IDB RECAPITALISATION: Upping the bid

21/03/2010 | Taimur Ahmad, Lucien Chauvin

Discontent is rising over the Inter-American Development Bank's performance. But without an increase, its lending will hit a wall – fast

The IDB’s annual gathering in Cancún could be a make-or-break moment for the 51-year-old institution as its shareholders consider expanding its capital base.

While the mood was almost unanimously sympathetic to the idea when it was formally proposed a year ago, a number of dissenting views have since surfaced, principally among the bank’s governors. Even supporters of a capital increase – the vast majority – argue that any deal must accompany deeper changes in bank governance and management.

The stakes are high for the bank. Its president, Luis Alberto Moreno, presents the dichotomy bluntly: without a capital increase, bank lending will hit a wall – fast – and at a time when the region can ill afford losing the firepower of a key development financier.

“This is the time for decision making,” he tells Emerging Markets in an exclusive interview. Failure to secure a capital increase “would put us in a very difficult situation”.

“Simply put, we are coming to our lending limits. We would be able to disburse around $11 billion this year, but in 2011 this would fall to $5.5 billion, and we would have to stop approving new projects.”

Such a drop in the bank’s disbursement capacity would mean not only a reduction of 25% in real disbursements compared to the 1994–2010 average, but also negative net flows to the region, the bank says.

The personal stakes are also high for Moreno himself: the outcome of the capital increase is likely to determine whether he stands and is elected in July to a second five-year term as president.

In a report last year that set out the rationale for a recapitalization, the arguments were twofold: first, the bank had not had a capital increase since its $100 billion boost in 1995; second, the deepest international financial crisis in generations highlighted the urgent need for development lenders to channel more resources to Latin America, to help countries ward off impending doom.

IDB lending in the past 12 months was $15.5 billion, double what it was lending annually in the last decade.

Moreno and other senior bank officials refuse to discuss the details of the bank’s funding request, but last year’s report set out various scenarios, with an increase ranging from $100 to $300 billion. Since then, the figure most often cited by those familiar with the discussions is $180 billion, a sum which proponents of the plan say would be enough to cover the projected increase in the bank’s regional operations.

Around 4% of the final amount would be paid in capital based on shares member countries have in the bank, while the rest would be in callable capital.

MAKING DEMANDS

Peru’s finance minister Mercedes Aráoz tells Emerging Markets: “Capitalization is important and we support it. But we need mechanisms so all the member countries are on the same page, which is why we are also supporting the idea of better operating practices for the bank, better standards to ensure the quality of loans.”

“We have not reached an agreement, but there is a trend toward consensus.”

However, an increasing number of major shareholders are demanding deeper reforms at the bank before agreeing to stump up more cash. Among them are the bank’s biggest shareholders, the United States and Brazil.

A senior Treasury department official tells Emerging Markets that while the US recognizes the IDB’s contributions to regional economic growth, it needs to see changes at the bank for the capitalization to be approved.

“Reforms to make the institution a more effective tool for reducing poverty in the region are essential prerequisites for US support for a capital increase,” says the official.

Among the reforms the US Treasury is calling for are better mechanisms for controlling project quality and measuring results, as well as greater focus on climate change and lending to the private sector.

CRITICS OF ALL STRIPES

Watchdog groups claim the bank has weakened procedures for loans and is not doing enough to fulfil its basic mandate of poverty reduction and regional integration. Other critics have slammed the bank’s so-called realignment for having robbed the bank of some of its best – and most experienced – technocrats.

And some say the institution was lax when it came to its own investment policies. The bank’s management was blasted after the institution took a major hit in 2008 from $1.9 billion in losses on its investment portfolio – as US senator Richard Lugar put it, some “10 to 100 times higher than the losses of the other development banks”. Although those losses have since been recouped, many believe they still point to a failure of responsibility among senior management.

But a more damning charge is that the bank has lost its way and failed in its mission at the height of the crisis. Brazilian finance minister Guido Mantega tells Emerging Markets in an interview: “We are not very happy with the IDB’s performance over the past couple of years. The bank had no role during the last crisis. It could have offered greater help and given more incentives.”

Mantega says the capitalization plan would only be approved “if there is a programme for change in governance and in management. This is a requirement.”

Similar criticisms are echoed by business people and politicians in the region, many of whom would ordinarily see eye to eye on very little.

Juan de Dios Olaechea, who runs Peru’s private Central Andean Railroad, says the best thing about the country’s recent investment-grade rating – Moody’s was the last agency to upgrade Peru to investment grade last December – is that it frees companies from having to look to the IDB for financing.

“The IDB is totally out of touch with the region. Its experts do not understand what it takes to make nations competitive,” says Olaechea.

Also in Peru, Ollanta Humala, head of the left-wing Nationalist Party, tells Emerging Markets a recapitalization “would only be justified if important transformations were made in management and the tools used by the bank to measure development. The IDB continues to commit the original sin of measuring development based on macroeconomic numbers.”

Given that the bank’s funding request would require approval in Peru’s Congress, Humala’s party could potentially sway the vote if reforms to the bank are not forthcoming as part of the capitalization process.

DEFENDING THE RECORD

Moreno argues the bank has already implemented a long list of changes – under its so-called better bank initiative – that has made it a much more solid institution, prepared to deal with the rapidly changing realities in Latin America.

He addresses the charges against the bank by pointing to its results. “I go to the facts. The reality is that few institutions can show net flows to the region at $7 billion, which we achieved last year,” he says. “We were very quick to respond to governments, very quick to do as much as we could in terms of our lending to accommodate many of the countries’ needs in the crisis.”

The bank disbursed $11.5 billion in loans in 2009, whereas approvals hit a record $15.5 billion. Financing for the poorest countries in the region also jumped significantly. Without front loading its existing financial capacity, the bank could disburse $11.1 this year, and approve a further $5.3, while approving $5 billion in 2011.

Moreno says the bank has also slashed its loan-approval time to seven months, half the time it took in 2007. It also reversed its 2008 operating loss ($972 million) and posted $1.29 billion in income last year.

Moreno defends the IDB’s so-called realignment – the bank’s restructuring process which aimed to boost its development effectiveness and organizational efficiency – claiming that it was precisely the changes he set in motion that allowed the bank to ramp up lending drastically, reduce the time needed for loan approval and disbursement and has kept administrative costs in line.

“Last year we increased the amount of projects significantly with the same amount of staff. Since we began this process of realignment, we have been able to do a lot of projects in country offices, which has reduced costs. But also, as you try to do more on development effectiveness and other reforms, there is a cost there. There has to be a balance between the two.”

He says he is confident the changes undertaken so far will allow for agreement on the capital increase: everything is pointing towards closing the deal in Cancún, he says.

GOING FURTHER

The bank’s leadership laid out its plan for the capital increase in a document prepared for the March 2 meeting of finance ministers. The rationale included a review of the last capitalization in 1995 and how the bank met the two mandates that conditioned that increase – lending to improve equality and lower poverty, and a concentration of loans to the region’s poorest nations.

The document reports that 50.4% of lending went to equality-poverty reduction, with poverty in the period between 1994 and 2008 dropping from 45.7% to 33.2% in the region. The bank provided 36.8% of loans to the poorest countries, slightly more than the 35% the governors established when approving the capital increase. Overall, the bank approved 1,230 loans for a total of $108.6 billion in the 1994–2008 period.

The bank maintains that it will go far beyond just the two goals established in the 1995 increase. This time it will include five general categories to make sure it is hitting targets, including: priorities for financing, regional objectives, indicators to measure progress, operational effectiveness and efficiency, and a results-based budget.

The document sets up five major strategic priorities for the coming years, including social policies for equality and productivity, infrastructure for competitiveness and social well-being, strong institutionality, international integration and environmental protection and climate change response.

THE HAITI FACTOR

But there is another element to the bank’s appeal for a capital hike: Haiti and the need for reconstruction after the massive earthquake in January that killed more than 200,000 and left the country destitute.

“It is important to have more paid in capital, to have more callable capital, and to have the possibility of giving more grants to Haiti, which will be a very important piece of what we do in the final analysis,” says Moreno.

Without a capital increase, grants to Haiti would drop from $128 million in 2010 to $40 million between 2011 and 2015. The bank’s concessional window would also become “unsustainable”.

Moreno says additional debt relief for Haiti would be discussed within the context of the capital increase. On the table will be proposals to alleviate $441 million in debt Haiti owes the IDB. The bank already provided more than $500 million in debt relief last year for loans incurred prior to 2004.

Peru’s Aráoz agrees that Haiti should factor into the debate on the capital increase, noting the IDB’s role in the immediate aftermath of the earthquake. “The bank’s ability to react to emergency situations is important. It is a consideration in the consensus that had developed” for the capital increase, she says.

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