World Bank to bypass restrictions in lending for infrastructure to Sub-National entities (May 2006)

Rethinking Bretton Woods | Mon, Mar 26, 2007

By Aldo Caliari and Paul Martin

 World Bank to bypass restrictions in lending for infrastructure to Sub-National entities

 By Aldo Caliari and Paul Martin

A World Bank report titled "Sub-National Development Program. A proposed World Bank Group initiative to scale up and mainstream technical assistance and financial support to sub-national entities" raises concerns about its potential to encourage further privatization and high levels of indebtedness by sub-national entities.

It is not clear that, in spite of the lack of national government guarantee this guarantee will not have to be provided in the case of a default (for example, direct lending by the private sector to Argentinean provinces had to be assumed by the National Government after the 2001 crisis). Further concerns are raised by the fact that some FTAs currently under negotiation, such as the Colombia "“US, make rules protecting foreign investors applicable not only to sovereign debt, but also to sub-national sovereign debt. (For an explanation of problems raised by these rules please check and

A brief summary and analysis of the main points of the document follows.
The Sub-National Development Program proposed by the World Bank Group is an effort to increase direct engagement at the state/municipal level, and is to build on the IFC Municipal Fund, initiated in 2003. Other arguments provided relate to the increased responsibility of sub-national authorities for providing public goods and their limited financial (and related technical) capability to fulfill this role. The nub of the projected program is the provision of technical assistance and financing for sub-national entities without sovereign guarantees, and preferably in local currency. Though the program's actual structure is yet unsettled, it would be an IBRD-IFC risk-sharing venture, formulated to avoid violating the IBRD's constitutional limitation on lending directly to sub-nationals.

As a justification for this program, the report notes the Group's historical support for increased decentralization, but lack of a tool combining policy advice with financial support directly at the sub-national level. Furthermore, it claims, demand for non-sovereign borrowing products has been rising, with several regional development banks extensively and successfully involved in the sector. It is thus apposite that the Bank "˜consolidate and scale up' financial support and institution building, so as to create "˜viable and fiscally responsible sub-national entities'.

Integral to the plan is the strengthening and deepening of domestic resource mobilization through the development of local financial markets; with the result being infrastructure services "“ the focus of efforts "“ that can better deliver, in terms of access, quality and affordability. In time, this strategy would lead to entities' self-sufficiency through their increased access to private finance. Therefore, the technical assistance side of the program (see below) is key. It should be noted, the proposal targets public utilities as well as municipal/state authorities. Financing "“ either guarantees (preferred) or loans "“ would be provided under market-based conditions.

The aim of the technical assistance side of the program is to strengthen financial management, build institutional capacity, improve investment planning, support policy analysis and reform, augment the legal and regulatory environment, advise on specific transactions and prepare projects for financial support. Privatization is not explicitly mentioned. But the program's direction embodied in expanding the relevant entities' operations, mobilizing local financial markets, and improving operational management tend to be associated, in Bank speak, with increased private sector participation in operations. The possibility of linking the program to existing technical assistance facilities like the PPIAF confirms this proposition.

The proposal notes that the focus would be on middle-income countries who have progressed with decentralization and capital market development, and "˜seek further assistance to reduce "¦ dependence on central government financing', a recurrent theme throughout the paper. Countries examined in the preliminary survey leading to formulation of the proposal include Brazil, China, India, Mexico, Poland, Russia and South Africa; these form a good representation of the sort of markets that would be targeted by the program. The report further notes that levels of institutional preparedness and creditworthiness of potential sub-national clients would limit the actual engagement of the Sub-National Development Program relative to the potentially large market size. Another limiting factor would be the existence of national governments' policies towards direct sub-national borrowing and prudent fiscal responsibility guidelines.

According to the report, there are three types of target sub-national entities. Where large regional and local government exists, such as in Russia or Brazil, direct Bank engagement with these governments will be the specific mechanism to achieve their "˜renewal and modernization'. In other cases, it is more appropriate to work through "˜sound, well-managed' development finance institutions (DFIs). Finally, public utilities "“that is, those owned by national or local governments"”which need to finance expansion programs. The report notes a mixed record working with DFIs, with problems arising where a strategic approach to developing capital finance markets was absent or preferential access to public funding existed and, hence, "stymied the growth of the private capital market."

An important feature of the program would be integration of the technical and financial sides of the operation. It appears, from the report, that activities carried out under the technical side would be framed as a pre-requisite for use of resources under the financial side. The report suggests that depending on country circumstances, program activities could be linked with other Bank instruments. Technical assistance, indeed, is explicitly mentioned as complementing existing Bank programs. Further to those mentioned above, limiting tariff regulation/subsidies, bettering collection/treasury systems, and refining capital market regulation/prudential supervision are all listed as possible technical assistance activities. There are reasons to doubt the report's argument that integrating the two instruments "would achieve greater results than with either instrument alone or with both instruments used independently." There are risks"”as with other technical assistance instruments of the Bank"”that technical assistance might be sought from the Bank not on the basis of higher quality, but simply to guarantee ulterior access to Bank financing. Another risk, given the track-record of the Bank, is that sub-national entities will be pushed into an unwarranted privatizing drive under the excuse that this is needed to ensure access to financing (either from the Bank or private financial markets).

An important principle of the program is the requirement for national sovereign consent before country deployment. It should be noted that consent would be sought generally, with the Bank choosing each sub-national entity independently. It is stressed, furthermore, that the legal and regulatory environments must be conducive to success; only those entities with the best prospects for "˜improved financial viability and sustained development' would be supported. Again, it should be pointed out that these characteristics tend to be associated, in the Bank's track record, with the de-regulation and adoption of market-based principles and practices. The report notes that, in terms of loan preparation, the program is likely to be less cost-efficient than other programs.

In terms of structure, the program is expected to involve effective integration of IBRD and IFC sub-national operations. The technical assistance funds provided by the Bank would come from the IBRD's DGF (Development Grant Facility) and an IFC Facility. The program's financial transactions would be subject to review and approval by the IFC Board of Directors. The program would pursue close working relationships with MDBs and bilateral agencies. The report notes donor contribution, possibly including MICs, is expected and it is hoped Bank funding will gradually decrease over time in relative importance.

Performance indicators would include the number of clients reforming existing policies or procedures, and obtaining/improving credit ratings. A secondary measurement would be the ability of clients to translate improved financial management into greater levels of financing from non-governmental sources. It is hoped approval for the project can be obtained in time for the program to commence on July 1, 2006.