While the World Bank’s resources for low-income countries have never been greater, they still pale in comparison with these countries’ needs. Governments always need to make hard choices between infrastructure needs, social programs, and fiscal discipline. One country was recently able to strike the right balance with the support of World Bank guarantees: Benin.
When Benin reached out to the World Bank, it had several objectives: getting support for poverty-reducing policy reforms, financing social investments, and refinancing short-term domestic debt. To achieve all these objectives the country could count on a $60 million IDA allocation. Benin's objectives called for an innovative solution.
World Bank guarantees in action
The government of Benin, their financial advisors (Rothschild), and the World Bank analyzed the situation and evaluated available options. Benin had relied exclusively on domestic debt markets and concessional financing to fund its budget deficit. The domestic bond market offered limited liquidity, relatively high interest rates (7 percent) and short maturities. Clearly, Benin needed to diversify its funding sources.
Benin hadn’t yet accessed the international commercial loan market. However, they didn’t have an international credit rating and was unknown as a borrower to this market. IDA (the part of the World Bank that helps the world’s poorest countries) offered to support Benin by providing a $180 million equivalent of policy-based guarantees (PBGs), which cover commercial lenders against the risk of debt service default by sovereign governments.
Benin was able to secure this guarantee despite only being allocated $60 million in IDA funds because the World Bank has a mechanism for low-income clients whereby only 25 percent of a guarantee’s value is booked against the country allocation. This meant that by allocating $45 million to PBGs, Benin could really receive $180 million-worth and use the remaining $15 million allocated as a regular IDA credit.
A key risk in such transactions is foreign exchange fluctuations. Benin and IDA wanted to ensure that any new debt wouldn’t add substantial foreign exchange risk. Since Benin’s currency has been pegged to the euro for decades, Benin decided to borrow in euro to mitigate the risk.
Another important point to know about World Bank guarantees is they only cover a partial amount of commercial financing raised by a country. In the case of Benin, IDA offered guarantees equal to 40 percent of the amounts to be raised. To get the best terms possible, Benin carried out a competitive tender to recruit international banks that would provide the PBG loans, encouraging innovative solutions.
Two banks were selected: MUFG of Japan and Credit Suisse of Switzerland. The MUFG loan was €260 million and Credit Suisse’s was €127 million, bringing the total raised to €387 million (about $450 million).
What did Benin do with the first €260 million loan? They used it to replace their short-term domestic debt with external commercial financing at longer maturity (12 years) and a much lower interest rate (about 4 percent). As a result, Benin rebalanced its debt portfolio, lengthened average maturity, and lowered the present value of the debt.
This implies savings of 0.5 percent of GDP (approximately €40 million) over the life of the loan. Additionally, the debt reprofiling freed up domestic resources and increased liquidity for the domestic financial sector. The IMF noted that this “debt reprofiling operation is a step in the right direction.” The initiative received high-profile support and attention from the government. Benin’s Minister of Finance and Economy called it out as a milestone in the country’s history.
What were the policy reforms?
Remember, this is a policy-based guarantee. Benin also carried out significant poverty-reducing reforms as a result. For instance, a critical issue for Benin has been reaching underserved communities with educators and health workers. Now, the government will deploy all newly recruited primary education teachers and 80 percent of newly recruited health care professionals to underserved communities, providing more equitable access to education and health services. And Benin is using the second PBG loan to invest further in health.
Another sector that benefits from the PBG is agriculture, which employs about 50 percent of Benin’s population. The country has many of the ingredients to be a successful agricultural exporter. However, the inconsistent supply of electricity has discouraged private investment. This operation facilitated changes in the power sector—including clearing arrears and introducing pre-paid energy meters as well as smart meters that will help the power utility provide more reliable service and become financially viable.
What will the future hold for Benin and policy-based guarantees?
Benin wants to attract additional foreign investors. This operation paved the way for new infrastructure financing by broadening the country’s investor base.
IDA PBGs also allow very efficient use of World Bank resources.
Following this successful example, several African countries reached out to discuss the possibility of preparing a PBG with the World Bank.
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