World Bank slashes loan

The World Bank has finally decided to restructure its lending programs in Indonesia, slashing its annual loan commitment for the next three years to only US$400 million, or less than one third of the previous level, but granting the country access to its interest-free credit window, the International Development Association.

The immediate impact of the new loan program will begin affecting the government's capital inflows only next year. This is because the $1.3 billion in loans pledged by the World Bank at the latest meeting of the Consultative Group on Indonesia (CGI) in Tokyo last October remains available for use this year.

However, starting next year, official capital flows will decline significantly because the World Bank itself usually accounts for one third of the combined annual loan pledges from the members of Indonesia's CGI creditor consortium. In the 1990s they ranged from $4.5 billion to $4.7 billion.

Though the steep loan cut was made in Washington on Tuesday only after consultations with the Indonesian government, several factors seemed to have forced the World Bank to adopt the new policy. Foremost among them is that the stock of the bank's outstanding loans to Indonesia is already close to its concentration limit for a single large borrower, which in this case amounts to about $13.5 billion. Moreover, the World Bank's share of Indonesian overseas public debt service already exceeds 20 percent. The country's official foreign debt of around $70 billion is already way above what is considered a manageable level.

However, the slash in loan will slightly be offset by additional benefits Indonesia will get from the restoration of its access to IDA's interest free loan. This was closed in 1981 after the nation's per capita income rose above $925 a year -- the threshold that qualifies a country borrower to that facility. Indonesia's per capita income has fallen to an estimated $580 due to the melting of the rupiah value and the economic crisis.

Besides charging no interest, IDA credit also has a much longer tenure of 35 to 40 years, including a 10-year grace period. This compares favorably with the 15 to 20 years for World Bank loans which have an annual interest charge of around 6.5 percent. This is precisely the kind of borrowing Indonesia now needs, given its severe liquidity crisis and heavy debt service burdens.

In contrast to World Bank loans which usually go mostly to the development of basic infrastructure, IDA allocates the bulk of its credit to poverty alleviation and social-sector programs, which also happen to suit better the nation's needs today. This is because the worsening living conditions caused by the economic crisis have plunged more than 100 million people into absolute poverty.

However, national per capita income below $925 will not automatically entitle a country to this facility. The competition for IDA credit is quite fierce as the demand from poor nations is always far larger than the supply. Different from the World Bank which has both the authorization and capability to raise its lending funds from the capital market, IDA derives its funds only from government contributions and the World Bank's profits.

The competition lies mostly in borrowers' willingness and ability to pursue good governance (which means combating corruption), sound macroeconomic management and bank/corporate restructuring. The World Bank did promise to eventually increase its loan and IDA credit to Indonesia up to $1 billion a year if the country could meet those conditions but this is most likely a long shot.

Herein lies the greatest challenge that the country is facing. Though the World Bank did not spell it out bluntly, one could easily infer from various recent remarks made by its senior executives that the bank has been disappointed with the poor record of the government related to the implementation of good governance and policy reforms and this is also one of the main reasons as to why it cut its loan program. This poor performance has also been responsible for the delay of the third tranche disbursement of the International Monetary Fund's $5 billion bailout funds from December.

The government therefore would be well advised to see the retrenchment in the World Bank's loan program more as a friendly warning from a loyal supporter (which has greatly assisted the country's economic development since 1968). It should jolt the government to pursue more persistently its administrative reform and restructuring programs.

After all, the conditions imposed by the World Bank are not an attempt to intervene in Indonesia's domestic affairs as often suspected by some officials and politicians. They are very similar to those set by the IMF for its bailout funds and also are the requirements asked for by other foreign creditors and investors.