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A Graduation Policy for the Bank's DMC's
Executive summarySince 1977, the Bank has had a three-tier classification system that forms the basis for determining the eligibility of its developing member countries (DMCs) to borrow from the Asian Development Fund (ADF) and for applicable limits on Bank financing of project costs. DMCs are classified into three groups based on two criteria: (i) per capita gross national product (GNP); and (ii) debt repayment capacity. Group A DMCs are fully eligible for ADF, Group B DMCs (“blend” economies) are eligible for limited amounts of ADF in particular circumstances, and Group C DMCs are not eligible for ADF financing. While per capita GNP has been identified as a criterion, Bank policy is that cutoff points for the various groups should not be rigid. Also, the debt repayment capacity criterion is assessed in a qualitative way. Classification is determined at the time of entry. No borrowing country has been formally graduated from one group to the next to date. Further, no DMC has been formally graduated from Bank assistance, because the current policy does not envisage a stage beyond Group C. As part of its policy review commitments made during the ADF VII negotiations, the Bank is required to submit proposals to the Board of Directors on a graduation policy for DMCs within one year of the effectivity of ADF VII. Donors suggested that the proposed approach should preferably be comprehensive, extending graduation from ADF-only through "blend" status to ordinary capital resources (OCR)-only status, and finally to graduation from regular Bank assistance. Since the inception of the classification system, per capita income and debt repayment capacity have been distinct classification criteria. Also, recognizing the importance of both criteria, Bank policy statements have been careful not to state that the per capita GNP criterion has primacy over the debt repayment capacity criterion. In practice, however, it has been assumed that low income goes with low debt repayment capacity, middle income with intermediate debt repayment capacity, and high income with high debt repayment capacity, i.e., there is an implicit assumption that per capita income and debt repayment capacity can be used interchangeably. Also, while there is a per capita GNP cutoff for ADF eligibility, there is no corresponding cutoff for OCR eligibility. As a result, high-income countries continue to be classified along with other regular OCR borrowers as Group C DMCs. Over the years, fundamental changes have occurred in the interrelationships between the levels of per capita GNP and debt repayment capacity within and across country groupings. A growing number of low-income DMCs have improved debt repayment capacities and access to international capital markets, indicating a need to reengineer the classification system. Further, the current economic crisis in the region underscores the need to build flexibility into the proposed policy to reflect changes in the economic conditions of DMCs. To this end, the Paper proposes a systematic approach to applying the two country criteria, viz., per capita GNP and debt repayment capacity, for determining ADF eligibility. The approach is captured in a decision matrix that is arrived at through a two-stage process: (i) in the first stage, the per capita GNP operational cutoff is applied to divide borrowing DMCs into two categories, i.e., those below and those above the cutoff; (ii) in the second stage, within each income category (i.e., below and above the per capita GNP cutoff) countries are further differentiated on the basis of debt repayment capacity. Unlike the income criterion, the debt repayment capacity of DMCs cannot be captured in a single indicator. To address this problem, a multidimensional evaluation procedure, combining quantitative and qualitative assessments, has been developed. The quantitative assessment of debt repayment capacity is based on the following indicators: (i) debt sustainability ratio, (ii) private capital inflow as a share of total capital inflow, (iii) gross domestic saving rate, and (iv) country size. The qualitative assessment of debt repayment capacity is based on the following categorical variables: (i) categorization as a heavily indebted poor country (HIPC) by the World Bank and the International Monetary Fund (IMF), (ii) volatility of export growth, (iii) main external financing source, (iv) degree of access to funds of the International Development Association (IDA), and (v) whether sovereign borrowing by the country is rated by Moody’s and Standard and Poor’s. The assessment of debt repayment capacity comprises two types of determinants. The first type consists of quantitative indicators on a continuous scale that capture trends over the medium term. The second type depends on factors that change over the longer term. Both types of indicators must be used in order to strike a balance. The joint application of the two criteria (i.e., per capita GNP and debt repayment capacity) yields the following system of DMC eligibility for ADF and OCR resources: (i) ADF-only (Group A); (ii) ADF with limited amounts of OCR (Group B1); (iii) OCR with limited amounts of ADF (Group B2); and (iv) OCR-only (Group C). Under the revised framework, the current ADF-OCR blend is proposed to be split into two groups: ADF with limited OCR (B1) and OCR with limited ADF (B2). As DMCs move out of Group A and progress towards Group C, they will have increasing access to OCR. Bank lending on OCR terms and Bank guarantees with counter-guarantees from a government or its agencies could be considered on exceptional basis for Group A DMCs for projects that are foreign exchange earning and are able to fully service their foreign debt from their net foreign exchange earnings. Resources for the Group B1 DMCs would be predominantly ADF with limited OCR financing for revenue-earning projects, determined on a case-by-case basis. This is consistent with the recommendation of donors that while country criteria would be the primary consideration for ADF access, project considerations could be applied as a secondary criterion. Graduation from one level of ADF access to the next would be triggered under the following conditions:
In the event of a combination of (i) and (ii), or (i) and (iii), the graduation would take place over two levels (for example, from A to B2 or B1 to C). Movement through the decision matrix can be bi-directional, i.e., graduation would not be irreversible. To avoid frequent movements back.iii and forth between groups, a time lag, say four years, should be provided between the achievement of the criteria and formal graduation. Eligibility for, or graduation from, ADF will normally be coterminous with the ADF replenishment exercise. In implementing the proposed framework, the current IDA operational cutoff of $925 at 1997 prices has been adopted for determining ADF eligibility. Joint application of the per capita income and debt repayment capacity criteria yields the following changes in the degree of ADF eligibility of DMCs:
The proposed policy would also be extended downstream to allow graduation from regular Bank assistance. The criteria applied here would be (i) per capita GNP, (ii) extent of reliance on commercial sources of external financing, and (iii) stage of development of economic and social institutions. In regard to the per capita GNP threshold, the International Bank for Reconstruction and Development (IBRD) operational cutoff of $5,445 at 1997 prices is proposed to be adopted. On this basis, four DMCs, Hong Kong, China; the Republic of Korea; Singapore; and Taipei,China would be formally graduated from regular Bank assistance. They would, however, be eligible for emergency assistance from the Bank. The broad features of the post-graduation relationship of DMCs with the Bank are outlined in this Paper. There would be changes in the project cost-sharing limits for the following graduating DMCs: (i) for Bangladesh, Cook Islands, Marshall Islands, Micronesia, Pakistan, Sri Lanka, Tonga, and Viet Nam, the limit will fall from 80 percent to 70 percent; (ii) for PRC and India, the limit will fall from 80 percent to 60 percent; (iii) for Papua New Guinea, Philippines, Thailand, and Uzbekistan, the limit will fall from 60 percent to 40 percent; and (iv) for Kazakhstan from 80 percent to 40 percent. It is proposed that the lower cost-sharing ceilings for the affected countries would be introduced in a phased manner, with a 5 percentage points reduction per year. Further, the provisions in the existing policy on project cost-sharing ceilings that, under exceptional circumstances and where justified on country and project grounds, Bank financing may exceed the country cost-sharing limit, will continue to apply. Cost-sharing norms are being proposed for technical assistance (TA). It is proposed that government contribution to TAs should be at least 15 percent of the total TA costs for Group A, 20 percent for Groups B1 and B2, and 30 percent for Group C. However, such contribution will be subject to the limit of total TA costs minus foreign exchange costs and costs of domestic consultants. Pending review of the policy for domestic preference in procurement of goods and civil works, the status quo will be maintained with regard to the current eligibility of individual DMCs under the domestic preference scheme.
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