IDA14 Debt Sustainability andFinancingTermsinIDA14: Further ConsiderationsonIssues andOptions International Development Association November 2004 SELECTEDABBREVIATIONS AND ACRONYMS CPIA Country Policy and Institutional Assessment DSA Debt Sustainability Analysis GDP Gross Domestic Product GFATM GlobalFundto Fight AIDS, Tuberculosis, andMalaria GNI Gross National Income HIPC Heavily IndebtedPoor Countries IBRD International Bank for ReconstructionandDevelopment IDA International Development Association IMF International Monetary Fund MDG WllenniumDevelopment Goals MVA Modified Volume Approach NPV Net Present Value PBA Performance-BasedAllocation PV PresentValue Table of Contents I. Introduction......................................................................................................................................... 1 I1. Grant Eligibility Issues: The Impactof RevisedAssumptions ................................... :..................... 2 A. EligibilityBased on RevisedDebt Thresholds............................................................................. 3 B. OtherEligibility Issues................................................................................................................. 5 I11. Grant Allocation Issues: The Incentive-RelatedPortionof the VolumeDiscount............................ 7 A. Overview of MainOptions and Issues.......................................................................................... 8 B. Implications of aPBA-BasedReallocationMechanism .............................................................. 9 C. SettingUp a Shocks Facility....................................................................................................... 12 IV. Grant FinancingIssues: The Charges-RelatedPortionof the VolumeDiscount............................ 14 A. Establishingthe 9% Volume Cut on Grants.............................................................................. 15 B. InvestinginBlendBorrowersat "Hard Terms'' ......................................................................... 15 C. Eligibility for Lending at "Hard Terms" ..................................................................................... 17 V. Conclusions................................................................................... :................................................... 18 VI. Issues for Discussion......................................................................................................................... 19 Text Tables 4 Table 2: Country GroupingsUnderNew CPIA Cut-offs............................................................................ Table 1: RevisedPolicy-DependentDebt andDebt-ServiceThresholds ................................................. 4 Table 3: Grant Eligibility Under the RevisedAssumptions......................................................................... 5 Table 5: Calculatingthe Overall Grant Share............................................................................................ 10 Table4: IDNIBRD BlendCountries........................................................................................................... 6 Table 6: InterestRatesand ResultingGrant Elements............................................................................... 17 Text Charts Chart 1: CorrelationsBetweenResourceTransfers and Performance After PBA-Based Reallocation............................................................................................................................ 11 Box 2: The Modified Volume Approach..................................................................................................... Box 1: The "Traffic Light" Grant Eligibility System.................................................................................. 3 Text Boxes 9 Annexes 1. Annex Tables ......................................................................................................................................... 21 A.2. PercentageDistancesfrom IndicativeThresholds.................................................................... A.1. Policy DependentDebt andDebt Thresholds Applied to Low IncomeCountries...................24 21 26 A.4. DebtDistress Rankingsand Grant Allocations by Country..................................................... A.3. Composite Index for RankingCountriesAccording to Debt Distress ..................................... 28 A.5. Overall Grant Shares for Low andHighCase Scenarios inFYO6-08...................................... 30 A.6. "Five-Light" System: Grant Shares for DifferentFY06-08 Scenarios..................................... 32 2. Replicatingthe Analysis under a "Five-Light" Eligibility System........................................................ 31 Annex Charts Chart A.1. CorrelationsBetweenResourceTransfers and PerformanceAfter PBA-Based Reallocationinthe Five-Light System.................................................................................... 32 Debt Sustainability and Financing Terms inIDA14: Further Considerations on Issuesand Options I.Introduction 1. This paper responds to the requestsmade by Participants at the thirdmeetingof the IDA14 negotiations for more work on selected elements of the proposal' to make the primary grant eligibility criterion inIDA14 acountry's risk of debt distress. At this meeting, Deputies stressed that while addressing the broadissue of debt sustainability, the new grant allocation systemfor IDA14should, to the maximum extent, preserve the performance and incentive aspects of IDA'SPBA system, as well as provide poor countries with an adequate volume of resource transfers in order to accelerateprogress towards the MDGs. 2. Like the two previous papers, this one takes as its startingpoint thejoint Bank-Fundwork on a debt sustainability framework which provides the analytical foundation for the link between debt sustainability and grant eligibility.2 While the principlesunderpinningthis work have been broadly endorsed by the Deputies, there i s also a clear preference for lowering the policy- dependent debt and debt-service thresholds to help lower the overall risk of actual debt distress situations. 3. The paper i s organized according to the same road-map as the previous papers, starting with issues related to eligibility criteria, followed by grant allocation issues and lastly financing issues. Section I1of this paper assesses the implications of the revised set of thresholds proposed by the staffs of the Bank andthe Fundfor IDA14 grant eligibility and for the overall grant share. It also contains a discussion on other grant eligibility issues, including exceptional HIV/AIDS grants for IDA-only countries that would be ineligible for grants under a debt distress criterion; grants for regional projects; and the "free rider" problem. Section III examines different options for reallocating the resources from the volume discount on grants associatedunder the proposed Modified Volume Approach.' Section N focuses on grant-financing issues and discusses the -workings of a "hard terms" window proposed to be set up usingthe charges-related portion of the volume discount. Summary conclusions are presented in Section V and suggestedissues for discussion are outlined inSection VI. Updatedexternal debt information and country rankings are presented inthe tables inAnnex 1. The implications of adopting five, rather than three, grant eligibility categories are examined in Annex 2. ' Referto IDA(2004a).Debt Sustainability and Financing Terms in IDAI4, IDNSecM2004-0327,Washington, D.C., June 24; and IDA (2004b). Debt Sustainability and Financing Terms in IDAI4: TechnicalAnalysis of Issues and Options,IDNSecM2004-0640,September22. See IMFandWorld Bank (2004a), Debt Sustainability in Low-Income Countries Proposalfor an - Operational Framework and Policy Implications, Washington, D.C., February 2004. Henceforthreferredto as the "Framework Paper." See also IMFandWorld Bank (2004b), Debt Sustainability in Low-Income Countries: Further Considerations on an Operational Framework and Policy Implications, Washington, D.C., September 2004, referredto hereas the "Modalities Paper". Box 2 summarizesthe mainfeatures of the Modified Volume Approach. - 2 - 11. GrantEligibilityissues: The Impactof RevisedAssumptions 4. The Bank-Fund debt sustainability framework links the risk of debt distress to the quality of policies and institutions in low-income countries. A key element of this approach i s the use of a set of indicative thresholds of external debt-burden indicatorsthat take into account countries' policies and institutions as well as their vulnerability to exogenous shocks. The Framework Paper (IMFand World Bank [2004a]) uses the Bank's Country Policy and Institutional Assessment (CPIA) index to measure countries' policy and institutional quality and to establish the debt thresholds accordingly. The grant eligibility proposalpresented in Hanoi and Washington (IDA [2004a, 2004bl) was basedinthe original Framework Paper's thresholds. 5. Duringthe Washington, D.C., discussions inOctober, Deputiesstated a preference for more conservative thresholds than those presented in the FrameworkPaper. More specifically, Deputies askedstaff to assess,jointly with the IMF,the implications of setting the debt and debt- service thresholds at levels consistent with a lower overall probability of debt distress. The results of this work -presented in ajoint Bank-Fundnote4to their respective Boards of Executive Directors - andits implicationsfor grant eligibility in IDA14 are summarized in subsection A. 6. Although debt distress risk i s proposed to remain the primarygrant eligibility criterion in IDA14, a number of other issues may have an impact on eligibility. They include HIV/AIDS operations incountries which are ineligible for grants under the debt-distress criterion, regional projects, andthe "free rider" problem. These issues are discussed in subsection B. 4 IMFandWorld Bank (2004~).Choice of Indicative Debt-Burden Thresholds-Alternative Options, OM2004- 0091, Washington, D.C., November2004. - 3 - Box 1. The "Traffic Light" Grant Eligibility System The country ranking system proposed in the Hanoi and Washington, D.C. discussions (see IDA [2004a, 2004bl) takes as its starting point a matrix of policy-dependent debt-burden thresholds. This matrix has been updated since the original version (see IMFand World Bank [2004a, 2004c]), and it now contains a more conservative set of debt thresholds (see Table 1inthe main text). The matrix i s converted into a country ranking system through a four-step process: Step 1: Appropriate debt-burden indicators are selected. 9 Revenues-basedindicators are excluded due to dataavailabilitykomparabilityissues, as well asthe riskof moral hazard. 9 The followingdebtratios are selected: NFV ofdebt-to-exports, NPVofdebt-to-GDP, anddebt service-to-exports. Step 2: Countries' relative positions with respect to the debt-burden thresholds are measured. P Percentagedistancesbetween actual debt-burden indicators andtheir respective thresholds are calculated. Step 3: A decision rule for the debt-burden indicators i s established. 9 Two variables arecomputed andcompared: (i) the average of the percentagesdistances of the two stock indicators (NPV of debt-to-GDP and NPV of debt-to-exports ratios) to their respective thresholds; and (ii) the relative distance o f the debt service-to-exports ratio to its threshold. 9 Thenumber that yields themost conservative (prudent) decisionintermsofdebt-distress classification is chosen. Step 4: A "traffic light" is assignedto countries according to the risk of debt distress. 9 A "green light" indicatesalow riskofdebt distress; a"red light" indicates ahighriskofdebt distress; and a "yellow light" indicates a medium riskof debt distress. Itis important to bear inmindthat, once the debt sustainability framework is fully implemented, the mechanism above will give way to a ranking system fully basedon the insights generated by debt sustainability analyses (DSAs). A. EligibilityBasedon RevisedDebt Thresholds 7. The original policy-dependent debt and debt-service thresholds presented in the FrameworkPaper were derived from the results of empirical analyses carried out independently at the Bank and the Fund.' While this work is robust from an analytical point of view, "it bears emphasizing that the implicit choice of distress probabilities remains a policy decision" as noted inthe FrameworkPaper (op. cit., p. 21). 8. Lower thresholds can be generated by reducing the overall probability of distress usedto calculate the thresholds, or by classifyingcountries according to performance in a different manner. The two methods can also be combined. The latter procedure i s proposed by Bank and Fundstaffs andwould imply NPV of debt-to-exports thresholds of 100/150/200.6Inline with a more cautious approach to the overall probability of debt Istress, and with absolute CPIA cut- 5 For the Bank's empirical analysis, see Kraay, A. and V. Nehru (2004). "When is Debt Sustainable?', World Bank Policy Research Working Paper, No. 3200. For the Fund's, see Gottschalk, J. and B.Loko (2003), "Debt Thresholds inLow-Income Countries", mimeo, partially replicated as Appendix Iof the FrameworkPaper. See IMFand World Bank (2004~).Compared to other options considered, the one proposed by Bank andFund staffs "has the advantageof presenting an internally consistent approach to the tolerable risk of debt distress between the HIPC Initiative and the forward-looking framework, applied to the `average' country." (p. 2). - 4 - offs of 3.25 (weak to medium performance) and 3.75 (mediumto strong performance), Table 1 below shows the new proposed thresholds for the NPV of debt-to-exports, as well as for the NPV of debt-to-GDP and debt service-to-exports consistent with the former. Table 1. RevisedIndicative Policy-DependentDebtand Debt-ServiceThresholds ~~~PerformanceCategory ~ Debt andDebt-ServiceThresholds(%) NPV of debt-to-GDP NPV of debt-to-exports . Debt service-to-exports Weak (CPIA13.25) 30 100 15 Medium 40 150 20 (3.25cCPIAc3.75) Strong (CPIA23.75)) 50 200 25 9. The new CPIA cut-offs imply that fewer countries would be classified as strong performers compared to the previous IDA14papers on debt sustainability and financing terms (see IDA [2004a, 2004bl). Inaddtion, performance categories would no longerbe defined in terms of percentiles. Table 2 shows which countries are now grouped into each performance category. Table2. Country GroupingsUnderNew CPIA Cut-Offs Performance Countries Category Stsong (12) Armenia, Bhutan, Cape Verde, Grenada, Maldives, Mauritania, Samoa, Sri Lanka, St. Lucia, St. Vincent and the Grenadines, Tanzania, Uganda. Medium (32) Albania, Azerbaijan, Bangladesh, Benin, Bolivia, Bosnia and Herzegovina, BurkinaFaso, Cameroon, Dominica, Ethiopia, Ghana, Guyana, Honduras,India,Indonesia,Kenya, Kyrgyz Republic, Lesotho, Madagascar,Malawi, Mali, Mongolia, Mozambique, Nepal, Nicaragua, Pakistan,Rwanda, Senegal,Serbia andMontenegro, Vietnam, Yemen,Zambia. Weak (37) Afghanistan, Angola, Burundi, Cambodia,CAR, Chad, Comoros, Congo DR, Congo Rep., Cote d'Ivoire,Djibouti,Eritrea,The Gambia, Georgia,Guinea,Guinea-Bissau, Haiti, Kiribati, Lao PDR, Liberia, Moldova,Myanmar, Niger, Nigeria, PapuaNew Guinea, Sao Tome and Principe, Sierra Leone,SolomonIslands, Somalia, Sudan, Tajikistan,Timor-Leste, Togo, Tonga, Uzbekistan, Vanuatu, Zimbabwe Note: Countries inbold are those that moved from one category to the next compared to IDA(2004b). 10. Impacton OverallGrant Eligibility. Onthe basis of the three-category "traffic light ~ystem''~originally proposed, 47 countries would become grant-eligible,* as indicatedinTable 3, ' Annex 2 spells out the implications of using a five-category eligibility system under the revised assumptions. Newly eligible countries are: Uganda, Samoa, Nicaragua, Senegal, Burkina Faso, Kenya, Georgia, Niger, Chad and Tonga. Having reachedits Completion Point under the HIPC Initiative on October 20,2004, Madagascar would be classified as a "green light" country under the "traffic light" system. - 5 - upfrom 37 inthe eligibility scenario presentedinOctober (see IDA[2004b]).9 This increase in the number of countries eligible for IDA grants has a significant impact on the overall share of grants in IDA14 (section 111). Table 3. Grant Eligibility Under the RevisedAssumptions Number of Countries'" Green 19 Yellow 5 Red 40 SDecial Transitional 2 Cgses`l Number of Grant- Eligible Countriesl2 47 11. Itis important to note that the classification presentedhere is likely to change over the course of IDA14 as the implementationof the secondpillar of the of thejoint Bank-Fund debt sustainability framework gets underway. This pillar will take a more dynamic view of the risk of debt distress through DSAs. B. Other EligibilityIssues 12. ExceptionalHIV/AIDS Grants. A concern with the debt-distress basedapproach to grant allocationproposed for IDA14 i s that it would exclude several "green light" IDA-only countries previously eligible under IDA13 for 100percent grants for HN/AIDS projects. Deputiesmay wish to consider whether there remains a case for the provision of 100percent grant financing for HIV/AIDS operations for "green light" IDA-onlycountries duringthe IDA14 period as well as for regional HIV/AIDS operations, or whether the demand for additional HN/AIDSgrants couldbemet by other available mechanisms such as the GlobalFundto Fight AIDS, Tuberculosis, and Malaria (GFATM). 13. Such potentialextension of grant eligibility for HIV/AIDS would enable to continue with the policy approach for IDA-only c~untries'~ inthis matter taken inIDA13, butit would also represent an exception to the proposed principlethat grants would be allocated on the basis of countries' risk of debt distress. A preliminary estimate of such an exception i s that it would increase the grants envelope in IDA14by about SDR 300 million, based on the FY05 volumes allocated to date to HIV/AIDS operations in "green light" countries and for regional HIV/AIDS programs under IDA13. This corresponds to about 1.3 percent of the base case level proposed for IDA14. The resources for these HIV/AIDS operations would come from countries' regular Including Kosovo and Timor-Leste. i o Table 3 excludes blend or hardened-term countries. 11 Kosovo and Timor-Leste. See IDA(2004b, p. 12). 12 ExcludesMyanmar for which IDA allocation for EyO6-08is zero. l3 It is assumedthat "yellow light" countries would finance HIV/AIDS operations from the grant portion of their allocation. - 6 - IDA allocations. Furthermore, to avoidincreased costs to IDA interms of foregone charge income, a 9 percent charges-related volume discount would needto be ap~1ied.I~ 14. Regional Projects.l5Deputies may also wish to consider establishing a provision for the grant financing of the portion of the cost of regional projects (other than HIVIAIDS) that i s attributable to all IDA-only countries that are eligible for 100percent grants underthe debt- distress criterion (thus excluding those classified as "yellow light"). A reasonable estimate of the associated increase in the grants envelope would be about SDR 495 million, or about 80 percent of the total envelope for regional projects for the IDA14 base case. Again, to avoid additional losses to IDA, a 9 percent volume discount would be applied to the grant component of regional projects. 15. Restrictions on Grant Eligibility: Blend and "Gap" Countries. As indicated in previous discussions, grant eligibility would be restrictedto IDA-only countries. IBRD/IDA blends, including hardened term "gap" countries and "notional"'6 blends wouldbe excluded. Table 4 below provides a complete list of countries that are grant-ineligible because of their blend status." Given the potential or actual ability of these countries to undertake market-based borrowing, their exclusion from grant eligibility in IDA14would help allay "free rider" concerns that couldbe triggered by a grant eligibility mechanism based on the risk o f debt distress (see further discussion below on this subject). Other countries subject to IDA lending on hardened terms but which are not IBRD/IDA blends would also be grant-ineligible. They are: Albania, Djibouti, and Honduras. Table4: IDMBRDBlendCountries Above ouerational cut-off Below operational cut-off Notionalblends Bosnia-Herzegovina Azerbaijan Nigeria Dominica Bolivia PapuaNew Guinea Grenada India Zimbabwe St Lucia Indonesia St Vincent Pakistan Serbia & Montenegro Uzbekistan 16. Restrictions on Grant Eligibility: The "Free Rider" Issue. A possible side effect of the provision of IDA grants to countries with a mediumor highrisk of debt distress i s that these countries' "space for borrowing" from other sources -including export credit agencies-may 14 See IDA (2004b) and Section IV below for the rationale of applying a charges-related volume discount on grants. l5 Refer to IDA (2003). Pilot Programfor Regional Projects. IDNSecM2003-0532, October 7. 16 Notional blends are borrowers that have a capacity or history of market-based borrowing and a per capita income below the IDA eligibility threshold, and which are currently unable to borrow from IBRDdue to marginal or deteriorating creditworthiness. 17 Also, refer to Section IV for a discussion on the eligibility issuesregarding the access of IBRDADA blend countries to a "hard terms" lending window. - 7 - expand'*. Potentially damaging consequences may be associated with the "free rider" issue: first, despite the fact that IDA would be extending grants, the overall risk of debt distress may increase if countries expand non-concessional borrowing inthe wake of a reduced share of credits intheir IDA portfolios. This i s a particularly serious concern for countries that have a history of market-based borrowing. Keeping blend and "gap" countries ineligible for IDA grants alleviates the problem, though there would still be situations inwhich IDA-only countries are able to borrow on non-concessional term^'^. Therefore, close coordination among lenders would be neededinorder to ensure that grant-malung by IDA does indeed help reduce countries' risk of debt distress. Second, if the provision of IDA grants frees up space for increasedborrowing from other sources, then IDA would, ineffect, be subsidizing other lenders at the expense of its future financial strength. 17. To address this issue, it is proposed that further consideration be given to restricting grant eligibility to those IDA-only countries that are infact unable or unwilling to borrow commercially. Inthis vein, staff would continue to explore the feasibility of developing a mechanism whereby a country could cease to be eligible for grants if its government contracts or guarantees new non-concessional loans2' during any year of IDA14. 111. GrantAllocationIssues: The Incentive-Related Portionof the Volume Discount 18. As discussedinHanoi andinWashington, under the Modified Volume Approach (see Box 2 for a summary of its mainfeatures), it is proposed that an upfront 20 percent discount be appliedto grants. This discount would be subchidedintwo components, each addressing a different objective: (i) an incentive-related portion (11percent), to help maintain the strength of IDA'Sincentive system; and(ii)charges-related (9percent) portion, to finance foregone charge a income on IDA14 grants. This section focuses on options for reallocating the resources from the incentive-related portion of volume discount.2' An overview of the main options andissues i s presentedin subsection A. Details of a PBA-based reallocationmechanismand of set-aside resourcesto deal with exogenous shocks are presented, respectively, in subsections B and C. 1s Itis important to bear inmindthat the "free rider" problemis not exclusively associated with grant-making and already affects IDA to some extent, given the highly concessional terms of its credits. Grants would, however, provide addedincentives for "free riders", by creating more fiscal space for non-concessional borrowing, further to the space already producedby concessional IDAlending. 19 This ability may beparticularlypronounced inoil-exporting and other mineral-rich low-income countries. 20 A key difficulty is the absence of a unique definition of concessionality. See IMF(2003). Extemal Debt Statistics: Guidefor Compilersand User, June, pp. 45-46: `There is no unique definition of concessionality, and the Guide does not provide nor recommend one. Nonetheless, the definition o f the OECD's Development Assistance Committee (DAC) is commonly used. Under the D A C definition, concessional lending (that is, lending extended on terms that are substantially more generousthan market terms) includes: (1) official credits with an original grant element of 25 percent or more using a 10percent rate of discount (that is, where the excess of the face value of a loan from he official sector over the sum of the discounted future debt-service paymentsto be madeby the debtor is 25 percent or more usinga 10percent rate of discount); and (2) lendingby the major regional development banks (AfricanDevelopmentBank, Asian Development Bank, and the Inter- American Development Bank) and from the IMFand World Bank, with concessionality determined on the basis of each institutions' own classification of concessional lending. All external debt not classified as concessional should be classified as non-concessional." It is proposed that the D A C definition be used for matters related to IDA14 grants. 21 A proposal on the use of the charges-relatedportion of the discount on grants is presented inSection IV. - 8 - A. Overview of MainOptions and Issues 19. The options discussed at the October meeting for usingthe resources from the 11percent discount can be subdivided into two groups:22 (i) mechanisms for automatic reallocation; and (ii) set-asidefunds established for a specific purpose. , 20. Ex Ante ReallocationMechanisms. The first group includedthe reallocation modality basedon an income criterion included in IDA (2004b), as well as a PBA-based reallocation mechanism discussed at the October meeting. While the former would present desirable features such as privileging the poorest countries in the access to additional resources, difficulties in establishing an analytically-justified income cut-off and the overall weakness of the economic rationale behind it would make it less attractive as an operational mechanism, therefore rulingit out as an option. A PBA-based mechanism, on the other hand, would directly address the reasonswhy an incentive-relatedvolume discount on grants would be made inthe first place. Subsection B spells out the implications of a PBA-based reallocation mechanism indetail. 21. Set-asides for Specific Purposes. The second group included: (i) aside resources setting for grants-based HIVIAIDS operations incountries otherwise ineligible for grants; (ii). creating an incentivemechanismto reward stronger export performance; and (iii) setting aside resources to address exogenous shocks on an expost, contingency basis. As noted in subsection W, it would be more practical to practical to fund an exceptional HIVIAIDS grants option for "green light", IDA-only countries from their PBA envelopes, rather than from a set-aside fundfor that purpose.23 Therefore, the discussion that follows will focus only on options (ii) and (iii). 22. Although both an export incentive mechanism anda facility against shocks have distinct advantages and dsadvantages, they share one basic common feature. They would require IDA resourcesto be earmarked, which inturn implies a reduction inthe level of resources that are allocated through IDA'Sregular PBA system. Specific earmarks have been avoided inIDA in view of long-standing consensusthat IDA resources shouldbe allocated according to broad measuresof performance, andbe programmedat the country level in accordance with country- driven development priorities. 23. As an incentive mechanism, option (ii) exacerbate the distortionary aspectsof could earmarking, since its narrow focus would undulyprivilege trade-related issues over and above other elements consideredinthe much wider PBA system. Therefore, the adoption of such a mechanism for IDA14 i s not recommended. The earmarkingof resources to address shocks on an expost basis faces similar issues, but would have greater synergy with the proposed debt- distress-based framework. This possibility i s examinedin greater detail in subsection C below. 22 Most of such options are discussed in greater detail inIDA (2004b). 23 FundingHIVIAIDS grants from countries' regular IDA envelopes rather than from a set-asidefund helps preserve equity across countries and maintainconsistency with IDA13 policies, besides facilitating management at the operational level. - 9 - Box 2. The Modified Volume Approach The Modified Volume Approach - discussed in detail inHanoi and Washington (see IDA [2004a, 2004bl) can - be briefly described inthree steps: Step 1: Allocate volumes basedon the Performance BasedAllocation system, as is currently the practice. Step 2: Assign grant and credit shares for each country's volumes, as follows: - -- Low risk of debt distress : credits = 100percent. Medium riskof debt distress : grants = 50 percent, credits =50percent. Highrisk of debt distress : grants = 100percent. Step 3: Apply a 20 percent upfiont volume discount on all grants. Through the upfront volume discount, the Modified Volume Approach provides a balancebetweenneeds and incentives inthe determination of IDA resource flows to poor countries: (i) Ithelps maintaina strong relationship betweenresourcetransfers and policyperformance; and (ii) This would be achieved without relyingontoo drastic a volume cut, which would lessenthe impact oncountries' prospectsof achieving the MDGs. B. Implicationsof a PBA-BasedReallocationMechanism 24. The mainconcern addressedby the applicationof the proposed 11percent incentive- relatedvolume discount on grants would be the preservation of IDA's incentive structure inlight of increased concessionality in IDA14, while avoiding excessively lar e volume cuts that could hamper the progress of the poorest countries inachievingthe MDGs?' Therefore, the chosen reallocation mechanismfor the resources thus generated should strive to minimize the risk of introducing any potential distortions inIDA's incentive system. 25. The most natural and neutral mode of reallocation of the resources from the discount would be through the use of a PBA-based rule. This mechanism is also very simple: the resources from the incentive-related portion of the volume dscount would be distributedto all IDA-only countries25according to their share inthe PBA (net of the share inthe PBA normof blends and hardened-term countries). The terms of such reallocation would be determined by the "traffic light system": the credits and grants mix for the reallocated resources would be the same as in the first round of allocation of IDA resources, that is, in accordance with countries' risk of debt distress. Grant eligibility would also continue to be restricted to IDA-only countries. For those countries receiving additional resources inthe form of grants, no further volume discount would be applied. 26. The overall grant share in IDA14 usingthe ModifiedVolume Approach and a PBA- basedreallocation mechanism would be determinedthrough the following steps: > Step 1: Allocate volumes.in accordance with the PBA system. 24 See IDA (2004a), for a fuller discussion of these trade-offs. 25 Redistribution is restricted to IDA-only countries because blend and hardened-termcountries were a priori excluded from the pool of grant beneficiary countries for equity reasons. Since they were not among those which could be targeted for volume cuts (given that they are grant-ineligible), blends and hardened-term countries should not benefit from the reallocationof the resourcesgeneratedby the discount. 26 After taking into account allocation adjustments made for ECA, EM, andLCR in the FYO6-08basecase. - 10- > Step 2: Assign grant and credit shares for IDA-only countries according to the "traffic light" system2'. > Step 3: Apply a 20 percent upfront volume discount on all grants. > Step 4: Reallocate resources from the incentive-related portion of the volume discount2*(11percent) to IDA-only according to a PBA-based mechanism. > Step 5: Apply the "traffic light" system to determine the terms of such reallocation. 27. Table 5 shows the grant shares that result from these various steps, usingthe base case for the FY06-08 IDA14 needs projections2'. Table 5. Calculatingthe Overall Grant Share Grant Sharein the Projected IDA14 Envelope (%) Before any discount 33.0 After 20% discount 26.4 'After reallocation 28.1 After HIV/AIDS Grants 29.3 After regionalproject grants 34.3 Memo Upfront Volume Discount 1596.1 Of which Incentive-related Portion `I 838.6 Charge-relatedPortion `I 757.6 Note: 1/inSDR million. IDA14base case scenario. 28. Implicationsfor the OverallGrantShare. The post-reallocationoverall grant share simulatedon the basis of IDA'SprojectedFYO6-08 envelope would be 28.1 percent, substantially higher than the 22-23 percent shares previously estimated, after the application of steps 1-5 above. It i s important to emphasize that the above numbers shouldbe interpretedas indicative, as the grant-credit mix inIDA14may be affected by factors such as updated external debt numbers, changesincountries' performance, and debt-distress risk ratings emerging from DSAs. 29. Theoverall grant share is estimatedto increaseto about 29.3 percent if "green light", IDA-only countries are given exceptional access to upto 100percent grant financing of HIV/AIDSoperations andifHIV/AIDS regional projects are fully grant-financed. Ifa provision i s made for the grant financing of the share in the total cost of non-HIV/AIDS regional projects '* " ExceptionalHIV/AIDS grants and grants for regionalprojects would be allocated inthis step. Resources from the charges-relatedportion of the volume discount (9%) would be set aside for a hard terms window and would return to countries only in the form of credits. See discussion inSection IV. 29 Table A.5 replicates the results of the grant share determination process for the low-case and high-case scenarios. - 11- attributable to IDA-only countries eligible for 100percent grants, the overall grant share would be estimated to rise to 31.3 percent. 30. Given the uncertainty inherent to a systemthat determines grant allocations endogenously, Deputies raised the possibility of setting a cap on the overall grant share, as discussed in October (see IDA [2004b]). A key policy decision in this regardi s the choice of the level at which a cap would be set. Ifthe cap i s set at a level which i s likely to be reached within , the IDA14period, then arationingsystem for grants would need to be putinplace andthe overall grant share would no longer be completely endogenous. Different rationing options were examined in detail inIDA (2004b). 31. Impacton ResourcesfromVolume Discount. A wider country grant coverage anda higher overall grant share would generate larger resources from the 20 percent volume discount - estimated at about SDR1,596 million, compared to SDR 926 million as presentedinIDA (2004b). The amount available for a PBA-based reallocation would be SDR 839 million, while the remaining SDR 757 million from the 9 percent charges-related discount would be used for a "hard terms" lendingwindow (see Section IV). 32. Implicationsfor IDA's Incentive Structure. The combination of more conservative thresholds, revised CPIA cut-offs, and a PBA-based mechanismto reallocate resources from the volume discount helps maintainthe strengthof the correlation betweenthe present value of IDA's resource transfers and the IDAperformance rating. This is clearly showninChart 1, which plots the post-reallocation present value of IDA's resource transfers against performance. Chart 1. CorrelationsBetweenResourceTransfersand PerformanceAfter PBA-BasedReallocation 25 1 A A A I = 2.45~+5.05 R2=0.20 y = 2.47x + 2.59 R2= 0.32 04 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 IDA PerformanceRating ]1 PBA Baseline A MVA -Linear(PBA Baseline)- - - Linear(MVA) I 33. The post-reallocation regression line indicates that resource transfers inpresent value terms would become more responsive to cross-country variations inperformanceincomparison with the undiscounted volume approach as presented in the first two papers (see IDA [2004a, 2004b]), and would be nearly parallel to the pre-grants PBA baseline regression line (estimated for the FY06-08base case scenario). This reflects the fact that better-performingIDA-only countries would be the main beneficiaries of the volume redistribution under the PBA-basedrule for the reallocation of the resources from the 11percent discount on grants. - 12- 34. Implications of Usinga Five-CategoryEligibility System. The introduction of a "five- light" system would increase country grant coverage, facilitating smoother transitions between eligibility categories. Although it would leadto a somewhat higher overall grant share (see annex 2 for details) if only a debt-distress criterion i s used, its increased grant coverage would reduce the need for the provision of exceptional HIV/AIDS grants to "green light", IDA-only countries. Infact, seven countries would become newly eligible for grants on the basis of the debt-distress criterion, and could finance eventual HIV/AIDS operations out of their regular debt-distress-based grant allocations. Inthe end, the overall grant share under a "five-light" system i s not expected to differ much from that emerging from the "traffic light" system. 35. However, as discussed inthe October meeting, the introduction of additional grant eligibility categories and the relatively greater ease with which countries could move from one "light" to another in-betweenfiscal years may complicate operational planningboth at the program and at the project level and increase uncertainty with respect to the terms applicable to countries. Such operational concerns would tend to weaken the "five-light" system as an alternative to the proposed "traffic-light" mechanism. Therefore, this paper recommends that a three-category grant eligibility system as proposed inHanoi and inWashington be adopted. C. Setting Up a ShocksFacility 36. Exogenous shocks are an important explanatory variable inpredicting episodes of debt distress. The provision of additional resources to mitigate the impact of shocks would therefore be a logical complement to the debt-distress-based grant eligibility system. Shocks are partly captured through the proposed system (since they affect the macroeconomic variables used to calculate the debt-burden indicators, and consequently the terms of IDA assistance). However, the ability of governments in low-income countries to carry out essential expenditures inthe short-term may be hampered inthe face of an exogenous shock.30 Whereas IDA does not necessarily have a comparative advantage inproviding short-term assistancefor shocks, there has beenconsiderable interest amongst Deputies inmaking a "shocks facility'' available for IDA14. This wouldbe aimed at providing a faster expost volume responseto shocks as they occur, conceivably reducing the long-term impact of shocks on growth. 37. To be effectively counter-cyclical, resources in response to a shock need to be provided quickly. Infact, the timeliness and volume of financing inresponse to a shock seems to be more important than simply changing terms inthe event of a shock. As described inthe March 2004 Technical Briefing Paper to the Board of Executive Directors on shocks, several instruments designed by the international community to address them in a more systematic way have failed to be fully effective largely due to lack of timeliness. If a decision i s made to proceed on the issue of a shocks facility, IDA would need to review and buildon past experience with expost shocks fa~ilities.~' 30 For instance, if governments are hit by shocks and lack supplemental finance, this could leadthem to adopt short-term adjustment measuressuch as delaying important longer-term reforms or postponing expenditures in other programs, including possibly poverty-focused spending. 3` See World Bank (2004). Exogenous Shocks in Low Income Countries: Policy Issues and the Role of the World Bank, March 8. Its annexes Iand I1provide a preliminary assessmentof past and current experiences with addressingshocks on an ex post basis inthe Bank, IMF,and EuropeanUnion. - 1 3 - 38. The frequency and severity of shocks in low-income countries seems to have been increasing over time, and low-income countries are disproportionately affected by shocks. Thus, the sheer magnitude of shocks in IDA countries in any given year is likely to leadto costs that would significantly outstrip the resources available from the 11percent discount. For instance, it i s estimated that in 2004 the impact of the oil price shock alone on low-income countries that are net importers was equivalent to approximately over one quarter of total IDA lendingfor that year. The mismatchbetween resources needed and available, and the inherent difficulty of predicting shocks, would create a difficult rationing problem to prevent a first-come, first-served allocation. At the same time, some IDA resources could have the potentialto catalyze additional grant assistance from bilateral and other donors to help mitigatethe impact of shocks. 39. IDApolicies (such as OP8.50 and 8.60) have been usedto address certain types of shocks, especially natural disasters. However, IDA'Sability to respond depends on the availability of unusedresources within a given replenishment period. Before IDA12, there was greater flexibility within IDA to provide resources inresponseto shocks. This flexibility has been reduced by greater capacity among countries to fully utilize their IDA allocations. This lack of flexibility has been particularly noteworthy towards the end of a replenishment period, as reflectedin comparatively smaller carry-overs of resources from previous replenishment^.^^ Makingresources available as a facility for shocks would help addressthis resource constraint. Onthe other hand, such an approach would then require earmarking a certainvolume of IDA when available resources could otherwise be fully utilized for PBA-allocateddevelopment purposes.33 40. The greatest difficulty of any expost instrument to deal with commodity price shocks i s the inherent complexity of shocks andthe difficulty in defining upfront what constitutes an exogenous shock for operationalpurposes.34 This i s further complicated by the needto ensure that such assistancedoes not prevent adjustment where required, or introduce other distortionary incentives. The difficulty indefining a shock for operational purposes i s especially noteworthy for terms of trade fluctuations which are often only pinpointedas shocks with the benefit of hindsight. It can also be difficult to distinguishbetween temporary fluctuations and structural relativeprice shifts. These lags in determining the extent of shocks, especially for the slow-onset variety, would affect the ability to provide timely assistance. 41. While analytical work on exogenous shocks and their impact on low income countries i s currently underway inboth the Bank and the Fund,additional research would be needed inorder to explore whether a methodology can be developed to address shocks more systematically. The current Bank work plan follows up on World Bank (2004). Several key areas will be subject to further review, including: a) further analytical work on the impact of shocks on growth, debt and debt distress, and possible mitigation approaches; b) further researchto determine what 32 As noted inIDA (2004a), the carryover from IDA12 was solely due to exchangerate movements at the end of' the replenishment. For IDA13 the carryover is once again expected to be close to zero as all resourcesare expectedto be fully committed. j3 Given the magnitude of the shocks faced by low-income countries and to avoid diverting IDA assistanceaway from country assistance strategies, an alternative would be to establish a separate "shocks facility" to be administered by IDA, but funded with resourcesadditional to the proposed IDA14 base case. j4 See World Bank (2004): "There is no consistent definition of shocks. This is because distinguishing shocks from volatility is largely a matter of degree." (p. 4). - 14- constitutes an exogenous shock, especially a "terms-of-trade" shock; c) an in-depth review of current expost instrumentsto deal with shocks, and further exploration of potential criteria and limitations for more systematic expost assistance; and d) a review of potential ex ante instruments to deal with shocks. 42. Given the uncertainty around the practical aspects of a systematic IDA facility to respond to shocks it i s recommended that a PBA-based reallocation mechanism be adopted for the use of the resources from the 11percent volume discount. Staff will continue to explore the feasibility of usingthese resources to respond to shocks, and will prepare a paper on this topic for the IDA14 md-Term Review. The impact of a shocks facility on the overall grant share would ultimately depend on the specific countries that would receive financial support through this mechanism. Terms of assistance would be determined on the basis of a country's "traffic light" (and grant assistancewould continue to be restricted to IDA-onlycountries). IV. GrantFinancingIssues: The Charges-RelatedPortionof the Volume Discount 43. The provision of grants by IDA entails lost reflows to IDA from bothforegone principal reflows and foregone charge income. Duringthe IDA14meetings inHanoi and Washington donors reaffirmedtheir commitment to finance the foregone principal reflows through additional donor contributions on a pay-as-you-go basis. With respect to the foregone charge income from the provision of grants they askedfor further work on how these resources would be used. Foregone charge income equals 9 percent of the face value of a standard IDA credit. This i s equivalent to 45 percent of the total volume dmount of 20 percent, or SDR 757 million as per the base case for the FY06-08IDA14needsprojections. 35 44. The 9 percent volume discount would only address the financing of foregone charge income due to IDA14 grants. Foregone principal reflows resulting from IDA14 grants, which represent some 75 percent of the total value of foregone reflows due to these grants, are not beingcovered through this volume discount. Foregone principal due to IDA14 grants would again be financed by donors on a pay-as-you-go basis. This Section focuses on the use of resources generated by the 9 percent volume reduction. 45. For IDA13, donors agreed to adopt a two-step approach to finance IDA13 grants. First, donors wouldprovide financing of foregone charge income on IDA13 grants through additional contributions inIDA14. Second, donors would provide financing for foregone principal as and when these losses are incurred, on a pay-as-you-go basis.36 ~~ 35 The 9% volume discount representsthe NPV of foregone service charges(fixed 0.75 percent per annum) and commitment charges (assumedat 0.50 percent per annum) on a regular IDA credit. The level o f IDA commitment charges varies from year to year inthe range of 0 to 0.50 percent to ensure coverage o f IDA'S administrative expenses. Ifcommitment charges were to be set at 0 percent, the NPV o f foregone charges would fall to about 8%. For FY05, IDA'S commitment charge has been set at 0.35 percent per annum, and it is expected that commitment charges for FYO6-08would range between 0.30 percent and 0.50 percent. Therefore, the NPV of foregone charges would be set at 9 percent level for the IDA14 period. 36 "Modalities o f IDA13 Grant Financing: Technical Note", May 2004. - 1 5 - 46. There are two possibilities with respect to the resources from 9 percent discount: (i) to invest these resources as part of IDA's liquid assets; or (ii) to find.a development oriented purpose for these resources. It was the latter possibility that generated the most interest during the October meeting, specifically the possibility of makingthe resources available for lending to IBRD/IDA blendcountries, by creating a "hard terms" lendingwindow. This would constitute an "investment" for IDA, and i s an approach that could also'beused for donors' contributions to cover foregone charges on grants inIDA13. 47. Ineffect, to ensure adequatefinancing of IDA for foregone charge income due to IDA grants, the use of grant financing resources would needto follow two general principles: (i) achieving a rate of return on investment that i s similar to the discount rate applied to calculate the net present value of foregone losses; and (ii) matchingthe investment horizon to the long- term cash flow profile from foregone reflows under IDA credits. These objectives could be accomplished by hardening the lendingterms through an interest rate charged on top of standard IDA charges. 48. It shouldbe notedthat ifDeputies decide not to usethe 9 percent volume reduction for lendmgto blend countries at hardterms, then the corresponding SDR volume of IDA14 resources would reduce the IDA14commitment authority envelope by an equivalent amount, becausethese resources would remain invested in IDA's liquidassets. Furthermore, unlike for other credit reflows, all future reflows (including principal payments) resulting from lending at "hard terms" would be usedto cover the share of IDA's administrative expensesrelated to IDA14grants; they would not be available to support new IDA assistancecommitments under future replenishments. A. Establishingthe 9 PercentVolumeReductionon Grants 49. Incalculatingthe cost of IDA14grants, Management applied a6 percent discount rate. This raterepresents the long-term average returnon IDA's liquidassets and is the same as the current fixed-rate equivalent of the IBRDlendingrate.37 50. When applying the 6 percent discount rate for IDA14, the net present value (NPV) of foregone service charges (fixed at 0.75 percent per annum) and commitment charges (assumed fixed at 0.50 percent per annum) i s about 9 percent of the face value of an IDA grant. This NFV calculation assumes a regular IDA credit, with a 40-year maturity anda 10-year grace period, because this would be the alternative use of funds in the absence of grants in IDA14. B. InvestinginBlendBorrowersat "Hard Terms" 51. CurrentIDA Terms. IDA lendingterms to IBRD/IDA blendborrowers feature 35 years of maturity including 10-yearsof grace, zero interest, 0.75 percent per annum fixed service 37 The average return on IDA's investment portfolio over the l0-year period FY1994-2004 was 5.8%. The fixed- rate equivalent of IBRD's USD-based lending products is used as a proxy for the alternative cost of SDR-based borrowing for IDA countries. The swap rate between a 30-year US Treasury security (the longest maturity available) and 3-month LIBOR was around 5.4% as of Sept. 30,2004, and IBRD's USD-based lending products currently feature a 57 bp average all-in spread over LIBOR, making the fixed-rate equivalent around 6%. - 16- charge on outstanding balances, and 0 - 0.50 percent per annum variable commitment charge on undisbursed balances.38 Startingin IDA13, IDA introduced"hardened terms", reducing IDA credit maturity to 20 years including 10 years of grace, with standard IDA charges. These terms are applicable for borrowers with per capita income above the operational cut-off of $895 (in FY05) for more than two consecutive years.39 52. InterestRateonOutstandingBalances. The grant element measuresthe degree of concessionality of IDA credits. For a standard 35-year credit to a blendcountry, the grant element at a discount rate of 6 percent i s about 57 percent. Intoday's dollars, for a $100 credit to a blendcountry, IDA would therefore receive reflows over the 35 year maturity periodof $43, resulting in a $57 economic loss to IDA. Table 6 below establishes the 57 percent grant element for the standard 35-year maturity of blend borrowers. The table shows various lower grant elements when applying interest rates of between 1.O and4.9 percent per annum, to be charged on top of standard IDA service and commitment charges. As shown, to arrive at a grant element of zero percent, the interest rate would needto be 4.9 percent. 53. To ensure sufficient borrower interest in a hardterms IDA lending.window, the interest rate to be charged should be sufficiently more concessional than the prevailing IBRDlending rate, converted into fixed-rate equivalent^.^' Therefore, IDA could set the interest charge for hardterms at acertain spreadbelow the IBRDlendingrate. Usinga possible spreadof 200basis points below the IBRDlending rate infixed-rate terms, this would mean an interest rate of currently about 4.0 percent. At this rate, IDA would forego about 11percent of the economic value neededto ensure full financing of charges, as shown inTable 6. This could be regarded as an acceptable loss level for being able to extend additional IDA financing to blendcountries at concessional lending rates, rather than investing these resources as part of IDA's liquid assets. This loss would be coveredthrough IDA'Sinternalresources (future investment income), hence slightlyreducingIDA'Sfuture lending capacity. 54. The interest rate for the hardterms window would bere-set annually for the next fiscal year, usingthe end-of-fiscal-year IBRDfixed-rate equivalent lending rate over 40 years. This would occur inconjunctionwith the annual determination of the level of IDA commitment charges for the following fiscal year4'. 38 An accelerationclausehas been included inIDA's credit agreements, since 1987 and modified in 1996, which enables a doubling of repayments to IDA from borrowers where per capita income has exceeded the operational cut-off for three consecutive years. 39 No accelerationclauseis provided for these credits. For a complete list o f IDMBRDeligibility and lending terms, go to www1.worldbank.org/operations/wbopcs/Preports~eport-Annex-D.asp. 40 Note that even the "harder terms" proposed would still fall within IDA's mandate under its Article of Agreement of providing financing on terms that "bear less heavily on the balance of payments than conventional loans", and would still be on terms that could not be provided by the IBRD. 41 An alternative approachto hard term lending that would be financially equivalent would beto reduce the amount to be disbursed by a certain percentage to be deducted from the credit principal, while keeping the nominal interest charge at zero percent and requiring the full repayment o f the principal at standardIDA terms. Inorder for IDA not to incur a loss, the up-frontreduction would have to be 57% of the amount to be disbursed. This option is not being considered due to the resultinglarge reduction in disbursed funds. - 17- Table 6: InterestRatesandResultingGrantElements Interest rate Grant element 0.0% 57% 1.0% 46% 2.0% 34% 3.0% 22% 4.0% 11% 4.9% 0% C. Eligibilityfor Lendingat "Hard Terms" 55. Blend countries represent a special category of countries with access to both IDA and IBRDresources. While blendcountries are IDA-eligible basedon the incomecriterion, they also have limited creditworthiness for IBRDlending. There are three groups of blendcountries in IDA: six middle-incomeblends abovethe operational IDAcut-off, includingsome small-island economies; six low-income blends below the operational cut-off; andthree so-called `notional' blends. Current blendcountries along these three categories are listedinTable 4. 56. When investingthe grant financing resources inblendcountries, as an alternative to investments inIDA'Sliquid assets, IDA faces significant country credit risk. To reduce these risks, lendingthrough the hardterms window would be restrictedto credtworthy blendcountries with per capita incomes below the operational cut-off for IDA but with an active IBRDlending program.42This would currentlyincludeIndonesia, India, andPakistan. 57. As mentionedinthe previous notes on this subject, the resources under the hardterms lending window would be additional to country allocations under IDA'Sperformance-based allocation system. Allocating these resourcesinproportion to the performance-based allocations inIDA14for the abovethree eligibleblendcountries would resultinthe following: 57.8 percent for India, 36.4 percent for Pakistan, and 5.8 percent for Indonesia. 58. Inview of the limitedvolume of the resources from the 9 percent discount on grants, this window i s not expected to have any material impact on the demand for IBRDlendngby blend countries. 59. Shouldthe actual demand for IDA credits on hardterms be lower than the resources available under the proposed new window, then the balance of resources would be invested in IDA'Sliquidassets to generatethe required investment returns. 42 As evidenced in the base-caselending scenario in the CAS. - 18 - V. Conclusions 60. The revised debt and debt-service thresholds andthe new absolute cut-offs for the CPIA, when combinedwith the "traffic light" system for grant eligibility would imply a broader country grant eligibility coverage, leadingto a higher pre-volume discount grant share (33.3 percent) than that presented inHanoi and Washington (22 - 23 percent). 61. The provision of grants by IDA runs the risk of increasing countries' space for additional borrowingfrom other sources, including non-concessional ones. To help reduce such risk, it i s recommended that a mechanismbe devised whereby a country could cease to be eligible for grants if its government contracts or guarantees new non-concessional loans during any year of IDA14. 62. After the application of a 20 percent volume discount, but before any reallocation of resources from such discount, the overall grant share becomes 26.6 percent. Since the grant share i s higher, the 20 percent volume discount generates a higher level of resources than those shown in IDA (2004b). Under the current scenario these resources amount to approximately SDR 1,540 million. 63. IfaPBA-basedreallocationmechanism for the resources fromthe 11percent discount is adopted, and provisions are made for exceptional HIV/AIDS grants as well as for regional project grants, an overall grant share of31.3 percent would result. This percentage shouldbe treated as indicative, since factors such as changes incountry performance, updatedexternal debt information, and debt distress risk ratings from DSAs may affect the grant-credit mix of the IDA envelope. In addition, this reallocationmode helps restore the strength of the relationship between the present value of IDA resource transfers and the IDA performance ratingvis-&vis the pre-grants PBA baseline. 64. An alternative use of the resources from the incentive-relatedportion of the volume discount would be to set aside resources to help provide an ex post response facility to shocks on a contingency basis. This would help address a key determinant of a country's risk of debt distress, which has not thus far been addressedinthe grant allocation system. However, there are major unanswered questions and issues (as notedin subsection IIIB)and, therefore, it i s recommended that further work be conducted to develop a systematic approach to determining eligibility for accessing these resources. A PBA-based rule for the reallocation of the resources would need to be adopted as an interim measure, while a possible alternative eligibility system for the set-aside resources is being explored. The overall grant share resultingfrom this option i s estimated to range from 26.4 to 31.3 percent of the IDA envelope, depending on the countries - and their applicable IDA terms from the "traffic light" system -that would benefit from assistance under a shocks facility. 65. Onbalance, given the operational intricacies involvedindeveloping the eligibility criteria for a successfulshocks facility, a PBA-based mechanism for reallocating the resourcesfrom the 11percent volume discount seems to be the appropriate course of action for IDA14. This could be reevaluated inlight of emerging results from the ongoingreview of shocks in the Bank, which would be discussed with Deputies at the Mid-Term Review. - 19- 66. The complexity and innovative nature of the proposed debt-distress-based grant- allocation system may require further refinements and some degree of fine-tuningonce its implementation i s underway. ,Again,the Mid-Term Review will provide an opportunity to assess the extent to which the proposedsystem will meet Deputies' expectations, and aprogress report will be producedby the time of the Review to facilitate their assessment. VI. Issuesfor Discussion 67. Deputies may wish to comment on the implications for grant eligibility of revised assumptions regardingCPIA cut-offs and debt thresholds, as well as on the paper's recommendations on different reallocation options for the resources from the proposed 20 percent volume discount on grants. 9 D oDeputies agree that, on balance, athree-category "traffic light" system outweighs an alternative five-category eligibility system on the grounds of practical implementability? > Would Deputies consider an option inwhich, consistent with practice under IDA13, HIV/AIDS programs for "green light" IDA-only countries and regionalHIV/AIDS projects would be fully financed by grants? > Would Deputies contemplate makinga provisionfor the grant financing of the share attributable to grant-eligible, IDA-only countries inthe total cost of non-HIV/AIDS regional projects? > Would Deputies consider makinga provision for the grant financing of the portion of the cost of regional projects (other than HIV/AIDS) attributable to IDA-only countries eligible to 100percent grants under the debt-&stress criterion? 9 DoDeputies agree that amechanism bedevelopedwhereby acountry couldceaseto be eligible for grants if its government contracts or guarantees new non-concessional loans during any year of IDA14? 9 Inlight of the uncertaintyregardingthe overall levelof grants inIDA14,would Deputies consider the introduction of a cap on the overall grant share, along the lines discussed inHanoi and Washington, D.C.? > D o Deputies agree that, on balance, a PBA-based reallocation mechanism for the resources from the 11percent volume discount seems to be the appropriate course of action for IDA14? 68. Deputies may wish to express their views on the options presented in the paper for using the resources from the charges-related portion of the volume discount on grants (9 percent discount) for a hard-term lending window in IDA14, as an alternative to investingthe funds as part of IDA'Sliquidassets. - 20 - P D o Deputies agreethat the resources generatedby the 9 percent volume reduction on IDA14 grants couldbe used for a hardterms lendingwindow, at regular blendcredit terms, with an interest rate set at 200 basis points below the long-term fixed-rate equivalent of the IBRDlendingrate, to be reset annually? P DoDeputies agreethat country eligibility would berestricted to blendcountries with sufficient BRD creditworthiness, as well as with a per capita income below the operational cut-off for IDA, and that resourcesbe allocated on a pro-rata basis according to IDA'Sperformance-basedallocation system? - 21 - Annex 1. Tables Table A. 1. Policy-Dependent Debt and Debt-Service Thresholds Applied to Low-Income Countries NPV/GDP ' NPV/EXP DSlEXP' Strong(CPIA23.75) 50 200 25 CapeVerde 42 0 155 3 12.7 Sri Lanka 47.0 125.7 11.7 St. Lucia'I 6.9 St. Vincent and the Grenadines'/ 7.4 Uganda 10.2 Grenada31 11.8 Tanzania 23.1 156.2 3.5 Armenia 31.7 133.3 13.2 Maldives 328 - I- 440 -- 4 8 I..--- Samoa 64.3 2112 . 9 8 Bhutan 58.4 *26x@. 4 9 Mauritania 79.9 - 2k32 7 5 Medium(3.25cCPIAc3.75) 40 150 20 Nicaragua 38.8 10.4 Senegal 138.3 8.7 Honduras" 124.5 16.0 India 3/ 16.1 119.9 19.0 Vietnam 32.3 64.9 6.8 Pakistan3/ Burkina Faso Ghana Indonesia 3' Madagascar5' 26.8 136.6 5.6 Yemen, Rep. 34.1 87.0 4.2 Azerbaijan 31 Bangladesh Bolivia " Nepal 31.2 123.0 7.0 Benin 29.6 145.4 5.6 Mali 8.4 Bosnia andHerzegovina " 33.9 135.5 12.0 Rwanda 17.3 Serbia andMontenegro " 5.5 Albania " Dominica'/ Kenya Lesotho Cameroon Mongolia Malawi Zambia KyrgyzRepublic Mozambique 34 5 74.6 2.8 Guyana 2 6 Ethiopia 11.4 - 2 2 - NF'V/GDP" NPV/EXP' DS/EXP' Poor (CPIAd.25) 30 100 15 Moldova 169.1 31.3 Georgia 171.7 .16,O Gambia, The 6.8 Niger 11.2 Chad 217A __ _10_ 3_ _ Guinea 1762 16.7. Sierra Leone 771.5 :248 Cote d'Ivoire 219.9 .--- 18.6 - - Djibouti ' 5.4 Tonga 9.5 Eritrea 7.6 Vanuatu Cambodia Tajikistan Congo, D.R. Congo, Rep. Burundi PapuaNew Guinea 31 LaoPDR Nigeria31 Guinea-Bissau Comoros SaoTome and Principe Uzbekistan31 Togo Sudan CAR Haiti Angola Zimbabwe3' Solomon Islands Liberia Myanmar Afghanistan Notes: 1/Inratios, boththenumerator anddenominatorrefer to 2002 data. 2/ Inratios, the numerator refers to 2002 data and the denominator refers to the three-year averageof 2000-2002. 3/ Blend-termcountry. 41Hardened-term country. 5/ Ratios reflect full delivery of debt relief under the HIF'C initiative ("Memorandum and Recommendationof the President of the IDA to the Executive Directors on Assistanceto the Republic of Madagascar under the Enhanced HIF'C Initiative", Table 14, p.41, the World Bank, Oct. 2004). 61N'V/GDP and NPVExp ratios are those excerpted from its DSA (2004). As per discussion inBox 1inthe main text of IDA (2004a), Ethiopia's debt stock ratios are those of its updated DSA insofar as it indicates that the ratios will breachtheir respective thresholds within the IDA 14period. ..Not available. ** Ratioshighlights indicate ratios abovethe indicative thresholds. are in percent. * NPV Grey of debt and debt service data for completion-point HIPCs are the latest available. Uganda'sNFV-of-debt data reflects its latest DSA. - 23 - ** Exports "PV of debt data for decision-point HIPCs do not reflect unconditionaldelivery of debt relief under the initiative. comprise the total value of goods and services exported as defined in the IMFBalance of Payments Manual, Version 5 (BPMS). - 24 - Table A.2. PercentageDistancesfrom IndicativeThresholds and RankingsBased on Individual Indicators PercentageDistancesfrom IndicativeThreshold Rankingof Debt Distress3' NF'V/GDP NpV/EXP DS/EXP NPV/GDP NpV/EXP DS/EXP Strong (CPIA13.75) Cape Verde 16.0 22.3 49.1 1 1 1 Sri Lanka 6.0 37.2 53.2 2 .1 1 St. Lucia '/ -22.7 46.8 72.4 3 1 1 St. Vincent and the Grenadines'/ 6.3 52.4 70.2 2 1 1 Uganda 33.8 -44.2 59.1 1 3 1 Grenada -43.3 31.6 52.8 3 1 1 Tanzania 53.8 21.9 86.1 1 1 1 Armenia 36.7 33.4 47.2 1 1 1 Maldives 34.4 78.0 80.8 1 1 1 Samoa -28.5 -5.6 60.7 3 2 ,I Bhutan -16.8 -33.5 80.3 3 3 1 Mauritania -59.8 -6.6 70.1 3 2 1 Medium(3.75cCPIA4.25) Nicaragua 3.0 -7.4 48.1 2 2 1 Senegal 3.1 7.8 56.3 2 2 1 Honduras2/ -17.0 17.0 20.0 3 1 1 India'/ 59.8 20.1 5.1 1 1 2 Vietnam 19.2 56.7 66.2 1 1 1 Pakistan It -9.3 -71.2 -38.0 2 3 3 Burkina Faso 41.7 -55.5 70.6 1 3 1 Ghana -2.6 32.6 70.9 2 1 1 Indonesia '' -89.2 -33.1 -29.5 3 3 3 Madagascar 32.9 8.9 72.2 1 2 1 Yemen, Rep. 14.7 42.0 79.0 1 1 1 Azerbaijan I' 54.5 69.0 60.9 1 1 1 Bangladesh 42.0 -6.3 47.5 1 2 1 Bolivia*' 5.7 -31.0 -16.8 2 3 3 Nepal 21.9 18.0 64.9 1 1 1 Benin 25.9 3.0 72.1 1 2 1 Mali -8.6 -19.1 58.2 2 3 1 Bosnia andHerzegovina2/ 15.3 9.7 39.8 1 2 1 Rwanda 0.8 -260.4 13.6 2 3 1 Serbia andMontenegro -96.1 -198.9 72.4 3 3 1 Albania 21 53.7 29.2 64.4 1 1 1 Dominica I' -86.5 4.4 58.1 3 2 1 Kenya 7.6 -2.3 22.7 2 2 1 Lesotho -47.9 12.9 -1.7 3 1 2 Cameroon -33.6 -22.7 32.0 3 3 1 Mongolia -41.6 20.1 56.1 3 1 1 Malawi -16.4 -17.1 63.7 3 3 1 Zambia -190.7 -182.0 -52.4 3 3 3 Kyrgyz Republic -103.1 -50.5 -47.0 3 3 3 Mozambique 13.8 50.3 86.0 1 1 1 Guyana -100.1 43.2 87.2 3 1 1 Ethiopia 12.2 -44.2 43.1 1 3 1 - 25 - ~ PercentageDistancesfrom IndicativeThreshold Rankingof DebtDistress 3' NPV/GDP NPVlEXP DSlEXP NPV/GDP NPV/EXP DS/EXP Poor (CPIAG.25) Moldova -153.9 -69.1 -108.7 3 3 3 Georgia -38.2 -71.7 -7.0 3 3 2 Gambia, The -153.2 -4.8 54.5 3 2 1 Niger 11.2 -76.1 25.6 1 3 1 Chad -5.4 -117.4 31.1 2 3 1 Guinea -50.5 -76.2 -11.3 3 3 3 Sierra Leone -202.7 -671.5 -65.0 3 3 3 CotedIvoire -168.1 -110.9 -24.0 3 3 3 Djibouti -23.2 1.7 64.0 3 2 1 Tonga -20.1 -71.7 36.9 3 3 1 Eritrea -75.2 -153.0 49.3 3 3 1 Vanuatu 22.0 63.0 90.1 1 1 1 Cambodia -122.3 -56.1 91.1 3 3 1 Tajikistan -147.8 -20.4 29.2 3 3 1 Congo, D.R. -391.0 -718.9 -502.1 3 3 3 Congo, Rep. -440.4 -101.3 93.4 3 3 1 Burundi -247.9 -1224.8 -174.2 3 3 3 PapuaNew Guinea '/ -186.3 -8.4 16.4 3 2 1 Lao PDR -183.9 -191.1 39.5 3 3 1 Nigeria '/ -141.1 -53.3 51.6 3 3 1 Guinea-Bissau -604.4 -635.7 -59.2 3 3 3 Comoros -150.0 -467.0 5.5 3 3 2 Sao Tome and Principe -644.6 -581.2 -146.9 3 3 3 Uzbekistan" -49.2 -32.7 -49.1 3 3 3 Togo -180.4 -163.6 80.2 3 3 1 Sudan -291.4 -757.3 91.6 3 3 1 CAR -137.3 -604.2 94.5 3 3 1 Haiti 22.3 -74.4 61.1 1 3 1 Angola -187.0 -31.3 22.9 3 3 1 Zimbabwe 'I -56.9 -94.0 80.9 3 3 1 SolomonIslands -80.4 -4.3 69.4 3 2 1 Liberia -1362.4 -1665.7 95.7 3 3 1 Myanmar 97.4 -64.9 -2.1 1 3 2 Afghanistan 62.5 -102.8 100.0 1 3 1 Notes: .. Not available. 1/ Blend-termcountry. 21Hardened-termcountry. 31Basedon option 2 of the classification system, whereby "1" indicatesgreen light, "2" yellow light, and "3" redlight (see Annex 2.C in IDA (2004a)). - 26 - Table A.3. CompositeIndex for CountriesAccordingto Risk of DebtDistress PercentageDistancesfromIndicativeThreshold DebtDistress CountrvRanking 3/ NPV/GDP NPV/EXP Average (a) Two-Stock DS/EXP(b) (a) or (b), according to the decisionrule 1 - - Strong(CPIA23.75) CapeVerde 16.0 22.3 19.2 49.1 1 Sri Lanka 6.0 37.2 21.6 53:2 1 St. Lucia -22.7 46.8 12.1 72.4 1 St. Vincent andthe Grenadines 6.3 52.4 29.3 70.2 1 Uganda 33.8 -44.2 -5.2 59.1 2 Grenada" -43.3 31.6 -5.9 52.8 2 Tanzania 53.8 21.9 37.9 86.1 1 Armenia 36.7 33.4 35.0 47.2 1 Maldives 34.4 78.0 56.2 80.8 1 Samoa -28.5 -5.6 -17.0 60.7 3 Bhutan -16.8 -33.5 -25.1 80.3 3 Mauritania -59.8 -6.6 -33.2 70.1 3 Medium(3.7542PIA4.25) Nicaragua 3.0 -7.4 -2.2 48.1 2 Senegal 3.1 7.8 5.4 56.3 2 Honduras' -17.0 17.0. 0.0 20.0 2 India " 59.8 20.1 39.9 5.1 2 Vietnam 19.2 56.7 37.9 66.2 1 PakistanI' -9.3 -71.2 -40.3 -38.0 3 BurkinaFaso 41.7 -55.5 -6.9 70.6 2 Ghana -2.6 32.6 15.0 70.9 1 IndonesiaI' -89.2 -33.1 -61.1 -29.5 3 Madagascar 32.9 8.9 20.9 72.2 1 Yemen, Rep. 14.7 42.0 28.3 79.0 1 Azerbaijan I' 54.5 69.0 61.8 60.9 1 Bangladesh 42.0 -6.3 17.8 47.5 1 Bolivia' 5.7 -31.O -12.6 -16.8 3 Nepal 21.9 18.0 20.0 64.9 1 Benin 25.9 3.O 14.5 72.1 1 Mali -8.6 -19.1 -13.9 58.2 '3 Bosnia andHerzegovina ' 15.3 9.7 12.5 39.8 1 Rwanda 0.8 -260.4 -129.8 13.6 3 SerbiaandMontenegro -96.1 -198.9 -147.5 72.4 3 Albania ' 53.7 29.2 41.4 64.4 1 Dominica I' -86.5 4.4 -41.0 58.1 3 Kenya 7.6 -2.3 2.6 22.7 2 Lesotho -47.9 12.9 -17.5 -1.7 3 Cameroon -33.6 -22.7 32.0 3 Mongolia -41.6 20.1 --28.1 10.7 56.1 3 Malawi -16.4 -17.1 63.7 3 Zambia -190.7 -182.0 --16.8 186.4 -52.4 3 KyrgyzRepublic -103.1 -50.5 -76.8 -47.0 3 Mozambique 13.8 50.3 32.0 86.0 1 Guyana -100.1 43.2 87.2 3 Ethiopia 12.2 -44.2 --28.5 16.0 43.1 3 - 27 - Percentage Distances fromIndicative Threshold CountryDistress Debt Ranking 3/ NPV/GDP NPV/EXP Average (a) Two-Stock DS/EXP(b) (a) or (b), according to the decision rule Poor (CPIA13.25) Moldova -153.9 -69.1 -111.5 -108.7 3 Georgia -38.2 -71.7 -54.9 -7.0 3 Gambia,The -153.2 -4.8 -79.0 54.5 3 Niger 11.2 -76.1 -32.4 25.6 3 Chad -5.4 -117.4 -61.4 31.1 3 Guinea -50.5 -76.2 -63.3 -11.3 3 Sierra Leone -202.7 -671.5 -65.0 3 CotedIvoire -168.1 -110.9 --437.1 139.5 -24.0 3 Djibouti -23.2 1.7 -10.8 64.0 3 Tonga -20.1 -71.7 -45.9 36.9 3 Erieea ' -75.2 -153.0 -114.1 49.3 3 Vanuatu 22.0 63.0 42.5 90.1 1 Cambodia -122.3 -56.1 -89.2 91.1 3 Tajikistan -147.8 -20.4 -84.1 29.2 3 Congo,D.R. -391.0 -718.9 -555.0 -502.1 3 Congo, Rep. -4+0.4 -270.9 93.4 3 Buundi -247.9 --101.3 1224.8 -736.4 -174.2 3 PapuaNew Guinea " -186.3 -8.4 -97.4 16.4 3 Lao PDR -183.9 -191.1 -187.5 39.5 3 Nigeria I` -141.1 -53.3 -97.2 51.6 3 Guinea-Bissau -604.4 -635.7 -620.1 -59.2 3 Comoros -150.0 -467.0 -308.5 5.5 3 SaoTome andRincipe -644.6 -581.2 -612.9 -146.9 3 UzbekistanI' -49.2 -32.7 -40.9 -49.1 3 Togo -180.4 -163.6 -172.0 80.2 3 Sudan -291.4 -757.3 -524.4 91.6 3 CAR -137.3 -604.2 -370.7 94.5 3 Haiti 22.3 -74.4 -26.0 61.1 3 Angola -187.0 -31.3 -109.1 22.9 3 Ziinbabwe I' -56.9 -94.0 -75.4 80.9 3 SolomonIslands -80.4 -4.3 -42.3 69.4 3 Liberia -1362.4 -1665.7 -1514.0 95.7 3 Myanmar 97.4 -64.9 16.2 -2.1 2 Afghanistan 62.5 -102.8 -20.2 100.0 3 Notes: 1/ Blend-termcountry. 21Hardened-termcountry. 3/ Basedonoption2 of the classificationsystem, whereby "1" indicatesgreen light, "2" yellow light, and "3" red light (see Annex 2.c inIDA (2004a)). - 28 - Table A.4. VolumeAllocationsand GrantShares, usingthe ModifiedVolumeApproach Modified Volume Approach Allocation Memo After a 20% Final Volume after Grants Share 20% Reallocationof Country FYo6-08Norm (a) Discount on PBA-based inFinal Discount (a)- 11% Grants (b) Reallocation(c) Volume (b) (c)-(b) Strong (CPIA13.75) Cape Verde 19 19 20 0% 0 1.o Sri Lanka 451 451 476 0% 0 24.3 St. Lucia" 7 7 7 0% 0 0.0 St. Vincent & the Grenadines" 5 5 5 0% 0 0.0 Uganda 735 661 701 45% 73 39.6 Grenada" 4 4 4 0% 0 0.0 Tanzania 1057 1057 1114 0% 0 57.0 Armenia 82 82 87 0% 0 4.4 Ma1dives 6 6 7 0% 0 0.3 Samoa 6 5 5 100% 1 0.3 Bhutan 34 27 29 100% 7 1.8 Mauritania 96 77 82 100% 19 5.2 Medium(3.75cCPIAc3.25) Nicaragua 112 100 106 45% 11 6.0 Senegal 213 192 203 45% 21 11.5 Honduras ' 134 134 141 0% 0 7.2 India" 2590 2590 2590 0% 0 0.0 Vietnam 1231 1231 1297 0% 0 66.4 Pakistan" 1550 1550 1550 0% 0 0.0 Burkina Faso 266 240 254 45% 27 14.4 Ghana 522 522 550 0% 0 28.2 Indonesia" 585 585 585 0% 0 0.0 Madagascar 455 455 479 0% 0 24.5 Yemen, Republic of 332 332 350 0% 0 17.9 Azerbaijan" 199 199 199 0% 0 0.0 Bangladesh 1674 1674 1764 0% 0 90.3 Bolivia' 119 119 119 0% 0 0.0 Nepal 526 526 554 0% 0 28.3 Mali 229 183 195 100% 46 12.3 Benin 169 169 178 0% 0 9.1 Bosnia-Herzegovina" 82 82 82 0% 0 0.0 Rwanda 197 157 168 100% 39 10.6 Serbia & Montenegro' 86 86 86 0% 0 0.0 Albania' 51 51 51 0% 0 0.0 Dominica" 3 3 3 0% 0 0.0 Kenya 448 403 427 45% 45 24.2 Lesotho 29 23 25 100% 6 1.6 Cameroon 192 153 164 100% 38 10.3 Mongolia 45 36 39 100% 9 2.4 Malawi 224 179 191 100% 45 12.1 Zambia 188 150 160 100% 38 10.1 Kyrgyz Republic 81 65 69 100% 16 4.4 Mozambique 366 366 386 0% 0 19.7 Guyana 18 15 16 100% 4 1.o Ethiopia 1426 1141 1218 100% 285 76.9 - 29 - ModifiedVolume Approach Allocation Memo After a 20% FinalVolume after Grants Share 20% Reallocationof Country FYo6-08 Norm (a) Discounton PBA-based inFinal Discount (a)- 11% Grants (b) Reallocation(c) Volume (b) (c)-(b) Poor (CPIAS3.25) Moldova 64 51 54 100% 13 3.4 Georgia 45 36 38 100% 9 2.4 Gambia, The 22 17 19 100% 4 1.2 Niger 141 113 120 100% 28 7.6 Chad 68 54 58 100% 14 3.7 Kiribati3/ 3 3 4 0% 0 0.2 Guinea 84 67 71 100% 17 4.5 Sierra Leone 92 73 78 100% 18 4.9 Cote dIvoire 231 185 197 100% 46 12.5 Djibouti ' 9 9 9 0% 0 0.5 Tonga 3 2 3 100% 1 0.2 Erikea 76 61 65 100% 15 4.1 Vanuatu 4 4 4 0% 0 0.2 Cambodia 79 63 67 100% 16 4.2 Tajikistan 78 62 66 100% 16 4.2 Congo, DR 1021 817 872 100% 204 55.1 Congo, Republicof 65 52 55 100% 13 3.5 Burundi 175 140 150 100% 35 9.4 PapuaNew Guinea" 31 31 31 0% 0 0.0 LaoPDR 43 35 37 100% 9 2.3 Nigeria" 1029 1029 1029 0% 0 0.0 Guinea-Bissau 11 9 9 100% 2 0.6 Comoros 5 4 5 100% 1 0.3 Sao Tome & F'rincipe 4 3 4 100% 1 0.2 Uzbekistan" 95 95 95 0% 0 0.0 Togo 18 14 15 100% 4 0.9 Sudan 634 507 541 100% 127 34.2 CentralAfrican Republic 9 7 7 100% 2 0.5 Haiti 106 85 91 100% 21 5.7 Angola 223 178 190 100% 45 12.0 Zimbabwe" 187 187 187 0% 0 0.0 Solomon Islands 3 2 2 100% 1 0.1 Afghanistan 563 450 480 100% 113 30.3 Liberia 69 55 '59 100% 14 3.7 Myanmar 0 0 0 0% 0 0.0 Somalia 0 0 0 0% 0 0.0 Timor-Leste4/ 31 25 27 100% 6 1.7 Kosovo" 10 8 9 100% 2 0.5 Total" 22172 20648 21486 28.1%" 1525 839 Notes: ** As IDA 13, in it is assumed that blend and hardened-term countries would be excluded from grant eligibility. Unit:inSDR millionunless otherwise specified. 1/ Blend-term country (100% credits). 2/ Hardened-term country (100% credits). 3/ No data on debt available. 100%of credits assumed. 4/ Special transitional case. 100%grants assumed (see IDA, 2004b). 5/ Part o f Serbia and Montenegro under UNadministration. 100% grants assumed (see IDA, 2004b). 6/ Excludes regional projects and the provision for Iraq. 7/Excludes grants for regional projects as well as exceptional HIV/AIDS grants. - 30 - Table AS. OverallGrant Sharesfor Low and High Case ScenariosinFY06-08 Low High Before any discount 33.1 32.3 After 20% discount 26.5 25.8 After reallocation 28.3 27.5 After HIV/AIDS grants 29.6 28.6 After regional projectgrants 31.7 30.4 Memo UpfrontVolume Discount 1485.3 1678.9 Of which Incentive-relatedPortion(11%) 777.6 884.1 Charges-relatedPortion(9%) 707.7 794.8 - 31 - Annex 2. Replicatingthe Analysis under a "Five-Light" Eligibility System As described in Section IIA of IDA (2004b), a debt-distress-based ranking system with five categories,would have different cut-offs. A "green light" i s assignedto countries with relevant debt indicators between25 percent below the applicable threshold and lower; a "blue light" to countries between 10 and 25 percent below the threshold; a "yellow light" to countries between 10percent below and 10percent above the threshold; an "orange light" to countries between 10 and 25 percent above the threshold; and a "red light" to countries 25 percent above the threshold and higher. For IDA-only countries, the grant-credit mix inthis systemwould be determinedas follows: 9 "Red": 100percent grants. 9 "Orange": 75 percent grants, 25 percent credits. 9 "Yellow": 50percent grants, 50percent credits. > "Blue": 25 percent grants, 75 percent credits. 9 "Green": 100percent credits. Interms of country grant coverage, sevenIDA-onlycountries would becomenewly-grant eligible compared to the results from the "traffic light" system discussed in Section I11of the maintext. They are: Bangladesh, Benin, Cape Verde, Ghana, Madagascar, Nepal, andSri Lanka. Those are "green light" countries under a three-category structure that become "blue light" under afive-category system. They would be assigned 25 percent rather than zero grants. Inaddition, sevenIDA-only countries would move from a "red light" underthe "traffic light" system to an "orange light" under the five-category scheme. They are: Afghanistan, Ethiopia, Lesotho, Malawi, Mali, Mongolia, and Samoa. They would be assigned 75 percent rather than 100percent grants43. The net effect of these changes would be a small, butnot negligible, increase inthe overall grant share, for all FY06-08 scenarios. These results are shown inTable A.6 below. 43 After a20% volume discount is applied, and aPBA-based reallocation of the resources from the incentive- related portion of the discount takes place, the post-reallocationgrant percentages applicable to different country categories would be: (i) "greens": 0 percent; (ii)"blues": 21 percent; (iii) "yellows": 45 percent; (iv) "oranges": 71 percent; and (v) "reds": 100percent. - 32 - Table A.6. "Five-Light'' System: Grant Sharesfor Different FY06-08 Scenarios Grant Share in the Projected FY06-OS Envelope (9%) Low Base High Before any discount 34.44 34.35 33.7 After 20% discount 27.6 27.5 26.9 L After reallocation 29.5 29.4 28.8 Memo 20% Volume Discount 1470.4 1589.3 1677.4 Of which Incentive-related Portion (11%) " 808.7 874.1 922.6 Charges-related Portion (9%) " 661.7 715.2 754.8 Note: 1/ inSDR million. Excludes grants for regional projects as well as exceptional HIV/AIDS grants. The base-casescenario would result in a post-reallocation overall grant share of 29.4 percent, compared to 28.1 percent under the "three-light" system. The resourcesfrom the 20 percent volume discount would also increase from SDR1,525 million to SDR1,589 million. Inpart, these results would reflect the fact that Ghana and Madagascar, despite having recently reached their Completion Points under the Enhanced HIPC Initiative, would still be eligible for some grants under IDA14. Chart A.l indicates that IDA'Sincentive system would be somewhat strengthened vis-&-vis a three-category system. Infact, the post-reallocation regression line indicates that per capita resource transfers inpresent value terms would become moreresponsive to cross-country variations inperformance incomparison with that obtained under the "traffic light system" (Chart 1inthe maintext). The regression line becomes clearly steeperthan the pre-grants PBA- baseline regression. This i s explainedmainly by the fact that resource transfers in present value terms increased (decreased) to relativebetter (worse) performers, namely, formerly "green" ("red") countries that became "blue" ("orange"). Chart A.1. Correlations BetweenResourceTransfers and Performance After PBA-Based Reallocation inthe Five- LightSystem I A A m a a 0 0 0 5 1 1 5 2 2 5 3 3 5 4 45 5 IDA Perlormanw Rating 1 m PBA Baseline A MVA -Linear(PBABaseline) - - -Linear(MvA)