Concessional financing is not without controversy - Report | Sunday Observer

Concessional financing is not without controversy - Report

18 April, 2021

Explicitly evaluating whether loans are concessional or adverse considering the combined consequence of the grant element and cost escalation on the tied element/unsolicited proposal would be advantageous for Sri Lanka.  By contrast, at present only the grant element is evaluated, noted a research report by Verite Research titled Financing Infrastructure: the (Non) concessionality of concessional loans.

Multilateral and bilateral borrowing is often favoured by governments such as Sri Lanka because such financing tends to have ‘concessional’ elements, relative to the international financial markets.

Such concessional financing of infrastructure development, however, is not without controversy; and there is a significant body of literature engaging with the consequential concerns of such financing.

The report aims to contribute to that literature by analysing the concessionality of 50 high-value loans to Sri Lanka from multilateral and bilateral sources to finance infrastructure, taken between 2005-2018.

These 50 loans are worth USD 13,068 million and accounted for 53% of the total value of foreign loans taken to finance infrastructure during that period.

Of the 50 loans, 33 loans had a grant element of above 35%, a benchmark level used by international agencies such as the International Monetary Fund (IMF), to classify a loan as concessional.

These 33 loans account for 72% of the value of the 50 loans analysed in this paper. These 33 loans consist of four loans from multilateral institutions (of a total of 15 loans) and 29 loans from bilateral institutions (of a total of 35 loans). ƒ

Sri Lanka is highly dependent on international loans from multilateral and bilateral sources to finance infrastructure development.

During 2005-2018, the Government took loans worth USD 24,582 million from bilateral and multilateral lenders to finance its infrastructure.  Five sources accounted for 82% of the value of those loans: China (33%), the Asian Development Bank (ADB) (17%), Japan (18%), the World Bank (7%) and India (7%). 

The paper investigates the financial and procurement terms and conditions attached to the 50 high value loans. The investigation is limited to two primary elements that undergird each loan: (1) the grant element and (2) the tied element. 

The study highlights the importance of strengthening regulations to reduce unsolicited procurement proposals. 

It notes that as much of the adverse borrowing can be linked to the acceptance of unsolicited proposals, Sri Lanka will benefit from strengthening the regulatory framework governing the management of unsolicited proposals, making the process more transparent, and less open to abuse.

It states improving Sri Lanka’s procurement framework can also reduce the adverse consequences resulting from tied procurement terms embedded in infrastructure loans. Limiting existing political and bureaucratic discretion to grant exceptions to competitive bidding, through signing loan agreements, can help to contain adverse borrowing practices.

An example of such a limiting mode would be mandating parliamentary approval for a loan that suspended competitive bidding in high value public procurements. 

Loans from multilateral and bilateral sources are considerably more concessional than international financial markets International agencies such as the IMF and the OECD (for Export Credits) classify a loan as concessional only when the grant element of the loan exceeds the benchmark rate of 35%.

Of the 50 loans analysed in the paper, 33 had a grant element above 35%, and these accounted for 72% of the total value of the analysed loans. These 33 loans consist of four loans from multilateral institutions and 29 loans from bilateral financial institutions.

This finding indicates that loans to Sri Lanka from multilateral and bilateral sources is considerably more concessional compared to the alternative of borrowing from international financial markets. 

Overall, loans from Japan have the highest average grant element. All loans from Japan exceed the 35% benchmark for the grant element.

Loans from the ADB and China have the lowest weighted average grant element. Most of the loans from ADB fall below the 35% benchmark for the grant element. However, most of the loans from China just exceed this 35% benchmark.

The concessionality of bilateral loans are significantly impaired by their tied elements, in contrast to loans from multilateral institutions. Twenty nine of the 35 bilateral loans (which account for 83% of the total value of bilateral loans) had a grant element above the benchmark of 35%.

In comparison, only four out of the 15 loans from multilateral institutions exceed the 35% benchmark (accounting for 24% of the total value of loans taken from multilateral institutions). 

However, this analysis finds that 28 of the 35 bilateral loans had tied elements, where a part or the entire value of the loan was tied to procurement of goods/services from contractors in the lending country. In contrast, the 15 loans taken from the multilateral institutions did not have any tied elements.

The projects funded through these loans went through international competitive bidding processes to select contractors. Loans with embedded tied elements restrict procurement to contractors from the lender’s country.

As a result, the tied element prevents the recipient country from using the tied funds to procure goods and services of the expected quality at the lowest cost through a process of competitive bidding.

Of these 28 tied loans, 14 had a tied element of 100%, six loans had a tied element between 60%-100% and two had a tied element of a minimum of 30%. For six loans, information was not available to assess the precise extent of the tied element. The value of these 28 loans is USD 9,249 million. These loans accounted for 71% of the value of all 50 loans analysed and 38% of the value of all foreign loans taken to fund infrastructure during 2005-2018.

All the loans taken from China and India had a tied element, and six of the 13 loans taken from Japan also had a tied element.

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