both start with the same set of financial projections for a project. Economic analysis goes beyond the financial projections to identify the opportunity or “shadow” prices for key outputs and inputs, which reflect the economic impact of a project. For items that are tradable, the main issue is the determination of the appropriate international prices that are free of taxes and other domestic price distortions. The appropriate international price must reflect long-term supply and demand conditions, so that project analysis is not biased by temporary price aberrations. For items not directly tradable, and whose values cannot be assessed on the basis of components that are tradable, emphasis in the analysis switches to the determination of the proper conversion factors. With the latter, local currency costs and benefits can be converted to international price equivalents.

The use of international prices for project analysis is based on the notion that these show opportunity costs or values from the country’s viewpoint. Thus, an import- substituting project implies a “make or buy” decision for the country, in which the true value of output is the import price of the same product, and the cost of inputs is either their actual import cost (if directly or indirectly traded), or their alternative export value in the case of domestically supplied, exportable items.

The ERR can and should capture many of the external costs and benefits associated with projects. For example, as stated at the outset, additional infrastructure provided by the state solely for a project would be included as a cost in the economic analysis. On the other hand, if substantial training costs are incurred, they might not be fully classified as economic costs if trained labor can be expected to remain in the economy even after leaving the particular project.

Besides focusing on industry and sector costs and prices, economic analysis of projects also involves analysis of country factors and project-specific calculation of returns and other parameters. These include the basic economic policy framework of the country, trade and tariff policy, public enterprise pricing, exchange rate policy, and domestic price controls.

Economic analysis of proposed investments serves as a barometer of the investment’s underlying commercial viability. This is because shadow pricing reveals whether a project would be likely to survive when fully exposed to market forces, without government protection or subsidies, as may be the case as structural adjustment proceeds. It also serves as a basis for dialogue with host governments about the effects and the desirability of changes in general or sectoral policies that affect the profitability of investments.


Recently, IFC’s Economics Department carried out an assessment of IFC’s development contribution by examining the extent of the economic benefits actually realized from IFC’s investments (see box). The evaluation was based on a sample of 110 projects drawn from two sources: sectoral studies undertaken by IFC’s Operations Evaluations Unit (OEU) and data on 53 projects from Project Completion Reports (PCRs). The sole selection criterion was availability of comparable data. Some of the sectors had been chosen for study by OEU because they were unusually problematic. Therefore, the OEU sample was not truly representative of the Corporation’s overall portfolio.

An important difference between the OEU and PCR estimates of ex-post project returns was the amount of actual operational experience of each project at the time the evaluations were made. Projects evaluated by OEU had more than two years’ operational experience at the time of re-evaluation, while the PCR re-estimates reflected little or no operational experience. Both the OEU and PCR re-estimations incorporated forecasts of costs and returns. Therefore, they were not “true” ex-post evaluations in the sense of being based on, say, 15 or 20 years of operational data.

A detailed study “The Development Contribution of IFC Operations, “from the Economics Department, was published as Discussion Paper Number 5, and is available without charge from the World Bank Publications Sales Unit, Washington, DC 20433 USA.

The main findings of this study are that the ex-post real ERRs averaged 11 percent in the projects selected from PCRs and 10 percent in the OEU group. These average returns are in line with the opportunity cost of capital in most developing countries, which is generally estimated at around 10 percent. In other words, the net economic impact of IFC’s project investments appears to have been positive overall, even for this sample containing problem projects.

The group averages, however, conceal a large degree of variation in economic returns from sector to sector. In both the PCR and OEU samples, projects involving agricultural production performed poorly in comparison with ex-ante projections (Table 1) and other sectors (Table 2), generating ERRs of only 2 percent on average. Agricultural processing projects gave barely adequate real returns (7 percent ERR) in the OEU sample, compared with the more satisfactory returns (11 percent ERR) of the PCR sample. While investments in all other sectors performed satisfactorily, the two samples give different indicators of the strength of each sector’s performance.

On average, ex-post ERRs were equal to or greater than ex-post FRRs in all sectors but one of the OEU sample and in half the sectors of the PCR sample. The reason for this is that the pattern of government interventions (i.e., taxes, subsidies, tariffs, price controls, regulations, and so on) affecting the firms in which IFC invests has, on average, a negative effect on cash flow. Rather than being assisted by distortions, a majority of firms involved in IFC projects either receive little help or are being penalized by government policies. The results also show that the 110 IFC projects, on average, performed well financially relative to the real cost of corporate funds, which, for example, averaged around 5 percent for US dollar funds in the 1980s, and they did so without overall reliance on protection or subsidies.

The ex-post rate of return calculations also provide IFC with the opportunity to reappraise project performance in the light of actual project construction costs, updated production figures, and revised projections of input and output prices. As a comparison of Tables 1 and 2 reveals, in a majority of sectors, there was a downward revision in the estimated rates of return between the ex-ante and ex-post stages. In some sectors, the extent of this downward revision was substantial, and several factors can be identified that contributed to this.

Table 1Ex-ante returns on IFC projects, by sector(In percent)
Number ofEx-anteEx-ante
Agricultural production152120
Agricultural processing192420
Pulp, paper41723
Group average (unweighted)1102320
Source: IFC, Economics DepartmentNote: Data refer to 110 projects from combined Operations Evaluation Unit and Project Completion Reports.
Table 2Ex-post returns on IFC projects, by sector(In percent)
PCR sampleOEU sample
SectorNumber of



Number of



Agricultural production22-31323
Agricultural processing611141474
Pulp, paper41415
Group average53111157107
Source: IFC, Economics Department.Note: Project Completion Reports and Operations Evaluation Unit samples are not overlapping.

The period under review—the late 1970s and early 1980s—was one of unusual economic uncertainty and change. Real exchange rates, overvalued in many developing countries, were drastically devalued after the debt crisis erupted in the early 1980s. Likewise, raw material prices declined steeply at that time, and world interest rates rose sharply. These discontinuities are part of the answer. However, more systemic reasons may also have been at work, as suggested by the fact that the World Bank’s experience with project performance has been similar to IFC’s long before the 1980s. The question, therefore, remains whether there is a systematic bias to optimism in project evaluation. It is a question which IFC is addressing in current project appraisals.

Financial performance

Since financial performance and economic performance of IFC projects usually did not differ widely, further insight into the probable development impact of IFC’s project finance can be obtained by examining the overall financial performance of the companies it assists. The average nominal return on assets (before taxes) for IFC’s active portfolio for which six or more years had elapsed since the last commitment of resources was 9.5 percent. Some 136 companies came in this category. In comparison, the average return on assets (before taxes) reported by developing country affiliates of US firms in 1986 was 8.6 percent, according to the US Department of Commerce. This suggests that the companies in IFC’s portfolio are at least on a financial par with purely commercial operations, even though IFC pursued development objectives in its investments.

Achieving these results, however, has not been a matter of chance. The Corporation invests only in projects that offer a satisfactory ex-ante ERR. This means that while policy distortions may be present in IFC’s projects, only those projects that do not depend on government assistance for their viability are acceptable. This is a crucial step in ensuring that business success does not result in inefficient resource use and a loss of national income.

Nonquantifiable benefits

Development encompasses not only real income growth for the nation as a whole, but also change: improved technologies, better management and work force skills, new financing techniques, in fact, the whole process of economic transformation. Quantitative measures tell only part of the development story. In almost every project handled by IFC, there are unquantifiable benefits that occur through the help given to firms in designing projects, choosing technologies, analyzing markets, dealing with environmental problems, keeping costs down, and overcoming a variety of problems (including government red tape).

By carefully screening and appraising projects, IFC not only weeds out inefficient and uneconomic projects, but also helps to redesign and restructure inadequately prepared project proposals. IFC assists the process of change through the application of its specialized engineering, technical, and financial skills on each investment; this feature more than any other distinguishes the IFC from purely commercial financial institutions.

Many, if not most, of the projects that come to IFC for financing are deficient in either financial or technical aspects. The most common financial weakness is undercapitalization relative to the size of the investments being planned. IFC staff seek to overcome these weaknesses during the appraisal stage by negotiating a better equity/loan structure, and on occasion, by seeking a redistribution of risks and rewards among the proposed investors and lenders. On the technical side, IFC engineering staff frequently encounter proposals that include technologies that are neither cost-effective nor technically efficient. In these cases, IFC not only tries to redesign the technology of the project, but also to provide advice on procurement, installation, and initial operation of equipment. This “hands-on” approach has proven to be a major factor in creating a positive development impact.

In an aluminum smelter rehabilitation project, for example, IFC was confronted with an obsolete plant producing intolerable levels of pollution. Before approving any financing, IFC staff analyzed and redesigned the project proposal to improve both the pollution control systems and the technology and marketing aspects of the plant’s operations. By the end of 1988, the project had been successfully implemented, and the smelter was operating profitably and cleanly.

Benefits that extend beyond the boundaries of a specific project are frequently important in the development contribution of IFC investments. In one case, IFC was asked to participate in a project to introduce sterilized milk technology in a developing country. Previously, the country had seen surplus milk being wasted in rural areas while there was insufficient milk available in urban areas. The new technology allowed milk to be preserved, transported, and sold in “long-life” packs. It not only boosted the income of dairy farming families but also increased nutrition levels of consumers as well. The success of this company stimulated competition from other milk suppliers and fruit juice processors, who also adopted the long-life technology and packaging. None of these demonstration effects could have been anticipated, much less measured, at appraisal. Indeed, some of them took years to materialize.

On a broader level, IFC has also been prepared to make investments in countries that many commercial lenders shy away from. During the 1980s, investors have held back from potentially profitable projects in a number of developing countries because of unfamiliarity with the business environment there, or because of heightened perceptions of country risk. IFC’s approach has been to assess the country situation and to structure project financing arrangements to accommodate contingencies. This approach helped break down country risk barriers and created a demonstration effect, thus encouraging other foreign investors to come in. While the risk appraisal approach used by the IFC offers no guarantees or certainties, experience indicates that even in the most difficult countries, if a project’s underlying competitiveness is sound, profitability and business success usually follow.

IFC’s role in promoting development through business success has clearly been strengthened by the synergy between project finance and technical assistance. Project finance has important developmental benefits and will continue to be the backbone of IFC’s operations. But project finance alone would leave many needs unmet and, as the discussion presented here emphasizes, can be most effective when it is combined with IFC’s appraisal and technical skills. It is the combination of project finance and advisory skills that has enabled IFC to promote economic development and business success simultaneously.

IFC at a glance

The International Finance Corporation (IFC) is the World Bank’s affiliate that promotes economic growth in developing countries through the private sector. To this end, the Corporation invests in private firms, mobilizes complementary financing, and advises on important aspects of private sector development, such as capital markets, foreign direct investment, privatization, and corporate restructuring. IFC was set up in 1956, but did not become very active in project finance until the 1960s.

From small beginnings, IFC has, especially over the past few years, grown into a substantial source of development assistance. In fiscal year 1970, for example, it financed some 40 projects. In FY 1989, IFC made 90 investments, committing $1.3 billion of its own resources and mobilizing an additional $8.4 billion from other investors. Over the years, IFC has evolved from a purely project investment body to a diversified group that offers a range of advisory and management services as well. Project investments, nevertheless, remain IFC’s dominant activity. At the end of FY 1989, IFC held investments in 468 firms in 79 countries, a significant increase over the 288 firms in the investment portfolio in 1980. In addition to its project investments, IFC seeks to promote development through its Capital Markets Department, established in 1971.

For a detailed look at IFC’s activities, see the special section “IFC: Promoting Private Sector Development,” in the December 1988 issue of Finance & Development.

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