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p. 2 of 10 BACK | NEXT Executive Summary I. The Context II. Present Bank Policies and Practices III. Graduation Policies of Other Multilateral Development Banks IV. Rationalizing the Bank's Classification and Graduation System V. Other Operational Implications VI.Conclusions VII. Recommendation

A Graduation Policy for the Bank's DMC's

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I. The Context

1. Since 1977, the Bank has had a three-tier classification system for determining the eligibility of its developing member countries (DMCs) for Asian Development Fund (ADF) funding and for applicable limits on Bank financing of project costs. Classification is determined at the time of entry. No borrowing country has been formally reclassified or graduated from one group to the next. Also, no DMC has formally graduated from Bank assistance, because the current policy does not envisage a stage beyond Group C. As part of the policy review commitments made during the ADF VII negotiations, the Bank is to submit proposals to the Board of Directors on a graduation policy for DMCs within one year of the effectivity of ADF VII.¹ Donors suggested that the proposed approach should preferably be comprehensive, extending graduation downstream, i.e., from ADF-only through "blend" status to ordinary capital resources (OCR)-only status and finally to graduation from regular Bank assistance. This Paper examines the issues relating to graduation and proposes an approach that would be consistent with the Bank’s role as a broad-based development finance institution.

2. The term “graduation policy” relates to the changes in the terms, the level, and the type of development assistance provided by multilateral development banks (MDBs) to a member country as it moves up the development ladder. In the early stages of a country's development, when its debt repayment capacity is weak and its per capita income is low, external assistance is provided on concessional² or "subsidized" terms. When the country reaches more advanced stages of development, MDBs do not need to maintain such a high degree of concessionality. Indeed, to do so would be counter-productive as it would constrict the freeing up and redirection of concessional resources towards countries that have a greater need for such resources (within the limits of their absorptive capacity). Lowering the level of concessionality of assistance at more advanced stages of development could be preceded by a gradual scaling back of the level of concessional assistance provided and a shift towards nonconcessional assistance. Changes in the terms and scale of development assistance are also typically accompanied by increasing resort to the use of indirect instruments such as guarantees, and by a shift from public to private sector lending. Eventually, the country is graduated from development assistance.

3. MDBs, including the Bank, do not merely supply official assistance but also facilitate the transition of member countries to greater reliance on private flows. Member countries are grouped according to their levels of development to allow for differentiation in operational guidelines across country groups. Graduating member countries from one group to the next as their development advances, moves them through configurations of terms, scale, and type of assistance consistent with higher stages of development.³ In this way, MDBs assist DMCs to progress from dependence on concessional assistance towards reliance on commercial capital resources, both external and domestic.

4. This Paper focuses on the process by which the Bank’s DMCs can graduate from one group in the classification system to the next. Two related topics are dealt with in separate papers: the issue of ADF loan terms⁴ and the allocation of ADF resources among countries with access to concessional resources.⁵ While these topics involve a complex set of issues and merit separate treatment, it is important to recognize the connecting facets: graduating DMCs across country groupings in step with their improved economic circumstances (i) moves them from terms that are highly concessional to terms that gradually approach commercial rates, and (ii) scales back the volume, first of concessional, then of nonconcessional, resources, culminating in graduation from regular Bank assistance.

5. This policy Paper on graduation is being discussed at a time when several Southeast and East Asian countries have, after decades of exemplary economic performance, suffered an unexpected reversal in their economic circumstances. An important lesson for the Bank’s graduation policy is the need to build into the policy framework adequate flexibility to accommodate changes in the DMCs’ economic circumstances, both positive and negative.

6. The rest of the Paper is organized as follows: Section II discusses the existing Bank policies and practices on graduation. Section III examines the graduation policies of other MDBs. Section IV proposes a framework for rationalizing the Bank's graduation system. Section V discusses other operational implications of the proposed changes in the Bank's classification system. Section VI includes conclusions and Section VII the recommendation.

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