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p. 16 of 18 BACK | NEXT Executive Summary I. Introduction II. Long-Term Vision and Strategy for ADF III. Operational Priorites IV. Use of ADF VII Resources to Date V. Financial Management A. Long-Term Strategy for Financing ADF B. ADF Resource Management C. ADF VII Financing Structure and Burden Sharing VI. Conclusions

Asian Development Fund VII: Progress Report (1999) : V. Financial Management

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B. ADF Resource Management

57. ADF resource management has undergone important and significant changes in the first two years of the ADF VII period. These changes are a consequence of the policy directions given to the Bank in the ADF VII Donors’ Report and the ensuing Board approval of major policy recommendations presented to them by Management. This subsection summarizes the changes in policy and their impact on the management of ADF resources, as well the Bank’s initial experience with the new policies and the implications for further work on ADF resource management.

58. Soon after the Board of Governors adopted the ADF VII Resolution in March 1997,²¹ the Board of Directors interpreted (on 15 April 1997) the Charter pursuant to Article 60 to confirm that: (i) in accordance with Article 40.1 of the Charter, the Board of Governors’ allocation to ADF of current year OCR net income that is in excess of reserves that the Governors consider necessary or appropriate and that would otherwise be available for distribution to members, is justified within the context of the Bank’s purpose and functions and is consistent with the Charter; and (ii) such net income transfers to ADF may be made consistently with the provisions of Article 10.1 of the Charter, which require the separation of the Bank’s OCR and Special Funds operations.²² In line with the preceding, the Board of Directors recommended to the Board of Governors that $230 million held as surplus be allocated to the ADF.²³ Moreover, the Board of Directors adopted the EACA and the associated establishment of a new financial planning framework for the management of ADF resources.²⁴

59. During 1998, the Board of Directors considered and approved the following further changes in policy concerning the management of ADF resources: (i) that resources made available as a result of annual loan savings and cancellations in the pre-ADF VII postreplenishment pool be allocated on an annual basis to the nondonor resource pool supporting EACA, thereby increasing EACA,²⁵ and (ii) that the loan terms for new loans to all ADF borrowers be amended with effect from 1 January 1999,²⁶ and that the service charge will be redesignated as an interest charge and will include a portion to cover administrative expenses and a portion that does not.²⁷

60. Together, the major impacts from these new policies for the management of ADF resources are considered to be positive. First, the efficiency in the use of ADF loan repayments and additional resource mobilization (other than new donor contributions to the current replenishment) to increase ADF commitment authority is maximized. Second, as a consequence, the Bank may continue to plan for progressive self-financing of ADF in the long term. Third, commitment authority in the current replenishment does not have to bear all risk associated with adverse movements in exchange rates affecting all ADF resources, as it has in previous replenishments. Fourth, ADF note encashment in the current replenishment is stable and predictable. Fifth, the Bank’s financial planning framework for ADF is much more congruent with the policies and practices in IDA, to which many donors to ADF also contribute. However, it is important to point out that, with the limited degree of hardening of ADF loan terms as approved by the Board of Directors, it is difficult to attain the goal of ADF self-financing without substantial new donor contributions to future replenishments.

61. These positive features notwithstanding, the implementation of these new policies, particularly in the context of the Asian financial crisis, have had results that merit attention and perhaps further study. First, under the new financial planning framework, which separates resources for the current replenishment from those provided and allocated to past replenishments, a direct relationship exists between the amount and timing of donor-sourced commitment authority and installment payments in the current replenishment; however, EACA is available at anytime during the calendar year. In ADF VII, annual EACA in 1997-1999 was fully committed very early in the year. Given the projected annual levels of EACA and the provisions in the ADF resolutions, which do not require donors to deposit their promissory notes until the last quarter of each calendar year, ADF has experienced intra- and inter-year funding gaps: that is, some loans are approved by the Board during the year on the condition that the loan may not be signed until the President has determined there are sufficient financial resources (i.e., additional commitment authority) to finance the loan. This has often resulted in unanticipated delays in loan signing and initial project implementation. On these considerations, it would be appropriate for the Bank to review mechanisms to address the problem.

62. The new ADF financial planning framework continues the policies and practices whereby donor contributions are usually denominated and paid in members’ currencies, and loan disbursements and repayments are generally made in relation to the basket of currencies that constitute the pool or stock of ADF resources (substantially equivalent to donor contributions to all ADF replenishments). The ADF unit of account is the same as the Bank’s unit of account, i.e., the US dollar.²⁸ Thus, the US dollar valuation of commitment authority in the current replenishment—be it derived from donor contributions or EACA—will change in relation to changes in the exchange rate of donor member currencies against the US dollar. In ADF VI, for example, the net effect was a gain in commitment authority, which was one reason why the Bank was able to extend the ADF VI period by one year. However, as a result of exchange rate movements during the first year and a half of ADF VII there was an extraordinary reduction from the planned levels of donor-sourced commitment authority and EACA, as a result of adverse change in exchange rates which contributed substantially to an ADF VII financing gap projected at $1.8 billion in relation to the agreed planned level of $6.3 billion in ADF VII lending.²⁹ It is not assumed that the ADF VII period can be shortened in these circumstances. Therefore, in this context, and considering the need to maintain ADF’s financial capacity to meet outstanding disbursement obligations over time valued in SDRs, the Bank should reexamine alternatives for minimizing ADF’s vulnerability to adverse movements in exchange rates and the institutional and legal implications of such alternatives. Relevant policies and practices in IDA provide an important point of reference. The Bank plans to report to donors on alternatives during the end of 1999.

63. When approving recommendations on the new ADF financial planning framework in April 1997, several donor members did so on condition that the Bank perform an early review of the experience with the ADF VII fixed encashment schedule. While these members appreciated the enhanced predictability and stability in ADF note encashment offered by the ADF VII fixed encashment schedule, their national policy required them to provide, from time to time, only that amount of resources necessary to meet the near-term disbursement requirements of ADF-financed loans. The results of the Bank’s experience with the ADF fixed encashment schedule in 1997 and 1998, and as currently projected for 1999, is given in Appendix 2. The appendix shows that actual ADF VII note encashment in 1997 and 1998 was insufficient to meet the donors’ pro rata share of ADF VII disbursement requirements: a deficit of $32.4 million had to be funded by temporary transfers from the resource pool supporting EACA. The table also shows a further deficit of $26.45 million is projected in 1999, and will again have to be met from resources supporting the EACA. Furthermore, with the EACA resource pool temporarily meeting these deficits, EACA availability in ADF VII will be reduced by $14 million. In this context, while it is intended to leave the ADF VII fixed encashment schedule unchanged, the Bank should formulate a different fixed encashment schedule for the next replenishment, to minimize the probability of annual deficits in note encashment set against the donors’ projected pro rata share of disbursement requirements.³⁰

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