47718 Lessons from World Bank Group Responses to Past Financial Crises 6 Lessons from World Bank Group Responses to Past Financial Crises Evaluation Brief 6 December 2008 The World Bank http://www.worldbank.org/ieg Washington,DC ©2009 Independent Evaluation Group Knowledge & Evaluation Capacity Development The World Bank 1818 H Street, NW Washington, DC 20433 USA E-mail: ieg@worldbank.org Telephone: 202-458-4487 Fax: 202-522-3125 http://www.worldbank.org/ieg All rights reserved This Evaluation Brief is a product of the staff of the Independent Evaluation Group (IEG) of the World Bank. The findings, in- terpretations, and conclusions expressed here do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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Contents v Preface vii Acknowledgments ix Summary 1 Chapter 1 Context 5 Chapter 2 World Bank Responses to Crises: Findings and Lessons 13 Chapter 3 IFC Responses to Crises: Findings and Lessons 19 Chapter 4 Lessons from MIGA Activity during Crises 21 Chapter 5 Conclusion Preface The current financial crisis differs from past From evaluations as well as other findings, crises in many respects--its roots in the financial several factors emerge as vital in today's crisis: systems of developed countries, its global reach, and its effects on both middle- and low-income · Speed and quality. Both the speed of the re- countries. Despite these differences, some of the sponse and the quality of the intervention are lessons from past World Bank Group (WBG) crucial. There are examples of quick WBG re- responses to crises have relevance today. Those sponse that can be built on. Quality encom- lessons are the subject of this paper. passes a content dimension--for instance, the value of focusing on public expenditure issues A review of the experience finds that programs or integrating social safety programs from the that focused on areas of World Bank strength-- early stages of any effort. whether public finance, social safety nets, trade, · Preparedness and early warning. The value or infrastructure--were much more successful of preparedness is likely to emerge as even than those that tried to cover a broad range of higher during the current crisis relative to past topics. Customizing policy advice to a country episodes. A more effective mechanism than was as important as assuring technical quality. It currently exists seems to be needed for early also finds that poverty in financial crisis did not warning of crises; the WBG could work with the get sufficient attention, and that it pays to factor it International Monetary Fund on its design and in from the beginning rather than later. implementation. · WBG resources. To achieve an adequate and Collaboration across sectors and among the WBG high-quality response may well require reliev- and partners has proven crucial, not only to ing constraints on budget allocations and maximize synergies but also to avoid unproduc- staffing skills, as well as broader constraints, in- tive tensions. Preparedness, timeliness, appropri- cluding through a greater leveraging of WBG ateness of instruments, and continuity of efforts with partners. follow-on operations have been determinants of · Monitoring, evaluation, and reporting. With effectiveness. These aspects can be strengthened the premium on speed, results frameworks that through organizational arrangements. link objectives, program costs, and benefits take v E V A L U AT I O N B R I E F 6 on added, not lessened, value. The focus on · Environment and climate change. Climate results is even more important when resources change and environmental problems need to are scarce. be factored into any crisis response much more · Fiduciary concerns. Financial and risk man- centrally than before. The WBG must build on agement as well as environmental and social the recent momentum in mobilizing funds to safeguards will continue to be vital to ensure address climate change and to foster greener that scarce resources reach intended benefi- development activities. ciaries and that negative consequences are avoided. · Poverty and social safety nets. During past These are enormously difficult times. It is critical financial crises, poverty issues did not get suf- that the actions of countries and the interna- ficient attention. It is crucial to factor in the im- tional community match the challenges not only plications for social safety nets from the in speed and scale but also in quality and impact. beginning of the crisis rather than later. Vinod Thomas Director-General, Evaluation vi Acknowledgments This paper is based on a detailed background ducted under the overall supervision and paper reviewing past World Bank responses to guidance of Vinod Thomas. crises prepared by Manuel Peñalver-Quesada and other background work by Jim Hanson, as Additional comments, inputs, and suggestions well as on substantive contributions from at various junctures in the preparation of the several other IEG staff and consultants. Cheryl paper were provided by Amitava Banerjee, Arup Gray, Jaime Jaramillo-Vallejo, Ali Khadr, and Banerji, Shahrokh Fardoust, Monika Huppi, Stoyan Tenev were responsible for shaping and William Hurlbut, Anjali Kumar, James Sackey, finalizing the draft based on the various inputs. Mark Sundberg, and Stephan Wegner, as well as Other contributors include (in alphabetical by the managements of the World Bank, IFC, order) Sidney Edelmann, Aurora Medina Siy, and MIGA. Heather Dittbrenner edited the final Sona Panajyan, Carolina Rojas-Hayes, Cherian document, and Corky de Asis and Geri Wise Samuel, Marvin Taylor-Dormond, Christine provided administrative support. Wallich, and Izlem Yenice. The work was con- vii Summary The ongoing financial crisis in the United States sis support was much more successful when it and other developed countries is spreading to was nested in a results framework (explicit or the developing world, middle- and low-income implicit) that incorporated post-crisis recovery, countries alike, threatening years of progress in had selective coverage, and focused on the poverty reduction. The World Bank Group is Bank's comparative strengths, for example, fis- uniquely positioned to help clients confront the cal and public expenditure policies. It is vital to crisis and mitigate its adverse effects. The institu- attend to poverty dimensions from the outset tion is planning a vast scale-up in support in the of a crisis, and not only in later stages. Cus- present crisis. tomizing policy advice to the country context is as important as assuring its technical quality. Experiences with past crises bring out substantial · Financing modalities and organizational differences in the effectiveness and results of arrangements. Programmatic Development Bank Group crisis support. With important Policy Loans (not available in previous crises) can modifications to reflect contextual differences usefully address crisis needs. Additional instru- between present and past events, these lessons ments may also be needed for initial liquidity can inform today's response and help improve support as part of multipartner packages. In- results. One such contextual change is the ternal organizational arrangements can make a increased urgency of simultaneous actions to deal big difference, as they affect the degree of pre- with the environment and climate change. paredness, cross-sectoral coordination, timeli- ness of response, and appropriateness of instruments--all factors in getting results. World Bank · Coordination with partners. Coordination Prior crises led to large temporary increases in among key partners is critical, as differences of Bank lending, often underpinned by ambitious view surface quickly during crises and are po- programs of policy reform. Experience, for tentially damaging to results. Collaboration example, during the events of the 1990s, points across the Bank Group (Bank, International Fi- to three broad areas requiring close attention: nance Corporation [IFC], and the Multilateral Investment Guarantee Agency [MIGA]) also · Quality, focus, and selectivity. The speed and strengthens program effectiveness, although quality of Bank response are both crucial for evaluations found little evidence of joint efforts good outcomes during and after crises. Past cri- during past crises. ix E V A L U AT I O N B R I E F 6 IFC sumptions (for example, on the availability of While the flow of new IFC investments tended to complementary sources of finance). fall sharply in the immediate wake of past crises, these events helped transform IFC's business MIGA model toward a broader range of investment and Evaluation work suggests that transparent, advisory services and increased field presence. competitive tendering of infrastructure, built-in Evaluations suggest the need for close attention flexibility for mutually agreed contract modifica- to the following areas: tion, and good fit with Bank country strategies and sector policies enhanced resilience of MIGA- · Nature and timing of IFC investments. Devel- supported projects during crises. Twenty-five opment success rates in projects approved post- percent of the total volume of MIGA guarantees crisis were on average 25­30 percent higher issued between 1995 and 2002 was in crisis- than in those approved pre-crisis. IFC's addi- affected countries--Argentina, Brazil, Pakistan, tionality is stronger following a crisis and is as- Indonesia, Ecuador, the Russian Federation, and sociated with better development results. Key Turkey--directed mostly to the financial sector IFC interventions--investment in flagship com- and infrastructure. panies, visible restructurings of major industrial clients, or large syndications of commercial bank MIGA's risk-mitigation capacity was tested by loans, for instance--that capitalize on its repu- these crises, during which two of the three claims tation as an investor and honest broker can in MIGA's entire history were paid. Political risk-- have a strong signaling effect that helps restore mitigation of which is MIGA's mandate--is often market confidence, particularly if announced heightened during crises, and infrastructure at the peak of market uncertainty. Conversely, fail- projects that are inadequately structured or ure to deal decisively and expeditiously with its awarded in a nontransparent manner were partic- own problem projects can undermine IFC's ef- ularly vulnerable to political risk events. fectiveness in responding to crisis. · Opportunities and constraints for bigger im- ***** pact. Crises can present opportunities to reach new clients and to be rewarded for risk taking. The present financial crisis is in many respects However, opportunities are often missed be- unprecedented, and the global economic cause staff attention was diverted and because contraction that it has triggered is leading to a of efforts to restructure existing projects, which rapid rise in unemployment and swelling the undermines IFC's ability to function as a coun- ranks of the poor. Bank Group provision of crisis tercyclical financier. Separating work-out and support to low- and middle-income countries new-business teams may help, in addition to (MICs), particularly in concert with other facilitating collaboration among Bank and In- development partners, can help confront the ternational Monetary Fund (IMF) teams. The severity of the economic slowdown and its social quality of a country's bankruptcy regime and impact. At the same time, given the limited its enforcement is a key driver of how effective availability of resources and their leveraging IFC's response is to restructuring needs dur- role--as well as the downside from their ing crises. potential misuse--every effort must be made to · IFC's internal practices. Speed of response is maximize the development effectiveness of the critical: IFC's effectiveness was better when it Bank Group's crisis support. Every crisis is acted quickly to adapt its strategies, programs, unique, and evaluative lessons from past crisis and exposure to deteriorating economic con- responses cannot yield precise guidance for ditions. Furthermore, projects approved or delivering effective crisis support today. They restructured in crises were more likely to be can, however, point to crucial factors that may successful when they were conscientiously make a difference to the effectiveness of today's documented and embodied conservative as- response. x CHAPTER 1 Context A worldwide financial crisis of enormous some banks and governments have used futures magnitude continues to unfold rapidly. Unlike contracts. Initially, the hardest hit countries have other crises in recent decades, the current been those that were more open to external episode is rooted in industrial countries' inflows, export-oriented, characterized by weak financial systems and is affecting low-income financial sectors and/or excessively dependent countries and MICs alike. Defaults on securitized on external finance. But eventually the crisis will sub-prime mortgages as a real estate market hurt all countries and challenge their macroeco- bubble burst led to failures or near-failures of nomic policy and financial sectors. several large financial institutions and a collapse of inter-bank and commercial paper markets. A These adverse effects on developing countries-- tightening of credit, combined with declining on top of the spike in food and energy prices consumer confidence, has brought on earlier in the year--threaten to reverse the worldwide recession with growing unemploy- substantial gains in poverty reduction of the last ment, and many fear that the downturn will be few years. Experience suggests that whether severe and protracted. At the same time, the crises start in the real or the financial sector, they rapidly multiplying signs of contraction are have negative effects as a result of the deteriora- prompting strong responses, including fiscal tion in nutrition, education, health care, and stimulus packages and reductions in benchmark social spending. Moreover, there is a risk that at lending rates, on the part of several of the least some countries will react to the crises with affected developed countries. protectionist policies and/or with policies that stem or even reverse recent progress on the Many developing countries, both IBRD- and IDA- environmental protection and climate change eligible, have already been hit, despite their agenda, leading to a further negative impact on maintenance--as a general but not universal growth over the long term. rule--of improved macroeconomic and trade policy stances and healthier financial sectors The Independent Evaluation Group (IEG) found compared with previous decades. New external that in the decade of 1993­2003 there were financing flows to them, including export credits, crises1 in 17 countries during which they received have declined sharply, and foreign debt and crisis-related support from the Bank, starting with equity funding is being withdrawn from many of Mexico and Argentina in the early 1990s and them. Developing countries' export growth is followed by Jamaica and then Thailand, Indone- already slowing, in turn reducing growth in their sia, and Korea in 1997. (Malaysia also experienced output and income, and the situation promises a smaller crisis but received no support from the to worsen further. Bank.) Crises also broke out in Russia, Brazil, Bulgaria, Bolivia, and Ecuador. In 2000­02, there In general, developing countries' financial were also crises in Argentina, Guatemala, Turkey systems do not feature substantial trading in (which had had prior crises in 1994 and 1999, and derivative instruments of the kind that created Uruguay. Beyond this definition, other countries problems in the industrial countries, although also experienced repeated episodes of sector- 1 E V A L U AT I O N B R I E F 6 specific financial crisis. For example, Mongolia Through the Bank Group's past crisis response had banking crises in 1992, 1994, 1996, and 1998 experience has considerable relevance to its (IEG 2006). response to the present crisis episode and can help inform it, contextual differences between the present and past crises must be factored in. Evaluation Can Help Inform the Crucially, the environmental and climate change World Bank Group's Response to agenda has much greater urgency today than a the Current Crisis decade ago, in part reflecting heightened The Bank Group is well placed to help mitigate concern (and to some extent understanding) of the impact of the current crisis with financing likely irreversibilities and catastrophic shifts in and advisory services, and its clients are already the absence of strong, sustained action. Given requesting increased support. A rapid, high- this change in context, it would be critical that quality response that combines financial and the Bank Group continue to build on the recent advisory support can do much to ease the momentum in this agenda during its response to inevitable ramifications of the crisis. Lessons crisis, as it has shown recent signs of doing. from evaluations of previous Bank Group responses to past crises can help inform the In turn, this may entail an imperative to look for response to the current crisis in order to increase ways for the Bank to link its crisis funding its effectiveness. support to concrete efforts to foster greener development activities, for example, through IBRD is gearing up to increase lending to $35 renewable energy development, with IFC and billion in FY09 (compared with some $13.5 MIGA providing complementary support to the billion in FY08), of which at least $15 billion private sector. In a similar vein, the greater reach could be crisis related. By front-loading IDA of disruption that characterizes the present crisis commitments, funding volumes for low-income compared with more regional or individual- countries could similarly increase substantially. country crises in the past may affect IFC's With such large increases being contemplated, capacity to fund its operations and to mobilize the challenge will be to ensure quality and private financing from developed economies, development effectiveness of the additional because the vulnerable positions of major IBRD and IDA funding, as well as its complemen- international financial institutions in developed tarity with the support provided by other and emerging markets may prevent them from partners, particularly the IMF. Speed of response fulfilling their roles as co-financiers. IFC may is also of the essence, of course. therefore need to focus on smaller projects and work more closely with other development IFC's likely response to the current crisis partners. encompasses a range of measures covering financial and real sectors and including invest- ments as well as advisory services. IFC is planning Note to provide advisory services to financial institu- 1. IEG evaluations have noted that there is no agreed tions to strengthen their capability to withstand definition of what constitutes a crisis. See IEG crisis conditions and to strengthen their financial Review of World Bank Assistance to Financial position. The planned response also includes Sector Reform (henceforth IEG 2006) and Develop- programs to provide short-term finance (includ- ment Results in Middle-Income Countries: An ing trade finance) to the real sector. IFC will Evaluation of the World Bank's Support (herein- provide capital to vulnerable banking systems after IEG 2007). IEG 2007 referred to crises as through a Recapitalization Fund, which would "abrupt and disruptive events--involving acute include contributions from IFC and other donors problems in the exchange rate, the banking system, or the external debt--[that] carried considerable and would recapitalize distressed banks, which costs in terms of economic recession and a worsen- may have a systemic impact. 2 L E S S O N S F R O M W O R L D B A N K G R O U P R E S P O N S E S T O PA S T F I N A N C I A L C R I S E S ing of poverty conditions." IEG 2006 identified traits large devaluation. The combination of events of typical crisis situations where there was "... both created problems for the corporate sector, which a banking crisis and a macroeconomic crisis, either could no longer service its loans, creating further simultaneously or in quick succession. The run on pressure on the banks and affecting outputs banks resulted in illiquidity and required govern- and investments; growth dropped and poverty ment action, and the macroeconomic crisis led to a increased." 3 CHAPTER 2 World Bank Responses to Crises: Findings and Lessons Patterns in Past World Bank the 1998 Argentina package of $3 billion (a $2.5 Crisis Responses billion Special Structural Adjustment Loan plus a Two major IEG evaluation reports (IEG 2006 and $500 million guarantee).3 Crisis lending to Turkey 2007) summarized lessons from previous crises. was more than $2.5 billion; Thailand and Indone- In addition, IEG conducted evaluations from sia received more than $2 billion each. In the individual country episodes, particularly for case of Russia, the actual amount of Bank lending countries affected by the East Asia crises of related to the crisis is more difficult to calculate: 1997­99 (Indonesia, Thailand) and other the Bank pledged $6 billion as part of the interna- countries in Eastern Europe (Russia and Turkey) tional rescue package but disbursed a much and Latin America (Brazil, Mexico, Argentina, and smaller amount, and there were large restructur- Colombia). This section distills lessons from past ings and cancellations of existing loans; as a crisis-related interventions on the Bank's part, result, the total amount outstanding only drawing largely on already completed IEG increased by $500 million during the 1998­2000 evaluations. period (from $6.3 to $6.8 billion). In aggregate terms, the extraordinary level of Increased Lending financial support provided by the Bank during The Bank's response to past crises included a the years of the "East Asia­plus" crisis can be large but temporary increase in lending, much of seen from the trends in adjustment lending it fast-disbursing, supporting a broad range of before, during, and after the crisis. From FY95 to reforms. In the 1980s, lending to address the FY97, total adjustment lending remained at an economic difficulties of several countries was average of about $5 billion per year. Adjustment already high: Turkey, for example received five lending more than doubled in FY98 (to $11 adjustment loans during the 1980s and total billion) and increased by a further 50 percent in lending volume exceeded a billion dollars a year FY99 (to $15 billion).4 By FY00, adjustment from 1986 to 1989, helping create a substantial lending returned to the pre-crisis level of about increase in economic growth (although newly $5 billion. emerging internal imbalances led to a new crisis episode in 1994).2 During the 1990s, the level of The large lending levels of the 1998­2000 period Bank assistance to crisis countries increased led to a big spike in total Bank commitments and substantially in absolute terms, but was modest disbursements (and, in turn, created short-term as a share of the total size of the rescue packages financial difficulties because of the high levels of and fell back to its previous levels soon loan loss provisions that they required in the thereafter. During the period 1993­2003, the Bank's balance sheet) before returning to a Bank provided about $21 billion in financial declining long-term trend. In relative terms, assistance to crisis countries (IEG 2006, page 40). however, the Bank contribution was in some cases modest relative to the total size of the The largest amount for a single country was for rescue packages. In the case of Korea, the size of Korea, with $7 billion, and the second largest was the total package was $58 billion. Of this, the 5 E V A L U AT I O N B R I E F 6 Bank pledged $10 billion, or about 17 percent included poor cooperation between the Bank (total disbursements were lower, for the total and the IMF (and with regional banks), as well as package and the Bank's component).5 In among several units within the Bank. Thailand, the August 1997 rescue package amounted to $17 billion, with the Bank pledging slightly over 10 percent, although it eventually Poverty Alleviation contributed a somewhat larger share. Crises pose a major threat to the more vulnerable segments of society, because of the recession and rising unemployment that usually accompany a Policy Dialogue crisis, as well as because of the curtailment of The increased lending to crisis countries was governmental social programs as a result of the accompanied by broad-ranging policy dialogue fiscal adjustment that often is required in the and conditionality in the adjustment loans. There aftermath of a crisis. IEG 2007 (on support to were multisector operations as well as loans MICs) noted that "deficiencies in crisis prepared- focusing on the financial sector, on macroeco- ness were particularly evident in the area of nomic adjustment, fiscal reform, corporate poverty." One qualification, however, is that crisis- distress and restructuring, social security, and related support from the Bank in other cases that poverty alleviation. Many operations had a signif- post-date the crisis episodes covered in this icant number of conditions, especially when they paper--typically instances where the crisis was were multisector. While the policy reforms confined to the recipient country or few sought were needed, and several countries countries--has not been systematically evaluated introduced them successfully, evaluations in terms of the effectiveness of how poverty indicate that some others were not prepared to concerns were handled. take some of the reform measures. In a few cases, the proposed reforms did not take country Evaluations of the experience in Brazil, Russia, conditions fully into account or may have been and Thailand show that in none of the three outright counterproductive. cases did the Bank have contingency plans that would have allowed the rapid launching of programs to strengthen the social safety net. In Effectiveness of Crisis Support Russia, where the impact on poverty was the World Bank loans were generally successful in most dramatic, the Bank's previous work on supporting financial and some public sector social protection had been mainly focused on reforms, but the poverty focus was insufficient. pension reform and the labor market conse- There were attempts to protect pro-poor quences of the restructuring of state enterprises, spending and reduce the poverty impact of the but the Bank was unable to interest the govern- crises (Brazil and Thailand), but overall attention ment in setting up formal protection mech- to this area was insufficient. There were also anisms that could serve as a safety net. In the disagreements with the IMF on exchange rate other two countries, the Bank's experience was policy (Mexico and Russia), on the scale of better. In Thailand, albeit with a year's delay, the macroeconomic adjustment (Indonesia and Bank responded to the authorities' concerns and Thailand), and on what balance to strike between approved a Social Investment Loan that short-term crisis management imperatives and effectively supported the poverty alleviation measures to alleviate corporate distress programs that had been set up by the govern- (Thailand). Evaluations also found that the loans ment or by local private and voluntary organiza- were excessively ambitious in the range of tions. In Brazil, the Bank emphasized social problems they tried to tackle and in the large protection and moved rapidly in the aftermath of number of conditions they included. In addition, the crisis with a budget support loan that specif- there were problems in several aspects of the ically protected 22 relevant programs from the Bank's institutional response to crises. These budget cuts that the government was making. 6 L E S S O N S F R O M W O R L D B A N K G R O U P R E S P O N S E S T O PA S T F I N A N C I A L C R I S E S Both initiatives proved fairly successful and were reform was particularly important in Latin rated as satisfactory. America and Africa. In the current scenario, trade policy is a major source of concern in the industri- In sum, given the centrality of poverty alleviation alized countries, but a slowdown in international in the Bank's work and the adverse conse- trade (and in trade financing) may generate a quences that crises have in this regard, a major return to increased protectionism and may point of focus in its crisis interventions should require attention by the Bank. be to facilitate the protection of vulnerable sectors and/or groups from adverse crisis-related impacts. Advance work could be done in Fiscal and Public Sector Reform countries at risk to define and prepare contin- Fiscal and public sector reform is one of the areas gent social protection measures--support for where the Bank has had the longest experience unemployed heads of households, food pro- in supporting countries experiencing crisis grams, and school subsidies, for instance--to be situations. This includes a long list of adjustment deployed at a time of need. operations in all regions since the early 1980s. In Turkey, where the three crises between 1994 and 2001 originated from substantial fiscal im- Macroeconomic Policy and Stabilization balances, the Bank supported fiscal reforms in This critical aspect of the policy response to the three occasions, unsuccessfully the first time crises will continue to be relevant in the present and more successfully in the two subsequent episode. In spite of a long tradition of Bank crises. Assistance for fiscal and public sector support for stabilization efforts under the aegis reforms was an important part of Bank lending of an IMF program or with that institution's in several crisis countries in the late 1990s. In comfort, and the frequent use of adjustment Brazil two of the five crisis loans were focused lending for this purpose since the early 1980s, on fiscal reforms (the other three focused on some experiences in the late 1990s show mixed social security and social protection). In Thailand results and the need for better cooperation with one loan was a Public Sector Reform Loan, the IMF. Support for stabilization was mainly the and several other operations included public responsibility of the IMF, and the Bank played a sector reform objectives. In Colombia fiscal limited role in this area. Nevertheless, disagree- adjustment operations followed interventions in ments emerged between the two organizations, the financial sector. for example, on the exchange rate policy in Mexico and Russia6 and on overall macroeco- The Bank's experience and the willingness of nomic adjustment in Indonesia and Thailand.7 governments to make some unpopular decisions Although many countries have improved their during crises have accounted for many successful macroeconomic performance during the last Bank interventions, at least in the initial phases. decade, as global credit tightens and interna- Also, the reforms needed at the early stages lend tional trade slows down, support for and discus- themselves easily to support through quick- sions about the adequacy of macroeconomic disbursing operations. Later stages of the reforms policies will regain importance. require more complex institutional actions (for example, civil service reforms) and thus are more challenging. Some unsuccessful cases (such as Trade Policy Russia's 1998 crisis) suggest that the need for Trade policy reforms were an important element urgent liquidity support may have led the Bank to in earlier crises episodes but were much less participate in support packages under fiscal important during the crises of the late 1990s, as conditions that were unsustainable. considerable improvements had taken place in trade liberalization worldwide, particularly in the In sum, experience suggests that Bank support East Asia countries. Previous support for trade for fiscal and public reforms does better when 7 E V A L U AT I O N B R I E F 6 there is a focus on structural issues related to the limited because it was delivered too late quality of public expenditures--including the (Colombia); better preparation and more timely targeting of pro-poor spending and the efficiency inputs could have contributed to faster reforms of the revenue system--and extends beyond the and lower crisis costs. Overall, the broad scope initial response to the crisis; objectives in the and ambitious objectives of many financial early stages should be modest. sector Bank loans and potential conflict with the specific circumstances and needs of multidonor rescue packages also raise questions related to Financial Sector loan design and adequacy of instruments. Underlying weaknesses in the countries' finan- cial sectors were the initial cause of some of the IEG also evaluated the Financial Sector Assess- earlier crises. In other cases they were a con- ment Program (FSAP) in late 2005;8 at that time sequence of the crisis (because of the economic more than 109 country assessments and 18 slowdown and corporate distress) and/or were updates had been completed or were ongoing. exposed after an external shock created addi- The FSAP consists of diagnostic studies to facili- tional financial stress. Under both sets of circum- tate early detection of financial sector vulnerabil- stances, financial sector stress, failures of bank ities and identification of financial sector and nonbank-financial institutions, and the need development needs. The evaluation found that for regulatory reforms and financial sector the FSAP is a good quality diagnostic mechanism restructuring were features of most crises. and that the overall concept for the program was sound, facilitated Bank-IMF collaboration, and The major finding of the IEG evaluations of 37 allowed for an integrated approach toward operations in 14 countries was that the Bank's financial sector vulnerabilities and development support achieved its objectives in many cases, needs while expanding the depth and quality of but the success rates of the loans including analytical expertise. IEG's findings on FSAPs support for financial reforms during crises were were recently confirmed through a self-assess- lower than for similar financial sector reforms in ment by the Financial and Private Sector noncrisis situations. The Bank paid insufficient Development (FPD) Sector Board. attention to financial sector issues in several countries in the years prior to the crises (Mexico, The IEG evaluation found some weaknesses Thailand, and Korea) or had underestimated the and limitations in the FSAP, including country warning signals and been excessively optimistic selection (the voluntary nature of the program in others (Indonesia and Turkey). limits its overall effectiveness in identifying systemic risks), poor prioritization of the many The financial sector reforms supported under recommendations (which limited the impact of many of the crises loans were extensive and the overall program), and uneven coverage of similar in nature and scope to those of loans specific sectors (better for the banking sector supporting "noncrisis" reforms; yet the opera- than for nonbank financial sectors). Overall, tions were designed quickly and often based on however, the experience with the FSAP should the promise of reforms that in some cases did facilitate the response to the financial sector not take place (for example, Indonesia). Some aspects of the current and future crises. In sum, of the specific reforms supported were, in the quality of assistance to financial sector retrospect, considered counterproductive (for reforms would have benefited from greater example, the closing of most finance companies attention to country-specific issues and from in Thailand). And even when satisfactory greater realism in conditionality; increased financial sector reforms were implemented by coordination with the IMF (mainly through the the government, the Bank's contribution was FSAP program) since then will undoubtedly 8 L E S S O N S F R O M W O R L D B A N K G R O U P R E S P O N S E S T O PA S T F I N A N C I A L C R I S E S have helped. Financial sector reform is now embedded in a medium-term results frame- recognized as more of a process and less of a work, and to focus on the Bank's comparative single cluster of reforms, and so may benefit strengths. Because crises touch a wide range of from multiple follow-up loans after initial areas, the instinctive reaction may be to seek to support with low conditionality. address a broad set of issues and reflect this in wide-ranging conditionality under crisis loans. Past crisis lending often featured a broad range Corporate Distress and Regulatory Reform of conditionality. But a more selective approach Support for regulatory and institutional reform, was generally more successful, notably in loans including enterprise restructuring, was a major directed at the financial sector. Programs with a thrust of Bank assistance to the transition well-defined results framework and selective economies (including Russia) following the conditionality tended to be more successful collapse of the Soviet Union in 1991 and the than those with front-loaded conditionality.10 protracted crises that these economies experi- Crisis lending was also less successful when it enced throughout the 1990s. Results of Bank involved areas outside of the Bank's compara- assistance in this area were mixed. During the tive strength: for example, loans emphasizing East Asia crisis, the issues of corporate distress macroeconomic conditions were less successful and restructuring and their interaction with than those focused on public expenditures. short-term crisis management became most important in the case of Thailand. Equally, it is important for the Bank to maintain focus on growth and poverty from the outset of a Arguably, some of the initial macroeconomic crisis. As noted earlier, previous Bank attention to (and financial sector) reforms supported by the poverty and social impact showed good results in IMF and the Bank exacerbated the level of Brazil and Thailand. But these central aspects of corporate distress (unnecessarily so in a context the Bank's mission received insufficient attention where the fiscal situation was not a major issue). in other cases, where Bank support was sprinkled More importantly, attention to corporate across too many areas. Criticisms of the Bank's restructuring issues took too long to emerge, crisis lending had already centered on its insuffi- and the lack of adequate knowledge of the cient emphasis on growth and poverty issues in country's legal framework led to inadequate earlier episodes (adjustment lending in the advice.9 The major lessons are the need for 1980s). The Bank could play a stronger role than adequate country knowledge, for early attention in the past in addressing growth and poverty to corporate distress, and for awareness of the reduction, its areas of comparative advantage, tensions between short-term crisis management within a multipartner crisis package. measures and medium-term regulatory and structural reforms that can mitigate the impact The customization of policy advice to the specific on the corporate sector, and thus on output and country context at hand is as important as its employment. technical quality. Effective policy advice requires depth of both country and technical knowledge, and a blend of the two. Solutions tailored to Areas of Attention for the Bank's country circumstances were generally more Current Crisis Response successful than generic advice, even where the latter was state of the art. Some of the advice on Selectivity and Areas of Focus financial sector and corporate restructuring The evaluation findings suggest that it is prefer- issues in Thailand was ineffective (or even able for crisis support from the Bank to have a counterproductive) because it was not suffi- selective rather than broad focus, to be ciently grounded in country knowledge. 9 E V A L U AT I O N B R I E F 6 Financing Modalities and Organizational times of crisis, when differences of opinion Arrangements surface more easily on macro issues (as they did New instruments, notably programmatic in the late 1990s) and there are tensions development policy loans, may help address between those, structural reforms, and poverty some crisis needs, particularly in the post-crisis alleviation efforts (as it happened in the recovery. Others, such as the Deferred- Thailand case mentioned above). Furthermore, Drawdown Options, could be used as precau- the European Union now has a major stake in tionary tools, but not in crisis situations. Thus, some of the countries, as shown by the recent appropriate instruments for initial liquidity Hungary package (with the European Union assistance as part of the rescue packages, and the providing more than 30 percent). This suggests role of the Bank in these packages, still need a need to cultivate incentives for the Bank to attention, particularly as the financial share of the foster cooperation and establish effective lines Bank in the packages may be even smaller than of communication with partners. Evaluations in previous episodes (for instance, about 5 also suggest that collaboration within the Bank percent of the package for Hungary). Group (among the Bank, IFC, and MIGA) enhances program effectiveness. The Bank's internal organizational arrangements in crisis response situations need attention to ensure preparedness and timeliness of response. Notes Crises put high demands on, and require close 2. The World Bank in Turkey, 1993­2004: An IEG coordination among, many parts of the Bank. Country Assistance Evaluation, IEG 2006 Organizational arrangements that preserve agility, (Chapter 2). draw on a broad range of resources, and maintain 3. In relative terms this was the largest Bank contribu- clear accountability lines are essential. The Bank's tion (36 percent of the total support package), as response to the Asian crisis during 1997­2000 the entire financial support package was $8.3 provides lessons: Regional management was billion. The effort failed to prevent the crisis, which overwhelmed by client country demands and peaked in 2001. 4. Adjustment Lending Retrospective, OPCS, 2001 could not mobilize sufficient skilled staff. The (page 2). The so-called adjustment "jumbos" Special Financial Operations unit established at amounted to $5.3 billion in FY98 and $6 billion in that time provided additional expertise, but only FY99. on financial (and to some extent corporate) 5. The largest rescue package before the one for Korea sector issues. It did not cover other areas, includ- in 1997 had been the 1995 Mexico package, which ing those central to the Bank's mandate (growth, also exceeded $50 billion. Funding for the Mexico poverty impact). Also, the unit had limited package came mainly from the U.S. Treasury and country knowledge and was not accountable to the IMF. The Bank participated later with a $1 billion the regions. Bank response to the current crisis financial sector loan; implementation was poor. could benefit from an arrangement whereby the 6. The Russia Project Performance Audit Report regions can have easy access to the technical (PPAR) (February 2003) rated the outcomes of SAL I expertise in the Bank's areas of comparative and SAL II unsatisfactory and noted, "The Bank's desire to gain a seat at the policy-making table strength, while maintaining their accountability. would have been more efficiently served by helping the IMF review the structural components of its EFF" (page 26). Coordination among Relevant Development 7. Indonesia PPAR (November 2003) and Thailand Partners PPAR (January 2006). The latter notes, "The action A coordinated approach among key partners is taken in Thailand indicated clearly that the IMF and crucial for effective interventions. The FSAP Bank did not agree up front on some of the most program has improved coordination with the basic principles and advice" and "the way in which IMF on financial sector issues. However, a crises are managed can compromise essential broader, more intensive effort is called for in structural reforms" (page 28). 10 L E S S O N S F R O M W O R L D B A N K G R O U P R E S P O N S E S T O PA S T F I N A N C I A L C R I S E S 8. Financial Sector Assessment Program: IEG Review 10.This does not, of course, imply causality running of the Joint World Bank and IMF Initiative, IEG from the use of well-designed results frameworks to 2006. higher success rates for Bank support: instead, it 9. The Thailand PPAR notes, "The failure to factor into may simply mean that results frameworks are more the design of the reforms the inadequacies of the likely to be drawn up and underpin Bank support in Thai legal and regulatory infrastructure led to countries that maintain stronger fiscal policy approaches that may have increased the cost of stances and better governance. cleanup." 11 CHAPTER 3 IFC Responses to Crises: Findings and Lessons Patterns in Past IFC Crisis Responses inadequate. The case of trade finance illustrates Over the past 15 years, IFC has invested nearly $5 the point. From fiscal 1998 to 2003, IFC commit- billion in 27 of the more than 30 developing ted 21 trade finance facilities for a total of $542 countries that experienced financial crises. million. Of the 21 facilities, 11 were never used, These investments supported portfolio com- and of the 10 that were used, the average utiliza- panies, provided liquidity and equity capital for tion rate was just 27 percent. Motivated initially de-leveraging, modeled corporate and financial by the need to respond to crises, over time IFC restructuring, helped in the resolution of built up the capacity to provide these services nonperforming assets, and aided the re-privati- and can no longer be viewed as a traditional zation of nationalized financial institutions. On project financier. Corporate finance now domi- average, IFC's investments in a crisis-affected nates IFC's business. Within a short period of country declined by 40 percent in the year of the time, the Global Trade Finance Program has crisis relative to the year before and returned to become a significant part of IFC's business. precrisis levels within three years. However, Concerning local currency financing, some there were significant deviations from the capabilities have been developed, but IFC's average: IFC investments rose sharply in Korea; capacity in this area is still inadequate relative to stayed roughly constant in Brazil, Russia, and private sector demand. IFC has also significantly Turkey; and fell in Argentina, Indonesia, Pakistan, increased its field presence. and Thailand. IFC's crisis interventions were small relative to the coordinated loan packages Crises also expanded demand for IFC's advisory of the IMF, World Bank, and other donors. services--for instance, to improve corporate transparency by enhancing reporting according Past crises helped transform IFC's business to international accounting standards, promote model, and IFC now has a broader range of better corporate governance practices, enhance investment and advisory services and is better risk management practices in financial institu- equipped to respond to private sector needs in tions, help build financial infrastructure includ- times of crises. Only a decade ago, IFC was a ing credit rating agencies and credit bureaus, and project financier working out of Washington and enhance regulatory capacity relating to new providing mostly nonrecourse dollar financing financial instruments and institutions. These for real-sector projects. Services demanded by activities expanded initially in response to struc- the private sector were different in a crisis: tural weaknesses made apparent by crises (par- balance sheet restructuring instead of financing ticularly during the Asian crisis) and have new productive assets, corporate instead of become an important part of IFC's advisory project financing, short-term liquidity and trade services operations. finance instead of medium- and long-term financ- ing, local currency instead of dollar financing. Some of IFC's post-crisis interventions com- bined investment and advisory services. IFC's Given IFC's focus on project financing, its banking investments, for example, were often response to these needs was often slow and accompanied by extensive advisory services 13 E V A L U AT I O N B R I E F 6 programs. Their goal was to help the banks evaluation) was a significant determinant of implement a reengineering and corrective action better development outcomes;13 and (iii) given program; upgrade their practices, systems, and that IFC's additionality, particularly financial technologies to international standards; and additionality, is stronger following a crisis, the improve their internal audit function and finding supports the thesis that higher IFC management information systems utilization.11 additionality is associated with better develop- ment results. Areas of Attention for IFC's Current Evaluations also indicate that visible, timely Crisis Response interventions can have a strong signaling effect. Across the various crisis episodes, the nature of Key interventions, such as visible restructurings crises and the scale and efficacy of IFC's crisis of major industrial clients, first recapitalizations responses have varied significantly. When taking of major banks, and large loan syndications have on board the lessons of the past, one needs to had strong demonstration effects and positive account for the differences in the nature of the impacts on market confidence (Korea, 1997; present crisis relative to past episodes, as well as Russia, 1998; Turkey, 2001). This effect is based for the vast changes that can take place as scenar- primarily on IFC's long-term orientation, track ios unfold. The crucial questions would be how record as a reputable and successful investor in the response can have a strong market effect and emerging markets, and ability to support key development impact while making sound restructurings through honest broker leadership business sense. With this in mind, the review of in steering committees of creditors and IFC's past responses to crisis suggests that close bondholders that can signal turnaround for the attention to three general areas may help entire sector and economy (as in the case of a improve the results of IFC interventions in the major bank in Argentina). proximity of the present crisis: the nature and timing of IFC crisis investments; opportunities The size of the effect depends on the visibility-- and constraints for bigger impact; and IFC's own investments in large key flagship companies of internal practices, notably arrangements for systemic importance for the country such as organizing and conducting its work. As indicated banks, industrials, or infrastructure companies earlier with regard to the Bank, IFC-Bank collab- are likely to send a strong signal. The timing of oration can also help results. the intervention is also important--announce- ment at the peak of market uncertainty can have powerful effects, as in Korea during the Asia crisis, Nature and Timing of IFC Investments in where IFC investment increased dramatically the Proximity of Crisis after a period of low involvement. Another Development results were better for projects example of IFC's catalytic role can be found with approved post-crisis than precrisis. According to respect to Turkey. In addition to restructuring evaluations, IFC achieved higher development major companies, IFC mobilized $100 million of success rates in projects approved post-crisis its own and commercial banks' funds in the wake than those approved pre-crisis--on average a of a major financial crisis, which was an important 25­30 percent difference. This finding reflects signal to the markets during the recovery of the several factors at work: (i) IFC operations financial crisis. However, difficult or badly approved before the crisis were not immune to implemented restructuring of IFC's own problem the sharp deterioration in the investment climate projects has negatively affected its ability to play as a result of the crisis;12 (ii) the better results of a signaling role. Some of the difficult restructur- post-crisis projects are consistent with the ing cases absorbed significant IFC resources, finding that improvement in the business attracted negative publicity, and inhibited IFC's environment (represented by beneficial changes ability to be more effective during the crisis in country credit ratings between approval and (Thailand, 1997). 14 L E S S O N S F R O M W O R L D B A N K G R O U P R E S P O N S E S T O PA S T F I N A N C I A L C R I S E S Although crises may distract attention from Indonesia, IFC anticipated banking consolida- longer-term objectives, they can also give rise to tion and made an early equity investment in a opportunities for expansion in strategic priority second-tier bank. Five years later, a major areas. IFC's priorities include clients in IDA foreign bank acquired majority control, result- countries, micro, small and medium-size enter- ing in a good financial return for IFC. The prises (SMEs), and environmental and social decrease in IFC's investments immediately after sustainability. In several respects, crises have crises reflects--in addition to factors related to largely been MIC phenomena and affected the drying up of new investment opportuni- large, first-tier companies to a greater extent ties--the dedication of staff time to restructur- than others. As a result, crises have tended to ing existing operations. For, example, in increase IFC's focus on MICs and large, first- Argentina, Indonesia, and Thailand, IFC restruc- tier companies in the crisis-affected countries. tured investments and injected liquidity. Compliance with environmental and social However, difficulties in restructuring absorbed standards suffers when companies are in significant resources and negatively affected financial distress. IFC's ability to play a contracyclical role. Establishing separate work-out and new- On the other hand, IFC typically has greater business teams could facilitate both restructur- leverage during crisis episodes as compared with ing of portfolio companies and response to new normal times to ensure adoption of good business opportunities. Separate teams may environmental and social standards when also help avoid perceived conflicts of interest engaging with new companies. Financial inter- and facilitate IFC cooperation with World Bank- mediaries that focus on lending to micro- IMF teams. In addition, the quality of the enterprises or to SMEs generally are only mildly bankruptcy regime and its legal enforcement impacted by a financial crisis. This is mainly can have a major impact on operations after the because their clientele is less affected by crisis crisis. A working bankruptcy regime, by encour- compared to large corporations. Microenter- aging cooperative out-of-court restructuring prises and SMEs generally borrow only small efforts among investors, has helped speed amounts in local currency, do not normally have recovery. Conversely, weak bankruptcy regimes long-term and foreign debts, are more focused have been used by unscrupulous shareholders on selling products and services with relatively to frustrate recovery efforts and maximize high demand in the local market, and can adapt private gains. In restructuring portfolio more easily to changing market conditions. companies, IFC has on occasion tested the bankruptcy regimes of some crises-affected In contrast, many large financial intermediaries countries (Thailand and Indonesia). In doing that lent mainly to large corporations and/or the so, IFC has raised awareness of structural issues crisis-afflicted country government experienced affecting corporate restructuring and has financial distress because their large borrowers helped strengthen investors' rights. became illiquid and/or insolvent as a result of the country being in crisis. Small borrowers are, An important element of IFC's restructuring however, disproportionately affected by tighten- strategy was cooperation with the World Bank to ing of liquidity during crises. Thus business and focus the government's attention on such developmental opportunities exist to expand systemic restructuring issues faced by the private support to micro and SMEs during crises. sector (Indonesia and Thailand, 1997). Unfortu- nately, in the end bankruptcy regimes did not improve much, which limited general investors' Opportunities and Constraints for interest and limited the effectiveness of IFC's Bigger Impact interventions predicated on the existence of Crises can create opportunities to reach new restructuring opportunities (for example, an clients and to be rewarded for risk taking. In equity fund was much smaller than originally 15 E V A L U AT I O N B R I E F 6 expected and ended up invested mainly in fact kept IFC from making large investments growth opportunities, not restructurings). while the crisis was still going on and direction of macroeconomic policy was uncertain. In effect, the guidelines limited IFC from taking high risks IFC's Internal Business Practices in Brazil in an uncertain environment. In many cases, the effectiveness of response depends on its being preceded by a progressive The speed of response is also crucial. IFC made sequence of steps to adapt to the outbreak and significant efforts to mobilize large amounts of spread of crisis. Timeliness, size, and relevance to capital through trade facilities, liquidity facilities, country and business needs were distinctly better and equity funds, but slow decision making when IFC had (i) recognized signs of deteriora- prevented timely response to opportunities tion in economic conditions, (ii) adapted country (Thailand and Indonesia). For instance, IFC was strategies to changing circumstances, (iii) slow to respond to the opportunities in the adjusted investment approaches by becoming earlier crisis in Russia. It had fewer staff working more selective and worked--including through on Russia following the 1998 crisis than before advisory services--with companies less vulnera- and did not have the resources to work with ble to currency fluctuations or with familiar potential Russian sponsors. On the other hand, sponsors, and (iv) taken measures to alleviate in Korea, where IFC had little activity prior to the exposure constraints (Brazil, 2002; Turkey, 2001). crisis, quick mobilization of resources led to an Conversely, IFC's effectiveness during a crisis was effective IFC response to the 1997 crisis. IFC has impaired when it had not adjusted the project experienced strong demand for local currency mix to economic deterioration (Argentina, 2001). financing during crises (East Asia and Pakistan), but its capacity to respond quickly, including by Protracted periods of economic uncertainty, as in borrowing locally and using the proceeds for on- Brazil in the late 1990s and early 2000, gave IFC lending to clients, has been limited. more time to adjust its approach. In Brazil, where IFC was facing exposure constraints at the time, Forecasting crises is inherently difficult, but good four equity investments were poorly timed just quality of work helps project outcomes. Predic- before the real devaluation in January 1999. tion of the size and timing of a crisis is by nature Brazil continued to have debt issues for some a very imprecise activity and IFC is subject to time after the devaluation and its growth was many of the same difficulties in forecasting crises hurt by the slowdown in neighboring Argentina. as other investors. IFC teams often discussed the The Bank Group's Country Assistance Strategies possibility of crises (in Turkey, for example, for 2001 and 2002 reflected Brazil's uncertain where the economic environment was consid- prospects. ered a key risk in IFC projects), but full-fledged scenarios were not typically developed. An exception to the exposure guideline in FY02 allowed IFC to play a larger contracyclical role Given the inherent difficulties in forecasting with 15 new approvals involving $1.5 billion crises, good quality of work contributes to the gross ($630 million on a net basis). In addition to resilience of projects. For instance, there were the change in the exposure limit, the rise in significant differences in quality among projects lending reflected the Country Assistance in Argentina that broadly mirrored differences in Strategy's shift to a renewed focus to less risky, ratings of IFC's upstream preparation activity first-tier companies because of their liquidity, among these projects. In a similar vein, conser- term financing, and export credit needs. Hence, vative assessment of the availability of comple- although the exposure guidelines slowed mentary sources of finance, which often dried up response to the 1997 real devaluation, they in in crises, was also important. Projects that were 16 L E S S O N S F R O M W O R L D B A N K G R O U P R E S P O N S E S T O PA S T F I N A N C I A L C R I S E S clearly and adequately documented--a sign of the table and facilitated IFC-Bank dialogue (trade good supervision--were more likely to be finance facilities in Korea and Argentina). successfully restructured (Argentina, 2001). Aggressive and timely loan and equity loss provisions that more accurately reflected the Notes larger risks to IFC's investment portfolio in crisis countries also helped restructuring by (i) 11. A lesson learned in this experience was the focusing staff attention on improving the portfo- importance of determining the true level of client lio quality and (ii) creating more room and commitment to improving corporate practices, and flexibility for negotiations with clients. this may be difficult to assess in a crisis situation. In Russia, for example, an IFC advisory services Finally, when managed well, IFC collaboration program was implemented under the auspices of with the Bank helps improve results. Collabora- the World Bank's Financial Sector Development tion with the Bank has enhanced the effective- Project. The program was expected to result in considerable transfer of technology and interna- ness of IFC's intervention by supporting private tional best practices to a Russian-owned operation, sector responses to policy measures (Korea). increasing its efficiency, improving service to World Bank advice and other interventions have clients, and helping develop local managers and on occasions been informed by IFC's knowledge staff. In the event, the advisory services program of the corporate and financial sectors in a crisis- was not successful, as the Russian bank lacked true affected country. IFC's signaling role can be an commitment, undertaking it more to give IFC the important complement to public sector inter- assurances required to obtain the much-needed ventions, and its role as creditor and shareholder loan financing. in key financial institutions or corporations can 12.The Asian crisis, for example, can be isolated as a be a powerful tool in corporate and industry primary reason for the significant deterioration of restructuring. development, business, and investment outcomes. 13.Of 37 projects approved in the three years following a crisis in major MICs (Brazil, Indonesia, Korea, IFC crisis interventions could have contributed Mexico, the Philippines, Russia, and Turkey), 67 to preservation of jobs, but IEG could not find percent achieved high development results evidence of joint efforts by the Bank and IFC on (compared to 61 percent otherwise). Projects in employment and poverty during crises. Bank-IFC Brazil, Korea, and Russia were particularly success- collaboration has been modest in general and ful. In contrast, the performance of the 96 evaluated not any better--and sometimes worse--during projects that were already under way when a crisis past crises. On occasion, IFC cooperation with hit (in Argentina, Brazil, Indonesia, Mexico, the the Bank and the IMF was impaired by perceived Philippines, Russia, Thailand, Turkey, and Uruguay) conflicts of interest on the part of IFC, especially were much weaker. Of these projects, 54 percent in highly publicized commercial disputes involv- achieved high development outcome ratings, ing IFC's clients. Large-scale, wholesale interven- compared to 64 percent for non-crisis-exposed tions through funds or facilities gave IFC a seat at projects. 17 CHAPTER 4 Lessons from MIGA Activity during Crises Twenty-five percent of the total volume of MIGA MIGA paid a claim for East Java Power Corp. guarantees issued between 1995 and 2002 were (Indonesia), one of several power projects in crisis-affected countries, including guarantees cancelled by a presidential decree in the late issued during crisis episodes in Argentina, Brazil, 1990s. The second claim was for a logistics Pakistan, Indonesia, Ecuador, Russia, and Turkey. services project in Argentina in the aftermath of Most of MIGA's guarantees in crisis-affected that country's financial crisis. However, crises countries were for financial sector and infrastruc- have also provoked several preclaim situations, ture projects. which MIGA successfully mediated. Political risk is typically heightened during crises, The former case suggests that infrastructure over concerns that host governments may projects, when inadequately structured or respond to stress in public finances by revisiting awarded in a nontransparent manner, may be their contractual commitments or by imposing particularly vulnerable to political risk events transfer and convertibility restrictions to stem an during crises, as their legitimacy is questioned, outflow of reserves. Similarly, there are concerns guaranteed revenue/off-take contracts cause that unpopular economic measures will increase fiscal distress for the government, or politically the likelihood of civil disturbance. untenable tariff increases are introduced. It also highlights the importance for large public-private The overall volume of MIGA guarantees grew infrastructure projects to be transparently and during crisis episodes in Russia, Turkey, and competitively bid and to allow for renegotiation Brazil, and there is some evidence that cancella- on mutually acceptable terms, to insure long- tions of active contracts tended to diminish in term political sustainability in the face of a crisis. difficult economic times. This may suggest that Evaluative findings also emphasize that the the demand for political risk cover for existing consistency of guaranteed investments with investments is particularly strong during World Bank country strategies and sector policies economic crises. MIGA's Convention however, helps to mitigate risk and is key to Bank support does not allow it to cover existing investments, in the case of claim situations. despite the positive impact of such cover on job preservation. However, if risk perceptions lead In the financial sector, an evaluation found that investors to pull back, political risk insurance MIGA's intervention supported crisis recovery by demand may decline, as happened with the underwriting credit when market conditions volume of MIGA guarantees in the Asian crisis were adverse and by providing positive signal- years and in Argentina, where investors withdrew ing effects in the aftermath of crises. MIGA- following government measures perceived as supported foreign banks also introduced special- expropriatory. ized products, good-practice risk management policies and innovation to local banking systems, Crises have tested MIGA's risk mitigation capacity increasing their resilience to future crises. Evalua- in several ways. Two of the three claims in MIGA's tion findings rated their development impacts as entire history were paid during crisis episodes: satisfactory. 19 CHAPTER 5 Conclusion As the most serious crisis since the Great Depres- official development partners; under the full sion of the 1930s, the current financial crisis is in impact of the crisis, there is a major risk that such many respects unprecedented. The economic sources will curb new flows, in some cases contraction that it has fueled is also rapidly severely. Owing to the possible reduction in increasing unemployment worldwide, casting leveraging power that international financial millions of households into absolute poverty. institutions may experience, as well as to the Provision of crisis support to low-income increased opportunity cost of its resources in countries and MICs by the World Bank Group, crisis times, there is a special premium on getting particularly in concert with other development the most from Bank Group crisis support in partners, can help mitigate the severity of the terms of development effectiveness. Because adverse social impact of the economic slowdown. every crisis has its unique features, the lessons of At the same time, resources mobilized by the evaluation from past experience cannot amount World Bank Group, always limited in the past, are to very precise guidance for delivering effective even more constrained today. Furthermore, Bank crisis support. However, they can and do point to Group resources have traditionally leveraged crucial factors that may make a difference in how large volumes of complementary resources from effective today's crisis response can be. private and voluntary sector partners as well as 21