Term Paper on Activities of World Bank
Subject: Finance | Topics:

Main purpose of this term paper is to analysis Activities of World Bank. Basically this term paper is to provide a synopsis of the World Bank’s activities related to international finance. Other objectives are to analyze on the issue International Finance and to disclose the precise scenario of the ‘World Bank’. Finally analyze and recommend on the mentioned issues.

 

Objective

The general objective of this term paper is to provide a synopsis of the World Bank’s activities related to international finance. It is also required for the completion of this course. Beside the general objective, the objectives behind this term paper are given below:

Main Objective:

The primary objective of the term paper is—

  • To analyze on the issue International Finance.
  • To disclose the precise scenario of the ‘World Bank’
  • To analyze and recommend on the mentioned issues.

Specific Objectives

The secondary objective to prepare this term paper is—

  • To fulfill the requirements of my course “International Finance”
  • To Relate World Bank activities with the issues covered in my course.
  • To gather experience and knowledge of preparing a professional term paper.

 

Methodology

This term paper covers the different aspects and activities that are required to make a term paper on ‘World Bank’. However, the term paper is prepared based upon the information collected from several books, journals, articles, magazines, annual term papers, the researcher’s own judgments and basically from the Internet. The findings are strictly structured upon information provided by these sources and some secondary sources. The focus here is on presentation of facts as discovered.

The methods that I followed to prepare the term paper are as follows:

  • At first I took the main issues studied in this course.
  • I clicked on the website of World Bank.
  • Related the issues studied with the World Bank activities.
  • Studied several books, articles, newspapers, and other secondary sources..
  • Collected information related to this term paper and the topic.
  • I have discussed with my honorable course instructor.

 

The Bank

Introduction

The World Bank is a vital source of financial and technical assistance to developing countries around the world. It is not a bank in the common sense. It is made up of two unique development institutions owned by 185 member countries—the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA).

Each institution plays a different but supportive role in its mission of global poverty reduction and the improvement of living standards. The IBRD focuses on middle income and creditworthy poor countries, while IDA focuses on the poorest countries in the world. Together they provide low-interest loans, interest-free credit and grants to developing countries for education, health, infrastructure, communications and many other purposes.

The World Bank differs from the World Bank Group in that the former comprises only the International Bank for Reconstruction and Development and the International Development Association, while the latter incorporates these entities in addition to three others. The World Bank was formally established on December 27, 1945, following the ratification of the Bretton Woods agreement. The concept was originally conceived in July 1944 at the United Nations Monetary and Financial Conference. Two years later, the Bank issued its first loan: $250 million to France for post-war reconstruction, the main focus of the Bank’s work in the early post-World War II years. Over time, the “development” side of the Bank’s work has assumed a larger share of its lending, although it is still involved in post-conflict reconstruction, together with reconstruction after natural disasters, response to humanitarian emergencies and post-conflict rehabilitation needs affecting developing and transition economies.

 

The World Bank Group

Working for a World Free Poverty

The World Bank group consists of the five closely associated institutions, all owned by member countries that carry ultimate decision-making power. Each institution plays a distinct role in the mission to fight poverty and improve living standards for people in the developing world. The team World Bank Group encompasses all five institutions. The term “World Bank” refers specially to two of the five, IBRD and IDA.

Annual Meetings

Each autumn, the Boards of Governors of the World Bank Group and International Monetary Fund (IMF) hold their Annual Meetings to discuss a range of issues related to poverty reduction, international economic development and finance. The Annual Meetings provide a forum for international cooperation and enable the Bank and Fund to better serve their member countries.

The Annual Meetings traditionally are held in Washington two years out of three and, in order to reflect the international character of the two institutions, every third year in a different member country. In addition to the meetings of the Boards of Governors, the Development Committee and the International Monetary and Financial Committee are officially convened.

Around these meetings, the Bank and the IMF organize a number of fora to facilitate the interaction of governments and Bank-IMF staff with non-governmental organizations (NGOs), journalists, and the private sector. Indeed, every effort is made to ensure that the Annual Meetings provide an effective forum for explaining to the public – directly and through the media – the tasks, objectives, and outcomes of the work of the Bank and the IMF. In this manner, the Meetings make a major contribution to openness and transparency.

About 10,000 people attend the meetings, including about 3,500 members of delegations from the member countries of the Bank and the IMF, roughly 1,000 representatives of the media, and more than 5,000 visitors and special guests drawn primarily from private business, the banking community and NGOs. In addition, Bank and IMF staff participate in the meetings with officials of government delegations.

Activities

The World Bank is one of the two Bretton Woods Institutions which were created in 1944 to rebuild a war-torn Europe after World War II. Later, largely due to the contributions of the Marshall Plan, the World Bank was forced to find a new area in which to focus its efforts. Subsequently, it began attempting to rebuild the infrastructure of Europe’s former colonies. Since then it has made a variety of changes regarding its focus and goals. From 1968-1981 it focused largely on poverty alleviation. From the ’80s and into the 1990s its main focus was both debt management and structural adjustment. Today the focus is on the achievement of the Millennium Development Goals (MDGs), goals calling for the elimination of poverty and the implementation of sustainable development. Of the two constituent parts of the Bank, the IBRD lends primarily to “middle-income countries” at interest rates which reflect a small mark-up over its own (AAA-rated) borrowings from capital markets; while the IDA provides low or no interest loans and grants to low income countries with little or no access to international credit markets. The IBRD is a market based non-profit organization, using its high credit rating to make up for the relatively low interest rate on its loans, while the IDA is funded primarily by periodic “replenishments” (grants) voted to the institution by its more affluent member countries.

The Bank obtains funding for its operations primarily through the IBRD’s sale of AAA-rated bonds in the world’s financial markets. The IBRD’s income is generated from its lending activities, with its borrowings leveraging its own paid-in capital, plus the investment of its “float”. The IDA obtains the majority of its funds from forty donor countries who replenish the bank’s funds every three years, and from loan repayments, which then become available for re-lending.

The Bank offers two basic types of loans: investment loans and development policy loans. The former are made for the support of economic and social development projects, whereas the latter provide quick disbursing finance to support countries’ policy and institutional reforms. While the IBRD provides loans with a relatively low interest rate, the IDA’s “credits” are interest free. The project proposals of borrowers are evaluated for their economical, financial, social and environmental aspects prior to their approval.

The Bank also distributes grants for the facilitation of development projects through the encouragement of innovation, cooperation between organizations and the participation of local stakeholders in projects. IDA grants are predominantly used for:

  • Debt burden relief in the most indebted and poverty struck countries
  • Amelioration of sanitation and water supply
  • Support of vaccination and immunization programs for the reduction of communicable diseases such as malaria
  • Combating the HIV/AIDS pandemic
  • Support civil society organizations
  • Creating initiatives for the reduction of greenhouse gases

The Bank not only provides financial support to its member states, but also analytical and advisory services to facilitate the implementation of the lasting economic and social improvements that are needed in many under-developed countries, as well as educating members with the knowledge necessary to resolve their development problems while promoting economic growth.

 

Areas of Operation

The World Bank is active in the following areas

Agriculture and Rural DevelopmentLaw and Justice
Conflict and DevelopmentMacroeconomic and Economic Growth
Development Operations and ActivitiesMining
Economic PolicyPoverty Reduction
EducationPoverty
EnergyPrivate Sector
EnvironmentPublic Sector Governance
Financial SectorRural Development
GenderSocial Development
GovernanceSocial Protection
Health, Nutrition and PopulationTrade
IndustryTransport
Information and Communication TechnologiesUrban Development
Information, Computing and TelecommunicationsWater Resources
International Economics and TradeWater Supply and Sanitation
Labor and Social Protections 

 

International Bank for Reconstruction and Development (IBRD)

Introduction

Founded in 1944 to help Europe recover from World War II, the International Bank for Reconstruction and Development (IBRD) is one of five institutions that make up the World Bank Group. IBRD is the part of the World Bank (IBRD/IDA) that works with middle-income and creditworthy poorer countries to promote sustainable, equitable and job-creating growth, reduce poverty and address issues of regional and global importance.

Structured something like a cooperative, IBRD is owned and operated for the benefit of its 185 member countries. Delivering flexible, timely and tailored financial products, knowledge and technical services, and strategic advice helps its members achieve results. Through the World Bank Treasury, IBRD clients also have access to capital on favorable terms in larger volumes, with longer maturities, and in a more sustainable manner than world financial markets typically provide.

Specifically, the IBRD:

  • supports long-term human and social development needs that private creditors do not finance;
  • preserves borrowers’ financial strength by providing support in crisis periods, which is when poor people are most adversely affected;
  • uses the leverage of financing to promote key policy and institutional reforms (such as safety net or anticorruption reforms);
  • creates a favorable investment climate in order to catalyze the provision of private capital;
  • provides financial support (in the form of grants made available from the IBRD’s net income) in areas that are critical to the well-being of poor people in all countries.

Middle-income countries, where 70 percent of the world’s poor live, have made profound improvements in economic management and governance over the past two decades and are rapidly increasing their demand for the strategic, intellectual and financial resources the World Bank has to offer. The challenge facing the IBRD is to better manage and deliver its resources to best meet the needs of these countries.

To increase its impact in middle-income countries, IBRD is working closely with the International Finance Corporation (IFC), the Multilateral Investment Guarantee Agency (MIGA), the International Monetary Fund (IMF) and other multilateral development banks. In the course of its work, IBRD is also striving to capitalize on middle-income countries’ own accumulated knowledge and development experiences and collaborates with foundations, civil society partners and donors in the development community.

The International Bank for Reconstruction and Development (IBRD) aims to reduce poverty in middle-income and creditworthy poorer countries by promoting sustainable development through loans, guarantees, risk management products, and analytical and advisory services. Established in 1944 as the original institution of the World Bank Group, IBRD is structured like a cooperative that is owned and operated for the benefit of its 185 member countries.

IBRD raises most of its funds on the world’s financial markets and has become one of the most established borrowers since issuing its first bond in 1947. The income that IBRD has generated over the years has allowed it to fund development activities and to ensure its financial strength, which enables it to borrow at low cost and offer clients good borrowing terms.

At its Annual Meeting in September 2006, the World Bank — with the encouragement of its shareholder governments — committed to make further improvements to the services it provides its members. To meet the increasingly sophisticated demands of middle-income countries, IBRD is overhauling financial and risk management products, broadening the provision of free-standing knowledge services and making it easier for clients to deal with the Bank.

 

International Development Association (IDA)

What is IDA?

The International Development Association (IDA) is the part of the World Bank that helps the world’s poorest countries. Established in 1960, IDA aims to reduce poverty by providing interest-free credits and grants for programs that boost economic growth, reduce inequalities and improve people’s living conditions.

IDA complements the World Bank’s other lending arm–the International Bank for Reconstruction and Development (IBRD)–which serves middle-income countries with capital investment and advisory services. IBRD and IDA share the same staff and headquarters and evaluate projects with the same rigorous standards.

IDA is one of the largest sources of assistance for the world’s 78 poorest countries, 39 of which are in Africa. It is the single largest source of donor funds for basic social services in the poorest countries.

IDA lends money (known as credits) on concessional terms. This means that IDA credits have no interest charge and repayments are stretched over 35 to 40 years, including a 10-year grace period. IDA also provides grants to countries at risk of debt distress.

Since its inception, IDA credits and grants have totaled US$182 billion, averaging US$10 billion a year in recent years and directing the largest share, about 50 percent, to Africa.

IDA at Work

In Bangladesh, the number of girls in secondary schools has more than tripled in 15 years thanks to tuition stipends. IDA helped take forward a government program on a major scale and introduced a transparent and innovative direct funding mechanism, replicated elsewhere since.

In Armenia, IDA’s judicial reform program helped put in place the building blocks for a modern judiciary. Twelve new or renovated courthouses, case management software, a revamped judicial training program and a TV show popularizing legal rights helped restore a measure of trust in the judiciary. A follow-up project aims to tackle remaining corruption.

In Nicaragua, IDA flexibility made it possible to quickly restructure an ongoing road project to tackle urgent needs following the devastation of Hurricane Mitch. A section of the Pan American highway, the country’s main route for exports, was restored, as well as over 3,000 km of roads reconnecting rural communities and rekindling a stalled economy.

In Tanzania, credit to the private sector increased by 250 percent in 6 years. IDA financed the transformation of the largest state-owned savings bank into a private microfinance bank, improving access by small and micro entrepreneurs to the fomal financial system.

In Vietnam, bringing electricity to 2.7 million people has transformed rural communities. A six-year IDA-supported rural energy project helped extend the national grid. Its long-term involvement in the power sector supports the government’s broader electrification program.

 

International Finance Corporation (IFC)

Reducing Poverty, Improving Lives

Introduction

IFC is in the business of creating opportunity and improving lives in developing countries. This brochure summarizes IFC’s vision, values, and what sets it apart. It highlights IFC’s financial products and advisory services, which offer businesses and entrepreneurs in the developing world the tools they need to meet the challenges of the global marketplace.

IFC’s Vision, Values, & Purpose:

IFC’s vision is that people should have the opportunity to escape poverty and improve their lives.

IFC’s values are excellence, commitment, integrity, and teamwork.

IFC’s purpose is to:

  • Promote open and competitive markets in developing countries
  • Support companies and other private sector partners
  • Generate productive jobs and deliver basic services
  • Create opportunity for people to escape poverty and improve their lives Their Shared

Mission

IFC, as the private sector arm of the World Bank Group, shares its mission:

“To fight poverty with passion and professionalism for lasting results. To help people help themselves and their environment by providing resources, sharing knowledge, building capacity, and forging partnerships in the public and private sectors.”

The Organization

IFC coordinates its activities with the other institutions of the World Bank Group but is legally and financially independent.

Ownership & Governance

IFC’s 179 member countries provide its authorized share capital of $2.4 billion, collectively determine its policies, and approve investments.

IFC’s member countries, through a Board of Governors and a Board of Directors, guide IFC’s programs and activities. Each country appoints one governor and one alternate.

IFC corporate powers are vested in the Board of Governors, which delegates most powers to a board of 24 directors. Voting power on issues brought before them is weighted according to the share capital each director represents.

The directors meet regularly at World Bank Group headquarters in Washington, DC, where they review and decide on investment projects and provide overall strategic guidance to IFC management.

Directors also serve on one or more standing committees, which help the Board discharge its oversight responsibilities by examining policies and procedures in depth. The Audit Committee advises on financial and risk management, corporate governance, and oversight issues. The Budget Committee considers business processes, administrative policies, standards, and budget issues that have a significant impact on the cost-effectiveness of Bank Group operations.

The Committee on Development Effectiveness focuses on operations and policy evaluation and development effectiveness with a view to monitoring progress on poverty reduction. The Personnel Committee advises on compensation and other significant personnel policies. Directors also serve on the Committee on Governance and Executive Directors’ Administrative Matters.

Doing Business with IFC

IFC, a member of the World Bank Group, fosters sustainable economic growth in developing countries by financing private sector investment, mobilizing private capital in local and international financial markets, and providing advisory and risk mitigation services to businesses and governments. IFC’s vision is that poor people have the opportunity to escape poverty and improve their lives. In fiscal 2007, IFC committed $8.2 billion and mobilized an additional $3.9 billion through loan participations and structured finance for 299 investments in 69 developing countries. IFC also provided advisory services in 97 countries.

How to Apply for IFC Financing and Services

A company or entrepreneur seeking to establish a new venture or expand an existing enterprise can approach IFC directly. The investment proposal can be submitted to the IFC field office that is closest to the location of the proposed project. IFC operates on a commercial basis. It invests exclusively in for-profit projects, fully shares risks with its partners, and charges market rates for its products and services. These cover three broad areas:

Financial products. IFC’s traditional and largest activity is to finance private sector projects in developing countries. IFC provides loans, equity finance, and quasi-equity. It also offers financial risk management products and intermediary finance.

Advisory services. IFC provides advisory services to private businesses and governments in developing countries. Areas include privatization, business-related public policy, and industry-specific issues.

Resource mobilization. IFC helps companies in developing countries tap into international capital markets. This effort includes the loan participation program, which arranges syndicated loans from banks, as well as structured finance transactions.

 

IFC’s Added Value

A unique role. Although IFC lends on market terms, it does not compete with, but complements, private capital. IFC is a long-term partner for good and bad times. IFC invests in projects that meet its investment criteria, but that cannot get financing or technical expertise elsewhere on reasonable terms.

Relationships and experience. IFC has extensive knowledge of how to do business in developing countries and excellent relationships with developing country governments. As an independent international organization, IFC can help companies and sponsors negotiate with host governments.

Expertise on sustainability. By working with IFC, companies draw on the expertise and reputation of a partner recognized for its strong social and environmental safeguards. Companies worldwide are recognizing that long-term profitability is best enhanced when investments are made in a sustainable way.

Project Eligibility

The project must be located in a developing country that is a member of IFC.

  • It must be in the private sector.
  • It must be technically sound.
  • It must have good prospects of being profitable.
  • It must benefit the local economy.
  • It must be environmentally and socially sound, satisfying IFC standards and those of the host country.

Products & Services

IFC is a dynamic organization, constantly adjusting to the evolving needs of their clients in emerging markets. They are no longer defined predominantly by their role in providing project finance to companies in developing countries. They have also:

  • Developed innovative financial products
  • Broadened their capacity to provide advisory services
  • Deepened their corporate governance, environmental and social expertise

IFC Project Cycle

IFC offers a wide variety of financial products to private sector projects in developing countries. The project cycle illustrates the stages a business idea goes through as it becomes an IFC-financed project.

Stages of the Project Cycle

Application for IFC Financing

  • There is no standard application form for IFC financing. A company or entrepreneur, foreign or domestic, seeking to establish a new venture or expand an existing enterprise can approach IFC directly. This is best done by reading how to apply for financing and by submitting an investment proposal.
  • After these initial contacts and a preliminary review, IFC may proceed by requesting a detailed feasibility study or business plan to determine whether or not to appraise the project.

Project Appraisal

  • Typically, an appraisal team consists of an investment officer with financial expertise and knowledge of the country in which the project is located, an engineer with the relevant technical expertise, and an environmental specialist.
  • The team is responsible for evaluating the technical, financial, economic and environmental aspects of the project. This process entails visits to the proposed site of the project and extensive discussions with the project sponsors.
  • After returning to headquarters, the team submits its recommendations to senior management of the relevant IFC department.
  • If financing of the project is approved at the department level, IFC’s legal department, with assistance from outside counsel as appropriate, drafts appropriate documents.
  • Outstanding issues are negotiated with the company and other involved parties such as governments or financial institutions.

Public Notification

  • Before the proposed investment is submitted to the IFC Board for review, the public is notified of the main elements of the project. Environmental review documents are also made available to the public.

Board Review and Approval

  • The project is submitted to IFC’s Board of Directors, which reviews the proposed investment.

Resource Mobilization

  • IFC seeks to mobilize additional finance by encouraging other institutions to make investments in the project.

Legal Commitment

  • If the investment is approved by the Board, and if stipulations from earlier negotiations are fulfilled, IFC and the company will sign the deal, making a legal commitment.

Disbursement of Funds

  • Funds are disbursed under the terms of the legal commitment signed by all parties.

Project Supervision

  • Once funds have been disbursed, IFC monitors its investments closely. It consults periodically with management, and it sends field missions to visit the enterprise. It also requires quarterly progress reports together with information on factors that might materially affect the enterprise in which it has invested, including annual financial statements audited by independent public accountants.

Closing

  • When an investment is repaid in full, or when IFC exits an investment by selling its equity stake, IFC closes its books on the project.

 

Multilateral Investment Guarantee Agency (MIGA)

Introduction

Acting Executive Vice President: James Bond

As a member of the World Bank Group, MIGA’s mission is to promote foreign direct investment (FDI) into developing countries to help support economic growth, reduce poverty, and improve people’s lives.

MIGA and FDI

Concerns about investment environments and perceptions of political risk often inhibit foreign direct investment, with the majority of flows going to just a handful of countries and leaving the world’s poorest economies largely ignored. MIGA addresses these concerns by providing three key services: political risk insurance for foreign investments in developing countries, technical assistance to improve investment climates and promote investment opportunities in developing countries, and dispute mediation services, to remove possible obstacles to future investment.

MIGA’s operational strategy plays to their foremost strength in the marketplace attracting investors and private insurers into difficult operating environments. The agency’s strategy focuses on specific areas where they can make the greatest difference:

Infrastructure development is an important priority for MIGA, given the estimated need for $230 billion a year solely for new investment to deal with the rapidly growing urban centers and underserved rural populations in developing countries.

Frontier markets—high-risk and/or low-income countries and markets—represent both a challenge and an opportunity for the agency. These markets typically have the most need and stand to benefit the most from foreign investment, but are not well served by the private market.

Investment into conflict-affected countries is another operational priority for the agency. While these countries tend to attract considerable donor goodwill once conflict ends, aid flows eventually start to decline, making private investment critical for reconstruction and growth. With many investors wary of potential risks, political risk insurance becomes essential to moving investments forward.

South-South investments (investments between developing countries) are contributing a greater proportion of FDI flows. But the private insurance market in these countries is not always sufficiently developed and national export credit agencies often lack the ability and capacity to offer political risk insurance.

MIGA offers comparative advantages in all of these areas—from their unique package of products and ability to restore the business community’s confidence, to their ongoing collaboration with the public and private insurance market to increase the amount of insurance available to investors.

Their Added Value

Confidence, security, and credibility. MIGA gives private investors the confidence and comfort they need to make sustainable investments in developing countries. As part of the World Bank Group, and having as their shareholders both host countries and investor countries, MIGA brings security and credibility to an investment that is unmatched. Their presence in a potential investment can literally transform a “no-go” into a “go.” They act as a potent deterrent against government actions that may adversely affect investments. And even if disputes do arise, their leverage with host governments frequently enables us to resolve differences to the mutual satisfaction of all parties.

Market Leader

MIGA is a leader when it comes to assessing and managing political risks, developing new products and services, and finding innovative ways to meet client needs. But they don’t stop there. They also provide expert advice to help countries attract and retain quality foreign investment, and a host of online services to make sure investors know about business opportunities in their developing member countries.

Complex Deals

MIGA can be the difference between make or break, by providing that all-critical lynchpin that enables a complex transaction to go ahead. MIGA offers innovative coverage of the nontraditional sub-sovereign risks that often accompany water and other infrastructure projects. They can also cover interest rate hedging instruments, as they did for a power project in Vietnam, as well as provide capital markets guarantees, which they recently did for residential mortgage-backed securities in Latvia.

PRI Market

MIGA complements the activities of other investment insurers and works with partners through its coinsurance and reinsurance programs. By doing so, they are able to expand the capacity of the political risk insurance industry to insure investments, as well as to encourage private sector insurers into transactions they would not have otherwise undertaken.

Their Development Impact and Priorities

Since its inception in 1988, MIGA has issued nearly 900 guarantees worth more than $17.4 billion for projects in 96 developing countries. MIGA is committed to promoting socially, economically, and environmentally sustainable projects that are above all, developmentally responsible. They have widespread benefits, for example, generating jobs and taxes, and transferring skills and know-how. Local communities often receive significant secondary benefits through improved infrastructure. Projects encourage similar local investments and spur the growth of local businesses. They ensure that projects are aligned with World Bank Group country assistance strategies, and integrate the best environmental, social, and governance practices into their work.

MIGA specializes in facilitating investments in high-risk, low-income countries—such as in Africa and conflict-affected areas. By partnering with the World Bank and others, MIGA is able to leverage finance for guarantee trust funds in these difficult or frontier markets. The agency also focuses on supporting complex infrastructure projects and promoting investments between developing countries.

MIGA’s technical assistance services also play an integral role in catalyzing foreign direct investment by helping developing countries define and implement strategies to promote investment. MIGA develops and deploys tools and technologies to support the spread of information on investment opportunities. Thousands of users take advantage of their suite of online investment information services, which complement country-based capacity-building work.

The agency uses its legal services to further smooth possible impediments to investment. Through its dispute mediation program, MIGA helps governments and investors resolve their differences, and ultimately improve the country’s investment climate.

 

Issues Covered

The International Financial Environment

  • Multinational Financial Management
  • International Flow of Funds
  • International Financial Markets
  • Exchange Rate Determination
  • Currency Derivatives

Exchange Rate Behavior

  • Government Influence on Exchange Rates
  • International Arbitrage and Interest rate parity
  • Relationships among Inflation, Interest Rate, and Exchange Rates

Exchange Rate Risk Management

  • Forecasting Exchange Rates
  • Measuring Exposure to Exchange Rates
  • Managing Transaction Exposure
  • Managing Economic Exposure and Translation Exposure

Asset and Liability Management: Long Term and Short Term

  • Direct Foreign Investment
  • Multinational Capital Budgeting
  • Multinational Restructuring
  • Country Risk Analysis
  • Multinational Cost of Capital and Capital Structure
  • Long Term Financing
  • Financing International Trade
  • Short Term Financing
  • International Cash management

 

 

The International Financial Environment

Trade and International Integration

The distinguishing feature of the World Bank work on international trade is that it is an integral part of the Bank’s work on development and poverty reduction. The World Bank assists developing countries to formulate liberal trade policies expressly in their process of development and poverty reduction and provides technical assistance or policy advice to the governments towards an open trade regime. The Bank undertakes research to better understand the role of international trade in development and poverty reduction. The Bank has also contributed significantly to the development of techniques and policy tools for analyzing the impact of trade policy reforms. At the same time, the World Bank through policy-based loans has supported trade reforms in many developing countries, such as reduction of tariffs, elimination of quantitative restrictions or improvement of foreign exchange systems, etc.

This website focuses on recent and on-going research on international trade in the Bank. In addition, through the main trade website the World Bank disseminates and provides training in best practice and cross-country experience in the area of trade policy.

Trade and Competitiveness

Washington, June 17, 2008 – A new database and ranking tool unveiled today by the World Bank shows that in 2007 most developing countries continued to improve trade policies supporting greater integration. Data in the World Trade Indicators 2008 – Benchmarking Policy and Performance, produced by the World Bank Institute, also show that, over the past decade, countries with lower barriers tended to have stronger, more consistent trade and export performance.

While high-income countries still have the world’s lowest tariff barriers, many developing countries are converging rapidly. Georgia, Haiti, Armenia and Mauritius, are among the 10 countries having the lowest tariffs as measured by the simple average MFN tariff. Neither the European Union nor Japan is among the top 10.

Developing countries showing large declines in import restrictions since the beginning of this decade include Egypt, which reduced its average MFN tariff from 47 to 17 percent; the Seychelles, dropping its average tariff from 28 to eight percent; India, reducing from 32 to 15 percent; and Mauritius, which reduced its average from 18 to just 3.5 percent.

These observations emerge from the World Trade Indicators (WTI), a unique new database and ranking tool that allows benchmarking and comparisons among 210 countries and customs territories, across multiple trade-related indicators. The easy-to-use web-based tool is aimed at helping policymakers, negotiators and researchers assess each country’s performance relative to others’ as well as relative to its historical achievements.

The Indicators show the Middle East and North Africa, South Asia, and Sub-Saharan Africa to be the developing regions with the highest average tariffs. About half of the countries among the 20 having the highest tariffs are in Africa.

But WTI data also show that high-income countries still have much higher maximum tariffs than low-income ones. High tariff peaks also remain in the sectors of greatest export interest to many developing countries.

Services trade liberalization could deliver large benefits, but movement has been slow in this area, especially in low-income countries. Locking in current levels of liberalization through the General Agreement on Trade in Services (GATS) would be an important first step towards a more ambitious reform agenda, especially for low-income countries. Improvements in low-income countries’ domestic institutions would boost their export performance, particularly in manufacturing and services, and help support new markets and new products. With trade costs now higher than tariffs in many countries, improvement in trade logistics in developing countries would deliver high payoffs in improved trade performance.

Despite global reductions in tariffs and preferential trading arrangements, low-income country exporters, as a group, still face the least favorable market access for their products, as they face average tariffs (3.7 percent) on their exports that are 32 percent higher than those faced by high-income country exporters (2.8 percent).

The Indicators also underscore the fact that developing countries are hurt by poorer institutional environments; countries with better behind-the-border policies and institutions are more likely to have a larger proportion of manufactures among their exports, as well as lower export concentration. Better logistics also boost trade integration.

International Capital Flows

The recent, striking changes in the magnitude and direction of international capital flows have been accompanied by equally remarkable changes in the composition of those flows. The importance of those compositional changes ultimately depends on how different the component flows are from one another. This paper examines the behavior of the major components and evaluates the extent of their differences. The international balance of payments statistics divide international capital flows into four main categories: short-term investment, long-term investment, portfolio investment, and direct investment. Some of these categories are said to be more volatile than others. For example, international short-term investment (STI) often is called “hot money.” Extensive reliance on such “hot money” occasionally prompts fears of sudden and destabilizing reversals of capital flows, particularly in developing countries. In contrast, foreign direct investment (DI) often is presumed to represent a more stable flow of capital, one that somehow is linked more closely to the permanence of physical capital. Yet, in principle, the various categories of capital flows merely represent alternative forms of financing of the same underlying economic activity. That the major categories of capital flows represent substitutable forms of financing suggests that they might not behave so differently from one another after all. ‘The authors would like to thank Stijn Claessens, Eduardo Fernandez-Arias, Leonardo Hernandez, and Nlandu Mamingi for helpful discussions. This paper was prepared for the International Economics Department (IEC) of the World Bank.

 

Exchange Rate Behavior

Why Local Currency?

Companies with revenues in local currency should generally borrow in their local currency, instead of borrowing in a foreign currency which leads to currency risk. By matching the currency denomination of assets and liabilities, companies can concentrate on their core businesses rather than worry about exchange rate volatility. The financial crises which have affected emerging markets in recent years demonstrated that even stable exchange rate regimes may not hold in times of crisis, and therefore being hedged against currency risk is a prudent financial strategy.

IFC has also made local currency financing a priority in order to help develop local capital markets. In addition, we are keenly aware that companies which receive financing in the same currency as their revenues are more creditworthy clients for IFC.

How IFC Provides Local Currency Loans and Hedges

IFC provides local currency debt financing in three ways: (1) loans from IFC denominated in local currency; (2) risk management swaps, which allow clients to hedge existing or new foreign currency denominated liabilities back into local currency; and (3) Structured Finance which enable clients to borrow in local currency from other sources. This note will explore further the first two of these mechanisms.

Collectively, local currency financing through loans or swaps is made possible by the existence of a swap or, more generally speaking, derivatives market. The existence of a long-term swap market between the local currency and dollars permits IFC to hedge its loans in the local currency and provide risk management products tied to the loan currency. Please see the markets in which long-term local currency swaps are currently available.

Local Currency Loan from IFC

IFC disburses in local currency and the client repays in local currency. Based on the preference of the client, the loan can carry a fixed rate or a variable rate. Variable rate loans depend on the availability of a liquid local reference rate, usually a short term interbank lending rate or government securities rate. The repayment terms for local currency loans are customized to meet the needs of the client. IFC stands ready to provide long-term local currency loans in over a dozen emerging market currencies.

The diagrams below show the cash flows associated with a Mexican peso loan at disbursement and over time.

 

Local Currency – Answers to Frequently asked Questions

Q: Why does the Fixed-Spread Loan (FSL) have to be denominated in a major currency, and then converted into local currency? Why not denominate the FSL in local currency to begin with?

A: The Bank would not commit an FSL in a borrower’s currency because it may not always be able to access the local currency markets when borrowers wish to have disbursements or at terms that are acceptable to them. Pre-funding loan commitments in local currency and holding the liquidity until disbursements are made might be a way to address such funding risk. However, holding liquidity in local currency is likely to result in negative cost of carry for the Bank given the volatility and illiquidity of emerging financial markets and the limited numbers of instruments with acceptable credit rating in which the Bank can invest. Pricing the funding and liquidity risks into the loan charges for an FSL in local currency would make these products uncompetitive. Therefore the Bank has opted to provide local currency financing through the use of currency swaps from a major currency into a borrower’s local currency.

Q: Why can’t undisbursed amounts of FSLs be converted into local currency?

A: The conversion of fixed-spread loans into local currency is limited to disbursed loan balances so that the Bank can intermediate the currency swap transactions on the basis of known projected cash flows. Converting undisbursed amounts of FSL into local currency is equivalent to having FSL commitments in local currency which would expose the Bank to financing and liquidity risks. Please refer to the answer to the previous question for further explanation.

Q: Why can’t the entire loan be converted into local currency?

A: The Articles of the Agreement permit the Bank to provide local currency financing only under exceptional circumstances. Since these circumstances are basically the same as those under which the Bank is authorized to finance local expenditures with foreign exchange, the amount of the loan that can be converted into local currency is limited to that part of the loan that is used to finance local expenditures.

Q: What local currencies are available?

A: As of November 2000, an indicative list of emerging market currencies in which the World Bank might be able to undertake currency swap transactions included South African rand, Czech koruna, Polish zloty, Thai baht, Hungarian forint, Philippine peso, Indian rupee, Brazilian real and Mexican peso. However, the availability of these currencies, and the terms and conditions that the Bank could obtain at a given point in time will depend on swap market conditions at the time of execution of the proposed transactions. At the same time, since conditions in emerging financial markets can change rapidly, the Bank would determine, upon a borrower’s request, whether conditions would enable it to offer financing in a specific currency.

Q: Swap maturities in most emerging market currencies are short. What happens if the Bank is unable to roll over a maturing local currency hedging transaction?

A: At the maturity of the Bank’s hedging transaction, an FSL will revert to the original loan currency. The remaining loan principal repayments will reflect any exchange rate adjustment, representing the difference between the exchange rate used in the initial swap transaction and the market exchange rate at the time of the final principal payment on the initial swap. Such calculation may cause the remaining principal repayments to be more or less than they would have been in the absence of a conversion. For further information, refer to Section 4.6.2, “Partial Maturity Currency Conversion” of the Guidelines for Conversion of Loan Terms For Fixed-Spread Loans (“Conversion Guidelines”).

In the case of free-standing local currency swaps whose maturity is shorter than that of the underlying FSL, on the maturity date of the swap there will be a principal exchange for an amount equal to the remaining principal on the underlying loan. The principal exchange on the currency swap will be settled on a net basis; i.e., the net of the payable and receivable legs of the swap will be settled in the local currency. At the maturity of the free-standing local currency swap, borrowers would have the option to enter into another currency swap for the remaining principal balance of the loan plus the net amount of the maturing currency swap, provided that market circumstances permit.

Q: Why has the volume of multilateral development bank’s (MDBs) local currency transactions been small?

A : The volume of local currency transactions by MDBs has been small mainly because of funding constraints. MDBs do not generally hold unhedged currency positions on their balance sheet either because of statutes’ restrictions or financial policy considerations. They confine their transactions to currencies for which a liquid swap market exists in order to be able to hedge the exchange rate, interest rate and liquidity risks. The requirement of a liquid swap market limits the transactions to a small number of local currencies. Furthermore, the MDBs’ competitive advantage is their clients in local currency financing is much lower than in foreign currency loans. The lower comparative advantage makes local currency financial products less attractive to some borrowers.

Q: How can a borrower request a conversion or hedge into local currency?

A : For FSL conversions, the borrower would submit a Conversion Request to the Bank’s Loan Department, substantially in the form specified in the FSL Conversion Guidelines (borrowers should refer to Section 2 of the Guidelines for Conversion of Loan Terms For Fixed-Spread Loans). The Bank will then investigate the availability of swaps in the requested local currency, and will inform the borrower. The details of the procedure for conversion of FSLs are set forth in the Conversion Guidelines.

In the case of free-standing hedges, a borrower must first enter into a Master Derivatives Agreement (MDA) with the IBRD. A borrower would also need to provide the IBRD with a list of signatures of officers authorized to request IBRD hedge transactions. After the MDA is in place, to request a hedge into local currency a borrower needs to send a Hedge Request form to IBRD’s Loan Department. (Model Hedge Request forms will be available soon on this site).

Q: What are the advantages of borrowing from the Bank in local currency, if the government can raise local currency funding at the same, or a lower price?

A: A government would not derive any cost advantage from borrowing from the Bank in local currency if it can raise the local currency at the same or lower cost. Nevertheless, some countries prefer to keep the management of sub-sovereign institutions at arm’s length from government and let sub-borrowers manage their financing independently. Some of these sub-borrowers may have limited access to the local capital markets on reasonable terms.

Q: Are the IBRD lending rates in local currencies expected to be higher than those of the major currencies?

A: In executing local currency swaps, the Bank will convert the full lending rate (i.e. the base rate and the total spread) applicable in the original loan currency into a local currency equivalent lending rate. The total spread over the local currency base rate will reflect the local currency equivalent of the FSL spread over LIBOR plus a basis swap adjustment. Depending on the interest rate differential between the original loan currency and the local currency and swap market conditions, the local currency spread over the base rate and the lending rate altogether could be higher or lower than those of major currencies.

Q: Why are the Bank’s indicative prices for local currency financing so high when its pricing in the major currencies is highly competitive?

A: Because of its fine credit rating in international capital markets, the Bank has a significant cost advantage over its borrowers in intermediating foreign currency-denominated financing. Many Bank borrowers have stronger credit rating in their local currency than in foreign currency. This explains why the indicative rates for IBRD’s local currency financing may not be as competitive as the rates for foreign currency financing.

 

Withdrawal of Currency Pool Loan

Q: When will the Currency Pool Loan (CPL) withdrawal take place?

A: The CPL will no longer be a choice for all loan commitments for which the invitation to negotiate is issued on or after March 1, 2001.

Q: Why was the Currency Pool Loan (CPLs) withdrawn?

A: The Bank’s decision to cease offering CPL terms for new loans is based on the fact that demand for currency pool loans had been on a steady decline since 1993, when the Bank started providing clients with a choice of financial instruments. Over the past two years, non-CPL products have accounted for 98% of new loan commitments. With the fixed spread loan (FSL) introduced in 1999, Bank clients can replicate the main characteristics of currency pool loans and also obtain access to a range of embedded risk management alternatives. Furthermore, while CPLs provided borrowers with relatively stable lending rate and currency composition of their loans, lack of pricing transparency and the difficulties associated with managing and monitoring the risks of their CPL liabilities have contributed to the decline in demand.

Q: How can the CPL’s positive features be replicated using IBRD’s new financial products?

A: Borrowers can replicate all the features of the CPL by using the FSL and risk management products the IBRD introduced in 1999. For instance, borrowers who want multi-currency obligations with slow moving average interest rates, can select an FSL in multi-currency tranches in their preferred currency proportions, and use the FSL’s embedded options to fix the lending rates over a period of time to achieve a moving average lending rate of their preference.

Q: What would be the effect on the financial terms of existing CPLs?

A: The financial terms of existing CPLs, including those loans which are still disbursing, will remain unchanged.

 

Interest Rate Swaps

Most financial market instruments are of such ancient lineage that the initial development is lost in history, but the birth of the interest rate swap is known precisely. The World Bank (more properly the International Bank for Reconstruction) borrows funds internationally and loans those funds to developing countries for construction projects. It charges its borrowers an interest rate based upon the rate it has to pay for the funds. The World Bank had a definite motivation to seek the lowest cost borrowing it could find. In 1981 the relevant interest rate in the U.S. was at 17 percent, an extremely high rate due to the anti-inflation tight monetary policy of the Fed under Paul Volcker. In West Germany the corresponding rate was 12 percent and Switzerland 8 percent. The problem for the World Bank was that the Swiss government imposed a limit on World Bank could borrow in Switzerland. The World Bank had borrowed its allowed limit in Switzerland and the same was true of West Germany.

IBM at that time, 1981, had large amounts of Swiss franc and German deutsche mark debt and thus had debt payments to pay in Swiss francs and deutsche marks. IBM and the World Bank worked out an arrangement in which the World Bank borrowed dollars in the U.S. market and swapped the dollar payment obligation to IBM in exchange for taking over IBM’s Swiss franc and deutsche mark obligations.

After the World Bank and IBM showed the way the market for swap grew by leaps and bounds. Now the amount of the funds involved in the swap market is many trillions of dollars.

The standard, sometimes called vanilla, swap is when one party holds fixed interest rate obligations and the other holds floating rate obligations. The party holding fixed rate obligations may think the short term interest rates are going to go down whereas the party holding the floating rate obligation may think the interest rate will go up. Then the two parties may be willing to exchange responsibilities for the interest and repayment.

While it might seems that it would be unusual to find two parties who want to do the opposite things the surprising thing is that any two parties facing different combinations of fixed and floating interest rates one will have a comparative advantage in fixed rate borrowing the other in floating rate borrowing. The calculator below makes the determination.

 

Front-end Fee Policy on IBRD Loans

For all IBRD loan commitments whose invitation to negotiate is issued on or after July 31, 1998, and signed prior to September 27, 2007, a front-end fee of 100 basis points will be charged, payable on the loan’s Effective Date. A front-end fee of 25 basis points will be charged on IBRD loan commitments signed on or after September 27, 2007.

In the event of loan cancellation, adjustments to the front-end fee will be handled as follows:

  • If the loan is fully cancelled prior to the loan’s Effective Date, no front-end fee will be charged.
  • If the loan is partially cancelled prior to its Effective Date, the amount of the front-end fee payable will be reduced on a pro rata basis and the adjusted front-end fee will be payable to the Bank upon the loan’s Effective Date.
  • If the loan is partially or fully cancelled on or after the loan’s Effective Date, no adjustment to the front-end fee will be made. This will apply equally to loans comprised of tranches: if, for example, a tranche were cancelled after the Effective Date, no portion of the front-end fee would be refunded to the borrower.

 

Exchange Rate Risk Management

Hedging Products through IFC

IFC is one of the few organizations prepared to extend long-maturity risk management products to clients in emerging markets. Our risk management products, or derivatives, are available to our clients solely for hedging purposes. By allowing private sector clients in the emerging markets to access the international derivatives markets in order to hedge currency, interest rate, or commodity price exposure, IFC enables companies to enhance their creditworthiness and improve their profitability.

IFC’s role is to bridge the credit gap between its clients and the market, offering clients access to products which they may not have on a direct basis due to credit or country risk. In offering risk management products, IFC acts generally as an intermediary between the market and private companies in the emerging markets. Since the inception of this program in 1990, IFC has transacted risk management products for about 60 clients in 30 countries.

IFC’s Comparative Advantage

IFC is in a unique position to offer companies in developing countries a broad range of financial risk management products. Some of the benefits we provide include the following:

  • Ability to take long term credit risk of emerging market clients.
  • A triple-A rating, allowing access to the global financial markets on the most favorable terms.

 Extensive Market Relationships

Technical and legal know-how in the area of financial risk management, arising from the extensive use of derivative products in IFC’s own financial operations, such as funding, liquid asset management, and asset liability management.

Illustration of Hedging Interest Rate Exposure

IFC offers clients products available in the international financial markets. In this example, a power company in a developing country is going to arrange a long-term contract with the local government. Under the terms of the contract the company is to receive a fixed amount of dollar revenue; however, the majority of its long-term financing is on a floating interest rate basis tied to LIBOR.

The company can protect itself against interest rate volatility by executing an interest rate swap with IFC, where the company pays a fixed rate to IFC and receives a LIBOR-based floating rate. The diagram below shows the cash flows associated with such swaps. Since the company’s debt service on its floating-rate loan is matched by the floating-rate cash flow received from IFC under the swap, the company is left with a fixed-rate obligation. As a result, the interest rate swap has effectively achieved fixed rate funding for the company, matching its fixed dollar revenues under its long-term contract.

Mitigating Currency Risk in Developing Countries

The way an investor perceives risk in a project is often more important than a country’s income level.  Given the long-term exposure of infrastructure projects to major political and economic risks, investors base much of their risk assessment on a country’s political and economic credibility. Since currency risk is a large component of total risk in emerging market investments, finding ways to manage or mitigate currency risk is critical to the success and financial closure of a project.

Currency risk in infrastructure projects can be broken into two distinct categories: currency transfer risk; and currency exchange-rate risk.  Both types are reflected in a country’s credit rating.  Transfer risk or conversion risk, refers to the ability and willingness of the sovereign government to allow its currency to be converted into foreign currency.  Transfer risk is present when a project needs to convert the currency in which it receives revenues into a foreign currency.  Currency conversions are done to purchase material inputs for project operations and to make offshore debt payments.  As a rule, transfer risk is addressed in project finance transactions by limiting the project’s rating to the credit rating of the country where the project is located.

A credit rating is an opinion of the creditworthiness of an obligor/or project with respect to a specific financial obligation.  Many factors are taken into consideration when determining creditworthiness.  Among these are guarantors, insurers, and other forms of credit enhancement pertaining to the obligation.  Also taken into account is the currency in which the obligation is denominated.  Credit ratings are used by lenders and sponsors to gain perspective on a project’s credit risk before investment and financing decisions are made.

A source of objective credit evaluation, credit ratings heavily influence the financing options available to a project.  Ratings are of critical importance since they reflect a project’s financial strength and determine the cost of financing as well as a project’s access to capital markets.  Loan maturities, loan amounts, and credit risk spreads are often decided based on credit ratings.  Potential investors can easily obtain credit and currency risk information from sources such as; The Institutional Investor Index, which furnishes data on transfer risk; and from companies such as, Standard & Poor’s and Duff & Phelps, which offer project finance rating services.

This paper will focus on the more complex problem of exchange-rate risk which refers to the change in value of one currency relative to another.  Exchange-rates are a result of the supply and demand forces for a currency and they rarely remain stable over long periods of time.  Exchange-rates or currency prices can be affected by many different factors including economic policies, political and economic conditions, and market psychology.

Exchange-rate risk is complicated and difficult to manage because it is project-specific and must be evaluated accordingly.  Projects are more limited in their ability to mitigate exchange rate risk than sovereign nations or corporations.  This is because projects generally do not have external sources of revenue, and because they usually have very high debt-to-equity ratios.  Without currency management, project expenses can quickly exceed project revenues and affect the ability of a project to meet its debt obligations.  Currency movements can also affect a project’s operations by increasing the costs of raw material inputs making a project more expensive to operate.  Appropriate incentives must be provided during construction and operation to draw necessary financial support from potential investors.

Investors will expect higher rewards from projects which subject them to higher risks.  Infrastructure investments can bring investors very high rates of return, but because of their long amortization periods they are also more exposed to currency movements.  However, in order to keep tariffs for project services at a reasonable level, long amortization periods are necessary.  Unfortunately, this long term exposure to currency movements adds to a project’s overall credit risk profile.  As discussed above, this can be devastating to a project because it discourages potential investment, makes it difficult to obtain long-term financing, and increases the cost of debt .

More projects are being successfully financed under difficult and risky conditions everyday.  Nonetheless, there are many viable projects and awarded concessions that have not been able to find or attract financing.  By restructuring projects and employing proper risk mitigation techniques financeable projects can be created .

 

Currency Risk Management

The globalization of financial markets has emphasized the need for a more comprehensive approach to currency risk management.  The threat of currency risk can unravel a viable project overnight causing severe financial and socioeconomic losses.  Workable projects which perform desperately needed services can be canceled as a result of improper risk structuring.  Investors in developing countries can lower the financial risks associated with volatile currencies by establishing a currency-risk management policy.  Policies which quantify and evaluate all currency exposures can help investors identify objectives, limits, and tactics for risk mitigation.  Designing project contracts and concessions to include risk management strategies can help investors avoid the financial risks that affect future cash flows.  To protect against currency movements, tariff structures should be dynamic and responsive to changes in project revenue streams.  Once the appropriate risk mitigation procedures have been identified and matched according to project needs, risks should be allocated efficiently among project participants.  The project must be structured such that risks fall to the parties most able to manage them.  This paper examines risk management tools investors have used successfully including futures, options, forwards, currency swaps and guarantees.  A case study and a hypothetical project finance sketch offer examples of best practices.  Although, it is not possible to entirely eliminate currency risk from a project, it is possible to increase the odds that a project will reach financial closure.  Well-structured projects which are completed on-time can expand and improve services yielding benefits to all parties involved (IFC 1996).

 

Asset and Liability Management

Asset Management Services

Portfolios for the World Bank Group and other official institutions, plus approximately $11 billion in pension fund assets for World Bank Group staff. These portfolios are invested in a broad range of fixed income, equity and special asset classes and are actively managed to enhance returns against external benchmark indices.

For the global fixed income portfolios, strategies comprise interest rate decisions, sector rotation and arbitrage. The investment management team includes a strong quantitative and research group, which assists in the development of the strategic asset allocation decision and risk management of the portfolios.

Pension Investment Partnerships (PIP)

Since the early 1990s, the World Bank has been providing policy advice to its member countries on the design of pension systems. The advice emphasizes flexibility of system design within a broad five-pillar conceptual framework, customized for individual country conditions and placing substantial importance on the key principles of affordability and sustainability.

Treasury supports this work, through the Pension Investment Partnerships (PIP) program, which assists funded official sector pension and social security schemes in our member countries to strengthen their investment management infrastructure and operations, thereby making these pension and social security schemes more sustainable. Treasury draws on its experience, skills and knowledge accumulated through managing about USD 15 billion in pension assets ranging from global equities and fixed income to private equity, hedge funds and real estate over the past 50 years. Treasury also manages over USD 60 billion in reserves and other assets in-house, allowing it access to a wealth of expertise, industry contacts, market information, and financial technology.

Recognizing the impact that governance has historically had on the performance of such schemes, PIP can advise plan sponsors on governance structures customized to the specific parameters of their scheme, which align the incentives of fiduciaries with those of multiple stakeholders and ensure transparency of and accountability for results. As part of advising on appropriate investment policy within an asset-liability context, PIP can also assist pension funds in evaluating existing levels of depth and liquidity in domestic financial markets and asset classes, appropriate investment avenues for pension assets and alternatives that could be created, international investment options, and innovative ways to manage currency risk issues that inevitably arise in such instances. PIP can also assist in educating policymakers on the implicit costs of the legal and political constraints that frequently characterize the investment of pension assets.

Possible subjects for training and advice (customized in each case to the client’s circumstances) may include:

  • Governance structures and Plan objectives
  • Asset-Liability management and foreign exchange risk management
  • Investment policy, including domestic versus foreign assets
  • Designing appropriate benchmarks for domestic asset classes
  • Outsourcing policy, and selecting and managing investment managers
  • Risk budget and tools for measuring, attributing, and allocating risk
  • Capacity building in financial systems and human resources
  • Communicating with multiple stakeholders, including employees, employers, pensioners, regulators, and government
  • Benefits administration infrastructure

Asset-Liability Management

The Asset Liability Management (ALM) team is responsible for allocating funding to various lending products, and for ensuring that the currency, interest rate and maturity sensitivity characteristics of the Bank’s assets and liabilities are within prescribed risk parameters. To achieve this, ALM makes extensive use of derivative instruments including currency swaps, interest rate swaps and other interest rate management products.

The ALM team develops new products and innovative market solutions tailored to meet clients’ individual hedging needs. As part of this, they collaborate with other units to provide technical training to borrowers on pricing, market execution and credit aspects of hedging products and participates in negotiations on Master Derivatives Agreements (MDAs) with borrowers. The ALM team works closely with clients to develop hedging strategies and market tools to achieve their specific debt management objectives.

 An Example: Risk Management Strategy and Execution for IFFIm

As the Treasury Manager, the World Bank manages, mitigates and monitors financial risks arising due to differences in currency basis and timing of pledges from donors, disbursements and debt service of IFFIm.  The risk management tools that are used include, among others, currency swaps and currency forwards, interest rate swaps and forward rate agreements.  IFFIm and the Treasury Manager have entered into a master derivatives agreement and the Treasury Manager hedges IFFIm’s risk positions using its counterparties in the market.

IFFIm’s risk management framework incorporates:

  • a prudent approach to balance sheet management, with the aim of mitigating and controlling financial risks;
  • suitable risk limits and policies and procedures formulated to ensure that the limits are not breached; and
  • appropriate systems, controls and reporting mechanisms for measuring and monitoring residual risks.

In this context, we provide the following services to IFFIm:

  • Policy Analysis: develop the risk management framework, taking into account IFFIm Board’s risk preferences, balance sheet dynamics and market limitations, as well as credit, interest rate, operational and foreign currency risks, and the different instruments available for risk transfer
  • Strategy Design: advise IFFIm’s Board on optimal risk transfer through a broad-based suit of risks to be hedged out and the instruments available, based on modeling and evaluation of risk management options
  • Structuring: Negotiating and Executing transactions to efficiently remove interest rate and foreign currency exposure based on IFFIm’s board-approved risk management strategy;  tactical decision-making on overall execution strategy and timing for transacting on the different currencies to accommodate to market and liquidity limitations; benchmark counterpart market quotes based on in-house models to negotiate prices and ensure best execution.

Treasury Operations

The Treasury Operations Department is responsible for Treasury’s middle and back office functions, all systems services, and provides Cash Management and Banking Relations services for the World Bank Group as a whole. Treasury Operation’s cross-functional staffs provide pricing and valuation, performance measurement, transaction and securities processing and compliance support functions. The middle office provides quantitative analytics support and operational risk reporting and coordinates Treasury’s control risk assessments related to internal corporate governance and risk management functions.

Treasury Operations implements and manages information systems in support of Treasury’s asset management, funding, pension investment, and cash operations functions. Their staffs participate in delivering services for client central banks under the Reserves Advisory and Asset Management Program (RAMP). Special projects are implemented on behalf of external and internal (World Bank Group) clients.

The operational units are structured to provide dedicated processing and analytical support for the Banking, Capital Markets and Financial Engineering (BCF), Investment Management (IMD), Quantitative Risk and Analytics (QRA), and Pension Investment (PID) Departments. This support includes ensuring the integrity and smooth transfer of financial data, the maintenance of legal documentation and prudential controls, and for the provision of all accounting, trade settlement and call monitoring activities for traded financial instruments (e.g. bonds, swaps, swaptions, etc.). Accounting information and financial reports are made available on a daily and monthly basis on Treasury’s secure Intranet and Client Center Internet web sites.

Treasury’s Information Systems infrastructure is supported by two systems divisions, TROFA, developing and maintaining critical financial applications, and TROIS, supporting trade capture and overall systems infrastructure.  Many business applications are supported, including trade entry, portfolio accounting, performance measurement, risk analysis, compliance monitoring, settlement, cash account reconciliation, and financial messaging.  The staff are also responsible for maintaining the trading room, ensuring information security, preparing for disaster recovery and business continuity, providing 24 x 7 support for critical systems, and implementing and managing Treasury’s internal and external web sites.

Systems staffs also participate in providing technical assistance to eligible central banks and international organizations.  Over the past several years, technical specialists have provided on-site assessments, recommendations and support to over a dozen central banks and have hosted focused training sessions for several more.

Public Debt Management

The Public Debt Management team (part of the Banking and Debt Management Department) is responsible for advising IBRD governments, and governments in low income countries in partnership with PREM (Poverty Reduction and Economic Management Network), the Bank’s Poverty Reduction and Economic Management Network, in designing and implementing debt management strategies. Our mission is to assist governments in building capacity in managing the risks of the sovereign debt portfolio.

Building capacity in public debt management involves:

  • Establishing key objectives and priorities
  • Establishing prudent risk management strategy and policy
  • Strengthening middle office analytical capability
  • Defining a framework for risk management
  • Ensuring consistency with other macroeconomic policies and objectives
  • Establishing an organizational structure that ensures clear accountability and transparency of responsibilities
  • Establishment of a legal framework
  • Recruitment of trained staff, and selection and implementation of effective management information systems

The Public Debt Management team is also the point of coordination in the collaborative work with the International Monetary Fund (IMF).

 

Foreign Direct Investment (FDI)

Why FDI?

The development needs today are stark. Billions of people live without access to safe drinking water or sewage treatment. Children can’t attend school because there’s no electricity to light classrooms in some countries, and no roads to get to school in others. The list goes on. Developing country governments cannot shoulder the burden—financially or technically—of addressing these needs alone.

Foreign direct investors can play a critical role in reducing poverty, by building roads, for example, providing clean water and electricity, and above all, providing jobs. By taking on these tasks, the private sector can help economies grow and avert the need for governments to use funds better spent on acute social needs, while taking advantage of the opportunity to make profitable investments.

IFC fosters sustainable economic growth in developing countries by financing private sector investment, mobilizing private capital in local and international financial markets, and providing advisory and risk mitigation services to businesses and governments. IFC’s vision is that poor people have the opportunity to escape poverty and improve their lives. In FY07, IFC committed $8.2 billion and mobilized an additional $3.9 billion through syndications and structured finance for 299 investments in 69 developing countries. IFC also provided advisory services in 97 countries.

Since Peru joined IFC in 1956, IFC has provided over $1.2 billion to more than 50 private enterprises in the country, including $300 million in syndicated loans.  In fiscal 2007 (July 2006 to June 2007), IFC invested $247.7 million in the country’s priority sectors. As of June 2007, IFC’s committed portfolio in the country reached $463.9 million.

IFC’s strategy in Peru addresses private sector challenges, with a focus on fostering sustainable development. Key sectors include financial, microfinance, infrastructure, agribusiness, and tourism. Promoting access to finance for small and medium enterprises and housing is also at the core of IFC’s strategy.  IFC provides added value to clients in extractive industries, helping raise social and environmental standards and increase impact in local communities.

Washington, D.C./Lima, February 5, 2008 — The Board of Directors of IFC, a member of the World Bank Group, on Tuesday approved financial and advisory support for Peru LNG, a natural gas export project that will support growth in some of Peru’s poorest regions and will be the largest foreign direct investment in the country’s history.

Totaling $3.8 billion, this landmark investment is the first liquefied natural gas export project in Latin America. It is expected to transform Peru into a net hydrocarbon exporter after operations begin in 2010. In addition to the $300 million loan approved today, IFC is advising Peru LNG on optimizing the project’s environmental approach and ensuring that local communities benefit.

“We very much value IFC’s support in helping us develop a project that follows best practice environmental and social standards and that extends the investment’s development benefits to the Peruvian people,” said Steve Suellentrop, President of Peru LNG.

The project consists of an LNG plant and a marine loading terminal 170 kilometers south of Lima on Peru’s central coast, as well as a new 400-kilometer pipeline that will connect to an existing pipeline network east of the Andes. The gas is expected to be sold to overseas markets.

Peru LNG will help generate significant annual tax and incremental royalty payments to the Peruvian government, equivalent to over 1.5 percent of current state revenues. The project will also support the regional economy through local purchasing of goods and services. The company and IFC are developing a community development program in line with Peru LNG’s commitment to sustained economic development.

“In Peru LNG we have found a partner who shares our commitment to supporting economic development through private sector investment,” said Somit Varma, IFC Director and Global Head for Oil, Gas, Mining, and Chemicals. “IFC plays an important role in helping ensure that project benefits reach the people that need them most.”

IFC will help the company purchase goods and services from local small and midsize companies. IFC will also support local authorities in efficiently managing and allocating incremental royalties resulting from the project. IFC seeks to extend local engagement in the project by giving community members opportunities to evaluate the company’s environmental and social performance.

The approval by IFC’s Board followed extensive consultation by IFC staff with affected people and civil society organizations.

The Peru LNG project consortium is headed by Texas-based Hunt Oil Company and includes Spain’s Repsol YPF, SK Energy of South Korea, and Marubeni Corporation of Japan.

 

Capital Budgeting and Investment Planning

Introduction

The capital budget is largely concerned with the creation of long-term assets (roads, pipes, schools, water treatment plants). The capital budget details the local government’s long-term capital improvement needs. Governments commonly establish a uniform and organized multi-year (5-year) capital investment plan (CIP) to outline the public facilities, infrastructure, and land purchases that the jurisdiction intends to implement during a multi-year period given the availability of funds.

Components of the Capital Budget

The capital budget process is usually a multi-step process, including:

  • Inventory of Capital Assets;
  • Developing a Capital Investment Plan (CIP);
  • Developing a Multi-Year CIP;
  • Developing the Financing Plan; and,
  • Implementing the Capital Budget.

IFC: Summary of Regular Capital Budgeting

Management has made difficult choices between desirable programs to strike the balance among pressing priorities. At the same time, Management is requiring productivity gains in investment operations to ensure that, even in a growth mode, IFC uses its resources efficiently. Toward this end, IFC departments have been given productivity targets such as the number of commitments per investment officer which will be monitored throughout the year.

Total Resources

The total resources used by IFC to deliver its overall operational program and development strategy are larger than the Total Budget alone. They include items such as contributions to Advisory Services (AS), and special programs approved by the Board in addition to the Total Budget. They also include spending which is not subject to Board budgetary approval such as the Corporation’s fee-based activities, because it is directly offset against related sources of revenue. In addition, there are resources such as those provided by donors which are used by IFC and which are outside of its financial statements but are keys in supporting advisory type developmental activity. Table provides a comprehensive statement of the total resources that are needed and used to deliver IFC’s full development impact. The table includes all items of this kind that have been approved by the Board, or are presented for Board approval this year.

 

Criticism of the World Bank

Some critics of the World Bank believe that the institution was not started in order to reduce poverty but rather to support United States’ business interests, and argue that the bank has actually increased poverty and been detrimental to the environment, public health, and cultural diversity. Some critics also claim that the World Bank has consistently pushed a “neo-liberal” agenda, imposing policies on developing countries, which have been damaging, destructive and anti-developmental. Some intellectuals in developing countries have argued that the World Bank is deeply implicated in contemporary modes of donor and NGO driven imperialism and that its intellectual output functions to blame the poor for their condition.

It has also been suggested that the World Bank is an instrument for the promotion of U.S. or Western interests in certain regions of the world. Consequently, seven South American nations have established the Bank of the South in order to minimize U.S. influence in the region. Criticisms of the structure of the World Bank refer to the fact that the President of the Bank is always a citizen of the United States, nominated by the President of the United States (though subject to the approval of the other member countries). There have been accusations that the decision-making structure is undemocratic, as the U.S. effectively has a veto on some constitutional decisions with just over 16% of the shares in the bank; moreover, decisions can only be passed with votes from countries whose shares total more than 85% of the bank’s shares. A further criticism concerns internal governance and the manner in which the World Bank is alleged to lack transparency to external publics.

The World Bank has long been criticized by a range of non-governmental organizations and academics, notably including its former Chief Economist Joseph Stiglitz, who is equally critical of the International Monetary Fund, the US Treasury Department, and US and other developed country trade negotiators. Critics argue that the so-called free market reform policies – which the Bank advocates in many cases – in practice are often harmful to economic development if implemented badly, too quickly (“shock therapy”), in the wrong sequence, or in very weak, uncompetitive economies.

World Bank standards and methods are, however, highly valued and adopted in areas such as transparent procedures for competitive procurement and environmental standards for project evaluation. World Bank also engages in funding the education of promising young people from developing countries through its graduate scholarship programs.

A young World Bank protester takes to the street in Jakarta, Indonesia.

In Masters of Illusion: The World Bank and the Poverty of Nations (1996), Catherine Caufield makes a sharp criticism of the assumptions and structure of the World Bank operation, arguing that at the end it harms southern nations rather than promoting them. In terms of assumption, Caufield first criticizes the highly homogenized and Western recipes of “development” held by the Bank. To the World Bank, different nations and regions are indistinguishable, and ready to receive the “uniform remedy of development”. The danger of this assumption is that to attain even small portions of success, Western approaches to life are adopted and traditional economic structures and values are abandoned. A second assumption is that poor countries cannot modernize without money and advice from abroad.

A number of intellectuals in developing countries have argued that the World Bank is deeply implicated in contemporary modes of donor and NGO driven imperialism and that its intellectual contribution functions, primarily, to seek to try and blame the poor for their condition.

Defenders of the World Bank contend that no country is forced to borrow its money. The Bank provides both loans and grants. Even the loans are concessional since they are given to countries that have no access to international capital markets. Furthermore, the loans, both to poor and middle-income countries, are at below market-value interest rates. The World Bank argues that it can help development more through loans than grants, because money repaid on the loans can then be lent for other projects.

 

Recommendations

Drawing from the testimonies and its own experience and analyses, the Panel believes that:

  1. There is a need and urgency to build upon local resistances and alternatives to the dominant economic free-trade and growth oriented paradigm, in order to strengthen alliances and movements, while confronting World Bank culture and ideology, challenging its political and economic role;
  2. Commons are for the common good and not for corporate profit. Therefore,  the Bank should abstain from supporting the privatisation of the commons and of life-supporting resources;
  3. Socio-economic audits of the World Bank should be undertaken and supported through similar Hearings and Tribunals. In cases of conflicts generated by World Bank projects or policies, a moratorium might be established to enable fair and informed resolutions of the conflicts;
  4. The concepts of social and ecological debt should be further developed and operationalized by organizing a session of the PPT on the historical, social, ecological and illegitimate debt;
  5. Parliaments and governments should initiate independent debt audits in order to identify historical responsibilities, and the social, economic and environmental, as well as juridical implications of debt for peoples’ rights and self-determination.

 

Conclusion

It is well known that the World Bank came into existence with the purpose of playing a significant role in creating markets, mobilizing resources while supporting infrastructure and productive capacity. Most recently, notably in the early 90s, it has repositioned itself in support of poverty alleviation while advancing a global free trade agenda through its lending and conditionalities. A parallel and unofficial history of the World Bank tells us years of resistance at the local and global level by social movements and communities eager to reclaim their right to self-determination and control over their resources.

The cases considered in the Hearing show that the World Bank has been extremely influential in dealing with the State and the public sector in borrowing countries. Its interventions have gone much beyond its formal limited role of a lending agency and went into policy-making, prioritizing, budgeting and planning in every sector of governmental action. This has enabled the Bank to generate and force a development paradigm that is market- and growth-oriented rather than aimed at meeting basic human needs while attaining social and environmental justice.  As a matter of fact, its lending conditionalities lead to the conversion of life-supporting natural resources such as land, food, air, seeds and energy into merchandise.

The Nicaragua case showed the failure of privatization of public utilities in guaranteeing full and broad access to electricity for the poor majority of the country, while generating huge profits for the Spanish monopoly Union Fenosa and indebtedness for the State.

As we could learn from the case of cotton in Mali, the local self-reliance and community-based labor-intensive economy has been threatened by the World Bank´s lending priorities that seemed to be linked to the liberalization agenda of, and relevant negotiations at, the WTO.  It is significant that the timing of World Bank programs in Mali coincided with the cotton liberalisation negotiations at the WTO.

One could wonder whether this is a contradiction to the World Bank´s stated goal and objective of reducing poverty , considering that such an institution might eventually become a hindrance to economic and political rights-based alternatives to build another possible world .

The Panel noted the remarks made by the witnesses as to how the World Bank is imposing conditions on countries negotiating a loan, leaving little or no room for these countries to choose their own direction. In at least two cases, we noted that access to the HIPC debt reduction processes was conditioned to the implementation of structural adjustments and liberalization of economies, thereby producing a vicious circle of forced payment of increasing volumes of debt.  Combined with an uneven distribution of resources and benefits, this has also resulted in a massive drain of national resources away from the imperatives that cold ensure distributional and social equity and self-reliance. In this process, the traditional, customary, cultural and territorial rights of local communities and indigenous peoples are compromised and sacrificed. International conventions and UN covenants such as ILO 169 on the rights of indigenous populations have been ignored if not violated.

The panel acknowledges the relevance of the concepts of ecological and social debt when dealing with the consequences of such development paradigm. Additionally, evidence of odious and illegitimate debt – such as in the cases of Peru and Nigeria – has been presented, whereby foreign debt accumulated during dictatorial regimes is  still being paid by the victims of the past.

In many cases, the Panel noted the points made about violations of peoples’ right to be proactively engaged at all levels of the decision-making process. The Panel notes this is not in agreement with the principle of prior informed consent on any policy or decision affecting their own lives, and territories.

Hence, through its policy advice, the Bank has prevented the full exercise of participatory and direct democracy, thereby widening the gap between governments and peoples, creating a fictional political space where genuine interests are overlooked if not ignored. In this context, Parliaments´ roles have frequently been shrunk to merely rubberstamping decisions already made in closed circles.

The Panel learnt, however, that in certain cases, such as in Malawi, countries might be able to find their own route to social justice, food sovereignty and food security, by rejecting World Bank conditionalities and continuing to subsidize local agriculture and markets, while fostering the inclusion of the poor.

The cases on mining in Peru and oil and gas extraction in Nigeria and Kazakhstan show the link between World Bank developmental priorities and the advancement of the interests of transnational companies. Pollution resulting from gold extraction, gas flaring and fossil fuel extraction has resulted in the violation of peoples’ rights to health, a clean environment, and water. No compensation of losses or replacement of livelihoods was ever ensured either by the Bank or by the government despite evidence produced by the Bank itself.

More generally, the continued support of the World Bank to fossil fuel extraction and use, with the associated greenhouse gas emissions, rather than small scale renewable energy,   raises serious questions about the Bank’s role in and commitment to  the Post-Kyoto process and  support for eco-friendly technologies. It is an another case of “institutional amnesia” considering that the 2004 Extractive Industries Review, supported by the Bank itself, recommended a phase-out of Bank financing of fossil fuel projects, the adoption of the principle of free, prior informed consent and compensation for affected communities. We believe these recommendations are still valid and should be implemented.

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