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Last week, AEI, CSIS, and CGD hosted a terrific forum with the heads of the British, German, Norwegian, and American development finance institutions (DFIs). It was billed as “$50 billion in one room,” a reference to the vast amounts of capital that these organizations bring to the table for development. Here’s what I took away from the session:
1. Development finance is the future. While we’ve likely reached “peak aid,” DFIs are just getting started. Demand is rising for capital going directly to private sector firms, especially as the development agenda shifts from grants for social services to, as the Managing Director of Norway’s Norfund Kjell Roland put it, “jobs, jobs, jobs.”
2. Most people still don’t know much about DFIs. While most developmentistas know all about DFID, USAID, and the World Bank, there’s much less familiarity with their private sector counterparts, the CDC Group, the Overseas Private Investment Corporation, and the International Finance Corporation. (Whenever I speak about OPIC, I always preface with a clarification that it’s not the oil cartel.) Despite their lower profile, DFIs are often the institution called when our governments need to respond to energy shortages, youth unemployment, or private sector growth.
3. OPIC could do a lot more with a simple rule change. Because of a stipulation going back to the Nixon Administration, OPIC can only make loans and is barred from taking equity positions. This is an anomaly among DFIs, who are supposed to make investments in the poorest and riskiest markets around the world where many companies are seeking early-stage equity rather than debt. Among the multiple reforms that my CGD colleague Ben Leo and I have proposed to unleash OPIC and make it a more effective US development finance corporation, this is probably fix #1. So I was glad to see Diana Noble, CEO of the UK’s CDC (primarily a DFI offering equity rather than debt), make the case for equity through its own experience and OPIC’s lack of it.
When US Treasury Under Secretary David Malpass appeared before Congress just five months ago, he indicated that the World Bank “currently has the resources it needs to fulfill its mission” and went on to characterize the bank and other multilateral institutions as inefficient, “often corrupt in their lending practices,” and ultimately only benefitting their own employees who “fly in on first-class airplane tickets to give advice to government officials.”
From that standpoint, it would be hard to imagine US support for a significant injection of new capital into the World Bank’s main lending arm, the IBRD, as well as the bank’s private sector lender, the IFC.
And yet, that’s exactly the surprising outcome just announced at the World Bank’s spring meeting of governors. Not only is the Trump administration supporting a $7.5 billion capital increase for the IBRD (and at that, one that is 50 percent larger than the capital increase supported by the Obama administration in 2010), it has also signed on to a policy framework for the new money that makes a good deal of sense.
Here are the highlights:
The capital increase package will better enable the institution to deliver on its commitment to be a leader on climate finance and more broadly in support of global public goods, aligning with key recommendations from CGD’s 2016 High Level Panel on the Future of Multilateral Development Banking. Under the agreement, the climate-related share of the IBRD’s portfolio will rise from the current 21 percent to 30 percent. The IFC’s share will rise even higher to 35 percent. New ambition on the climate agenda also includes commitments to screen all bank projects for climate risks and incorporate a carbon shadow price into the economic analysis of projects in emissions-producing sectors. For global public goods more generally, the agreement newly commits a (very modest) share of IBRD annual income to global public goods.
The package introduces the principle of price differentiation based on country income status, with higher income countries paying more than the bank’s other borrowers. This proposal, which was also put forward by CGD’s High Level Panel in 2016, will generate additional revenues for the bank and asks more of countries that have less financing need. While the introduction of the principle marks an important step forward, the actual price differentiation is extremely modest—at most, the spread between high income borrowers will be just 45 basis points on IBRD lending rates of about 4 percent.
The package assigns new guidelines for the IBRD’s overall lending portfolio to channel 70 percent of the bank’s resources to countries with per capita incomes below $6,895 and 30 percent to countries above this so-called “graduation threshold.” These targets would not be binding when it comes to crisis lending. In practice, these new guidelines seem to align with the existing pattern of IBRD lending, as indicated in the figure. In this sense, the idea that these guidelines amount to cutting China's access to World Bank loans appears exaggerated, though over time, as more countries join the higher income category, the 30 percent share will be allocated across more borrowers.
The package also attempts to identify a new financial framework that requires greater discipline when it comes to tradeoffs between lending volumes, loan pricing, and the bank’s administrative budget. This framework, which reportedly was a priority for the US government, may not ensure that this will be the last ever capital increase for the World Bank (as an unnamed US official promises), but it does appear to introduce a greater level of coherence around financial/budgetary decisions that have historically proceeded in a disjointed fashion within the institution.
Finally, even as the agreement seeks greater differentiation among countries, it reaffirms the World Bank’s commitments to stay engaged with all its client countries, including China. In fact, given US rhetoric, it’s surprising that the agreement does not stake out any new ground on the subject of country graduation. In fact, it seems to go out of its way to reassure all current bank borrowers that they are still welcome and that the decision to graduate from assistance is theirs to make. In the end, as much as ending China’s borrowing from the bank would have been a political prize for the Trump administration, US officials appear to have taken a sensible policy path that favors good incentives over polarizing fiats.
As China’s Communist Party paves the way for President Xi Jinping’s indefinite leadership, the international community should expect the Belt and Road Initiative (BRI)—President Xi’s signature global infrastructure plan spanning Asia, Europe, and Africa—to be further cemented as China’s primary strategy of global engagement for years to come. In a new CGD paper, we assess the likelihood of debt problems in the 68 countries we identify as potential BRI borrowers.
The big takeaway: BRI is unlikely to cause a systemic debt problem, yet the initiative will likely run into instances of debt problems among select participating countries—requiring better standards and improved debt practices from China.
Here’s what we found:
BRI creates the potential for significantly increased debt sustainability problems in at least eight countries. In BRI countries vulnerable to debt distress, we incorporate an identified BRI pipeline of project lending to estimate changes in a country’s public debt and concentration of debt with China as a creditor. Along these two dimensions, we identify eight countries of particular concern where China, as the dominant creditor, will be in the key position to address problems that may arise:
Looking at the entire range of countries in the initiative, the risk of debt distress is not widespread. The majority of BRI countries will likely avoid problems of debt distress due to BRI projects:
China should demonstrate its commitment to a responsible role on the international stage by adopting and advancing multilateral standards for debt sustainability and improving debt management practices. China’s track record managing debt distress has been problematic, and unlike the world’s other leading government creditors, China has not signed on to well-established rules of the road when it comes to avoiding unsustainable lending and addressing debt problems when they arise. Given the likelihood of debt problems in select cases, we make the following recommendations for how China and major BRI partners can better align with existing disciplines and standards:
Multilateralize the Belt and Road Initiative: Currently, institutions like the World Bank and Asian Development Bank are lending their reputations to the initiative while only seeking to obtain operational standards that will apply to a very narrow slice of BRI projects: those financed by the MDBs themselves. Before going further, the MDBs should press the Chinese government when it comes to the lending standards that will apply to any BRI project, no matter the lender.
Consider additional mechanisms to agree to lending standards: We suggest a post-Paris Club approach to collective creditor action, the implementation of a China-led G-20 sustainable financing agenda, and the use of China’s aid dollars to mitigate risks of default.
At a recent CGD event, World Bank President Jim Yong Kim argued that the World Bank Group (which includes the IFC) is doing more in middle income countries (MICs) because “most poor people are in middle income countries.”
President Kim went on to say:
The first question that I asked as well, for our board, is we committed to ending extreme poverty in the world so… what percentage of people living in extreme poverty live in middle income countries? And now it’s probably 65 percent.
That matches what IFC Spokesman Frederick Jones said in response to our work on the IFC portfolio. And it sounds completely reasonable—indeed, based on our calculations, World Bank statistics suggest 24 percent of the world’s extreme poor live in low income countries, 58 percent in lower-middle income, and 18 percent in upper-middle income countries. So moving beyond low income countries (LICs) makes sense for an institution focused on ending extreme poverty. But does the IFC follow through by focusing on the countries that are home to the extreme poor? Not really.
It is true that the IFC (absolutely) invests more in countries that are home to greater numbers of poor people. Figure 1 plots absolute IFC commitments over 2011-16 against the number of people living at or below $1.90 per day (note the log scale). It shows that the average absolute IFC investment in middle and low income countries with more than 10m poor people is $641 million compared to average absolute IFC investment of $405 million in countries with less than 10 million poor people living at or below the $1.90 threshold.
Figure 1: Poverty and IFC investments
Figure 2 looks at the proportion of extreme poor in a country and IFC's investments as a percentage of recipient GDP. The average 2011-16 IFC investment as a percentage of 2010 GDP in countries with more than 20 percent poor people ($1.90) is 0.35 percent compared to average IFC investment as a percentage of GDP in countries with less than 20 percent poor people ($1.90) of 0.19 percent.
Figure 2: IFC investment in developing countries
However, a focus on poverty in middle income countries does not really explain IFC’s investments in Turkey, the largest recipient of IFC funding at $4.9 billion, home to 0.2 million poor people at the $1.90 threshold. Nigeria, which is home to 424 times the number of poor people at the same threshold, only got $1.5 billion in IFC financing over the same period.
And it is worth illustrating how poorly IFC investments are targeted if the aim is to focus on countries home to the world’s extreme poor. Figure 3 lines up countries along the x-axis according to their absolute number of extreme poor (countries with no people living under $1.90 a day come first). The y-axis reports cumulative IFC investments in those countries (note some countries are excluded for lack of recent poverty data).
The first thing to note is that the IFC has invested $4.5 billion over the 2011-16 period on countries home to no extremely poor people. And it has invested over $18 billion in countries collectively home to fewer than nine million extreme poor. More than half of the total value of IFC investments 2011-16 are in countries collectively home to just 45 million poor people—leaving countries home to 724 million extreme poor people to share the remainder. Put another way, countries home to those 45 million poor people get 18 times the IFC investment per extreme poor person than do the rest of IFC’s client base.
Figure 3: Cumulative IFC investment in developing countries
The defense that IFC is targeting where the extreme poor live nowadays is only partially vindicated. But President Kim did provide a possible explanation:
Now in terms of IFC risk… what the IFC representatives will say when I ask the question, is that, look, go back to the founding principles of the institution. You have to balance your portfolio with the risky investments and the not-so risky investments, and you know, to say to IFC, you have to put all your money into fragile and conflict-affected states or IDA states, if they did that they’d have to close down fairly soon. And right now we’re in a capital discussion. And so it’s just, you know, if you’re going to go into the low income countries, you need more capital, not less
That leaves another defense from the institution: that the IFC is focusing within countries on investments that better target poverty than the country-level statistics suggest. Once again we'd welcome the IFC publishing the necessary data to test that idea, but still question if a choice to invest more in richer countries focusing on a small share of poor people is the most powerful approach for an institution supposedly so focused on ending extreme poverty.
You can download the Stata code and raw data we used to produce these figures here.
Yet many of the world’s poorest countries in sub-Saharan Africa have shown they can reform and improve governance. The Heavily Indebted Poor Countries Initiative and Multilateral Debt Relief Initiative supported by the world’s major donors in the early 2000s took $75 billion in debt off the benefiting countries’ balance sheets—see the March 2016 World Bank-IMF update—and motivated wide-ranging macroeconomic and structural reforms that reduced poverty. Along with rapid growth in China and the commodity price boom, the result was a decade of high growth across the region.
But the momentum is fizzling out. In a new round of tough reforms, African leaders will need to do the heavy lifting. Africa is still poor, and not yet able to finance the investments critical to a new round of growth and poverty reduction. Here’s what donors could do:
Help jump-start a big push on regional infrastructure to knit together many small economies and create economies of scale for local producers. That requires attracting Foreign Direct Investment (FDI) since even the best-managed countries in sub-Saharan Africa (consider Rwanda, Côte d’Ivoire, or Senegal) cannot rely on market financing because maturities are too short and interest rates too high.
To find the money, securitize a small portion of the over $40 billion in annual aid flows that sub-Saharan Africa now receives, as outlined in a recent Project Syndicate article, to finance the public portion of public-private “blended” investments in major cross-border power and transport (the Lagos-to- Dakar highway is a good example)—with benefiting countries servicing these loans, which will be superior to market alternatives on cost and maturity.
Africa needs a new round of success stories. Success requires a big push not just on infrastructure but also on sustained policy and institutional reform. African leaders must take the lead. Donors can help.