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p. 4 of 4 BACK | NEXT I. Introduction II. Background III. Proposed Approach IV. Conclusions and Recommendations

Review of Lending Foreign Exchange for Local Currency Expenditures on Projects

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IV. Conclusions and Recommendations

45. In recent years, the Bank has grown in size and complexity and, with the adoption of the strategic planning approach, it now pro ides greater country focus and gives specific importance to poverty reduction, social concerns, and environmental issues. At the same time the needs of the Region for development assistance an Id external resources have increased. The implications of these for the Bank's LCF policies are as follows:

1. The need for extending LCF on a selective basis continues.

2. LCF should be used to support the achievement of the Bank's medium-term strategic objectives.

3. While the existing LCF policies have generally met their objectives, a close monitoring of LCF is need d to achieve a more effective allocation of LCF resources under the Bank' changing strategic directions.

46. This review has generally confirmed that the LCF policies enunciated in 1983 continue to be relevant for guiding Bank operations in the future. It continues to be appropriate for the Bank to distinguish between local currency expenditures and foreign currency expenditures, and to provide a policy framework for the financing of local currency costs as envisaged by the Charter limitation. Within the Charter's mandate, the Bank has gradually liberalized its LCF policy, and since 1983 has used LCF as a means of supporting social sector projects and to ease tight resource situations in DMCs. This approach has given rise to a distinction between country considerations and project considerations in the Bank's LCF policy. The former addresses the need to provide resource support for DMCs facing an investment saving gap, provided their domestic resource mobilization effort is adequate. The latter focuses on the need for the Bank to bear a reasonable part of the cost of a project that has a high priority on strategic considerations but a low foreign exchange content. However, it is recognized that a close monitoring of the utilization of LCF is needed to ensure that excessive use of LCF does not act as a deterrent to dome tic resource mobilization and that LCF is used for supporting high priority projects. Paras. 47-50 deal with the institution of a framework for a more rigorous implementation and monitoring of the Bank's LCF policy.

47. While determining maximum cost sharing ceilings in public sector projects, an important issue is whether the DMC has provide a minimum contribution to project financing, to confirm its commitment. This contribution i based on the capacity of the DMC to raise resources from both domestic and external sources, and is broadly reflected in its per capita income level. The existing standard percentage financing limits, which are based on country groupings, therefore continue to provide an appropriate basis for determining maximum cost- sharing ceilings for each DMC. There are no strong reasons for changing the standard percentage limits at this stage. However, these limits should not be automatically applied and should be periodically adjusted, taking into account the country's performance in domestic resource mobilization, the balance-of-payments situation, and special circumstances that may prevail from time to time. Management should review the country cost-sharing limits periodically, preferably at the time of country program paper discussions, and determine the effective country cost-sharing limits in the case of each DMC.

48. In practice, programming considerations broadly limit the actual cost-sharing percentage for a project. With a given amount of programmed assistance for a DMC in a year and the number of projects that can be progressed for approval in that year, the actual cost- sharing limits for the various projects are determined in a broad way. Apart from this, in determining the actual allocation of the Bank' share in the total project cost for each project, differentiation should be made between sector that generally have the institutional capacity and the demand base to raise local resources (e.g., power, transport, industry) and those that are relatively weak (e.g., social infrastructure). In general, the Bank's share of the total project cost should be lower in the former than in the latter. However, the following considerations are also relevant for determining the contribution of the Bank: (i) institutional capacity of the implementing agency to raise local resources, (ii) priority of the sector in the allocation of budget expenditures, (iii) availability of cofinancing, (i) availability and affordability of domestic capital market resources for the project, and (v) the relationship between the project owner and the borrower (see para. 42). These considerations supplement the project level considerations which were prescribed in the 1983 Review of LCF policy (para. 9) and are currently in use. Significant variations in cost sharing between similar projects in the same sector should be explained in the Report and Recommendation of the President (RRP) with reference to these factors. As before, sectors that can contribute to such cross-cutting concerns as poverty reduction, human resources development, environmental improvements, as well as rural infrastructure projects, will merit high priority for LCF. Keeping in view the individual country ceilings determined periodically at the time of country Program Paper discussion, Management will determine the actual cost-sharing limit for each project (at the Management Review Meeting) based on an analysis of an appropriate cost-sharing arrangement among the Bank, the government, and other agencies.

49. The Compendium of Country Notes should, in the case of each DMC that is an active borrower, include a section on the Ban's LCF policy towards the DMC. Subject to this, the RRPs on individual projects should provide justification for specific projects: (i) country grounds (i.e., the country ceilings in practice should not be applied automatically but should be based on an assessment of whether the borrower is making adequate efforts towards mobilizing domestic savings and external capital from other sources on appropriate terms), and (ii) project cost-sharing grounds (i.e., if the specific project has too little foreign exchange cost to permit the Bank to achieve its project objectives by foreign exchange financing alone). The country justification should be based on an analysis of he DMC's development performance, particularly in the fiscal and external sectors of the economy, as presented in the Economic Review and Bank Operations Paper (ERBOP). If no significant developments have taken place since the presentation of the ERBOP, a short reference in the RRP to the analysis given in the ERBOP should suffice.

50. An information system is need d for systematically reporting the commitment of LCF in each DMC. At the end of the year, the Programs Departments will prepare a report to Management on the amount made available LCF to each DMC in that year. This analysis should appropriately touch upon balance-of-payments and fiscal performance of each DMC and the measures undertaken to improve domestic resource mobilization. A summary of this report l should be presented in the next Compendium of Country Notes and in the ERBOP.

51. The resources situation in the Bank’s DMCs in general remains weak compared with their investment needs. The Bank's medium-term strategic framework has aIso placed considerable emphasis on projects that address socioeconomic concerns such as poverty reduction and human resource development. These suggest that the Bank should continue to r use its LCF policy for the socioeconomic betterment of its DMCs in the medium term. However, in its lending operations, the Bank will continue to emphasize foreign exchange financing, since it is felt that the main constraint to economic development of Bank DMCs in the foreseeable future will be a shortage of foreign exchange resources.

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