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p. 11 of 53 BACK | NEXT Classification of Developing Member Countries in Bank Operations Bank Operations in Pacific Island Developing Member Countries Lending and Relending Policies (Ordinary Capital Resources) Lending and Relending Policies (Asian Development Fund) Sector Lending Program Lending Assistance to Private Enterprises Financial Intermediation Loans/Credit Lines Financing of Interest and Other Charges During Construction Financing of Indirect Foreign Exchange Cost of Projects Lending Foreign Exchange for Local Expenditures on Projects Retroactive Financing Supplementary Financing of Cost Overruns of Bank-Financed Projects Use of Surplus Loan Funds Foreign Exchange Risk in Bank Operations Sector Development Programs Technical Assistance Guarantee and Security Arrangment for Bank Loans Environmental Considerations in Bank Operations Gender and Development in Bank Operations Project Performance Management System The Bank's Cooperation with NGOs Emergency Rehabilitation Assistance Loan for Small DMCs Rehabilitation Assistance After Disasters Cooperation Arrangements with International Organizations and Bilateral Sources Coordination with Aid Agencies Regional Cooperation Cofinancing Japan Special Fund Guarantee Operations Bank's Operational Missions Communication with Members of the Board of Directors Processing of Loan Proposals Project Financial Management Systems, Financial Analysis and Financial Performance Indicators Economic Analysis of Projects Procurement of Goods and Works Use of Consulting Services Formulation and Implementation of Loan Convenants Effectiveness of the Loan Agreement Loan Disbursement and Loan Closing Project Accounting, Financial Reporting, and Auditing Post Evaluation Country Planning and Programming Incorporation of Social Dimensions in Bank Operations Poverty Reduction ADB Accountability Mechanism Involuntary Resettlement Internal Audit Confidentiality and Disclosure of Information Indigenous Peoples Governance Anticorruption Enhancing the Asian Development Bank's Role in Combating Money Laundering and the Financing of Terrorism

Operations Manual

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This OM has been superceded by OM H3

OM Section 11: Issued on 12 December 1995
Lending Foreign Exchange for Local Expenditures on Projects

Bank Policies (BP)

Introduction

1. Article 13, subparagraph (ii) of the Bank's Articles of Agreement permits the Bank to finance, in special cases, a portion of the local expenditures with foreign exchange, under the following terms: "In special cases when, in the opinion of the Bank, the project causes or is likely to cause undue loss or strain on the balance of payments of the member in whose territory the project is to be carried out, the financing granted by the Bank to meet local expenditures may be provided in currencies other than that of such member; in such cases, the amount of the financing granted by the Bank for this purpose shall not exceed a reasonable portion of the total local expenditure incurred by the borrower."

2. Section 3.05 of the Regulations of the Asian Development Fund authorizes the Bank to "provide foreign currencies to meet a reasonable portion of the local expenditures on a project when in the opinion of the Board of Directors this is necessary or appropriate, having regard to the economic position or prospects of the recipient country and to the nature and requirements of the project."

3. "Local currency," as used here, means the currency of the developing member country (DMC) where the project is to be carried out. "Foreign currency" or "foreign exchange" means any currency other than local currency. "Local expenditure" or "local currency expenditure" means expenditure in the currency of the member in whose territory the project is to be carried out for goods produced in and services supplied from the territory of such member, excluding, however, expenditure on the import content of any such goods and services - i.e., the indirect foreign exchange cost.¹ Lending foreign exchange for local expenditures is often referred to, for convenience, as local cost financing (LCF).

4. Some local expenditure financing occurs when a local supplier or contractor is awarded a procurement contract as a result of international competition, but such local costs will be treated as if they were in foreign exchange under the uniform percentage financing arrangement.² Such local expenditure financing is not included in the scope of the Bank's LCF policy.

Rationale for Local Expenditure Financing

5. LCF by the Bank is, in general, based on three considerations:

(i) It reflects a recognition that the low levels of per capita income prevailing in many of the Bank's DMCs seriously constrain their capacity to generate the domestic savings needed for development. The provision of LCF by the Bank is intended to help ease that constraint.

(ii) It is a means to ease the strain on a DMC's balance-of-payments situation directly, by providing a portion of the external capital needed to finance the excess of domestic investment over domestic savings, and indirectly, by providing foreign exchange to meet part of the demand for imports that may be generated by the project concerned.

(iii) It supports the achievement of the Bank's strategic objectives and increases the effectiveness of the Bank's assistance to DMCs with the Bank bearing a reasonable part of the cost of a project that is of a high priority on strategy considerations but has a low foreign exchange content in its cost.

Determination of LCF

6. Under the present policy framework, adopted in 1983, the Bank may finance a certain percentage of the total cost of a project; and the amount of LCF, if any, would then be the excess of the amount of the Bank financing over the Bank-financed share of the foreign exchange cost of the project up to the percentage limit or cost-sharing limit. The percentage of the total project cost financing to be applied in a particular case is determined by country and project considerations.

7. The following are the cost-sharing limits, i.e., the maximum proportion of project cost that the Bank may normally finance, in each of the three country groups:³

Group A countries : 80 percent
Group B countries : 60 percent
Group C countries⁴ : 40 percent

8. These percentage limits reflect the policy of the Bank that DMCs should bear a reasonable proportion of project financing as a mark of their commitment to and ownership of the projects. Operationally, the cost-sharing limit⁵ is to be understood as the ceiling up to which the Bank could normally finance a project in a DMC, e.g., the Bank will normally finance not more than 60 percent of the total cost of a project in a Group B country, and will generally finance a lower proportion of project cost. The cost-sharing limit of the relevant country grouping will, however, not be applied mechanically or automatically to each DMC; they will be periodically reviewed by Management and adjusted taking into account the DMC's performance in domestic resource mobilization, the balance-of-payments situation, and any special circumstances that may prevail. DMCs classified by the United Nations as "least developed" will receive high priority for LCF. The Bank will also continue to be prepared to consider financing the entire direct and indirect foreign exchange costs of a project, even if this would cause Bank financing to exceed the applicable cost-sharing limit. Under exceptional circumstances and where justified on country and project grounds, Bank financing may also exceed the country cost-sharing limit.

Project-level Considerations

9. Project considerations also will determine the actual cost-sharing by the Bank for specific projects financed. Projects in sectors that generally have the institutional capacity and the demand base to raise local resources (e.g., power, industry, transport) will normally have a lower percentage of the project cost financed by the Bank; projects in social infrastructure will have a higher percentage. Such project level considerations will be supplemented by the following considerations:

(i) institutional capacity of the implementing agency to raise local resources,

(ii) priority of the sector or subsector in the DMC budget allocation,

(iii) availability of cofinancing,

(iv) availability and affordability of domestic capital market finance for the project, and

(v) the relationship between the project-owner and the borrower.

10. Projects that contribute to Bank concerns such as poverty reduction, human development, environmental improvement, gender equity, capacity building, and rural infrastructure projects will merit high priority for LCF.

Cofinancing

11. When substantial amounts of cofinancing are involved, the proportion of the total project cost that the Bank will finance will generally be smaller than the applicable cost-sharing limit. However, in justifiable cases in the poorer DMCs, combined external financing may exceed the cost-sharing limit or even occasionally cover almost the entire project cost.

Technical Assistance

12. LCF in technical assistance (TA) operations may be provided up to 15 percent⁶ of total TA financing by the Bank, irrespective of whether the TA is financed by a grant, a loan, or a combination of grant and loan. This arrangement is applicable only to "stand-alone" TA projects and TA program loans, and not to the consulting services and training components included in the usual loan projects. Consulting services and training components included in a loan project will be financed out of the proceeds of the loan determined by the application of the overall cost-sharing percentage. Items eligible for LCF under TA include rental, operation of vehicles and equipment, local travel, secretarial services, office supplies, and may include other domestic expenditures.⁷

Sector, Program, and Development Finance Institution (DFI) Lending

13. Subprojects under a sector loan are eligible for LCF. LCF is not applicable to program loans which are policy based loans. LCF is permissible for DFI credit lines and in suitable loans to the private sector.

Ineligible Items

14. Items that are not eligible, as a rule, for LCF include taxes and duties, costs of land acquisition and payments of rights-of-way, working capital other than incremental and initial working capital, interest and financial charges other than those on Bank loans, and expenditures not directly attributable to Bank-financed projects.

Operational Procedures (OP)

1. Local cost financing by the Bank is considered justified if:

(i) the DMC concerned is making a reasonable effort towards development in general and towards mobilization of resources for development in particular;

(ii) the available resources are being allocated by the DMC concerned in a reasonably prudent manner to finance its development program;

(iii) the financial requirements of the development program of the DMC concerned will exceed the reasonable limits of domestic savings and expected availability of foreign resources; and

(iv) the financing requirements cannot be met adequately by financing only foreign exchange costs of development projects.

2. Items (i)-(iv) in para. 1 above should be interpreted with flexibility and not applied rigidly so as to maintain the effectiveness of the Bank's operations particularly in some of the relatively advanced DMCs, because the provision of LCF in those DMCs would allow the Bank greater flexibility in directing its finance to projects of high development priority and thus contribute to their overall development efforts.

3. The loan amount determined, considering the applicable cost-sharing limit, will be allocated among the various cost items: the direct and indirect foreign exchange costs and the local currency costs. Against this loan amount, the first charge must be the foreign exchange costs other than interest and other charges during construction (IDC). The remaining amount available can be applied to IDC (if such financing by the Bank is considered appropriate)¹ and to local expenditures in any proportion favored by the borrower, subject of course to such local expenditures being eligible for Bank financing and to the Bank's cost-sharing limit. Any additional local expenditures made possible through the borrower's decision not to seek Bank financing of a part or the whole of the IDC on the Bank loan will not be regarded as LCF for the purpose of reporting the amount of LCF in the Report and Recommendation of the President.

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