Are national development financial institutions (DFIs) still relevant? What are the critical factors that make these institutions succeed? What are concrete examples of sound, well-administered and innovative DFIs? Why do they still remain in business in countries with large and sophisticated financial systems? How can we assess their economic and social impact? Have our views on DFIs evolved in the past decades?
All these interesting questions were discussed during the Global Symposium on Development Financial Institutions, an event jointly organized by Bank Negara Malaysia and the World Bank Group on September 19 and 20 in Kuala Lumpur, Malaysia. With the theme “Balancing Sustainability and Social Mandate: Development Financial Institutions in a New World” the Global Symposium brought together 500 participants from Malaysia and around the world to discuss the challenges and opportunities faced by DFIs.
These are my three main takeaways from the Global Symposium:
Development financial institutions remain relevant. Historically, DFIs have been created by governments around the world to promote economic growth and support social development. They typically provide credit and a wide range of capacity-building programs to households, SMEs, and even larger private corporations whose financial needs are not sufficiently served by private banks or local capital markets. In doing so, they seek to promote strategic sectors of the economy, such as agriculture, international trade, housing, tourism, infrastructure, and green industries, among other sectors.
Although many of the institutions were created several decades ago, data shows that many governments around the world still see them as a relevant instrument to pursue economic goals. It is estimated that around 20% of all development financial institutions currently in operation around the world were created in the past 17 years. A further 33% were set up during the 80s and 90s – the decades in which mass privatizations took place in various parts of the world.
Views towards national development financial institutions have evolved over the years. For decades, the World Bank Group has worked with development financial institutions in many countries by providing lines of credit, guarantees, and technical assistance programs. Our approach towards these institutions have changed from full support for their establishment during the 60s and 70s to a more cautious approach during the 80s and 90s which saw more closure or privatization of state-owned financial institutions. Since the global financial crisis of 2008, we are seeing a more balanced appreciation of their role and mandate.
During the 2008 Global Financial Crisis, development financial institutions played an important countercyclical role in many jurisdictions, by scaling up their lending operations when private financial institutions experienced temporary difficulties in granting credit. Moreover, in the aftermath of the global financial crisis the loan portfolio of more than two thirds of DFIs has continued to expand at double digit growth rates, thus contributing to global economic recovery efforts.
Financial sustainability and good governance are critical elements for the success of DFIs. It is a risky activity to finance projects in strategic sectors of the economy where there is insufficient financing from the private sector. To be effective, DFIs need to have business models that ensure long-term financial sustainability. They also need to have sound risk-management tools and high corporate governance standards that insulate them from undue political interference.
In the past, we have seen multiple examples of poorly performing development financial institutions that have become a heavy fiscal burden. Their poor performance has led to credit market distortions that displace and crowd out private financial institutions. When they’re weak, they also become vulnerable to political interests, resulting in high non-performing loans and wasting of taxpayers’ money.
During the Global Symposium it was clear that we all need to learn lessons from the past. Financial sustainability and good governance of development financial institutions are critical elements that cannot be compromised. To achieve that, the institutions need to have well-defined mandates, be subject to high standards on corporate governance and transparency, and be regulated and supervised with standards applicable to other financial institutions. Moreover, owners of development financial institutions need to have the ability to properly monitor their business activities, assess their social and economic impact, and compare their interventions versus other public policy alternatives.
The timing of this global symposium could not be better. We need to think of innovative instruments to attract and channel new resources to finance our developmental aspirations, as outlined in the 2030 Sustainable Development Goals now more than ever. Reliable and well-administered development financial institutions with a well-defined mandate and sound governance framework will continue to be an important vehicle to accelerate economic and social development. They can create new channels to crowd-in the private sector. Moreover, they can play a catalytical role by generating new knowledge, convening stakeholders, and providing technical assistance to build capacity in the private and public sectors.
The recent debate on whether it makes more sense to measure Gross Domestic Product (GDP) in Ringgit or in Dollars is a healthy one. It reflects a sound interest by many segments of Malaysian society in statistics that measure economic development and how it changes people’s living standards. This is the fundamental question: what does GDP really mean in the daily life of Malaysians. There are sound arguments on both sides and, in a way, both are right, depending on what perspective is taken.
In the World Bank, we use different ways of measuring GDP depending on what kind of comparison we would like to make. For the most part, and when it comes to measuring how the living standards of Malaysians are changing over time it makes sense to calculate incomes, production or spending in ringgit terms. In doing so, we correct for the effects of inflation by adjusting nominal changes into real terms, to capture real change over time – be it quarter by quarter, or year by year. In other words, we develop a real GDP estimate that is linked to constant prices from a base year, and therefore capture real growth in income over time, removing the impact of inflation. In this case, it does not matter if this is done in Ringgit, Dollars, bushels of wheat or any other unit of account. This allows us to have a clear picture of real changes over time.
However, it is important that we not lose sight of the fact that in practice, prices are constantly changing across the economy for fundamental reasons other than inflation. For instance, this could be a change in the supply of a Malaysian export or the demand for it, which pushes real prices up and down. These are important changes to look at, and reflect real changes in the country. It is the same with looking at the exchange rate, which is just another price.
Now, Malaysian companies and manufacturers who trade internationally will rightly worry about how their costs (especially the costs of inputs they must import) and sales (especially their exports) change due to movements in the exchange rate. If their profit margins drop because their dollar-denominated imported inputs are more expensive with the higher exchange rate to the dollar, they may feel that the country’s strong GDP growth statistics mean little. The same thing applies to Malaysian parents whose children study abroad, and who must spend more ringgit to meet the same educational expenses they had last year.
These are legitimate concerns, but not ones that can be resolved by changing the way we measure GDP. Rather, we should focus not on changing the estimate, but rather by looking at the large number of factors impacting the exchange rate – many of which are outside of the control of policymakers.
At this point, it should be noted that in some cases, it does make sense to measure GDP in US dollars. This applies in cases where we need to compare Malaysia with other countries, say for example either the size of the economy, or the share of the population living below the local poverty line. To do this we need to convert into a common measurement. This could be any currency, but in practice it is usually the US Dollar.
However, the real question is whether GDP is a useful measure of development, irrespective of whether it is denominated in ringgit or in US dollar. Malaysia has set itself the goal of becoming a high-income economy within a generation. In purely mathematical terms, this means reaching a specific threshold. In the World Bank, we consider countries to be “high income” if they have a GNI (Gross National Income, a measure close to GDP) of at least US$ 12,235 per capita in 2018. We use the “Atlas method” which means we take a three-year average exchange rate adjusted for inflation to lessen the effect of fluctuations and abrupt changes.
However, this is just one indicator of progress. The true nature of a successful and prosperous nation cannot be distilled into one number, whether GDP, GNI or whatever. Malaysia’s true prosperity is to be reflected in the productivity of its human capital, in the opportunities facing Small and Medium Enterprises (SMEs) to grow, flourish and even fail, and in an economy where entrepreneurs and risk-takers face level playing fields and equal chances to succeed, and to fail.
Finally, and perhaps most importantly, measuring growth in GDP or GNI in per capita terms – no matter what the currency – is just an average. It’s a useful tool, but one that tells us very little about who is benefitting from growth and how wealth and prosperity is shared across the population. Is GDP growth being shared by all? Are the incomes of the highest and lowest earners converging or moving apart? This is of equal importance for policymakers, who concern themselves not only with triggering growth, but also its dispersion across regions and segments of the population.
Capturing this type of development requires counting a lot more than just one number. So, the real question should be: Is GDP growth enough?
Income growth is not the sole aim of economic development. An equally important, albeit harder to quantify objective is a sense of progress for the entire community, and a confidence that prosperity is sustainable and shared equitably across society for the long term.
Inclusive and sustainable development looks beyond GDP growth and can strengthen nations for generations to come. However rising income inequality has impeded social mobility, increased social tensions, and undermined effective governance in many countries in recent decades. In the World Bank Group, we are firmly committed to our twin goals of helping reduce the number of people living in extreme poverty, and to promoting shared prosperity, particularly among the bottom 40 percent of the population.
Investments in infrastructure are essential for meeting both goals. Whether it be by connecting farmers to markets or by providing families with electricity and clean water, infrastructure investments can transform lives for the better. However, analysts estimate that developing countries require between US$1.7 trillion annually in infrastructure investment just to keep up with the rate of growth, while actual investment pledged each year is closer to US$880 billion – far short of the region’s needs.
To close this huge infrastructure gap, we need more options for investment financing. It would be better yet if these options adhere to our principles of sustainable development, particularly given the specter of climate change. A tall order, but not impossible.
Recently, with support from the World Bank, Malaysia launched a new initiative that addresses both these principles: financing sustainable, climate-resilient growth.
When Islamic finance shot to prominence in 2008, performing well even during the global downturn, the investment community started taking notice. Though representing a tiny portion of the global financial market, growth of Islamic finance has been rapid. By 2015, the industry had surpassed US$1.88 trillion in size and its banking assets had doubled in merely four years.
Islamic finance may just provide that extra helping hand to deliver more infrastructure to emerging markets and developing economies.
Central to the premise is the sukuk, a bond that generates returns to investors without infringing Islamic ‘shariah’ principles, which prohibits the payment of interest. Given that the Islamic capital market is still relatively small, sovereign and quasi-sovereign sukuk can be used to finance infrastructure projects that can facilitate further inflows of private capital. Project-specific sukuk, instead of general-purpose sukuk, may be particularly helpful in bolstering infrastructure financing.
In parallel, another development pioneered by the World Bank Group – ‘green bonds’ – is also making headway. Since 2008, the World Bank has issued US$10 billion in bonds through our green bond program for climate-sensitive investments, and has brought greater transparency and clarity to issuers and investors by participating in the crafting of the Green Bond Principles (voluntary guidelines framing the issuance of green bonds) and by setting best market practice for reporting on the use of proceeds. New issuances in the global market are expected to exceed $120 billion in 2017.
Enter Malaysia with its innovative ‘green sukuk’ initiative, which will channel sukuk for climate-friendly investments, thus helping close the gap for both infrastructure and green finance.
Malaysia is already a global leader in leveraging Islamic finance for infrastructure development, issuing more than 60 percent of the world’s infrastructure sukuk. Now the country’s regulators are taking one step further and using investments to achieving a public good. Launched this July with the issuance by a Malaysian company of MYR 250 million (about US$59 million) in bonds to finance a 50-megawatt solar photovoltaic plant, the ‘green sukuk’ is a bold new tool for development.
The framework underlying this instrument is the result of collaboration between the Securities Commission of Malaysia, the Malaysian Central Bank and the World Bank Group. This was envisioned when Malaysia and the World Bank Group celebrated 58 years of partnership with the formal opening of our Global Knowledge and Research Hub in Malaysia in 2016.
The ‘green sukuk’ is one of various corporate fixed-income securities of this type coming out of Malaysia. We hope that many similar issuances will follow, in Malaysia and in other countries, and that innovative green financing becomes the norm, not the exception. This development would take us one step closer towards our goal of sustainable and inclusive growth.