assessment of adb’s response€¦ · in preparing any country program or strategy, financing any...

March 2011

Assessment of ADB’s Response

to the Global Economic Crisis 2007–2010

ABBREVIATIONS

ADB – Asian Development Bank ADF – Asian Development Fund BOP – balance of payments CSF – countercyclical support facility DMC – developing member country EBRD – European Bank for Reconstruction and Development EGP – employment generation program GDP – gross domestic product GFC – global financial crisis IMF – International Monetary Fund MDB – multilateral development bank OCR – ordinary capital resources PBA – performance-based allocation PESF – public expenditure support facility PPP – public–private partnership SDPL – special development policy lending SMEs – small and medium-sized enterprises SPL – special program lending SSNP – social safety net program TA – technical assistance US – United States

NOTE

In this report, "$" refers to US dollars.

Director General K. Sakai, Strategy and Policy Department (SPD) Director I. Bhushan, Strategy, Policy, and Interagency Relations Division, SPD Team leader K. Takamiya, Senior Planning and Policy Economist, SPD Team members M.J. David, Strategy and Policy Officer, SPD

G. Jorge, Strategy and Policy Assistant, SPD J.W. Kang, Senior Economist, SPD E. Pike, Strategy and Policy Officer, SPD V. Reppelin-Hill, Principal Planning and Policy Economist, SPD G.A. Sevilla, Strategy and Policy Analyst, SPD G.M. Umali, Senior Strategy and Policy Officer, SPD

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

The views expressed herein are those of the consultant and do not necessarily represent those of ADB’s members, Board of Directors, Management, or staff, and may be preliminary in nature.

CONTENTS

Page

I. BACKGROUND OF THE GLOBAL ECONOMIC CRISIS.. ............................................... 1

II. OVERVIEW OF ADB’S RESPONSE TO THE CRISIS ..................................................... 3

A. Loan Approvals 3 B. Loan Disbursement 8

III. USE OF SPECIFIC ASSISTANCE MODALITIES ........................................................... 10

A. Countercyclical Support Facility 10 B. Precautionary Financing Option 11 C. Program Lending 12 D. Trade Finance Program 14 E. Knowledge Products and Services 14

IV. DEVELOPMENT PARTNERSHIP .................................................................................. 15

V. CRISIS RESPONSE BY OTHER MULTILATERAL DEVELOPMENT BANKS ............... 15

VI. LESSONS AND CONCLUSIONS ................................................................................... 16

A. General Observations 16 B. Steps Forward 16

APPENDIXES

1. Country Case Study of ADB’s Crisis Response: Bangladesh 18 2. Country Case Study of ADB’s Crisis Response: Indonesia 23 3. Country Case Study of ADB’s Crisis Response: Kazakhstan 33 4. Country Case Study of ADB’s Crisis Response: Mongolia 41 5. Country Case Study of ADB’s Crisis Response: Tonga 46 6. Crisis-Related Knowledge Products and Services 50 7. Evaluation of Crisis Response by Other International Financial Institutions 54

I. BACKGROUND OF THE GLOBAL ECONOMIC CRISIS 1. The 2007 subprime financial crisis, which originated in the United States (US), rapidly spread to financial markets of the rest of the world as the global financial crisis; the resulting great recession in the real economy had global outreach.1 The history of post World War II financial crisis episodes reveals striking similarities in the pattern of their making and impacts of their aftermath. Each crisis is preceded by a rise in home and equity prices, acceleration in capital inflows driven by optimistic investors, a rapid buildup of debt, and slowdown of growth. The typical financial crisis also leads to a prolonged downturn of the real economy. The capital and asset market bubbles following the high US current account deficit exhibited this typical pattern.2 However, this crisis was different from most others in one important aspect—its global outreach. Unlike major crisis episodes in the latter half of the 20th century, where adverse impacts were mainly contained in the host country or a few other countries through market contagion, this crisis was transmitted rapidly across borders to reach not only financial markets but also the real economies of the entire world. The magnitude of global impacts was precedented only by the early phase of the Great Depression of the 1930s. However, on a positive note, the crisis was different from the Great Depression in another important aspect—the speed of the recovery. The unprecedented response of governments, central banks, and international financial institutions (Box 1) helped bring the great recession to an end much quicker than the Great Depression (Figure 1).3

Figure 1: World Industrial Production, Then versus Now

Source: B. Eichengreen and K.H. O’Rourke. A Tale of Two Depressions. Available at: http://voxeu.org.

1 In this paper, the financial aspect of the global economic crisis is referred to as ―global financial crisis‖ and the real

economy aspect as ―great recession‖, while the latter does not necessarily reflect technical definition of the term. Interaction between the two (macro-financial linkages) would be an important theme for future research.

2 C. Reinhart and K. Rogoff. 2009. This Time Is Different: Eight Centuries of Financial Folly. Princeton and Oxford:

Princeton University Press; C. Reinhart and K. Rogoff. 2009. The Aftermath of Financial Crises. NBER Working Paper 14656. Cambridge: National Bureau of Economic Research; C. Reinhart and K. Rogoff. 2008. Is the 2007 U.S. Subprime Financial Crisis So Different? An International Historical Comparison. NBER Working Paper 13761. Cambridge: National Bureau of Economic Research.

3 See discussions in P. Krugman. 2009. The Great Recession versus the Great Depression (20 March); Green

Shoots, 1930 (23 June); The Story So Far, in One Picture (3 November). The Conscience of a Liberal. http://krugman.blogs.nytimes.com; B. Eichengreen and K.H. O’Rourke. A Tale of Two Depressions: What Do the New Data Tell Us? In VOX: Research-Based Policy Analysis and Commentary from Leading Economists. http://voxeu.org; A.S. Blinder and M. Zandi. 2010. Stimulus Worked. Finance and Development. December. pp. 14–17.

http://voxeu.org/

http://krugman.blogs.nytimes.com/

http://voxeu.org/

2

2. Asia, that was initially forecasted by some observers to have been ―de-coupled‖ from the crisis, 4 had been hard-hit by early 2009, but its V-shaped recovery led the global growth thereafter. By the first quarter of 2009, adverse impacts of the crisis were transmitted to Asia through various channels. First and foremost, the great recession in the real economies of industrialized countries and resulting collapse of global trade affected exports,5 which were important sources of aggregate demand in export-oriented Asian economies. In 2009, global trade decreased by 12.2%; for most developing countries, this crisis was a trade crisis. 6 Secondly, this real economy impact of the recession was preceded or accompanied by cross-border contagion of the global financial crisis in some parts of Asia. While the region was relatively less exposed to toxic financial assets, the loss of confidence in global markets tightened Asia’s financing conditions in capital markets, trade finance, and even remittance. For instance, the credit spread of offshore bonds of Asian issuers shot up rapidly, depriving governments of these countries of crucial resources for developing expenditures. However, from the second quarter of 2009 onward, Asia rebounded rapidly. A number of economies badly hit by the early phase of the crisis soon recorded double-digit quarterly gross domestic product (GDP) growth, partly supported by aggressive use of fiscal and monetary stimulus. At this time, the Asian Development Bank (ADB) substantially expanded its assistance.

4 To the contrary, ADB was assessing in the early phase of the crisis that there is no evidence pointing to decoupling,

on the ground that Asia’s regional integration remained structurally linked to final demand from major industrial economies. See ADB. 2007. Asian Development Outlook 2007: Growth amid Change. Manila.

5 World Trade Organization. 2010. World Trade 2009, Prospects for 2010 (Press Release on 26 March). Geneva.

6 R. Boldwin, ed., 2010. Great Trade Collapse: Causes, Consequences, and Prospects. London: Centre for Economic Policy Research.

Box 1: Global Solution for the Global Crisis: G20 Calls for Countercyclical Actions by International Financial Institutions

The global outreach of the crisis required global resolution, with countercyclical response from all regions of the world. At the 2 April 2009 summit in London, at the height of the crisis, Group of 20 (G20) members urged multilateral development banks (MDBs) to step up their countercyclical efforts in respective regions, to offset capital flight and maintain demand by providing finance for fiscal expansion, support to social safety nets, trade financing, bank recapitalization, and infrastructure investment in emerging markets and low-income countries. They emphasized MDBs’ countercyclical role in supporting their longer-term development mandate, and called for the adoption of flexible, fast-disbursing, and front-loaded instruments designed to substantially and quickly assist developing countries. MDBs swiftly responded to the G20 call. Asian Development Bank’s crisis-related lending assistance amounted to about $8.6 billion for 2008–2010. This includes $5.3 billion for program and project lending, grants, private sector loans, and guarantees; $2.5 billion for countercyclical support facility, and $850 million for the Trade Finance Program. ADB also provides crisis-related support through grants for policy analysis and capacity building. The African Development Bank established a $1.5 billion liquidity facility and the Inter-American Development Bank a $6 billion facility. The World Bank enhanced term-setting flexibility for its special development policy lending. The International Monetary Fund established the flexible credit line and called on G20 countries to mobilize fiscal stimulus accounting for 2% of the global gross domestic product, while tripling its lending capacity. Asia, particularly East Asia, received the largest fiscal stimulus of any region of the world. This was made possible as most Asian countries entered the economic downturn with a relatively sound precrisis fiscal status.

Source: Asian Development Bank

http://www.adb.org/Economic-Crisis/ADB-Response-Operations.asp

http://www.adb.org/Economic-Crisis/ADB-Response-Operations.asp

3


3. The rest of this paper assesses7 relevance of ADB’s assistance in the Asia-Pacific region, in the context of its V-shaped drop and recovery of the regional growth during the four-year period of 2007-2010. The relatively small amount of ADB’s resource vis-à-vis the sheer size of the Asia-Pacific economies makes it difficult to quantify its direct contributions to the region’s recovery. Rather, the paper tries to assess if ADB mobilized its limited resources effectively in response to and to suit the context of the crisis.

II. OVERVIEW OF ADB’S RESPONSE TO THE CRISIS

A. Loan Approvals

4. During 2008–2009, ADB’s resource mobilization in support of Asia’s recovery closely corresponded to the unfolding impacts of the crisis. ADB responded promptly to help its developing member countries (DMCs) cope with the impacts of the global economic crisis. With the completion of the fifth general capital increase (GCI V) and successful ninth replenishment of the Asian Development Fund (ADF X), ADB was able to provide much more assistance in a countercyclical manner. When regional growth dipped to its lowest level at 5.4% in 2009 from the decade’s peak of 10.1% in 2007, ADB’s total operations reached a historic high of $16.1 billion to support the Asian economy’s impressive recovery toward the end of the year. As the region’s recovery path became increasingly more solid in 2010, the amount of assistance declined (Figure 2).

7 This paper serves as a self-evaluation of ADB’s crisis, mainly focusing on policy-based lending. ADB’s Independent

Evaluation Department is conducting an independent evaluation on the broader spectrum of ADB’s crisis response separately.

Figure 2: Crisis Timeline and ADB’s Response

Notes: (i) Data on Asian Development Bank (ADB) total operations for 2007–2009 are net of cancellations, while the 2010 figure is based on gross approvals; and (ii) Data on ADB total operations for 2007–2010 exclude official loans and commercial cofinancing. Sources: ADB. 2010. Asian Development Outlook 2010 Update: The Future of Growth in Asia. Manila; and ADB.

4

5. The increase in ADB loan approvals from the early phase (2007–2008) of the crisis to the recovery phase (2009–2010) is apparent across all country groups (Table 1), partly due to incremental resource generation from both ordinary capital resources (OCR) and ADF. In volume terms, incremental resource mobilization for OCR borrowers (Groups B and C) was substantial. It was partly made possible through short-term resource mobilization of $2.5 billion through establishment of the Countercyclical Support Facility (CSF).8 By setting the spread of 200 basis points over the London interbank offered rate (higher than 20 basis points applicable to conventional loans from OCR, while lower than 400 basis points applicable to special program lending established in 1999 mainly to cope with balance-of-payments [BOP] crisis9) and shorter maturity of 5 years (rather than 15 years applicable for standard program lending), the CSF generated additional resources without hindering ADB’s risk-bearing capacity.10 Capital headroom, although trending to deplete (even with the general capital increase) as a result of rapid loan growth prior to the crisis, was adequate in the short term. It enabled ADB to extend time-bound crisis response with short-term instruments and higher prices as compared with the standard OCR loan.11 The crisis response to ADF-only countries (Group A) averaged $1.3 billion from 2009 to 2010, recording the largest increase over the precrisis period. Part of this expansion used the excess ADF liquidity of $400 million (through the legacy conversion option for special drawing rights, reducing the required provision for foreign exchange volatility).12 Both the CSF for OCR-eligible countries and the ADF excess liquidity for ADF-only countries were time-bound arrangements for 2009–2010.

Table 1: ADB Assistance by Country Group (2007–2010)

6. ADB assistance concentrated on the recovery phase of the Asia and Pacific economies. The CSF and ADF excess liquidity, both established with approval by the ADB Board of Directors in June 2009, supported Asia’s strong recovery since the second quarter of the year.13

8 ADB. 2009. Enhancing ADB’s Response to the Global Economic Crisis: Establishing the Countercyclical Support

Facility. Manila; ADB. 2010. Countercyclical Support Facility: Annual Report 2009. Manila. 9 ADB. 1999. Review of ADB’s Program Lending Policies. Manila.

10 The time-bound budget support instrument with shorter maturity enabled ADB to expand its lending within the capital adequacy framework as measured by the preshock equity-to-loan ratio. While the pricing was set at precrisis credit spreads of dollar-denominated offshore bonds of Asian issuers, it helped rationalize the size of the modality vis-à-vis anticipated demand. A commitment charge was included as an incentive for quick utilization in line with the countercyclical mandate. Indeed, $2.5 billion of the $3.0 billion CSF was taken up followed by quick disbursement.

11 At the time of the crisis, ADB’s credit quality, while lowered, was not affected significantly as the credit condition of sovereign members in the region was generally sound. ADB’s nonsovereign exposure was still a small portion of the total outstanding portfolio.

12 ADB. 2009. Crisis Response of ADF—Allocation of Additional Liquidity. Manila.

13 History shows that premature withdrawal of expansionary macroeconomic policy was the cause of prolonged economic downturns in other parts of the world, including the Great Depression in the 1930s. C. Romer. 2009, The Lessons of 1937. The Economist. 18 June. ADB’s countercyclical actions in the recovery phase of the crisis reflect this important lesson from history.

Item

2007–2008 (annual average)

2009–2010 (annual average)

Increase (%)

ADB 11,208 14,707 31

Group A 791 1,338 69

Group B 4,197 5,101 22

Group C 6,159 7,473 21

Regional 60 795 1,225 Notes: (i) 2007–2010 data is based on gross approvals; and (ii) the 2009 regional figure includes the regional trade finance program of $1 billion. Source: Asian Development Bank.

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In this connection, ADB’s interventions to this crisis certainly helped DMCs sustain fiscal stimulus until the V-shaped recovery path was truly confirmed by 2010. However, the CSF and ADF excess liquidity did not exist when the impact of the crisis began to materialize by the first quarter of 2009. Having permanent crisis response mobilization instruments available would have better prepared ADB to help mitigate the worst of the crisis immediately upon a DMC’s request, provided that its risk bearing capacity in terms of the equity to loan ratio is well managed.

7. Allocation of incremental OCR under CSF was determined on the basis of eligibility criteria for DMCs requesting financing, comprising adverse crisis impacts, soundness of the precrisis macroeconomic management, and existence of the countercyclical development expenditure program. On the other hand, the ADF was allocated using a performance-based allocation (PBA) approach, which did not take the crisis impacts into account. Under the current PBA formula for ADF resources, the biannual lending for DMCs is determined on the basis of the country performance assessment of medium-term macroeconomic policy, structural and institutional reforms, and portfolio performance, aside from population and per capita gross national income. As a resource allocation mechanism established for a noncrisis situation, the formula does not take crisis impacts into account. Thus, the recent record does not indicate a positive correlation between the drop in a DMC’s growth rate under the crisis and the increase in ADF allocation for each country (Figure 3). Unlike the case of OCR, the current PBA policy does not allow flexibility to adjust the lending level for ADF borrowers and recipients, and this issue warrants some concern when redesigning the effective mechanism for crisis response for low-income countries in the future.

-50%

0%

50%

100%

150%

200%

250%

-15 -10 -5 0 5 10 15

GDP growth change b/w 2006-2007 and 2008-2009 (%p)% C

ha

ng

e in

PB

A b

/w 2

00

7-2

00

8 a

nd

20

09

-20

10

♦ ADF-only countries

Figure 3: ADF Allocation under the Global Economic Crisis

Note: Data excludes a postconflict country (Afghanistan). ADF = Asian Development Fund, b/w = between, GDP = gross domestic product, PBA = performance-based allocation. Source: Asian Development Bank.

6

8. ADB provided flexibility to ADF borrowers to front-load their allocation. However, it was not a popular option and was not used by many DMCs. Only four countries—Armenia, Georgia, Mongolia, and Papua New Guinea—opted to avail of the flexibility, while nine other countries front-loaded within their policy limit. ADF countries were reluctant to front-load their allocations for fear of jeopardizing their ongoing development programs. Only those countries with access to alternative form of financing, such as OCR, opted for the flexibility since they could use such financing to offset the declining ADF allocation in future years. ADB experience shows that a quick response to an exogenous shock is vital. Such shocks can significantly damage the economies of ADF countries and are beyond the control of their governments. ADF countries have limited capacity to protect themselves against such shocks. At the time of a crisis, countries need additional resources—front-loading within the same envelope is not an attractive option.

9. ADB mobilized various assistance instruments for sovereign and nonsovereign operations, as well as policy advice and advocacy. While supporting DMCs’ countercyclical response, ADB assistance helped ensure provision of resources for critical development expenditures for long-term growth, and protected the most vulnerable from the fallout of the crisis. The focus of sovereign investment lending, which accounted for a majority of ADB operations, was to sustain development momentum in Asia and the Pacific. Assistance was provided also through quick-disbursing, policy-based lending for fiscal stimulus (CSF) and structural reforms (program lending), expansion of the Trade Finance Program and other forms of nonsovereign operations, and knowledge products and services (Figure 4).

Figure 4: ADB’s Overall Crisis Response

ADF=Asian Development Fund, CSF=Countercyclical Support Facility, OCR=ordinary capital resources, TFP=Trade Finance Program. Notes: (i) OCR and ADF commitments are based on gross approvals; (ii) technical assistance (TA) includes grants from the Technical Assistance Special Fund, other TA grants, and TA cofinancing; and (iii) TA and cofinancing figures for 2007–2009 are net of cancellations. Source: Asian Development Bank.

Nonsovereign Lending

Sovereign

Lending

Demand-based support for Fiscal expansion

Social protection

Maintenance of development momentum

Demand-based support for

Easing liquidity constraints

Building business confidence

Countercyclical Support Facility

Trade Finance Program

Regional and subregional support

Policy Advice and Advocacy

Strengthening of national monitoring and surveillance

Policy analysis and knowledge support

Early Phase (2007–2008): OCR Commitments: $17.5 billion ADF Commitments: $4.9 billion

Technical Assistance: $524 million Cofinancing: $1.6 billion

Recovery Phase (2009–2010): OCR Commitments (including CSF and TFP): $23.1 billion ADF Commitments: $6.3 billion Technical Assistance: $594 million Cofinancing: $6.9 billion

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10. Policy-based lending accounted for a significant part of ADB’s crisis response for financing and facilitating DMCs’ countercyclical development expenditures. Policy-based lending, including CSF loans, accounted for 26% (or $7.7 billion) of total ADB assistance during 2009–2010. The quick-disbursing characteristics of policy-based lending turned out to be crucial for fast mobilization of resources that were necessary to sustain development expenditures. The importance of policy-based lending to support DMCs’ public expenditure is also reflected in the increased share of operations in the area of public sector management that accounted for 22% of the entire operations (Figure 5). The ADB-wide ceiling for conventional policy-based lending set under the 1999 policy on program lending (20% under normal circumstances) was exceeded because of the exceptional crisis situation in 2009. For ADF, the ADB Board of Directors approved a waiver to exceed its 22.5% ceiling.14 Still, the vast majority of ADB’s operations were directed for investment lending.

11. Apart from incremental resource generation, shortened processing time also contributed to the concentration of loan approvals, particularly those for policy-based lending operations during the crisis and recovery phase. The processing time for ADB’s entire operations averaged 14 months in 2009, much shorter than the historical average of 2 years. By lending modality, ADB processed policy-based lending much faster than project lending, 8 months on average for program lending, compared with 16 months for project lending (Table 2).

14

ADB. 2009. Proposed Waiver of the Asian Development Fund Program Lending Limit for 2007–2009. Manila; ADB. 2010. Proposed Waiver of the Asian Development Fund Program Lending Limit for 2008–2010. Manila. The program lending volume has risen sharply in 2009. Because of the averaging effect of the program lending approvals across years, the indicative 3-year moving average exceeded the ceiling despite relatively modest lending levels in preceding and succeeding years.

Figure 5: ADB Assistance, by Instrument and Sector, 2009–2010 ($ million)

ADB = Asian Development Bank, ICT = information and communication technology, MFF = multitranche financing facility, TA = technical assistance. Note: 2009–2010 data are based on gross approvals. Source: Asian Development Bank.

Agriculture and Natural Resources, $1,303 , 5%

Education, $314 , 1%

Energy, $5,875 , 20%Finance,

$3,596 , 12%

Health & Social

Protection, $326 , 1%

Industry & Trade, $116 ,

0%

Water Supply & Other

Municipal Infrastructure & Services, $1,570 , 5%

Public Sector Management, $6,270 , 21%

Transport & ICT, $6,962 ,

24%

Multisector, $3,082 , 11%

B. By Sector

Project, $9,922 ,

34%

Program , $5,180 ,

17%

Counter-cyclical Support Facility,

$2,500 , 8%

MFF-Tranche, $7,249 ,

25%

Special Assistance , $199 , 1%

TA Loan, $41 , 0%

Non-sovereign

Operations, $1,959 , 7%

Guarantee, $2,379 , 8%

A. By Instrument

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12. Among policy-based lending operations in particular, CSF loans were committed promptly to help recipient countries combat the crisis through timely fiscal measures. The time between receipt of the official request from DMC governments and ADB approval of the CSF loans averaged 83 days, much shorter than the record for conventional program and project lending in 2009. This is primarily due to the CSF’s design feature as a special instrument for short-term crisis response, including its abbreviated business processes and absence of need to negotiate unrelated medium-term structural reforms. With the exception of the CSF loan for Bangladesh, whose processing was postponed until October 2009, this quick processing feature of CSF’s business processes was fully exploited.15 However, when the first CSF loan was requested by the Philippines on 21 May 2009, the CSF had not yet been formally established, and substantiation of loan processing had to wait for Board approval on 16 June. ADB could have acted more promptly if the CSF had existed as a regular lending instrument at inception of the crisis.

Table 3: Delivery of Countercyclical Support Facility Loans

Country DMC Request

Receipt ADB

Approval

Request-Approval (days)

Bangladesh 30 Jun 2009 13 Oct 2009

105

Indonesia 09 Jul 2009 07 Oct 2009

90

Kazakhstan 13 Jul 2009 10 Sep 2009

59

Philippines 21 May 2009 24 Aug 2009

95

Viet Nam 09 Jul 2009 15 Sep 2009 68

Average 83 DMC = developing member country. Source: Asian Development Bank.

B. Loan Disbursement

13. Loan disbursements followed a similar trend as approvals, and peaked in 2009. Overall disbursement for the year totaled $10.4 billion ($7.9 billion from OCR and $2.5 billion from the ADF), 34% higher than the annual average for 2007–2008 (Figure 6). The increase in disbursements in 2009 was mainly the result of fast-disbursing policy-based lending, which accounted for nearly half of total disbursements in 2009 ($5 billion or 47%). Compared with the annual average in 2005–2008, disbursements for policy-based lending almost doubled in 2009. Among policy-based lending operations, CSF loans were disbursed within an average of 2 months after ADB Board approval, marking a substantial departure from the typical duration of

15

The CSF loan for Bangladesh was packaged with the conventional program loan (Public Expenditure Support Facility) for structural reforms; the abbreviated business processes were not fully adopted.

Table 2: Average Processing Time by Modality and Country Group, 2009 (months)

Modality ADB Total

OCR- only

Blend ADF-Only

Projects 16 23 17 8

Programs 8 7 7 10

Total 14 21 13 8 ADB = Asian Development Bank, ADF = Asian Development Fund, OCR = ordinary capital resources. Source: Asian Development Bank. 2009. Development Effectiveness Report 2009. Manila.

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nearly a year for conventional ADB project and program lending operations. Disbursements of all CSF loans were completed promptly in 2009, except for Indonesia.

14. The pace of disbursements was accelerated. Disbursement velocity is assessed by categorizing ADB’s commitments into ―new‖ and ―old‖ groups of the active sovereign lending portfolio for 2007–2009. New disbursements refer to disbursements made in a given year from loans approved within the same year, while old disbursements are provided in a given year from loans approved in previous years. Data shows that disbursements under new loans peaked at 44% in 2009 (compared with 24% in 2007, and 27% in 2008). The significant increase comes from the huge jump in the disbursement for policy-based lending, of which the CSF accounted for 87% (Figure 7).

4,747

5,793

6,914

8,692

10,445

7,873

-

2,000

4,000

6,000

8,000

10,000

12,000

2005 2006 2007 2008 2009 2010

Am

ou

nt in

$ m

illio

n

OCR

ADF

Total

Figure 6: ADB Disbursements by Fund Source, 2005–2010

ADF = Asian Development Fund, OCR = ordinary capital resources. Note: ADF disbursements include those for loans and grants. Source: Asian Development Bank.

24%

27%

44%

0

2,000

4,000

6,000

8,000

10,000

2007 2008 2009

Am

ou

nt i

n $

mill

ion

"old" disbursements "new" disbursements

Figure 7: Pace of Disbursements, 2007–2009

Source: Asian Development Bank.

10

III. USE OF SPECIFIC ASSISTANCE MODALITIES

A. Countercyclical Support Facility

15. The $3 billion CSF was established in June 2009 to provide support for fiscal stimulus by middle-income countries. Drawing on the recommendation made under ADB’s internal review of business processes, 16 the CSF was designed as an instrument to support middle-income DMCs’ countercyclical development expenditures with an aim to help sustain aggregate macroeconomic demand and growth. No microeconomic structural reforms were required. While this feature was partly a reflection of the external origin of the crisis, it also benefited from critical lessons learned from the experience of the Asian currency crisis in 1997–1998. These are (i) a crisis, once it happens, requires macroeconomic resolutions; microeconomic structural reforms have little immediate relevance (and are possibly counterproductive);17 and (ii) a decline in aggregate demand needs to be responded to with countercyclical, not procyclical, macroeconomic policy. 18 CSF loans totaling $2.5 billion were provided to five DMCs (Bangladesh, Indonesia, Kazakhstan, Philippines, and Viet Nam) to mobilize the countercyclical development expenditure programs. Each country borrowed $500 million from the facility. Country case studies on CSF loan implementation are provided in Appendixes 1–3, summaries for Bangladesh, Indonesia, and Kazakhstan are presented in Box 2.19

16

ADB. 2009. Review of the Implementation of ADB’s Business Processes. Manila. 17

M. Feldstein. 1998. Refocusing the IMF. Foreign Affairs. 77 (2). pp. 20–33. 18

See discussions in J. Stiglitz. 2002. Globalization and Its Discontents. London: Penguin; and K. Rogoff. 2003. The IMF Strikes Back. Foreign Policy. 134 (January/February). pp. 38–46. As Stieglitz points out, the standard macroeconomic prescription at the time of recession should be expansionary in nature, rather than contractionary. As Rogoff argues, however, preserving sufficient fiscal space at the noncrisis time should be regarded as a prerequisite for expansionary crisis response. For this reason, CSF set a sound fiscal position and broader macroeconomic management as eligibility criteria.

19 ADB. 2009. Report and Recommendation of the President to the Board of Directors: Proposed Program Loans to the People's Republic of Bangladesh for the Public Expenditure Support Facility Program and the Countercyclical Support Facility Support Program. Manila; ADB. 2009. Report and Recommendation of the President to the Board of Directors: Proposed Loan to Indonesia for Countercyclical Support. Manila; ADB. 2009. Report and Recommendation of the President to the Board of Directors: Proposed Loan to Kazakhstan for the Kazakhstan Countercyclical Support Loan. Manila; ADB. 2009. Report and Recommendation of the President to the Board of Directors: Proposed Loan to Philippines for the Countercyclical Support. Manila; ADB. 2009. Report and Recommendation of the President to the Board of Directors: Proposed Loan to Viet Nam for the Countercyclical Support. Manila; ADB. 2010. Countercyclical Support Facility: Annual Report 2009. Manila.

Box 2: Countercyclical Support Facility for Middle-Income Countries

The Countercyclical Support Facility (CSF) supported social safety net programs in Bangladesh. The Asian Development Bank (ADB) provided the CSF loan to help the government of Bangladesh implement its countercyclical development program involving vastly higher spending for expanded social safety net programs, as well as a new public–private partnership scheme, and a much larger allocation for Annual Development Program infrastructure projects. Implementing the expanded social safety net programs served the twin functions of immediately addressing the needs of the poor and vulnerable affected by the global crisis through income and food support, and providing strong stimulus to growth. Combined with the parallel provision of program lending from the Public Expenditure Support Facility aimed at enhancing fiscal management, the CSF loan freed up the government’s resources to finance other components of the countercyclical development program, in particular, the planned scaling up of infrastructure investment.

11


B. Precautionary Financing Option 16. In Indonesia, where acute repercussions in the capital markets through early 2009 surfaced as a serious concern (Figure 8), ADB and the World Bank, in partnership with the governments of Australia and Japan, established the Public Expenditure Support Facility (PESF).20 The PESF was designed as a contingency instrument, under which the country can exercise the precautionary financing option when market conditions reach predetermined triggers. By signaling availability of development partners’ contingent support, the PESF helped sustain recovery of confidence in the capital market that once recorded a sharp rise in international bond spread. Within ADB’s existing policy, the precautionary financing option allowed a borrower to postpone drawing a loan for a defined drawdown period after the loan agreement is declared effective.21 With the global financial system stabilizing by mid-2009 and Indonesia’s macroeconomic framework sound, the drawdown triggers were not exceeded and hence no disbursements were made under the PESF. The contingent loan was financially closed on 31 December 2010 as planned (Appendix 2 provides the country case-study on Indonesia).

20

ADB. 2009. Report and Recommendation of the President to the Board of Directors: Proposed Program Loan to the Republic of Indonesia for the Public Expenditure Support Facility. Manila.

21 Independent Evaluation Group. 2010. The World Bank Group’s Response to the Global Economic Crisis: Phase 1. Washington, DC: The World Bank Group.

The CSF loan for Indonesia enhanced budget predictability, essential for the government’s countercyclical action. In the context of the real economy downturn and the emerging fiscal constraint, the government asked ADB to provide a CSF loan to support its public expenditure program for the second half of 2009 and 2010. The request for financing stemmed from the government’s concerns about ensuring predictability in its budget financing, given the necessity for a temporary fiscal stimulus in 2009 and its continuation in 2010. The government had estimated a budget deficit of 2.4% in the Revised Budget 2009 with a net

financing requirement of Rp129.8 trillion,a and a proposed budget deficit of 2.1% for the Revised

Budget 2010 and a net financing requirement of Rp133.7 trillion. The objective of the CSF loan was to fill part of these budget shortfalls. By doing so, it supported fiscal stimulus through infrastructure investments aimed at improving the welfare of targeted groups in the social sector, competitiveness-enhancing projects in the agriculture and traditional distribution sectors, and other investments with a clear development impact. It also supported the scaling up of social assistance programs in 2009 and maintenance of spending in 2010. The CSF supported implementation of the employment generation program and the anti-crisis plan of Kazakhstan. Both of these plans supported key sectors of the economy and generated additional jobs. The CSF package was designed to contribute financing for the employment generation program and leverage the government's commitment to pursue the anti-crisis plan. Counterpart funds generated from the loan proceeds were comingled with government funds to support and reimburse the government’s budgetary spending for the employment generation program. The CSF support for the fiscal stimulus through these programs helped Kazakhstan mitigate the impact of the global economic crisis. GDP growth recovered to 1.2% in 2009, indicating a reversal of the recession experienced by the country during the first half of 2009. The momentum was maintained in 2010, as observed in GDP growth of 8.0% from January to June 2010. a

RP9,088 = $1.00


12

Figure 8: Indonesia: Market Development (credit default swaps)

Source: Asian Development Bank. 2010. Asian Development Outlook 2010: Macroeconomic Management beyond the Crisis. Manila.

C. Program Lending 17. ADB’s program lending in the precrisis period helped OCR-eligible middle-income DMCs to create some fiscal space for countercyclical response. It also helped advance reforms in low-income ADF countries. Asia’s active countercyclical response during the crisis was made feasible by sound macroeconomic management in the time preceding the crisis,22 to which some of ADB’s program lending made crucial contributions. For instance, in the Philippines, consolidation of public finance implemented under the Development Policy Support Program since 2004 has created fiscal space that enabled the government to mitigate the poverty impact from the crisis in 2009–2010.23 The sense of emergency at the time of the crisis also enabled ADB to seize the opportunity to accelerate structural reforms. This was important in low-income countries where needs to advance structural reforms were still prevalent to prepare a sufficient foundation for receiving incremental assistance, as was the case for the Economic Support Program for Tonga and the Social Sector Support Program for Mongolia, both financed by the ADF (Box 3 and Appendixes 4–5).

22

As recovery took hold and the economic crisis receded in 2010, ADB called for the region to remain faithful to sound and sustainable fiscal and monetary policy, while adapting those policies appropriately. ADB. 2010. Asian Development Outlook 2010: Macroeconomic Management Beyond the Crisis. Manila.

23 See ADB. 2010: Completion Report: Development Policy Support Program Cluster in the Philippines. Manila.

13


18. Imposing somewhat detached reforms in the midst of the crisis may run the risk of incurring unnecessary burdens on both ADB and the governments, as was observed in the initial stage of program loan processing for Central and West Asia (Georgia’s Growth Recovery Program, Armenia’s Crisis Recovery Program Loan, and Tajikistan’s Crisis Recovery Program, all approved in June 2009). Unlike the case of the CSF loan for Kazakhstan, these conventional program loans required reform conditionality and that had undesirable impacts on the timely delivery of crisis response. One of the lessons from these operations was the need to balance requirement to impose reforms with crisis-responsiveness in the program design, especially when time is critical. Structural reforms certainly play crucial roles in the medium term, but that should not be confused with the immediate objective of protecting growth from the crisis. 19. Special program lending, ADB’s permanent lending instrument for a BOP crisis, was not used, partly because of its excessively high pricing24 and contextual mismatch in many surplus countries in Asia that did not require traditional BOP support.25

24

ADB’s current spread over the London interbank offered rate (LIBOR) for the special program loans is 400 basis points. For alignment with the International Monetary Fund’s BOP support, the World Bank reduced its minimum over-LIBOR spread to 200 basis points in 2009.

25 Among the five regions of developing Asia, only South Asia has recorded a current account deficit in 2010; Central Asia, East Asia, Southeast Asia, and the Pacific all recorded a surplus (ADB. 2010. Asian Development Outlook Update: The Future of Growth in Asia. Manila). For further assessment of global imbalance, see ADB. 2009. Asian Development Outlook: Rebalancing Asia’s Growth. Manila.

Box 3: Program Lending for Low-Income Countries

The Economic Support Program for Tonga (2009) helped sustain overall reform momentum. The Asian Development Bank (ADB) provided $10 million of budget support financed by the Asian Development Fund (ADF). The program was designed to lessen the economic downturn while paying special attention to the needs of the vulnerable. It was underpinned by solid diagnostics, communication, awareness-raising initiatives, and a commitment to a longer-term engagement. Proceeds from the program were scheduled for release in two tranches of $5 million each. Learning from the lessons of past programs, care was taken to work within country-led approaches and to build on areas of historical involvement (in particular, reforms of state-owned enterprises and economic management). The program was designed to achieve the objectives of (i) providing budget support to protect the vulnerable, (ii) maintaining fiscal sustainability and reform momentum, and (iii) promoting local stakeholders’ ownership.

The Social Sector Support Program for Mongolia (2009) enhanced the priority accorded to the country’s social sectors through public financial management reform. The program, comprising a $43.1 million ADF loan and a $16.9 million ADF grant, is supporting fiscal adjustment under the stand-by arrangements of the International Monetary Fund and protecting social sector expenditure by providing budget support. The program is also implementing a set of policy measures for social welfare, health, education, and urban development to provide essential social services. In particular, policy measures are supporting long-term social sector structural reforms and long-term efficiency and sustainability of social expenditures through better targeting, rationalization, and consolidation of social transfers in the health, insurance, education, and social welfare sectors.


14

D. Trade Finance Program

20. The Trade Finance Program was very successful in responding quickly and effectively to crisis needs. In March 2009, following the crisis and market needs, the Trade Finance Program limit was increased to $1 billion and transaction tenor was extended to 3 years. It supported significant volumes of trade in Asia ($5 billion during the crisis period), mobilized risk mitigation resources ($3 billion), and enabled trade credit lines to remain in place. It provided liquidity to local banks, ($54 million in 469 pre-export loans) and helped develop local banks in the targeted countries (101 issuing banks). By extension, this helped reinforce the small and medium-sized enterprise (SME) sector during the downturn (612 SME transactions completed). E. Knowledge Products and Services

21. ADB provided significant support to DMCs to build their institutional capacity and support for policy analysis and advice, and other knowledge work in order to cope with the impact of the economic crisis, mainly through technical assistance (TA) grants. ADB provided TA support to improve regional, subregional, and national economic surveillance and monitoring. At the country level, support was also provided by some resident missions when requested by their government counterparts for specific and prompt policy advice. ADB convened a series of forums to facilitate discussions on the impact of the global economic crisis in Asia. For instance, the Regional Forum: Impact of the Global Economic and Financial Crisis held on 14–15 January 2010 26 engaged DMCs across the region in knowledge sharing of in-country and global experiences to minimize adverse effects and cope with the global crisis. Participants explored mechanisms and measures that have been successful in mitigating adverse impacts, including stimulus measures, policy coordination and adjustments, and monitoring of systemic risks for maintaining financial stability; and discussed the regional dimensions of the crisis for dealing with contagion effects. It was followed by the Regional Forum: Impact of the Global Crisis on Asia, Lessons Learned, Policy Insights and Outlook held on 4 November 2010. Participants from 16 DMCs assessed the robustness of recovery, and discussed how to enhance resilience, sustainability, and inclusive growth. 22. The Asian Development Outlook and its update, Asian Economic Monitor, and other forms of research works,27 as well special notes on crisis and recovery issued from time to time, were instrumental to the formulation of ADB’s crisis response. In the Pacific, global economic crisis research, policy, and advocacy work primarily centered around three publications: (i) Navigating the Global Storm, A Policy Brief on the Global Financial Crisis;28 (ii) Taking the Helm, A Policy Brief on a Response to the Global Crisis;29 and (iii) the quarterly Pacific Economic Monitor, which commenced in May 2009. (Appendix 6 provides more examples of ADB’s crisis-related knowledge products and services).

26

This event was preceded by the South Asia Forum on the Impact of the Global Economic and Financial Crisis held on 9–10 March 2009. The forum brought together public and private sector representatives from seven South Asian countries to share cross-country experiences on the impacts of the crisis, and the ongoing and planned measures to preserve financial stability, stimulate growth, and ensure social protection in their respective economies.

27 For instance, W.E. James, D. Park, S. Jha, J. Jongwanich, A. Terada-Hagiwara, and L. Sumulong. 2008. The US Financial Crisis, Global Financial Turmoil, and Developing Asia: Is the Era of High Growth at an End? ADB Economics Working Paper Series. No. 139. Manila.

28 ADB. 2008. Navigating the Global Storm: A policy brief on the global financial crisis. ADB Pacific Studies Series, December. Manila.

29 ADB. 2009. Taking the Helm: A policy brief on a response to the global economic crisis. ADB Pacific Studies Series. April. Manila.

15


IV. DEVELOPMENT PARTNERSHIP

23. ADB stepped up cofinancing efforts to keep up with the mounting needs for crisis response. As the adverse impacts of the crisis unfolded in Asia, the overall cofinancing more than doubled, from $647 million in 2007, to $1.56 billion in 2008, and to $3.32 billion in 2009; it was estimated to have declined to $2.76 billion when the recovery path continued to be solid in 2010. From 2007 to 2009, the number of development partners that worked with ADB on project cofinancing also increased significantly from 10 to 23. Apart from formal cofinancing, all of the policy-based lending operations were packaged in close contact with the International Monetary Fund (IMF). In the Pacific, key development partners committed to support a common government-led matrix of policy actions under the economic recovery support programs in Samoa and Solomon Islands. In Indonesia, close collaboration with Australia, Japan, and the World Bank was key for the success of the precautionary financing option under the PESF.

V. CRISIS RESPONSE BY OTHER MULTILATERAL DEVELOPMENT BANKS

24. To date, the World Bank Group and European Bank for Reconstruction and Development (EBRD) have completed evaluation of the crisis response, both presenting favorable results. The World Bank Group’s crisis response comprised (i) supporting the most vulnerable, (ii) maintaining long-term infrastructure investment, and (iii) sustaining the potential for private sector-led growth. In fiscal years 2009–2010, the group committed $128.7 billion and disbursed a record $80.6 billion—the amount is greater than any other international financial institutions, including IMF. This was largely as a result of large financial headroom inherited by the International Bank for Reconstruction and Development. 30 The report prepared by the Independent Evaluation Group31 concluded that the World Bank Group responded well to the nature of the crisis that called for the countercyclical fiscal expansion to compensate for sharply declining trade and private capital flow. By the end of 2009, EBRD committed €5.5 billion and disbursed €3.2 billion for 115 projects in 28 countries. Generally, EBRD’s intervention focused on addressing liquidity constraints in the financial sector. The evaluation 32 recommends enhancing EBRD’s crisis readiness to allow for quicker and more effective response in the future, including setting aside capital and liquidity as part of annual business planning and development of new products to address immediate liquidity needs. IMF’s independent evaluation focused on the performance in the run-up to the crisis.33 (Appendix 7).

30

In contrast, capital of the International Finance Corporation was constrained as a result of equity write-downs, an increase in nonperforming loans, and transfers to the International Development Association (IDA) from surplus. IDA’s funding envelope determined before the crisis enabled a lesser increase. The assessment left an open issue on balancing the immediate crisis response and long term financial capacity.

31 World Bank Independent Evaluation Group. 2010. The World Bank Group’s Response to the Global Economic Crisis: Phase 1. Washington, DC.

32 EBRD Evaluation Department. 2010. Special Study: The EBRD’s Response to the 2008–2009 Crisis. London.

33 According to the evaluation, IMF provided few clear warnings about the risk and vulnerabilities associated with the impending crisis before its outbreak. IMF Independent Evaluation Office. 2011. IMF Performance in the Run-UP to the Financial and Economic Crisis: IMF Surveillance in 2004–07. Washington, DC.

16

VI. LESSONS AND CONCLUSIONS

A. General Observations

25. The world’s economic history shows that financial crises repeat, and typically lead to the downturn of the real economy. At least 14 episodes of severe banking issues have been experienced, including the one that led to the Great Depression.34 On average, GDP per person dropped by more than 9% from its peak, taking almost 2 years to reach the bottom, leaving dragging effects on employment and hence people’s lives. The best thing that the international community (or multilateral development banks, in particular as institutions set up to promote inclusive growth) can do would be, while continuously pursuing establishment of more efficient but stable global financial markets, to stay prepared for future crises.35 Obviously, the next crisis may not be exactly the same and responses may have to be adjusted on a case-by-case basis. Flexibility should be built into ADB’s institutional capacity. At the same time, some common lessons can be drawn; a discussion follows. 26. The CSF and ADF excess liquidity provided necessary additional resources to augment ADB’s regular financing. The CSF loans totaling $2.5 billion accounted for 23.6% of ADB’s entire sovereign loans approved in 2009 and the ADF excess liquidity of $400 million accounted for 12.8% of ADF operations for the year. These vast incremental resources helped ADB support DMCs. Such innovative approaches provided much needed liquidity to DMCs, while quickly bringing the reflows back to ADB’s balance sheet under the V-shaped economic turnaround. However, both were not available at the height of the crisis in the first quarter of 2009. Also, they were designated as transitory arrangements for 2009–2010 leaving ADB unequipped for the next crisis. 27. Another lesson is the importance of maintaining ADB’s financial readiness to respond with crisis lending. Financial readiness would depend on (i) the credit quality of the portfolio and (ii) capital headroom (risk-bearing capacity). It is important to respond to countercyclical lending while maintaining financial sustainability in the long term. Regional banks with natural geographic concentration in the portfolio along with nonsovereign exposure could generally be more vulnerable. The extent of countercyclical response impacts the planning of lending levels and resources in the long term.36 The Work Program and Budget Framework should take into account possible crisis response need. B. Steps Forward

28. It is desirable that CSF is mainstreamed as a permanent lending modality for middle-income countries, so that it can be utilized immediately when needed. Trying to create a new facility only after the outbreak of the crisis inevitably leaves time lags, making it difficult for ADB to act swiftly during the worst part of the crisis. As an increasing number of ADB’s DMCs in Asia

34

Argentina (2001), Columbia (1998), Hong Kong (1997), Indonesia (1997), Republic of Korea (1997), Malaysia (1997), Philippines (1997), Thailand (1997), Japan (1992), Finland (1991), Sweden (1991), Norway (1987), Spain (1977), and US (1929). C. Reinhart and K. Rogoff. 2009. The Aftermath of Financial Crisis. The listing represents only major bank-centered crisis episodes that took place before the global financial crisis and the current eurozone crisis, and does not cover the oil crises in the 1970s, Latin American debt crisis in the 1980s, European currency crisis in 1992–1993, and Tequila Crisis (Mexico) in 1994.

35 Because of this, ADB should continuously monitor the regional economies through the Asian Economic Monitor and Pacific Economic Monitor.

36 While ADB responded to the crisis and substantially increased its actual and/or planned OCR lending in 2009–2011 over that designated in the original Work Program and Budget Framework, ADB lowered its sustainable level of lending during the process of general capital increase discussions.

17


record a lower deficit and even a current account surplus, traditional BOP support is not necessarily the most appropriate mode of crisis response in many countries. As experience with the recent crisis showed, these countries needed an instrument for countercyclical budget support to act as a fiscal stimulus to help counter the economic downturn in a timely manner. The CSF should be permitted exceptionally under the crisis situation and only in the volume that does not hinder ADB’s risk-bearing capacity. The World Bank Group’s recent independent evaluation also notes the relevance of ADB’s CSF, and recommends that the World Bank introduce a similar short-term crisis response instrument.37 29. There is a need for discussion with ADF donors on possible establishment of some mechanism to flexibly allocate additional ADF resources at the time of a crisis. The crisis response requires a more flexible approach than is available under the current PBA system. The country performance assessment criteria for PBA are primarily aimed at ensuring the policy framework to enhance supply-side efficiency for medium-term growth. All of these criteria may not be directly relevant at the time of crisis. Under a crisis situation, discretionary financing may be required to stimulate aggregate demand for sustaining short-term growth, and the DMCs need a certain degree of flexibility in their policy response, even to partially depart from those prescribed under the PBA system. As in the case of CSF, DMCs’ financing request needs to be assessed in relation to the specific crisis impacts for each country and policy dialogue should focus more on macroeconomic management. On account of the crisis situation, imposition of structural reform conditionality at the microeconomic level could be exceptionally forgone.

37

Independent Evaluation Group. 2010. The World Bank Group’s Response to the Global Economic Crisis: Phase 1. Washington, DC: The World Bank Group. ADB staff welcomes this recommendation by the World Bank’s Independent Evaluation Group.

18

Appendix 1

COUNTRY CASE STUDY OF ADB’S CRISIS RERPONSE: BANGLADESH

1. Because of prudent macroeconomic management, Bangladesh historically maintained internal and external balances and was able to cope with repeated natural disasters and major external shocks, while sustaining its growth momentum. The fiscal deficit (less than 4% of gross domestic product [GDP] during FY2006–FY20101) was maintained well below the level required to stabilize public debt in relation to GDP. The debt–GDP and debt service ratios declined significantly over time and remained low. In the external sector, healthy growth in exports and a surge in remittances—the two traditional growth drivers—resulted in current account surpluses for the past half a decade, contributing to sizable foreign reserve accumulation. Inflation remained moderate around 7%, except in FY2008 when natural disasters and the surge in food and commodity prices pushed inflation up to 9.9% and the larger budgetary allocations for social safety net spending in the wake of the crises raised the fiscal deficit to 4.7% of GDP. As these crises abated, the inflation rate came down to 6.7% and the fiscal deficit moderated to close to 4% in FY2009. 2. Bangladesh recorded average real GDP growth of 6.3% during FY2004–FY2008. Surviving the external and internal shocks during FY2008, the economy gained momentum in the first quarter of FY2009 (July–September 2008) before it began to experience the impact of the global crisis. During this period, exports surged by 42.4%, import payments grew by 34.9%, workers’ remittances rose by 43.5%, private sector credit expanded rapidly by 26.6% year-on- year, and firms were poised to scale up their operations and expand production capacity. The 13.5% growth in the manufacturing index and 30% growth in industrial term loans indicated an upbeat business environment and brisk private sector activity. 3. At the end of the first quarter of FY2009, key indicators still pointed to a sound macroeconomic outlook in the near term with growth picking up. The only major challenge facing the government was the moderate inflationary pressure caused by the exogenous price shocks. The new government (installed in office in January 2009) increased support to boost agricultural output through better access to inputs such as seeds, fertilizers, irrigation, and credit. Along with good weather conditions, these resulted in successive bumper rice crops. The exporters of readymade garments had no difficulty securing orders and were anticipating a good year for their business. At the onset of the global economic crisis, Bangladesh was generally expected to remain largely unaffected because of its insulation from the international financial market. However, as the crisis unfolded, its impact began to be felt. 4. GDP growth in FY2009 declined to 5.7% from 6.4% in FY2007 and 6.2% in FY2008—falling below 6% for the first time in several years, even though the government took several fiscal stimulus measures to support and provide protection to sectors of the economy affected by the global economic crisis. Although agriculture performed well and acted as an important rebalancing factor, slower growth of exports and remittances affected industry and services in FY2009 and business confidence and the domestic economic outlook. The services sector, with its strong links to industrial activity and domestic and international trade, moderated due to the slowdown in these activities as well as weaker private consumption because of slower growth of remittance inflows.

1 The fiscal year (FY) of Bangladesh ends on 30 June. FY before a calendar year denotes the year in which the

fiscal year ends.

19


Appendix 1

A. Transmission Channels

1. First-Round Effects

5. The direct impact of the global economic crisis on the Bangladesh economy was transmitted through international trade and remittances. The financial sector did not experience any major disturbance from the global financial meltdown because of its limited linkages with the international financial system. The capital market experienced only moderate volatility and suffered negligible losses compared with other countries. The domestic economy also did not experience a liquidity crisis as the commercial bank-dominated financial sector in Bangladesh was not directly affected by the international crisis.

6. International trade. From the beginning of the second quarter of FY2009, export growth decelerated sharply once the economic crisis in the industrial countries that are the major destinations of Bangladeshi exports, took hold. During the last three quarters of FY2009, overall export growth year-on-year was only 1.4%, a steep decline from 23.7% in the same period a year earlier. By the end of FY2009, while the readymade garments posted still healthy growth of 15.4%, exports of other products (mainly frozen foods, leather, and jute) had declined by 5.7% on weak demand and lower prices. The growth in overall exports declined from 17.4% in FY2008 to 10.1% in FY2009. In FY2010, export growth declined further to 4.2%, with a decline early in the year and improvement in later months. 7. Remittances. Workers’ remittances were still growing in FY2009, but the pace of growth decelerated. The number of workers leaving Bangladesh for work abroad fell rapidly, while the number of people returning home rose significantly. The growth of workers’ remittances slowed from 32.4% in FY2008 to 22.4% in FY2009. The sharp rise in job placements abroad during FY2007–FY2008 was triggered by brisk construction and rise in other economic activities in middle-eastern countries following the oil price surge. This contributed to the still respectable growth in remittances. Labor demand in these countries declined subsequently following the moderation in oil prices because of the global economic slowdown. In FY2010, remittances continued to rise, although at a slower pace (13.4%), with the number of new migrants falling and the number of returnees rising.

2. Second-Round Effects

8. The marked slowdown in export and remittance growth in FY2009 affected the broader domestic economy through intersectoral linkages. The domestic manufacturing sector depends heavily on export sector developments and thus on the performance of the global economy. Remittances are also responsible for a significant part of expanding domestic demand and supporting imports. Business confidence in Bangladesh, as elsewhere, suffered because of the uncertainties about the economic outlook created by the global crisis, which again contributed to a slowdown in private investment activity. Firms adopted a wait and see policy for new investment programs to ride out the slowdown in the global economy. Largely consistent with this approach, disbursement of industrial term loans declined during FY2009 compared with a 62.6% rise recorded in the preceding fiscal year. Contracting in the second half from previous year levels, imports plummeted to only 4.2% growth in FY2009 sharply down from 25.6% in FY2008. In FY2010, growth in imports recovered slightly to 5.4%. 9. Growth in government tax revenue also slowed significantly as a result of lower imports and slower domestic economic activity. Revenue collection recorded a surplus relative to target in the first quarter of FY2009, but thereafter turned into a rising deficit. Tax revenue growth in

20

Appendix 1

FY2009 was only 10.1%, far lower than the 23.2% growth in FY2008. The total revenue-to-GDP ratio dropped to 10.4% in FY2009. Tax revenue annual growth, however, recovered to 21.0% in FY2010, and total revenue rebounded to 11.5% of GDP. Revenue collection responded to the recently adopted reform measures, including strengthening tax administration and expanding the tax net for both income and value-added taxes, and better compliance by large taxpayers. B. ADB’s Role in Responding to the Crisis

10. Countercyclical Support Facility. On 13 October 2009, ADB approved the Countercyclical Support Facility Support Program (CSF)2 to help the government implement its countercyclical development program (Table A1.1). The government announced the program in June 2009 in the FY2010 budget. It involved vastly higher spending on four categories: a new public–private partnership (PPP) scheme, a much larger allocation for annual development program infrastructure projects, expanded social safety net programs (SSNPs), and a fiscal stimulus package. The $500 million CSF loan was declared effective on 6 November 2009 and disbursed on 10 November 2009 as a single tranche.

Table A1.1: Government's Countercyclical Development Program ($ million)

Item FY2010 FY2009 % Increase

Fiscal Stimulus Package 724 495 46.3 Social Safety Net Programs 2,509 2,005 25.2 Annual Development Program 4,416 3,330 32.6 Public–Private Partnership 362 0 Introduced in FY2010

Source: Government of Bangladesh. 11. The CSF loan was designed to contribute to implementation of the expanded SSNPs—a key component of the government's countercyclical development program. Implementation of the expanded SSNPs was expected to serve the twin functions of (i) immediately addressing the needs of the poor and vulnerable affected by the global crisis through income and food support, and (ii) providing strong stimulus to growth. This, in turn, would free up fiscal resources to finance the other components of the government's countercyclical development program, in particular, the planned scaling up of infrastructure investment. 12. Public Expenditure Support Facility. ADB approved the Public Expenditure Support Facility (PESF) Program 3 for Bangladesh jointly with the CSF. The two programs were processed together considering the positive synergy resulting from both policy complementarity and funding additionality. The PESF comprised three loans: (i) $100 million in ordinary capital resources; (ii) an amount equivalent to SDR64,036,0004 from ADB’s Special Funds resources; and (iii) an amount equivalent to SDR28,720,000 from ADB’s Special Funds resources. 13. The PESF was designed to support reforms for enhancing economic and social policies essential for long-term growth and scaling up of SSNPs. It focused on helping the government

2 ADB. 2009. Report and Recommendation of the President to the Board of Directors: Proposed Loans to the People's Republic of Bangladesh for the Public Expenditure Support Facility Program and Countercyclical Support Facility Support Program. Manila.

3 The PESF was disbursed in two tranches on 10 November 2009 and 23 November 2010, upon compliance with 41 tranche conditions and approval of a waiver of the requirement for one condition. ADB. 2010. Progress Report on Tranche Release for Bangladesh: Public Expenditure Support Facility Program. Manila (Loans 2566-BAN, 2567-BAN, 2568-BAN); and ADB. 2010. Corrigendum 1 to Document on Release of Second Tranche, Public Expenditure Support Facility Program (Bangladesh). Manila.

4 SDR = special drawing right.

21


Appendix 1

put in place policy actions in three areas: (i) delivering services more effectively through expanded SSNPs, gender targeting, and oversight opportunities for vulnerable groups; (ii) developing a conducive investment climate, by strengthening the government's ability to attract private investment, in particular through PPPs; and (iii) strengthening the public financial management system and increasing the fiscal space. 14. Trade finance and support under the Trade Finance Program. ADB expanded its Trade Finance Program in Bangladesh with the signing of 12 more agreements (bringing the number up to 14) with local banks in December 2009. These agreements gave the banks additional room for offering trade finance support to importers and exporters and helping maintain trade flows in the face of the global economic slowdown. 15. Crisis-related advocacy and knowledge management. ADB also processed (at the request of the Ministry of Finance) a small-scale capacity development technical assistance (TA)—Strengthening Macroeconomic and Fiscal Monitoring at the Ministry of Finance.5 This TA includes specialist assistance to enhance the Finance Division’s analytical and policy formulation capabilities. Earlier, ADB (Bangladesh Resident Mission) commissioned a study—Global Economic Crisis: Impact on Bangladesh and Policy Response by engaging a staff consultant. The consultant also conducted a debt sustainability analysis as a part of the assignment. C. ADB’s Coordination with Other Development Partners

16. No other development partners extended any crisis-related assistance to Bangladesh. However, in preparing the CSF and the PESF, ADB coordinated closely with all major development partners to enhance complementarities and avoid duplication with their ongoing support for SSNPs, investment climate, and public financial management. D. Impact of ADB Support

17. The CSF has helped ensure sufficient funding for the specific SSNPs designated for support under the program by providing livelihoods for workers who lost their jobs and enhancing social services, while also freeing public resources for other priority expenditures. The CSF aimed to contribute to coverage of about 20% of the total cost of $2.5 billion of SSNPs. According to the latest information, at least 64% of the FY2010 budget allocation for the SSNPs financed under the CSF has been utilized. 18. The CSF ensured sustained external financing for ongoing and planned infrastructure projects to maintain the growth momentum. The policy measures introduced by the government to expedite annual development program disbursements have proven quite effective. Of the annual development program FY2010 allocation of $4.4 billion equivalent, 85% has been implemented, which is an improvement over earlier years (77% in FY2009 and 70% in FY2008). Progress in implementing the new PPP scheme has however been slower than envisaged. Against the budgetary allocation of $362 million equivalent for supporting PPP in FY2010, no spending took place in the absence of an integrated policy on PPP. But with ADB support to the PPP cell and for the development of a PPP operating framework, important steps have been taken since August 2010 (in FY2011) to develop alternative sources of funding, including setting

5 ADB. 2009. Technical Assistance to the People's Republic of Bangladesh for Strengthening Macroeconomic and

Fiscal Monitoring at the Ministry of Finance. Manila.

22

Appendix 1

up of the Bangladesh Infrastructure Finance Fund, to address critical infrastructure constraints and meet other development expenditures. 19. Of the $724 million budget allocation for fiscal stimulus in FY2010, close to 90% was spent. The fiscal deficit was however limited to 4.5% of GDP, well within the 5% of GDP earlier envisaged, mainly because of the better than expected revenue outturns. The government’s countercyclical response to the crisis helped stabilize demand and achieve GDP growth of 5.8% in FY2010 by boosting domestic consumption—in the face of the decline in the growth in exports and remittances. The CSF, together with the strong revenue outturns, also helped maintain macroeconomic stability by reducing the need for inflationary bank borrowing, while enhancing availability of credit to the private sector. At the same time, the positive impact of the CSF on investment and growth is expected to be felt mostly in FY2011, now that the development project approval process and the private sector infrastructure guidelines have been revised6 and PPP project preparation facilitated through ADB support for the PPP cell. 20. Under the PESF program, opportunities for aligning resource allocation and policy priorities with actual needs have improved. Progress has been made in terms of better targeting budget support to protect and empower hardcore poor and vulnerable populations including through establishing consolidated databases for such categories of population. Enhanced transparency on utilizing public resources and more timely access to information facilitated by the program are major steps in ensuring greater accountability in public service delivery and more efficient investment. 21. Significant advances have been realized during the program period in improving the investment climate mainly through a major revision of the 2004 private sector infrastructure guidelines. Another positive development under the program is the better access to financial services available for small and medium-sized enterprises and women entrepreneurs, which contribute importantly to job creation and inclusive growth. 22. Public financial management has improved considerably throughout the entire budget cycle under the program. The number of ministries and divisions brought under the medium-term budgetary framework rose to 33 from 16. For most ministries and divisions, annual accounts are now being submitted within 1 month. The use of web posting by ministries, divisions, and agencies has improved considerably in terms of quality and timeliness. 23. These reforms are an important component of a series of institutional and behavioral changes requiring further work to deepen their effects and enhance sustainability. Progress achieved in implementing the policy actions under the PESF within a year since loan effectiveness testify to the government’s commitment to reforms for putting in place more effective policies and systems to support pro-poor and gender inclusive growth.

6 These were two critical measures implemented as part of the second tranche conditions under the PESF.

23


Appendix 2

COUNTRY CASE STUDY OF ADB’S CRISIS RESPONSE: INDONESIA 1. The crisis response of the Asian Development Bank (ADB) to Indonesia comprised a sequence of modalities. First, ADB staff continuously monitored the macroeconomic environment with follow-up policy advice to senior policy makers at the Ministry of Finance, Bank Indonesia, and the National Planning and Development Agency (Bappenas), among others. Policy dialogue on the crisis was also channeled through established government–development partner forums including the Development Policy Support Program loan series. Second, ADB participated in the design, development, and cofinancing of the Public Expenditure Support Facility (PESF) with a contingent loan of $1 billion financed from ADB’s ordinary capital resources.1 The program was to be completed by 31 December 2010. Third, ADB provided a Countercyclical Support loan of $500 million financed under the Countercyclical Support Facility (CSF) in October 2009.2 2. This case study indicates that the combined ADB package of assistance to Indonesia was effective in addressing the increased risks to the financial system and the fiscal stress resulting from the global financial crisis (GFC). The effectiveness of ADB’s assistance was supported by the following factors:

(i) Coming into the GFC, Indonesia’s economy was relatively sound with strong economic growth momentum in 2007 and 2008, a low budget deficit, and a very low public debt to GDP ratio of 33% providing fiscal space, and a well-capitalized banking system.

(ii) Prior to and during the GFC, ADB staff remained continuously engaged in policy dialogue with government thereby supporting the government’s proactive policy response to the increased risks to the macroeconomy.

(iii) The PESF and CSF designs were well-sequenced and targeted the key macroeconomic vulnerabilities of the Indonesian economy. The PESF helped mitigate the increased risks of the global credit crunch on Indonesia’s ability to access international credit markets to finance the national budget and debt amortization. The CSF provided budget support for the fiscal stimulus to mitigate the second-round effects of the GFC on the real economy.

(iv) The government had arranged with other development partners for additional budget support and made arrangements with key trading partner mechanisms, such as currency swap agreements, to protect trade flows.

(v) The government already had in place effective social assistance programs that were easily scaled up to mitigate the adverse impacts of the economic slowdown on the poor and vulnerable households.

(vi) Bappenas had earlier established a project monitoring and evaluation division that ensured effective coordination and monitoring of the government’s fiscal stimulus program.

3. The case study provides two critical lessons for ensuring future fiscal stimulus programs are timely, well targeted, and temporary. First, the government’s temporary scaling up of well-targeted social assistance programs and timely tax cuts (set within a longer-term tax reform program) appear to be effective in boosting private consumption in the short term and mitigating

1 ADB. 2009. Report and Recommendation of the President to the Board of Directors: Proposed Loan to the

Republic of Indonesia for the Public Expenditure Support Facility Program. Manila. 2 ADB. 2009. Report and Recommendation of the President to the Board of Directors: Proposed Loan to the

Republic of Indonesia for Countercyclical Support. Manila.

24

Appendix 2

the worst effects of the crisis on the poor. Second, an efficient public financial management system is critical to ensure budget spending and in particular infrastructure spending is timely and an effective stimulus. While Indonesia has been implementing reforms to its public financial management system for almost a decade, it remains inefficient. This was a drag on disbursements of the infrastructure component of the stimulus package. Budget data demonstrate that 70.0% of disbursements were made in the last 2 months of 2009, about 5 months after the worst effects of the GFC on the real economy were realized. The late disbursements did provide support to the economic recovery in 2010. 4. The GFC, which intensified after September 2008, affected the Indonesian economy in four related respects: (i) the first-round effects of the global financial crisis had repercussions for the domestic financial sector, leading to significant capital flight and exchange rate depreciation in the second half of 2008, and increased cost of financing of public debt; (ii) the second-round effects of the sharp contraction in global demand hurt the real economy, resulting in a slowdown in economic growth from the fourth quarter (Q4) of 2008 until the third quarter (Q3) of 2009; (iii) the crisis had feedback to fiscal policy, resulting in a decline in tax revenue collection and a wider government budget deficit than initially planned, at a time of limited access to global credit markets; and (iv) the economic impact of the GFC threatened to undo recent gains in reducing unemployment and poverty.

5. Financial sector repercussions. Large and negative impacts on the Indonesian economy emerged in October 2008 resulting from Indonesia’s relatively open capital account and significant foreign ownership of the country’s bond and stock markets. These impacts were manifested in a number of forms: (i) the stock market declined by 31% during October 2008, (ii) yields on medium-term domestic bonds increased by nearly 400 basis points, (iii) Indonesia’s international bond spreads surged by about 650 basis points, and (iv) the rupiah depreciated by 17% against the US dollar. In addition, the government lost almost $7 billion of its international reserves during the same month—falling to $50.6 billion at the end of October. 6. The direct effect of the global crisis on Indonesia’s banking system has been minor because of lack of direct investment in the troubled US assets. However, the indirect impacts on the Indonesian financial sector were significant. Two major impacts were (i) liquidity in the banking system had been very tight during the fourth quarter of 2008 and first quarter of 2009 because of a rapid increase in domestic lending of about 30%, in part attributable to the squeeze on US dollar lines and capital outflow; and (ii) elevated risk perceptions about the Indonesian financial sector and economy limited Indonesia’s access to international credit markets and raised the cost of borrowing. 7. The second-round effects of the contraction in global economic growth adversely affected the domestic economy. This impact was manifested in several ways. While domestic consumption growth remained positive in the first semester of 2009, partly supported by the government’s effective fiscal stimulus, economic growth weakened to 4.0% in Q2 2009 from 4.4% in Q1, and continued though Q3 of 2009. The 27% contraction in exports in the first semester of 2009 and collapse in foreign direct investment were the key factors behind this sharper than expected economic slowdown.3

3 Imports declined by 36% in the first semester of 2009 over the same period in 2008 in line with the fall in exports

and softening domestic demand.

25


Appendix 2

8. Fiscal impact. Government finances were especially vulnerable to spikes in global risk aversion and contagion from external markets because of the country’s large gross financing needs. The term structure of Indonesia’s bonds led to sharply higher debt issuances in 2007 and 2008, and high amortization continued through to 2011. During normal market conditions, Indonesia was able to raise more than $12 billion from domestic and international markets in both 2007 and 2008. However, tighter global liquidity and higher risk premiums combined with high gross financing needs raised interest rates on Indonesian debt compared with other economies in the region. With prohibitive yields on domestic and US dollar bonds, the government could not access funds from the credit markets in Q4 2008, increasing concerns about possible budget financing constraints in 2009. Indonesia also experienced temporary fiscal stress because of the economic slowdown. Tax revenues declined by 6.2% in the first semester of 2009 over the same period in 2008 and nontax revenue (primarily natural resource revenues) declined by 33% over the same period. Debt interest costs rose by an additional $1 billion in the revised 2009 national government budget because of higher interest rates on government debt issuances. 9. Government’s policy response. The government took a number of proactive measures aimed at reducing the likelihood of disruption, and maintaining the confidence and stability of the financial system. Key measures included (i) establishment of a financial safety net regulation that clearly established the roles, responsibilities, and procedures that govern the actions and responses of Bank Indonesia, the minister of finance, and the Deposit Insurance Corporation in the event of the failure of a financial institution; (ii) the central bank strengthened its lender of last resort facility; (iii) coverage of the deposit insurance scheme increased; and (iv) the central bank eased liquidity in banking through monetary expansion. With these measures in place, some indicators showed signs of improvement at the end of 2008. The stock market and the rupiah have stabilized since November 2008, and the international reserves position remained sufficient at around $55 billion at the end of March 2009. 10. The government’s fiscal policy response to the economic slowdown was swift. It announced a revised national budget in February 2009 that included significant countercyclical spending measures including tax cuts and increases in existing social assistance programs, and additional spending on infrastructure and maintenance in July 2009 as part of its fiscal stimulus package. It also introduced measures to speed up disbursement of critical public spending. The government included a more modest second-round fiscal stimulus in the 2010 budget. 11. ADB estimates the total stimulus measures to be around Rp138 trillion. Figure A2.1A shows the composition of the fiscal stimulus implemented in 2009. About 95.0% of commitments were implemented in 2009. Tax cuts amounting to Rp53 trillion accounted for the largest component at 38.0% of the stimulus package, followed by capital maintenance and material spending, social assistance, and the additional infrastructure program. Figure A2.1B shows the composition of the infrastructure component of the fiscal stimulus. About 94.7% of commitments were disbursed and implemented in 2009. Projects under the Department of Public Works accounted for 57.0% of implemented projects covering construction and rehabilitation of national roads, bridges, rail infrastructure, and ports; followed by projects implemented under the Ministry of Transportation (19.0%).

26

Appendix 2

Figure A2.1: Composition of the Fiscal Stimulus Package Implemented

A. Key Stimulus Measures B. Infrastructure Component

Source: Ministry of Finance and Ministry of National Development and Planning (BAPPENAS).

A. ADB’s Role in Responding to the Crisis

12. Crisis related policy support. ADB staff continuously monitored the macroeconomic situation in Indonesia (and other Southeast Asian economies) starting in early 2008 with the commencement of the surge in global food prices. Briefing notes focused on identifying macroeconomic and financial sector risks and vulnerabilities from the series of external shocks in 2008, as well as potential measures to mitigate adverse effects on poverty. The notes provided background material for ADB’s dialogue with government and other development partners. Some of the recommended measures were incorporated into ongoing policy-based programs such as the Indonesian and the Philippines development policy support programs.

13. Public expenditure support facility. In the context of the first-round effects, in September 2008 the government asked the World Bank to provide a PESF of $2 billion and to facilitate financing of an additional $3 billion–$4 billion from other development partners. The government stated it intended to exercise this financing only under certain circumstances set out in its financing plan, such as difficulties in accessing credit markets. The World Bank agreed, and shortly after September 2008, ADB, and the governments of Australia and Japan agreed to join the PESF. The request for financing stemmed from concerns about Indonesia’s ability to meet its gross financing needs, which were high in the next 2 years because of the maturity structure and servicing costs of its existing debt. Therefore, the PESF served two purposes: (i) to encourage the government to first mobilize resources from commercial markets by capitalizing on the expected confidence created by the PESF support; and (ii) to serve as an insurance policy to provide additional financing to the government for its larger fiscal stimulus in the event it cannot be fully funded from market financing. The PESF included a set of policy measures aimed at boosting confidence in the financial system and improving efficiency in budget execution to support an effective fiscal stimulus. The government and development partners believed that the announcement of a support package, backed up by a program of confidence-boosting policy measures, would send a strong positive signal to the markets, increasing the likelihood of Indonesia meeting its commercial market borrowing targets for 2009.

14. The PESF was designed to be a single-tranche loan with scheduled and multiple withdrawals to be made during the program period on the condition that, prior to each withdrawal, the government (i) had met the drawdown triggers set out in the financing plan,

Ministry of Trade 3%

Ministry of Health 1%

Ministry of Labor and

Transmigration 2%

Ministry of Transportation

19%

Ministry of Public Works

60%

Ministry of Housing 4%

Others11%

Social

assistance 33%

Tax cuts

38%

Infrastructure

7%

Capital

maintenance and materials

22%

27


Appendix 2

(ii) had maintained an appropriate macroeconomic framework, and (iii) had not reversed any policy actions under the policy matrix. With the global financial system stabilizing by mid-2009 and Indonesia’s macroeconomic framework sound, the drawdown triggers were not exceeded and hence no disbursements were made under the PESF. The contingent loan was financially closed on 31 December 2010 as planned. 15. The PESF also established a macroeconomic monitoring mechanism through which quarterly reports and meetings between the government and development partners were held. This mechanism was used to monitor the macroeconomic performance under the CSF. The formulation of the CSF loan proposal greatly benefited from this consultative and monitoring process, as it was an invaluable vehicle for providing the government with input on its countercyclical fiscal program, additional measures to mitigate the increased downside risks to the macro economy, and ways to strengthen poverty monitoring and coordination efforts 16. Countercyclical Support Facility. In the context of the second-round effects on the real economy and the emerging fiscal constraint, the government asked ADB to provide a countercyclical support loan of $500 million to support its public expenditure program for the second half of 2009 and 2010 (footnote 2). The request for financing stemmed from the government’s concerns about ensuring predictability in its budget financing, given the necessity for a temporary fiscal stimulus in 2009 and its continuation in 2010. The government estimated a budget deficit of 2.4% in the Revised Budget 2009 with a net financing requirement of Rp129.8 trillion and a proposed budget deficit of 2.1% for the Revised Budget 2010 and a net financing requirement of Rp133.7 trillion. Therefore, the objective of the CSF loan was to provide additional official financing to the government for its larger fiscal stimulus in 2009 and 2010. The CSF loan supported the government’s infrastructure investments aimed at improving welfare of targeted groups in the social sector, and especially competitiveness-enhancing projects in the agriculture sector, the traditional distribution sector, and other investments with a clear development impact. It also supported the scaling up of social assistance programs in 2009 and maintenance of this spending in 2010.

17. A central feature of the CSF loan was monitoring of the government’s countercyclical fiscal stimulus program. The government, in coordination with ADB and other development partners, established a monitoring mechanism for its fiscal stimulus program. Semiannual reviews of macroeconomic performance and implementation of the government’s countercyclical expenditure program are carried out under the mechanism. The monitoring mechanism is based on country monitoring systems and comprises three parts: (i) the established interministerial committee for monitoring the fiscal stimulus—Bappenas—is responsible for reporting on implementation of the infrastructure component of the fiscal stimulus, (ii) country public financial management systems are used for aggregate budget data, and (iii) civil society organizations and development partners’ mechanisms are used for monitoring selected projects supported under the loan.

B. ADB’s Coordination with Other Development Partners

18. Consultation and coordination with development partners, primarily the Government of Australia, the Government of Japan and the World Bank was extensive. It was well established by the Indonesian government through the development policy support program series. The PESF also established a macroeconomic monitoring mechanism through which quarterly reports and meetings between the government and development partners were held. The

28

Appendix 2

development partners did not have a CSF-type facility. The World Bank also provided additional budget through supplementary funding of its development policy loan in 2009. C. Impact of ADB Support

1. Macroeconomic Management in 2009

19. While separating out the effects of the different instruments is difficult, the policy support and assistance helped Indonesia weather the GFC and its real economy impacts better than anticipated late in 2008. The success of the government’s macroeconomic management against the increased risks to the economy from the GFC is reflected in a respectable economic growth rate in 2009 and a stronger recovery in 2010, a better than expected fiscal outturn, an improved balance of payments, and yields on government bonds converging to lower pre-GFC levels. The government’s fiscal stimulus, its measurable front loading of budget financing in the first semester of 2009, and an accommodative monetary policy contributed to better than expected performance in 2009.

20. After declining in three consecutive quarters since Q4 2008, economic growth began to recover in Q3 2009. With stronger economic activities toward the end of the year, economic growth in 2009 was 4.6%, better than earlier projections of growth in the range of 3.0%-4.0%. Consequently, the negative output gap of 1.4% was much lower than the 3.0% anticipated in 2009. As Figure A2.2A shows, the negative output gap in 2009 turned out to be much smaller compared with negative output gaps arising from external terms of trade shocks in the early 1980s and the 1997 Asian financial crisis. While the earlier shocks were different in nature and the economy is much more diversified today than it was in the 1980s, the difference is also indicative of the government’s better macroeconomic management in 2009. 21. The government’s fiscal stimulus package contributed to the lower than expected negative output gap. Government consumption on routine expenditure items expanded by 17.0% year-on-year, which contributed to more than one-third (or 1.4 percentage points) to the expansion on the economy—much larger than the 1.4 percentage points, as the latter figure excludes additional public capital outlays (Rp9.2 trillion) and the stimulus effects of the tax cuts (Rp53 trillion) on household consumption. In the national income accounts, public investments are recorded in the investment component and not the government consumption component. ADB staff estimate the overall fiscal stimulus in the range of 1.6–1.8 percentage points of GDP in 2009. Thus, economic growth would have been in the range of 3.0% in 2009 without the stimulus package. Household consumption remained resilient in 2009 expanding by 4.9%, aided by sizeable tax cuts made early in 2009. Exports also recovered toward the end of 2009, after contracting sharply during the first half of the year. However, the contribution of exports was offset by stronger import recovery. Investment growth, except for the construction category, remained subdued throughout 2009 with large contractions in the machinery, equipment, and transport categories (Figure A2.2).

22. The stronger pickup in economic growth that began in Q4 of 2009 continued through to 2010, with the economy expanding 6.2% by early 2010. Consumption and investment were the main drivers of growth in 2010; all categories of investment rebounded strongly. Government spending contracted relative to 2009 as the government began to unwind its fiscal stimulus. 23. The improved confidence in the economy resulted in yields for both dollar and rupiah bonds declining significantly across all tenors. Reflecting improving economic prospects and

29


Appendix 2

lower risks, the rating agencies upgraded Indonesia's foreign and local currency sovereign bonds.4

Figure A2.2: Indonesia’s Growth Performance

A. Actual and Potential Economic Growth B. Components of Economic Growth (quarterly growth, year-on-year) (quarterly growth, year-on-year)

-5

-3

-1

1

3

5

7

9

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

Actual Growth Potential growth

-30

-20

-10

0

10

20

30

2008 2009Q1 Q2 Q3 Q4 2010Q1 Q2

% g

ro

wth

yo

yGC PC INV EX IM

C. Components of Investment Growth D. Economic Growth with and without the

(quarterly growth, year-on-year) Fiscal Stimulus

-20

-15

-10

-5

0

5

10

15

20

25

2009Q1 Q2 Q3 Q4 2010Q1 Q2

Construction Machinery and equipment Transport

0

1

2

3

4

5

6

7

2005 2006 2007 2008 2009 2010

% g

row

th

Growth with stimulus Growth w/o stimulus

Notes: GC = government routine spending, PC = private consumption, INV = public and private investment, EX = exports, IM = imports. GDP = gross domestic product. Indonesia's potential economic growth rate is estimated using the Hodrick-Prescott filter, which estimates a nonlinear trend in the economic growth data. The difference between the potential and actual growth figures is defined as the output gap. Projected growth figures for 2010. The fiscal response assumes a fiscal multiplier of slightly above 1.0 with smaller carry-over effects into 2010. Sources: National Income Accounts, Central Bureau of Statistics, Jakarta. Ministry of Finance, Jakarta. Asian Development Bank staff estimates.

4 Moody's in September 2009; Fitch and Standard & Poor's in early 2010.

30

Appendix 2

2. The Government’s Countercyclical Fiscal Stimulus Program

24. The government included fiscal stimulus measures in the revised 2009 national government budget announced in February 2009 and announced an additional infrastructure stimulus package in July 2009. ADB estimates the total stimulus measures were around Rp138 trillion. About 95.0% of commitments were implemented in 2009. Tax cuts amounting to Rp53 trillion accounted for the largest component at 38.0% of the stimulus package, followed by capital maintenance and material spending, social assistance, and the additional infrastructure program. About 94.7% of commitments under the infrastructure package were disbursed and implemented in 2009 (Table A2). 25. Disbursement of capital expenditure improved significantly following the policy to simplify disbursement procedures introduced in early 2009. This contributed to the higher than normal rate of disbursements for 2009. However, despite this improved disbursement rate, the spending pattern was still severely skewed toward the end of the year. Almost 50% of the budgeted capital expenditure was disbursed in Q4 of 2009. About 67.0% of infrastructure projects under the fiscal stimulus were disbursed in the last quarter of 2009 (Figure A2.3). This skewed spending pattern limited the timeliness of the fiscal stimulus from infrastructure spending, as the fiscal impulse was most needed in the first half of 2009 when the economy was slowing sharply. Thus, continuing strengthening of public financial management systems remains important in this regard. On the other hand, the tax cuts implemented in early 2009 and scaling up of social assistance had a timely impact on household consumption and economic growth.

Figure A2.3: Disbursement Rate of the Infrastructure Component of the Fiscal Stimulus in 2009

0 2.3 4.5

13.9

27.8

47.5

62.9

94.7

0

20

40

60

80

100

Mar Jun Jul Aug Sep Oct Nov Dec

% o

f to

tal pla

nned

Note: The total budget allocation for the infrastructure component of the fiscal stimulus was Rp10.2 trillion. Of this, 94.7% was disbursed and implemented in 2009. Source: National Development and Planning Agency (Bappenas). 2009. Report on Monitoring the Fiscal Stimulus. December.

31


Appendix 2

Table A2: Indonesia—Selected Infrastructure and Social Assistance Programs

Program

Program Description

Targeted Beneficiaries for 2009

Budget Allocations in 2009 and 2010 (where applicable)

Implementation Progress (as of Dec 2009)

Infrastructure Programs

Investments in the Social Sector

1. Low-cost housing program for poor families

a

2. Low cost housing program for families of police and army personnel, and for students in poor and remote locations

a

Provides low-cost housing for poor families in remote coastal villages and engaged in fisheries Provides low-cost housing for police and army personnel and students; up to 40 complexes to be constructed in remote locations

Poor families engaged in fishing; program targets 12,000 new jobs Police and army personnel, and students in remote locations Program targets 8,000 new jobs

Additional low-cost housing budget for 2009 is Rp400 billion

99.3% (Rp397.0 billion) disbursed and Implemented from the Department of Housing

Competitiveness Enhancing Investments in the Production Sector

3. Enhancing rural sector productivity projects

a

Construction and rehabilitation of rural feeder roads and irrigation systems

Farmers in rural areas Program targets 60,000 new jobs

Total budget for 2009 Rp650 billion

0%. No disbursements made from the Department of Agriculture

4. Enhancing trade facilitation through better infrastructure projects

a

Construction and rehabilitation of national roads, bridges, rail infrastructure, airports, and ports

Private sector enterprises Program targets 282,000 new jobs

Total budget for 2009 Rp8.9 trillion

98.5% (Rp8.5 trillion) disbursed and implemented under the departments of public works and transportation

5. Enhancing competitiveness of traditional distribution sector projects

a

Construction and rehabilitation of traditional urban wet and dry markets and construction of facilities for micro, small, and medium-sized informal traders

Small traders in traditional markets and other informal traders Program targets 43,000 new jobs

Total budget for 2009 Rp335 billion

94.3% (Rp316 billion) disbursed and implemented under the Department of Trade

6. Other capital maintenance and material spending

Capital maintenance for roads and other infrastructure, and material spending increased

Covers beneficiaries across the economy

Increased spending in 2009 budget of Rp31 trillion over the 2008 budget

96.0% (Rp29.8 trillion) disbursed

Social Assistance Programs

7. Unconditional cash transfer (UCT)

UCT provides income support of Rp100,000 per month to recipient poor families

UCT extended for 2 months in 2009 and covered 18.5 million families

Total budget: 2009: Rp3.7 trillion

100% (Rp3.7 trillion) disbursed in the first 2 months of 2009

32

Appendix 2

Program

Program Description

Targeted Beneficiaries for 2009

Budget Allocations in 2009 and 2010 (where applicable)

Implementation Progress (as of Dec 2009)

8. Conditional cash transfer program (CCT)

a

CCT provides income support with attached conditions related to children’s attendance at primary school, regular checkup of children under the age of 5 years, and pregnant mothers at the health clinic

CCT is pilot tested among 720,000 families in 13 provinces

Total budget: 2009: Rp1.1 trillion 2010: Rp1.1 trillion

100% (Rp1.1 trillion) disbursed in 2009 CCT for 2010 under way

9. Operational Aid to School Program

a

Provides block grants to schools to cover operating costs and capital expenditures Scholarships are provided to school students under the program

Virtually all elementary schools nationwide targeted

Total budget: 2008: Rp12.5 trillion 2009: Rp19.1 trillion 2010: Ro19.8 trillion

Rp17 trillion disbursed in first semester of 2009 compared with Rp9.7 trillion in first semester of 2008

10. National Community Empowerment Program

a

Provides block grants to communities for community-based development projects, health programs, and others

Covers 6,408 subdistricts in 2009, up from 3,999 subdistricts in 2008 Community committees are established to decide on community-based investments

Total budget: 2008: Rp4.2 trillion 2009: Rp8.2 trillion 2010: Rp12.9 trillion

100% (Rp8.2 trillion) disbursed in 2009 Implementation for 2010 under way

11. Rice subsidy program

Provides subsidized low-quality rice to poor families

Provides 3.3 million tons of rice to 18.5 million poor households Rice distributed each month


51% was disbursed in the first semester of 2009.

12. Health insurance (Jamkesmas)

Provides payment of social health insurance premiums for poor families

Targeting 74.5 million persons nationwide


Implementation under way.

a Program to be supported by the Countercyclical Support Loan to Indonesia.

Source: Ministry of Finance, Republic of Indonesia.

33


Appendix 3

COUNTRY CASE STUDY OF ADB’S CRISIS REPONSE: KAZAKHSTAN

1. The global financial turmoil severely affected the Republic of Kazakhstan. Gross domestic product (GDP) growth dropped to 3.3% in 2008 after averaging 9% annually during 2000–2007.1 The impact of the crisis deepened in the first half of 2009, when GDP contracted by 2.4%. The crisis also adversely impacted Kazakhstan’s fiscal position. The government was forced to lower its tax revenue targets for 2009 by about 12% compared with 2008; an additional cut of 20% was made in the April 2009 budget revision. To cushion the revenue shortfall, the government was forced to draw from the National Fund of the Republic of Kazakhstan (NFRK), which is intended to finance long-term national development requirements. However, the government had to be careful not to draw too much from the NFRK, as doing so would risk provoking market fears of a systemic financial sector failure.

2. To address the deepening economic crisis, the government embarked on two crisis mitigating programs: the employment-generation program2 (EGP) and the anti-crisis plan (ACP) of 2009–2010. Both programs required significant financial resources. The ACP was fully funded by the NFRK, while the EGP was to be financed by the budget.

A. Impacts of the Global Crisis3

3. The Kazakh economy was struck by two rounds of exogenous shocks: the international liquidity crunch (the first-round shock) and the slowdown in global demand for commodities thereafter (the second-round shock). Figure A3.1 presents the dynamics of these two rounds of shocks. 4. First-round shocks to the financial sector. During 2004–2007, Kazakh bank lending had grown increasingly reliant on international credit markets through the issuance of short-term debt and cheap access to international refinancing and rollover options. The onset of global turmoil in August 2007 brought about a sudden reversal in capital inflows. International liquidity for Kazakhstan and other emerging markets started to freeze, and debt spreads widened. The sharp decline in asset quality and performance impaired the role of the financial sector in supporting the expansion of aggregate domestic demand. Nominal credit growth to the private sector in 2008 was just 2.7%, in stark contrast to the 54.7% annual credit growth in 2007 that fueled growth in real estate activity and the consumption of durables. In late 2007, the self-reinforcing dynamic in property prices burst, triggered by the sudden standstill in bank lending. Property prices plummeted in many cases to less than half of the peak, and revealed demand for property had evaporated as real estate transactions nearly ceased in 2008. 5. These factors affected borrowers' ability and willingness to service bank loans, and credit losses rose steeply. Mortgage loans classified under the ―loss‖ category rose sharply from 1.2% of the loan portfolio in early 2008 to 9.7% in June 2009. Provisions for loan loss rose from 5.9% at the end of 2007 to 31% in June 2009. Foreclosures in the second half of 2008 added real property to bank balance-sheets at valuation levels that increasingly differed from market prices, if the latter could be established at all.

1 This case study is based on Asian Development Bank. 2010. Completion Report: Kazakhstan: Countercyclical

Support Loan. Manila. 2 The Roadmap for Recovery through Job Creation of the Government.

3 This section is based on Asian Development Bank. 2009. Report and Recommendation of the President to the

Board of Directors: Proposed Loan to the Republic of Kazakhstan for the Kazakhstan Countercyclical Support Loan. Manila.

34

Appendix 3

6. Against this backdrop, from 2007 onward the government implemented a number of (i) anti-crisis measures aiming to unlock the capacity of financial intermediation to provide credit to key sectors of the economy, and (ii) countercyclical measures to increase public investments to support aggregate expenditure and employment generation. However, bank lending remains stagnant. The nominal growth in the first half of 2009 of 12% year-on-year in banks' outstanding credit is mostly a reflection of the 20% depreciation of the Kazakh tenge in February 2009. 7. Second-round shocks to external demand. A combination of factors strongly affected growth in external demand for Kazakhstan's output in the last quarter of 2008 and first 6 months of 2009. In contrast with the nominal export expansion that occurred in 2008, which in a direct way had mitigated the negative effects on economic growth of the 2007 sudden stop in capital inflows, the collapse in international commodity prices brought down the total export turnover of Kazakhstan by 51% when compared with the same period in 2008 (i.e., year-on-year), despite an increase in the volume of exports in the first half of 2009.4 This was a significant demand shock to the economy, resulting partly from the economic slowdown in the Russian Federation, a large importer of energy and metallurgical products from Kazakhstan. As a consequence, industrial activity declined by 5% year-on-year during January–June 2009.

4 Such as in oil and gas by 7.5%, copper by 20%, aluminum by 57%, and coal by 24.1%.

Sharp reduction in

economic activity in all main sectors of the economy leads

to slowdown in incomes and

aggregate demand

Sudden Stop in

Access to International Debt Markets

in 2007

Difficulties in Banking

First Round Shocks: The

rollover of debt syndications

came to a halt

Induced Effects: sharp slowdown in

bank lending triggers the burst in property prices and a collapse in

demand for nontradable

output like construction

services.

Induced Effects: The decrease in private sector creditworthiness affects banks' profitability and asset quality

Risks of additional economic

disruption if systemic

problems occur in banking

Global Economic

Slowdown in 2008 and

2009

Second Round Shocks: collapse in international prices and global demand

for Kazakh export commodities


Figure A3.1: Dynamics of the Impact of Global Crisis on Kazakhstan

35


Appendix 3

B. ADB’s Crisis Response

8. On 10 September 2009, the Asian Development Bank (ADB) Board of Directors approved $500 million for the Kazakhstan Countercyclical Support Loan (KCSL) under the Countercyclical Support Facility (CSF). The intended impact of the KCSL was to help Kazakhstan mitigate the impact of the global economic crisis. Its intended outcome was greater fiscal stimulus, and its principal output was full-fledged implementation of the ACP and EGP.5 Both of these plans supported key sectors of the economy and generated additional jobs. The KCSL was designed to contribute financing for the EGP and leverage the government's commitment to pursue the ACP. The loan was signed on 14 September 2009 and disbursed on 12 November 2009 in a single tranche. Counterpart funds generated from the loan proceeds were comingled with government funds to support and reimburse government’s budgetary spending for the EGP.6 9. The outcome of the KCSL was to provide the government with greater fiscal stimulus in 2009. The government attained this by achieving a fiscal deficit of 1.5% of GDP in 2009.7 This was partly financed by the KCSL. On-budget and off-budget expenditures arising from both crisis mitigation programs totaled slightly less than T1 trillion (T182.3 billion from the EGP and T805.3 billion from the ACP), equivalent to 6.2% of GDP.8 The government disbursed 99.6% of the expenditures for the EGP and 67.3% for the ACP in 2009.

10. The intended impact of the KCSL was to help Kazakhstan mitigate the impact of the global economic crisis. GDP growth for 2009 was 1.2%, indicating a reversal of the recession that the country experienced in the first half of 2009. The momentum has been maintained in 2010, as GDP growth from January to June 2010 was 8.0%. 11. Prior to the KCSL, ADB had limited policy-lending engagement with Kazakhstan, with only one policy-based loan, i.e., the Pension Reform Program in 1996. In September 2010, ADB approved the Small and Medium Enterprise Investment Program to help sustain job creation and economic recovery.9 C. Key Results of the Government’s Crisis Mitigation Measures

1. Employment-Generation Program 12. The EGP had four outputs: (i) public works; (ii) staff retraining; (iii) job creation for the socially vulnerable; and (iv) internships. The government successfully implemented all four outputs. The total allocation for the EGP was T186.3 billion, of which T134.8 billion was from the republican budget and T51.5 billion from local budgets (Table A3.1). The national government disbursed T130.7 billion (97% of the total allocation) from the republican budget in 2009 to fund the EGP, while local governments disbursed T51.3 billion (99.6% of the total allocation). Except for staff retraining, all allocated resources were fully utilized in 2009 as planned.

5 For the purpose of this case study, the components of the ACP and EGP are referred to as outputs and their

subcomponents as activities. 6 Since disbursement was achieved in November 2009, the KCSL retroactively financed part of the EGP.

7 This is for the general government, which includes oil revenues. This statistic is taken from International Monetary

Fund. 2010. Article IV Consultation, Staff Report. July. Washington, DC. 8 T147.4 = $1.00

9 ADB. 2010. Report and Recommendation of the President to the Board of Directors: Proposed Multitranche

Financing Facility to the Republic of Kazakhstan for the Small and Medium Enterprise Investment Program. Manila.

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Appendix 3

Table A3.1: Disbursements under the Employment-Generation Program (as of 31 December 2009, T billion)

Output

Allocation Execution in 2009 Utilization Rate (%)

Total RB LB Total RB LB Total RB LB

Investment Projects for Road and Facilities Repair

168.93 117.43 51.50 168.23 116.62 51.31 99.96 99.31 99.63

Staff Retraining 9.74 9.74 6.56 6.56 67.39 67.39

Jobs for Socially Vulnerable

4.40 4.40 4.40 4.40 100.00 100.00

Internships

3.20 3.20 3.20 3.20 100.00 100.00

Total 186.27 134.76 51.50 182.30 130.78 51.31 98.25 97.05 99.63

LB = local budgets; RB = republican budget. Source: Ministry of Labor and Social Protection, Government of Kazakhstan.

13. Investment projects for road and facilities repair. The government aimed to generate 256,245 temporary jobs through public works projects such as (i) repairs, reconstruction, and development of municipal systems; (ii) road repair works; (iii) repair of schools, hospitals, and other social facilities; and (iv) repair of sociocultural facilities. Of the planned 5,271 investment projects, it completed 5,261 projects, with only 10 municipal repair projects left uncompleted. The government finished 2,478 investment projects to repair schools, hospitals, and social facilities; 1,119 projects to repair roads; 846 municipal works projects; and 818 projects to repair sociocultural facilities. In terms of results, road works covered reconstruction of 70 kilometers (km) of roads, and repair of 2,800 km of oblast (regional) and raion (district) streets. The repair of social facilities included the repair of 1,681 educational facilities, 492 health facilities, 55 sports facilities, 206 cultural facilities, and 44 social facilities. 14. The investment projects provided 258,585 jobs, exceeding the target of 256,245 (Table A3.2). Of these, 247,822 were filled. About 74% of those employed found their work through government employment centers. The average employment period was 4 months. The average monthly wage was T29,700, which is more than double the minimum wage of T13,717. The total wage bill of the investment projects amounted to about T28 billion—about 16% of the total disbursement for this activity. Most of those employed were in South Kazakhstan (15.2%), East Kazakhstan (13.1%), Karaganda (11.0%), Aktobe (8.9%), Almaty City (8.1%), and Almaty region (8.0%). About 57.7% of those employed came from the seven poorest regions, with the majority coming from Almaty region, East Kazakhstan, Karaganda, and South Kazakhstan.10

10

The poorest regions are based on 2008 per capita regional GDP. Arranged in terms of lowest per capita GDP, these regions are South Kazakhstan, Zhambyl, Almaty region, North Kazakhstan, East Kazakhstan, Akmola, and Karaganda.

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Appendix 3

Table A3.2: Temporary Employment Generated by Investment Projects (as of 31 December 2009)

Activity

Jobs Created Persons Employed Average Monthly

Wage

Average Period

Employed (months)

Planned

Actual

% of

Planned

Number

% Referred by ECs

Repair, reconstruct, and develop municipal systems

81,419 81,471 100.1 77,128 70.3 T28,100 4.0

Repair roads 55,195 55,383 100.3 54,294 67.7 T30,300 4.5 Repair and insulate schools, hospitals, and other social facilities

99,726 101,018 101.3 98,239 78.2 T21,000 3.3

Repair sociocultural facilities in cities, villages

19,905 20,713 104.1 18,161 82.2 T27,100 3.1

Total 256,245 258,585 100.9 247,822 73.7 T29,700 4.0

EC = employment center. Source: Ministry of Labor and Social Protection, Government of Kazakhstan.

15. Staff retraining program. Under the EGP, the government signed contracts with 416 educational institutions to retrain 88,436 people. The actual number of trainees was 97,699. This was achieved in an efficient manner, with only 67% of allocated resources being used. The program included retraining of (i) 52,006 displaced specialists, (ii) 13,789 people to fill existing vacancies, (iii) 20,240 people for export-oriented professions, (iv) 10,078 people to replace expatriate staff, and (v) 1,586 medical staff. By 31 December 2009, 70,668 trainees had completed the retraining program. Of these, 41,131 (58.2%) found permanent employment after retraining. Beneficiaries sent for retraining were spread across Kazakhstan, with Atyrau, East Kazakhstan, and Almaty region having the greatest share of beneficiaries (10%–13% each). The seven poorest regions accounted for 47.5% of beneficiaries. 16. Jobs for socially vulnerable people. In 2009, the government signed 9,796 contracts with social institutions to provide temporary jobs to socially vulnerable people. The institutions were to engage 50,640 people under these contracts. Actual temporary employment reached 73,430, exceeding the target by 45%. The average monthly wage was T26,343. Of those who obtained temporary jobs, nearly 21,000 eventually found permanent employment. The jobs were distributed across the regions, with Almaty region, South Kazakhstan, and East Kazakhstan (all poor regions) having the greatest share. The seven poorest regions accounted for 41.6% of temporary social jobs created.

17. Internship program. The government signed 12,788 contracts with enterprises to provide internships to 35,225 people. Actual participants in the program reached 51,186 by the end of 2009, exceeding the target by 45%. A total of 9,742 (19% of participants) found permanent employment after the internship program. About 21% of the beneficiaries were in South Kazakhstan, which is the poorest region in the country. The remaining six poorest regions accounted for 21.5% of interns.

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Appendix 3

2. Anti-Crisis Plan of 2009–2010

18. While the KCSL proceeds did not finance the ACP, the KCSL leveraged government commitment for the $10 billion plan. Samruk-Kazyna, the government-owned holding company for all public enterprises, is the main implementing agency of the ACP. By December 2009, about 67% of the ACP had been disbursed to its intended final beneficiaries (Table A3.3).11 Implementation progress among the five outputs varied.12

Table A3.3: Disbursements to Final Beneficiaries under the Anti-Crisis Plan, 2009–2010 (as of 31 December 2009, (T billion)

Output Allocation Disbursement % Disbursed

Financial Sector Stabilization 476.1 476.1 100.0

Real Estate and Construction Support 360.0 186.9 51.9

Small and Medium-Sized Enterprise Support 120.0 120.0 100.0 Agro-Industrial Support 120.0 18.1 15.1 Infrastructure, Innovation, and Industrial Projects

a 120.0 4.2 6.5

Total 1,196.1 805.3 67.3

Note: The exchange rate of T120 to $1 is used in the conversions since this was the exchange rate at the time of approval and disbursement of funds to implementing agencies. a

Disbursement as of 18 February 2010. Information was taken from the Financial Monitoring Supervisory Agency’s Press Release No. 199 on the 19 February 2010 meeting of the Working Group to Control the Use of Financial Resources of the National Fund of the Republic of Kazakhstan Allocated for the Anti-Crisis Plan.

Sources: Ministry of Economic Development and Trade, Financial Monitoring Supervisory Agency, Samruk-Kazyna, and Asian Development Bank estimates.

19. Financial sector stabilization. In 2009, the government, through funds raised by Samruk-Kazyna from the NFRK, disbursed 100% of the T476 billion allocation to either recapitalize or infuse government deposits (or both) in four major banks: BTA Bank, Alliance Bank, Halyk Bank, and Kazkommertzbank. These disbursements helped mitigate the risk of systemic bank failure. 20. Government deposits in Kazkommertzbank and Halyk Bank provided funds to increase bank lending to the economy.13 Lending was largely for refinancing, and no interest rate ceiling was imposed. Using the government deposits as revolving funds, the two banks lent T154.8 billion, mainly to large corporations. Kazkommertzbank lent T90.4 billion to 45 borrowers that employed 27,653 persons. Its lending was largely to trade (40% of total loans) and industry (35%). Halyk Bank lent T63.4 billion to 346 borrowers that employed 15,418 workers. The bulk of its lending was to food production (23% of total loans), agriculture (17%), and utilities (15%). 21. Real estate and construction support. Government support under this output comprised two activities: (i) T240 billion to support real estate and construction through the completion of stalled projects; and (ii) T120 billion for mortgage refinancing. Disbursement of the T240 billion allocation has been slow—only T66.4 billion was disbursed in 2009. More disbursement was expected in 2010. At 30 September 2010, disbursement for this activity only

11

Under outputs 2, 3, and 5 of the ACP, Samruk-Kazyna disburses the funds to intermediary institutions, which in turn, disburse funds to the final beneficiaries. KazAgro implements output 4 of the ACP.

12 Most of the information in this section is from Ministry of Economic Development and Trade. 2010. Information on the Implementation of the Joint Action Plan of the Government of the Republic of Kazakhstan, National Bank of Kazakhstan, and Agency of the Republic of Kazakhstan on Regulation and Supervision of Financial Institutions to Stabilize the Economy and Financial System in 2009–2010. 19 January. This government report contains information until November 2009. Updates for the remainder of 2009 were provided by the Damu Entrepreneurship Development Fund, KazAgro, and Samruk-Kazyna.

13 Information on lending by Halyk Bank and Kazkommertzbank is as of 30 September 2009.

39


Appendix 3

reached 51%.14 The final beneficiaries under this activity are in Almaty city and Astana city. ADB discussions with the government during the review mission indicate that disbursement of the funds under this activity was difficult.

22. In the mortgage refinancing activity, borrowers refinanced their loans at interest rates of 9%–11%, allowing for smaller monthly mortgage payments (about 30% lower than those of the original mortgage loan). The total allocation of T120 billion was fully disbursed by 11 commercial banks to 31,304 borrowers. BTA Bank, Kazkommertzbank, Halyk Bank, and Alliance Bank accounted for more than 75% of the amount disbursed. While refinancing was spread across the country, 28% of refinanced borrowers were from Astana city (15%) and Almaty city (13%). The Karaganda and East Kazakhstan regions had an 11% share each.

23. Small and medium-sized enterprise support. Samruk-Kazyna lent T120 billion to the Damu Entrepreneurship Development Fund (Damu) at a rate of 5.5% for 7 years. Damu relent T117 billion to 12 commercial banks for onlending to SMEs, and directly lent T3 billion to SMEs at 7.5%–8% for 7 years. Damu disbursed all funds in 2009.

24. In 2009, bank onlending benefited 2,466 SMEs and created 3,053 jobs. About 70% of onlent funds were used for working capital and the rest were used for investment purposes. From a sector perspective, trade (45%) and services (30%) were the key beneficiaries of the bank onlending. Only 51% of bank lending went for refinancing—below the target of 70%. The remaining 49% funded new SME loans. The cities of Almaty (33%) and Astana (16%) received the most funds. The government’s completion report indicates that at September 2010, due to the revolving nature of the Damu lending program, 2,971 SMEs have benefited and created 3.590 jobs.

25. Damu directly lent T3 billion to 12 SMEs through its Damu–Koldau Program. This program provided funding to SMEs in agriculture processing and food manufacturing at a fixed rate of 8.5%, and required participating SMEs to obtain bank guarantees to cover the borrowing.

26. Agro-industrial support. This output, which had an allocation of T120 billion, was to finance agro-industrial projects and be implemented by KazAgro through two subsidiaries: KazAgro Finance and Agrarian Credit Corporation. KazAgro identified 11 investment areas to support the development of agro-industries: (i) greenhouse development and networking; (ii) vegetable storage facilities; (iii) fruit and vegetable production, including use of drip irrigation; (iv) poultry farm development and networking; (v) dairy farm development and networking; (vi) agricultural machinery assembly and production; (vii) feedlots to support cattle production; (viii) slaughterhouses; (ix) meat processing; (x) fine-wool production and processing; and (xi) grain processing infrastructure.

27. In 2009, the government selected 28 agro-industrial projects, amounting to about T40 billion. However, because of the lengthy project selection process, the allocated funds could not be fully disbursed in 2009. By the end of 2009, only T18 billion (15% of total allocated funds) had been used to fund advance payments for equipment in selected projects. As of 30 September, only T29.3 billion had been used to finance such investment projects (footnote 13). The rest of the funds were used to purchase grain and to provide working capital loans to agriculture producers.

14

Information was taken from the Financial Monitoring Supervisory Agency’s Press Release No. 228 on the 6 October 2010 meeting of the Working Group to Control the Use of Financial Resources of the National Fund of the Republic of Kazakhstan Allocated for the Anti-Crisis Plan.

40

Appendix 3

28. Support for infrastructure, innovation, and industrial projects. The government allocated T120 billion for financing innovative, industrial, and infrastructure projects. Samruk-Kazyna increased the capitalization of the Development Bank of Kazakhstan by T115 billion, which in turn would provide the project financing for selected projects identified by the State Committee on Modernization of the Economy. Thirty-one projects worth $23 billion were being considered. Construction of these projects would generate 46,839 jobs, and once operating would employ 10,351 workers. But only three projects were selected for implementation, with a total allocation of T27.2 billion. As of 31 December 2009, the Development Bank of Kazakhstan had disbursed T4.2 billion. More recent information indicates that as of 30 September 2010, the total disbursement had increased to T10.6 billion (footnote 13). D. Lessons

29. The KCSL provides four lessons on the appropriate modality for crisis response:

(i) ADB’s business procedures for processing crisis response programs should be streamlined and abbreviated, as in the case of the CSF. This allows for crisis responses to be timely and prevent further deterioration of the economy.

(ii) By not having any policy conditions other than the government’s countercyclical expenditure programs, the KCSL was an effective and efficient instrument to respond to the financial crisis. While reforms to correct policy inconsistencies during crisis situations might be desirable, countries that are in the middle of financial crises would find it difficult to simultaneously undertake both crisis mitigation and reforms. What these countries need most urgently in times of financial crisis is quick and timely fiscal support to address the economic and social impact of the crisis. However, as crises open opportunities for reforms, policy dialogue should be initiated for follow-up operations. But such dialogue should not at any time delay the timely provision of financial crisis support.

(iii) The success of a financial crisis response is highly contingent on the government’s ability to quickly put together its own anti-crisis plan. ADB intervention can be in the form of financing the plan. In the case of the KCSL, the government already had its EGP in place, and was able to use the KCSL funds immediately to finance the EGP. However, since the KCSL is a budget support instrument, tracking and linking the financing with specific development results (e.g., which public works project it funded) is difficult.

(iv) Crisis response operations can be more successful if the government has well-defined implementation arrangements and monitoring mechanisms, as was the case with the KCSL.

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Appendix 4

COUNTRY CASE STUDY OF ADB’S CRISIS RESPONSE: MONGOLIA

1. The Mongolian economy was hit hard by the impact of the global financial crisis through a sudden large drop in the price of its main export commodities, most notably copper in late 2008; the economy contracted by 1.6% in 2009. The contraction in gross domestic product (GDP) followed robust average growth of 9% during 2004–2008, when world commodity prices were rising. 2. Mongolia is narrowly specialized in the production of a few primary goods with minerals comprising 70% of total exports. In 2008, the mining sector generated 81% of total exports, around 32% of total government revenue, and 30% of GDP. From April 2008 to March 2009, the price of copper, the country’s main export, fell by as much as 65% from $8,700 per ton to $3,000 per ton. Prices of other key export commodities—cashmere coal, crude oil, and zinc—also fell significantly. 3. Macroeconomic policy was overly expansionary and highly procyclical during the boom years as reflected in negative real interest rates and unsustainable increases in public expenditure. Fiscal policy was also overly expansionary and highly procyclical. While the budget showed an average surplus of 4.3% during 2005–2007, government finances became increasingly dependent on volatile revenues from mining. As a consequence of lax fiscal and monetary policy, large internal and external imbalances built up and the economy became increasingly vulnerable to shocks. Inflation peaked at 34.2% year-on-year in August 2008. From 2007 to 2008, the current account dropped from 6.7% of GDP to minus 14%. 4. The commodity-driven boom–bust cycle in combination with procyclical economic policy, weak corporate governance structures, and weak regulation and supervision increased the vulnerability of banking and eventually led to the emergence of severe banking distress. The nonperforming loan/total loan ratio across the entire banking system increased from 2.8% in September 2008 to 17.5% in December 2009, before falling to 14.5% in May 2010. Annual lending growth turned negative in July 2009, before entering positive territory at the end of 2009 and increasing by 16.7% in August 2010. Annual deposit growth fell from nearly 50% in early 2008 to minus 10% at the end of 2008. At the end of 2009, deposits started to grow again on an annual basis and increased by 51% in August 2010. 5. A combination of previous rapid credit expansion, high domestic inflation, falling terms of trade, and rumors of banking failures started to erode confidence in the tugrog in the second half of 2008. Initially Bank of Mongolia (BOM) tried to cope with the situation by selling and rationing its foreign exchange reserves to essential imports, leading to a loss of almost $500 million of foreign exchange between July 2008 and January 2009. Despite this support, the currency depreciated by about 38% from the end of October 2008 to mid-March 2009. Increasingly the official BOM exchange rate started to diverge from the exchange rates prevailing at the commercial banks and a parallel market emerged. A. Response by Development Partners to the Crisis

6. To adjust to the terms of trade shock and return the economy to a sustainable path, in March 2009 the government agreed to an 18-month stand-by arrangement (SBA) with the

42

Appendix 4

International Monetary Fund (IMF) for $229 million in balance of payment support.1 The fiscal gap under the SBA was estimated at $144 million for 2009 and $60 million for 2010. The main elements of the SBA have been fiscal consolidation, monetary tightening, and a higher degree of exchange rate flexibility. 7. Following the IMF SBA, Parliament approved a budget amendment in March 2009 with a deficit of 5.4% of GDP. The amended budget adopted large expenditure cuts, in particular for public investment. Further elements of the fiscal consolidation were a wage and hiring freeze, cuts in bonuses, and some untargeted social allowances. The government committed, as part of the IMF SBA, to undertake a comprehensive overhaul of the entire system of social transfers. On the revenue side, measures were limited to increases in excise taxes and customs duty, totaling an estimated 0.25% of GDP. To restore confidence in the tugrog, BOM raised its key policy rate to 14.00% from 9.75% on 11 March 2009, which brought real interest rates closer to positive territory. Since 31 March 2009, BOM abandoned foreign exchange rationing by buying and selling foreign exchange through an auction mechanism. 8. The SBA set out a solid macroeconomic framework and provided the basis for the government to approach the broader international community for support to fill the fiscal financing gap. Major development partners in Mongolia aligned and committed budget support under the umbrella of the SBA, including World Bank ($70 million),2 ADB ($60 million), Japan ($50 million), and Australia ($3.5 million). As a result, the projected fiscal gap was broadly filled. The four development partners disbursed their pledged amounts for 2009 budget support ($133.5 million in total) in July 2009. The IMF, meanwhile, disbursed about $169 million in 2009 under the SBA in balance of payments support for BOM. The SBA was successfully completed in September 2010. All the relevant performance criteria for the fifth and sixth (final) reviews were met. B. ADB Response to the Crisis

9. ADB’s crisis response, in cooperation with other major development partners and under the umbrella of the SBA, mainly comprises the (i) Social Sector Support Program (SSSP),3 (ii) Education for the Poor—Financial Crisis Response Project,4 and (iii) Policy and Institutional Support for Banking Sector Systemic Risk Management technical assistance (TA).5

1 The SBA is a nonconcessional loan to be repaid in 4 years (with 2 years grace). It gives Mongolia exceptional

access to IMF resources. This agreement recognizes the extraordinary external shock coming from the collapse of copper prices. The total amount of IMF resources made available under the arrangement equals 300% of the country’s quota.

2 World Bank support came in the form of two single-tranche development policy credits (DPCs, $40 million for 2009

and $30 million for 2010) on International Development Association terms supporting reforms in the policy areas most affected by the downturn. The two DPCs focus on (i) fiscal policy management, (ii) social protection, (iii) the financial sector, and (iv) mining. The first DPC was disbursed in July 2009 and the second was approved on 26 October 2010 and ratified by Parliament on 6 January 2011.

3 ADB. 2009. Report and Recommendation of the President to the Board of Directors on a Proposed Asian

Development Fund Loan and Grant and Technical Assistance Grant to Mongolia for the Social Sectors Support Program. Manila (a $43.1 million equivalent loan and a $16.9 million grant).

4 ADB. 2009. Report and Recommendation of the President to the Board of Directors: Proposed Asian Development

Fund Grant to Mongolia for the Education for the Poor – Financial Crisis Response Project. Manila ($17 million grant).

5 ADB. 2009. Technical Assistance to Mongolia for the Policy and Institutional Support for Banking Sector Systemic

Risk Management. Manila ($2 million grant).

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10. The SSSP6 was to be implemented from April 2009 to December 2010. The Government of Japan, through the Japan International Cooperation Agency (JICA), provided $50 million cofinancing. The SSSP is based on a joint policy matrix developed by ADB and JICA. Upon compliance with 15 policy conditions, the ADB portion of the first tranche ($40.7 million) was released in July 2009 and the JICA portion ($30 million) was released in August 2009. ADB will provide $20.1 million for the second trance and JICA $20 million. 11. The SSSP is supporting fiscal adjustment under the IMF SBA and protecting social sector expenditure by providing budget support. It is also implementing a set of policy measures for social welfare, health, education, and urban development to provide essential social services. In particular, policy measures are supporting long-term social sector structural reforms and long-term efficiency and sustainability of social expenditures through better targeting, rationalization, and consolidation of social transfers for health, insurance, education, and social welfare. 12. Of the 17 policy conditions for release of the second tranche of the SSSP originally targeted for December 2009, 16 have been met, including drafting and submitting to Parliament amendments of the Social Welfare Law (SWL), which target and consolidate social welfare benefits, approval and pilot-testing of a revised drug discount system, approval of an expansion plan for household nutrition fortification, introduction of Medicard for the poor, and capacity building for the development of ger areas. The key remaining condition relates to the passage of the draft SWL by Parliament. Major obstacles are the use of proxy-means tests to identify the poor, the targeting of households rather than individuals, the allocation of MNT100 billion to the targeted poverty benefit, and the use of external entities instead of government agencies to identify the poor.7 13. The SSSP was recently extended by 6 months until 30 June 2011 to continue policy dialogue and the provision of technical support to facilitate the passage of the draft SWL and ensure the completion of the nationwide identification of poor households through proxy means tests. 14. The Education for the Poor Project complements the SSSP by helping safeguard achievements in the education sector and mitigating any negative effect of the economic and financial crisis on the poor (footnote 4). In particular, the project provides support for (i) financing of meals at preschools for children ages 2–5 to protect poor children’s access to preschools; (ii) continuation of the targeted provision of textbooks to secondary school students from poor families; (iii) provision of block grants to schools in need of operation and maintenance funds; and (iv) capacity building at the Ministry of Education, Culture and Science in financial management, budgeting, and monitoring and evaluation to enable the ministry to better deal with budget constraints. 15. The Policy and Institutional Support for Banking Sector Systemic Risk Management TA is expected to establish a conducive and prudent policy and operating framework for systemic

6 The policy reforms under the SSSP have technical and advisory support from ADB TA (TA 7300-MON, approved

on 24 June 2009, for $700,000) attached to the program to support implementation and coordination of policy reforms under the SSSP. Specifically, the TA is (i) supporting policy reforms on targeting social assistance and improving social sector efficiency; (ii) strengthening statistical analysis and data collection; (iii) building capacity for the management of an intersectoral national database of beneficiaries of social assistance and other government subsidies; (iv) developing consensus on targeting social assistance with national and local government officials and the public; and (v) developing environment and social safeguard capacity for urban development stakeholders in Ulaanbaatar.

7 MNT1,359 = $1.00

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Appendix 4

risk management of banking and distressed asset resolution.8 The TA is (i) reinforcing BOM and government leadership, authority, and capacity in systemic risk management of banking, (ii) strengthening corporate governance and internal controls of commercial banks; and (iii) supporting a multifaceted approach for NPL resolution. Despite recent increased business activity in the banking, addressing the fundamental vulnerabilities revealed during the crisis remains the priority for the government, bank management, and shareholders. Given the upcoming mining boom, when demand for credit will increase substantially, banks must be well-capitalized and able to extend credit. C. Economic Recovery from the Crisis

16. The Mongolian economy has recovered substantially since mid-2009 supported by comprehensive and strong macroeconomic policies of the government as well as international and bilateral budget and balance of payments support, and TA. The economic recovery has been fuelled by the rebound in copper prices, strong demand for copper and coal from the People’s Republic of China, and investment in mining. In October 2009, the government signed an agreement with an international mining company to exploit the Oyu Tolgoi copper and gold deposit. Investment in this project is expected to total $5 billion, with about $760 million spent in 2009 and $1.5 billion to be spent in 2010. Production is projected to start in 2013. The development of the resource sector reflects a fundamental, permanent structural shift of the Mongolian economy. 17. GDP increased by 3.4% year-on-year in the second quarter of 2010. This was the third quarter of growth, following 7.6% growth in the first quarter of 2010 and 3.9% in the fourth quarter of 2009. The current account deficit narrowed to around 7.4% of GDP in the second quarter of 2010, after peaking at 14% in the first quarter of 2009 on 4-quarter rolling sum basis. Consumer prices increased by 11.1% in August 2010 and inflation is likely to stay high in 2011, given that the economy is operating close to capacity. GDP growth is projected at 7.0% for 2009 and 6.5% for 2010 based on a huge increase in Oyu Tolgoi- related infrastructure spending.9 18. The budget deficits targeted under the SBA of 5.4% of GDP for 2009 and 5.0% for 2010 have been met with a comfortable margin due to the surge in fiscal revenues (in line with strong copper prices and the economic recovery) and large cash payments received by the budget as part of the Oyu Tolgoi investment agreement. Political pressure to increase spending in 2010 has been substantial. Despite higher spending, the fiscal deficit for 2010 is expected to fall to 2% of GDP, well below the target of 5% of GDP under the SBA. 19. To avoid a repeat of the boom and bust government spending pattern, Parliament, as part of the IMF SBA, enacted the Fiscal Stability Law in June 2010. The law aims to ensure that mining revenues are better managed in the future, and will be an essential component of putting in place a strong policy framework to manage the upcoming mining boom. 10 The newly approved Central Bank Law mandates BOM to concentrate solely on price stability. The government submitted a comprehensive bank restructuring program to Parliament.

8 ADB. 2009. Technical Assistance to Mongolia for Policy and Institutional Support for Banking Sector Systemic Risk

Management. Manila (for $2 million). 9 ADB. 2010. Asian Development Outlook 2010, Update. Manila.

10 The law includes three complementary fiscal rules: (i) a ceiling on the structural deficit, (ii) a debt ceiling, and (iii) a ceiling on expenditure growth.

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20. While the medium-term economic outlook is favorable, sizable risks remain, in particular relating to banking solvency and near-term fiscal pressures in the next few years before the sharp increase in mineral revenues associated with the Oyu Tolgoi mining project. In particular, the abolishment of the windfall profit tax (a decision in October 2009) becomes effective on 1 January 2011 and will entail estimated net revenue losses amounting to 2% of GDP, while aid funding for budget support is rapidly diminishing.

46

Appendix 5

COUNTRY CASE STUDY OF ADB’S CRISIS RESPONSE: TONGA

1. Tonga has a small, remote economy that is highly vulnerable to external economic shocks and natural disasters. Its small size means that the country lacks the economic density needed to take advantage of economies of scale and specialization. In the absence of a thriving

private sector to drive economic growth, economic activity in Tonga—like in many small, remote

economies in the Pacific—has tended to be driven by the public sector, and by remittances from

its transnational population. Public sector spending on wages, purchases, and contracts make a vital contribution to the Tongan economy, stimulating considerable production and consumption activity. Remittances also make a vital contribution to the economy, supplementing income and providing households with investment opportunities and consumption possibilities. 2. Over the last decade, Tonga’s economic growth has been modest. From FY2001 to FY2010, real gross domestic product (GDP) growth averaged about 0.8%. In the same period, the average annual growth rate for real GDP per capita was lower, at a little under 0.2%. Typical of small economies, GDP growth tends to be somewhat volatile in Tonga. Over the last decade the economy has grown by as much as 3.2% of GDP, and contracted by as much as 1.2%. 3. The main impact of the global economic crisis on the domestic economy came from a sharp decline in remittances, resulting from the economic downturn in the key remittance-sending countries for Tonga—the United States, New Zealand, and Australia. Prior to the global economic crisis, remittances were the equivalent of over 30% of GDP. In FY2009, remittances fell by about 14% in pa’anga terms, or 21% in US dollar terms. In FY2010, remittances fell further, by more than 10% in pa’anga terms, or again by 21% in US dollars. By FY2010, remittances were the equivalent of only 22% of GDP—their lowest of any year in the previous decade. This sharp decline in remittances reduced the income of remittance-receiving households, reducing their expenditure and thereby contributing to the contraction in domestic economic activity. 4. Economic activity was also dampened by a decline in tourism receipts and a contraction in exports. After rising in FY2009, tourism receipts fell by over 13% in pa’anga terms in FY2010, which was a 24% decline in US dollar terms. The fall in tourism receipts stemmed from both a decline in cruise ship arrivals (of nearly 25% on the previous year) and a decline in air arrivals (of nearly 7%, but on a market more than 2.5 times the size of the cruise ship market). In FY2009, the nominal value of exports fell by just over 50% in pa’anga terms (around 56% in US dollar terms). In FY2010, while the nominal value of exports remained constant in pa’anga terms, this constituted a 12% fall in US dollar terms, due to the depreciation of the pa’anga. 5. In FY2010, the country experienced three natural disasters. The tsunami of September 2009 caused loss of life and significant material damage. The February 2010 cyclone caused material damage, including to agricultural crops. In addition, a drought affected production in the agriculture sector.

A. ADB’s Role 6. The Asian Development Bank (ADB) provided budget support of $10 million to Tonga through the Economic Support Program grant in late 2009.1 The program was designed to lessen the economic downturn while paying special attention to the needs of the vulnerable. It was underpinned by solid diagnostics, communication and awareness raising initiatives, and a

1 ADB. 2009. Proposed Asian Development Fund Grant—Kingdom of Tonga: Economic Support Program. Manila.

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commitment to a longer-term engagement. Proceeds from the program were scheduled for release in two $5 million tranches. 7. Learning from the lessons of past programs, care was taken to work within country-led approaches and to build on areas of historical involvement (in particular, reforms of state owned enterprises and economic management). The program was designed to achieve the following five outputs:

(i) Budget support to protect services to the vulnerable. Provide general budget support to protect delivery of essential social services, and to support priority budget expenditure.

(ii) Maintenance of fiscal responsibility. Implement complementary policy actions to safeguard the overall fiscal position, and secure fiscal sustainability.

(iii) Maintaining Reforms Momentum. Continue structural and governance improvements to support medium-term prospects for economic growth.

(iv) Helping the Vulnerable. Adopt policy actions to provide opportunities for the vulnerable to make economic growth more inclusive.

(v) Promoting Local Ownership. Engage private sector and civil society stakeholders in public policy to deepen local awareness, understanding, and ownership of the programs.

8. Even before provision of budget support to Tonga, ADB's response to the global economic crisis in the Pacific had already commenced with analytical work in late 2008. It circulated two briefs: Navigating the Global Storm: A policy brief on the global financial crisis (at the 2008 Forum Economic Ministers Meeting) 2 and Taking the Helm: A policy brief on a response to the global economic crisis, 3 which led to the formulation of a common analytical framework that underpinned ADB's engagement with Tonga and other Pacific developing member countries on the crisis response. 9. This analytical work is ongoing, and enhanced economic monitoring and surveillance is in place. The Pacific Economic Monitor was established in early 2009 and produced on a quarterly basis during the crisis period. It is now produced on a tri-annual basis and widely disseminated and used in the Pacific. 10. Technical assistance is also helping Tonga, and other Pacific developing member countries, prepare and implement their response to the economic slowdown. The Pacific Economic Management TA is supporting economic monitoring, analysis, and policy advice.4 It is focused on helping formulate and implement country-specific actions in response to the global economic crisis. The scope of assistance extends to revitalization of economic management systems, including support for improved engagement with stakeholders, and budget and structural reform actions. In Tonga, the TA’s efforts have focused on assisting the National

2 ADB. 2008. Navigating the Global Storm: A policy brief on the global financial crisis. ADB Pacific Studies Series,

December. Manila. 3 ADB. 2009. Taking the Helm: A policy brief on a response to the global economic crisis. ADB Pacific Studies

Series. April. Manila. 4 ADB. 2009. Technical Assistance for Pacific Economic Management. Manila.

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Reserve Bank of Tonga to strengthen monetary policy formulation and macroeconomic management. B. ADB’s Coordination with other Development Partners 11. ADB worked closely with other development partners to help Tonga prepare and implement a response to the global economic crisis. Indeed the European Union has taken the second tranche conditions of the Economic Support Program as the basis for release of a preapproved €$7 million in budget support under its V-Flex facility. 12. ADB initiated, and now regularly coordinates, a meeting of development partners in Tonga. The meeting was initially aimed at providing a joint development partner response to the crisis, but its focus has since evolved to the provision of longer-term support aimed at creating an economy more resilient to future shocks. The importance of this improved coordination is underscored by Tonga’s efforts to reduce its high debt through a program of fiscal consolidation; in other words, development support will be even more critical for Tonga to achieve its development goals. 13. Importantly, development partners agree that in the future, continued coordination of development support around a core set of government-led policy issues (as with the program policy matrix) should be pursued, as is ongoing policy dialogue on these issues with the government. C. Constraints Faced in Responding to the Crisis 14. The main constraint faced was the lack of implementation support given capacity limitations in key ministries such as the Ministry of Finance. This resulted in, among other things, delays in public infrastructure spending (to inject a fiscal stimulus into the economy). 15. However, concerted support through the Pacific Economic Management TA, a country TA (to assist the Ministry of Finance with macroeconomic policy), and staff support (to assist the Ministry of Finance establish a conceptual framework for medium-term budgeting) have helped to alleviate this constraint. D. Assessed impact of ADB Support. 16. Budget support to protect services to the vulnerable. The provision of budget support helped reduce a large financing gap (created by the sharp decline in nongrant revenues) and alleviated significant pressure on the government’s expenditure programs. 17. In FY2010 a budget deficit of 1.0% of GDP was posted. This achievement, however, was largely the result of the first tranche of $5 million in budget support from ADB. In the absence of budget support, the deficit would have been much larger at around 2.3% of GDP (even with stringent expenditure cuts). In FY2011, the budget support grants that are expected to be received from the ADB and other partners are estimated to turn a projected deficit of 2.9% of GDP into a surplus of 1.5%. 18. The FY2010 budgets for health and education were substantively maintained—based on a year-on-year comparison of actual outturns—despite cuts to the expenditure programs of other ministries. This protection of social services expenditure meant that provision of services to the poor and vulnerable was largely unaffected.

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19. Maintenance of fiscal responsibility. A number of policy actions to strengthen fiscal management and maintain fiscal responsibility were implemented. These include the completion of a public expenditure and financial accountability assessment, the reactivation of the Macroeconomic Policy Committee to agree on one set of economic forecasts, the use of forward estimates in the FY2011 budget to provide a more strategic snapshot of resources allocation, the use of financial ratios to promote fiscal sustainability, the approval of a debt management strategy and public procurement regulations, and the completion of treasury instructions and manuals. 20. Maintaining reform momentum. During the last decade, Tonga has embarked on important reforms in a number of areas including improving the performance of public enterprises, and reducing the extent of the burden that regulations place on investment and business activity. The importance of these reforms was underscored by the economic downturn, which helped focus attention on the underlying structural weaknesses in the economy. These weaknesses tended to be less visible when the economy was expanding. 21. The Tongan government was very open to policy discussions on reforms with development partners given the extent of the impacts of the crisis on the economy and its commitment to pushing ahead with reforms to strengthen future resilience and to improve prospects for growth in the medium term. The program, therefore, allowed ADB and other partners a seat at the table on policy discussion, and enabled support for the continuation of structural reforms in a time of crisis. 22. The program policy matrix also provided a means for ongoing dialogue on these reforms, and allowed ADB and other partners to regularly and systematically review implementation progress. This, in turn, provided the basis for improved coordination among development partners and provision of support to critical areas on a timely basis. 23. Helping the vulnerable. The program was instrumental in getting new policy issues on the agenda, in particular, social welfare and social protection issues. Cabinet endorsed a an issues paper on vulnerable persons, which identified vulnerable groups, assessed the adequacy of existing social safety net systems, and provided options for enhanced social protection policies. In addition, public expenditure reviews were completed for the ministries of health and education to enable significant improvements in expenditure efficiency and quality over the medium term. 24. Promoting local ownership. Local ownership and country-driven implementation were key features of the program. The implementation of the policy matrix was government-led and allowed for recognition of implementation progress and achievement. A communications and engagement strategy was adopted and monthly reports and ministerial television appearances explained the government response to the economic crisis.

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Appendix 6

CRISIS-RELATED KNOWLEDGE PRODUCTS AND SERVICES

A. Regional and Subregional Cooperation

1. The Asian Development Bank (ADB) facilitated experts' discussions and the exchange of ideas among developing member countries (DMCs) by organizing events such as conferences, seminars, and workshops on the global economic crisis. Several events were organized in association with other development partners in the region, including the following:

(i) A high-level conference, The Impact of the Global Economic Slowdown on Poverty and Sustainable Development in Asia and the Pacific, was held in Hanoi, Viet Nam on 28–30 September 2009. It provided a venue to exchange information on how countries in the region adjust to address the social and environmental impact of the global economic crisis on Asia and the Pacific, especially on the poor and vulnerable. Discussions also focused on opportunities presented by the crisis to make social and economic development and growth in Asia more inclusive. An output of this conference is a publication, Poverty and Sustainable Development in Asia: Impacts and Responses to the Global Economic Crisis, which suggests that the crisis is an opportunity to rethink the model of development in Asia for growth to become more inclusive and sustainable.1

(ii) ADB’s Office of Regional Economic Integration organized an international

conference, Global Crisis—Financial Policy Reponses and Lessons from the Crisis, on 30 September and 1 October 2009 in Seoul, Republic of Korea. The conference drew lessons from the crisis and identified areas to further safeguard regional financial systems. It provided a venue for regional and global financial regulators and policy makers to share their experience in dealing with the crisis.

2. Under a regional technical assistance, ADB convened a series of forums on the impact of the global economic crisis in Asia. The first forum, South Asia Forum on the Impact of the Global Economic and Financial Crisis held on 9–10 March 2009, brought together public and private sector representatives from seven South Asian countries to share cross-country experiences on the impacts of the crisis, and the ongoing and planned measures to preserve financial stability, stimulate growth, and ensure social protection in their respective economies. 3. To continue the dialogue, the second forum, Regional Forum: Impact of the Global Economic and Financial Crisis on 14–15 January 2010, was conducted in a wider scale engaging DMCs in Central, East, South, Southeast, and West Asia in knowledge sharing of in-country and global experiences to minimize adverse effects and cope with the global economic and financial crisis. Participants explored mechanisms and measures that have been successful in mitigating adverse impacts including stimulus measures, policy coordination and adjustments, and monitoring of systemic risks for maintaining regional and domestic financial stability; and discussed the regional dimensions of the crisis for dealing with contagion effects and strengthening regional coordination.

1 ADB. 2010. Poverty and Sustainable Development in Asia: Impacts and Responses to the Global Economic Crisis.

Manila.

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4. The last in the series, Regional Forum: Impact of the Global Crisis on Asia, Lessons Learned, Policy Insights and Outlook, was held on 4 November 2010. Participants from 16 DMCs assessed the robustness of recovery, and discussed how to enhance resilience, sustainability, and inclusive growth. 5. In the Pacific, global economic crisis research, policy, and advocacy work primarily centers around three publications: (i) Navigating the Global Storm, A Policy Brief on the Global Financial Crisis;2 (ii) Taking the Helm, A Policy Brief on a Response to the Global Crisis;3 and (iii) the quarterly Pacific Economic Monitor, which commenced in May 2009. These publications were, and in the case of the Pacific Economic Monitor continue to be financed by existing regional technical assistance. In addition, a TA for Pacific Economic Management—Response to the Global Crisis (Subproject 1) helped Pacific DMCs reduce the effects of the global crisis through better policy analysis and dialogue.4 Aside from supporting country-level dialogue, the TA offered structured and targeted regional dialogue by bringing together heads of treasuries and ministries of finance, central banks, and market regulators and supervisors to help them define their own policy position by sharing experiences and debating policy issues. B. Country-Focused Work 6. Under Mongolia’s Social Sector Support Program (SSSP), ADB provided a technical and advisory TA in June 2009 for $700,000 to support implementation and coordination of policy reforms under the SSSP.5 Specifically, the TA is (i) supporting policy reforms on targeting social assistance and improving social sector efficiency; (ii) strengthening statistical analysis and data collection; (iii) building capacity for the management of an intersectoral national database of beneficiaries of social assistance and other government subsidies; (iv) developing consensus on targeting social assistance with national and local government officials and the public; and (v) developing environment and social safeguard capacity for urban development stakeholders in Ulaanbaatar. 7. ADB also provided TA to Mongolia for Policy and Institutional Support for Banking Sector Systemic Risk Management in November 2009. 6 The expected outcome of the TA is the establishment of a conducive and prudent policy and operating framework for systemic risk management of banking and distressed asset resolution. Despite recent increased business activity in the banking system, addressing the fundamental vulnerabilities revealed during the crisis remains the priority for the government, bank management, and shareholders. Given the upcoming mining boom, when demand for credit will increase substantially, banks must be well-capitalized and able to extend credit. 8. For the People’s Republic of China (PRC), ADB provided TA resources to improve access to financial services for the poor and vulnerable households and to strengthen the legal, regulatory, and supervisory framework of the country’s finance sector. Several knowledge products and TAs related to the crisis were produced. The International Conference on Global

2 ADB. 2008. Navigating the Global Storm: A policy brief on the global financial crisis. ADB Pacific Studies Series,

December. Manila. 3 ADB. 2009. Taking the Helm: A policy brief on a response to the global economic crisis. ADB Pacific Studies

Series. April. Manila. 4 ADB. 2009. Technical Assistance for Pacific Economic Management. Manila.

5 ADB. 2009. Report and Recommendation of the President to the Board of Directors on a Proposed Asian

Development Fund Loan and Grant and Technical Assistance Grant to Mongolia for the Social Sectors Support Program. Manila.

6 ADB. 2009. Technical Assistance to Mongolia for Policy and Institutional Support for Banking Sector Systemic Risk

Management. Manila (for $2 million).

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Financial Crisis and Distressed Assets was held in Beijing in November 2009. It addressed the impacts of the crisis on balance sheets, banking restructuring, stimulus measures, and recovery; and offered advice on how to strengthen the regulatory framework and to manage distressed assets. Furthermore, national workshops dealing with fiscal and financial management topics were conducted, leading to more efficient treasury cash management and enhanced management of local government debt. 9. ADB provided topical, demand-driven, and timely advice to the PRC’s Ministry of Finance (MOF). Since the onset of the crisis in late 2008, the department has actively supported MOF though the provision of timely policy advice to address the impact and challenges brought about by the global economic crisis. Policy advice has been mainly channeled through the PRC Resident Mission’s series of policy notes, Observations and Suggestions, which aims to provide senior policymakers in the PRC government with information and advice relevant to priority issues in the country. The selection of topics has been guided by specific requests from MOF and by the resident mission’s own initiative on topics expected to emerge as government policy or reform priorities. This feature makes the Observations and Suggestions series flexible in terms of adjusting to rapidly changing circumstances and government requests, as was the case in 2009 and 2010. For that reason, the additional work triggered by the onset of the crisis was easily accommodated and did not require reprioritizing other work activities. Moreover, and as per MOF’s request, in November 2010 the resident mission prepared a lengthy policy note with recommendations for the PRC to avoid the middle-income trap, and secure sustainable growth in the longer term.

10. Other TA-related support in the PRC includes two ongoing subprojects under a facility TA (Application of Labor Contract Law to Informal Employment and Impact of Fiscal and Monetary Policies on Employment during the Crisis). The reports, which have a strong focus on employment issues during the crisis, are under way but are not yet available. Further TA support includes the Support for Policy Reforms in High Priority Areas, which comprises a component on the management of subnational government debt. In late 2008, a CNY7.38 trillion economic stimulus package was launched and subnational governments had to step in to provide matching funds that spurred the rapid expansion of extrabudgetary financing platforms. The TA provided timely answers on how to better estimate, evaluate, and manage local government debt. 11. For Bangladesh, ADB provided a small-scale capacity development TA, Strengthening Macroeconomic and Fiscal Monitoring at the Ministry of Finance MOF, which includes specialist assistance to enhance MOF’s analytical and policy formulation capabilities. Also, at the request of MOF, the Bangladesh Resident Mission commissioned a study, Global Economic Crisis: Impact on Bangladesh and Policy Response, including debt sustainability analysis. The study sought to identify the channels through which Bangladesh was impacted by the global economic recession; assess its impact on various sectors of the domestic economy; and assess the size and appropriateness of the authorities’ policy response, with particular focus on the policy stance announced in June 2009 in the FY2010 budget. The study also identified major uncertainties on the macroeconomic front due to the crisis and the risks in implementing the expansionary fiscal stance announced by the government. It was used as a major input in developing the crisis-related program loans for Bangladesh, especially the Countercyclical Support Facility (CSF) Support Program.7

7 ADB. 2009. Report and Recommendation of the President to the Board of Directors: Proposed Loans to the People's Republic of Bangladesh for the Public Expenditure Support Facility Program and Countercyclical Support Facility Support Program. Manila.

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12. A small-scale project preparatory TA for Marshall Islands, Responding to Economic Crisis, aimed to identify options for improving revenue growth, containing expenditure, and improving data and systems in priority areas. 13. A capacity development TA for Cambodia, Capacity Development for National Economic Policy Analysis and Development Management, Phase III, was designed to improve the government’s ability to formulate, coordinate, implement, and monitor key policies and strategies effectively to promote sustainable economic development. C. Other Knowledge Works

14. ADB prepared and published various papers, reports, presentations, and books related to the economic crisis. These knowledge works have been made available to the public through the ADB webpage. Their findings, lessons, and recommendations provide much valuable input to policy and DMC decision makers. The Asian Development Outlook and its update, Asian Economic Monitor, and other forms of research works8 as well special notes on crisis and recovery issued from time to time, were instrumental to the formulation of ADB’s crisis response. 15. Lessons from processing and administering crisis-related projects and program loans and Countercyclical Support Facility assistance also provide significant insights on how to address the impact of the economic crisis in a much more timely and relevant manner. Initial responses to the global economic crisis included ways on how to better track and understand its impact, and protect critical budgetary expenditures from further shocks. Thus, reliable, sound, and frequent economic and financial monitoring systems and budget implementation arrangements were needed. 16. In DMCs with weak public financial management systems, providing technical assistance as part of the ADB crisis response was crucial to help mitigate fiduciary risks and concerns, among others. Allocating the utilization of counterpart funds generated from loan or grant proceeds could only be meaningful if adequate government mechanisms were available for tracking expenditures. Thus, TA assistance is crucial to provide this capacity, even when government requests for assistance focus more on urgent financial needs. Also, the scope and coverage of independent audits on the utilization of counterpart funds should be very clear and precise. 17. Going forward, ADB could be better prepared to assist its DMCs through macroeconomic events that threaten to set back development achievements. More regular involvement in macroeconomic and financial sector assessments in its DMCs (e.g., International Monetary Fund review missions) would assist ADB country teams and management build assistance scenarios beforehand. Country-specific macroeconomic analysis (e.g., country chapters for the Asian Development Outlook) should be more integrated and other diagnostic analysis done with better information flow and policy dialogue. Even if crisis events are difficult to foresee, these recommendations would help ADB identify sources of country vulnerability to external or domestic shocks and direct its policy dialogue toward embodying contingency planning into country programming.

8 For instance, W.E. James, D. Park, S. Jha, J. Jongwanich, A. Terada-Hagiwara, and L. Sumulong. 2008. The US

Financial Crisis, Global Financial Turmoil, and Developing Asia: Is the Era of High Growth at an End? ADB Economics Working Paper Series. No. 139. Manila: Asian Development Bank.

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Appendix 7

EVALUATION OF CRISIS RESPONSE BY OTHER INTERNATIONAL FINANCIAL INSTITUTIONS

1. Among the international financial institutions to date, the European Bank for Reconstruction and Development (EBRD) and the World Bank Group have completed evaluation of the crisis response. Independent evaluation by the International Monetary Fund focused on the performance in the run-up to the crisis.

A. World Bank Group 2. The World Bank Group’s crisis response comprised (i) supporting the most vulnerable; (ii) maintaining long-term infrastructure investment; and (iii) sustaining the potential for private sector-led growth. In the fiscal years 2009–2010, the group committed $128.7 billion and disbursed a record $80.6 billion—more than any other international financial institutions, including the International Monetary Fund. The report, prepared by the Independent Evaluation Group,1 concluded that the World Bank Group’s response fit the nature of the crisis that called for countercyclical fiscal expansion to compensate for sharply declining trade and private capital flow. However, a closer look reveals that performances varied among institutions within the group. While the financial headroom available to the International Bank for Reconstruction and Development enabled it to launch a large-scale response in middle-income countries, resource mobilization to low-income countries from the International Development Association was relatively modest due to its inelastic funding envelope and rigid performance-based allocation system. The International Finance Corporation was initially preoccupied with protecting its own portfolio, rather than helping others.

B. European Bank for Reconstruction and Development

3. EBRD formulated its operational response program in October 2008. By the end of 2009, EBRD committed €5.5 billion and disbursed €3.2 billion for 115 projects in 28 countries. However, only €0.9 billion was disbursed by the end of the second quarter of the year, implying that its interventions were more relevant in the recovery phase of the crisis, rather than its liquidity and/or containment phase. Generally, EBRD perceived the 2008 crisis as the ―financial‖ crisis, rather than the broader economic crisis, and its intervention was focused upon addressing liquidity constraints in the financial sector. The evaluation2 presents a view that EBRD was not designed as an institution to cope with the financial crisis, in terms of its strategy, policies, processes, and tools. On this account, the evaluation recommends enhancing EBRD’s crisis readiness to allow for quicker and more effective response in the future, including setting aside capital and liquidity as part of annual business planning and development of new products to address immediate liquidity needs.

C. International Monetary Fund 4. The Fund provided few clear warnings about the risk and vulnerabilities associated with the impending crisis before its outbreak. Its evaluation

3 recommends: (i) creation of an environment that

encourages candor and dissenting views; (ii) modifying incentives to ―speak truth to power‖;

1 World Bank Independent Evaluation Group. 2010. The World Bank Group’s Response to the Global Economic

Crisis: Phase 1. Washington, DC. The Independent Evaluation Group also calls for introduction of a short-term instrument modeled on ADB’s countercyclical support facility.

2 EBRD Evaluation Department. 2010. Special Study: The EBRD’s Response to the 2008–2009 Crisis. London.

3 IMF Independent Evaluation Office. 2011. IMF Performance in the Run-UP to the Financial and Economic Crisis:

IMF Surveillance in 2004–07. Washington, DC.

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(iii) better integration of macroeconomic and financial sector issues; (iv) overcoming the silo mentality and insular culture; and (v) delivering a clear, consistent messages on the global outlook and risks.

assessment of adb’s response€¦ · in preparing any country program or strategy, financing any...

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