Ambitious Vision Crystallises

In the two years since he became president of the World Bank, James Wolfensohn has articulated an ambitious vision for the Washington-based development institution. In the past few months he has turned this vision into concrete plans, securing finance from the banks shareholders and putting new managers in place to implement them. But the World Bank has undergone revolutions before: will this one deliver?

Mr Wolfensohn arrived in H Street conscious that the world was changing in ways that were leaving the bank behind. For some developing countries, private capital had become far more important as a source of finance. But many other nations remained unable to attract investors, a problem compounded by waning support for official aid in many industrial countries. So while some countries have become better integrated into the world economy, many remain shut out.

The development business was changing, too: fresh sources of advice and technical assistance had emerged and there were calls for more emphasis on the environment, good government and investment in health, education and social cohesion. At the same time, technology was creating new ways to share knowledge within and between organisations, exposing the inflexibility of the banks vast, hierarchical bureaucracy.

The banks inability to respond to these trends had painfully clear results: more than a third of its projects had unsatisfactory outcomes; demand for its loans was flat; its financial tools painful budget cuts which his predecessor, Lewis Preston, had been urged to make by industrial countries.

At a time when public-sector bureaucracies around the world were under pressure to retrench - and when there were pressing calls on the banks net income - this proved too much to swallow.

Mr Wolfensohn was forced to rethink and come back to the board with a new proposal. He promised to spread the $250m increase over three annual budgeting rounds and then to reduce running costs to their present level of $1.1bn by 2001, reducing the cost of the compact over that period by $122m. Mr Wolfensohns colleagues knew that he would walk out if rebuffed again, but the board accepted the new plan unanimously - although some directors remained pretty sceptical.

The board warned Mr Wolfensohn that it intended to keep the compact - and its costs - under close scrutiny. It demanded semi-annual progress reports from the banks management, the first of which was discussed last week. Coming only two months after the budget allocation for the compact was agreed, the report draws few concrete conclusions. The centrepiece was a scorecard allowing the board to track progress through a set of performance indicators.

Management is being given the benefit of the doubt, says a study of the bank prepared for Commonwealth finance ministers. It is too early to tell if the reforms, even if fully implemented, will be sufficient to restore the bank to full health. The bank has been in the process of reorganisation for the past decade with a view to becoming cost effective, efficient and finding a ....sation process and - at least temporarily - its service to clients has suffered. Loan commitments by the International Development Association (IDA), the banks softloan arm for the poorest countries, fell by almost a third in the 1997 financial year to $4.6bn. This was the sharpest decline in IDAs recent history and left commitments 15 per cent below the lower end of the $5.3bn to $6.6bn planning range for the year. The biggest shortfall was in lending to Africa, for which the reorganisation was at least partly to blame.

But whatever the teething troubles and transaction costs of operating this internal market, many executive directors see decentralising the Banks relationships with borrower countries as an important goal. At the end of June three of the Banks 48 country directors were located in local offices - Mexico, Kenya and Ivory Coast. Now the total is 15, leaving 45 per cent of country management costs to be controlled by local offices. The new local operations include China, Indonesia, India, Pakistan, Bangladesh and Russia, each of which is one of the Banks biggest borrowers. Brazil and Argentina should be locally managed by early next year.

The effectiveness of devolved country management is likely to be an important topic of conversation when Mr Wolfensohn meets finance ministers from borrower countries in Hong Kong over the next few days. Another will be the banks growing interest in the promotion of good governance and anti-corruption measures, which formed the centrepiece of his speech to last years annual meeting. The bank must persuade developing country governments that it does not intend to encroach on their sovereignty, but that tackling graft is in their own interest to promote development and to help reduce poverty.

After some hasty rewriting carried out at the request of the board, the bank agreed a policy document and a set of staff guidelines on anti-corruption earlier this month. By designing effective anti-corruption strategies for its client countries and joining the international campaign to fight this deep-seated problem, the bank believes its efforts help to make a difference, the document said. It focuses on preventing fraud and corruption within bank-financed projects and on providing advice on anti-corruption measures. Bank staff have tended to shun the corruption issue, but now they will be encouraged to search it out and analyse its effects.

Bank lending to a country can be expected to be reduced if there is evidence of corruption affecting bank financed projects, or more generally if corruption is compromising economic reform programs or the development objectives of the country in other ways, one official argues. There is no intention, however, to link bank lending in a mechanistic way to some measure of corruption in a country.

Together with the impact of the financial crisis in Asia, corruption is likely to be one of the big talking points in Hong Kong. Less visible, but just as important, will be discussion of the Banks long-term financial position and ever-present tension between the interests of its richer shareholders, middle-income borrowers and poor countries.

At the April meeting of the Development Committee, which gives ministerial guidance to the boards of the bank and the International Monetary Fund, Mr Wolfensohn warned that the banks income was set to halve over the next 10 years. Relatively lucrative fixed-rate loans are expiring and lending on the banks standard terms is no longer profitable at the margin. By the 1999 financial year, income will not even be high enough to inflation-proof the banks capital base, the president said.

In the 1996 financial year the bank earned around $7.9bn in interest on its loan portfolio and $700m from investments. After interest payments on borrowing, administrative expenses and contributions to special programmes, net income was around $1.2bn. Net income has been used in several ways: $250m was used to protect the banks reserves to loan ratio, $300m was allocated to the International Development Association, $90m was placed in a trust fund for Gaza and the West Bank and up to $500m was allocated to the debt relief initiative organised by the bank and the IMF for highly indebted poor countries.

But many middle-income developing countries are unhappy with the way the banks net income is used. They believe they have been left to shoulder an increasing and disproportionate burden of the banks activities; they provide much of the institutions income while the proceeds are spent on soft loans and debt relief for poorer countries, plus special projects in areas such as the Middle East.

Meanwhile, the US fails to make its promised contributions to the International Development Association and many industrial countries are unwilling to finance their debt initiative adequately. But the industrial countries in turn point out that they are subsidising both the middle-income borrowers and poor countries because they demand no dividend payments from their shares in the banks capital.

The debate is likely to mount as the bank begins to fund more special initiatives out of a dwindling net income over the coming years, the Commonwealth finance ministers have been told. The argument has also been advanced that the bank needs to set aside larger amounts to reserves, given weaknesses in its portfolio.

Squaring this circle will be one of Mr Wolfensohns biggest challenges in the remaining years of his presidency. He could boost the banks income by charging more for its loans, which are three percentage points cheaper than their private sector equivalent. But, despite their attractive price, demand for the banks loans is already stagnating. Hence the strategic compacts emphasis on providing new products with quicker delivery, more flexibility and less onerous conditions. He could charge higher prices if the non-price features of the loans were more attractive.

Beneath the Harvard management rhetoric of vision and renewal, Mr Wolfensohn faces a difficult task reconciling these tensions, ensuring the success of the strategic compact and making sure that the bank remains a serious participant in the development business.

Over the past few months he has explained exactly how he intends to set about it. The rich shareholders, big borrowers and poor countries all wish him well, but the remain to be convinced.