World Bank Management Comments

World Bank management would like to thank the Independent Evaluation Group (IEG) for undertaking this evaluation of the World Bank Group’s engagements addressing country-level fiscal and financial sector vulnerabilities. Lessons learned from the evaluation are directly relevant to recent challenges and policy commitments and will inform World Bank support to client countries facing adverse fiscal and financial shocks exacerbated by the coronavirus (COVID-19) pandemic.

The COVID-19 crisis and its far-reaching impacts have highlighted the importance of integrating monitoring of macrofinancial risks across sectors of the economy. The World Bank has scaled up monitoring of macrofinancial risks, including by focusing macrofinancial reviews on crisis-related risks and their management, stepping up real-time monitoring of revenue developments, increasing surveillance on fiscal risks from state-owned enterprises (SOEs), and enhancing surveys on the accumulation of public expenditure arrears in client countries. Monitoring of fiscal developments in countries participating in the Debt Service Suspension Initiative, undertaken jointly with the International Monetary Fund (IMF), has identified fiscal impacts and responses as well as additional financing needs in low-income countries. To help countries monitor fiscal impacts and design appropriate fiscal strategies, the World Bank has established a COVID-19 fiscal policy window that provided support to 20+ countries by mid-April 2021.

Management notes the IEG evaluation’s conclusion that the Bank Group’s work on addressing fiscal and financial sector vulnerabilities in client countries is both relevant and effective. Management agrees that “the Bank Group has generally carried out timely and relevant analyses at the country level” and that countries that received Bank Group support “were generally better prepared to respond to a major shock today than previously.” Management acknowledges that this has been possible, among other reasons, because “the World Bank Group has strong staff skills, motivation, and capacity to support clients in identifying and helping to reduce fiscal and financial sector vulnerabilities.” Management believes that the World Bank’s strong country presence contributes greatly to this high level of effectiveness. This evaluation’s findings will enrich management’s continuous efforts to help clients manage fiscal and financial risks and build resilience to external shocks, particularly in the most vulnerable countries.

Management is pleased that the report recognizes the country engagement model’s catalytic role in guiding lending and advisory services and analytics to address fiscal and financial sector vulnerabilities and notes that stakeholder engagement is critical to this model. The report notes that “in all case study countries, a review of diagnostic work and subsequent World Bank–supported country strategies indicates that identified vulnerabilities informed Bank Group lending and subsequent ASA [advisory services and analytics].” This finding highlights the country engagement model’s core strength: that it builds selectively on countries’ own development priorities and articulates results-based engagements based on solid analytical diagnostics and stakeholder consultation. Management agrees with the report that the latter is particularly relevant for efforts to address fiscal and financial vulnerabilities, which are intensely political and subject to vested interests opposing appropriate policy reforms. The report also recommends ensuring dialogue with a broad range of stakeholders (parliaments, local institutions, and the public) to educate and build support for critical reforms. Management emphasizes that such dialogue is already part of the country engagement model and at the core of its operational, policy, and analytical work. This dialogue also includes close engagement with other multilateral development banks (for example, through country platforms on debt issues), which has not been captured in the report.

Management appreciates the rigor with which the case studies were conducted and concurs with the report’s assertion that its “external validity is limited and may apply to countries with similar characteristics to those of the case studies.” Given the context-specific nature of fiscal and financial risks, which vary considerably in origin, impact, management, and government involvement, some of the general conclusions and lessons learned would benefit from further qualification. Notable examples include broad statements about the inability of Debt Sustainability Analysis (DSA) to capture and estimate risks, a statement that is based on evidence from one country (Benin) collected before the revision of the Low-Income Countries Debt Sustainability Framework (LIC DSF) in 2018. Notwithstanding these limitations, some of the lessons the evaluation provides shed light on areas for further improvement.

Management shares the view that data quality and transparency are essential for continuous monitoring of country-level vulnerabilities. Fostering greater debt transparency is one of the key aspects of the implementation of the Sustainable Development Finance Policy (SDFP) introduced in FY21. The SDFP creates incentives, particularly in the poorest countries, to make progress on performance and policy actions related to addressing debt vulnerabilities. The performance and policy actions help increase transparency (for example, on publication of detailed information on debt, including SOE debt), which informs external and domestic stakeholders and increases scrutiny. The report could better reference (i) how SDFP implementation—outside the period under evaluation—brings the issues of data quality and transparency to the forefront of World Bank dialogue with IDA clients, and (ii) the conclusions of the Non-Concessional Borrowing Policy (NCBP) review after the transition from NCBP to the SDFP in FY21. Several complementary adjustments on the macroeconomic and growth side will be critical to dealing structurally with debt vulnerabilities, and the policy dialogue on debt issues must be anchored in a country program of broader fiscal, macroeconomic, and structural reforms, as the evaluation suggests. Lessons learned from debt relief initiatives, such as the Heavily Indebted Poor Countries and the Multilateral Debt Relief Initiative, highlight the importance of building a strong track record of fiscal, macroeconomic, and structural reforms to address debt vulnerabilities. Debt-related policy dialogue often spills over into broader reform engagements. For example, in some countries, the policy dialogue on debt ceilings in the context of IDA’s NCBP significantly deepened reform engagements in other related areas, such as debt management and debt transparency.

Management agrees on the need to integrate risks from contingent liabilities into policy dialogue. In addition, countries are exposed to a wide variety of exogenous shocks that the report does not consider. Addressing fiscal and financial sector vulnerabilities often requires managing certain risks up front, for example, through early warning systems, food reserves, and so on. Crisis preparedness and risk finance can help vulnerable countries secure prearranged funding to respond to these exogenous shocks, including through market-based financial solutions such as insurance. Quantifying such compound risks and embedding them within financial risk management frameworks is a crucial starting point. The discussion of risk monitoring, which focuses on DSA and the Financial Sector Assessment Program (FSAP), could have acknowledged that managing fiscal and financial sector risks also requires a good understanding of potential risks and their impact, likelihood, and possible mitigation measures.

The claim that the DSA framework is systematically biased to underestimate fiscal risks and does not always capture some extreme scenarios is noted. Realism of growth and financing projections in DSAs is being reviewed more thoroughly. Additionally, the LIC DSF revised in 2018 places greater emphasis on fiscal risks and aims by default at near complete debt coverage of the public sector in the baseline scenario, including risks from SOEs, extrabudgetary funds, and subnational governments, among others. Management is revamping efforts to assess additional risks (for example, natural disaster and climate-related risks) as part of fiscal and debt sustainability assessments. For example, an enhanced approach in the revised LIC DSF expands the stress testing framework to more systematically capture vulnerability to natural disasters and climate shocks.1 The World Bank along with the IMF has piloted assessments of climate-related financial sector risks and regulatory responses in the context of FSAPs, and further work is under way.

Management concurs that support to smaller economies to address fiscal and financial vulnerabilities should be provided whenever requested and justified and believes that its work through FSAP in these countries is not adequately characterized in the report. Although the report highlights that the “World Bank’s diagnostic work on the financial sector was comprehensive and credible . . . in part [due to] the FSAP and associated technical assistance,” it also claims that the division of labor between the World Bank and the IMF “may have constrained the Bank Group in its ability to provide timely support to smaller economies that are not deemed systemically important.” Notwithstanding the benefits of close collaboration between the World Bank and the IMF in this area, the report could have recognized the modular approach embedded in the FSAP, including the World Bank’s ability to support smaller economies by conducting stand-alone FSAP development modules. The FSAP development modules do not require IMF participation and focus primarily on financial sector development challenges, with the timing and country selection left to the World Bank’s discretion and subject to country demand.

Management is pleased that the report highlights the World Bank’s critical role in supporting client countries in strengthening social safety nets (SSNs) but notes that SSN adaptability depends on country contexts. The report’s recommendation to build adaptive SSNs to respond to cyclical and uncommon downturns cannot be generalized for a broader range of World Bank clients. Focusing on SSN adaptability as the key dimension to evaluate crisis preparedness may be appropriate for countries where such systems already exist, but for the many low-income countries that initially have no such systems (for example, Benin, Mozambique, and Tajikistan in the sample), crisis preparedness may be more reasonably evaluated by whether that system was put in place or not.

International Finance Corporation Management Comments

International Finance Corporation (IFC) management would like to thank IEG for this evaluation report, which provides valuable insights on the effectiveness of the Bank Group interventions in addressing fiscal and financial sector vulnerabilities. Although the scope of the analysis was mostly on the public sector efforts supported by the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA), we welcome the lessons learned from the review and appreciate IEG’s recognition of IFC’s contributions to building resilience in these areas.

Building resilience has been at the heart of IFC’s mission, as has been evident in our work to support our clients during the COVID-19 pandemic. We appreciate that IFC is well-recognized in this report for its complementary role to IBRD’s projects in building resilience in the financial sector through its direct project and advisory support as described in the case studies on Ukraine, Tajikistan, Mozambique and Bangladesh. In fact, IFC’s approach to resilience building in our client markets is underpinned by multiple IFC solutions: country-level tools to identify risks, analytical products to gain insights, upstream and mainstream investment and advisory services across global, regional, and country levels. IFC Advisory Services team works collaboratively with IBRD in areas including the support in building and improving financial infrastructure, and policy advisory on public-private partnership frameworks and investment. IFC’s collaboration with IBRD via the Joint Capital Markets Initiative supports the development of local capital markets, contributing to building resilience of the financial markets as it promotes the mobilization of stickier, local capital. IFC is well positioned to support the Bank Group Cascade approach, which allows the freeing up of considerable government resources and, therefore, significantly reduces fiscal vulnerabilities.

IFC management appreciates the lessons learned of the report and observes the critical role the private sector can play in addressing vulnerabilities. Given that public-private partnerships can be a sizeable presence and source for contingent liabilities, it would be critical to examine the role IFC can play through both advisory services and investment projects to contribute to the strengthening of resilience in the fiscal space as they identify project-related liabilities and the likelihood of these to materialize. Furthermore, the report mentions the challenges faced by IBRD operations in conducting adequate surveillance, in particular on those countries whose financial systems are not considered to present systemic importance, yet are recognized to be potentially highly vulnerable. In our view, this presents an opportunity for IFC’s risk assessment and surveillance procedures to play a supplemental role. Doing so may require an in-depth analysis on how best to integrate existing reporting, analysis, and insights, leveraging country-level tools such as Country Private Sector Diagnostics or country and regional strategies.

IFC management strongly agrees on the challenges surrounding data, especially on contingent liabilities and SOE vulnerability. Data on contingent liabilities and SOEs may not always be systematically collected or may be treated as confidential and accordingly not disclosed beyond a close government circle. Systematic collection of contingent liability and SOE performance data would critically improve crisis preparedness but will require concerted action with the IMF and others, and a long-term investment in capacity building. Data availability will help in more accurately assessing the problem and in fostering transparency. Although the availability of data will help building fiscal resilience, it is also essential to acknowledge that the risk of contingent liabilities in terms of size and/or unpredictability and controllability shall not be overstated, as terminations or similar payments are generally under the control of the government making this type of risk more manageable as any other subsidy, whereas nontermination type of ongoing costs and contingencies are limited.

IFC management believes that digitization plays a critical role in strengthening SSNs. The section on SSNs in this report makes valuable points on the need to preposition beneficiary registries and cash transfer mechanisms that could be scaled up in crises to provide expanded SSNs. The report also addresses the value clients placed on Bank Group support for credit bureaus and other activities that help bank lending practices. This would argue for the potential for the World Bank and IFC to do more using beneficiary registries and cash transfer mechanisms to advance financial inclusion, digitized payments and the use of transaction-based data to break down information asymmetries that impede access to credit and the reach of banks and nonbanking financial institutions. Progress in integrating the potential for e-commerce, e-government (including tax payments) and outsourced credit scoring could lessen vulnerabilities by improving credit underwriting and indirectly by strengthening incentives for formalizing economic activity.

Strong banking system and financial institutions are a key part of financial sector resilience. Although outside of the scope of this evaluation, bottom-up efforts from the private sector that contribute to addressing financial sector vulnerabilities are essential. IFC works on financial sector resilience as it engages with systemically important banks, where we invest in equity, quasi-equity and subdebt instruments. Through its investments in financial institutions, IFC aims to strengthen capitalization and solvency of our clients and doing so with systemically important banks of our client countries greatly contributes to market-wide stability. These efforts are often also accompanied by technical assistance to improve risk management to build resilience in a bottom-up manner. Moreover, as mentioned in the Jamaica and Ukraine examples, IFC through the Distressed Asset Recovery Program aims to build financial ecosystems to absorb distressed assets in economic downturns and crisis. The program contributes to the resilience of financial systems as it helps the financial sector offload nonperforming assets of systemic banks, resulting in quicker recovery of lending activities. Finally, understanding the vulnerability in the financial sector is critical for an effective support for countries, and data collection efforts like IFC’s recent survey on the impact of the COVID-19 pandemic on financial institutions can be used to help clearly identify challenges faced.

Finally, IFC’s response to the COVID-19 pandemic focuses on helping clients weather the negative impact of the pandemic, preserving jobs, rebuilding markets, and enabling long-term development of the private sector in the postcrisis period. The IFC 3.0 strategy aims at placing development at the heart of IFC operations; IFC’s role in building the resilience of financial sector via its projects is featured in the Anticipated Impact Measurement and Monitoring system, setting incentives for investment and advisory projects to address vulnerabilities in the financial systems. IFC has had a rapid response to the COVID-19 pandemic, introducing expedited procedures and facilities, resulting in the deployment of $11 billion investment, directly related to COVID-19 relief in from the fourth quarter of FY20 February 2021 (including mobilization and short-term finance). As part of its framework of Relief, Restructuring and Resilient Recovery, IFC continues to focus in the next years on resilience building in emerging economies, further increasing its contribution and strengthen its complementary role to the Bank Group’s work to build resilience in the economies.