Center for Economic Justice
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Investing in World Bank Bonds: What are the Risks?
Current and potential investors in World Bank bonds should consider both the opportunities and risks associated with purchasing the bonds. This briefing paper provides an overview of some of the potential risks involved. Some of the risk factors, examined in more extensive detail below, include: A growing number of World Bank borrowers have defaulted on payments to the institution, or may be forced to do so in the future; The U.S. government‟s financial and political backing to the World Bank is not assured; The largest U.S. private pension system, TIAA-CREF, sold most of its holdings in World Bank bonds in 2002, citing insufficient returns; Many World Bank loans are poorly monitored and are not sustainable, which may increase risks of non-payment; and A growing campaign which urges investors not to purchase the bonds, the World Bank Bonds Boycott campaign, is increasing risks associated with holding the bonds. What is the World Bank? The World Bank is one of the most powerful financial institutions in the world. Founded in 1944, the Bank‟s initial mandate was to provide loans to support European reconstruction following World War II. Since its early days, however, the World Bank‟s purview and power have expanded dramatically, as it now operates in more than 100 low- and middle-income countries. How is the World Bank Financed? The World Bank is composed of five branches. The International Bank for Reconstruction and Development (IBRD) is the Bank‟s largest branch, and it provides loans to developing countries at near-market rates. The IBRD raises nearly all of its funds by issuing bonds on the private financial market. The International Finance Corporation (IFC), which lends money to private corporations for activities in developing countries, also raises funds by issuing bonds. IBRD and IFC bonds are purchased by a wide range of private and institutional investors in North America, Europe, and East Asia.1 The bonds are “AAA” rated and thus perceived by many to be safe investments. However, investors may wish to consider some risks associated with investing in the bonds.
World Bank, “Where We Get Money,” www.worldbank.org.
What Are the Risk Factors Associated with Investing in World Bank Bonds? 1. World Bank borrowers may default on their loans. In late 2002, Argentina, the Bank‟s fourth largest debtor, suspended payments of $805 million to the World Bank because it didn't have sufficient cash flows to make the payments.2 Argentina was unable to pay because of an economic crisis which was exacerbated by IMF/World Bank supported policies such as an unsustainable dollar-peso peg (which made Argentina's exports uncompetitive). Though Argentina resumed payments to the institutions in January 2003, there is reason for continued concern. Despite some recovery, Argentina is still in very dire economic straits and may not be able to generate the export revenue needed to meet all its social and external liabilities. Other major World Bank/IMF debtors may default on their loans as well, and the Economist, among other publications, has noted the possibility of a trend of defaults on sovereign and multilateral debt.3 Brazil's total external debt has jumped from 29% to 65% of GDP since 1994, and the country is maintaining extremely high interest rates in excess of 25.5%. This level of debt is clearly unsustainable, and Brazil may consider default in the future.4 Default by either Argentina again or Brazil, respectively the fourth and fifth largest debtors to the World Bank, would increase the risk of investment in World Bank bonds. Moody‟s Investors Service, in its October 2002 analysis of World Bank bonds pointed out that “The biggest risk to the Bank‟s financial position would come if more than one large borrower were to go on non-accrual.”5 Moody‟s also notes that in addition to Brazil and Argentina, other major IBRD borrowers such as Russia and Indonesia could face further dislocations due to political and structural problems in the coming years; the four countries combined make up 28.3% of the Bank‟s gross outstanding loans.6 2. The U.S. government’s political and financial commitment to back World Bank bonds is not assured. The U.S. government and governments in other World Bank donor countries provide the collateral that backs World Bank bonds each year by authorizing “callable capital.” This money is available to cover the World Bank‟s obligations to its bondholders in the event of default. Although the World Bank has never actually called on these pledges, this governmental quasiguarantee helps to assure the AAA bond rating of World Bank bonds. However, a decision by Congress to cut funding for callable capital could well have the effect of making the bonds less attractive and reducing their investment rating.
Alan Beattie, “Argentina Defaults on World Bank loan,” Financial Times, November 15, 2002. The Economist, “The hole gets deeper,” November 23, 2002. 4 AmericaEconomia, the leading business publication in Latin America, published an interview in October 2002 with Michael Pettis, managing director of Bear Stearns. Pettis argued that default in Brazil is inevitable. 5 Moody‟s Investors Service/Global Credit Research, International Bank for Reconstruction and Development Analysis, October 2002, p.2. 6 Ibid, p. 4.
In the spring of 1999, the U.S. House of Representatives voted to revoke $648 million previously appropriated as callable capital for the World Bank, the Inter-American Development Bank, and the Asian Development Bank. While this is a small portion of the $12.5 billion annual authorization of callable capital, the Associated Press reported at the time that then Treasury Secretary Robert Rubin “warned it would establish a dangerous precedent and introduce „serious skittishness‟ in financial markets about the depth of America's backing to the lending institutions. Heightened concern in the markets would raise the cost of borrowing money by these agencies.”7 At the time, Rubin reported that World Bank President James Wolfensohn was “deeply disturbed” about the impacts of the House‟s decision to cut callable capital on the Bank‟s ability to raise money. The Bretton Woods Committee, an organization of prominent business and political leaders that support the institutions, wrote a letter to House Speaker Dennis Hastert about the cut in callable capital. In the letter, James Orr, executive director of the group, wrote, “Disturbing reports from Wall Street say some bondholders are already growing nervous over the threat and are dumping their World Bank bonds.”8 Though the cuts were ultimately rescinded, the possibility for the Congress to remove its backing is a real risk that potential investors in World Bank bonds should consider. This risk has currency given the growing skepticism of the U.S. Congress towards the World Bank and IMF, among both Republicans and Democrats. The Meltzer Commission, a bi-partisan panel with a Republican majority, and appointed by the Republican-controlled congress in 1999, recommended in its final report in March 2000 a significant downsizing and transformation of the World Bank into a grant-making institution. Meanwhile, Congressional Republicans and Democrats have led efforts to stop or sharply condition new monies to the IMF and World Bank. Moreover, given the large deficits that are once again appearing in the U.S. government budget, it is plausible to expect further consideration by Congress of cuts in callable capital to lending institutions that already enjoy little popular support. The Bush Administration is known to be skeptical of the role of international financial institutions, and is already creating alternative funding mechanisms for international development, including the Millennium Challenge Accounts; these moves may presage reduced support for the World Bank from the current administration. 3. The largest private pension system in the U.S., TIAA-CREF, sold its World Bank bonds in 2002 because the bonds did not offer sufficient returns. TIAA-CREF said it sold its holdings of World Bank bonds in 2002 because the bonds did not produce high enough returns for the $270 billion fund. "We have held World Bank bonds and we no longer do," TIAA-CREF spokesman Patrick Connor told AFX Global Ethics Monitor, a business news service, in November 2002. "...The returns would not be as attractive as other investments," Connor said.9 As a leader among pension systems, TIAA-CREF‟s decision sent a
Martin Crutsinger, “Rubin criticizes House budget for tapping lending institutions‟ funds,” Associated Press, March 25, 1999. 8 Ibid. 9 Abid Aslam, “TIAA-CREF Says It Sold its World Bank Bonds for Market, Not Moral Reasons,” AFX NewsGlobal Ethics Monitor, November 6, 2002.
signal to other institutional investors that are looking to make investments that are both safe and offer competitive returns. 4. Many World Bank loans are poorly monitored and projects are not sustainable, which may increase the risks of non-payment. World Bank projects have a high failure rate. A report commissioned by the Joint Economic Committee of the U.S. Congress in 2000 found that 55-60% of World Bank projects fail to achieve sustainable results.10 Part of the reason for this is a strong emphasis on project approval and moving funds rather than on quality and sustainability. This critique – that the World Bank emphasizes project approval over quality – has been leveled at the institution for more than a decade dating back to the 1992 Wapenhans report, an internal review led by a former World Bank Vice President, which found that 37.5% of World Bank projects were failures.11 Project failure may lower returns on the World Bank‟s investments in the country, which may in turn increase the risk of non-payment. 5. A growing campaign which urges investors to stop buying World Bank bonds, the World Bank Bonds Boycott, is increasing the risks associated with holding the bonds. Launched in April 2000, the World Bank Bonds Boycott is organizing institutional investors and public institutions to adopt policies against investment in World Bank bonds. Already, nearly 90 institutional investors have made commitments not to invest in World Bank bonds for social and financial reasons. Among the municipalities and investors that have made this commitment are seven U.S. cities including Milwaukee, Wis.; San Francisco, Ca.; Boulder, Colo.; Oakland, Ca.; and more than two dozen unions, including the 1.5 million member International Brotherhood of the Teamsters and the 1.4 million member Service Employees International Union (SEIU). Moreover, ten investment firms, including Calvert Group, Parnassus Fund, and Citizens Funds, with a combined $16 billion in assets, have adopted policies against investment in World Bank bonds. The campaign is growing and targeting dozens of other city governments, major institutional investors such as state employee pension funds, religious denominational investors, and others. As more investors adopt policies against investment in World Bank bonds, campaigners hope to drive down the “AAA” rating of World Bank bonds, which would make the bonds riskier for investors to hold, while putting significant pressure on the World Bank for fundamental change. If the World Bank were to lose its “AAA” rating, the increased risk would lower the value of the bonds.
International Financial Institutions Advisory Commission (Meltzer Commission), Final Report, March 2000. http://www.house.gov/jec/imf/meltzer.htm 11 Willi A. Wapenhans, The Wapenhans Report, Portfolio Management Task Force, Washington, DC: World Bank, 1992.