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CGD seeks to inform the US government’s approach to international development by bringing evidence to bear on questions of “what works” and proposing reforms to strengthen US foreign assistance tools.
The policies and practices of the US government wield formidable influence on global development. CGD seeks to strengthen US foreign assistance tools with evidence of “what works” and propose reforms grounded in rigorous analysis across the full range of investment, trade, technology and foreign assistance related issues. With high-level US government experience and strong research credentials, our experts are sought out by policymakers for practical ideas to enhance the US’s leading role in promoting progress for all.
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.
This week, Congress passed the African Growth and Opportunity Act and Millennium Challenge Act Modernization Act (H.R. 3445). Once signed, it will give MCC the long-awaited authority needed to pursue regional programming more effectively. The change is a technical one that will permit the agency to have multiple, concurrent compacts with a single country—allowing MCC to pursue both a standard, bilateral compact with a partner, as well as a regionally focused investment with coordinated interventions in neighboring countries. With this authority, MCC will be better placed to address cross-border constraints to growth—which is often critical and potentially very high return in many of the places the agency works.
MCC has been angling for concurrent compact authority for years. The agency first put the idea forth as a legislative priority in 2010, though at that time, it was focused on using the authority to manage pipelines and address unobligated balances. Though concurrent compacts fell down the agency’s legislative priority list for a few years after that, by 2015, MCC had turned back to the idea, this time as a critical tool to enable regionally focused programming. Now that MCC and its partner countries have the green light to think beyond national borders, how can they make the most of it?
Regional programs are much more complicated than bilateral programs, often take longer, and can carry more risk. And MCC’s particular way of doing business—working only with countries that maintain good governance and giving partner countries the lead in program identification and implementation—will add layers of complexity. The agency has undoubtedly started thinking through how it would structure a regionally focused investment using concurrent compacts. As MCC solidifies this thinking and moves to pilot initial programs, there are several questions the agency will need to answer.
How will cross-border investments be identified? Will the agency structure constraints to growth analyses specifically to look at regional issues and/or allow for a regional investment to emerge from the findings of an individual country growth diagnostic? To what extent will MCC seek to support components of pre-existing regional initiatives?
How will regional anchors outside the MCC sphere be taken into account? In most regions, the regional economic powerhouse is not an MCC partner country, due either to its income level (South Africa) or its governance quality (Nigeria), or—in the case of India—its economic size and disinterest in the kind of aid MCC offers. But these countries are likely to play an important role in regional development initiatives and cross-border economic activity. How will the agency incorporate these actors in ways that don’t involve direct funding?
How will MCC deal with suspension or termination of individual countries in a multi-country program? MCC has had to suspend, terminate, or otherwise curtail funds to a number of partner countries whose policy choices became inconsistent with MCC’s good governance requirements. The decision to pull funds is always a difficult one for MCC to make; it would be more challenging if multiple countries are involved. Would MCC suspend/terminate just the activities in the particular country? What if the economic viability of the investment were contingent upon the activities and associated reforms in the suspended/terminated country taking place?
What will the local implementation unit(s) look like? MCC’s bilateral programs are run through local implementing units, typically set up as new government units. Will the units that manage cross-border investments be new multiparty structures, or would existing country units be restructured (and expanded) to take on new roles? What structure will best manage the complexity of multiple stakeholders?
How can MCC best structure incentives across multiple parties when costs and gains are unlikely to be equally shared? In order for MCC investments to yield their expected results, partner country governments must often agree to tackle difficult reforms. These can be tough negotiations even when the gains from the investment would accrue primarily to the country in question. In a cross-border investment, costs and gains may not be equally shared. How can MCC ensure the success of multilateral negotiations when one party may have reduced incentive to undertake necessary but difficult political reforms if the benefits accrue disproportionately to another party?
These questions are complicated, as are many other issues that MCC will undoubtedly grapple with as it moves ahead. But complicated doesn’t mean prohibitive. It just means that MCC would be wise to proceed conservatively, undertaking a small number of pilots with opportunities for learning built in. Sean Cairncross, the nominee to be MCC’s new CEO, recognizes this, pointedly saying that it would be important for the agency to pursue regional investments “carefully” and “in a focused manner.” Sounds like a good plan.
International actors have criticized decisions by the Trump administration to reject the Paris Climate Accord, abandon the Trans Pacific Partnership, and withdraw from a United Nations declaration intended to protect the rights of migrants. However, there is one international body, the Paris Club, whose members may be rooting for the United States to leave. That’s because, in the absence of congressional action, continued US membership in the Paris Club could impair the economic prospects of some of the poorest countries in the world.
Some context on the Paris Club
The Paris Club, which first convened some 60 years ago, is a group of government representatives whose most important function is to negotiate agreements to reduce or relieve outstanding debt between debtor countries and Paris Club members. Over the years, the Club has concluded 433 agreements with 90 different debtor countries, with the number of agreements peaking at 24 in 1989. In recent years, as shown in the chart below, there has been little to no activity:
Paris Club Agreements by Calendar Year
In its negotiations with debtor countries, the Club operates in accordance with six principles:
Case by case: The Paris Club makes decisions on a case-by-case basis in order to tailor its action to each debtor country's individual situation.
Comparability of treatment: A debtor country that signs an agreement with the Paris Club agrees to seek comparable terms from all bilateral creditors, including non-Paris Club commercial and official creditors.
Conditionality: Agreements with debtor countries will be based on IMF reform programs that help ensure the sustainability of future debt servicing.
Consensus: Paris Club decisions cannot be taken without a consensus among the participating creditor countries.
Information sharing: Members will share views and data on their claims on a reciprocal basis.
Solidarity: All members of the Paris Club agree to act as a group in their dealings with a given debtor country.
The United States has historically played a major role in the Paris Club, due, in part, to the large number of loans and guarantees it has extended to other countries over the years. But as the result of a shift from loans to grants, US credit exposure to sovereign governments has fallen dramatically—from over $90 billion USD in 1999 to roughly $35 billion today—and much of what remains is in the form of guarantees. The number of countries that owe the United States money or have a guarantee has dropped from 135 to 85 over the same period.
US Government Credit Exposure to Official Obligors
Here’s the problem:
In cases where the US government is still a creditor, the consensus principle (cf. principle 4 above) stops any Paris Club debt negotiation from proceeding without US participation, but the United States is unlikely to participate in any agreement that requires debt reduction due to current budget constraints.
At the beginning of each negotiation process, the IMF seeks assurances (“financing assurances”) from individual Paris Club creditors that they are willing to provide the debt relief needed to fill the financing gap built into the debtor country’s IMF program (cf. principle 3 above). Historically, the US Paris Club representative has not provided such assurances without having the necessary authorization and appropriation of funds for debt reduction from Congress.
Under the Federal Credit Reform Act of 1990, an appropriation by Congress of the estimated cost of debt relief—on a net present value basis—is required for debt reduction. And there is a value for all debt owed to the United States, even if it hasn’t been serviced in decades (which is the case for several countries that currently owe money to the United States).
Unfortunately, the United States currently lacks any authorization or appropriation for debt relief so it is not in a position to provide the IMF with any financing assurances. Moreover, the outlook for future US funding isn’t great. The administration’s FY 20198 budget request seeks reduce the foreign assistance budget by almost 30 percent and there is no request to authorize debt relief. Congress, too, has shown little interest in providing funding for debt relief. Appropriators consistently rejected requests to fund the US commitment to the Multilateral Debt Relief Initiative—to the point where the Obama administration stopped asking.
What’s more, the US budget process itself creates an enormous obstacle to future US participation in Paris Club agreements. The process for formulating a budget begins almost a year before the fiscal year begins, which means that Treasury Department planners are asked to anticipate the need for funding almost two years in advance of an actual request for financing. This is at odds with events in the real world, where liquidity and solvency issues in debtor countries can evolve quickly.
To date, neither the executive nor the legislative branch have demonstrated a willingness to establish “rainy day” funds for unforeseen emergencies. In the past, this problem has been avoided by packaging a request for debt relief money as part of a large, multilateral initiative such as the Heavily Indebted Poor Country Initiative, or by including it in a supplemental budget request for an emergency, such as defense spending for Iraq or the emergency spending for Tsunami relief. But amid growing budget pressures, future debt relief cases are unlikely to be able to take advantage of these vehicles.
The United States and the Paris Club are likely to confront this US funding problem head on when a country from sub-Saharan Africa comes to the Paris Club for debt relief, whether that’s one of the three remaining HIPC Initiative countries—Sudan, Somalia, and Eritrea—or a country currently in debt distress such as Zimbabwe.
A potential nightmare scenario
In the summer of 2018, the IMF and the Government of Somalia agree on a staff-monitored program (SMP) that meets the standards needed for HIPC debt relief. Somalia fulfills the SMP requirements and requests an IMF funded program in 2019. So, in July of 2019, the IMF requests financing assurances from Paris Club members, at which point the United States refuses to provide assurances—due to the absence of authority and lack of funding—and stops Somalia from receiving debt relief despite support from every other creditor. Condemnation of the US position begins.
What can be done to prevent this nightmare scenario? I offer three potential options:
In the FY 2019 budget, Congress should re-institute language authorizing a transfer of resources from State Department to Treasury to cover the cost of bilateral debt relief. While the Treasury Department has been the US agency that has traditionally had to include the appropriation for debt relief in its budget, it makes more sense for State Department to take on this role, particularly given that Treasury has almost $2 billion USD in unmet commitments to the multilateral development banks.
Like many states have done to protect themselves from unforeseen emergencies, the executive branch should work with Congress to establish a “rainy day” fund that can be tapped when needed to cover the cost of bilateral debt relief. Congressional oversight could proceed by subjecting its use to a rigorous congressional notification process.
The executive branch and Congress should work to secure an understanding that the loans extended to countries before the Federal Credit Reform Act went into effect and which have not been serviced in decades are “uncollectible” and that no authorization and/or appropriation is required for the United States to participate in a Paris Club debt treatment agreement (the legal basis for doing this is subject to interpretation).
In the absence of one of these three options or some other creative means to address the lack of funding for bilateral debt relief, the United States will find itself in the position of preventing some of the poorest countries in the world from normalizing their relations with the international financial community—stifling their access to support for critical development needs. The administration and Congress can work in concert to avoid this truly untenable position, but if they fail, the United States may no longer be welcome in Paris.
Last week, Congress completed work on a spending package that funds the federal government through the remainder of the fiscal year. As far as development and diplomacy are concerned, the bill is an unmistakable rejection of the deep cuts proposed by the Trump administration.
Here are a few standouts from CGD’s most-watched list.
Fortifying the base
With a topline of just over $54.1 billion, the State and Foreign Operations (SFOPs) division of the bill comes in slightly higher than last year’s omnibus—though total SFOPs spending falls by just over $3 billion compared to FY 2017, when you take into account the supplemental bill signed into law in late 2016.
Figures in all tables are in millions and include funding from draft appropriations bill released in the House and Senate.
*A CBO re-estimate puts the administration’s request at closer to $40.5B.
Importantly, the bill shifts a greater share of funding to the base budget, reducing reliance on off-budget Overseas Contingency Operations (OCO) funds—which weren’t intended as an enduring budget option. This move comes at a critical time after lawmakers reportedly agreed to non-defense OCO caps of $12 billion in FY18 and $8 billion in FY19, as part of the two-year budget deal reached last month.
Protecting State and USAID
Congress jettisoned the administration’s proposal to merge a number of bilateral assistance accounts—most notably the Economic Support Fund (ESF) and USAID’s Development Assistance. It also landed on a figure for these functions that is 60 percent higher than the president’s request.
Economic Support Fund
$3,969 supplemental ESF$1,031
Assistance for Europe, Eurasia and Central Asia
$750 supplemental AEECA$157
Economic Support, Democracy, and Development Assistance
In addition, both the bill text and the accompanying explanatory statement send clear signals that Congress will be keeping close watch over the redesign process underway at the State Department and USAID. Specifically, lawmakers direct the administration to provide detailed descriptions of any planned redesign or reorganization activities, accompanied by assessments of how proposed actions would lead to greater efficiency and effectiveness, the likely impact on broader aims to advance the US national interest, cost estimates, and an accounting of staff involvement.
In a similar vein, the bill and statement include a variety of reporting requirements related to personnel levels, likely reflecting concerns over the failure to fill key vacancies at both agencies and the departure of career diplomatic staff—including a number of top officials—at the State Department.
The bill’s explanatory statement also requests ongoing consultation on USAID’s pursuit of strategic transitions—the agency’s effort to support the development of partner countries’ capacity to finance and manage their own development and eventually transition away from needing aid. Congress clearly wants to be kept in the loop, including about the metrics that will help inform decisions about whether, when, and how to begin transitioning country partnerships, the resources involved in the effort, and descriptions of transition plans. All issues of worthy of early consideration.
Interestingly, Congress provides an explicit allocation of $23 million for USAID’s Development Innovation Ventures (DIV), a venture capital-like unit that seeks to identify and rigorously test new solutions to development problems and help scale those that prove successful. (My colleagues highlighted the work of DIV in this piece on advancing the evidence agenda at the agency.) While DIV is still pursuing a number of evidence-oriented functions, it’s been operating in a more limited manner since last July, when “shifting resource constraints” prompted USAID to stop accepting new applications for funding through DIV. This move spurred conversations on Capitol Hill about the importance of DIV’s work in finding innovative ways to help the poor—and now, it appears, a new spending directive.
Responding to crises
When President Trump’s first budget request arrived, members were quick to decry significant reductions in critical accounts that support humanitarian assistance—cuts which were viewed as callous in the face of multiple complex crises. The funding levels in the final bill passed by Congress better reflect the considerable need for life-saving aid around the globe.
International Disaster Assistance
Food for Peace Title II*
*This funding is provided through the Agriculture Appropriations bill and is not tallied in the topline figure.
Migration and Refugee Assistance (MRA)
$2,431 Supplemental $300
In addition, the bill would allow ESF funding to be used to contribute to the World Bank’s Concessional Financing Facility, which was established to support middle-income countries hosting large refugee populations. As a CGD-IRC joint report notes, active engagement from development actors like the World Bank in this area is a notable change from the past, but a critical one in addressing the complex challenge of protracted displacement.
Meeting the multilateral request
As my colleague Scott Morris has pointed out, the Trump administration frequently exhibits skepticism toward multilateral engagement. While the administration’s FY18 request for US contributions to the international financial institutions largely met existing obligations, it lacked any ambition. Despite a low starting point in the House, Congress ultimately fulfilled the administration’s request and included a bit of additional funding for the Global Environment Facility. But the real test for both the administration and Congress is likely to come over the next couple of years as the World Bank’s International Development Association and a number of regional development banks and vertical funds hold replenishments.
International Financial Institutions (IFIs)
The bill’s explanatory statement includes language that could help pave the way for a future multilateral aid review. Federal agencies will be required to submit a report that includes:
1) a description of the current tools, methods, and resources, including personnel, employed by the Department of State, USAID, the Department of the Treasury, and other relevant Federal agencies, to assess the value of, and prioritize contributions to, international organizations and other multilateral entities; and (2) recommendations for the development of more effective tools and methods for evaluating United States participation in, and contributions to, such organizations and entities.
Restoring global health spending
Proving once again that US global health spending enjoys strong bipartisan support on Capitol Hill, the bill restores funding for global health programs that were shortchanged in the President’s budget request.
Global Health Programs
The bill also explicitly calls on the administration to bring together actors from across the federal government to produce a global health security strategy. My global health colleagues assure me that an infectious disease outbreak requiring substantial US action and leadership is a matter of when, not if. Advancing a proactive agenda to address the threat of future pandemics is smart policy.
In addition, where the Trump administration’s FY18 budget had zeroed out family planning and reproductive health spending, the omnibus bill ignores that completely providing level funding ($607.5 million) compared to FY17.
Development finance: continuing support, awaiting reform?
The president’s budget request for FY18 indicated the administration planned to wind down the Overseas Private Investment Corporation (OPIC). Thankfully, the administration’s position has evolved considerably since then. The omnibus bill provides a slight boost to OPIC, just as debate heats up on proposed legislation that aims to strengthen US development finance.
With growing talk of reform, the explanatory statement asks the relevant federal agencies to review and report on how best to ensure coordinated development finance that delivers development impact—building off language in the report that accompanied the House bill.
To say that John Bolton, President Trump’s latest pick for National Security advisor is a well-known UN critic would be an understatement. But it’s well worth noting that he has opinions about the IMF and the multilateral development banks too.
In a post-election opinion piece, Bolton affirmatively invoked an earlier call to shut down the IMF, made nearly twenty years ago by former US officials who had in turn been out of office for at least ten years. There’s not much value in debating the merits of the IMF today based on the institution’s performance during the Asian financial crisis circa 1998.
But I do want to focus on Bolton’s ideas about the World Bank and other multilateral development banks. Bolton argues that the development banks should be privatized, except for “the one for Africa.” (For the record, it’s called the African Development Bank). His argument is two-fold: the world is awash in private capital today, rendering the MDBs irrelevant; and, US support for the MDBs is subsidizing lending to “our competitors.”
But the panel’s conclusion was clear. We should not confuse public aims, which require public financing in some form, with the aims of private investment. This confusion also plagues President Trump’s much-touted infrastructure plan, which relies overwhelmingly on tax breaks for private firms, an approach that will likely waste public resources and not achieve its stated aims in key areas of public infrastructure like roads and bridges.
When it comes to the MDBs, the range of endeavors we call global public goods—mitigating the effects of climate change, avoiding fast-moving pandemics that can leap from poor countries to rich ones in a matter of months, working across countries to manage the flow of refugees fleeing violence in their home countries—all of these call for a response at the international level, and none can be adequately addressed by relying exclusively on private capital.
Fortunately, the MDBs have already proven themselves to be effective in these and other parts of the global development agenda. They certainly could be more effective, which is why CGD’s panel has offered a range of recommendations for reform. But removing them from the equation entirely would be devastating.
As for Bolton’s argument that the United States is subsidizing the competition by supporting the MDBs, most of the MDBs’ heavily subsidized lending and grants today go to Sub-Saharan Africa, the region that Bolton seems to be ok with supporting through the development banks.
That’s not to say that US backing, and that of other major shareholders (including China), does not act as a subsidy on the banks’ other activities. Yet, setting aside support for the very poorest countries, direct US capital contributions to the World Bank over the entire 75-year history of the institution have totaled $2.8 billion. That’s less than 10% of what the United States spends annually on foreign assistance.
Is this modest support “subsidizing” our competitors? In part, that depends on whether you see a zero-sum global economy, or one in which growth in poorer countries means new export markets for US goods and services, as well as more stable societies that are less prone to the global public “bads” that afflict the world today.
Bolton would do well to listen more closely to our military leadership, which has gone out of its way to praise the role of the MDBs in supporting the goal of avoiding military conflict. For example, as Commander of US Southern Command, Admiral James Stavridis wrote of the Inter-American Development Bank’s “tremendously positive influence” on Latin America based on what he saw on the ground in his region of operation.
US leadership at the IMF and World Bank has been essential to their strength over many decades, particularly when it comes to ensuring that they have adequate resources to do their jobs. That’s why the timing of Bolton’s pick could be particularly troubling at the World Bank, where negotiations for a capital infusion from the United States and other member countries are coming to a head. The US Treasury has already been taking a hard line with the institution, demonstrating considerable reluctance to put more money in. With Bolton at the White House, Treasury hard-liners now have a powerful ally next door.
Perhaps the least noticed, but most impactful, addition to the US foreign assistance toolkit in recent years has been the US sovereign bond guarantee (SBG). However, the Trump administration’s proposed FY 2019 budget leaves out any request for authorization of new SBGs—and it isn’t entirely clear why. As Congress begins to consider the FY19 budget request, I offer three recommendations on the SBG program so that its role in US foreign assistance going forward can be carefully considered.
A Brief History of SBGs
The genesis for the SBG program was a 1990 agreement for the United States to provide a 100 percent guarantee for loans made to Israel by the private sector. The proceeds were used to help pay for housing for a wave of new immigrants from the Soviet Union after it lifted its ban on emigration. The benefit to Israel was substantial since a US guarantee extended the full faith and credit of the US government to these loans, making them basically risk-free investments for creditors. This allowed the interest rate paid by the Israeli government to be much lower than in the absence of the US guarantee.
This guarantee was followed in 1993 by a much larger five-year $10 billion guarantee program for much the same purpose. The program size fell to US$9 billion in 1997 but then jumped to roughly $13 billion in 2003. In 2005, Congress agreed to authorize an extension of loan guarantees to Egypt and Turkey to provide a financial incentive for their cooperation and continued support for the war in Iraq. In the end, Egypt borrowed $1.25 billion under its $2 billion authorization but Turkey did not take up the offer.
In the wake of the Arab Spring, the Obama administration began using SBGs to support Tunisia and then Jordan. The program was extended to the Ukraine following the Russian invasion in early 2014. Most recently, the US provided a guarantee to Iraq in January 1997 for US$1 billion in bonds. In sum, there are now 19 outstanding guarantees to five different countries (Egypt fully repaid its loan in 2015), with a total credit exposure of a little over US$18 billion. This represents over half of US government foreign credit exposure to official obligors, compared to less than 10 percent at the end of 1997, as seen in the following chart:
SBGs Yield Big Benefits
As mentioned with respect to Israel, governments that receive the loan guarantees benefit from the interest rate savings. The 2017 five-year US-guaranteed Iraqi sovereign bond was priced at a coupon rate of 2.149 percent. A five-year non-guaranteed bond for the same amount issued in August 2017 carried a coupon price of 6.752 percent, roughly 460 basis points (4.6 percent) higher. In other words, on a US$1 billion issuance, the US guarantee provides a savings of $46 million per year.
And the beneficiary governments don’t have to do much in return for the financial benefit. Though the US government asserts that the provision of guarantees is conditioned upon economic policy reforms, the reality is that these reforms generally reflect conditions in pre-existing IMF or World Bank programs, and others are vague or not strictly applied. The conditions in the Iraq agreement are illustrative:
Condition #1: Iraq shall implement the economic reforms and prior actions necessary to obtain IMF Board approval for the first review of its Stand-By Arrangement (SBA). The first review had been completed one month before the US-Iraq agreement; this included waivers on a number of the conditions in the original SBA.
Condition #2: Iraq shall pay arrears to the Basrah Gas Company, as specified in the Memorandum of Economic and Financial Policies agreed to by Iraq as part of its Stand-By Arrangement with the IMF. This condition is basically superfluous since the first condition already says that Iraq is expected to remain in compliance with the terms of the SBA.
Condition #3: Iraq shall promote government financial transparency through publication of budget information including the most recent budget audit. The amount and nature of information disclosed does not seem to have substantively changed as a result of the guarantee.
Condition #4: Iraq shall commit to implement the proposed World Bank Public Financial Management Institutional Development and Capacity Building project. The loan agreement between Iraq and the World Bank had been signed the previous month.
Condition #5: As agreed to in the IMF Memorandum on Economic and Financial Policies, Iraq, acting through the Central Bank of Iraq, shall strengthen banking supervision operations. Again, rather superfluous since the first condition already says that Iraq is expected to remain in compliance with the SBA.
Condition #6: Iraq shall issue unenhanced sovereign bonds internationally no later than four months after the US guaranteed issuance. This is the only condition that effectively goes beyond what Iraq already had committed to under a different program. It did eventually issue unenhanced bonds in August 2017.
From the perspective of the United States, an SBG offers the advantage of providing financial support for a country at a de minimis cost to the US taxpayer. In accordance with the Federal Credit Reform Act, the US government must calculate the “subsidy cost” of the guarantee and “score” it against the foreign assistance budget authority. But if there is no default on the underlying bond, there is no outlay of taxpayer funds, so there is no impact on the budget deficit. It also provides an important political benefit to the United States.
It must be acknowledged that a beneficiary country may actually prefer receiving a grant that is equivalent in amount to the subsidy cost rather than the guarantee. For example, in the case of Iraq the subsidy cost was said to be over $250 million (the exact amount is not made public). This is more than the $230 million in interest savings the guarantee generates, even before the present value of the lower interest payments is calculated. However, a grant is not an option since the US guarantee is intended to set the stage for a non-guaranteed issuance.
But SBGs Have Some Big Drawbacks
There are two significant drawbacks to the SBG. One is that they are a contingent liability in the sense that in the event of a default on a bond payment, the bondholders would need to be made whole by the US government within a brief period. The United States, in turn, would become a creditor to the defaulting government and would need to seek authorization and appropriation for any cost associated with any subsequent debt treatment negotiated by the Paris Club. The other drawback is that the United States has absolutely no control over how the funds are used by the beneficiary government. In a worst-case scenario, the beneficiary government changes to one that is hostile to the United States and the proceeds of a US guaranteed bond are used to support activities or investments counter to US interests.
Recommendations to Guide the Future of SBGs
Given the potential costs and benefits of the SBG, I suggest the congressional committees with jurisdiction over US foreign assistance take the following three actions:
Ask the Government Accountability Office to undertake a thorough review of the costs and benefits of US sovereign loan and bond guarantees that have already been extended, and an assessment of the advantages and disadvantages of applying the instrument more broadly.
If the findings of the GAO report are generally favorable and Congress finds merit in continued use of SBGs, draft legislation authorizing an SBG program on a permanent basis. Such legislation could spell out the parameters for use of any guarantees as well as the institutional structure for administering and managing the program.
Regardless of whether the first and second actions are taken, Congress should insist that USAID report on the performance and impact of the SBG on a regular basis, in accordance with the Foreign Aid Transparency and Accountability Act of 2016. As it stands, there is no publicly available information on the extent to which the beneficiary governments are adhering to the conditions associated with the individual guarantees, nor any information on how the guarantees are benefiting the United States on an ongoing basis.