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Drowning by numbers

The IMF, the World Bank and North-South Financial Flows.

by David Woodward

Bretton Woods Project

Thank you to all those who commented on the report.

Thank you to the C. S. Mott Foundation for their continued support.

David Woodward is a freelance writer and researcher on development issues, working mostly for non-governmental organisations, and is the author of Debt, Adjustment and Poverty in Developing Countries (1992) and Direct Investment and Equity Investment in Developing Countries: the Path to Prosperity or the Road to Ruin? (forthcoming). He previously worked as an economic adviser in the UK Foreign Office and the UK Executive Director’s Office at the IMF and World Bank.

Edited by Angela Wood, Bretton Woods Project.

Cover design by Shaun Askew,

Executive Summary
Chapter 1: The new paradigm of international finance.
Chapter 2: Why governments need finance and the cost of commercial flows.
Chapter 3: The impact of commercial flows on economic policies and development.
Chapter 4: The Volume and Terms of World Bank and IMF Resources
Chapter 5: Debt Relief Versus Aid?
Annex 1


This summer the World Bank surveyed 700 opinion-leaders in industrialised countries to see what they think about international aid and the role of the World Bank. The first question was whether interest in official aid has declined in recent years, then a chance to comment on four possible reasons why this might be the case:

  • confidence in aid effectiveness has dropped;

  • public sector finance is not necessary because the private sector is doing the job;

  • budget cuts mean less money is available for aid;

  • debt relief is more important than other forms of assistance.

These questions are vital when considering the future roles of the World Bank and IMF, but frequently NGOs and researchers do not take time to address these trade-offs in depth, and conclude what arguments they will put forward.
The World Bank and IMF were established to mediate international financial flows to poorer countries and to regulate the world economic system to prevent further 1930's-style slumps and trade wars. The context for their operations has changed dramatically since they were established, partly due to their promotion of international economic integration and private sector investment. The view that foreign private investment can resolve the world’s serious poverty problems appears almost unchallenged in official circles, with the end of the Cold War, the establishment of the World Trade Organisation and aid being conditioned on all countries adopting the same “right policies”.
Yet at the same time this consensus is under assault. The East Asian financial crisis, the Jubilee 2000 campaign, the postponement of negotiations on a Multilateral Agreement on Investment, and the admission by the World Bank that the Washington Consensus model was limited and not relevant for all countries all show that space is opening to put forward alternative analyses. Unless pushed, however, it is likely that many officials will just propose minor modifications rather than rethink their model from first principles.
This report questions some of the basic assumptions underlying models which champion private foreign investment as the key to growth and aims to fill a gap for campaigners and researchers. It is not just relevant to discussions on the Bank and Fund, how much debt relief can be provided, and whether the IMF should have the right to press countries to liberalise their capital accounts, but also on issues such as international trade agreements, investment codes and declining aid budgets.
The arguments here cannot conclude discussion on the areas outlined above, but will, we hope contribute to a more informed debate and appreciation of the pitfalls of the current narrow economic thinking, its irrelevance for many of the world’s poorest citizens and its dangers for the world system as a whole.
Chapter One outlines the paradigm shift advocated by the World Bank and the International Monetary Fund, which promotes free-flowing commercial capital flows.
Chapter Two examines the financial cost of these flows and whether they are affordable to developing countries and a substitute for official finance.

Chapter Three considers the impact commercial flows have an a government’s ability to choose between policies and their impact on a country’s economic development.
Chapter Four looks at the opportunities for reducing the cost and increasing the volume of World Bank and IMF loans.
Chapter Five weighs up the trade-off between debt relief and aid and proposes alternative sources of funds for debt reduction which could help to reduce this trade-off.
Alex Wilks and Angela Wood

Bretton Woods Project


Facilitating Private Sector Flows

The IMF and World Bank are advocating a new paradigm for capital flows founded on the efficiency of free-flowing private capital. This implies limiting the role of public sector institutions (including the IMF and the World Bank) to helping the market to operate effectively, intervening directly only where it fails to operate.

The IMF and the World Bank have pursued and are further pushing this paradigm shift through:

 structural adjustment programmes (SAPs);

 direct support for the private sector via the International Finance Corporation and Multilateral Investment Guarantee Agency and other guarantees;

 capital account liberalisation (CAL);

 the Heavily Indebted Poor Country Debt Initiative; and

 strategic use of research, conferences, training and high-profile publications.

Aided by these actions, there has been a massive growth in the flows of Foreign Direct Investment (FDI), portfolio equity investment and commercial lending to developing countries in recent years. This trend has coincided with a decline in official flows of grants and loans. According to the logic of their paradigm commercial capital flows should be able to compensate for this decline, yet poverty is pervasive and crises in Mexico, East Asia and Russia show a continuing need for official flows.
The Financial, Policy and Development Costs of Commercial Flows

However, there are a number of serious doubts about over-reliance on these types of investments as mechanisms for North-South financial flows, especially in low-income countries.

 They are extremely expensive in foreign exchange terms, especially for poorer countries. As a result, maintaining a positive net resource transfer requires a continual and increasing flow of new capital, which entails a very rapid build-up of foreign exchange liabilities.
 They are strongly skewed away from poorer countries, whose efforts to compete for the available flows reduce the potential benefits to the host country.
 They are volatile, procyclical and (in the case of equity investment) subject to serious problems of contagion, increasing vulnerability to external shocks.
 They seriously limit a government’s economic policy options, and over the longer term, they may seriously weaken the political system by increasing the role of TNCs.
A universal opening to all forms of capital flows for all purposes should be avoided. This suggests a need to retain some degree of control over commercial capital flows. This is incompatible with the proposed extension of the IMF’s mandate to include capital account liberalisation. What is needed is a selective approach, to ensure that flows are limited to those which confer net benefits from a long-term developmental perspective. Simply seeking to sustain the volume of North-South financial flows could be seriously counterproductive if the liabilities created by commercial flows prove unsustainable; or if the wider effects of the flows themselves, or of the processes of opening the economy to them and attracting them, have negative effects on economic or human development.

This suggests that:
 portfolio investment should generally be avoided by low income countries, as being too expensive and too volatile;
 direct investment should be limited as far as possible to the creation of new capacity for the production of exports which will not have an adverse effect on other developing countries (eg., by depressing commodity prices), and other sectors where the benefits of foreign investment to the rest of the economy outweigh the potential costs of the investment (eg., telecommunications); and
 competition for FDI flows which reduces their benefits to host countries (eg., tax breaks, direct or indirect subsidies and preferential treatment) should be avoided.
For middle-income countries, the balance between the costs and benefits of commercial financing tends to be more favourable: the cost is lower; the build-up of the stock of investment is slower; economies are less subject to other external shocks (eg., due to the greater diversification of their export bases); and political systems are generally more robust. Nonetheless, caution is required; and the volatility of portfolio investment is likely to be a particular problem, as demonstrated by the East Asian crisis.
Apart from their limited access to commercial flows, their high cost and volatility will seriously limit the extent to which most low-income countries can rely on this source of finance. Commercial capital flows cannot simply substitute for official sources of finance. Therefore, if financial flows to low-income countries are to be increased significantly in such a way as to enhance rather than damage long-term economic and human development, this will require an increase in net official flows; more grants or loans on concessional terms; and/or a substantially greater degree of debt reduction than is currently envisaged (without an off-setting reduction in new flows).
The Volume and Terms of World Bank and IMF Resources

The scope for lowering the interest rates on IBRD, IDA and ESAF loans is limited. This suggests that a better option for improving the terms of World Bank and IMF resources would be to lengthen the repayment and grace periods.

 Extending the maturity of IBRD loans would help to off-set the effects of the recent increase in interest rates and charges. This would have little or no impact on the Bank's financial position.
 Extending the maturity on IDA loans could only be achieved at the expense of reducing future IDA loans. IDA credits are not generally too expensive for IDA borrowers, so it is probably only realistic to argue for more concessional terms in specific circumstances where there is a particular need, for example:

  • the poorest low-income countries;

  • other low-income countries which already have unsustainable debt burdens;

  • countries in post-conflict situations, where liquidity can be expected to be weak (or to require new borrowing) for an extended period; or

  • projects and programmes where the foreign exchange benefits are indirect or slow to materialise, particularly in the social sectors (eg., health, education, safety net programmes, etc.).

 Extending the maturity of ESAF loans would need to be subsidised from bilateral aid budgets. Since this would immediately affect the availability of resources, and the policy conditions attached to IMF loans make them less attractive than bilateral loans, this would be undesirable. In principle, the IMF could contribute to the ESAF subsidy account from its own resources, including sales of its gold reserves, but this is unlikely and probably less desirable than using the available resources to finance the HIPC Initiative.

The scope for increasing the volume of resources for Bank and Fund lending is also limited. The mechanisms available for doing so represent little more than a switch of control over an essentially fixed amount of aid from bilateral to multilateral donors. Since most bilateral aid is provided on grant terms and IDA and ESAF provide loans, this is unlikely to be justifiable.
The cost of multilateral loans arises partly from their terms of repayment, partly from the transfer of policy control from borrowing governments to the Bank and Fund and partly from frequent weaknesses in the preparation, design and implementation of their programmes and projects. This suggests that there may be more scope for improving the quality than the quantity of multilateral lending. A number of measures could be taken to achieve this.
 IMF and World Bank staff could ensure that governments participate fully in the process of formulating programmes and projects and that civil society is consulted.
 Flexibility could be built into the programme cycle so that programmes coincide with a government’s term in office rather than an arbitrary 3-year cycle.
 Improvements could be made to the Bank’s internal quality control mechanisms such as the Operations Evaluation Department and the Inspection panel; and an independent evaluation mechanism called be established for the IMF.
 The Bank’s incentive structures could be changed so that staff are rewarded for the results of projects rather than the volume of money spent on them.

 A mechanism could be developed whereby the Bank would assume a portion of the burden of repayment for projects which fail due to poor Bank advice or project design.

Financing Debt Reduction and the Trade-off With Official Flows

On the whole it would be undesirable to transfer more bilateral aid to the World Bank and IMF. Thus there is a trade-off between using Bank and Fund resources for maintaining current levels of lending (or improving the terms and size of IDA and ESAF loans) and providing more debt relief.

A preliminary analysis of the trade-off suggests that it would be preferable to provide debt relief rather than aid. However, the extent of this trade-off will depend critically on how the Bank and Fund contribute to the HIPC Initiative and any further debt reduction. This suggests that resources should first come from those sources which will have the least impact on official financing in the future, particularly to the poorest countries, and used in sequence until the point is reached where the costs to developing/low-income countries of reduced capital flows equal the benefits of debt reduction. The sequence implied by this approach is broadly as follows:
 Bank and Fund loan loss provisions;
 The capital proceeds of sales of IMF gold reserves (with the largest volume of sales politically attainable);
 IBRD reserves released by relaxing the capital-plus-reserves constraint on lending;
 Bilateral contributions;
 IDA reserves and reflows.
While the cost of using bilateral contributions to finance multilateral debt reduction is relatively high, this would not be the case if genuinely additional resources could be generated. One possibility for this would be to secure agreement from those bilateral donors which are not already doing so to meet their international commitment to provide development assistance of 0.7% of GNP for a single year, on a one-off basis, expressly for debt reduction, for example to mark the Millennium. This would generate additional resources of around $100bn - equivalent to about half of the total debt of all the HIPCS (in present value terms), even before taking account of the debt reduction likely under existing mechanisms.
If current efforts to provide adequate debt-reduction for low-income countries were to fail, other financing mechanisms might be feasible in the long term. These would include, for example, the proceeds of a "Tobin tax" - an internationally-applied tax levied at a very low rate on all international currency transactions. The sheer volume of such transactions means that such a tax would raise very considerable sums (possibly hundreds of billions of dollars per year), which would provide plentiful resources for debt reduction and other priority development needs.
To achieve just and sustainable financial flows will require political mobilisation by concerned people and governments to press the World Bank and IMF to reconsider their models and operations.



The nature of capital flows between developed and developing countries changes considerably over time. In the 1970s, such flows were based largely on syndicated loans from commercial banks. In the 1980s, as this source of financing largely dried up following the Mexican crisis of 1982, official flows became relatively much more important. From the end of the 1980s, there has been a major growth of foreign direct and portfolio investment, which by the mid-1990s represented the majority of net capital flows to developing countries as a whole.

This transformation largely reflects a deliberate paradigm shift by the IMF and the World Bank. They have wrought this shift through several channels.
 Structural adjustment programmes (SAPs): the pro-market conditions attached to SAPS have included the liberalisation of foreign exchange and financial systems, the privatisation of state-owned enterprises, the development of stock exchanges and their opening up to foreign investors, and liberalisation of foreign investment regimes.
 Direct support for the private sector: the operations of the International Finance Corporation (which supports private sector projects in developing countries) and the Multilateral Investment Guarantee Agency (which guarantees foreign investors against certain risks involved in investing in low-income countries) - both part of the World Bank - have grown in recent years.
 Capital account liberalisation (CAL): the IMF is seeking to change its mandate to enable it systematically to pursue CAL in all its member countries.
 The Heavily Indebted Poor Country Debt Initiative - which, by reducing the debt overhang, will help to make the poorest countries more attractive to private capital.
Strategic use of research, conferences, training and high-profile publications.

Facilitating Private Sector Flows

In this new paradigm, as in the neoliberal model at the national level, the market takes the predominant role. This means that commercial capital flows1 (described in Table 1) are, as far as possible, allowed to operate freely, while the role of public sector institutions (including the IMF and the World Bank) is to help the market to operate effectively and to intervene directly only where it fails to operate.

For countries with ready access to commercial flows this implies a relatively limited role for the Bank and Fund. Such countries have recently included the major economies of Latin America and East and South East Asia (at least until the 1997-8 East Asian financial crisis). In these countries, the role of the Bank is likely to be limited to project support for purposes for which commercial finance is unavailable (eg., health, education and environmental protection). In normal times, the IMF has no role beyond its regular monitoring function. When a crisis arises, however, these roles change, and the IMF and the World Bank are at the centre of financial support packages.

In some other countries, the IMF and World Bank help to encourage commercial flows. IMF programmes provide a "seal of approval", which is intended to act as a signal to private investors that the country is following good economic policies; and the World Bank provides partial guarantees for commercial finance to reduce the risks for investors and loans for projects in the private sector. The aim is primarily to mobilise commercial flows to these countries rather than to provide finance directly.
In many countries, especially low-income countries, there is as yet little sign of commercial flows rising to levels where they can provide adequate support for development. Here, the Fund and Bank can be expected to play a much greater and more direct financial role, somewhat closer to that of the 1980s.
For those countries identified as highly-indebted poor countries (HIPCS), the Bank and Fund are to provide debt reduction, as part of a coordinated package with other creditors, intended to reduce debts to sustainable levels - that is, to levels which can be repaid by governments without them rescheduling or accumulating arrears. For most of these countries, debt reduction is to be phased over a six-year period, with increased adjustment lending in the interim. It is hoped that debt reduction, together with further adjustment, will encourage commercial flows in the future.
Beyond the promotion of financial flows at the national level through adjustment programmes, the IMF is seeking an amendment to its Articles of Agreement to widen its mandate to include capital account liberalisation - that is, the removal of restrictions on financial flows in and out of a country. Economic theory dictates that “free capital movements facilitate a more efficient global allocation of savings, and help channel resources into their most productive uses, thus increasing economic growth and welfare. From the individual country’s perspective, the benefits take the form of increases in both the potential pool of investable funds, and the access of domestic residents to foreign capital markets.” (Fischer, 1997, p3)
If the IMF’s Articles of Agreement are changed, this would introduce a mechanism to seal in the liberalisation of financial flows, in much the same way that liberalisation of current account transactions are promoted at present. It is likely that countries could remove restrictions gradually, but once removed restrictions could not be reimposed except in response to a crisis, and only then with IMF approval2.

Types of Financial Flows

Rather than being based on loans from governments and international institutions such as the World Bank and IMF to governments and state-owned enterprises, new international financial flows now mainly comprise various types of investment flows and loans between private sector investors and private companies for commercial purposes. (See Table 1)3.

While these flows represent private transactions, some are officially guaranteed. Payments on some export credits and other bank loans are guaranteed against commercial risks by the government of the recipient country; and some export credits are insured by agencies in the lending country. In the case of non-payment of these debts, the burden of repayment is assumed by the creditor or debtor government4.

In addition, governments themselves are regaining access to financing from commercial sources. Since syndicated bank loans were mostly discredited by the Latin American debt crisis of the 1980s, developing country governments now raise most private finance via bond issues: bond issues accounted for 83% of net public and publicly-guaranteed borrowing by developing countries from commercial sources in 1996, compared with just 7% in 1980 (World Bank, 1998).
Recent trends in financial flows are shown in Figures 1 and 2. There are three dimensions to the shift in financing5:
 a shift from official to commercial sources of finance (A);
 a shift from public to private recipients of financial flows (B); and
 a shift from loans to equity instruments (including direct investment) as mechanisms (C).

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