Dubious Development: The World Bank’s Foray Into Private Sector Investment

By Charlie Cray

Traditionally known for lending money to governments, in recent years the World Bank has increasingly loaned to and invested directly in corporations doing business in developing countries. The International Finance Corporation (IFC) — the private sector lending arm of the bank — is now the fastest growing component of the World Bank Group.

The IFC says its mission is to “promote private sector investment in developing countries, which will reduce poverty and improve people’s lives.” The idea is that strategic investments and interventions by the IFC can create jobs and spur sustained growth.

“Sustained economic growth is essential for poverty reduction, and the private sector is the main engine of growth,” says Ludwina Joseph, a press officer with the IFC.

But critics charge that, as a profit-making concern, the IFC prioritizes the pursuit of profit over economic justice, social or environmental concerns. Rather than promote development and alleviate poverty, they say, the IFC uses taxpayer dollars to subsidize multinational corporations and businesses connected to local elites. Recently, the IFC has attempted to respond to claims of favoritism to big companies with new initiatives; but these new programs themselves raise a host of new questions about institutional accountability.

These charges are particularly serious since the IFC’s role will continue to grow in importance so long as the Bank and International Monetary Fund continue to push privatization policies and market-based solutions to alleviating poverty.

The Profit Mentality

The IFC supports the private sector by making loans directly to corporations, investing directly in private projects, and by syndicating loans through financial intermediaries.

By investing its own money or making loans without government guarantees, the IFC seeks to assure private investors — both national and international — that investments in developing nation markets are a worthy risk. In this manner, the IFC says it is catalyzing much greater private sector investment in “frontier” areas — developing countries and sectors that might otherwise be overlooked were it not involved. Risks and management responsibilities are left principally to the companies carrying out projects receiving IFC funding.

Critics say the IFC’s investments and loans are driven by a profit-making mandate, while little attention is paid to measuring the impacts its activities have on rates of poverty. The bulk of IFC money goes to lucrative infrastructure projects that have significant social and environmental costs, as well as financial intermediaries who allow the IFC to remove itself from any oversight responsibilities.

“The IFC’s portfolio is oriented toward the interest of corporations rather than environmentally sustainable development,” says Carol Welch of Friends of the Earth USA, which last year published “Dubious Development,” a critique of the IFC. “Many of the projects they are involved in — such as oil, mining and gas, coal-fired power plants and luxury hotel chains — fail to deliver on their own mission of alleviating poverty and often contribute to environmental crises such as global warming.”

The IFC’s harshest critics say that it should be closed: private investment flows to developing nations have exploded in the last decade, reducing the need for the World Bank’s private-sector arm, which was created in 1956. They contend that borrowing companies, particularly multinationals with access to deep pockets, should be able to stand on their own legs without the support of the IFC.

“Our criteria for working with multinational clients is that they offer modern technology and management techniques in their fields, are interested in transferring those skills and knowledge to local partners in developing countries, and are committed to working with the Bank’s guidelines for social and environmental responsibility,” counters the IFC’s Joseph.

Perhaps the most unwelcome criticism of the IFC came in March of 2000, when the U.S. Congressional Advisory Commission on International Financial Institutions (dubbed the “Meltzer commission” after the commission’s chair, Allan Meltzer) spelled out its assessment of the IFC in just two short paragraphs out of a 124-page report. The commission concluded that “private-sector involvement by the development institutions should be limited to the provision of technical assistance and the dissemination of best practice standards.” The IFC’s core functions, along with those of the Multilateral Investment Guarantee Agency (MIGA), a World Bank arm that provides investment guarantees to private investors, should be left to the private sector, the Meltzer report urged. “Investment, guarantees and lending to the private sector [by the World Bank] should be halted.”

“The cause of private sector development would be ill-served without IFC and MIGA’s support for ‘frontier’ investments and breakthrough demonstration projects,” responds the IFC’s Joseph.

IFC officials say the IFC remains the single largest source of investment in poorer developing nations, and that its involvement is critical to creating private sector-driven growth in both low-income countries and rural regions of middle-income countries. Between 1993 and 1999, the IFC expanded its reach from 55 to 78 countries and expects this number to expand further. IFC officials add that a new strategy involving smaller-sized businesses will also expand its mission.

But the IFC’s new strategy is still slow in coming, with its investments and loans still concentrated in a handful of middle-income countries. According to the IFC’s 2000 annual portfolio review, the IFC “continues to face a significant concentration of exposures in a few countries, notably Argentina and Brazil. In addition, the largest 10 country exposures account for 57 percent of IFC’s portfolio.”

Meanwhile, the profit imperative may be the biggest obstacle to operating in the poorest parts of the world. The IFC reports that non-performing loans in frontier markets averaged 14 percent between 1996 and 2000, compared to an average of 8.2 percent for the corporation as a whole. “While a few specific equity investments in frontier markets have done well, these are concentrated in two or three countries while the remainder of IFC’s equity investments in frontier countries had significantly lower financial returns compared to the rest of the portfolio,” the IFC’s latest portfolio review admits. “If the corporation were to increase significantly its relative investments in frontier sectors, it could potentially face lower net income.”

A Poor Report Card

It is not just external critics who have challenged the IFC’s performance. The IFC’s internal watchdog — the Operations Evaluation Group (OEG) — issued its year 2000 internal evaluation report this February. A copy of the confidential report was leaked to Multinational Monitor.

OEG says there is little strategic coherence to the IFC’s approach to private-sector lending: “IFC does not systematically form expectations for, nor monitor, projects’ diverse development impacts, distribution effects or poverty impacts,” the OEG says. “This gap between IFC’s recently adopted mission statement and its operational procedures limits accountability, affects staff incentives and poses risks to IFC’s reputation.”

The OEG attributes the IFC’s problems to a variety of factors, including:

• a “lack of objectivity and depth of due diligence in appraising sponsors and managers;”
• a “failure to specify project development objectives with monitorable indicators, coupled with a near-exclusive supervision focus on IFC’s loan performance as distinct from both development impacts and the quality of equity outcomes”; and
• “inadequate environmental structuring, reporting and supervision.”
  

OEG officials add that even the IFC’s own economists believe the IFC suffers from an “approvals culture, which provides a disincentive for rigorous analysis [that] still persists today.” This “approvals culture” is fueled by the fact that investment officers’ job performance is assessed on the amount of money they can move out the door, not on the success of projects or the social, environmental or development impacts of the projects.

The basis for the OEG’s critique is revealed in the IFC’s project record. IFC investment officers continue to develop projects like luxury resort hotels and shopping malls, which may generate modest foreign exchange and create employment but few other benefits, especially when the investors and occupants are foreigners.

The IFC is also pushing the use of technologies which have already demonstrated adverse environmental impacts and have been criticized as being dirty or obsolete, including chemicals, aluminum and waste disposal technologies.

In India, for instance, the IFC is considering loaning $20 million to Chemplast, for the transfer of a “partially erected but unused PVC and VCM (vinyl chloride monomer) plant” from Bulgaria. The production of PVC involves the creation of dioxin and other cancer-causing chemicals. There is no clear need to demonstrate the viability of this industry in India, which already has a significant number of PVC and other plastics producers.
Similarly, the IFC is proposing to build a medical waste incinerator as part of the “Alexandria Cleanliness Project” in Egypt. The project would be the IFC’s first investment in the waste business. “We believe that the benefits of introducing modern technology and management techniques, and the multiplier effect that this has on similar operations elsewhere, outweigh the losses from dividend repatriations and should result in a very positive economic return for the country,” says William Bulmer, Manager of the IFC’s Infrastructure Department.

But critics in the Global Anti-Incineration Alliance say the project has the potential to create higher unemployment and lower recycling rates because it threatens to displace an informal network of tens of thousands of waste collectors who currently divert a high percentage of waste for recycling and composting.

“There are also safer, more economically viable alternatives to incineration (which emits dioxins and other toxic pollutants now subject to elimination under the POPs Convention), including autoclaving and microwaving,” says Neil Tangri of the Global Anti-Incineration Alliance and Essential Action, a project of Multinational Monitor’s publisher, Essential Information.

Bulmer says no final decisions have been made on the selection of technologies and other issues.

Size Matters

IFC executive vice president Peter Woicke says that the IFC continues to develop infrastructure services such as power plants, water supply and telecommunications because they are “fundamental to the quality of life in the developing world. Without reliable and reasonably priced access to these services, people suffer and companies have difficulty surviving.” Yet internal documents suggest the IFC gravitates towards large infrastructure projects involving telecommunications, mining and electricity generation mostly because they are among the most profitable.

Extractive industries — oil, mining and gas — represent about 11 percent of the IFC’s portfolio and, according the IFC, have “by far the highest equity return.” Just two joint ventures accounted for nearly 40 percent of the IFC’s total dividends in FY2000.

At the same time that it is pursuing large infrastructure projects, according to Peter Woicke, the IFC is also regearing its approach towards “increasing support for small and medium enterprises (SMEs). This effort is particularly important as state-owned enterprises downsize and continue to be privatized.”

Yet “IFC’s experience in direct SME investments has not been positive from a financial standpoint,” the IFC’s Annual Portfolio Performance Review for 2000 states.

These small, low-return projects receive less IFC staff attention. “IFC is neglecting its supervisory and administrative responsibilities towards small-sized projects,” the OEG says.

The IFC’s solution: farm out direct oversight to financial intermediaries which, in turn, make smaller loans to downstream companies and retain responsibility for overseeing the social and environmental impacts of the subprojects they lend to.

Although direct investments in SMEs actually make up only a tiny volume of IFC approvals — under 2 percent throughout the 1990s — the IFC is increasing its use of financial intermediaries and wholesale lenders. While it is difficult to measure the extent of IFC’s support for SMEs through intermediaries, by 2000, financial services (including intermediaries) grew to represent almost half of IFC’s approvals.

IFC officials contend they will actually improve their oversight of SMEs through the use of financial intermediaries. “Since 1998, IFC has had special requirements for financial projects. These requirements may range from the provision of training for financial intermediary staff to IFC review and monitoring of all subprojects,” says Ludwina Joseph of the IFC’s press office.

But the use of private intermediaries raises basic questions about accountability. Do these intermediaries share the IFC’s purported commitment to social, environmental and development goals, as well as profit? How effectively does the IFC monitor projects funded by intermediaries for compliance with the IFC’s environmental and social safeguards? How does the IFC remedy instances where intermediaries fail to comply with these safeguards and force future compliance?

Privately, IFC officials agree there are no good answers to these questions. An IFC “Roadmap for Sustainability” — a Powerpoint presentation made to employees at a recent IFC retreat — suggests that when it comes to financial services, “we just don’t know the impact and have little leverage — this is where the next stakeholder issue will come.”

Those “stakeholders” might be environmentalists, who point out that financial intermediaries are not required to disclose the environmental impacts of a subproject unless they are classed as “Category A,” meaning they “may result [in] diverse and significant environmental impacts.” Judging a project as “Category A” triggers a requirement to conduct a detailed (and costly) environmental assessment. Project sponsors who want to keep their costs down thus have an incentive to avoid increased environmental oversight.

It’s also not clear how much the poor will be able to benefit from some of the new financial instruments created by the IFC and its financial intermediaries to service poorer countries. In June, for instance, the IFC announced a plan to establish a market for weather derivatives in Morocco. “Everyone would be delighted to do this,” Diego Wauters, the executive director of Societe Generale, the project sponsor, gushed to Derivatives Week magazine. But “everyone” may not include poor farmers.

Strange Synergies

Jerome Levinson, a member of the Meltzer Commission and professor at American University Law School, says that, even if more effectively undertaken, the IFC’s programs on small and medium enterprises would be meaningless in the context of other Bank and IMF activities.

“I don’t see how the IFC can itself create an adequate source of credit for small and medium enterprises,” Levinson says.

“With the policy of the indiscriminate opening of capital markets, which has been the leitmotif of our Treasury [Department] as well as the World Bank and IMF, you simply open the door to the concentration of economic power,” Levinson contends. “In a country like Argentina, for example, the domestic banking system has been taken over by foreign banks. One of the first things the foreign banks have done is curtail lending to the small and medium enterprise segment. There is a gap or vacuum of the availability of credit for small and medium enterprises, which is leading to a concentration of economic power and of course a growing income inequality. It’s not clear to me that an IFC or any foreign entity can really compensate for that, so it seems to me that the IFC is a feel-good dabble-around-the-edges throwaway to American rhetoric for private enterprise.”

If there is any coherence to the IFC’s work with the IMF and other parts of the World Bank, it may be to prey upon economic weaknesses induced, at least in part, by Bank and IMF policies.

For example, in July 1999, a year after the Asian financial crisis (widely acknowledged to have been caused, at least in part, by IMF policies), the IFC proposed to take a $48.8 million equity stake in Kookmin Life Insurance Co., Ltd. (KL), which became insolvent during the crisis. The IFC proposes to restructure the company in partnership with New York Life International, Inc. “The new company,” the IFC said, “will further expand its business by taking over the books of a number of other failed life insurance companies when they are auctioned by the Government at a later time. This would enable the new KL to quickly reach a critical mass and become one of the largest life insurers in Korea.”

A Key Role in Privatization

The Bank openly acknowledges that its pro-privatization policies are creating an increasingly important role for the IFC.

“The Bank and IFC now collaborate in the formulation of country assistance strategies (CAS) that guide our collective work,” says Peter Woicke, who was hired in 1999 to both lead the IFC and serve as a managing director of the Bank itself, a joint appointment that signaled World Bank President James Wolfensohn’s intent to more closely integrate IFC and World Bank operations.

The Bank’s CAS’s often recommend privatizing services formerly operated by governments, including transportation, telecommunications, education and water — sectors that the IFC is increasingly investing in and lending to, a situation which has left the IFC open to charges that its public interest mission conflicts with its drive for profits.

In the Bank’s draft private sector development strategy, issued in June, the Bank proposes to “unbundle” projects so that the profit-making parts are carved out for corporations to bid on while other groups (e.g., non-governmental organizations) administer subsidies through the loss-making parts of the project. The IFC’s role would be to pick up “all good deals left on the table” by the private sector.

Critics say the move to unbundled projects appears to create opportunities for the private sector to move into risky situations by absolving corporations of significant social, environmental and financial responsibilities. Instead of having to plow profits back into the loss-making part of a project (such as environmental clean-ups or subsidies for the poor), corporations would walk away with their profits, leaving the rest to the public.

But while the IFC and Bank are working to build synergies in their approach to investment policies, they have done little to build meaningful synergies when it comes to environmental and social policies. A new World Bank environmental strategy developed for two years and approved by the Bank’s executive board in July (and intended to provide stronger incentives for Bank staff to pay attention to environmental issues) does not apply to the IFC or MIGA.