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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.
Senior Fellow, Director of the US Development Policy Initiative
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.
In advance of adopting a new Policy on Public Information, the AIIB is inviting suggestions on how it could best align public disclosure with its guiding principles of “promoting transparency, enhancing accountability and protecting confidentiality.” The adoption of the new policy provides AIIB President Jin Liqun and the AIIB shareholders an opportunity to demonstrate that this newest of multilateral development banks (MDBs) is serious about its commitment to adopting international best practices.
The current practice of co-financing most projects with the traditional MDBs helps President Jin Liqun validate his claim that the AIIB is committed to transparency and accountability. The standards applied by the traditional MDBs are generally considered “best practice,” even if their application has not always been perfect. But as the AIIB increases the number of projects where it is not a co-financier, there are concerns that China’s traditional wariness about disclosing the details of its own bilateral development finance programs will begin to replicate itself within the halls of the AIIB. This makes it all the more imperative that the new disclosure policy display a serious commitment to presumption of disclosure.
In reviewing the AIIB website and the observations of others, such as the US-based Bank Information Center, I identified a number of actions that the AIIB could take to improve its disclosure practices. Here are my top three recommendations:
1. Post all official project-related documents on the AIIB website, including loan agreements and information on the status of projects during implementation.
Despite President Jin Liqun’s laudatory rhetoric and commitment to international best practices, the AIIB has yet to demonstrate a willingness to disclose information equivalent to that which is provided by the traditional MDBs. To illustrate, I compared the information provided by the World Bank and the AIIB on the Indonesia Slum Upgrading Project that is being co-financed by the two institutions. In the case of the World Bank, a number of documents are made available on its website, including project descriptions drafted at the concept and appraisal stages, environmental impact assessments, the project proposal that was provided to the Board of Directors, the actual loan agreement and associated paperwork, and three reports on implementation status and results to date.
In the case of the AIIB, a project summary and a project document are available that are reduced versions of the World Bank’s project information documents. The project summary also includes a link to the environmental and social safeguard information disclosed by the World Bank. But the AIIB does not disclose other documents, most importantly the actual loan agreement and the monthly progress reports that the borrower is required to provide to the AIIB. It should not only provide these documents, but also links to the websites of the government entities involved in implementing the projects it finances.
2. Establish a publicly available database on procurement contracts awarded for public sector projects financed by the AIIB.
President Jin Liqun should be commended for requiring open, fair, and nondiscriminatory procurement processes for projects financed by the AIIB. This is consistent with the practices at the traditional MDBs (though it should be noted that the Asian Development Bank continues to discriminate against firms from non-member countries). But despite the commitment to transparency, it appears that the AIIB is woefully lagging when it comes to disclosing information on contracts that have been awarded.
The vast majority of AIIB loans have been to projects co-financed by other MDBs, so information on procurement contracts awarded for these projects is readily available through those MDBs’ websites. But very little information is available on contracts awarded under stand-alone projects (projects not co-financed by other MDBs). In the case of the Bangladesh Distribution System Upgrade project, the AIIB does include a link to a two-page document describing the contracts awarded by the Bangladesh Rural Electrification Board, but there is no information on contracts that have been awarded in either the Oman Duqm Port project or the India Gujarat Rural Roads project. As with my first recommendation, the AIIB should seek to provide procurement information through links to the borrowers’ own websites.
3. Disclose the financial details of all loans to public entities on a monthly or quarterly basis.
Given past debt crises and concern mounting over future defaults, all creditors to sovereign governments, including the AIIB, should disclose the terms and status of their loans to help the public understand the potential risks of new borrowing. The World Bank and the Inter-American Development Bank serve as good models in this regard. In both cases, they make available on their website the current status of all loans and credits approved by their respective boards of directors. The information includes, among other things, the currency of the loan; the amount borrowed, repaid, and outstanding; and the interest rate being charged. The AIIB could go one step further and provide the information in a manner that is easily searchable and where the information could be downloaded in machine-readable format for further analysis.
Given the advancements in information technology, each one of my recommendations would involve little additional cost, but would provide significant benefit. They would allow the public to see what results are being achieved, who is doing the work and how much are they being paid for it, and what are the ongoing financial commitments of the borrowers.
As the World Bank makes a case to its shareholders for a capital increase this year, they are grappling with an uncomfortable truth: one of their biggest borrowers, China, happens to hold the world’s largest foreign exchange reserves, is one of the largest recipients of foreign direct investment, enjoys some of the best borrowing terms of any sovereign borrower, and is itself the world’s largest sovereign lender.
The World Bank was created to support countries that could not access capital on reasonable terms to meet their development needs. That doesn’t seem to describe China today, a point that US officials are quick to point out in the current discussions around the World Bank’s own capital needs.
So, is there actually a case for China’s continued borrowing? And why in fact does China continue to borrow?
On the latter, it’s clear enough that China does not borrow to meet a financing need, or even to exploit a financial subsidy. Annual bank lending to China of about $2 billion means almost literally nothing in an $11 trillion economy. And with China’s favorable borrowing terms in bond markets, the implicit subsidy it receives on IBRD loans is just 50 basis points or so. These two facts combine to suggest that Chinese officials care very little about the bank’s lending as lending per se.
Beijing officials have often characterized their borrowing as a useful way to achieve a number of aims: project-level standards and disciplines that help improve operations at the local and provincial levels, particularly in western China where capacity remains low; incentives to boost domestic investment on behalf of climate mitigation; and more generally, access to expertise across a range of sectors in support of development goals. In each of these arguments, officials make a particular case about the effectiveness of lending relative to other modes of engagement, such as technical assistance or bank studies.
But should the case that China makes for itself carry the day with the rest of the World Bank’s shareholders? On balance, I think so and generally see four reasons to continue the bank’s China lending:
The bank’s founding mission, defined around meeting capital needs at the national level, has evolved in recent years, such that countries that have ready access to capital markets also demonstrate the value of using World Bank loans to incentivize and prioritize development objectives. This holds in two important ways. First, it helps address the paradox of today’s development landscape, which is partly defined by large economies with large poor populations. When these populations are regionally or locally concentrated, bank loans can help national governments prioritize engagement in these areas. Second, there is a global “public goods” agenda, with climate change mitigation at the forefront, that requires action from large economies. Bank loans similarly help to incentivize investments in these areas by offering subsidies (modest in China’s case) for public goods-related activities.
China’s borrowing is a useful “market” signal when it comes to assessing the quality of World Bank assistance. Unlike the bank’s poorest borrowers, for whom bank loans are a critical source of public financing, China will only continue to borrow to the degree it sees a net benefit to the loan package. This likely entails some weighing of non-financial costs (e.g., the degree to which bank projects are cumbersome) and benefits (the degree to which the bank delivers on the elements described earlier). Because China can afford to have a take-it-or-leave-it attitude, the country’s borrowing gives us a clearer picture of the quality of effort provided by the bank over time. It’s good to know that China sees value now, and it will also be good to know if they render a different judgement in the future.
World Bank lending may not deliver a significant financial benefit to China, but it does significantly benefit the bank’s balance sheet by virtue of China’s creditworthiness. Put simply, the bank could not simply swap out $2 billion a year to China for El Salvador and Vietnam. There are legitimate questions about the fair allocation of scarce World Bank capital, but it is not the case that one dollar less of China lending is one dollar more available to other countries.
Finally, there can be no “China” graduation policy. China is situated among 56 upper-middle-income borrowing countries, and any policy aimed at ending lending to China would have to do the same for many of these countries. This could be problematic in individual cases and in toto. Does the United States also feel strongly that Mexico should no longer be able to borrow from the World Bank? Turkey? What about the 30 other borrowing countries at or above China’s level of per capita income?
Graduating China from World Bank assistance may be misguided, but asking more from China and other higher-income borrowers is not. CGD’s High-Level Panel on the Future of Multilateral Development Banking last year identified differentiated loan pricing as a useful way to seek more from these borrowers in return for the benefits they derive from bank engagement. Their role as donors to the bank should also be on the table, whether as contributors to the International Development Association (IDA) or through other mechanisms in support of public goods. China has already stepped up considerably as an IDA donor and would be smart to continue this trajectory. Defining a new relationship with the bank as leading shareholder, client, and donor could increase China’s influence in the institution in ways that are not wholly positive, but for the institution itself, such a role would better reflect the needs of today’s global agenda.
Happy New Year, and welcome to 2018 from all of us at CGD.
Here at CGD, we’re always working on new ideas to stay on top of the rapidly changing global development landscape. Whether it’s examining new technologies with the potential to alleviate poverty, presenting innovative ways to finance global health, assessing changing leadership at international institutions, or working to maximize results in resource-constrained environments, CGD’s experts are at the forefront of practical policy solutions to reduce global poverty and inequality.
Watch our video to hear from our experts directly, and get an in-depth look below at their thoughts on the 2018 global development landscape:
The role of international cooperation
“We’re in a difficult time for development policy. People feel as if we’re in competition with the developing world, and I think we have to get back to recognizing that we have shared problems that we need to solve together. The premise of international development cooperation—now rightly enshrined in the Sustainable Development Goals—is that we are in this together: we all benefit from shared prosperity, openness, trade, security, values, rights, and justice. We are in danger of seeing the world as zero sum—in which improvements in some parts of the world are wrongly believed to be at the expense of success elsewhere. If we allow this idea to take root, it will undermine support for development cooperation, and take us in directions that erode global cooperation and the institutions that protect and sustain our shared security and prosperity.”
The effect of transitioning away from aid: asking the right questions
“I think 2018 is going to have to be about countries transitioning away from aid, and as a result it’s going to have to be about how we invest limited resources to get the best return for that investment. What happens to social spending commitments towards global health priority areas such as vaccinations and infectious diseases, as Ministries of Finance are increasingly asked to allocate their own domestic resources to replace diminishing donor funds? How do national health insurance funds procure pharmaceutical products and other health commodities as LMICs leave purchasing clubs such as Gavi and GFATM whilst having to deal with the growing burden of chronic diseases such as diabetes and cancer? How can technological and organisational innovation address the gap left by departing global purchasing arrangements?
What are the role and responsibilities of norm setting agencies such as the WHO in shaping resource allocation at national level as countries commit to and implement universal coverage for their populations? When are aspirational targets as the ones set through standard treatment guidelines, disease specific norms or the Essential Medicines List, justified and when do they distort local spending priorities and aggravate inequalities?”
New leadership, limited funding: an opportunity for global health aid
“In 2018, I’m looking forward to seeing economists more deeply embedded in all things global health. First, Peter Sands takes the helm as new executive director at the Global Fund to Fight AIDS, Tuberculosis and Malaria where the focus needs to be value for money—more impact, more rigorously measured, for the same or less money. It’s not just the right thing to do, it’s also a requirement for a portion of future DFID funding. To get this done, better economics should be deployed to inform resource allocation within programs, implement rigorous performance verification and evaluation approaches, and select most cost-effective diagnostics, drugs, and devices for purchase.
Second, at the World Health Organization (WHO), newly elected Dr. Tedros is finalizing his General Program of Work, a 2019-2023 plan that governs the rest of his tenure as Director-General. Faced with many demands and conflicting priorities from its member countries, WHO leadership could benefit from a chief economist (more on this here and here). The goal? To help prioritize demands amid scarce funding, to promote value for money in all policies, and to make the critical link with ministries of finance.
Third, with US tax reform passed, global health aid—like the rest of discretionary spending in the US budget—may face cuts, despite bipartisan support. In the UK, there’s also an uncertain outlook. It’s a clear case of ‘hope for the best, plan for the worst.’ And that’s where the dismal science can contribute: planning for these uncertainties and contingencies, and maybe finding some opportunities for efficiencies along the way. Look to recent work on aid transitions, priority-setting, domestic resource mobilization, innovative financing, value for money, fiscal policies for health, financing global public goods, and our forthcoming work on rationalizing future global health procurement should provide some fodder for policymakers to consider.”
“In 2018, I’m very much looking forward to continuing to explore China’s emergence as a leading development actor. Increasingly, this will mean defining a leading role on international policy commensurate with China's role as a leading development financier globally. In settings like Davos and institutions like the World Bank and the IMF, Chinese officials will inevitably be more prominent in 2018 and will just as inevitably come under increasing pressure to align Chinese policy on issues like sustainable lending with international norms. All of this will likely occur against a backdrop of US retrenchment in these multilateral fora.”
“I’m really excited about the relationship between technology and development, and to begin to examine how we can master the challenges that come with integrating a set of powerful new technologies and ensuring that they deliver the best options for poor people everywhere. Technological innovation has been a driving force of development and this continues to be the case. The current revolution in digital technology, big data, robotics, and artificial intelligence holds enormous promise to deliver development services more effectively and efficiently. However, these forces will need to be harnessed to ensure that the benefits flow to all segments of society in the developing world and the ‘losers’ from this transition are supported in ways that are economically, socially, and politically sustainable. This is a fertile and urgent area for conceptual and empirical research to underpin better policymaking by developing country leaders and the international community.”
“In 2018, I’m excited about expanding our research on the policies that will most effectively help refugees and migrants integrate into their host communities. At a challenging time for migrants and refugees, we are focused on analyzing and generating solutions that can simultaneously advance outcomes for refugees, migrants, and host communities. One of our main projects will highlight policies and programs that benefit sending and receiving communities, as well as emerging innovations such as the Global Skill Partnership. Building on our work on refugee compacts, we'll expand our work on how to achieve impact with new financing mechanisms that support developing countries, which host 86 percent of the world's refugees, to deliver services to refugees and citizens. A key part of this will be research on how to increase refugees' access to labor markets and more deeply engage the private sector, so refugees can become self-reliant by finding jobs and starting businesses—and spurring local markets in the process.
Latin America’s elections: choosing the right leadership to restore peace and prosperity
“In 2018, we will witness a huge cycle of presidential elections in Latin America. My big hope for the year is that the citizenship chooses the right leadership to be able to face the upcoming challenges. The recent elections in Chile (December) and Honduras (November) will be followed by six Presidential elections in 2018: Colombia, Mexico, Brazil, Costa Rica, Paraguay and, potentially, Venezuela. This highly charged electoral cycle comes at a time when populations’ discontent with the results of democracy is on the rise as reported by the reputable poll Latinobarometro. This change in attitude follows the significant deterioration in Latin America’s economic and institutional quality indicators in recent years, reflecting both the end of the period of super high prices of commodities exported by the region and the outburst of corruption and crime in many countries. In this environment, the risk of electing populist (notably in Mexico) or authoritarian leaders (notably in Brazil) is high. Populism and authoritarianism are not strange to Latin American history and their disastrous results on economic and social prosperity are extensively documented (with Venezuela’s recent experience being the latest example). The incoming elections will test whether Latin Americans can avoid repeating the painful mistakes of the past and will choose governments able and willing to put in place the needed reforms to restore economic growth and sustainably enforce the rule of law.”
“In 2018, what I would like to see is the gender gap in financial services reduced. The gender gap in financial services is stuck at a 7 percent gap globally and a 9 percent gap in developing economies. According to the latest data, while the number of bank account holders has increased globally between 2011 and 2014, the gender gap has not shrunk. In 2018 we can do better. So far, a lot more attention has been paid to particular constraints women face in accessing financial services, than to what women actually want from financial products. Focusing on women potential clients as a distinct market segment is a first step. Second, in addition to “know your customer requirements,” the industry should have “know your bank standards” as well, and examine potential gender biases, explicit and implicit, in the delivery of financial services. Banks should examine and correct internal gender biases. Encouraging signs include the commitment of development agencies (including an 8-agency gender data partnership coordinated by Data2X and GBA) and some banks to invest in data, both supply and demand-side, and in testing innovative financial products and delivery systems to increase women’s access to financial services (including experimental evaluation work we at CGD and partners are completing this year). These and other partnerships should help shrink the gap in the short term, especially if large private sector banks globally also act.”
The United States is apparently driving a hard bargain with World Bank President Jim Kim, who is hoping the bank’s 189 shareholders will agree to increase the current capital of the bank’s “hard” window (for middle-income countries with over $1200 in per capita income) sometime in 2018. A deeper capital base would allow the bank to lend more—more each year than the almost $30 billion of loans approved in 2016. But the US wants to link any support for a recapitalization to World Bank “graduating” China—and perhaps other member countries with good access to private capital markets who don’t seem to “need” the World Bank.
But cutting off China is not something Jim Kim and senior management at the World Bank want to do. There are sensible arguments on both sides of this divide. And there is a simple way to begin to thread the needle and get to yes, but first some background (readers familiar with the US position and the World Bank counter-arguments may want to skip to the “getting to yes” section below).
The US position has some merit
On the face of it, the US position is not unreasonable. China doesn’t “need” to borrow; it can easily self-finance its own development investments. Indeed, China is a donor and a lender to other countries, with massive lending by its ”policy banks” (China Development Bank and China Exim) both inside and outside China (and long-run plans to lend heavily to other countries as part of its Belt and Road Initiative; China is also the single largest shareholder in what the US might consider a “rival” multilateral bank to the World Bank, the Asian Infrastructure Investment Bank founded under its leadership in 2015. And from the point of view of the US, China’s status as one of the biggest borrowers at the World Bank (with almost $2 billion in approvals in 2016, behind only Peru, India, and Kazakhstan) means that ending its borrowing would free up existing World Bank capital for other smaller and poorer countries that face tougher terms if they borrow on private markets.
Then why does China want to borrow?
China wants to borrow, the World Bank often argues, because along with the money for any particular project or program comes valuable technical and policy advice based on World Bank staff’s expertise and experience acquired in other countries. China could in principle “buy” advice from the World Bank, but may well prefer to bundle money with advice; that way World Bank management has skin in the game on the success of a major investment. Moreover, for China the process of borrowing and implementing World Bank projects brings lessons on how to manage procurement, avoid corruption, develop high standards of project analysis, and avoid costly environmental and social risks. In addition, the central government as gatekeeper to the World Bank (and the Asian Development Bank) manages a healthy competition among state and local governments; only high-value proposals consistent with central government priorities get approval to open negotiations with the outside lender.
Why does the World Bank want to lend?
And the World Bank wants to lend—especially to China. The hard window of the World Bank, as in any bank, has to pay for itself if its development mission is to be sustained and furthered. Having “strong” as well as “weak” borrowers is at the heart of its business model as a collective cooperative or global club for lending. China’s risk of default is low, and it’s a big economy; the transaction costs of doing big loans to big economies are in general lower than for most other borrowers. Net income from lending to China thus helps subsidize the higher costs and greater risks of lending to smaller and less financially hefty borrowers. In addition there is the argument that the bank benefits in non-financial ways from its work in China--quoting President Kim—that “the lessons we learn in China…are very helpful to other middle income countries”. Finally, the Bank argues that 73 percent of the world’s poor (using the $1.90 a day line of absolute poverty) live in middle-income countries; and though fewer than 2 percent of China’s population is estimated to live below the poverty line now, median consumption is still surprisingly low, at $7.66 per person per day compared for example to Poland at $14.20, until recently another large, middle-income borrower.
Is it just China? What else is motivating the US position?
First, a recapitalization would require the Trump Administration to ask Congress for money. To add $40 billion of paid-in capital to the bank’s current ledger (which would more or less double its current equity capital would require Congress come up with about $6 billion (given its 15.9 percent share in total ownership of the bank)—not a huge amount but politically a heavy lift for an administration arguing the US bears too much of the burden of global peace and security. Even during the Obama Administration, US Treasury sought to keep capital increases at the MDBs to a minimum, even as they acknowledged the need for more capital following aggressive MDB counter-cyclical lending in the face of the global financial crisis.
Second, there is ideology to consider. In 2000, in the waning days of the Clinton Administration, the Republican majority of the members of the “Meltzer” Commission recommended the World Bank end lending to “middle-income” countries on the grounds that those countries had adequate access to foreign capital markets—similar to today’s discussion, and that therefore the World Bank and the other multilateral banks were competing with private capital. (With the subsequent election of Republican George Bush in 2000, the resulting discussion and debate was worrying for supporters of the World Bank’s business model and its development mission in the US and Europe, and for middle-income countries who wanted continued access to loans on the better terms the multilaterals provided, and motivated this report of the Carnegie Endowment for International Peace criticizing the Meltzer commission analysis—and with recommendations I invoke below.)
And third, China is special. Why not formally “graduate” Poland and other borrowers with income per capita higher than China? China’s huge economy makes it a geopolitical power that now rivals the US—and then there is the Trump Administration unhappiness with China’s persistent trade surplus with the US.
Moreover, the US has the stronger hand in any negotiation—with President Kim and with other country shareholders
Why? The US’s 15.9 percent of the bank’s capital makes it the largest single shareholder. In principle the US could step aside and allow other countries to contribute to a recapitalization, but that would dilute its current ownership and in current circumstances, with Trump Administration support for multilateral institutions at best unclear, that might make it costlier for the World Bank to borrow. The World Bank’s AAA++ rating and resulting ultra-low costs as a borrower, depends in some unclear measure on continuing and active US support; in the end US steadfast political support is central to what the rating agencies rely on. So the World Bank needs the US in on any recapitalization.
In a sense it’s a good sign that the Trump Administration hasn’t just said no, and prefers to get something back by negotiating. Perhaps even the Trump administration doesn’t want to give up entirely the big leverage the World Bank provides in support of US foreign policy, market-driven growth, enhanced global security, reduced poverty, and in general a better world—all at bargain rates for US taxpayers.
Getting to yes: Differential pricing
The World Bank’s arguments are sensible and technocratic; the United States argument is rooted in its fiscal straits, its longstanding market (laissez-fare) orientation, more marked during Republican administrations, and the Trump Administration’s unfriendliness to its new global rival.
But both sides want to get to yes. The Trump Treasury Department is probably looking to limit the size of any recapitalization, and to see China “graduated.” The World Bank and its middle-income borrowers don’t want to accept the idea that any borrower that is otherwise in good standing can be excluded from the borrowing club, and particularly in a case where it is one or more non-borrowers that want a club member pushed out.
One way of getting to yes is for the US to take the position that it is time for the World Bank to change its pricing. At the moment, all borrowers face the same rate for any particular type of loan—the poorest IBRD countries (think Guatemala or Zimbabwe) borrow at the same rate as China. All get a subsidy in the amount of the spread between the IBRD loan and the higher cost (and terms in general, including maturity) of loans on the private market. The table below includes countries that have been or are currently among the bank’s biggest borrowers. As the table below shows, using as an example a 10-year fixed loan from IBRD of 2 percent or 200 basis points, the more costly a country’s alternative on the private market the bigger would be its subsidy were it borrowing today.
GDP per capita (current US$)
10-year fixed loan rates
Subsidy assuming World Bank lending rate of 2%
In most banks, terms of loans are related to the borrower’s creditworthiness—more risky borrowers face higher costs. But the World Bank is a development bank; it would make sense to tie the effective subsidy, whatever it is to some measure of countries’ wealth—so that the richer the country the smaller its subsidy. That form of differential pricing was a recommendation of the 2001 Carnegie Endowment report referred to above (The Role of the Multilateral Development Banks in Emerging Market Economies), co-chaired by Paul Volcker (a firm believer in encouraging countries to “graduate”) and Angel Gurria (then a former Finance and Foreign Affairs minister of Mexico and now the head of the OECD). The first recommendation of that report was that graduation should be “voluntary, but coupled with incentives to avoid prolonged dependence.”
The logic of voluntary graduation
The logic of voluntary graduation is that countries do in fact ‘self-graduate’ as the spread borrowing on the private market and borrowing from the World Bank shrinks. By the year 2000, 26 countries had done so—and demonstrating one logic of voluntary graduation, four (Korea, Malaysia, Chile and Costa Rica) had returned by 2000 to borrowing, showing voluntary graduation gives the MDBs the flexibility to respond when they are needed with counter-cyclical lending during global systemic crises. Since then many more have without fan-fare self-graduated, including apparently Poland.
The Volcker-Gurria commission wanted at the same time to avoid “prolonged dependence” and encourage countries to rely on private capital; so the World Bank and the other MDBs “should increase further the incentive to graduate by differentiating their pricing according to borrowers’ per capita income.”
That idea still makes sense, and could help the parties get to yes on a recapitalization and on graduation soon if not immediately of China.
A simple and predictable change in pricing according to per capita income would not be new at the World Bank, where already countries in the category “low-income” borrow from IDA, the soft window, at much lower rates than countries in the category “lower middle-income.” Thus, for example, Malawi and Honduras borrow at lower rates than Ghana and Paraguay. However, lower middle-income countries such as Ghana and Paraguay currently borrow at the same rates as countries in the category “upper-middle income” such as South Africa, China, and Brazil. Of the countries listed in the table above, all are “upper middle income” except India, Indonesia, and Ukraine.
As a start on differential pricing, the bank’s shareholders could agree on a different rate for the lower middle-income borrowers than for higher middle-income borrowers. For China, in the latter category, that would still mean a subsidy but a smaller one than now (see table).
Note that an increase in the cost of borrowing for all upper-middle income countries, including China and high-income Poland, would make sense in other ways. For example, it would increase the incentives inside the World Bank to minimize the delays and relatively high “hassle” costs that “strong” borrowers like China face, extracting some efficiency gains from the new pricing policy. And it would not eliminate access of countries like China to policy advice; even now some countries that have voluntarily graduated “purchase” that advice from the bank—including Chile and countries like Saudi Arabia which has never been a borrower.
Of course, a policy tying borrowing costs to per capita income would not be welcomed by upper middle-income borrowers, and the specifics would have to be negotiated not only between the US and the bank, but by all the shareholders.
But negotiating is all about in the end getting to yes—and in this case getting closer to a healthy recapitalization and a more optimal “development” use of the bank’s lending resources.