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IDA Is and Must Continue to Be the Standard Setter for Responsible Lending

Financing conditions for frontier economies have been tough since the COVID-19 pandemic. Simultaneously hit by a credit crunch in financial markets created by higher interest rates in advanced economies and the decline in Chinese finance, many low-income and lower-middle-income countries have seen more external finance leave their economies than enter. 

This external financing crisis is a development crisis. The post-COVID downturn is profound for many of the world’s poorest countries; combined with high debt levels and a shortage of external funds, it has left governments across the world struggling to avoid an explosive outcome.

The World Bank Global Economic Prospects last April was particularly somber:

“By the end of this year, one in four developing economies will be poorer than it was on the eve of the pandemic. By 2026, countries that are home to more than 80 percent of the world’s population would still be growing more slowly, on average, than they were in the decade before COVID-19.” 

The Nairobi-Washington Vision—issued by the presidents of the United States and Kenya during Kenyan President William Ruto’s State visit in May—attempts to fix part of this financing crunch. It builds on a speech by US Treasury Under Secretary Jay Shambaugh laying out a “vision for international finance where all stakeholders are incentivized to sustain net positive flows to IMF- and MDB-supported countries who are doing the right things, pursuing responsible macroeconomic policies, and prioritizing ambitious sustainable development goals.” For these countries (referred to as “high-ambition countries” in the Nairobi-Washington Vision), the document calls for creditors to commit to three major actions:

  1. Bilateral creditors should commit to high-quality positive flows, including debt suspensions, reprofiling/restructurings, or new budget support flows.
  2. The international financial institutions (IFIs) need to provide bigger coordinated packages
  3. The multilateral development banks (MDBs) need to provide incentives to private creditors to refinance expensive debt (e.g., credit enhancements).

The vision provides a compelling organizing framework for responding to today’s development finance challenges. Of course, it’s high-level. And, to work in practice, policymakers must tackle the core political and technical challenges that bedevil the debt and development finance landscape, including grappling with the absence of an enforcement mechanism that ensures all creditors play by the same rules of the road. While the Shambaugh speech is understandably focused on the IMF’s pole position in the debt architecture, the World Bank’s IDA has just as vital—and often overlooked role—both as a provider of finance and a standard setter for responsible lending.  

Much of today’s debt and development crises are playing out in the world’s poorest countries (i.e., countries that use the World Bank’s IDA window for grants and concessional loans). In many ways, IDA has exemplified the model creditor behavior described in the Shambaugh speech. Throughout the pandemic, IDA moved faster than the rest of the system and expanded its net disbursements more than other MDBs.  This is in large part thanks to donors scheduling an early replenishment to infuse IDA with cash ahead of schedule. But IDA also sets a good example by calibrating its terms to countries’ debt levels, meaning that if a country is at high-risk of debt distress, IDA automatically converts from loans to grants. As a result, in recent years, IDA has been the largest single source of positive inflows into IDA countries in sub-Saharan Africa.

This year, donors will replenish IDA and much of the focus is rightly on IDA’s development effectiveness. But, IDA’s macro role in the broader development finance architecture is profoundly consequential. While IDA is a creditor that walks the talk, there’s scope for it to do more to adapt to the heterogeneous financing needs of its clients in a world that has significantly shifted over the past decade. Here are some ideas on what IDA can do to help carry forward the Nairobi-Washington Vision and continue to set the standard for sustainable development financing:

  • IDA must maintain grant financing for countries at high risk of debt distress. IDA’s strongest debt relief mechanism is its policy to provide grants to countries at high risk of debt distress. (Most other IDA countries borrow on a scale of concessional terms calibrated to their macroeconomic profile.) Still, grants have become a growing financial strain for donors because they effectively yield a net loss for the institution. Between 2010 and 2020, IDA provided around $3.3 billion a year in grant funding. Amid deteriorating debt dynamics, that number has more than tripled to $9.7 billion per year since the pandemic. In an environment where donors are increasingly parsimonious, some stakeholders might be drawn to the idea of bolstering IDA’s financing firepower by rationing grants and replacing them with highly concessional loans. But this push would be fundamentally at odds with the economic and financial realities of many of the world’s poorest countries. It would also make IDA’s argument for staying out of debt restructurings less persuasive. Instead, IDA should raise the ante by calling on all bilateral creditors to coordinate lending terms and adopt IDA’s grant framework.

  • By mainstreaming debt suspension clauses, IDA can help ensure that countries are less shock-prone. The World Bank is piloting debt suspension clauses (DSCs) for small island states, but IDA should go a step further and make them available for its full membership. DSCs allow countries to pause repayments on their debt in the event of a pre-defined external climate shock (generally a hurricane) and can be powerful temporary liquidity relief tools. IDA also has an opportunity to advance a new market standard for DSCs. It should encourage countries requesting them in their IDA loans to also include them in new loan agreements with bilateral and commercial creditors. IDA should explore expanding the triggers for DSCs to include other significant shocks, such as pandemics and famines. 

  • IDA can do more to help countries reprofile and roll over their private debt in the face of adverse market conditions.

    • A new approach to guarantees. Many African countries that went to the market when interest rates were low facedifficulty refinancing their private debt. This year, sub-Saharan African countries that issued eurobonds in the first quarter of 2024 paid a hefty coupon averaging 8.5 percent. In a paper exploring MDB guarantees, we found that these instruments can help countries access the markets at much cheaper rates (i.e., can lower borrowing costs by as much as 3 percent). IDA has had some past successes with guarantees for sovereign commercial debt (known as “policy-based guarantees”), especially for syndicated loans, which are more straightforward and easier to price than enhancements for eurobonds. But for the most part, policy-based guarantees have remained an underexploited part of IDA. There’s a lot that IDA can do to make these more appealing instruments for countries. One approach would be to pilot a window within IDA that would allow eligible countries to take out guarantees without using funds from their country envelope. IDA could also provide full guarantees (the MDBs only provide partial instruments) and reduce the fees associated with guarantees.

    • A semi-concessional funding pool. For countries where guarantees are not financially workable, IDA could offer semi-concessional funding to help amortize external debt rather than taking out new external commercial debt. IDA would finance this pool out of its market borrowing program and the loans would cost IDA’s funding cost plus a small spread (say a total of 4.5 percent). So rather than paying the markets 8.5 percent like many frontier issuers did earlier this year, they could borrow from an IDA pool at half the cost. Such a program would need strong guardrails to be workable. Still, it could be an important source of liquidity for high-performing countries (i.e., “blend” countries, which are creditworthy enough to have partial access to other World Bank funds, and IDA-only countries with a low risk of debt distress) facing a difficult external financing environment. IDA’s non-concessional commitment has remained a small chunk of its portfolio (a little under $3 billion a year over the past five years), and it has financial headroom to scale this up significantly at no cost to donors.

I would be remiss if I did not underscore that all roads to a better IDA run through a bigger IDA. But as Charles Kenny and I fret (both in a blog and regularly in the halls of CGD), there’s a real risk that a big headline could be orchestrated by making the poorest pay more. This would be fundamentally at odds with the direction of travel laid out in the Nairobi-Washington Vision. The core thrust of the vision is that the way to stem the debt crisis is by going big on liquidity and long-term investments. The gamble is that this will help countries grow out of the debt crisis. Donors must put their bets on IDA: a big IDA is an investment in better debt dynamics, which will lower their bills down the line.

Disclaimer

CGD blog posts reflect the views of the authors, drawing on prior research and experience in their areas of expertise. CGD is a nonpartisan, independent organization and does not take institutional positions.


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