Developing countries face historic challenges brought on by the COVID-19 pandemic and accompanying economic crisis. In response, international development finance institutions like the World Bank are helping their client countries contain, manage and recover from COVID-19 and the social and economic havoc it has wrought.
Since early March, the World Bank Group has mounted an unprecedented response to the crises, with emergency financing already approved for over 100 countries. Much of the Bank's emergency response funding will be channeled as development policy finance (DPF). This type of lending aims to support development objectives through a combination of policy reform and fast-disbursing general budget support.
Climate change policies haven't featured prominently so far in the policy lending packages. Yet, climate-focused DPF should be an important part of Bank-supported recovery efforts going forward. The nature of today's recovery efforts will likely influence economic development pathways for many years to come. As its COVID-19 response moves into a longer-term recovery phase, the World Bank should actively identify client countries with ambitious climate objectives, high potential to mitigate climate change, or acute climate vulnerability. The Bank should prioritize these countries for supportive DPF programs.
Why Development Policy Finance?
The Bank is already scaling up DPF. From January through July 2020, the Bank approved 62 DPF operations for a total commitment of approximately $14.6 billion, an amount that exceeds the Bank's DPF commitments for all of fiscal year 2019 ($13.8 billion).
This trend is not confined to the World Bank. Many of the Bank's peer institutions — including the Asian Development Bank, the Inter-American Development Bank and the African Development Bank — also engage in DPF, and it is likely to be an important part of those banks' COVID-19 responses. The Asian Development Bank has already more than doubled its DPF commitments in 2020 relative to 2019.
DPF differs from the more straightforward investment project financing through which the Bank funds specific investments in, say, power generation or transportation infrastructure. With DPF, the Bank provides governments with fast general budget support in exchange for a pre-agreed program of institutional and policy reforms referred to as "prior actions."
Individual DPF operations can require, for example, economy-wide macroeconomic and fiscal reforms, or reforms in specific sectors of countries' economies. Once the borrowing country demonstrates that it has completed all prior actions, the World Bank disburses funds as non-earmarked budget support in the form of World Bank loans, grants or guarantees.
Policy lending is not without controversy. In the past, "conditionality" has generated political controversy in borrowing countries and has often failed to meaningfully improve development outcomes. But DPF remains an important tool for crisis response. While individual timelines from approval to disbursal vary, DPF provides governments with fast-disbursing, sorely-needed budget support.
Today, governments around the world face increased pressure on public budgets to meet multiplying urgent needs, while economic shocks are simultaneously depleting tax revenue and reserve funds. Governments need the fast, flexible support that DPF provides now more than ever. Done right, DPF operations can also promote policy reforms that foster successful crisis response and sustainable growth, without undermining political support for the government that takes out the loans.
What Can Policy Lending Do for Climate and the Environment?
The World Bank and client countries can use policy lending to pursue reforms related to climate change and the environment. A decade of environmental policy lending suggests that DPF works best when policy issues are the central barrier to improving environmental outcomes and when there's already strong political buy-in. Additionally, environmental DPF has sometimes proven challenging in countries with high poverty and may be easier to support in large middle-income countries.
WRI recently reviewed a representative sample of 26 recent DPF operations (out of 62 approved this year) to consider the extent to which these operations included policies related to climate change and the environment. Note that data on the impact of prior actions on the environment rely solely on the Bank's own assessments; we have not independently verified these. With this caveat in mind, we found that:
1. Most development policy loans extended during the COVID crisis appear to contain prior actions that are good for the environment and/or mitigate climate change.
All but five lending programs in the sample include at least one prior action that the Bank identified as having positive environmental effects. That said, while Bank policy directs its internal project teams to assess prior actions for likely significant environmental effects, it does not establish formal procedures for doing so. Teams look to guidance documents dating back as far as 2004 for help implementing this requirement.
2. Few environment-damaging prior actions seem to be showing up in loans.
The 26 programs in the sample include 119 prior actions. Of those, the Bank's project teams described just four as having potentially negative environmental effects. These include, for example, measures that could increase the use and disposal of hazardous medical supplies and a measure to defer corporate taxes.
3. Prior actions with potential environmental benefits are spread across a wide range of sectors.
Environmentally-friendly policies show up in prior actions related to public administration, finance, education, health and social protection, not just in more traditional sectors like agriculture, transportation, water and energy.
Read with Caution
There are reasons to be skeptical. A past Independent Evaluation Group (IEG) evaluation found that the Bank tended to underreport potential negative environmental impacts. IEG reviewed the policy measures in 100 DPF operations between 2005 and 2014 and identified 66 policy measures that posed potential environmental risks, of which Bank staff had identified only 35.
In addition, prior actions identified as having positive environmental effects vary widely. For some, the potential benefit is clear. For example, one prior action requires Uruguay to adopt a national climate change adaptation plan for its agriculture sector. For others, the connection to the environment is tenuous or not easily discernible. One program calls for Kenya to establish a public database of government procurement tenders and contracts. While such reforms may create environmental benefits, project documents do not always explain those benefits or the likely cause and effect.
There is also a difference between DPF operations that include one or two environmentally beneficial prior actions and DPF operations whose overarching development objective relates to the environment or climate change. Based on program development objectives, only 17 of the 62 DPF operations approved this year include an overarching objective related to climate change or the environment.
Additionally, the Environment, Natural Resources, and Blue Economies Global Practice (ENR GP) — the Bank department that serves as the locus of environmental expertise — has led just three of the 62 DPF operations. The majority are led by the Bank's Macroeconomics, Trade, and Investment Global Practice. While ENR GP is not the only team that could lead climate-focused DPF operations, it is among the most likely to prioritize these objectives given its environmental expertise.
For instance, one of ENR GP's development policy finance operations promotes climate-resilient landscape management and cleaner energy and transport systems in Vietnam. Another seeks to enhance climate and disaster resilience in St. Vincent and the Grenadines through measures to strengthen building codes, reduce the vulnerability of schools to disasters and improve management of the government's disaster contingencies fund. The third is the program in Uruguay to increase the resilience of the country's agricultural sector with a national agriculture adaptation plan and policy reforms to enhance the national emergency system.
Another DPF program with a clear overarching objective related to climate change is the First Sustainable and Inclusive Growth DPF in Côte d'Ivoire. It promotes green growth through a series of reforms to improve the sustainability of Côte d'Ivoire's cocoa sector while facilitating investments in renewable energy and energy efficiency. The program was prepared in close collaboration with the German Government, which is providing co-financing and technical assistance to support implementation of the reform measures.
What's Next for the World Bank's Policy Lending?
It is unsurprising that most of the programs approved so far do not prioritize climate or environmental objectives. In this initial emergency response phase, World Bank attention and resources have appropriately focused on helping countries navigate the health, social, economic, and financial crises brought on by the pandemic. And the fact that many of these programs prioritizing other development objectives contain potential environmental co-benefits is important.
Going forward, however, Bank processes must require greater scrutiny of prior actions for potential environmental effects. The guidance the Bank currently applies dates back to 2004 and 2008. Up-to-date guidance on assessing prior actions for environmental impacts would be an important first step. It is also important that the Bank improve the capacity of project teams to identify and report potential negative effects, given past IEG evaluation findings pointing to underreporting.
Ultimately, country demand matters most, so environment- and climate-friendly DPF operations will materialize when more countries welcome or even ask for them. As countries bring the pandemic under control and transition to a longer-term recovery phase, the Bank should actively identify opportunities for DPF operations with explicit environmental objectives and raise them to the attention of client governments. Especially important are climate-focused policy reforms with potential to support near-term economic recovery and job creation. Also, as the example of Côte d'Ivoire above suggests, bilateral donors should provide more co-financing and technical assistance to incentivize climate-focused DPF operations in more countries.
The policies countries embrace today as they recover from the pandemic-induced crisis will affect their future development, their carbon emissions and their climate readiness. Using DPFs to simultaneously support economic recovery and climate action is essential. The World Bank Group and donor counties can take steps now to make "climate-smart" policy lending the rule, not the exception.