A proposal for a World Bank led Trust Fund dedicated to countries having addressed their debt distress situations and confronted to the needs to enhance growth recovery and prioritize green transition projects.
The war in Ukraine, the second major global shock in less than two years had particularly large effects on developing countries. Accelerating inflation, exchange rate depreciation and declining private inflows have put considerable pressures on already fragile macroeconomic frameworks.
As a result, debt crises will continue to accelerate and move from relatively small economies to larger emerging markets. Yet, as recent experiences have shown, debt restructuring tends to be a slow and uncertain process, subject to both geopolitical disputes and brinkmanship as well as complex dynamics with private creditors.
Countries that have gone through holistic debt restructuring processes generally continue to operate under tight fiscal constraints for a certain number of years. The post-restructuring fiscal consolidation period is often coupled with limited access to international finance related to a scarcity of affordable sources of funding compatible with the contemplated debt trajectory. This may affect the conduct of growth enhancing projects essential for the countries to pursue their green transition and/or create jobs. The difficulty to bounce back from a restructuring explains why countries tend to delay the reckoning, often increasing long-term costs.
This note argues that the World Bank could play a much more important role in unlocking new financing for post-debt restructuring countries to foster a more growth and resilience-enhancing path. We propose to build on the new “Crisis Facility” set-up by the World Bank last month in order to meet the budget short-falls of the Crisis Response Window, with more ambitious targets, but also more ambitious impact which could appeal to donors.
In previous notes, the Finance for Development Lab argued that 1. IDA’s financing model is at risk due to its exposure to countries at high-risk of debt distress, shifting its commitments from credits to grants and making it less sustainable; 2. That IDA financing for high-risk countries was less effective when other creditors tend to obtain more debt service than new loans, thus equivalent of a soft bailout by the World Bank; 3. That the World Bank could provide more new loans for countries in restructuring to unlock the stalemate between Paris Club creditors, China, and private creditors, provided those creditors accept deep enough haircuts restoring debt sustainability.
How would the World Bank deliver new funds?
First, the Fund would constitute the sole instrument through which Multilateral Development Banks (MDBs) participate in debt restructuring processes. Such an initiative would contribute to moving away from the interpretation of MDBs Preferred Creditor Status as not respecting “Comparability of Treatment”, to a fairer interpretation of Comparability of Treatment that take grant elements and the amount of new money provision into consideration. In that perspective, it could resolve the protracted debt restructuring processes we have been witnessing over the last three years while preserving MDBs preferred creditor status.
Second, this kind of surge funding would not be allocated arbitrarily but conditional on a successfully debt restructuring. In doing so, it would not substitute for the need of a rapid growth in the balance sheet of IDA, but provide a resource for countries in debt distress. It would not seek to substitute to needed debt restructuring but to provide post program funding. This could be achieved by funding specific projects with high public returns such as climate adaptation.
Third, this is initiative would also come as way to address the urgent call from debtor countries to have the appropriate means to grow out of debt in post restructuring contexts and meant their developmental imperatives. A reform of IMF program frameworks could support such an evolution, as argued by Reza Baqir, Ishac Diwan and Dani Rodrik.
Fourth, under reasonable hypotheses on losses by other creditors, we estimate that new required IDA financing would be between $2 and $5 billion over three years, according to our calculations considering the ability to leverage donor contributions. In other words, this would be in line with current fundraising efforts.
A risk is, of course, that this initiative would be used to provide existing creditors eligible to the restructuring with more generous terms?
On the one hand, providing additional concessional financing would alleviate Balance of Payment and fiscal constraints . On the other hand, these funds are supposed to be additive to the existing identified mix and therefore impact external debt and debt service indicators. The channel through we would like to see this facility affect the restructuring terms is mainly through growth. Therefore, the growth impact will be a key selection factor. the amounts and the type of projects financed by this new lending should be calibrated such that its net impact on the interest rate/growth differential is negative (r-g<0).
The underlying operational obligation is that the positive impact of the external and fiscal constraints outweighs the additional burden on the DSA indicators, up to a certain quantum of IDA funding.
Alternatively, we could envisage that such post-programme funding would not be accounted for in the programme DSA (neither in the needs related to the projects, nor in the financing), to ensure additionality.