Thursday, September 21, 2006

IMF and World Bank : Where do India's interests lie?

A lot of people have been thinking about the evolution of the IMF and the World Bank. I wrote an article Fund and Bank: Where do India's interests lie? in Business Standard yesterday offering an Indian perspective on the question.

An Indian perspective on the IMF

Many in India view the Fund as a potential source of assistance in the event of a future currency crisis, as was the case in 1981 and 1991. This thought process leads to concerns about a better relationship with the Fund in a future crisis scenario.

I think that India's globalisation has gone so far that it will not be easy to mount a 'rescue' in the event of a currency crisis. In four years time, we will be a $1 trillion GDP with much more than $1 trillion moving in and out of the country every year. The IMF lacks the resources to cope with a currency crisis for a country of this size.

More importantly, the tools are at hand for largely eliminating the risk of a currency crisis. If we embrace a policy framework comprising a floating exchange rate, convertibility, and a narrow inflation-targeting central bank, then the contest between currency speculators and central banks (for which the IMF was designed) does not arise. It is better for India to walk down this path, where there will be no need for an IMF program in the future. Once we start thinking like a mature market economy, we lose interest in issues of who controls the IMF.

An Indian perspective on the World Bank

As far as the World Bank is concerned, there is a consensus on two issues. Gross capital formation in India is slightly below $200 billion a year. In this, $1 to $3 billion from the World Bank is just not a big deal, even after the problem of India's current account surplus is firmly out of the way. More generally, the market-oriented economics that has transformed India's growth opportunities and thus poverty reduction is now sustained by a domestic process of policy reform, where the World Bank is not an actor. The core business of Indian GDP growth, leading to poverty alleviation, seems to be driven entirely by private capital and the domestic political economy that sustains liberal economic policies.

That leaves the argument about knowledge riding alongside a World Bank loan. (See notes from Singapore by Ila Patnaik).

I am a skeptic on the knowledge inputs that the World Bank is able to bring when it comes to day to day reality. When we look at a program like Sarva Shiksha Abhiyan (SSA), where the World Bank was involved, it seems to look more like a traditional Indian government program - riddled with design problems - rather than a program that has been embellished with state of the art microeconomics of information and incentives. (Bibek Debroy's recent article Scrap the SSA is of interest in this regard).

Can the World Bank help by improving monitoring and evaluation? I didn't see that happening with SSA. It was Pratham - and not the World Bank - which discovered (at a tiny cost) that the kids getting enrolled through SSA aren't learning much. The bureacratic incentives of the World Bank are probably as unfriendly to discovering bad news as are those within the GOI.

Another perspective is that of incentives. Compare private sector financing versus World Bank financing in an infrastructure setting. Suppose a expressway project is packaged by Goldman Sachs and has private sources of equity and debt. Compare this against a traditional World Bank financed expressway project. I think the private sector version is superior for two reasons. First, there is generally less leverage with greater private sector involvement, which leads to more healthy project structure. Second, the private owners have an incentive to fight on all aspects of project success, from effective execution to O&M to revenues. In contrast, a World Bank bureaucrat is more likely to lose interest in a project once it is signed. It is better for India to have private financing rather than World Bank financing.

Finally, I instinctively dislike bundling. It is hard to think rationally about either knowledge services or cost of capital when the two are bundled together. I think unbundling of finance and knowledge leads to better procurement of both. The Indian project would be better off separately procuring the best knowledge services, and then procuring the lowest cost equity and debt capital. Mixing them up hinders clear thinking.

Hence, I'm unable to see an important role for the World Bank in a country like India or China, where high growth rates have already been ignited. High GDP growth, and thus poverty reduction, now rides on the domestic political problems of economic policy in these countries.

On the other hand, there are much more daunting problems with "failed states" which could merit a focused effort on institution building through an agency like the World Bank. These are big threats to global prosperity, in this post 9/11 age. If we think of WMD scenarios like a nuclear bomb on Manhattan island or an antiobiotic resistant smallpox virus that is let loose into the world, then the failed states count as major threats to global prosperity. I know, the World Bank's mandate prohibits involvement in political issues. But there is plenty of low-intensity work to be done in building a State, that I call "nation-building", which is not inconsistent with the World Bank's charter.

All around us, India has countries in dire need of nation building: Pakistan, Afghanistan, Central Asia, Nepal, Bangladesh, Burma, Sri Lanka. It is in India's best interest if these countries are able to achieve sound institutions and ignite high GDP growth. From a selfish Indian perspective, that's a great role for the World Bank - to give us a safer neighbourhood and enormous trade growth in our immediate neighbourhood.

That leaves the problem of a funding model. At present, the World Bank needs customers like India and China to make ends meet. If the Bank reorients itself to focus on nation building, it needs new sources of financing. In resolving this problem, I think it helps to see that nation-building in Afghanistan or Sudan is about producing global public goods. Everyone benefits when these countries are set on track. Placing the brunt of financing of these global public goods upon India and China does not sound like a fair arrangement. A reasonable solution could be to pass the hat around to the 25 biggest countries of the world, and ask for contributions in proportion to GDP.

5 comments:

  1. While I agree with most of what you say with respect to India, I am not sure why if the World Bank knowledge sharing doesn't work on Indian projects, they are any more likely to succeed in other troubled countries. The WB bureaucrat will still sign that paper and not bother to follow up or implement best practices.

    I am sure it will make everyone feel good that someone is helping to generate the global public goods. But that someone is not (and has for the most part never been) very good at it.

    The current global institutions like the UN and WB have proven time and again as useless institutions (or at worst perpetuating problems perennially). But still we pay homage.

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  2. My guess is that in troubled countries like Nepal and Afghanistan, the most obvious and basic inputs brought by the World Bank would be a step forward when compared with what the locals are doing by themselves.

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  3. Hi
    I have recently done a cartoon on India's under-representation at IMF. It will be great to know what you think. The link is http://www.pointblank2006.blogspot.com/

    Thanks
    Vikram

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  4. In the context of India integrating further into the global economy, it should strive to strengthen the multilateral institutions and assume greater responsibilities. Making judgments on the efficiency and/or relevance of an institution based on the failure of one project is misguided. There is a lot of cross-country expertise at these institutions that can be gainfully used, including in the Indian context, and I beg to differ from some of the rhetoric.

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  5. I'm all for more knowledge inputs and more study of international experiences. But does that require a bundling of loan + knowledge? And, is the commercial banking crew of the World Bank the best equipped do knowledge inputs?

    My counterfactuals would be as follows.

    1. Suppose Goldman Sachs is structuring a road project. Do you believe the knowledge inputs on either engineering or economics would be inferior to the work done by the World Bank? (Or would it be a bit better?)

    2. Suppose an Indian effort unbundles the debt from the knowledge. Suppose debt is obtained by open competitive bidding and knowledge services are obtained by open competitive bidding. If the World Bank is the best source of the knowledge, sure, it should get the knowledge services contract, but this doesn't *have* to be the case.

    3. In a lot of situations, project structure in India tends to have too much debt and not enough equity. The World Bank's financial model is not equipped to do equity, so there's an undue emphasis on leverage. This is not necessarily optimal.

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