IDA14 Modalities of IDA13 Grant Financing Technical Note International Development Association 1 During the IDA14 discussions on February 18-20, 2004 in Paris, Deputies reaffirmed their commitment to maintain and safeguard IDA's financial strength. With this in view, Deputies decided to explore a grant financing proposal for IDA13 grants which would provide a commitment for full financing in IDA14 of foregone charges, and financing of foregone principal reflows as these arise over the longer term. 2 Specifically, the proposal is to approach the financing of IDA13 grants in two l segments: The first segment would consist of foregone service and commitment charges reflecting IDA's costs of doing business. These foregone charges would be financed by donor contributions in IDA14 which will be additional to donors' regular IDA 14 contributions. l The second segment would consist of foregone principal reflows associated with IDA13 grants. These foregone reflows (which occur over a time frame of 1l-40 years) would be financed by additional donor contributions as they arise (i.e., on a pay-as-you-go basis). 3 Deputies have asked IDA Management to prepare a technical note detailing the proposal on IDA13 grant financing by donors. This note builds on the detailed technical analysis of two earlier notes which were preparedby Management for the IDA1 3 Mid- Term Review in November 2003' and the IDA14 meetings in Paris in February 2004.2 Specifically, this note follows up on the above-mentioned proposal for IDA13 grant financing and illustrates how the financing of foregone charges would translate into additional donor contributions in IDA14. The modalities for converting the financing of foregone principal reflows into donor contributions would be addressedby Deputies during future IDA replenishrnents, as and when foregone reflows arise. I. Background 4 Assuming that IDA will deliver 19.5% of the total envelope of development assistanceas grants during the IDA13 period (FY03-05), IDA will forego about SDR 4.1 billion of nominal reflows over a 40-year period.' Since IDA credits do not carry interest charges and are of a very long maturity, the NPV of these foregone reflows is significantly lower, equivalent to approximately SDR 1,436 million.4 ' Compensnting IDA $51~tk Cost ofIDA GWZLS,IDA, October 2003 e ' Further Options for IDA13 Grnnf Financing, IDA, January 2004. The value of 19.5% is the mid-point of the agreed share of grants of 18-2 1% of total IDA13 resources. ' Regular IDA credits have a maturity of 40 years with a grace period of 10 years. NPVs (Net Present Value) represent the value today of a future stream of payments. They are calculated using a 5% discount rate per annum and have been valued as of the start of the IDA14 period in FY06, that is, as of July 2005. A 5% discount rate has been used in all prior discussions and notes on the subject of IDA1 3 grant financing. -2- 5. Of this amount, SDR 1,064 million representsthe NPV of foregone principal repayments, while the balance of SDR 371 million representsthe NPV of foregone service charge (SDR 324 million) and commitment charge (SDR 47 million) income? Table 1 shows the detailed breakdown of foregone credit reflows due to IDA13 grants bv principal v repayments, service charge income and commitment charge income. Table I: Estimated Foregone Reflows due to IDA13 Grants Nominal Terms NPV Terms I/ Item (SDR million) (in %) (SDR million) (in %) I I I I Principal Repayments Foregone I 3,413 I 84% 1 1,064 1 74% I I I I Service Charge Income (0.75%) Foregone I 603 I 15% I 324 I 23% I I I I Commitment Charge Income (0.50%) Foregone: 50 I 1% ; 47 I 3% I I Total Foregone Reflows from IDA13 Grants : 4,065 [ xlO% ; 1,436 : ml% I/ NPVs are valued as of July 2005 (FY06) II. Additional Donor Contributions During IDA14 6 To finance the foregone charge income of SDR 371 million (in NPV terms), donors would make financing contributions in addition to their regular IDA14 contributions. The specific amount of additional donor commitments in IDA14 would vary depending on the time schedule for encashments to be applied for these donor contributions. The longer the period of encashment, the larger the resulting nominal amount of additional donor commitments.' 7 In the note prepared for the IDA13 Mid-Term Review in November 2003, Management used a 3-year encashment schedule for illustrative purposes, assuming three equal annual payments of donors' additional IDA14 commitments.7 Under this 3-year encashment schedule, the nominal amount of additional IDA14 donor commitments would equal approximately SDR 410 million. 8 In recent IDA replenishments, donors have used both 6-year and 9-year encashment schedules. Table 2 provides the encashmentprofiles for these schedules. The choice of encashment schedule is typically not finalized until the last meeting of a replenishment round. As was the practice during previous IDA replenishments, individual countries would have the option to agreewith IDA on alternative encashment scheduleswhile maintaining the present value of their payments. Grant financing contributions by donors ' It is assumed that IDA grants continue to carry no commitment charge, while IDA credits would carry a service charge of 0.75% p.a. and a commitment charge of 0.5% p.a. as is currently the case. ' A longer encashment schedule would result in more substantial discounting of donor payments in outer years due to the discount rate applied, therefore reducing the present value of these payments. Compensating IDA for the Cost of IDA13 Grants, IDA, October 2003, paras. M-20. -3- would carry IDA voting rights and burden-sharing arrangements for IDA13 grant financing U would follow those in IDA1 3. 9 As shown in Table 2, when applying a 6-year encashment schedule, additional donor commitments in IDA14 would equal approximately SDR 450 million in order to reach the agreed target NPV value (SDR 371 million) for foregone service and commitment charge income due to IDA13 grants. When applying a 9-year encashment schedule, additional donor commitments in IDA14 would equal approximately SDR 470 million. Table 2: IDA Encashment Schedules and IDA14 Financing Amounts Donor Encashments (in %) Fiscal Years Upfront 3-year Schedule 6-year Schedule g-year Schedule I 100.0 33.3 5.4 3.0 2 33.3 13.1 10.0 3 33.3 22.0 16.0 4 24.5 18.0 5 23.4 16.0 6 II .6 13.0 7 10.0 8 8.0 9 6.0 Total Encashments 100 100 100 100 Discount Rate Applied 5.0% 5.0% 5.0% Total in NPV Equivalent 90.8 83.2 79.2 IDA14 Financing Amounts for IDA13 Grants (SDR Million nominal) 371 410 450 470 10 The specific SDR amounts for each donor relating to the additional donor contributions in IDA14 can only be determined once Deputies have decided on the type of encashment schedule for IDA14. Annex 1 lists the SDR amounts to be contributed by each donor under a 6-year and a 9-year encashment schedule.* Donor commitments would be expressedin SDR terms. SDR commitments would be converted into the same payment currencies, and at the same exchange rates, as applicable for donors' regular contributions to the IDA14 replenishment. 11. As in previous replenishments, the IDA13 arrangements included a "structural financing gap" of about 9% of total donor contributions.9 For the IDA13 grant financing payments, that gap amounts to between SDR 42 million and SDR 44 million, depending on whether a 6-year or 9-year encashment schedule is selected. To fill this gap, the following IDA13 resources would be used: (i) an amount of about SDR 29 million (representing the pro-rata share for charge income) from the GBP 100 million (SDR 112.9 million) financing contribution made by the United Kingdom contingent upon agreement by 8 Deputies would, in any event, discuss and agree on burden-sharing terms for their regular IDA14 contributions during the IDA14 discussions, as has been the practice in previous IDA replenishments. 9 The structural financing gap arisesbecause the burden shares of all donors do not add up to 100%. -4- Deputies on financing IDA13 grants; and (ii) an amount in the range of SDR 13 million and SDR 15 million (depending on whether a h-year or 9-year encashment schedule is used) from the SDR 100 million allocation set aside during IDA13 as a carry-over item from IDA12 to finance the long-term cost of IDA1 3 grants. Details on the proposed use of these two financing items are provided in Annex 1. III. Additional Donor Contributions During Subsequent IDA Replenishments 12 . As described above, donors would finance foregone income from service charge and commitment charge through additional contributions in IDA14. By contrast, foregone principal reflows due to IDA13 grants would be financed over time as they arise (i.e., on a pay-as-you-go basis). Table 3 summarizes the expected profile of foregone principal reflows over 40 years.lo The modalities for converting these foregone principal reflows into donor contributions would be addressedby Deputies during future IDA replenishments. Table 3: Foregone Principal Reflows due to IDA13 Grants Fiscal Years Annual Principal Reflows (in SDR million nominal) 2013 23 2014 46 2015-2022 68 2023 91 2024 114 2025-2042 137 2043 91 2044 46 Total Volume lo Foregone credit reflows are based on the assumption that IDA1 3 grants would be provided in equal annual volumes during fiscal years 2003-2005. -5- Annex 1: IDA14 Donor Contributions for IDA13 Grant Financing using 6-year and 9-year Encashment Schedules based on IDA13 Basic Shares IDA13 IDA14 Donor Contributions Basic Share 6-year Encashments 9-year Eneashments Contributing Members (4OO SDR Million SDR Million Argentina 0.05% 0.23 0.24 Australia 1.46% 6.57 6.86 Austria 0.78% 3.51 3.67 Belgium 1.55% 6.98 7.29 Brazil 0.61% 2.75 2.87 Canada 3.75% 16.88 17.63 Czech Rep. 0.05% 0.23 0.24 Denmark I .58% 7.11 7.43 Finland 0.60% 2.70 2.82 France 6.00% 27.00 28.20 Germany 10.30% 46.35 48.4 1 Greece 0.12% 0.54 0.56 Hungary 0.06% 0.27 0.28 Iceland 0.04% 0.18 0.19 Ireland 0.18% 0.81 0.85 Israel 0.10% 0.45 0.47 Italy 3.80% 17.10 17.86 Japan 16.00% 72.00 75.20 Korea 0.91% 4.10 4.28 Kuwait 0.14% 0.63 0.66 Luxembourg 0.10% 0.45 0.47 Mexico 0.05% 0.23 0.24 Netherlands 2.60% 11.70 12.22 New Zealand 0.12% 0.54 0.56 Norway 1.52% 6.84 7.14 Poland 0.03% 0.14 0.14 Portugal 0.20% 0.90 0.94 Russia 0.08% 0.36 0.38 Saudi Arabia 0.39% 1.76 1.83 Singapore 0.14% 0.63 0.66 Slovak Republic 0.01% 0.06 0.06 South Africa 0.08% 0.36 0.38 Spain 1.80% 8.10 8.46 Sweden 2.62% 11.79 12.31 Switzerland 2.43% 10.94 11.42 Turkey 0.09% 0.41 0.42 United Kingdom 10.14% 45.63 47.66 United States 20.12% 90.54 94.56 Venezuela 0.03% 0.14 0.14 Sub-total 90.63% 407.85 425.98 St)"Uctural~nancing gap 9.37% 42.15 44.02 Total additional contributions 100.00% 450.00 470.00 Proposed coverage ofslrzkctural financing gap (i) UK supplemental funds (up to SDR 112.9 Million total) 29.17 29.17 (ii) IDA12 carry-over item (up to SDR 100 Million total) 12.98 14.85 Structural financing gap 42.15 44.02