L IDA14 FinancingFrameworkfor IDA14: PendingIssues InternationalDevelopmentAssociation November 2004 FinancingFrameworkfor IDA14: PendingIssues 1. Followingthe meetings in Washington, DC on October 4-6, 2004, a number o fDeputies inquiredabout various issues relatedto the IDA14 financing framework as currently proposed by management. This note covers the following three topics: (i) the size ofthe structural financing gap inIDAl4, including the gap for HIPC financing; (ii) the availability o f commitment authority for IDA14 grants and its linkage with advancing donor contributions; and (iii) the expected volume o f IBRD net income transfers during IDA14. The note addresses these three topics and provides recommendations for consideration by Deputies. StructuralFinancingGap in IDA14 2. At the third replenishment meeting, Deputies received illustrative tables showing each donor's contribution under three scenarios: the base case of +30% over IDAl3; a low case o f +20%; and a high case o f +40%. The tables also includedthe foreign exchange reference rates for IDA14, as well as standard and accelerated encashment schedules. Subsequentto the meetings inWashington, several Deputies inquiredabout the nature o f the structural financing gap indonors' burden shares and requested additional informationon encashment schedules for IDA14 contributions, including for HIPC-relatedcosts. 3. The attached Table 1 shows IDA14 contributions for the base case (+30%) scenario. Donor contributions are broken down into three components: regular contributions; contributions to reimburse foregone charges on IDA13 grants; and HIPC-related contributions during IDA14. As suggested by some Deputies, Table 1 displays HIPC-relatedcontributions segregated from regular contributions and IDA13 grant contributions. This presentation may be particularly helpful for those donors intendingto channel their HIPC-relatedcontributions through the HIPC Trust Fund. 4. Size of the Structural Financing Gap. The illustrative tables providedto Deputiesused IDA13 basic shares as the starting point to calculate donors' contribution inIDA14; actual IDA14 burdenshares may differ from IDA13, depending on donors' funding decisions. In IDA13, donors' basic burdenshares added up to 90.61% of total donor contributions, leaving a structural financing gap of 9.39%. This structural financing gap in IDA13 was partially filled through donors' supplemental contributions and incentive contributions, and through additional resources derived from accelerated encashments o f donor contributions. As a result, the IDA13 structural financing gap was reducedto 2.86% of total donor contributions. 5. For IDA14, the structural financing gap of 9.39% is equivalent to SDR 1.28 billion inthe base case (+30%) scenario. Ifall donors provided their contributions according to the +30% base case scenario and usedthe standard 9-year encashment schedule for IDA14, the final - 2 - volume o f IDA14 commitment authority would needto be reducedby that amount since the gap would not be closed." To reduce or close the gap, three main options are available: Increasing financing contributions. Ifindividualdonors wanted to increase their support for IDA14 beyond the +30% base case scenario, they could do so by increasing their country's contributions beyond the base case volume. This would reduce the structural financing gap by an equal percentage amount, without affecting burdenshares for other donors. Conversely, reducing individual country contributions below the +30% base case scenario would increase the structural financing gap. 0 Accelerating encashments. Donors could accelerate their encashments inIDA14 and pass on the economic gains to IDA, without claiming a contribution discount, thereby reducingthe financing gap. Recalculating burdenshares. After all donor contributions for IDA14 are known, burdenshares could be recalculated to reduce or eliminate the financing gap. 6. These options could be combined to lower the financing gap for IDA14. With respect to increasing donors' financing contributions, the following discussion focuses on HIPC costs where the elimination ofthe financing gap has beensuggestedby some Deputies. The options of accelerating donor encashments and recalculating burden shares are also discussed below. 7. Increasing Contributions for HIPC Costs. A number of Deputies raised specific concerns about the existence of a structural financing gap for the HIPC-relatedcontributions during IDA14. They pointed out that there should be no financing gap for HIPC contributions since the full nominalvolume (100%) ofdonor contributions was neededto reimburse IDA for foregone debt service payments due to the HIPC debt initiative. For their HIPC-relatedcontributions, therefore, donors should apply higher burdenshares than those used inIDA13 inorder to eliminate the financing gap. As a result, donors would needto proportionately scale up their financing contributions to fill the HIPC-related financing gap o f about SDR 109 million. This scaling up o f HIPC contributions i s illustrated inthe attached Table 2 inwhich total donor contributions for HIPC costs add up to SDR 1.16 billion or 100% o f total HIPC costs inIDA14. 8. Donor Accelerations. The primary contributing factor towards reducingthe structural financing gap inIDA13 was the decision o f most donors to provide their contributions on an accelerated schedule o f six years, rather than usingthe standard encashment schedule o f nine years. For IDA14, donors may again want to accelerate their contributions. The accelerated encashment schedules proirided inOctober 2004 at the Washington meeting displayedfour acceleration options: Schedule A - lump-sumencashment inthe first year; Schedule B - encashment over three years, Schedule C -encashment over four years, and Schedule D - encashment over six years (as inIDA13). " Notethat the structural financing gap in IDA14 affects regular contributionsand HIPC-relatedcontributions only. The structural financinggap for contributionsrelated to financing foregone charges on IDA13 grants has already beencoveredthroughthe IDA13 contributionsfrom the UnitedKingdom. - 3 - 9. For example, as illustrated inthe table below, incase all donors were to provide their contributions over three years (ScheduleB) and without reducing their encashment volumes (no "discounts"), the additional resources generatedwould amount to SDR 1.18 billion, or 8.41% of total donor contributions. This would almost eliminate the structural financing gap o f 9.39%. Donors providing additional resourcesthrough accelerated encashmentswould receive additional subscription votes, equivalent to a "credit" of 9.26% over their encashment volumes incase of a three year schedule, as shown inthe table. IDA14: Base Case Scenario Additional Resources Provided Through Accelerated Encashments Add1Resources YOoftotal Options EncashmentPeriod Credit SDR million Contributions ScheduleA one year 13.08% 1,668.44 11-89% ScheduleB three years 9.26% 1,181.18 8.41Yo ScheduleC four years 7.47% 952.85 6.79% ScheduleD six years 2.73% 348.23 2.48% 10. A number of donors have expressed interest inbenefitingfrom a "discount" on their encashment amounts when accelerating their contributions. Donors would pay their contributions net of the discount amount. Discounts would not generate additional resources to help fill the structural financing gap. Donors would needto advise IDA which encashment schedule and option (credit or discount) they choose. 11. Recalculating BurdenShares for Regular IDA14 Contributions. For their regular IDA14 contributions, Deputiesmight want to reduce or eliminate the structural financing gap by recalculating the actual percentage burdenshares for each donor, after the final IDA14 contributions are known. This would effectively reducethe final size o f the IDA14 replenishment by an amount equal to the reductiono f the financing gap. 12. Inthis context, Deputiesmay want to consider the potential benefits ofretaining some financing gap as part of regular IDA14 contributions. While the size o f the current gap of 9.39% might be considered overly large, maintaining a smaller gap o f say 5% could provide desirable flexibility for adjustments o f donor contributions that may occur subsequent to completing the IDA14 discussions and also for future replenishments. For example, ifa donor decidedto accelerate or increase contributions, the existence of a limited financing gap would allow for an increase of the donor's burdenshare without a needfor recalculating burdenshares o f other donors. - 4 - 13. Considerationsfor Deputies. As inpast replenishments,IDA's burdenshares may not addup to 100%. Inthis context, Deputiesmay want to provide guidanceon the following issues: to what extent each donor expectsto accelerate its IDA14 contributions,without claiming a discount, so as to reducethe size ofthe financinggap; whether they agree that HIPC-relatedcontributionsinIDA14 shouldbe proportionally increasedto eliminate the financing gap for HIPC costs; and whether, after the final IDA14contributionsby donors are known, burdenshares for donors' regular IDA14 contributions shouldbe recalculatedto reducethe IDA14 financing gap to about 5% of regular donor contributions inIDA14. CommitmentAuthority for IDA14 Grants 14. At the start of the IDA14periodinJuly 2006, commitment authority availableto approve new grants will be very limited. This is becauseprincipalreflows derivedfrom credits extended inreplenishmentsprior to IDA11cannot be usedfor the financin ofgrants as the associated replenishmentresolutions did not authorize the makingof grants. At the same time, credit 9, reflows from the most recentthree replenishmentsare not yet available insufficient size, due to the 10-yeargrace periodon IDA credits. This issue is specific to grant commitmentsonly; credit commitments would be backedby IDA'Sinternal resources inIDA14 which become available immediatelyfollowing approvalby IDA'SExecutiveDirectors ofthe use of IDA's internal resources duringthe IDA14period. 15. IDA, therefore, needs to rely on freshcontributionsfrom donors underthe IDA14 replenishmentinorder.toback new grant commitments during IDA14. Since the first tranche of donor resources inIDA14 would generallynot become available untilthe first months of calendar year 2006, IDA's ability to extendgrants duringthe first six to nine months of FY06 (July 2005 -March2006) would almost exclusively depend on donors providingtheir Instrumentsof Commitment inan early, advancedmanner. Only transfers out ofIBRD net income inFY05 of $300 million, expectedto become available by October 2005, couldbe used for new grant commitments. However, this volume would be insufficientto meet the expected demand for grant financingduringthe first six to ninemonths of IDA14 of up to $2 billi~n.~' IDA'sArticles of Agreement (at Article V, Section2 (a)) specify that IDA shall providefinancing inthe form of loans. IDA may provide financingother than inthe form o f loansusingonly two specifiedsources: (i) out of finds subscribedand their reflowsand income, providedthe authorizationfor such subscriptionexpressly provides for such form o f financing; and (ii)out of supplementaryresources and resultingreflows and income but, again, subject to the same proviso as to the original authorization. Replenishmentauthorizations from IDA11onwards have made provisionfor financing in the form ofgrants. This number will dependon the grant percentagein IDA14. Basedon the IDA13 grant percentageof about 20 percent, and considering an average assistance volume of some $11 billion per annum (= the +30% base case for IDA14) in IDA14, grant commitments would equal $2 billion duringthe first year o f IDA14. With a higher grant percentagethan 20 percent duringIDA14, this grant volume could be reachedafter only six to nine months. - 5 - 16. InIDA14, this issue wouldbecomea moreacuteproblemthanit was duringthe early months ofthe IDA13 replenishment, becauseoftwo factors. First, the IDA14grant percentageis likely to be higher than inIDA13. Second, under the proposeddebt sustainability framework for IDA14, many IDA countries may receive IDA resourcesexclusively inthe form of grants, not a combinationof grants and credits as inIDA13.4'As a result, some grant-eligiblecountriesmight haveno access to IDA14 financing until sufficient donor resourcesbecome availableto provide the neededcommitment authority for grants inIDA14. The loweringof the debt sustainability thresholds suggestedby Deputiesat the meetinginWashingtonwould add to this issue since a larger number of countrieswould be classifiedas receiving 100% grants during IDA14. 17. One avenueto overcomethis issue inrecentreplenishmentshas beenthe IDA advance contributionscheme (ACS). This mechanismis an arrangement whereby donors allow IDA to commit their resourcesprior to effectivenessofthe replenishment." This providesIDA with commitment authority during the early stages ofthe replenishmentperiodto minimize interruptions inIDA'Soperations. Unless a donor specifies otherwise inits notificationof participation,its contributionis includedinthe poolof resources available underthe ACS. The ACS has typically become effective when contributions from membersrepresenting20% oftotal contributions are received. 18. Underthe ACS, IDA will be able to make commitments of up to one third of the amount of total contributions receivedfrom the participants inthe scheme. Applyingthe 20% threshold for the ACS usedinIDA13,this wouldresult incommitment authority of approximately$1.2 billion under the ACS inIDA14 6', still less thanthe estimateddemand for grants duringthe first six to ninemonths of IDA14. Moreover, the timing ofthe effectiveness ofthe ACS would depend onthe speedwith which donors provide their contributionsto IDA. InIDA13, the ACS became effectiveon December 13,2002; inIDA12, the ACS becameeffectiveon October 13, 1999. 19. There are several options to addressthe commitment authority issue for IDA14 grants. Managementwould like to seek guidance from Deputieson the following possible solutions: 0 Advancing donor contributions. Donors couldstart submittingtheir Instrumentsof Commitments (IOCs) as soon as the IDA14 Replenishment Resolutionis approvedby the Boardof Governorsto helpreachthe 20% effectiveness threshold of the ACS as early as possible. To the extent that IDA will have receivedIOCs from donors by the start ofthe IDA14period, IDA couldapprove grants against these donor contributions. 0 Modifyingor eliminatingthe Advance ContributionScheme. Incase the ACS does not become effective uponapprovalo f the IDA14 ReplenishmentResolution, donors "Debt Sustainabilityand FinancingTerms in IDA14: Technical Analysis of Issuesand Options", IDAiSecM2004-0640,dated September22,2004. The threshold for the effectiveness of the replenishmenthas been set at 60% of total donor contributionsin IDA13, and at 80% in IDA12, respectively. Regular donor contributionsin IDA14 under the +30% base case are about $18.3 billion equivalent (SDR 12.5 billion). 20% o f this volume would equal nearly $3.7billion, with the first tranche (1/3) of donor contributions representingabout $ 1.2 billion. - 6 - could lower or removethe 20% thresholdfor the ACS inIDA14 andprovidefor their contributionsto be usedas and whenthey are receivedby IDA. Ifthe thresholdwas eliminatedentirely, this could result inavailabilityof up to $1.2 billion of commitmentauthority for grants inIDA14,providedthat donors make their IOCs available ina timely manner. Furthermore, duringthe first year of IDA14 donors could allow IDA to commit more than one-third,possiblyupto two-thirds,oftheir total IDA14 contributions. Donors allowingIDA to commit morethan one-thirdoftheir contributionsduringthe first year of IDA14 wouldnotify IDA that they agree to waive their pro-ratarights7' normallyexercisedduring the second year of IDA14. 0 Introducingconditionalgrants. Grants approvedinthe first six to nine months of IDA14could be approvedconditionaluponsufficient commitment authority becomingavailable. As andwhen additionaldonor contributions are receivedby IDA, funds could be released for disbursement. Giventhe typical nine-year disbursementprofileunder investment operations,this wouldnot cause implementationdelays for most investmentprojects. However, it may lead to unacceptabledelays indisbursement for emergency operations, SWAPS, andpolicy basedoperations such as SACSor PRSCs. Conversionof creditsto grants. IDA14 grant operationscould be approved as credits inthe first six to ninemonths of IDA14with anautomatic conversionto grant terms as and when sufficient donor resources become available. Conversionswould take place inthe same sequence as Boardapprovals. Uponconversion,any IDA service and commitmentcharges paidunder the credit would be refunded. This would allow IDA to use its internalresources at the start of IDA14to back future grants. The benefit for countrieswould be IDA's ability to disburse funds without delay. However, some countriesmay not be preparedto signcredit agreements, evenwith the knowledgethat credits would be convertedto grants uponreceipt by IDA of sufficient donor contributions. Other countries may encounter delays as a result of the needfor legislativeapprovalfor the incurringof debt. 20. Considerationsfor Deputies. Deputiescould decidethat the usual arrangementsfor the advance contributionscheme be revisedto reflect the changes to the ACS describedabove. In addition, it is recommendedthat Deputiesconsider providingtheir Instrumentsof Commitments for IDA14 as early as possible. Furthermore,to the extent required, managementwould adopt a combinationof conditionalgrant approvals andconversionofcredits into grants, as described above. 7' This refersto a donor's right to reduce IDA's ability to commit againstthe second or third tranche of its subscription and contributionon a pro-ratabasis with any shortfall in contributions from the United States of America. - 7 - IBRD Net IncomeTransfersduringIDA14 21. Followingthe IDA14 meetinginWashington, a number of Deputiesreiteratedthe view that IBRDnet income transfers during IDA14 shouldbe increasedabove the volume shown in the illustrativeIDA14 financing framework as presentedto Deputies inOctober 2004. Some Deputiesalso suggestedthat IBRD continue its transfers to the HIPC Trust Fund, beyondcurrent commitments. 22. IBRD CommitmentsDuringIDA13. IBRD committedto net income transfers during IDA13 of $900million(equivalent to about SDR 700 million at IDA13 foreignexchange referencerates), Inaddition, IBRDtransfersto the HIPC Trust Fundfor IDA'Sdebt reliefcosts during IDA13 are $720 million. IBRD is expectedto make a final transfer to the HIPC Trust Fundof $210millionduringOctober2005 from FY05 net income, completingIBRD's pledge for a total of $2.15 billion o f HIPC-relatedtransfers in 1998NPV terms. Donorsare beingasked to cover future HIPC-relateddebt reliefcosts of IDA, starting with an estimatedcost of about $1.7 billion (about SDR 1.2 billion) during IDA14. Illustrative IDA14 Funding Framework, SDR billion - IDA14 IDA13 Illustrative (As agreed) YOChange Sources 1. Donor contributions 2. Regular contributions 12.5 10.0 25% 3 Carryover from IDA12 contributions 0.0 0.1 nla 4. Foregone chargeson IDA13 grants - 0.4 - nia 0.0 5 . Sub-total donor contributions 12.9 10.1 28% 6. Donor financing for HIPC debt relief costs 1.2 0.0 nla 7. Internalresources 8. Internalresources (net of HIPC debt relief costs) 8.7 6.4 36% 1 9. HIPC Trust Fundreimbursements - 0.0 - nia 0.9 I O . Total internal resources 8.7 7.3 19% 1I.IBRD net income transfers 0.7 0.7 0Yo 12. Total sources (Lines 5,6,10,11) 23.5 18.1 30% Uses 13. IDA14 commitment authority 14. Regular commitments(PBA based) 23.1 17.5 32% 15. Assistance to 3 IBRD countries HIPC - - 0.0 - nia 0.6 16. Total commitmentauthority 23.1 18.1 28% 17. NPV of administrative cost ofIDA13 grants 0.5 0.0 nia 18. Less UK financing duringIDA13 a/ - 0.1 - nla 0.0 19. Net administrative cost of IDA13 grants 0.4 0.0 nla !O. Total uses (Lines 16,19) 23.5 18.1 30% Note: IBRD net income transfers are subject to further discussion, as mentioned in para. 24. - 8 - 23. IDA14 FinancingFramework. The financing framework as presentedduring the third IDA14 meeting is shown inthe table above. Inresponse to broad-basedrequests from Deputies for a higher IBRDtransfer figure than the $900 million usedinIDA13, following the second IDA14 meeting inHanoi inJuly 2004, management increasedindicative IBRDnet income transfers inIDA14 to $1.02 billion or SDR 700 million, flat in SDR terms versus IDA13, but representing a 14% increase inUSDterms. 24. Consistent with the views expressedby a number of Deputies subsequent to the Washington meeting, management is analyzing the possibility o f an increase inthe IBRD contribution to IDA, subject to financial prudence and expectedavailability of IBRDnet income. Decisions about the actual utilization o f IBRDnet income will be made on an annual basis by the IBRDBoardof Governors. Any increaseinthe volume of IBRDnet income transfers beyond those includedinthe current financing framework for IDA14 would increasethe total size of the replenishment. Conclusionsand Issues for Discussion 25. Deputiesmay want to discuss and provide guidance onthe following issues: Reducingthe Structural Financing Gap inIDA14 0 to what extent each donor expects to accelerate its IDA14 contributions, without claiming a discount, so as to reduce the size o f the financing gap; whether Deputies agree that HIPC-related contributions inIDA14 should be proportionally increased to eliminate the financing gap for HIPC costs; and 0 whether, after the final IDA14 contributions by donors are known, burdenshares for donors' regular IDA14 contributions should be recalculated to reduce the IDA14 financing gap to about 5% of regular donor contributions inIDA14. Providing Sufficient Commitment Authority for IDA14 Grants 0 to what extent each donor expects to advance the first tranche o f its IDA14 contributions by providing the Instrument o f Commitment as soon as possible, following the approval of the IDA14 ReplenishmentResolutionby the Board of Governors; and 0 whether Deputiesagree to modify the advance contribution schemefor IDA14by removing the 20% effectiveness threshold and allowing IDA to commit up to two- thirds of donor contributions. 26. Regarding IBRD net income transfers during IDA14, management is currently reviewing the possibility of an increase inIBRDcontributions. Larger IBRD contributions than those includedinthe current financing framework for IDA14 would increase the total size ofthe replenishment. 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