IDA14 Modalitiesof IDA13 Grant Financing Technical Note International Development Association May 2004 Modalities of IDA13Grant Financing 1. During the IDA14 discussions on February 18-20,2004 in Paris, Deputies reaffirmed their commitment to maintain and safeguard IDA'sfinancial strength. With this in view, Deputies decided to explore a grant financingproposal for IDA13 grants which would provide a commitment for full financingin 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 segments: 0 The first segment would consist of foregone service and commitmentcharges reflecting IDA's costs of doingbusiness. These foregonecharges would be financed by donor contributionsin IDA14 which willbe additionalto donors' regular IDA14 contributions. The second segment would consist of foregoneprincipal reflows associatedwith IDA13 grants. These foregonereflows (which occur over a time frame of 11-40 years) would be financed as theyarise (i.e., on a pay-as-you-go basis). 3. Deputies have asked IDA Management to prepare a technicalnote detailingthe proposal on IDA13 grant financingby donors. This note builds on the detailedtechnical analysis of two earlier notes which were preparedby Managementfor the IDA13 Mid- Term Review in November 2003.1and the IDA14 meetings in Parisin February 2004.2 Specifically, this note follows up on the above-mentioned proposalfor IDA13 grant financing and illustrates how the financingof foregonecharges would translate into additional donor contributions in IDA14. The modalitiesfor convertingthe financing of foregone principal reflows into donor contributionswould be addressedby Deputies during future IDA replenishments, as and whenforegone reflows arise. I. Background 4. Assuming that IDA will deliver 19.5%of the total envelopeof development assistance as grants during the IDA13 period (FY03-05), IDA willforego about SDR 4.1 billion of nominal reflows over a 40-year period.3 Since IDA credits do not carry interest charges and are of a very long maturity, the NPV of theseforegonereflows is significantly lower, equivalent to approximatelySDR 1,436million? 1 CompensatingIDA forthe Costof IDA13 Grants,IDA, October 2003. Further Optionsfor IDA13 Grant Financing,IDA, January 2004. The value of 19.5% is the mid-point of the agreed share of grantsof 18-21%of total IDA13 resources. 4 Regular IDA credits have a maturity of 40 years witha graceperiod of 10years. NPVs (Net Present Value) represent the value today of a future streamof payments. They are calculated using a 5% discount rate per annum and have been valued as of the start of the IDA14period in FY06, that is, as of July 2005. - 2 - 5. Of this amount, SDR 1,064million representsthe NPVof foregoneprincipal repayments, while the balance of SDR 371million representsthe NPV of foregone service charge (SDR 324 million) and commitmentcharge (SDR 47 million) income.5 Table 1 shows the detailed breakdown of foregonecredit reflows due to IDA13 grants by principal repayments, service charge income and commitmentchargeincome. Table 1: Estimated Foregone Reflows dueto IDA13 Grants Nominal Terms Item NPV Terms 1/ (SDRmillion) (in %) (SDRmillion) (in %) I I I I Repayments Principal Foregone I 3,413 84% 1,064 74% I Service Income Charge (0.75%) Foregone 603 75% 324 23% Commitment Income Charge (0.50%) Foregone: 50 7% 47 3% Total ForegoneReflows from IDA13 Grants 4,065 700% 1,436 700% 1/ NPVsarevaluedas of July 2005 (FY06) II. Additional Donor Contributions During IDA14 6. To finance the foregone charge income ofSDR 371million (in NPV terms), donors would make financing contributionsin addition to their regular IDA14 contributions. The specific amount of additional donor commitmentsin IDA14 would varydepending on the time schedule for encashmentsto be appliedfor these donor contributions. The longer the period of encashment, the larger the resulting nominal amountof additionaldonor commitments.6 7. In the note prepared for the IDA13Mid-TermReviewin November 2003, Management used a 3-year encashment schedulefor illustrativepurposes, assuming three equal annual payments of donors' additionalIDA14 commitments.7 Under this 3-year encashment schedule,the nominal amount of additionalIDA14 donorcommitments would equal approximately SDR 410 million. 8. In recent IDA replenishments,donors haveused both 6-year and 9-year encashment schedules. Table 2 provides the encashmentprofiles for these schedules. The choice of encashment schedule is typically not finalizeduntil the last meeting of a replenishment round. As wasthe practice during previous IDA replenishments,individualcountries would have the option to agree with IDA onalternativeencashment scheduleswhile maintaining the present value of their payments. Grant financingcontributionsby donors It is assumed that IDA grants continueto carry no commitmentcharge, while IDA credits would carry a service charge of 0.75%p.a. anda commitmentcharge of 0.5%p.a. as is currentlythe case. 6 A longer encashment schedule would result in more substantialdiscounting of donor payments in outer years due tothe discount rate applied, thereforereducing the present value of these payments. 7 Compensating IDA for the Cost of IDA13 Grants, IDA, October 2003, paras. 18-20. - 3 - would carry IDA voting rights and burden-sharingarrangementsfor IDA13 grant financing would follow those in IDA13. 9. As shown in Table 2, when applying a 6-year encashmentschedule,additional donor commitments in IDA14 would equal approximatelySDR 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 applyinga 9-year encashment schedule, additional donor commitmentsin IDA14 wouldequal approximatelySDR 470 million. Table 2: IDA Encashment Schedules andIDA14 Financing Amounts Donor Encashments (in%) Years Fiscal Upfront Schedule 3-year 6-year Schedule 9-year Schedule 1 33.3 100.0 5.4 3.0 2 10.0 33.3 13.1 3 16.0 33.3 22.0 4 18.0 24.5 5 16.0 23.4 6 11.6 13.0 7 10.0 3 8.0 9 6.0 Total Encashments 100 100 100 100 DiscountRate Applied 5.0% 5.0% 5.0% Total in NPV Equivalent 79.2 90.8 83.2 IDA14 FinancingAmounts for IDA13 Grants 41 371 nominal) (SDR Million 0 450 470 10. The specific SDR amounts for each donor relating to the additionaldonor contributions in IDA14 can only be determinedonce Deputies have decided on the type of encashment schedule for IDA14. Annex 1lists the SDR amountsto be contributedby each donor under a 6-year and a 9-year encashment schedule.8 Donor commitmentswould be expressed in SDR terms. SDR commitmentswould beconverted into the same payment currencies, and at the same exchangerates, as applicablefor donors' regular contributions to the IDA14 replenishment. 11. As in previous replenishments,the IDA13 arrangementsincluded a "structural financing gap" of about 9% of total donor contributions.9 For the IDA13 grant financing payments, that gap amountsto between SDR 42 million andSDR 44 million, depending on whether a 6-year or 9-year encashment scheduleis selected. Subsequentto the IDA14 discussions in Paris in February 2004, the United Kingdom hasinformed IDA Management of its agreementto finance this gap in its entirety from the GBP 100million (SDR 112.9 million) financing contributionmade by the United Kingdom contingentupon 8 Deputies would, in any event, discuss and agree on burden-sharingterms for their regular IDA14 contributions during the IDA14 discussions,as has been the practice in previousIDA replenishments. The structural financing gap arises because the burden shares of alldonors do not addup to 100%. -4- agreementby Deputies on financing IDA13 grants. The financingof this gap by the United Kingdom will be in additionto the United Kingdom's financingof its own burden share of foregone charge income. 12. Management would utilize the paymentsreceived from donors to cover the administrative expenses associated with theprovision of IDA13 grants. The share of donor encashments received in advanceof future administrativeexpenses would become available for additional developmentassistanceas they wouldconstitute internal resources (liquidity) available for future IDA commitment authority. III. Additional Donor Contributions During Subsequent IDA Replenishments 13. As described above, donors would finance foregone income from service charge and commitment charge through additionalcontributionsin IDA14. By contrast, foregone principal reflows due toIDA13 grants would be financedover time as they arise (i.e., on a pay-as-you-go basis). Table 3 summarizesthe expectedprofile of foregoneprincipal reflows over 40 years." The modalities for convertingthese foregone principal reflows into donor contributions would beaddressedby Deputies during future IDA replenishments. Table 3: Foregone Principal Reflowsdue to IDA13 Grants Fiscal Years Annual Principal Reflows (in SDR million nominal; 2013 23 2014 46 5-2022 201 2023 91 2024 114 2025-2042 137 2043 91 2044 46 Total Volume 3413 10Foregone credit reflows are based onthe assumptionthat IDA13 grantswould be provided in equal annual volumes during fiscal years 2003-2005. - 5 - Annex 1: IDA14 Donor Contributionsfor IDA13 Grant Financing using 6-yearand 9-year Encashment Schedules based onIDA13Basic Shares IDA13 IDA14 Donor Contributions Basic Share 6-yearEncashments 9-yearEncashments Contributing: Members (%) 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 1.58% 7.11 7.43 Finland 0.60% 2.70 2.82 France 6.00% 27.00 28.20 Germany 10.30% 46.35 48.41 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 0.9 %1 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 SaudiArabia 0.39% 1.76 1.83 Singapore 0.14% 0.63 0.66 SlovakRepublic 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 Structural financing gap a/ . 9.37% 42.15 44.02 Total additionalcontributions 100.00% 450.00 470.00 a/ The UnitedKingdom has agreed tofinancethe structural financinggap in its entirety.