Zeljko Bogetić and Jeff Chelsky. International financial institutions use different names for policy-based financing (PBF) and PBOs/PBLs. The World Bank generally refers to this type of support as development policy financing (DPF), delivered through different types of the DPF instrument, depending on the nature of the financing provided. A development policy loan or development policy operation is the most common type. If the financing is a grant (typically provided to low-income country recipients), the PBF will usually be a development policy grant.
Development policy financing can also be a guarantee, for which a policy-based guarantee (PBG) is used,45
or as financing contingent on the activation of an indicative trigger related to, for example, natural disasters or health crises. DPF can be provided through a single, stand-alone operation or through a programmatic series of operations, linked by indicative triggers. DPF is provided to sovereign national governments of World Bank member states and, sometimes, to subnational governments.
The World Bank’s policy on DPF states that “DPF is aimed at helping a Member Country address actual or anticipated development financing requirements that have domestic or external origins. The [World] Bank may provide a Bank Loan to a Member Country or to one of its Political Subdivisions; and it may provide a Bank Guarantee of debt incurred by a Member Country or by one of its Political Subdivisions.”46
DPF aims to help the borrower achieve sustainable poverty reduction through a program of policy and institutional actions. These may include, for example, strengthening PFM, improving the investment climate, addressing bottlenecks to improve service delivery, or diversifying the economy. DPF provides general budget support, meaning that the funds are disbursed into the general budget of the client government and are not earmarked for specific purposes.
Approval by the Board of Executive Directors and implementation of a set of policy and institutional actions (prior actions) are required before financing can be disbursed. Prior actions are expected to advance, catalyze, or signal meaningful movement along the results chain toward the achievement of clearly specified objectives. The objectives of each development policy operation are expected to be consistent with the recipient’s national development goals and the World Bank–supported strategy for the country. Well-defined results indicators, with clear baselines and time-bound targets, monitor progress toward objectives along a credible results chain (or theory of change) that links prior actions, complementary other activities, and reforms to targeted outcomes. The policy framework underpinning a DPO is developed through a dialogue between the World Bank and the recipient government.
Over the past decade and a half, DPF operations have accounted for one-quarter to one-third of World Bank financing commitments. The use of DPF increased during the global financial crisis in 2007–09, when it was used to provide countercyclical financing to many developing country recipients. It has also increased during regional crises and most recently, in response to the COVID-19 pandemic.
This chapter reviews the evolution in DPF at the World Bank and provides evidence on the performance of the instrument between 2005 and 2019, as reflected in the recent literature and IEG evaluations. It also describes recent changes to IEG’s evaluation framework for PBF operations. The principal findings are:
- Policy-based lending has been an important financing instrument of the World Bank, accounting for about one-quarter of its total financing during 2005–19 but increasing to about 40 percent in times of crises. It often plays an important countercyclical role in developing countries. Budget support operations have supported short-term and longer-term policy and institutional reforms geared toward poverty reduction and shared prosperity.
- The World Bank uses DPF as a key instrument in supporting country clients in crisis. During crises such as the global financial crisis, the focus on fiscal management, effectiveness of public expenditures, and targeted social programs supported countercyclical policies.
- Several types of budget support are in use, including standard, stand-alone operations; programmatic series of operations; and PBGs and deferred draw-down options. This variety makes DPF a versatile financing instrument that can be deployed in a wide variety of contexts to support short-term goals (such as macroeconomic stabilization, natural disaster emergency, post-conflict budget financing support, and arrears clearance) and long-term goals (such as poverty reduction and shared prosperity). For this reason, governments have often requested this instrument, especially in times of crises, when national budgets are under stress and quick-disbursing financing, combined with corrective policy actions, is an economic and social imperative.
- The COVID-19 crisis and its unprecedented global health, economic, and social impact prompted the World Bank to rapidly scale up its financing to developing country recipients to cushion impact. At the start of the pandemic, it committed to deliver $160 billion in overall financial support by the end of June 2021. In the event, $157 billion was delivered, including $28 billion in DPF.
- IEG evaluations have generally assessed World Bank DPOs positively, with the overall outcomes of about four-fifths of operations rated moderately satisfactory or higher. However, within this, the share of operations rated satisfactory has declined while the share rated moderately satisfactory has risen.
The framework for evaluating DPF at the World Bank was recently revised to produce more operationally relevant findings and lessons better tailored to this instrument. IEG has similarly revised its validation framework for evaluations of DPF operations to give greater attention to World Bank performance more generally, including the relevance and quality of prior actions, appropriateness of results indicators, and the adequacy of the ex ante assessment of risks to the achievement of objectives. IEG began using this new framework in late 2020.
World Bank policy-based and project lending (on commitment bases) for 2005-20 is shown in Figure 7. While both PBO (DPF) and non-PBO lending rose sharply in 2020, the ratio of policy-based lending to total lending at about 30 percent fell well below the World Bank’s ratios during earlier crisis (e.g., 2008–10) when ratio rose to 35 percent.
Note: PBL = policy-based lending
Source: IEG, the World Bank.
Comments by Cheryl Gray
This chapter provides a useful, concise, and well-written summary of the evolution of the World Bank’s approach to PBF and methods to evaluate it. It shows the careful thinking undertaken by the World Bank as it has struggled to deliver effective support to countries, often in complex and difficult settings.
As the chapter illustrates, PBF has long been a major instrument of international development support, valued in the hundreds of billions of dollars annually across development agencies. Its breadth and complexity have made it exceedingly difficult to study, and evidence of its results remains elusive. This chapter sheds light on what is known, although for perhaps unavoidable reasons the picture is still incomplete.
The first point worth stressing is the practicality and value-added of the World Bank’s evaluation architecture. Over more than three decades the World Bank has designed, implemented, and continuously improved a cohesive structure to document results from all its operations—both investment and PBOs—in a practical and cost-effective manner. The process begins with a self-evaluation, using standard criteria applicable in all similar operations, by the task team, whose members know the operation best. IEG then reviews and assesses that self-evaluation.
The fact that 100 percent of self-evaluations are assessed by IEG creates an incentive for task teams to report accurately while also producing a complete database of operation-level reviews across the institution. IEG sometimes follows up with more in-depth evaluations or broader sector or thematic evaluations, adding further context and evidence on results. The entire evaluation architecture is oriented toward documenting activities and outcomes, creating opportunities for learning through self-evaluation and analysis.
These routine World Bank evaluations are not in-depth impact evaluations with rigorous causal inference. They do not compare performance against counterfactuals to identify and measure cause and effect. Occasionally, it is possible to apply impact evaluation techniques to specific interventions in specific settings, but it is not possible to do so across the board, given the breadth and complexity of most World Bank operations, particularly PBF.
The chapter describes the criteria for self-evaluation and validation of DPF (the World Bank’s term for PBF). These criteria have changed over time to reflect changes in the design of PBF. When policy-based lending began ay the World Bank, in the 1990s, loans were disbursed in several tranches triggered by successful completion of policy reforms and institutional milestones. Today, DPFs provide all the financing upfront, upon completion of a small number of key prior actions. This policy differs from the policy lending of the EU, which includes a performance element and disburses in part based on the achievement of results.
The World Bank’s approach puts a heavy weight on a small number of upfront policy and institutional changes it considers key to the country’s success. Having a small number of prior actions simplifies the lending process and focuses the World Bank’s oversight, but it runs the risk that the assumptions regarding the impact of reforms may be wrong.
Recently, the World Bank moved from rating the relevance of a DPF operation’s objectives (the standard approach in evaluations of investment operations) to rating the relevance of the prior actions, the only conditions for the operation directly within the World Bank’s control. The World Bank is also putting greater weight on evaluating the relevance and quality of the operation’s results indicators, World Bank performance, and the treatment of risk. These judgments are largely qualitative. To ensure these ratings are robust, it would help to track whether guidelines, dialogue, and practice are converging in reasonably common standards across operations and over time.
An important aspect of DPF operations missed by the World Bank’s evaluation approach is the impact of the resource transfers themselves—that is, the impact of transferring hundreds of millions of dollars to recipient countries through DPF. Some have argued that the increased availability of funds for governments to spend may be the biggest impact of PBL, greater than the support to policy and institutional reforms provided by the loans.
The chapter reviews the data on the results of DPF operations over time, highlighting several academic studies and thematic evaluations that have tried to draw conclusions from these data. In addition to the inherent limitations on results measurement noted above, a few points stand out. First, there is a high prevalence of “moderately satisfactory” ratings for outcomes and World Bank performance.
Second, thematic evaluations emphasize the prevalence and salience of DPF prior actions related to PFM. Managing public finances is an important and powerful responsibility of government that strongly influences the distribution of resources and effectiveness of public programs. It is an area that the World Bank has focused on and influences relatively effectively through its operations. The World Bank can bring expertise and resources to the technical aspect of PFM, such as budgeting processes, computer systems, and auditing. Other areas of governance reform, such as election systems, public employment, or direct anticorruption efforts, may be as (or even more) important for development outcomes. They have been more difficult for the World Bank to address in the political environments in which it works. These sensitivities put limitations on what kinds of prior actions are feasible in DPF operations, limiting their potential development impact.
Third, one of the academic studies cited concludes that the level of macroeconomic stability is positively associated with the success of DPF operations.47
As noted in the chapter, it is impossible to untangle causation (whether the World Bank’s operation influenced the country’s policies or good policies made it possible for the World Bank to lend). The fact that government ownership is also key to achieving outcomes and that “the World Bank’s policy lending is significantly and positively correlated with the quality of social policies and institutions”48
reinforce the overwhelming importance of committed country counterparts.
Attributing causal impact to DPF operations themselves is not likely to be supported by the evaluation techniques available. But the evidence strongly supports the finding that enlightened leadership, pro-development policies, and effective World Bank support go hand in hand.
- 45
In a PBG, instead of providing financing directly to the client government, the World Bank provides a guarantee for a portion of the principal or interest on a loan, or both, which is provided by commercial creditors, or the client government issues an international bond. - 46
Chapter 6 in this volume. - 47
Lodewijk Smets and Stephen Knack. 2014. “World Bank Lending and the Quality of Economic Policy.” World Bank Policy Research Paper 6924, Washington, DC. - 48
Željko Bogetić and Lodewijk Smets. 2017. “Association of World Bank Policy Lending with Social Development Policies and Institutions.” World Bank Policy Research Paper 8263, Washington, DC.