Free the MDBs

IFR Asia - Asian Development Bank 2009
6 min read

Multilateral development banks are political beasts. In this article an ex-ADB staffer talks about the historic and organisational issues that complicate the aid logistics of development banks, and the urgent need for reform.

Only two years ago, almost US$1trn in foreign direct investment (FDI) poured into developing countries. The Institute for International Finance predicts that net capital flows to the developing world will drop to about US$160bn this year, while net lending from commercial banks is likely to be negative.

Risk aversion is at the heart of the matter. Developing countries’ perceived risk has risen in tandem with the rise of the global economic recession, even though the epicentre of the crisis (this time) is Wall Street, and in some cases developing countries’ own growth rates and fiscal positions are significantly stronger than their developed country counterparts.

Traders and investors are sitting on the sidelines waiting for the global economy to improve. While this is occurring, developing countries’ balance sheets are deteriorating as their dependence on the global supply chain and external sources of finance grows.

Ordinarily, multilateral development banks (MDBs) and bilateral sources of aid would step in such times to fill the gaps in trade and investment finance, and help keep the wheels of commerce moving.

But these traditional sources of assistance are themselves under pressure, largely because the major funding sources – developed countries – are severely strained.

While MDBs have invested much effort over the past decade to build their private sector operations, official sector lending has remained comparatively stagnant. For example, the World Bank can increase its lending to about US$35bn this year, but this is not nearly enough to compensate for hundreds of billions of dollars that developing countries need to address budget deficits and foreign currency shortfalls.

Even when MDBs join forces – as was recently done by the World Bank, the European Bank for Reconstruction and Development, and the European Investment Bank to support banking systems in Europe, and by the World Bank in tandem with national export credit agencies to support trade finance – the tens of billions of dollars they produce is not enough to make a real impact.

The International Monetary Fund (IMF) is similarly feeling the pinch, having come to the rapid rescue of European countries such as Iceland, Hungary and the Ukraine, and depleting resources that would under normal circumstances have been earmarked for less developed countries.

Fortunately, some MDB and IFI (international financial institutions) donors have risen to the occasion and approved important increases in capacity for some institutions. The IMF has received approval to double its lending capacity to US$500bn and the Asian Development Bank (ADB) will soon treble its capital to US$165bn. The ADB also recently approved a very significant increase in its Trade Finance Facilitation Program, from US$150m to nearly US$1bn.

As developing countries’ importance in the global economy continues to rise, developing country donors seek greater influence in the lending decisions of the MDBs and IFIs, and are reluctant to commit additional financial resources in the absence of a greater say in how these institutions are run.

If developed countries will agree to shed the World War II-era structure of these institutions into a more sensible governing structure more reflective of present day realities, the ability to lubricate the global financial system in times of duress would surely be enhanced.

If this had been done five years ago, MDBs such as the ADB would have been able to respond to the current economic crisis in a much more rapid and meaningful fashion.

Why, then, has much needed reform been delayed? The MDBs’ inertia is representative of a larger issue. The same mindset that prevents developed countries from ceding influence over lending decisions to developing countries permeates and impacts the operations of these institutions.

Many of the MDBs continue to focus on poverty alleviation to the poorest developing countries – and they should do so. But at the same time, many of the same MDBs maintain a focus on providing development assistance to countries that in reality no longer need their help, having either graduated to middle-income status or being well on their way to doing so.

MDBs continue to provide assistance to countries that either no longer have severe poverty, have their own significant financial resources, or have themselves become major donor nations.

China is a case in point. Why should an MDB lend money to China to promote development when China has US$2trn in foreign exchange reserves and will, soon enough, become the largest economy in the world? And how can China, which rightly demands a place at the governing table of the MDBs by virtue of its size and strength, rightly accept hundreds of millions of dollars of development assistance from the MDBs each year?

The fact that China continues to be a major aid recipient of MDBs – instead of taking a role in leading the agenda and funding of these organisations – truly symbolises how difficult it is to change the strategic direction of these bodies. A fact that complicates the ability of an entity such as the ADB to respond to an extremely complicated, fast-moving crisis such as the current credit crisis.

Daniel Wagner (managing director, Country Risk Solutions)