Policy-based guarantees (PBGs) have long been a multilateral development bank (MDB) instrument in search of a purpose. PBGs—a credit enhancement for sovereign market borrowing—have been around for decades but their uptake has been limited. In most instances, they have proven remarkably effective in helping to reduce governments’ external financing costs and mobilize large volumes of private capital. As we enter a period of heightened global economic volatility, PBGs could become a particularly useful instrument for emerging and frontier markets seeking to maintain access at affordable rates. They could also be a useful tool for countries seeking to reprofile external debt or restructure their commercial debt.
In a new note, we review 13 PBGs issued by MDB over the past 10 years and find that they helped lower countries’ cost of funding by 330 basis points (bps) on average. We also find that PBGs are distinctly catalytic—the $4 billion in guarantees included in our sample have crowded in $7.2 billion worth of total commercial financing, or 78 percent more than would have been possible using traditional MDB loans.
Several factors can influence the success of a PBG operation, many of which depend on the MDBs’ own internal financial policies. Chief among these is the way in which MDBs count guarantees against country lending limits. While all MDBs book guarantees like loans on their balance sheets, some MDBs have set-aside windows that allow them to only count PBGs on a 1:4 basis against a country’s lending limit. This reduces the opportunity cost for a country pursuing a PBG instead of a loan, thereby increasing the financial appeal of a PBG.
Going forward, we see a greater rationale for PBGs for countries borrowing from the concessional windows and smaller economies. In the current economic context, they could be particularly useful for countries with sound macroeconomic fundamentals facing unfavorable external financing conditions. PBGs could also be useful instruments in the context of sovereign debt negotiations to entice private sector participation. Finally, a major untapped PBG angle is to bring together countries’ interests in advancing their environmental, social, and governance (ESG) policy objectives with private investor interest in boosting the ESG share of their portfolios. To date, much of the MDBs’ PBG policy agenda has focused on macroeconomic reforms, but PBGs could be used to support ESG policies and programs.