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p. 1 of 27 BACK | NEXT Executive Summary I. Introduction II. The Performance-Based Allocation Policy III. Lessons, Issues, and Directions IV. Enhancements to the Policy V. Implementation VI. Recommendation Appendixes

Review of the Asian Development Bank's Policy on the Performance-Based Allocation of Asian Development Fund Resources

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Executive Summary

In a context where the link between Asian Development Fund (ADF) allocations and performance had not been transparent or concerted, in March 2001, the Asian Development Bank’s (ADB’s) Board approved the Policy for the Performance-Based Allocation of ADF Resources. The new approach explicitly recognized that in seeking to reduce poverty, ADF concessionary resources would be best directed to good performers. In doing so, the policy sought to create incentives for improved performance. Beyond the performance measurement and allocation framework, the policy provided management with an important tool to strengthen development effectiveness through more focused policy dialogue, better country planning processes, and improved operations.

The review of the policy and the associated proposals are based on extensive discussions with donor shareholders’ and borrowers’ representatives that took place during the ADF IX replenishment process. The review also draws on parallel developments in other multilateral development banks, particularly the International Development Association (IDA).

The policy has led to more resources being allocated to better performing countries. Even though the link between performance and allocation is not as strong as the policy anticipated (and is less evident for Pacific developing member countries), no link was discernable before the policy was introduced. However, for given performance, PBA outcomes have not favored lower-income countries as they should have. While less populous countries have received larger per capita allocations than more populous countries, compared with historical allocations, the share of larger countries in ADF has increased.

Adjustments to formula allocations intended to attenuate “abrupt” or “sharp” changes in lending volumes have had an important influence on outcomes. Although these adjustments have been consistent with the provisions of the policy, they have created entitlements based on historical allocations and, as such, detract from the performance characteristics of the system.

Resources allocated outside the formula have been sizable, ranging from 15% to 25% of total ADF resources. These “set-asides” have been dominated by allocations to support postconflict reconstruction and peace in Afghanistan and, to a lesser extent, selected projects in Indonesia. About 5% of ADF resources have also been earmarked to support subregional projects. Although the ADF VIII Donors’ Report endorses support for subregional projects, the policy provides no guidance on project eligibility.

Assessments of country-specific performance criteria (“triggers”) have had only a modest impact on allocations, but borrowers and ADB have incurred significant costs in implementing them. Triggers have also presented funding challenges. On balance, assessments have favored higher lending scenarios. As no additional resources have been available to fund higher lending volumes, reduced allocations for countries that met baseline requirements were required to remain within the ADF resource envelope.

Operations departments have been responsible for country performance assessments and for allocation decisions. Although a good deal has been achieved, there have been a variety of implementation challenges. In particular, PBA activities have not always dovetailed well with country programming.

A number of factors have complicated communication with country authorities. Most important, demands that were unanticipated at the time of the ADF VIII replenishment have squeezed resources available for other country programs. Consequently, strong and improved performance has not always attracted more resources.

Enhancements proposed by the review reflect stakeholders’ interests in a strengthened policy and both reflect and contribute to an emerging international consensus on ways to promote and invest in better performance in low-income countries and strengthen accountability for the use of scarce concessional resources. Enhancements seek to (i) improve country performance assessments, (ii) elevate the role of governance, (iii) strengthen the link between performance and allocation, (iv) sharpen ADF’s focus on small countries, (v) clarify criteria for extra-formula allocations, (vi) deepen client involvement, (vii) improve transparency and accountability, and (viii) reduce costs.

To help improve the quality of country performance assessments, the review proposes alignment with World Bank performance criteria and use of World Bank performance assessment guidelines. The advantages of alignment outweigh any benefits of customization. The credibility of PBA and of ADB’s engagement with ADF clients will, however, continue to depend on the independence and full ownership of ratings by ADB. Strengthened processes for client consultation, ratings review, and accreditation are proposed. Public disclosure of numerical ratings from 2005 will also enhance transparency.

The review proposes that the weight of governance in the measurement of country performance be raised from 30% to 50%. This will give governance a more central role in the allocation process. However, the review concludes that the application of IDA’s governance factor would be highly nontransparent, and proposes an alternative allocation model.

To strengthen the link between performance and allocation and incentives for better performance, the review proposes that the allocation formula be recalibrated so that changes in performance exercise a more powerful impact on allocations. For the largest ADF borrower, a 10% improvement in performance would attract a 13% increase in allocation under the current policy. For an identical improvement, the smallest borrower would be rewarded with about an 18% increase in allocation. For a 10% improvement in performance, the allocation formula proposed by the review would increase allocations for the largest ADF borrower by 30% and for the smallest borrower by nearly 45%.

Although small countries have performed broadly on a par with larger countries, their shares in ADF have declined during the ADF VIII period. Less populous countries have been losing resources because the policy’s small country bias is not as pronounced as the bias in historical allocations. The review proposes recalibrating the population weight to arrest the drift of resources to larger countries. The strengthened performance characteristics of the allocation model will ensure that allocations are increased only for small countries that are performing satisfactorily.

Determining allocations for special needs is not possible on a formula basis. Such decisions are best made case-by-case. Even so, the policy must provide clear guidance on circumstances that would warrant ADF support and provide criteria for determining suitable allocations. Proposed revisions to the policy provide eligibility and allocation criteria for subregional projects and reiterate the commitment made in the Disaster and Emergency Assistance Policy to adopt the IDA 13 framework to guide postconflict allocations. The policy recognizes that even though allocations to weakly performing countries should be limited, the need for close engagement will remain.

The review advocates deeper client involvement in PBA. The review proposes closer consultations on country performance ratings during the rating exercise and then focused dialogue that draws on the ratings during country programming. Although country teams will be required to share their preliminary assessments with country authorities, it is equally important that ratings are not negotiated with borrowers. Senior operations staff should explain ratings outcomes and explore possible strategic responses with country authorities. ADB will arrange regional training workshops on PBA methods in 2005.

The proposed public disclosure of numerical ratings, beginning with the 2005 country performance assessment, will be an important step toward improved transparency and strengthened accountability for the policy. Country authorities would be invited to comment on ratings and their views would be published with ratings. Public disclosure of ratings should help improve their quality and strengthen the compact with clients.

The review proposes that responsibility for ADF allocations be moved from the operations sphere to a PBA Focal Point in the Office of the Director General, Strategy and Policy Department. The director general of the Strategy and Policy Department, who reports directly to the President, will be accountable for matters related to implementation of the policy. The PBA Focal Point will also be responsible for coordinating country performance assessments. With full numerical disclosure of ratings, mechanisms intended to ensure full operational and corporate ownership of ratings are proposed. The Vice Presidents of Operations Groups and Knowledge Management and Sustainable Development will be responsible for ratings accreditation.

Allocations under the proposed revisions will be made on a biennial rather than on an annual cycle. This will provide greater operational flexibility in the use of allocations and help ease the bunching of loan approvals. The use of the “collar” will be discontinued. Given the need to closely monitor the circumstances of postconflict and weakly performing countries, their allocations will continue to be determined annually. To ensure that information is current, country performance assessments will continue on an annual cycle and numerical ratings will be disclosed each year.

In summary, the proposed revisions to the PBA elevate the performance characteristics of the system. They also limit and provide more explicit guidance on extra-formula allocations. Clients should benefit from reduced transaction costs, closer engagement, and greater transparency. Incentives for improved performance, particularly in relation to governance, have been accentuated. Contingent on their performance, ADF’s smaller clients will continue to attract larger per capita allocations.

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