BANKING: Asian Development Bank's strategic shift
Far Eastern Economic Review
Sept 17,1998

Strategic Shift:

 The Asian Development Bank failed to see the warning signs before the
 economic crisis hit the region; to regain credibility, it's helping to
 rebuild weak financial systems -- at the cost of its poorer member-states

By Salil Tripathi in Manila

1983 Words


Just two months before last year's devaluation of the Thai baht, the
Asian Development Bank published Emerging Asia -- a book that
optimistically concluded that the next three decades in Asia would see
the same go-go growth as the last three. That reading couldn't have been
more wrong. As one senior official admits: "Nobody wanted to consider
the alternative scenario."
   For the ADB, however, it didn't end there. Its failure to predict the
crisis was matched by an inability to take the lead in battling its
effects. The result hurt the bank's credibility and in some ways its
relevancy within Asia. Then, as it struggled to find a new identity, the
International Monetary Fund overshadowed it. Indeed, an accord signed
last November by the ADB's governing board relegated the bank to playing
a supporting role alongside the IMF. "The IMF snatched the lead from our
hands," says another senior ADB official.
   On top of all that, the ADB's participation in IMF-led bailouts of
Thailand, Indonesia and South Korea triggered a huge and controversial
shift of the bank's lending from poverty alleviation -- its traditional
role -- to rebuilding weak financial systems. That focus looks likely to
persist at least for the next few years as the crisis plays out. But
poorer member-states say they're paying the price because fewer funds
are available to help their poor.
   Even within the ADB itself, debate rages over how and where the bank
should spend its money. That debate may be settled at the end of
September, when outgoing President Mitsuo Sato recommends a new strategy
to the board. The impending change at the ADB helm is prompting fresh
worries, though: Japanese Finance Ministry bureaucrat Tadao Chino --
known as a consensus-follower -- will replace the dynamic Sato later
this year.
   To be fair, the ADB wasn't the only organization to miss the warning
signs of the brewing crisis. "It is difficult to predict an earthquake,"
says Pradumna Rana, a senior economist at the bank. The ADB has only 10
economists at its research wing. The IMF, by comparison, has about 100
looking at Asia and has access to hundreds of policy experts. Yet it
didn't publicly predict the crisis, either. The ADB, however, wasn't
just wrong in its economic forecasts, it was spectacularly off course.
   Now, as a new scenario unfolds -- of recession, possible
hyperinflation, a retreat from liberalization, and slower future growth
-- the bank has lined up behind the IMF's bitter prescriptions. Even
that has proved problematic for the bank's image in the region: IMF
austerity was unpopular to begin with, and is now increasingly being
questioned. (The IMF, with contributions from the ADB and other groups,
provides money aimed at creating macroeconomic stability. Then the ADB
and World Bank provide additional funds for structural reforms.)
   Since the crisis set in, the ADB has contributed greatly towards the
IMF bailouts: $4 billion to South Korea, $1.8 billion to Indonesia and
$1.2 billion to Thailand. All of the Korean money, and most of the funds
to the other two countries, goes towards shoring up their reserves to
stabilize the currency. Some of the rest is funnelled into government
budgets to be spent on ADB-prescribed programmes for financial reform
and on social welfare initiatives. The ADB is considering more
financial-reform packages independent of the IMF bailouts.
   The ADB also deploys experts and hires outside consultants to conduct
bank audits and help train a country's bank staff to adopt best
practices. The bank is also helping to set up an economic surveillance
unit for Southeast Asia (See related illustration -- FEER Sept. 17,
1998). The long-term benefits of these measures could be enormous:
Balance sheets will be credible, banks will lend prudently and bubbles
will not inflate -- in theory at least. "The ADB can be accused of sins
of omission, not of commission," says Paul Dickie, the bank director in
charge of financial restructuring.
   That's of little comfort to the poorest ADB members, who will be hit
hard by the redirection of funds to richer, but crisis-stricken,
countries. The recent reorientation towards financial reform is a step
away from the poverty alleviation programmes that have been at the heart
of the ADB since its creation in 1966. In a policy overhaul in 1994, the
ADB moved from being a project-based lender to a policy-based lender,
fighting poverty not so much by building cement plants but by
reforesting lands and encouraging parents to send their daughters to
school. The recent move towards financial reform comes at the expense of
such projects. Among projects postponed in Thailand, for example, are
schemes for wastewater management, pollution control and water supply
worth about $500 million.
   The proportion of total lending to finance-oriented reform programmes
swelled to 56% this year, up from 49% last year. Historically, financial
programmes have commanded about 16% of the bank's resources. Notes H.
Satish Rao, the assistant chief in the ADB's policy division: "We had to
lend to countries we don't lend to normally; we had to lend to sectors
which were new to us; and we had to assemble the package much more
quickly than in the past." The cost has been high: The ADB's annual
lending rose to $9.4 billion in 1997 from $5.5 billion in 1996. To fund
that leap, the ADB last year raised $5.6 billion in international
capital markets, a huge jump from the $1 billion it raised in 1996. This
year it will raise $9.5 billion through new bond issues, and it may need
$6 billion-7 billion next year.
   The shift in lending to crisis casualties means the bank has less
money available for its soft-loan window, the Asian Development Fund,
which assists very poor nations such as the Pacific islands and Bhutan
and Nepal. The ADF lends to these countries at no interest; they pay
only a 1% service charge. But while the ADB's commercial loans rose to
$7.8 billion in 1997 from $3.9 billion a year earlier, its ADF soft
loans fell to $1.61 billion from $1.66 billion. That $50 million
shortfall is more than all the Pacific islands combined get in some
years. The bank, meanwhile, reaped operating profits of $467 million in
1997. Normally, it appropriates a hefty portion of its profits to the
ADF. But this year, because financial-sector reforms are eating up so
much of its funds, it didn't plough back any profits into the ADF. As a
result, the fund may have to be replenished sooner than expected.
   Countries such as flood-ravaged Bangladesh are feeling the pinch:
Approved lending to Dhaka has risen, but the amount of money disbursed
has fallen. Bangladesh's finance minister, Shah A.M.S. Kibria, spoke for
many at the ADB's annual meeting in Geneva in May: "The low-income
countries which depend primarily on concessional assistance note with
some apprehension the decline in the level of official development
assistance." These poor countries are getting less than they're used to:
Bangladesh got only $193 million in disbursements in 1997, a third less
than the $300 million it received in 1996. (In its annual report,
however, the ADB blames Bangladesh for poor project implementation.)
   Even among the richer crisis-hit countries that got about two-thirds
of ADB lending last year, there's a debate over whether the bank's
billions are being spent wisely. Only a modest part is going towards
building social-safety nets. These include arranging a $500 million
package that will provide employment training and medical insurance for
newly unemployed Thais. The ADB will have to be mindful of critics who
say that the bank cares for the rich bankers and their clients, but not
for the poor who are losing their jobs.
   Bank officials admit it's not enough. For example, the number of
newly jobless in Thailand will hit 3 million by year-end, and the ADB's
safety net will cover 100,000 at the most. "It is a humbling experience
to see how big the problem is and how little one can do," says Rajat
Nag, an ADB manager in Manila who oversees the bank's programmes in
Thailand and Indochina. "People are hurting real bad and the crisis in
Bangkok has rippled through the rural areas. A lot needs doing, but we
feel the only way to get the real sector going is to get the financial
sector going first."
   Finance vs. the "real," or productive, economy -- it's a
chicken-and-egg choice. Kamal Malhotra, a development economist at Focus
on Global South, a think-tank at Chulalongkorn University in Bangkok
that the ADB often consults, says: "The policy ignores the needs of the
real economy. The banks won't become healthy immediately. But at the
rate at which businesses are failing and people are losing jobs, will
there be anyone left for the banks to lend to in future?"
   The ADB believes the answer is Yes. Says Rao, the assistant policy
chief: "Countries realize that for the real sector to get credit, the
banks had to be set right first. Serious restructuring is needed." Neil
Saker, chief economist at SG Securities in Singapore, gives the ADB
credit for taking the lead in telling bankers to start cleaning house.
"The bank has done superb work in bank restructuring, and it is doing it
quietly," Saker says. "The steps seemed tentative at first, but now we
can see that the ADB has exerted influence to get people together and
hammer out a strategy."
   It's still too early, however, to form an overall judgment of the
ADB's response to the crisis. The progress so far:
   -- In South Korea, the ADB is drawing up rules that will help to
steer the financial supervision commission away from Finance Ministry
control. Owners' equity in some banks is being written down to zero, and
banks deemed worth saving are being recapitalized to prepare them for
sale to the highest bidder. Although this plan was trumpeted by Kim Dae
Jung, the ADB has been involved in its design and implementation since
mid-December, when the government sat down to hammer it out with the
bank and the IMF.
   -- In Indonesia, a $1.5 billion ADB programme focuses on
financial-governance reform. The first tranche of $500 million has
already been disbursed. To improve supervision, the ADB is introducing
senior officials of Bank Indonesia (the central bank) and Bapepam (the
stockmarket regulator) to best practices worldwide. Another $300 million
will provide scholarships aimed at encouraging parents to keep their
children in school. The combined $1.8 billion in lending represented by
these two programmes falls under the IMF bailout; separately, the bank
is also providing $39 million for environmental projects. It is also
helping to set up an automated interbank settlement system and a central
depositary for the stock exchange. And it may take a stake in a proposed
mortgage fund.
   -- In Thailand, the $1.2 billion contributed by the ADB to the IMF
programmes includes $200 million for a rural project, $500 million for
safety-net measures and $500 million more for financial reforms. Outside
the IMF funding, the ADB has also arranged a $1 billion package to be
used for export guarantees, including its own $50 million contribution.
   If they work, these programmes will lead to stronger and more
resilient institutions in Asia, ADB officials hope. Dickie says: "This
region has strengths: It has the savings, and it can develop an
infrastructure to deploy those savings. And the ADB's competitive edge
lies in its being closer to the ground and understanding the region."
   As the bank helps develop the region's financial infrastructure, it
will have to come up with ideas and institutions that capitalize on its
experience in Asia. Better-run and more-transparent capital markets,
bond markets and mortgage institutions are needed to reduce the region's
dependence on banks as the primary source of finance. Building
institutions will take time, but as the Asian economic crisis has shown,
real development takes time. Only if the ADB policy succeeds will
member-states look forward to go-go growth again.