IDA13 Grants and Concessionality in IDA13 International Development Association November 2001 Grants and Concessionality in IDA13 1. There is a wide diversity of views among donors regarding the extent to which IDA should utilize grants in its support of the poorest countries of the world. Most donors are of the view that IDA should retain its role as primarily a lending institution. There is, however, broad support for ensuring continued and if possible enhanced concessionality in its operations. Concessionality can be affected by the level of grants, and also by changes in the terms of IDA's credits. 2. This note explores ways in which IDA's use of grants and increased concessionality of its lending terms could be framed. Its purpose is to seek consensus among donors in the context of the IDA13 replenishment. It sets out the possibilities of addressing the issue along two dimensions -- functionality of the use of grants, and concessionality of IDA's operations. The note then looks at possibilities for combining grant activities for specific purposes and introducing additional concessionality on IDA credits. Expanding on an idea put forward in Paris, such combinations could be explored on the basis of both sectoral and country needs. Finally it provides an estimate of the financial costs to IDA. Functional Uses of Grants 3. The functional areas where grants could increase IDA's effectiveness as a development institution should underpin the use of grants in IDA's operations. The IDA Deputies' discussion in Paris indicated varying levels of support for different functional uses of grants in this context. Post conflict, including in UN administered territories, was most strongly supported, followed by grants for communicable disease control, especially for regional programs, natural disasters, capacity building and education. In terms of volume, some donors were in favor of relatively large amounts of grants, while others felt grants should remain a small part of IDA's operations. On the whole, the sense was that the use of grants should be constrained, with several donors focusing on a 10% figure. 4. Table 1 presents the functional use of grants as discussed in Paris, and provides both a `high-end' estimate for the use of grants in these functional areas, as well as a `constrained' estimate -- which attempts to set out a basis for the use of grants in the context of the functional preferences expressed by IDA Deputies in Paris, and in line with a grant window that would be 10% of IDA13 lending -- assuming a $22 billion IDA13 envelope.1 A grant window could of course reflect different combinations of grant uses. Similarly, a narrower subset of functional purposes for grants could also be specified, as well as a grant window that is smaller, or larger. 1 The IDA13 replenishment target is SDR 18.1 billion, including HIPC support of 0.5 billion. The net amount of IDA13 lending thus is SDR 17.6 billion, or $22.3 billion (at the SDR/$ rate of 1.26502 established for the replenishment). -2- 5. In allocating grants across categories, other objectives for grant usage can also be achieved. For example, under the constrained estimate that has been formulated, grants represent up to 50% of projected social sector financing for IDA-only countries in IDA13.2 6. The constrained estimate that is illustrated sets out how grants could be used if a grant window of a particular size were to be established. Once the overall size of the grant window is established and a set of functional uses are agreed, IDA would need to have flexibility to allocate smaller or larger amounts of grants to any particular agreed purpose, subject to the overall ceiling, taking into account emerging needs. 7. Donors also discussed an alternative approach which consists of providing grants to countries as a share of their IDA allocation (for example 50%) on the basis of poverty i.e., to a subset of IDA's poorest borrowers. Under such an approach, it may not be possible to tie grants exclusively to the functional uses discussed above. Increasing Lending Concessionality 8. The second dimension explores various modalities for increasing the concessionality of IDA's credits. As noted in Paris, IDA's concessionality has decreased over time (measured in terms of the grant element in IDA credits) and it would be useful to look at ways to reverse this decline. 9. Softening IDA's lending terms to increase concessionality can be achieved by increasing the grace period and/or maturity on IDA credits, and/or by reducing the service charge. Obviously, there are several combinations for altering the parameters of IDA credits. Table 2 sets out the added concessionality that can be achieved through three selected approaches -- increasing the grace period by five years, increasing the maturity by 10 years, and waiving a portion of IDA's service charge and the cumulative effect on concessionality if these approaches are combined. 10. As the table shows, concessionality of up to an additional 15 percentage points could be obtained through the softening of terms along these lines, and would increase the concessionality of IDA's credits to IDA-only countries from 64% currently to 79%. Combining Grants with Lending Concessionality 11. Possibilities for combining grants with softened IDA terms could be considered on the basis of the above dimensions. Table 3 sets out five possibilities. 2 Assumes roughly half of the post-conflict and natural disaster reconstruction grants would be used for social sector projects, and thus grants for social sectors would be about 9% of IDA financing. Social sector lending in IDA13 for IDA-only countries is estimated to be approximately 18% of total IDA commitments -- the same level as in IDA12. -3- · Scenario 0 represents the status quo, current lending terms, plus a very limited amount of grants (in essence less than 1% of IDA's overall financing); · Scenario 1 presents a 10% grant window; · Scenario 2 combines a 10% grant window with softened lending terms (extended grace and maturity) for the poorest borrowers -- per capita income at or less than $350 (i.e., average income less than a dollar a day); · Scenario 3 is much the same as Scenario 2, but with IDA's credit terms softened further by also including a service charge waiver; and · Finally, Scenarios 4 and 5 provide, for comparison, the effect if grants are provided on the basis of country poverty rather than for specified purposes. In Scenario 4, 50% of IDA's financing would be provided on grant terms for IDA-only borrowers with per capita income at or below $350, and Scenario 5 sets out the effect of providing grants to all IDA-only countries. 12. Table 3 provides (a) the proportion that the grants would represent in terms of the social sector financing done by IDA in those countries, (b) the overall concessionality of IDA to IDA-only countries, and (c) the concessionality provided to borrowers below a per capita GNI threshold (if applicable) as a result of the provision of grants and softened terms. It shows for example, that Scenario 3 provides the same concessionality (81%) to the poorest borrowers, as Scenarios 4 and 5. In other words, Scenario 3 would provide the equivalent concessionality for the poorest countries of opening a 50% grant window for them. The share of grants provided under Scenario 3 would be up to 50% of social sector financing in IDA-only countries, and represent 10% of IDA13 overall lending. Clearly, the grant window could be set to be smaller or larger than 10% overall, the softening of terms could be structured differently by choosing different elements, and/or a different GNI per capita threshold could be adopted for the use of softened lending terms. However, it is hoped that these scenarios, and perhaps Scenario 3 in particular, could provide a way forward in the discussion. Financial Impact of Providing Grants and Lending Concessionality 13. Increased concessionality through softening terms and/or the provision of grants provide financial benefits to IDA's borrowers, but have a corresponding effect in terms of financial costs to IDA. The consideration of increased concessionality in IDA's operations cannot be divorced from its costs to the institution. These costs can be characterized in terms of the NPV reduction of IDA's reflows, or in terms of actual cash flow reductions to IDA over several decades. Table 4 provides an estimate of these costs to IDA for each of the scenarios illustrated. 14. As is to be expected, greater levels of concessionality (whether provided by grants or softened terms) correspond to a greater overall cost for IDA in both NPV and cash flow terms. Thus, Scenario 1 has the lowest overall cost, and Scenario 5 is the most expensive. As noted above,other combinations are possible, and would have different cost implications. These figures give an estimate of the range of costs that Deputies -4- would need to consider in their deliberation on increasing the use of grants and softening IDA's credit terms. Conclusion 15. To sum up, this note provides some possibilities for IDA to increase its use of grants, and soften its credit terms as a means of providing additional financial support to its clients. It draws upon the Deputies' discussion in Paris to define some basic scenarios that could bridge the diversity of views and provide building blocks towards agreement on how grants and concessionality can be structured in the context of IDA13, taking into account the functional use of grants and ways in which IDA's credit terms could be made more concessional. The choice of appropriate instruments would need to be guided by: (a) the extent to which grants are needed to increase IDA's effectiveness by establishing the necessary preconditions for development; (b) the need to keep IDA's resource allocation process and instruments simple, clear and transparent; and (c) the impact on IDA's finances. -5- Table 1. Possible Uses of Grants in IDA13 "Constrained Estimate" of Possible Grant Use in IDA13 Uses "High-end" Estimate of Possible Grant Use in IDA13 1/ Subject to a 10% Overall Ceiling 2/ 3/ 4/ 3/ 4/ $ million % $ million % 1. Post Conflict 700 3% 400 2% 2A. Disease (Regional) 500 2% 400 2% 2B. Disease (National) 2,500 11% 400 2% 3. Natural Disaster Reconstruction 500 2% 200 1% 4. Capacity Building in Social Sectors 200 1% 200 1% 5. Basic Education for Disadvantaged Groups 1,000 4% 400 2% Total 5,400 24% 2,200 10% 1/ The High-end Estimate is based on the possible demands for grant usage in IDA13 including, in some areas, such as disease and education, a stepping up of current efforts. It also includes a higher level of grants for post conflict (revised upward post September 11), and capacity building for social sectors (suggested by IDA Deputies in Paris). 2/ The Constrained Estimate reflects an attempt to set out the purposes for the use of grants in the context of preferences expressed by IDA Deputies in Paris, subject to a 10% ceiling . Clearly, a smaller subset of purposes for grants could be specified within the 10% ceiling. In any event, IDA would need to have the flexibility to allocate smaller or larger amounts to any particular agreed purpose, taking into account emerging needs, subject to the overall ceiling. 3/ Rounded to the nearest $100 million. Details do not add up due to rounding. 4/ Percentage based on a projected $22 billion IDA13 program. -6- Table 2. Increasing Lending Concessionality by Softening IDA Terms Increase of Concessionality (Grant Element) 1/ Concessionality of Softened Terms Extending Grace Period by 5 Years 2/ 4% 68% Extending Maturity by 10 Years 3/ 5% 69% Waiving 50b.p. Service Charge 6% 70% Combination of All Three 4/ 15% 79% 1/ The grant element is calculated as the present value differential between credit disbursements and debt service payments in percentage terms. The NPV of credit disbursements is determined under a standard 8-year disbursement schedule for IDA investment projects. The discount rate we use in the grant element calculations for IDA assistance is the commercial interest reference rate (CIRR) for SDR-denominated loans as of the end of FY 2000. CIRR-SDR rates are also used for NPV valuation of IDA credits in the context of HIPC debt relief. The CIRR is the minimum interest rate applicable to official financing support of export credits, in accordance with the Arrangement on Guidelines for Officially Supported Export Credits of the OECD. 2/ 15-year grace period; 40-year maturity, standard 75bp service charge. Amortization schedule after the grace period: 2% in the first 10 years, 4% in the next 5 years and 6% in the last 10 years. 3/ 10-year grace period, 50-year maturity, standard 75bp service charge. Amortization schedule after the grace period: 2% in the first 30 years, 4% in the last 10 years. 4/ 15-year grace period, 50-year maturity, 25bp service charge. Amortization schedule after the grace period: 2% in the first 20 years, 4% in the last 15 years. -7- -8- -9-