ADB: from finance to social issues

As more and more international donors pay extra attention to women's and environmental issues, the Manila-based Asian Development Bank (ADB) is increasing funding in these areas in addition to help raising the profile of non-governmental organisations (NGOs), a senior ADB official says.

"We are changing from a project financing institution to a more broad-based institution where we provide services to policy-based programme lending and cross cutting issues like women, the environment and the role of NGOs," said Tadashi Kondo, resident representative of the ADB's newly set-up office in Colombo. Mr. Kondo, who opened the ADB's first mission in Colombo in November last year, spoke to The Busines Sunday Times senior correspondent Feizal Samath in a wide-ranging interview dealing with issues like the reasons for setting up an office here, its funding portfolio and the bank's new direction.

Q: Why did ADB decide to set up an office in Colombo?

A: This has been long overdue. The government has been requesting us to open an office over the past so many years. But the ADB expansion depends on the board of directors who would have to decide whether the budget permits such expansion. Recently ADB's operations have become complex. We are changing from a project financing institution to a more broad-based institution where we provide services to policy-based programme lending and cross-cutting issues. The coverage of our programmes has become far wider.

Q: So what is the focus now?

A: We are focusing on policy dialogue, capacity building, good governance, mobilisation of co-financing, and sub-regional co-operation - in this area its perhaps South Asia co-operation. South Asia is still not in full swing but we started a project between India and Bangladesh in the energy sector.

Q: Is the new focus a result of a restructuring of the ADB?

A: This direction has been given by the board. It is not a new direction but simply that we have expanded in terms of coverage. Money-wise too we are becoming bigger in terms of lending volumes. It is not merely lending the money to projects but ensuring that every project incorporates all issues. That's how we address each project. That has been the change that we are going through. That requires more monitoring of projects starting from the feasibility study, project processing, implementation and so on.

Previously an ADB mission would come here only once or twice a year and they work on certain projects and return. That is not an effective way of ensuring our presence. That's why we felt the need to set up an office here.

By being closer to our clients, we believe we can deliver much better our services. Of course, our office is still small. There are six of us. In terms of operations, there are only two of us. We started a modest office and we had hoped to expand but that has not happened. We have to observe the first year operations and assess what is the critical mass of an office like this. If the office is too small we may not be effective and we may be spending too much money. We would like to arrive at a critical mass and this exercise would be done after one year.

Q: What are the projects that the ADB is funding in Sri Lanka?

A: There is the agriculture sector which includes rural development, plantations, perennial crops (that accounts for about 29 percent of our total current spending); resources like urban development and social infrastructure (29 percent), roads (10 percent), emergency rehabilitation for Ceylon Petroleum Corporation oil tanks which were damaged three years ago (20 percent), and the rest is in the financial sector — small and medium scale industries and development financing.

Our portfolio is around $US 860 million. That is the size we are managing, which is the accumulated total of ongoing projects. On an annual basis, funding is in the region of $US 160 million. Each project has a duration of five years.

Q: Do you work in environment projects?

A: In the past, our involvement in the environmental sector per se was, may be not so much, but now under our new operational strategy for Sri Lanka we are emphasising on environment and social sectors. We do emphasise on green environmental issues rather than brown, like solid waste management, etc. Green environmental issues are more like preventive measures and management of them. We have a forthcoming project on forestry and bio-diversity conservation management and comprehensive water resources management and coastal resources management. These are heavily environmental-aided projects, specifically addressing environment issues.

In the past, social and environment issues were also addressed but those projects had economic growth as the primary objective. Our emphasis is gradually changing from purely economic growth to other cross cutting issues like environment and social concerns. Those are now high up on our list of priorities and what we call medium-term planning direction. Bank-wise there are five strategic development objectives — promoting economic growth, reducing poverty, supporting human development, improving the status of women and protecting the environment. Perhaps earlier women may not have been a target group but now we will try to specifically target women. We want to incorporate that kind of component in a project we finance, or at least we must identify what issues we must address in relation to women's role in development.

Some four or five years ago, our emphasis was largely on, economic growth but now we are incorporating other objectives in a project and some projects are specifically targeted, like environment for example.

Q: Sri Lanka appears to have the best social infrastructure in the South Asian region and our social investment, despite the ongoing war, has been hailed as a model for the region. But are we doing enough?

A: High defence spending may affect this sector to some extent. But Sri Lanka's problem is unemployment and the incidence of poverty. So to address these, our strategy is to maintain a high rate of economic growth. That is a primary objective here. But if you aim at higher growth, there will be a problem in the transition period in terms of environment and social issues. Therefore we also have to address those areas. Economic growth alone cannot solve the problem of poverty, or women, or rural poor or rural poor women.

We are upgrading the marketable skills of the labour force. This is one of the main thrusts of our operation, specifically addressing the rural poor and women in the rural areas. We provide the skills so that these people who are left out of this economic growth curve, would have their own means of livelihood.

Q: How are the ADB programmes carried out here? Is it totally through government agencies or to some extent through the private sector?

A: On the economic growth side, the private sector can also play an important role. We provide some facility to the private sector. But that is somewhat limited. We are basically working with the government. What we do is to increase the private sector role in this country's economic activity. We want to encourage the government to create an environment that is conducive to private sector operations.

The government has a clear policy framework for private sector involvement in infrastructure, for instance. But at the same time when we specifically target poor women in rural areas, we work through the government.

Q: In poverty alleviation, there is a general perception that the current programme and ones in the past don't reach the poorest of the poor. Your perception?

A: Geographically, we are not addressing the problem of Colombo, but outside the capital where there is large scale poverty. To reach out to poor people, the ADB alone cannot do it. The ADB is now finalising its policy on cooperation with NGOs and I think with new policy initiatives, which would mean increased cooperation or more structured cooperation with NGOs, we may be able to reach a wider group of people. Or at least we may be able to be more skillful in identifying the real people who need the assistance.

Q: Has the ADB worked with NGOs before or is this a new area?

A: Yes, we have worked with NGOs before. But we have not been so structured in the way we cooperated with NGOs. Sometimes it's by coincidence, sometimes because we know them. This resident mission is going to play an important role as a bridge between local NGOs and the government and also with the headquarters in Manila.

Q: Do you see the role of the NGOs as complementary to what the government does; to be able to work in areas where the government is unable to due to lack of financial resources?

A: Our role is to encourage the dialogue between NGOs and the government. Not all governments like NGOs.

Q: Is this NGO focus a new concept for the ADB?

A: No, there is a policy paper on cooperation between ADB and NGOs worldwide. In 1987, ADB produced its first policy paper on NGOs-ADB cooperation. Now we have revised this policy paper to give it a sharper focus. The resident mission becomes a focal point in the new policy. This new policy will be discussed and approved by the ADB board later this month.

Q: Are NGOs a big component of the ADB's programme in Sri Lanka?

A: We don't earmark any specific amounts for NGOs. They will become a part of our projects and will be able to do part of our work. They can facilitate or implement one or two components of a bigger project. So that's how I think we will involve them. Also it depends on the capability of the NGOs. Overall the government will manage the project. They are the executing agency but in the design stage we can identify what areas the NGOs can help.

Q: The direction of the economy. Is the government going about it in the right way?

A: The economy recovered in 1997 from 1996 in many aspects like GDP growth increasing, unemployment rate decreasing and interest rates falling.

A balance of payments surplus was recorded and inflation also fell. With the new budget and the continuing conflict in the north and the east, there are areas we have to be cautious but the ADB thinks this recovery would perhaps continue in 1998 basically because the government policy appears to be in line with what has already been done. Another area of concern is the South East Asian and East Asian crisis which impact has not been felt in Sri Lanka so far.

But if this crisis persists it may have some impact here. Sri Lanka has maintained a gradual depreciation of currency policy and I think it has worked well. Because of a slowdown in the other economies in Asia, overseas workers' remittances by Sri Lankans may reduce and also investments from Korea, Malaysia may decrease. This is a double impact.

Q: Are there any remedies here and what steps could Sri Lanka take to minimise the impact?

A: The gradual depreciation of the rupee against the dollar is good. In terms of capital inflows and outflows, this country is protected.

Q: In what sense?

A: Like falling investment portfolios. In this case the stock exchange and real estate are well protected. Those are the causes of the problems in Southeast Asia but this is not the case here so perhaps the impact is not as great. I am not saying that this is a good policy. Maybe it is better to liberalise. But you can do that only when you have internal control, monitoring surveillance framework - legal and regulatory, the capability to control excess money and only then the liberalised economy would work efficiently. But in Southeast Asian countries, these were not in place, and yet they freed the market. That was the problem. Here we have something to learn from that experience.

Q: Sri Lanka has not freed the capital account? Will we ever do that in the context of the financial crisis confronting parts of Asia?

A: What is important is that we improve the financial sector and some donors like the World Bank are interested in seeing that this country does not become vulnerable to external shocks.

Q: Is the government's privatisation programme on track?

A: They have done a great job last year in telecommunications and plantations. We helped in tea, rubber and coconut providing a policy-based loan towards policy changes with an eye to privatisation. That is an ongoing process. This year we are going to pursue this policy even further.

Q: Are donor funds drying up? Is there less money for developing countries now?

A: In terms of money availability, the ADB has two sets of resources. One is Ordinary Capital Resources (OCR) which is a commercial loan. Whereas in Sri Lanka we have ADF — Asian Development Fund — which is an interest-free loan with an amortization period including a 10-year grace period. But this ADF depends on donor contribution from our members. The volumes or magnitude of the money and also the timely availability of the money, are the two key issues. I think the ADB has some problems in this area because the negotiations of the ADF with the donors are getting more difficult.

In the case of Sri Lanka we are still providing $US 160 million a year, which is number two in terms of volume after Japan. The World Bank is the third largest donor to Sri Lanka. The three institutions combined are the country's major donors - something like 80 percent.

Q: Asia has been touted as the fastest growing region in the world but now we have a part of Asia struggling with a financial crisis. Will a lot of money be pumped into those countries to revive their economies?

A: The ADB provided a large amount of money to Korea, Thailand and Indonesia and last year our lending volumes shot up to more than $US 9.0 billion in total compared to an ordinary year of lending which is in the region of $US 5.5 to 6.0 billion. But that increase came from ordinary capital resources which has an interest rate of 6.5 or 7 pct. So, it is different from the ADF which is for the poorest countries, like in this region Bangladesh and to some extent Pakistan.

Q: Does the ADB help in private sector development?

A: On an average year, around five or six pct of our lending goes to the private sector as direct investments. These investments are usually in development financing institutions and infrastructure like BOT projects, ports, energy and power, expressways.

Q: Is the ADB involved in rehabilitation of the north and the east?

A: We are not involved in that yet. So far, the government has not requested us for help. The ADB also has had some bad experience before when the peace process was on. At that time the ADB helped rehabilitate some of the infrastructure but the war started again and those things were destroyed. That is a situation we must avoid and we are now cautious. In future, we would take into account issues like is there a permanent peace process, and will it hold.

Way out of bad banking

The lack of proper regulatory control over the banking system is said to be one of the cause of the East Asian financial crisis. In an article entitled "A way out of bad banking" published in the London Financial Times, Tom Petri and Bert Ely say that a private guarantee system for banks would have the benefits of current government supervision without its costly drawbacks.

They state categorically that government oversight of individual banks is not working. Although govts stand ready to support big banks against failure to maintain the health of the banking system and ensure the uninterrupted operation of the payments system, the writers feel there is a serious drawback. By offering protection against the consequences of bad banking, they say, government regulation helps inadvertently to encourage it.

The writers say that because of this protection, loan interest rates do not incorporate a sufficient risk premium and hence uneconomic projects are too easily financed, fostering speculative bubbles that eventually burst.

The writers make the point that "the political reality is that many banks as well as entire banking systems are simply too big to fail" yet, they say, their rescuers are not paid in advance for the risks they bear because "government regulatory monopolies cannot properly price risk."

Petri and Ely question the "conventional wisdom that only governments should supervise individual banks". After all, they say competitive markets produce better outcomes than government monopolies. According to the writers, another aspect, the "one-size - fits-all rules, such as the Basle risk-based capital standards constricts banking strategies and this, in turn fosters banking homogeneity and the herd instinct that often leads to crisis. Hence it is legitimate for governments to want sound banking in order to ensure systemic stability.

The writers contend it is not axiomatic that public officials must directly ensure sound banking on a bank-by-bank basis. Private sector companies and individuals, they say, who place their own capital at risk would be much more diligent in pricing and monitoring bank insolvency risks than government bureaucrats who doå not have wealth at stake "and are rarely fired even after a banking crisis".

The writers propose a new division of responsibility between government and the private sector. Governments should remain responsible for ensuring systemic stability and for devising a mechanism to achieve that goal. Governments should delegate the supervision of individual banks to a new "cross-guarantee" system.

The writers go on to describe the system they envisage. Each bank would negotiate a prudential regulatory contract with an ad hoc syndicate of voluntary guarantors,, largely other banks. They would guarantee against loss all of the individual bank's deposits and other sources of funding, regardless of the currency in which that funding was denominated. In return the guarantors would receive a negotiated risk-sensitive premium. The premium would be frequently adjusted to reflect changes in the guaranteed banks riskiness. Premium formulas would be based on leading indicators of banking risk, such as exposure to emerging speculative bubbles. Competitive pressures would force the inclusion of these premiums in loan interest rates, thus inhibiting the formation of bubbles. A bank's compliance with contractually specified prudential practices tailored to suit its business strategy would be monitored by a private sector "syndicate agent" chosen by the guarantor and the guaranteed. Each cross-guarantee contract would have to conform to the government's risk dispersion rules. They would ensure that all bank insolvency losses are borne within the universe of guarantors.

The writers say existing deposit insurance schemes have many elements of the cross-guarantee concept and their proposal merely privatises these schemes. The scheme would require a large pool of banks. Cross-guarantees would grow as individual institutions obtained contracts. Increased numbers, say the writers, would further strengthen the cross-guarantee system's capacity to absorb "shocks far worse than the Great Depression". They conclude by saying that in the interest of economic efficiency and systemic stability, governments should try market-based regulatory mechanisms. The cross-guarantee system meets that need.

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