May 23, 2023

Background Memo: Prepared for Council of Councils Annual Conference, May 7–9, 2023, Council on Foreign Relations, New York, NY

The 2030 UN Agenda for Sustainable Development called on multilateral development banks (MDBs) to undergo a paradigm shift to play a critical role in mobilizing the private sector for global development. In this context, the World Bank achieved a historic capital increase in 2018 for its International Bank for Reconstruction and Development (IBRD), which serves middle-income countries, and its International Finance Corporation (IFC), which serves the private sector. The World Bank also initiated market-oriented financing for its International Development Association (IDA). In short, the World Bank is expected to become bigger and better and elicit more development results.

However, the 2018 capital increase was only designed for a mid-scale crisis that would occur once in a decade. The multiple global crises today have undermined the 2030 Agenda’s sustainable development goals (SDGs) and significantly exposed the World Bank’s scale limits. With global interest rate hikes, the developing world is facing higher financing costs and greater growth challenges. In response, the new Group of Twenty (G20) agenda is enhancing the capacities of the World Bank and other MDBs. For example, the Indian G20 presidency this year established a dedicated MDB expert panel. At the end of 2022, the World Bank itself also released a new Evolution Roadmap (hereinafter referred to as the roadmap), initiating a new round of debate on its vision, mission, and financial and operational models.

World Bank Supply-Side Constraints

The roadmap states that the World Bank is exhausting its crisis buffer and will once again face a financial cliff in 2024. Yet a meaningful resource expansion for the World Bank faces various constraints.

First, market discipline has limited the Capital Adequacy Framework reform efforts. The framework, submitted to the G20 finance ministers by an independent panel, recommends how several hundred billion dollars in additional lending can be mobilized. This increase has been a G20 priority since at least the global financial crisis in 2008. In line with the framework, the IBRD’s equity-to-loans ratio was already lowered from 37 percent in 2008 to 20 percent in 2014, and it is reported to be further reduced to 19 percent under the roadmap. However, this move can only add about $5 billion of new World Bank resources annually. Moreover, tightening financial markets do not leave much room for such measures.

Second, capital increases face political constraints. On the one hand, major donors are all facing growing domestic financial expenditure pressure, making it politically difficult to increase foreign aid. The United Kingdom was once the largest donor to IDA, but it has cut multilateral aid significantly since Brexit. The Russia-Ukraine conflict and the energy crisis it triggered have also severely damaged European economic growth, reducing EU countries’ willingness and ability to increase their contributions. As for the United States, the Joe Biden administration filled the gap left by the United Kingdom by increasing U.S. contributions to the twentieth IDA replenishment cycle in 2021. It remains to be seen whether the United States will continue to increase its support as it continues to confront inflationary pressures and Congressional Republicans scrutinize its aid budget. Emerging donors also face many challenges at home. However, the incentive mismatch for a new general IBRD capital increase is a more fundamental obstacle for the World Bank’s resource mobilization, as the established donors are concerned about the dilution of their voting power. This option has so far remained off any official agenda.

Third, traditional donor countries are increasingly using non-core funding mechanisms, harming the unity of the World Bank. According to the Organization for Economic Cooperation and Development (OECD), despite consolidating the funding structures of the World Bank and the United Nations around 2018 and 2019, shareholders continue to call for new trust funds to push for their own foreign policy priorities. After the COVID-19 pandemic broke out, the G20 launched the World Bank hosted Financial Intermediary for Pandemic Prevention, Preparedness, and Response. Countries are also calling on the IBRD to promote new climate financing funds. However, this measure not only involves a complicated division of labor and coordination with the UN Framework Convention on Climate Change (UNFCCC), but also exacerbates the fragmentation of the World Bank.

Intensified Demand-Side Competition

Because both fiscal and market-oriented measures cannot promise the substantial new resources of an MDB, many experts are raising serious concerns about the intensified competition in the World Bank’s resource allocations.

The first such area of competition is between World Bank climate financing and poverty reduction. The Biden administration has pledged to double its annual public climate financing to developing countries by 2024 to over $11 billion, and direct MDBs to set ambitious climate finance targets. The International Monetary Fund (IMF) also launched a new Resilience and Sustainability Trust, while incorporating climate change considerations into its mainstream policies. However, the push by the United States and others for the World Bank to add sustainability as its third mission alongside poverty reduction and shared prosperity has caused grave concerns among African and other developing countries. Chinese scholars are also concerned that this move could deflect from the most urgent needs of developing countries.

The second area of competition for World Bank resources is between middle-income countries and low-income countries. The World Bank’s climate ambition will lead to a shift of resources to middle-income countries. The roadmap pointed out that “while the 2018 capital increase for IBRD and IFC interpreted ‘serving all clients’ as reorienting lending towards [low-income countries], the need to make progress on global challenges would require a rebalancing of this strategy to identify opportunities to better respond to [middle-income country] clients.” China and other emerging countries have always advocated that the World Bank should continue to maintain cooperation with middle-income countries. However, the World Bank itself has warned that the pandemic could push more than one hundred million people back to extreme poverty at a time when low-income countries are facing rising debt risks. If the World Bank shifts resources toward middle-income countries, it will run against the spirit of international development equity.

The third area of competition is for World Bank resources between crisis-oriented needs and development needs. In a globalized world, regional and global financial crises have become more frequent, as evidenced by the Asian financial crisis in 1997 and the global financial crisis in 2008. The frequency of geopolitical conflicts and health and humanitarian crises has also increased. The World Bank and MDBs are required to do more in addressing global challenges and to make up for the shortcomings of the IMF and the global financial safety net,. Those shortcomings have seriously affected the developing countries’ development needs, such as infrastructure construction.

Additionally, with an eye to the future, the world should pay more attention to the effects of geopolitical conflicts on the World Bank’s resource allocation for low-income countries. Two examples come to mind. First, the intensified strategic competition between the United States and China has spread to the World Bank. A Boston University study found that countries closely tied to the Belt and Road Initiative get fewer resources when applying for IMF assistance. Second, Ukraine’s postwar reconstruction could conflict with international development in the next five to ten years. Since the outbreak of the Russia-Ukraine conflict, both MDBs and the IMF have broken their own policy restrictions to provide unconventional support to Ukraine. According to devex, the World Bank promised to provide $3 billion for Ukraine, $1 billion coming from IDA resources, which are intended for the lowest-income nations. The World Bank has also mobilized a total of $20.6 billion from donors for Ukraine through trust funds as of March 9, 2023. On March 31, 2023, the IMF board approved a new $11.6 billion loan program as part of the $115 billion rescue plan aimed at helping Ukraine overcome wartime economic difficulties, including helping it to repay its foreign debts and maintain its debt sustainability. On March 23, 2023, the World Bank, in conjunction with the United Nations, the European Union, and the Ukrainian government, assessed that rebuilding Ukraine would take ten years and cost up to $411 billion.

 

Recommendations

• The World Bank should utilize all options to substantially increase its financing. Over the next few years, financial reform measures can help alleviate certain pressures, but in light of the demand gap, they will fall short. To meaningfully increase its ability to mobilize resources, the World Bank should expand the capital base of its core institutions, including supporting the IBRD’s capital increase and the IDA’s twenty-first round of capital increase. Amid mounting domestic budget pressure in major economies, the IMF should explore expanding Special Draw Rights, and transferring them to the World Bank and other MDBs. This move would be the most cost-effective way to boost resources for international financial institutions considering the current political and economic difficulties.
• Major World Bank shareholders should protect the poorest against further marginalization as the bank faces more competitive demands. The World Bank’s reform agenda should be put in the context of current setbacks to alleviating extreme poverty and worsening indebtedness in low-income countries. Major shareholders should increase cash contributions to the upcoming twenty-first IDA replenishment, which would enable the World Bank to provide more concessional resources to low-income countries and help them manage the currency risks. This measure is vital to ensure that the G20’s Common Framework for debt treatment of low-income countries moves forward more quickly, given that the World Bank insists on its preferred creditor status and refuses to participate in the process directly.
• The World Bank should reframe climate change efforts as an integrated part of a host country’s development and should consolidate the development finance system. The World Bank’s global climate agenda, which is primarily driven by donor countries, has caused broad concerns in the developing world. Traditional OECD donors have established numerous thematic vertical funds focusing on climate change and other global challenges. This effort is largely driven by incentives to demonstrate the additionality and ability to get results, but it also leads to a divided climate and development agenda and an increasingly fragmented development finance system, which is not in the interests of developing countries. China holds a more ambivalent view of climate and development and supports a climate financing strategy tailored to the host countries’ own priorities and conditions. The World Bank should persuade its donors to focus on increasing its core capital, rather than setting up new climate financing facilities that further complicate its institutional structure and division of labor vis-à-vis the UNFCCC.
• The World Bank should leverage its independent, orchestrating role in an increasingly divided world. Trust between major World Bank shareholders has fallen to historical lows in the past few years. Simultaneously, their competition for influence at the bank has increased. The World Bank should take advantage of its autonomous fiscal space, partnership with the private sector, professional knowledge, and entrepreneurship in fostering whole-package deals in its complex agenda of international development, climate finance, and debt treatment, among others. The renewed leadership of the World Bank is a great opportunity for this shift to happen.

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