World Bank Sanctions $511 M Loan

WILL THE Clinton visit to India be followed by a relaxation of economic sanctions against India? A straw in the wind is the clearance by the governing board of the World Bank on Tuesday of three loans totalling $511 to support reforms and improved governance in Uttar Pradesh.

The US, Japan and Germany abstained on the vote. France, Italy, Switzerland and Austria were among those that supported the loan, raising hopes that a formal relaxation of sanctions may be round the corner.

The group of seven richest countries (G-7) has announced no formal change of policy. Its position is it will clear World Bank loans for basic needs and poverty alleviation but not others. Based on this principle, loan proposals for infrastructure projects like highways and power transmission are in cold storage.

Can the UP loans be described as loans to meet basic needs or to alleviate poverty? Only by stretching definitions. One of the loans is, in effect, the first structural adjustment loan ever given to a state, and constitutes budgetary support in return for promises of fiscal reform.

The loans also aim to support power reforms, improve governance and curb corruption. These are not conventional loans with a focus on education, health or rural development. They constitute a new category that aim at policy changes rather than projects. A case can be made that fiscal, power and governance reforms in UP will help the poor. But by the same token it can be argued that roads and electricity will reduce poverty, yet loans for these are formally banned by the G-7.

Last year the bank gave Andhra a loan for power reforms, which constituted the first dilution of sanctions against infrastructure projects. The UP loans confirms that the G-7 wants World Bank lending to rise, and are willing to be creative in their definition of basic needs. The impact of sanctions is thus being diluted without formal dilution. That signals hope. But the test is if the G-7 agrees to consider an updated version of the mothballed loans. The Indian governor on the World Bank board, B P Singh, avoids making a prediction but is optimistic. Research including that of the World Bank shows aid is fungible. Aid given for one purpose can be used for an altogether different purpose.

Suppose a state has enough cash for 12 projects meriting the highest priority. Suppose a donor decides to fund the first project, which is the best. Money intended for the first project will now be freed, and will be invested in a 13th project. Thus money from the donor, ostensibly aimed to finance the best project, actually ends up financing the worst one.

So the earmarking exercise of the G-7, which claims to finance basic needs but not infrastructure, is a charade played out for political reasons.

What matters ultimately is whether total bank lending goes up. What also matters is whether the state governments in questions have the political will to carry out the promised reforms.

Haryana has reneged on power reforms, so bank lending for that sector has been suspended. Such political economy problems may turn out to be greater hurdles to aid flows than G-7 sanctions.

What do you think?