(VOLUME 1 MAIN REPORT)

Transcription

1 ANNUAL REPORT ON PORTFOLIO PERFORMANCE FISCAL YEAR 2004 JANUARY 31, 2005 (VOLUME 1 MAIN REPORT)

2 ACRONYMS AND ABBREVIATIONS AAA Analytical and Advisory Activities LICUS Low Income Countries Under Stress ACS Activity Completion Summary LIL Learning and Innovation Loan AFR Africa Region M&E Monitoring and Evaluation ARPP Annual Report on Portfolio Performance MDG Millennium Development Goals ARDE Annual Rpt. on Development Effectiveness MIC Middle Income Countries APL Adaptable Program Loan MNA Middle East and North Africa Region AROE Annual Report on Operations Evaluation MP Montreal Protocol BW Business Warehouse OC Operations Committee CAE Country Assistance Evaluation OED Operations Evaluation Department CAS Country Assistance Strategy OETF Organizational Effectiveness Task Force CAW Country Analytical Work OPCS Operations Policy and Country Services CD Country Director OPE Overall Performance Evaluation CDF Comprehensive Development Framework OPR Operational Performance and Results CEM Country Economic Memorandum PAD Project Appraisal Document CFAA Country Fin. Accountability Assessment PER Public Expenditure Review CODE Committee on Development Effectiveness PIP Portfolio Improvement Program CPAR Country Procurement Assessment Review PRSP Poverty Reduction Strategy Paper CPIA Country Policy and Institutional Assessment PRSC Poverty Reduction Support Credit CPPR Country Portfolio Performance Review PREM Pov. Reduction and Econ. Mgmt. Network CRM Corporate Resource Management Group PSD Private Sector Development DEC Development Economics PSI Private Sector Devt & Infrast Network DO Development Objective PSAL Programmatic Structural Adjustment Loan EAP East Asia and Pacific Region PSR Project Status Report ECA Europe and Central Asia Region QEA Quality at Entry Assessment EFT Education Fast Track QAG Quality Assurance Group ERL Emergency Recovery Loan QER Quality Enhancement Review ESSD Env. and Socially Sustainable Dev. Network QSA Quality of Supervision Assessment ESW Economic and Sector Work RBCAS Results Based CAS FIL Financial Intermediary Loan RVP Regional Vice President FSAP Financial Sector Assessment Program SAD Sectoral Adjustment Loan FSE Finance Network SAL Structural Adjustment Loan FY Fiscal Year SAR South Asia Region GEF Global Environment Facility SB Sector Board HDN Human Development Network SD Sector Director HNP Health Nutrition and Population SIL Specific Investment Loan IAD Internal Auditing Department SSP Sector Strategy Paper ICA Investment Climate Assessment SWAp Sector Wide Approach ICR Implementation Completion Report TAL Technical Assistance Loan IG Investment Grade Country TF Trust Fund IP Implementation Progress TTL Task Team Leader IRIS Integrated Records and Information System VPU Vice Presidential Unit ISR Implementation Status Report WBI World Bank Institute JSA Joint Staff Assessment WDR World Development Report LCR Latin America and the Caribbean Region WSS Water Supply & Sanitation

3 ANNUAL REPORT ON PORTFOLIO PERFORMANCE FISCAL YEAR 2004 CONTENTS PAGE EXECUTIVE SUMMARY...i REPORT I. Introduction...1 II. Portfolio Size and Composition...2 III. Portfolio Performance and Quality IV. AAA Size, Composition and Quality V. Progress Implementing the Results Agenda VI. Recommendations TEXT TABLES Table 2.1 Fast Disbursing Loans/Credits by Region/Network...3 Table 2.2 Portfolio by Client Grouping...8 Table 2.3 FY04 Portfolio by Sector of Focus and Theme Table 2.4 FY04 Portfolio by Lending Instrument Table 3.1 Trends in Quality at Entry and Supervision Table 3.2 Quality of Project Supervision, FY Table 3.3 Net Disconnect between DO and OED Outcome Ratings, FY96-FY Table 4.1 AAA by Major Type Table 5.1 FY05 Action Plan FIGURES Figure 2.1 Trends in Portfolio Size and Resource Transfer...2 Figure 2.2 (a) Investment Commitments...4 Figure 2.2 (b) Adjustment Commitments...4 Figure 2.3 Portfolio Distribution by Region, FY99 and FY Figure 2.4 Portfolio Distribution by Network, FY99 and FY Figure 3.1 Proportion of Operations with Satisfactory Outcomes Figure 3.2 Outcomes by Region, FY Figure 3.3 Countries with Operations Showing Outcomes of >85% Sat Figure 3.4 Countries with Operations Showing Outcomes of <65% Sat Figure 3.5 Outcomes by Sector, FY Figure 4.1 AAA Spending as a Share of Total Country Services Figure 5.1 Results Reporting System... 30

4 BOXES Box 2.1 Mexico Decentralized Infrastructure Reform and Development Project...5 Box 4.1 AAA in the Infrastructure Action Plan Box 4.2 ECA Region AAA Knowledge Fair Box 5.1 The Development Impact Evaluation Initiative Box 5.2 IDA 14 Results Measurement System ANNEXES Annex 1 Guarantees Annex 2 The Portfolio An Overview Table Annex 3 Basic Portfolio Definitions Annex 4 FY05 PIP Countries and PIP Projects VOLUME II: STATISTICAL APPENDIX ACKNOWLEDGEMENTS This report is the product of a Bank wide team effort, with input from many VPUs across the Bank. It was prepared by a team managed by Tray Sinha and David Steel, and included Robert Drysdale, Hans Wyss, Jason Mayfield, Melvin Vaz and Leila Cruz. Helpful advice and contributions were received from a number of colleagues across the Bank including, Gerard Byam, Irene Xenakis, Richard Cambridge, Jody Kusek, Marisa Fernandes-Palacios, Christian Rey, Alain Colliou, Sally Zeijlon, Parvaiz Rashid, Marsha Olive, Ali Mansoor, Ulrich Zachau, Gisu Mohadjer, Arun Banerjee, Hasan Tuluy, Aloysius Ordu, Afef Haddad, Setareh Razmara, Shantayanan Devarajan, John Roome, Barbara Kafka, Axel Baeumler, Rae Liu, Nicholas Krafft, Odin Knudsen, Jan Bojo, Kevin Cleaver, Sushma Ganguly, John Underwood, Susan Stout, Poonam Gupta, Elizabeth White, Lada Strelkova, Leslie Villegas, Jack van Holst Pellekaan, Jeffrey Balkind, Paul Hubbard, Lazlo Lovei, Stefan Koeberle, Tevfik Yaprak, Alfred Nickesen, Alan Carroll, Christopher Hall, Omowunmi Lapido, Stuart Stephens, Sudhir Shetty, Aline Courouel, Daniel Ritchie, Philippe Dongier, Ariel Fiszbein, Laura Rawlings, Shahrokh Fardoust, Eric Swanson, Misha Belkindas, Padmanabha Hari Prasad, Ajay Chhibber, Alain Barbu, Soniya Carvalho, Krishna Challa. Prem Garg, Director, Quality Assurance Group, guided the overall effort.

5 Annual Report on Portfolio Performance FY04 i EXECUTIVE SUMMARY 1. The Annual Report on Portfolio Performance (ARPP) provides the Board and Senior Management with a strategic overview of the effectiveness of the Bank s lending and AAA portfolio in delivering results to its clients. It also provides Senior Management with real time information to assess what is working well, or less well, together with recommendations on measures to maintain or improve the quality of the portfolio a key vehicle for delivering results to our clients. LENDING PORTFOLIO SIZE AND COMPOSITION 2. The portfolio size continued to shrink for a fifth year. Total net commitments decreased from a level of $97.3 billion to $95.1 billion. Portfolio size has declined most significantly for those countries that have better credit risk ratings and are classified as investment grade (IG). The portfolio size for IG countries and China has decreased by almost half since FY99, and the decrease of $2.7 billion in FY04 accounted for all of the Bank s portfolio reduction in that year. There is a substantial opportunity to simplify Bank processing procedures to these countries and to improve the Bank s responsiveness in view of the relatively mature nature of their institutions and good performance on project outcomes (OED satisfactory ratings of about 90%). Expanded use of SWAps, country systems, and a quicker and more simplified approach would be responsive while remaining prudent. Continued lending to IG countries is advisable as there are substantial needs for modernization of country systems, regulatory framework and infrastructure in these countries as well as pockets of poverty. In addition, continued lending to these countries also helps the Bank to maintain the quality of its loan portfolio. 3. Net commitments for the active portfolio in lower income countries increased modestly by $2 billion (6%) since Within the group of lower income countries, lending and net commitments to Lower Income Countries Under Stress (LICUS) increased the fastest, by 52 percent since 1999, and by 17 percent in 2004 alone. This is mainly due to an increase in lending to post conflict LICUS countries reflecting the IDA 13 exceptional post-conflict allocations. Lending to other LICUS countries has increased very slightly. LICUS countries, both post conflict and others, had a high level of commitments at risk (29%), as well as a high level of disconnect (15%) between regional staff and OED ratings in FY04. A very rapid increase in commitments prior to institutional/policy strengthening can be problematic, and is reflected in rather low OED Satisfactory ratings of about 64 percent. The realism of reporting in LICUS client grouping was also rather low in FY04 at 64 percent overall, and specially low for its sub grouping of post-conflict countries at 42 percent. The approach to these countries needs to be reviewed with a greater emphasis on realism, and candor to inform lending decisions and to guide actions on risky portfolio. A review is currently being done by OED. 4. The Networks with the largest portfolios remain Infrastructure, ESSD and HDN. Together they account for 86 percent of the Bank s portfolio. All three major networks shared in the decline of the portfolio in absolute terms, though the Infrastructure Network was affected the most. It declined in both absolute and relative terms with the portfolio shrinking by $16 billion since The Infrastructure and Agricultural / Rural Sectors have

6 Annual Report on Portfolio Performance FY04 ii prepared detailed action plans to reverse the decline in lending. The action plan for Infrastructure has started having an impact on the Transport portfolio for which both new approvals increased by 31 percent and total net commitments rose by 6 percent in FY04. However the recent increases in new approvals, specially for Power and Water, have not been sufficient to overcome previous declines so total net commitment for the active infrastructure portfolio still declined in FY04. Renewed dialogue and efforts at the country level with major borrowers through targeted and results oriented AAA is needed on key policy and regulatory issues to allow Power and Water portfolios to recover in a prudent manner. The Rural Sector also showed a modest decline of 2% in net commitments as the increase in new approvals of 4% was not sufficient to offset previous declines. This may change as some of the large Borrowers such as India are recognizing the need to focus more on rural development for alleviating poverty. PORTFOLIO PERFORMANCE 5. The FY03 ARPP noted an apparent marked decline in the proportion of satisfactory development outcomes for operations that exited the portfolio in FY03. This followed several years of rising outcome performance. The Board asked that the FY04 ARPP analyze this decline in more detail. This ARPP conducted a detailed review of the evolution of development outcomes and the factors which determine them. This was based on more complete data for FY03 exits and about 160 operations that were completed in FY04 and evaluated by December 31, The analysis finds that the FY03 decline may have been an isolated event. There is substantial year-to-year volatility, and outcome trends are best analyzed using three year moving averages. The analysis shows that lending portfolio performance has improved from a low level of 60 percent Satisfactory in FY90 and reached a relatively high plateau of about 76 percent Satisfactory in FY With continued improvements in quality of lending and supervision, it should be possible to improve the level further to the 80 percent plus range, which is both desirable and feasible, and is consistent with current corporate target of achieving results. However, depending on regional client grouping and country context, it is likely that there will be varying performance which should be realistically noted in appraisal documents. 6. The analysis of contributory factors, covering some 1200 projects that exited the Bank portfolio in FY00-04, also shows that project ratings correlate most strongly with Borrower implementation performance. But Bank performance is also an important contributory factor as satisfactory Bank performance during supervision is likely to lead to better identification and mitigation of risks during implementation, thereby contributing to successful outcomes. However, a recent QAG review of the quality of supervision done in Fall 2004 (QSA6) shows that improvements in quality of supervision have stagnated. While supervision quality, rated moderately satisfactory or better, is 90 percent, the fully satisfactory supervision is 65 percent. There is substantial scope for improving supervision of projects. The supervision of risky projects in particular is not handled well. The FY03 ARRP had recommended that more resources should be allocated to risky projects. However a review of budget allocations shows less than a 5 percent differentiation in allocations between risky and non risky projects. More effort is needed to improve management attention, the quality of supervision teams, and supervision budget for risky projects. Projects in countries and less developed rural areas that have inadequate information at entry,

7 Annual Report on Portfolio Performance FY04 iii could benefit from project restructuring as more information and experience becomes available during project implementation. While mid-term reviews and project restructuring are recommended in such situations, process impediments, inadequate budgets, and rigid evaluation criteria for project outcomes have created disincentives for such mid-course corrections. Consequently these tools are insufficiently used to improve outcomes. 7. Several actions have been taken by the management to improve portfolio management. Explicit provision in OPEs for managerial oversight has been added. The disconnect between OED and PSR ratings has been reduced. Intensified training has started for operations staff and managers in project performance rating and reporting methodology in order to enhance the accuracy of reporting and thus the quality of the institutional level databases. Project Status Report (PSR) system has been improved and the new system, now called the Implementation Status and Results Report (ISR), has been launched. Simplified restructuring process and evaluation criteria which give positive incentives for such restructuring have been agreed with OED and should be implemented soon. AAA SIZE, COMPOSITION AND QUALITY 8. In FY04 the rapid increase in AAA outputs and expenditure that had occurred since FY02 leveled off. There was also evidence of a shift from core diagnostics towards more country tailored products, which should enhance the contribution of AAA to CAS objectives and outcomes. Several Regions are taking steps to improve management oversight of overall AAA balance and effectiveness. This should strengthen due diligence of AAA performance at the country level. Harmonization of AAA in terms of sharing knowledge between development partners is making progress, but the next step is to reduce duplicative work by partners at the country level, which will benefit clients and partners alike. 9. The quality of individual AAA products remains high, but the quality of country AAA programs and processes was rated as somewhat weaker in a recent QAG assessment. Better coordination within the Bank would result in more coherent programs, and better dissemination and follow up dialogue with clients would strengthen impact and results. Management oversight can be improved, in particular to strengthen alignment between CASs and Bankwide sector strategies. The existing CAS completion reports (CASCRs), in combination with the new CAS Progress Report, and QAG country level assessments, would strengthen due diligence on CASs at the corporate level, and provide real time learning for Bankwide lessons on country AAA results. A promising body of Regional experience developing results frameworks for AAA suggests an emerging consensus in this direction. PROGRESS IMPLEMENTING THE RESULTS AGENDA 10. Bank management is progressing on a variety of fronts in implementing the results agenda, including the results reporting system. The Results Based CAS (RBCAS) is emerging as an instrument with much potential to help implement the agenda. But the remaining agenda is substantial. To complete the reporting system gaps still need to be filled at the sector, country and corporate levels. At the sector level, results frameworks and indicators for all sectors and themes need to be developed, and used operationally. At the country level, the CAS Completion Report will be the focus of results reporting. At the

8 Annual Report on Portfolio Performance FY04 iv corporate level, Bank activities that are not yet fully incorporated into the reporting system need to be included. Incentives, resources and structure need to be better aligned to support the results agenda, particularly with respect to the role of the sectors and the effectiveness of the sectoral structure. This remaining agenda reinforces earlier judgments that the transition will take time, but, that 2007 remains a realistic target date to put in place the fully articulated framework. To ensure that the results agenda remains an institutional priority, management needs to continue a high visibility, coherent effort across the organization to align all parts of the Bank with the results agenda. At the same time management needs to remain aware of the need to avoid the emergence of a reporting mentality, M&E overload, and negative incentives. KEY RECOMMENDATIONS (a) Strengthening Lending and Portfolio Management: The Infrastructure action plan has made a good beginning with new approvals for Infrastructure in FY04 of $6.6 billion of which about 56 percent is for transport. However the recent increases in new approvals, specially for Power and Water, have not been sufficient to overcome previous declines so total net commitment for the active infrastructure portfolio still declined in FY04. Strengthened dialogue backed by high quality AAA would be helpful in improving both the quality and quantity of Infrastructure lending (para. 2.19). MIC clients: The Bank is reforming its approach to MIC clients, specially those with relatively mature institutions and good performance as is the case with China and IG countries (OED satisfactory ratings of about 90%). A quicker and more simplified processing of new operations backed by appropriate country systems would be responsive to their needs while remaining prudent (para 2.13, 2.14). LICUS clients need more assistance as indeed is being offered to post-conflict countries. However, the high level of unsatisfactory outcomes (36%) and disconnect (15% in FY04) point to design and implementation problems. The experience with LICUS lending will be reviewed by OED with a view to improving results (para. 2.15, 2.16). Risky Projects: More effort is needed on risky projects. The focus should be on management attention, quality of supervision teams, candor in reporting, as well as budget adequacy for project work out. Regional Quality teams should monitor the budget allocation to risky projects to ensure that sufficient supervision budget is allocated for risky projects by Country Departments. They should report outliers to RVP for corrective actions (para 3.12, 3.13). Result Outcomes should be improved from current level of about 76 percent satisfactory rating to 80 percent plus, consistent with agreed corporate targets. This will require quality-at-entry and project supervision to be improved. Currently only about two-thirds of operations are identified as fully Satisfactory and this affords substantial scope for improvement (para 3.1, 3.13).

9 Annual Report on Portfolio Performance FY04 v (b) Analytic and Advisory Assistance (AAA) AAA management: Regions should consider including AAA in regular CPPRs conducted with clients, either integrated into the CPPR or done as a separate exercise; and to examine causes for slow delivery and droppage to determine if there are any patterns or systemic lessons (paras.4.23, 4.26). (c) Results Framework Implementation Results reporting: mainstream the RBCAS cycle, including the RBCAS Completion Report and the new CAS progress report, and issue accompanying guidance to staff by the end of the third quarter of FY05. Complete the development of results frameworks for all sectors and themes. Continue to expand the scope of the ARPP by extending its coverage to Bank activities not yet included (paras. 5.4, 5.7, 5.8, 5.15). Systems and procedures: management may want to consider the role of additional guidance on how sector and country program priorities can be aligned better, and how CASs and SSPs should be linked; and to refine the Bank s reporting systems to permit more comprehensive reporting, as well as analysis on newer Bank instruments such as multi-sector projects (paras. 5.6, 5.15).

10 Annual Report on Portfolio Performance FY04 1 OBJECTIVES AND APPROACH I. INTRODUCTION 1.1 The Annual Report on Portfolio Performance (ARPP) provides the Board and Senior Management with a strategic overview of the status and trends in quality of the Bank s lending portfolio and Analytic and Advisory Assistance (AAA) program. It also provides Senior Management real time information to assess what is working well, or less well, together with recommendations on measures to maintain or improve the quality of the portfolio a key vehicle for delivering results to our clients. The main objectives of the FY04 ARPP are: assess the current status of the Bank s portfolio and AAA program, and review management efforts and results to strengthen portfolio and risk management; assess likely trends and challenges to the portfolio over the medium-term and identify priority actions needed to address issues, and report on incentives and process and system changes; and, review progress in creating the results framework in the portfolio and AAA program as well as the transition to a more comprehensive approach to results reporting. 1.2 The FY04 ARPP draws on materials that are prepared as part of regular portfolio monitoring functions carried out by the Regions and Networks, supplemented by project/portfolio data in the Bank s management information systems. The FY04 ARPP also draws on assessments and data commissioned from several special studies. Consistent with past ARPPs, the report uses a five-year time frame (FY99-04) to examine medium-term trends in the portfolio. In preparing the ARPP, extensive consultations were held with managers and staff from around the Bank. STRUCTURE AND COVERAGE 1.3 The report is organized into six Chapters. Chapter II reviews the recent trends in size and composition of the lending portfolio. Chapter III assesses overall portfolio performance as well as issues associated with measuring and reporting the risk that operations will not achieve their development objectives. It also provides a brief review of incentives and process and system changes. Chapter IV reviews the Analytic and Advisory Assistance (AAA) portfolio and focuses on progress in strategic integration, and on developing a results framework. Chapter V examines the progress in creating the results framework in the portfolio and AAA program as well as the transition to a more comprehensive approach to results reporting. Recommendations are summarized in Chapter VI. A second volume contains a detailed set of supporting statistical material.

11 Annual Report on Portfolio Performance FY04 2 II. PORTFOLIO SIZE, AND COMPOSITION 2.1 This chapter analyzes active portfolio size and trends and finds that net commitments are still declining, though at a decelerating rate. The drop in FY04 in net commitments of about $2.2 billion is mainly due to a reduction in the lending to the better performing countries of the East Asia and Pacific Region (EAP). Amongst networks, ESSD, Infrastructure, and PREM shared in the decrease more evenly. An action program to strengthen the demand in MICs has been initiated but needs to be sustained as there are significant opportunities and needs to which the Bank should be responding. Actions have been initiated in Infrastructure and ESSD Networks through the Infrastructure action plan and Rural Development and Agricultural Strategy and some good results are visible. These efforts need to be sustained and broadened. A more detailed analysis of trends is presented below. PORTFOLIO SIZE AND TRENDS 2.2 The Bank s active portfolio for FY04 consisted of 1,469 operations with net commitments of $95.1 billion, 1 which represents a $2.2 billion (2%) drop in nominal terms in FY04 from the level in the previous year (Fig 2.1). FIGURE 2.1 : TRENDS IN PORTFOLIO SIZE AND RESOURCE TRANSFER (FY96=100) Approvals in FY Disbursements Active Portfolio 2.3 In resource transfer terms, both new approvals and disbursements show a recovery from levels in the post financial crisis period of FY New approvals in FY04 reached a level of $20.4 billion, which was 8 percent higher than new approvals in FY03 though still below the pre-financial crisis levels of FY96 (Figure 2.1). Going forward new lending is 1 For purposes of the ARPP, the active portfolio is defined as all active loans, credits and grants approved and still under implementation at the end of the fiscal year. A more detailed definition is in Annex 3. Trend lines (Figures 2.1 to 2.3) are in real terms. All other commitment figures are in nominal terms. The deflator for IBRD / IDA commitments has varied by less than 5% during

12 Annual Report on Portfolio Performance FY04 3 expected to increase $1.5 to $2.0 billion in FY05. If this is realized new approvals will finally recover to the level they were in FY End year active portfolio information does not capture some quick disbursing operations which enter and exit the portfolio in the same fiscal year because of their singletranche design. There are typically about 20 such fast-disbursing operations a year. These are therefore shown separately (Table 2.1). In FY04, they accounted for a small proportion (about 11%) of annual approvals. TABLE 2.1: FAST DISBURSING LOANS/CREDITS BY REGION (Amounts in $M) FY99 No. of Projs Amts FY00 FY01 FY02 FY03 FY04 No. of No. of No. of No. of No. of Projs Amts Projs Amts Projs Amts Projs Amts Projs Amts FY99-04 No. of Projs Amts Region AFR EAP 6 4, ,654 ECA , ,203 LCR 4 1, , , , , ,151 MNA SAR ,896 TOTAL REGION 16 6, , , , , , ,541 IBRD PORTFOLIO 2.5 The Bank portfolio is composed of IBRD loans and IDA credits and GEF/MP/SF grant funds. The IBRD portfolio, continues to be predominant part of the Bank portfolio at 58 percent of the total in FY04. It declined by about 8 percent in FY04 to $55.5 billion. This is mainly due to reductions in new IBRD approvals for investment lending, which now average about $6 billion per year compared to an average of about $12 billion per year between FY90 and FY98 (Figure 2.2a). This is in sharp contrast to IBRD adjustment lending which has remained fairly steady around an average level of $5 billion per annum between FY00 and FY04, slightly above the pre-financial crisis average of about $4 billion (Figure 2.2b). 2.6 The fall in new IBRD investment lending approvals can be ascribed to several factors as noted in the report of the Working Group on Bank support for Middle-Income Countries (MICs), 2 which appear to affect investment lending but not adjustment lending approvals. One factor specially mentioned by several major clients is the cost of doing business with the Bank in addition to financial charges. The process of ensuring adequate safeguards for infrastructure investments for example is seen by some borrowers as unnecessarily slow and cumbersome which for them adds to the cost of doing business with the Bank and makes Bank lending less competitive than other sources of financing. 2 Report of the Working Group on Enhancing World Bank Support to Middle-Income Countries, May 2004.

13 Annual Report on Portfolio Performance FY04 4 FIGURE 2.2 (A) INVESTMENT APPROVALS Amount (US $Billion) IBRD IDA FIGURE 2.2 (B) ADJUSTMENT APPROVALS Amount (US $Billion) IBRD IDA 2.7 The Bank is modifying its approach and simplifying its internal processes to respond to Borrowers needs in a more timely and flexible manner. The use of Sector-wide Approaches (SWAps) and country systems where appropriate is one element of this. While SWAps have been used in HD sectors for many years, the approach is gaining momentum in infrastructure lending as well. A recent example is the Mexico Decentralized Infrastructure Reform and Development Project (Box 2.1). The use by the Bank of well-performing country systems in specific fiduciary areas (financial management and NCB procurement) has also gradually been increasing. In September 2004, the Board endorsed the idea of pilot

14 Annual Report on Portfolio Performance FY04 5 testing the use of country environmental and social safeguard systems and is considering other proposals (para 2.8). Following a review of the experience with implementing the pilot projects, proposals for wider adoption of the approach would be considered. BOX 2:1 MEXICO DECENTRALIZED INFRASTRUCTURE REFORM AND DEVELOPMENT PROJECT A US$108 million loan for the Mexico Decentralized Infrastructure Reform and Development Project was approved by the Board in June, This Sector-Wide Approach (SWAp) investment lending operation combines policy and comprehensive sector strategy formulation for infrastructure sectors approved upfront, with financing of investment programs, and simplified procedures through output oriented disbursement triggers for the investment component. As a satisfactory and comprehensive sector strategy and policy framework was established upfront, a broad version of the Sector Wide Approach (SWAp) could be applied and an extensive use of country systems frameworks can safely be used to govern operational policies and practices in financial management, procurement and environmental and social safeguards. Since satisfactory policies would be applied to all investments in the selected sectors, spanning Bank and other donor financing as well as federal transfers and state budgetary funds, a considerable leverage and development impact is gained. IMPLEMENTATION OF MIC AGENDA 2.8 Following up on the conclusions of the Working Group on MICs, management is acting on several factors concurrently to increase IBRD support to MICs, including investment lending, over both the short- and medium-term. Several of the short-term components have already been implemented, while others involve Bank policy changes that are being discussed with the Board. The President s Annual Meeting Speech highlighted MIC development support, but a broader external communication strategy needs to be developed and implemented. The Board has discussed an issues paper on the use of country systems with a proposed governance framework for a two-year pilot program for safeguard cases and ICB procurement and international selection of consultant cases. External comments have been invited (on the Bank s external web) and a revised paper with a request for authorization will be presented to the Board in FY05. More flexibility in CAS implementation is planned; a draft note has been internally agreed and an operational memorandum will be issued shortly. The Board has approved a revised policy for Development Policy Lending (OP/BP 8.60) and a series of good practice notes on development policy lending has been issued; several operations under the new policy have already been approved. Management also has issued a guidance note on the use of conditionality in both development policy lending and investment lending. A guidance note on output based disbursement was prepared in September 2004 and is under review. Revisions of Bank policies on supplemental or additional lending (OP/BP13.20) and on emergency lending have been prepared for discussion with CODE.

15 Annual Report on Portfolio Performance FY To offer MIC clients more choices, the use of existing IBRD financial products is being promoted through outreach as the availability of such choices is often not well known. This includes outreach on existing products in over 25 countries and transaction opportunities for local currency lending. Two local currency loans have already been made to Mexico and work is underway in eight other countries. Management is also moving to better exploit Bank Group synergies in supporting development efforts in MICs. This includes a Group framework for lending to financial intermediates, including municipal funds. Two transactions (in Mexico and South Africa) have been completed and others are under preparation. More broadly, a working group has been established to outline a proposal for a Bank Group facility for sub-sovereign lending. Collaboration with other donors is also being strengthened. IDA AND TRUST FUND PORTFOLIO 2.10 The IDA portfolio has increased marginally by about 6 percent in last five years and stands at around $37 billion up from $35 billion in FY99. New IDA approvals increased in FY04 to $8.7 billion. Still, the small increase in IDA commitments since FY99, at the rate of about one percent per annum, is a concern as it would make it difficult for the Bank to support in a sufficiently responsive manner the global commitment to achieve MDG targets. A speedy conclusion of IDA14 negotiations with a sizeable increase in IDA resources is essential to maintain the needed resource transfer to low income countries accompanied by policy, technical and safeguard measures which assure quality. In addition to IBRD and IDA, the portfolio includes trust funds (GEF/Montreal Protocol) and special financing operations. These are currently about $2.5 billion which is less than 3 percent of the total. The GEF and the Montreal Protocol portfolio both have about $800 to $900 million each in commitments. Special Financing programs, which are funded out of the Bank s net income, also stand at about $800 million. While these programs are small, they serve to satisfy the demand in some niches where IBRD or IDA funding cannot be used which provides justification for continued support at this level. REGIONS AND COUN TRIES 2.11 Regional Trend. The FY04 portfolio shows a varying pattern in lending trends by regional and country groupings. Africa Region with mainly low income countries has shown an increase in portfolio size in the last five years, whereas the other higher income regions have shown a shrinkage in portfolio size (Figure 2.3). Overall the increase in lending to lower income countries has not matched the decline in lending to higher income countries, so that the total portfolio size has declined by $28.7 billion (23%) in five years. Amongst the regions, only Africa has shown an increase in commitment size in absolute terms, while commitments in South Asia have remained almost constant. Going forward it is expected that with the simplification of processes that are now being introduced, and increased efforts, new lending will increase substantially in East and South Asia, and that the overall portfolio will show a small (2%) recovery from the current relatively low level of $95 billion.

16 Annual Report on Portfolio Performance FY04 7 FIGURE 2.3: PORTFOLIO DISTRIBUTION BY REGION, FY99 AND FY04 (US$B) AFR EAP ECA LCR MNA SAR FY99 FY Portfolio Concentration. The FY04 portfolio includes operations in 135 countries, with a heavy concentration in eight countries (China, India, Argentina, Turkey, Brazil, Mexico, Vietnam, and Indonesia) which account for about half of net commitments, 3. In comparison, about 65 of the smallest borrowers account for only 5% of the commitments in the portfolio. Despite the large disparity in the share of net commitments, each of the two groups (the eight largest and the 65 smallest) each account for about a 20 percent of the portfolio in terms of number of projects. This illustrates the adaptability of the Bank lending program to the diverse needs, interests and capabilities of different borrowers Portfolio Trend by Country Groupings. Analyzing portfolio trends by countries grouped according to level of income and performance provides interesting insights (Table 2.2). Portfolio size has declined most significantly for those countries that have better credit risk rating and are classified as investment grade (IG). There are some 17 countries in this grouping including Mexico, Poland, and Thailand. Between FY99-04 portfolio size decreased by almost half from $12.1 billion in FY99 to $6.6. billion. These countries are generally good performers and OED Outcome ratings have been high with 90% of Projects rated Satisfactory at exit. In view of the relatively mature nature of institutions in these countries and good performance, it is advisable to expand the use of quicker disbursing programmatic loans in IG countries and to use country systems, where permitted under the Bank s existing policy framework. As institutional strength in better performing countries and sectors is stronger, it should be possible to implemented several elements of the MIC agenda at an accelerated pace. Continued lending to IG countries is advisable as there are substantial needs for modernization of country systems, regulatory framework and infrastructure in these countries as well as pockets of poverty. 3 These largest borrowers also represent well over half of the total population of the Bank s Part II member countries and a similar share of the world s absolute poor.

17 Annual Report on Portfolio Performance FY04 8 TABLE 2.2: PORTFOLIO BY CLIENT GROUPING Commitment (US$B) FY99 FY03 FY04 % Change FY FY04 % Commit At Risk FY00-04 Unsat Outcome % IBRD Investment Grade IBRD Only (Others) China India Blend IDA Only Licus Bankwide Note: Client groupings are mutually exclusive. IBRD only grouping excludes IBRD Investment Grade and China; Blend grouping excludes India; and IDA only grouping excludes LICUS China and India, the two economies each with populations of over one billion and substantial diversity of income and poverty at sub-national levels, need a different approach. They need lending to sub national entities with a differentiated products between better performing coastal States, similar to MICs, and poorer income provinces in the interior similar in some respects to LICUS. China, with higher income and growth rate behaves more as an IG country, and Bank portfolio has declined substantially by about a third in a manner similar to IG countries. China needs assistance specially for poorer provinces in which it has less adequate infrastructure and substantial pockets of poverty. In view of more efficient project implementation in China, which is reflected in low commitments at risk (3%), and high proportion of Satisfactory Outcomes (90%), the Bank should consider simplifying processing procedures to increase the speed and responsiveness of Bank s assistance to China Another country grouping is the Low Income Countries under Stress (LICUS) with over 30 countries in the group. These countries have relatively lower CPIA ratings, and consistent with that, the OED outcome record for these countries is also low. For the LICUS country grouping, only about 64 percent of projects have Satisfactory outcomes. However, Table 2.2 shows that the active loan portfolio in LICUS countries expanded by 17 percent in FY04 and by over 50 percent in the last five years. This is mainly due to an increase in lending to post conflict LICUS countries reflecting the IDA 13 exceptional post-conflict allocations. Lending to other LICUS countries has increased very slightly by 11 percent since There are substantial country-to-country variations around this average trend A focus group of selected LICUS Country Directors and team members met in December 2004 for a discussion on factors affecting LICUS portfolio performance. Factors identified by this group included: (i) highly uncertain external environments needs, constraints, objectives and financing provided by government or other donors frequently change over the lifetime of a project; (ii) it is still difficult to attract experienced staff to work on LICUS countries; (iii) there is inadequate sharing of simple project design elements which have a track record of working in LICUS environments; (iv) the mission model of supervision is not suited to LICUS environments, which require more consistent, field-based support; (v) due to low implementation capacity, projects in LICUS are more likely to be

18 Annual Report on Portfolio Performance FY04 9 overage, and current supervision budget allocation guidelines penalize such projects; and (vi) finally, LICUS are by definition high risk: a roughly two-thirds satisfactory rating may not be particularly inappropriate given the high-risk/high-return nature of these environments. It has been agreed that OED will review the approach to this country grouping more closely specially in view of the high level of commitments at risk (29%), unsatisfactory outcomes (36%) as well as high level of disconnect (15%) in FY The two remaining client groupings are IDA only and Blend countries. Both have a level of Unsatisfactory Outcome in the 25 to 27 percent range, which is rather high when compared with corporate target of 15 to 20 percent. The approach to these countries may need to be modified with more emphasis on less complex project design consistent with current realities regarding institutional capacities in these countries. This should be accompanied with a more measured and realistic pace for institutional strengthening. More ambitious project design should only undertaken following institutional strengthening and more realistic assessment of absorptive capacity. NETWORKS, SECTORS AND THEMES 2.18 The Networks with the largest portfolio size remain Infrastructure, ESSD and HDN (Figure 2.4). Together they account for about 86 percent of the portfolio size. All the three major networks shared in the decline of Bank s portfolio in absolute terms, though the Infrastructure Network was affected the most. It declined in both absolute and relative terms with the portfolio shrinking by $16 billion. Portfolio of ESSD and HDN Networks also declined but relatively less than Infrastructure. FIGURE 2.4: PORTFOLIO DISTRIBUTION BY NETWORK, FY99 AND FY04 (US$ B) ESSD FSE HDN INF PREM PSDN FY99 FY Infrastructure and ESSD Networks have prepared detailed action plans to reverse the decline in lending. The action plan for Infrastructure has started having an impact on the less complex Transport sector but less so on the more complex Power and Water Supply Sectors where regulatory, tariff, and safeguard issues take more time to resolve. The total net commitments for Transportation sector which is dominated by Roads / Highway operations, increased by 6 percent in FY04. The active portfolio in other sectors of the Infrastructure

19 Annual Report on Portfolio Performance FY04 10 Network continued to decline as new FY04 approvals (portfolio entries), were still smaller than portfolio exits in FY04. Accordingly the total net commitments in FY04 for Power subsector declined by 23 percent and for Water & Sanitation sub-sector, by 3 percent. Continued dialogue and effort at country level to resolve key policy and regulatory issues is essential, specially in Power and Water Supply sectors where there are substantial needs and opportunities. High quality AAA (Chapter 4) can inform the dialogue and make a persuasive case for needed policy and institutional changes while suggesting provisions for protecting any vulnerable groups that may be affected by tariff and institutional reforms Within the ESSD Network, the net commitments for Agricultural sector declined marginally by about one percent to $9.1 billion in FY04. The relative share of Agriculture portfolio increased marginally from 9% of total in FY99 to 10 percent of total in FY04. Within Agriculture, renewed efforts have yielded results for the irrigation and drainage subsector portfolio which increased by about 10 percent in FY04. However the impact has been less on the Agricultural Research and Extension (ARE) portfolio for which total net commitments declined by 5 percent in FY04. The ARE portfolio has reduced by half in last five years in terms of both numbers of project and total net commitments. There has been some success in addressing institutional and financial sustainability issues for ARE operations in Middle Income Countries such as China, where an Agricultural Technology Project has recently been approved, but fewer similar successes in lower income countries. As ARE operations can have substantial impact on reducing poverty by improving productivity of agriculture, greater support for ARE operations is needed. This may involve greater use of modern mass communication techniques and community organizations to increase effectiveness and reduce information dissemination costs In terms of themes, the portfolio composition continued a steady shift towards social protection, social development and human development orientation combined with a sharper focus on public sector management and governance over the FY99-FY04 period (Table 2.3). At the same time the share of the portfolio in Finance and PSD showed the largest relative decrease (from 24% to 17%). The share of Rural portfolio remained fairly stable between FY99 and FY04, at about 14 percent of the total net commitments. TABLE 2.3: FY04 PORTFOLIO BY SECTOR OF FOCUS AND THEME (Commitments, % Share) Sector FY99 FY04 Theme FY99 FY04 Agriculture 9 10 Economic management 3 1 Education 9 9 Environment and natural resources management Energy & mining 16 9 Financial and private sector development Finance 5 6 Human development Health and other social services Public sector governance 7 8 Industry and trade 5 4 Rule of law 1 2 Information and communications 1 1 Rural development Law and justice and public administration Social dev/gender/inclusion 6 9 Transportation Social protection and risk management 5 7 Water, sanitation and flood protection Trade and integration 3 4 Urban development 12 12

20 Annual Report on Portfolio Performance FY04 11 INSTRUMENTS 2.22 Investment lending remains the dominant portion of the portfolio. Specific Investment Loans (SILs) continue to be the most widely used instrument, representing about 71 percent of net commitments. Two other investment instruments now account for a significant proportion of the portfolio. Adaptable Program Loans (APL) have grown rapidly from 2 percent of the portfolio in FY99 to over 9 percent of portfolio today, and the Emergency Recovery Loan (ERL) is also growing steadily to about 5 percent of the portfolio in FY04. APL and Learning and Innovation Loans (LILs) are relatively recent innovations. LILs particularly appear not to have been very successful and their use has fallen steeply during the last three years from 17 operations approved in FY02 to only 4 operations in FY04. Clients have not found the processing of LILs notably simpler while others prefer to use bilateral grant funds for pilot scale testing of new approaches rather than loans (Table 2.4). TABLE 2.4: FY04 PORTFOLIO BY LENDING INSTRUMENT No. $B No. $B Investment FY03 FY04 FY03 FY04 Adjustment FY03 FY04 FY03 FY04 SIL Specific Investment Loan SAD Sector Adjustment APL Adaptable Program Loan SAL Structural Adjustment Lending TAL Technical Assistance Loan PSL Programatic Structural Adj Loan LIL Learning and Innovation Loan PRC Poverty Reduction Support Credit SIM Sectoral Investment and Maintenance SSL Special Structural Adjustment Lending ERL Emergency Recovery Loan FIL Financial Intermediary Loan ,460 1, TOTAL INVESTMENT + ADJUSTMENT 1,519 1, In contrast, the use of the APL has grown considerably from $1.8 billion in commitments in FY99 to $8.1 billion in FY04. While there are some issues with the use of APLs as progression from first APL to subsequent phases has proved more difficult than anticipated, the continued growth in the use of this instruments suggests that APLs continue to be attractive. To evaluate and utilize early lessons of experience in the use of these instruments, OPCS is preparing a review of APLs and LILs which is expected to be presented to CODE in March Adjustment lending accounted for 30 percent of new IDA/IBRD approvals in FY04. As shown earlier in Figure 2.2 (B), adjustment operations vary substantially from year to year depending on special short-term financial needs; in years of financial crisis such as FY99 and FY02, they formed about half of the total IBRD and IDA annual approvals. The fast disbursing nature of adjustment lending is specially attractive to Borrowers to meet short-term cash flow needs in a financial crisis and it has held up better than investment lending A new approach to lending, Programmatic Lending, that employs both investment and adjustment instruments, has emerged in recent years. It involves a series of operations to support a sequenced set of strategic goals agreed with the Borrower. Among the instruments labeled programmatic are investment lending products such as the APL, and adjustment loans including Poverty Reduction Support Credit (PRSC). While the overall scale of