ADB funds merger — what it means for stakeholders

During the Asian Development Bank’s recent annual meeting in Astana, Kazakhstan, President Takehiko Nakao hinted at a major operational move that could potentially beef up the bank’s financial muscle without necessarily asking for more money from its shareholders. Nakao plans to merge two of the bank’s financial instruments — the Asian Development Fund and the Ordinary Capital Resources — to optimize ADB’s resources and thus finance more development projects in Asia-Pacific by “doing more with less.” “The rationale is to do more for poverty alleviation in the region, with less burden on the donors by introducing a mild market leverage that would not impact the financial strength [or] credit rating of ADB, nor the core mandate [or] strategy,” a senior bank official told Devex. ADF, a special fund established in 1973, offers “loans at very low interest rates as well as grants to help reduce poverty in ADB’s poorest countries.” The fund is currently at about $33.3 billion, most of which comes from donors and bank shareholders. On the other hand, OCR covers the majority of ADB’s loans “generally made to [developing member countries] that have attained a higher level of economic development.” Its capitalization is now $16.4 billion and comes from a mix of donors, bank earnings, debt payments from member countries, and borrowing from the international and domestic capital markets. The need to double down on the bank’s financial leverage has never been higher in the region, especially for infrastructure development, where investment needs are estimated at an annual $800 billion for the next 10 years — and this is excluding efforts in areas like health, education or climate change. While ADB has been keen to partner with the private sector and other development stakeholders, including a co-financing approach, much more capital must be injected. During his opening news conference in Astana, Nakao explained that the ADF-OCR merger is innovative and trailblazing, as the Manila-based institution will be the first IFI to implement such an approach, despite some similarities with the World Bank’s move to pool the resources of the International Development Association and the International Bank for Reconstruction and Development. “This is different from other organizations, where the concessional window may in fact be a separate legal entity,” the ADB official said. “ADF is merely a special fund account within ADB. Thus, the merger of the two accounts within ADB may be legally less complicated than across two separate legal entities.” How it will work Although the idea may sound a bit technical, a Manila-based expert told Devex the plan may actually work and achieve Nakao’s goals. George Manzano, a senior economist at the University of Asia and the Pacific, explained that in terms of policy, ADF is more “strict.” Because of the risks associated with lending to poorer countries, ADF loans come only from the money ADB has on hand. OCR is “more liberal in a sense that they can lend more” than what ADB currently has. He compared the funds to debit and credit cards: ADF is a debit card, meaning that you can only use the money that you have inside the card, while OCR is the credit card, through which you can spend money that you may not yet have thanks to your credit worthiness and financial capability. “In ADF, you can only lend but you cannot leverage,” Manzano noted, adding that by combining the two funds, ADB could lend more than it currently can. In other words, it can lend more because it can borrow more. OCR’s absorbing ADF will also give ADB greater leverage to borrow more money in the international capital market, thus increasing the bank’s own capital base to fund development projects without necessarily sacrificing its AAA credit rating; the higher the credit rating, the lower the interest rate when borrowing. ADB explained that by merging the two funds, its equity-to-loan ratio would gradually improve and become more conservative, reducing the risk for the lenders the bank borrows from. By having a conservative equity-to-loan ratio, Manzano explained, “what you are lending is not coming from other people but comes from you.” Risks Despite the inherent objective of the plan, there have been concerns regarding the repercussions it might bring, especially to poor countries still heavily dependent on ADF money. Some experts and development practitioners have suggested the merger could be discriminatory to poor countries if the interest rate increases. ADF loans are currently pegged at about 2 percent interest at their peak, while OCR’s is floating. The burden, for instance, might not be shared equally by borrower countries. Joji Reyes, technical director of the Manila-based development firm and ADB project contractor ICF GHK Consulting, wonders how the merger will affect pricing of the ADB loans. “Does this mean a blending of the costs?” Reyes asked, telling Devex that if it is, it would mean “higher costs for less-developed member countries and lower costs for the more developed member countries.” But ADB clarified that combining the funds will not change conditions currently being implemented by the bank. In addition, some of those countries might soon graduate into middle-income status. “No change in terms of lending [or] borrowing conditions for the borrower countries. Only the lending volume may increase,” the ADB official explained. “[The] rationale reflects the historical development in the region since the ADF was first founded 40 years ago … [that] ADF countries have accumulated a good record of debt servicing and are generally considered more creditworthy.” Manzano agreed, saying he suspects ADF-eligible countries would have graduated from being “very poor to maybe middle-income, in which case they are not qualified to get ADF anymore. The market for ADF, then, shrinks.” The ADB official further added that during the transition period, ADF-eligible countries will have access to a “concessional lending” window from the OCR. This will be “fully funded from the strengthened equity” and will not rely on ADB’s market borrowings for funding, “making it independent of market interest rate movements.” Asked about ongoing projects contracted to nonsovereign stakeholders, the bank official noted that “there will be no implications (particularly no negative implications) [on] all ongoing projects.” Manzano is not so sure about that. “They said that there will be no implication to ongoing [contracts] but what we don't know is what will happen to the future projects,” he said, echoing the concerns of several ADB contractors. For these contractors, the more pressing concern is what will happen after their contracts end and whether operations and policies will change — in terms of winning projects from ADB — in the next few years. 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