World Bank Conditionality Review Nordic-Baltic Position Paper

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1 World Bank Conditionality Review Nordic-Baltic Position Paper Key Points The Nordic and Baltic Countries (NBC:s) welcome the World Bank review of conditionality, and as input into the review process suggest the following five key principles to guide World Bank conditionality for policy-based programs: 1. Strengthened ownership 2. Tailor conditionality to borrowing country circumstances 3. Increase focus on outcomes 4. Reduce the burden of conditionality through improved coordination and harmonisation 5. Transparency for accountability, greater predictability of resource flows and adequate response to inadequate performance Introduction The concept and application of conditionality has stirred much debate in international development fora during the past decade. Whilst conditionality has promoted development in some cases by strengthening the hand of reformist governments, it actually harmed the development of other countries the during the 1980 s when applied in association with structural reforms, as the lack of social protection for those hurt by reforms was not sufficiently taken into account. Thus, recent research suggests that traditional conditionality has not efficiently promoted policy reform, growth and poverty reduction. This has altered the general understanding of the factors influencing aid efficiency, and consequently our approach to conditionality has changed. 1 This development has also shaped the World Bank's policy and thinking on conditionality over the last decade. Against this background, the World Bank is undertaking a review of its policy and practise of conditionality for policy-based lending. The Nordic and Baltic Countries (NBC:s) welcome this initiative and commend the Bank s intentions to subsequently undertake a review of investment lending conditionality, which covers a larger part of the Bank s commitments. We also consider the review timely in light of the Paris Declaration on Aid Effectiveness. The NBC:s appreciate the open approach the Bank is adopting to the review, by conducting several stakeholder consultations. In particular, we believe that it is important to have a broad dialogue with borrowing countries on this issue. Academic research, previous policy reviews and bilateral experiences of aid effectiveness lead 1 The work of the World Bank has been particularly influential. See for example, Burnside, C. and Dollar, D. (2004) Aid, Policies and Growth: revisiting the evidence. The World Bank, Policy research Working Paper, No (march), Dollar D. and Prichett, L. Assessing Aid: What works, What Doesn t and Why, World Bank Policy Report, 1998 and World Bank, 2003 Annual Review of Development Effectiveness the Effectiveness of Bank Support for Policy Reform, OED.

2 NBC:s to suggest five key principles to guide World Bank conditionality for policybased programs. The case for conditionality By conditionality we refer to factors that lender and borrower agree will influence the disbursement of funds. These factors may consist of actions or undertakings on policy or process, as well as performance measures, benchmarks and indicators of various sorts. In essence, the rationale for linking conditions to the provision of aid is to improve efficiency and mutual fiduciary accountability. 2 We see conditionality as a tool for the Bank and the recipient country to manage funds for development results and to provide accountability towards their constituencies. In addition, the terms and conditions stipulate the rules of the game and make the disbursement of funds more predictable to borrowing countries. Moreover, conditionality can be a means of focussing attention on those key areas that are critical for the success of the overall policy program. If applied correctly conditionality can also serve to secure the quality of the reform process by for instance setting environmental and social standards or benchmarks for civil society participation and good governance. Finally, there is the argument that conditionality may serve as an outside anchor for a weak but willing democratic government in cases where reform has clear benefits in terms of growth and poverty reduction for the majority of the population, but is opposed by a minority with special interests. In sum, we believe that performance should influence financing and that there is a valid case for the attachment of terms and conditions to loans. In our view, therefore, the issue is not whether the World Bank should apply conditionality, but rather what the guiding principles for these conditions should be. An holistic perspective The NBC:s believe that it is necessary for the Bank not to look at conditionality in isolation. The conditionality review is merely one part of a larger reform of World Bank lending policies, (i.e. moving towards simplification and modernization of operational policies and increased use of country systems). Furthermore, in order to ensure coherence and to successfully decrease the burden of aggregated conditionality, it is imperative that the review is coordinated with parallel international efforts to harmonize and align aid, in particular the ongoing IMF review of conditionality and the DAC Task Force on Harmonization, in a concerted effort to bring both multilateral and bilateral agencies together around this issue. In addition, the main recommendations related to country ownership and enhanced predictability in the OECD/DAC Good Practice Paper on budget support are of high relevance to the World Bank s conditionality review. Allocation and lessons learned The NBC s strongly emphasize the need for a new approach to conditionality, based on mutually agreed benchmarks and indicators drawn from the countries' own development strategies. Recent research on development effectiveness has emphasized the importance of fundamental factors such as good policy, institutional environment and country ownership to successful development reform and pro-poor growth. It is now 2 This is in accordance with the Paris Declaration on Aid Effectiveness (2005), paragraph 47. 2

3 conventional wisdom that donors can only advice and support, not buy or induce, reforms. Imposed conditionality is not effective on the contrary it weakens the partner country ownership and commitment to reforms. The donor s role is therefore to assist poor people and countries in creating optimal conditions for their struggle to reduce poverty. While we are aware of the conscious effort to strengthen ownership that the Bank has made in some areas, for example through the use of PRS:s, we believe that these findings underline the need for a conditionality review. The lesson that aid efficiency increases with domestic commitment and strong capacity to reform has strengthened the argument that donors should be selective concerning which countries to support. Still, donors are committed by the Millennium Development Compact to give priority also to those countries that have made least progress in the last decade. 3 This raises the question about how to address the needs of poor people in poor counties where aid is found to be less effective. Conditionality must not imply that funds are constricted to countries with a good track record, whilst countries with a government that is too weak to address development issues are marginalized. The classification of poor performers needs to become more flexible few recipients perform poorly in all areas over a long time period. However, for countries were the government is uncommitted to poverty reduction and development, aid allocations should be reduced. It is important that the Bank continues the discussion on appropriate aid and conditionality modalities for poor performers and develops a clear framework for supporting favourable conditions to poverty reduction in difficult partnerships, engaging through dialogue or involvement through other donors when policy lending is deemed inappropriate. In sum, there is an increased recognition that policy reforms need to be country specific and based on contextual economic and social analysis, if they are to be effective one size does not fit all. 4 The conditionality review offers an opportunity for all of us to learn from this and take it into account in future lending operations. Against this background, the NBC:s propose five principles to guide the World Bank conditionality on policy-based lending. Five principles to guide World Bank conditionality 1. Strengthened ownership Local ownership that development strategies are developed by recipient countries, their governments and people, reflecting their priorities, rather than the priorities of donors is a key condition for successful and effective development assistance. While ownership is notoriously difficult to gauge, conditionality cannot be used as a substitute for ownership, but must be conducive to ownership by providing policy space for recipients. When borrowing countries themselves formulate national development strategies, and when the conditions and benchmarks agreed upon are in line with these national development strategies, they are more prone to enjoy strong domestic support, 3 UNDP (2003) Human Development Report 2003: millennium development goals, a compact among nations to en human poverty. 4 See for example World Bank Economic Growth in the 1990 s: Learning from a Decade of Reform, Washington

4 making them more likely to be sustained. It is therefore imperative that the Bank respects, encourages and aligns with country leadership, for example by giving room for flexibility in timetables for implementation, and assists in strengthening the borrowing countries capacity to exercise it. In this context, we would like to underline the importance of accountability and transparency from both parties concerning the conditions posed, how these conditions are derived, as well as the grounds and procedures according to which aid flows are reduced or interrupted. Both parties should be accountable to their constituencies (citizens and parliaments) for the use of resources. 2. Tailor conditionality to specific country circumstances The World Bank boasts a vast diversity of member countries, each with their specific binding constraints to growth and development. Strengthened ownership presupposes clear principles for conditionality, but also that assistance is increasingly tailored to these specific country circumstances. We believe that conditionality should be consistent the common understanding between lender and borrower should be based on fundamental economic principles but this does not translate directly into institutional solutions. The modalities of conditionality must allow for country-specific policies, as well as the opportunity for borrowing countries to learn and benefit from successful precursors. 5 Consequently, we also think that conditionality needs to be approached differently depending on the country characteristics, i.e. capacity for implementation and monitoring, aid dependency, reform readiness, fiduciary framework, macroeconomic and financial vulnerability to crises. The Bank should aim at aligning with, strengthening and using country systems and procedures to the maximum extent possible. 3. Increase focus on outcomes A good, inclusive process of development strategy formulation does not guarantee strong implementation and performance. An increased focus on the outcomes and impact of policy, rather than on the policies themselves, can both strengthen ownership and improve aid management. In accordance with the Joint Marrakech Memorandum (2004) as well as recommendation (1) in the OECD/DAC GPP on budget support the NBC would therefore like to see the Bank move increasingly towards results-based conditionality. To the greatest extent possible, indicators and benchmarks should be drawn from the countries own development strategies. Any indicators outside that framework should be agreed upon through consultation with the borrowing country in question. 6 Monitoring of results should typically be made in conjunction with the annual evaluation of the country s Poverty Reduction Strategy or a similar overarching development strategy. In this light, we are pleased to note the promising results of the piloting of the results-based CAS. Although still in its infancy, we believe that it, if carefully prepared and correctly implemented, will further link Bank-supported activities to the overall country development strategy and thereby enhance country ownership and country capacity. We are convinced that this will lead to increased development impact and effectiveness of the Bank's operations. However, an appropriate mix of performance and policy indicators depending on country characteristics appears advisable. For example, it makes sense to apply 5 Rodrik, D. (2004) Rethinking Growth Policies in the Developing World, Rodrik, D. and Mukand, S.W. (2002) In Search of the Holy Grail: Policy Convergence, Experimentation and Economic Performance 6 This is in accordance with the Paris Declaration on Aid Effectiveness (2005), paragraphs 16 and 45. 4

5 fiduciary and good governance criteria (i.e. absence of systemic corruption in the public financial system, the existence of an acceptable rule of law), to ensure that support is not misused. There could be some problems associated with the application of resultsbased conditionality, such as substantial time lags, lack of data availability and reliability, as well as the risk for borrowers to be penalised if exogenous factors outside their control influence the policy outcome. Result-based conditionality should therefore be used with caution as a trigger for disbursement decisions. The World Bank has an important role to play in managing these potentially negative effects by addressing the capacity building requirements of borrowing countries, to enable them to take an active role in the formulation of indicators, as well as the monitoring of results. 4. Reduce the burden of excessive conditionality through improved coordination, harmonisation and alignment It is imperative to continue the efforts to reduce the burden of excessive conditionality, and to improve coordination and harmonisation alignment of procedures between multilateral and bilateral lenders. It appears that the average quality of policy lending decreases with a larger number of conditions. 7 Although the average number of conditions per World Bank loan or credit has been decreasing since the nineties, the number of conditions risks to increase, and the quality and relevance of the program to suffer when more donors participate in the design of assistance programs. The burden of transaction costs associated with conditions can make loans unattractive, prompting creditworthy middle-income countries to seek alternative sources of credit. Harmonisation therefore implies that all parties, including the World Bank, reduce and prioritise among conditions. This may produce better outcomes for those conditions that remain. To increase donor coordination the Bank should also, where appropriate, consider entering into silent partnerships, delegating authority to lead donors. 5. Transparency for accountability, greater predictability of aid flows and an adequate response to inadequate performance As previously stated, both parties in the aid relationship should be accountable to their respective constituencies for the use of aid funds. In our view it is of outmost importance that the Bank clearly outlines the principles that might cause it to reduce or withdraw aid flows, as well as the modalities of the response mechanism. In order to strengthen mutual accountability both the Bank and the recipient government should be transparent and open about their mutually agreed benchmarks and expected outcomes in the loan covenants. 8 The application of conditionality, by its very nature, implies that assistance may change if conditions are not met. Nevertheless, long-term predictability is desirable as it enhances effectiveness by enabling recipients to plan better and integrate aid flows into their macro-economic and budgetary management. In order to avoid high volatility and consequent disruptions to the recipient country budget management arising from donors switching on and off simultaneously, the Bank should explore mechanisms for gradual response through proportionate adjustments of aid instruments or volume of aid flows in the case of unsatisfactory performance. The Bank should also explore mechanisms to avoid in-year volatility of aid flows. 7 The World Bank (2005), Conditionality and Policy Based Lending Trends. 8 This follows recommendation (4) in the OECD/DAC GPP on budget support. 5

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COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE AND THE COMMITTEE OF THE REGIONS

EUROPEAN COMMISSION Brussels, 13.10.2011 COM(2011) 638 final COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE AND THE COMMITTEE OF THE