A Tricky Balance for Development Banks and the Developing World

A regular series on the choices faced by international economic policymakers

Navigating the Trade-Offs: IMF, China, and the Financing Dilemma in Low-Income and Emerging Markets

Heidi Crebo-Rediker

Many low-income and emerging market countries face an increasingly precarious economic future as they grapple with mounting debt burdens. Creditors include international financial institutions, the private sector, bilateral official creditors, and in many instances China. China’s prominence poses a strategic conundrum for the International Monetary Fund (IMF) and the non-China official-sector lending community: how to balance China’s role, given the limited sources of finance for low-income and emerging markets, while managing the trade-offs between geopolitical influence, economic stability, and financing sustainable development goals.

Over the past decade, China has grown to become the world’s largest bilateral official lender to low-income countries, dwarfing the lending of the World Bank, IMF, or all twenty-two Paris Club governments combined. Eighty percent of Chinese lending has been made to countries now in debt distress with some undergoing complex debt restructuring processes. China’s role has also raised serious concerns about the leverage Beijing could hold over debtor nations.

Meanwhile, the IMF has to judge how and when to use the public funds it manages to support distressed countries and guide them on paths back to growth and sustainable development. The challenge for both the IMF and for the debtor countries is in deciding whether to encourage China to rollover its debts and continue lending—thereby possibly extending its geopolitical influence—or to help wean countries off China and promote financing from other sources, even if this means using the IMF and multilateral development banks (MDBs) to repay debts to China.

The trade-off is stark: encouraging China to rollover debt and remain a major lender risks increasing Beijing’s influence in those debtor countries. This influence can manifest in various forms, from preferential treatment in government contracts to sway over political decisions, securing natural resources, or establishing Chinese strategic outposts. Conversely, using multilateral, official bilateral, or private resources to repay debts owed to China could reduce dependence on the country but could also pose greater economic uncertainties and compromise any sense of fairness allowing China to be repaid in full when an IMF program is agreed.

Recently, Chinese flows have been negative. As referenced by U.S. Treasury Undersecretary Jay Shambaugh in a recent speech, “for over forty low- and middle-income countries, cumulative net debt flows from Chinese creditors since 2019 are now negative. Almost all of these have had recent IMF programs,” even while Paris Club financing has held steady in aggregate. Shambaugh underscored the critical role of the IMF and MDBs in supporting countries’ reforms and investment plans, urging IMF shareholders not to withdraw their own financing in parallel, which would counteract those efforts.

But the sustainability of non-China funding is uncertain, given that financial flows out of poor and emerging market countries have recently intensified. Notably, the private sector, traditionally a significant source of capital for emerging markets, has withdrawn more than $300 billion from developing countries over the past two years, according to a recent study from Brookings. This retreat by bondholders and banks complicates the ability of the IMF and MDBs to muster with certainty sufficient resources without knowing where additional funds will originate.

U.S. Deputy Secretary of State Robert Zoellick’s call in 2005 for China to act as a “responsible stakeholder” invites reflection on what such a role entails in the current global context. Being a responsible stakeholder could imply that China should not necessarily lend less, but rather continue to lend under more transparent and globally cooperative terms. This would include China participating actively in international debt resolution frameworks like the G20 Common Framework and aligning its lending practices with global standards for sustainability and transparency.

The IMF should continue to engage with Beijing to foster more transparent and sustainable lending practices and constructive engagement in debt-restructuring processes. The recent example of Zambia’s delayed debt treatment under the Common Framework presents a nuanced picture of China’s engagement. In the end, Beijing agreed to terms aligned with other official creditors. But the process took too long and investors were left concerned that China’s treatment of private capital poses longer-term risks.

But China cannot be relied on to act constructively in all cases. So, the trade-off remains one in which the IMF should be considering how to mobilize more non-China official lenders and more private capital to replace that of China in those instances where it declines to refinance. The Partnership for Global Infrastructure and Investment is one example of a potential alternative to China’s lending, though it is nascent, underfunded, and not structured for direct government support.

The IMF and international stakeholders need an approach that not only addresses the immediate financial needs of debtor countries, but also safeguards their long-term strategic and economic sovereignty and stability. Achieving this balance will be pivotal in shaping the next phase of the global economic order.

Balancing the Interests of Rich and Poor at the World Bank

Sebastian Mallaby

National governments have multiple objectives, so policymakers inevitably face trade-offs. Multilateral bodies, obliged to respond to a plethora of global stakeholders, confront this problem on steroids, especially when they have a mission as capacious as that of the World Bank. Originally founded in 1945 to finance the reconstruction of war-torn Europe, the bank later pivoted to promoting economic growth in developing economies; in different eras, it has emphasized physical infrastructure and human infrastructure, rural development and urban development, economic stabilization (prudent tax and spending policies) and political stabilization (police and judicial reform).

But the central trade-off facing any World Bank leader pits the demand for expeditious lending, often voiced by developing countries, against the calls to attach conditions to such lending, often voiced by analysts and activists in rich donor countries. Since the World Bank answers to a board representing both poor countries and rich ones, there is no obviously correct way of balancing those pressures. There is a trade-off between lending speedily and conditionally, between a stance that is borrower-friendly and one that is donor-friendly. The bank needs to forge a compromise.

This trade-off is reflected in conflicting views of the World Bank’s identity and role. Is it primarily a bank—that is, a body whose mission is to lend money, supporting priorities chosen by its clients in developing countries? Or is it primarily a knowledge broker, accumulating wisdom from decades of development experiments and retaining a brainy cadre of consultants to spread the resulting lessons across the developing world?

Most World Bank leaders—including the current one—have tried to fudge this question. They are sensitive to the charge that the bank acts far more sluggishly than private lenders; besides, they need to maintain lending velocity to generate sufficient revenues to cover the bank’s operating costs. (The World Bank makes grants to the poorest developing countries, while middle-income clients get loans on which they pay interest.) But the World Bank’s leaders also know that their advantage relative to private lenders is their credibility as policy advisers.

This split identity—lending versus consulting—is further mirrored in the World Bank’s periodic rebalancing between regional experts and sectoral ones. Under James Wolfensohn, president from 1995 to 2005, the regional experts were preeminent. Wolfensohn believed that poor countries should “own” their own development agendas, so power at the World Bank resided with country officers: like bankers, their job was to understand their clients’ priorities and source the relevant technical advice on water infrastructure, education policy, and so on. But both before and after Wolfensohn, the technical experts have enjoyed more agency. In periods when it is fashionable to stress the World Bank’s identity as a knowledge bank, power resides with the consultants.

In national policymaking as in multilateral development, trade-offs are usually impossible to resolve. But it is healthy to acknowledge them. Next time the World Bank is criticized for financing a project that damages the environment, recall that rigorous conditionality results in slower lending. Next time the World Bank is pilloried for sluggishness, recall that its good intentions on the environment are part of the cause.

Increasing the Firepower of Multilateral Development Banks

Brad Setser

The World Bank and other multilateral development banks (MDBs) are, fundamentally, banks. To do more, they need to either acquire more outright equity capital or stretch their existing capital further by increasing borrowing and taking on more risk. This trade-off is the oldest in banking, but it increasingly matters because many countries around the world want MDBs to do much more. Many shareholders who are calling for reform, however, are also reluctant to use their budgets to provide the banks with more equity capital.

The developing world has pressing needs for investment in new clean energy supplies—development does still take energy. But private-market financing is either not available or ridiculously expensive. Additionally, the Chinese policy banks have cut back their development lending. The World Bank stepped up during the pandemic, but without more scope to lend, its flows to developing and low-income countries will slow at a time when there is not a financially viable replacement.

Simply put, no better mechanisms exist than the traditional development banks when it comes to providing developing countries with financing that is sustainable for both the borrowers and the banks’ contributing countries. The World Bank took roughly seventy years to lend about $500 billion; Chinese policy banks did it in about ten years.

If the World Bank hopes to expand its financial impact in the face of rising global challenges and expensive private finance, its shareholders seem to face a simple trade-off: accrue more capital or leverage more funds to fund development efforts. There are, however, ways to work through the trade-off between equity and debt. Two proposals stand out.

The first is to make more efficient use of the bank’s callable capital. Right now, the World Bank operates with a belt and two pairs of suspenders—it has a conservative gearing ratio, lending on a preferred basis that insulates it from the risk of loss and backing all its loans with callable capital. That is probably too conservative.

Counting a fraction of the World Bank’s callable capital as equity can be viewed as a way of recognizing that with two sets of braces the bank can take on a bit more risk. Reducing the leverage ratio to 16 percent, for example, would allow the bank to lever its $50 billion six-to-one, and thus increase its lending by $50 billion without any new equity contributions.

A second proposal is to tap into the pool of trapped Special Drawing Rights (SDRs) held by the advanced economies and China. Issuing SDR bonds, similarly, can be viewed as a way of improving the trade-off between debt and equity. The World Bank would be providing current holders of SDRs with a service—the bank would give SDR holders a cash-settled bond in exchange for their SDRs, which are now effectively locked up in a deposit account at the International Monetary Fund. The bank’s Treasury could exchange the SDRs for cash, and in return it would get long-term financing without paying a premium.

The issuance of an SDR bond does not create any new equity per se, but it is a particularly safe form of borrowing. This proposal is attractive not only for the World Bank’s primary lending arm, the International Bank of Restructuring and Development, but also for helping to meet the funding needs of the bank’s concessional lending arm, the International Development Association (IDA), at a time when green investment is largely infeasible for developing countries. IDA needs long-term financing to match its long-term lending, but it currently can only raise long-term funds in the market by paying a premium over the risk-free rate. This hinders its ability to deliver on its development mission. The SDR bond offers an alternative.

Bottom line: the World Bank is, in fact, a bank, and its shareholders need to decide how much capital to put in and how much additional risk they want the bank to take. A bigger bank is urgently needed, but it requires managing the trade-offs inherent to any banking model.