An Older, Wiser IFC

When the International Finance Corporation (IFC), the private sector arm of the World Bank, was founded in 1956, its role was to promote sustainable private investment in developing countries to reduce poverty and improve lives. Fifty years on, the world is a very different place.


With private sector investment playing an increasingly big role the world over, it’s time for the cash-rich International Finance Corporation to invest more.

When the International Finance Corporation (IFC), the private sector arm of the World Bank, was founded in 1956, it was to fulfill a small but significant role – promote sustainable private investment in developing countries to reduce poverty and improve lives. Fifty years on, the world is a very different place.

The iron curtain has been flung wide open. Europe has come together to form the world’s second-biggest trade block. Large countries that were once financial pariahs, like Russia, have embraced foreign investment that in turn is fueling growth.

Rather than simply relegating infrastructure and other projects to state-run companies, governments are increasingly seeking private funds to either complement or entirely finance their development plans.

Plus, countries like Argentina and Brazil that went cap in hand time and again to development banks are paying loans ahead of schedule, and emerging markets in general are enjoying a surge in private sector inflows as investors across asset classes seek higher yields.

Meanwhile, according to World Economic Forum data, annual private capital flows to developing countries have risen nearly six-fold since the early 1970s, to $301 billion, while demand for World Bank loans last year was a comparatively meager $104.4 billion.

Clearly, the private sector has overtaken the public sector in financing development. It’s time for the IFC to shine.

“We know today that for every dollar in aid, there are four dollars in private sector money,” says Lars Thunell, the IFC’s recently appointed executive vice president (see profile, p. 18). “We are never going to get development without a vibrant and well diversified private sector,” Thunell insists.

The IFC has more flexibility than its umbrella organization, the World Bank, to which governments of 184 countries contribute cash. For example, the private arm can invest in state-run companies like utilities and even municipalities without backing from the country, whereas the World Bank needs a sovereign guarantee before it can extend money to, say, quasi-governmental entities or private companies working on infrastructure projects.

“There is a terrible mismatch and the IFC could play a much bigger role,” explains Richard H. Frank, who managed the IFC’s finances for a spell during the 1990s.
Frank, who these days is chief executive officer of the emerging markets firm Darby Overseas Investments, proposes that the World Bank allot more capital to the IFC.

As of the end of 2004, according to the World Economic Forum, the World Bank had $78 billion in unused capital, some of which the IFC could utilize. This cash cushion will surely grow as countries continue to honor their debts. Net repayments hit a record $67 billion in 2005, according to data from the Institute for International Finance.

“Fundamental changes are needed,” Frank asserts. “I see no less reason to be as imaginative and bold as governments were 50 years ago.”

First Mandate: Europe
The World Bank traces its beginnings to a meeting of representatives from 44 countries in Bretton Woods, New Hamphire that took place in July 1944 as World War II was nearing its end in the European theater and countries there desperately needed aid to rebuild.

The bank extended its first loan, a $250 million credit to France, in 1947. Today, France is the fifth biggest donor to the International Development Association, which was established in 1960 by the 40 wealthiest World Bank members to make interest-free loans and grants. Association members inject fresh capital every three years.

In December 1945, Bolivia became the first Latin American country to sign the Articles of Agreement of the International Bank for Reconstruction and Development, one of the five elements of the modern-day World Bank.

It was one-time World Bank vice president Robert L. Garner, a US banker and General Foods Corporation executive, who decided to carve out a private sector arm – the IFC – that could act more like a company and take equity positions.

The idea was to commit capital and assume equal commercial risks alongside private investors, and in the process to create jobs, increase foreign exchange flows and boost tax revenue. By taking on a private role, Garner thought, the bank could help replicate first world success stories in developing countries.

Today, the IFC is the largest multilateral provider of financing in the developing world. In its 50-year history, the IFC has committed more than $49 billion of its own funds and arranged $24 billion in syndications for 3,320 companies in 140 countries. At the end of 2005, the IFC had a worldwide committed portfolio of $19.3 billion for its own account, and $5.3 billion for participants in loan syndications.

Last year, the IFC posted record net income of $2.01 billion – about a tenth of what Citigroup reported – and operating return on average net worth of 22.6%.

No Project Left Behind
Peter Woicke, who ran the IFC for six years through 2005, thinks the agency should use its hefty earnings to invest in niches that aren’t attracting much private investment, such as renewable energy and for-profit education.

The IFC also needs to focus more of its efforts on the world’s poorest countries, critics say.

Last year, the IFC committed just 7% of its $6.45 billion in fresh investment to sub-Saharan Africa despite the fact that close to half the population in that part of the world lives in extreme poverty, or on less than $1 a day. Of the roughly billion people living in such conditions around the globe, more than a third of them are on the “lost continent.”

Even though the IFC has launched multi-million dollar initiatives in Africa, it has had trouble attracting partners to a continent that is widely seen as plagued by corruption.

“We see the last big development challenge in Africa. Even there we see private money willing to invest if there is more transparency and institution building,” Woicke says.

His replacement, Thunell, insists that the agency plans to play a bigger role in Africa. “Most other countries are moving in the right direction, but Africa is moving in the wrong direction,” says Thunell.

Likewise, in desperately poor western hemisphere countries such as Haiti, private investors point to decrepit local infrastructure and difficult business environments as the reasons why they won’t invest there. And so, such countries are often limited to grants from organizations like the World Bank.

Atul Mehta, the IFC’s director for Latin America and the Caribbean, says: “The World Bank works with the governments of these countries, but we say, ‘Have you considered all these factors that our clients are telling us are critical for them to be able to invest?’”

Although the IFC’s intentions are admirable, critics say the agency is not acting on them quickly enough. “If the IFC’s mission is to address a market failure by promoting investment in countries with limited access to development finance, they should be moving much more aggressively to support local companies in low-income countries,” says Manish Bapna, executive director of the Bank Information Center, a Washington think tank.

It’s questionable, for example, whether the IFC should have provided $115 million in financing last year to Mexican home mortgage lender GMAC Financiera, which is wholly owned by US conglomerate General Motors. Plus, with annual per capita income around $10,000 and investment grade status, Mexico is definitely a “middle income” territory.

“The process of graduation, or applying its (the IFC’s) funds in more needy countries, should be accelerated,” injects Citigroup’s senior vice-chairman, Bill Rhodes, whose career in Latin America spans more than four decades.

The IFC’s reluctance to move on from success stories like Mexico is part habit – only a decade has passed since the so-called Tequila Crisis – and equal parts caution. Markets that have matured enough to attract private finance can just as easily succumb to economic crises.

Mehta defends the IFC’s involvement in large Latin American countries by noting that despite the size of their economies, the gaps between rich and poor are enormous, with some parts of Brazil and Mexico on par with the most down-and-out countries in the hemisphere.

Getting Better All the Time
In spite of criticisms, the IFC has come a long way since making its first investment, in 1957, when it entrusted $2 million to German technology giant Siemens, which then extended $8.5 million to a Siemens unit in Brazil.

To date, the IFC has injected cash into 670 emerging market companies.

Even its modest investment in sub-Saharan Africa for 2005 represents a substantial increase compared with commitments to the region in previous years.

Some of the IFC’s most notable work has involved taking equity positions. In 1974, it invested $1.3 million in equity, made a $16 million loan and mobilized $5 million in funds from international commercial lenders for South Korea’s LG Electronics, which was then known as GoldStar.

GoldStar was established in Seoul just five years after the Korean War ended in 1953. In its early days, the South Korean company made cheap radios, TVs and domestic appliances like washing machines. LG has since evolved into a world-class multinational corporation with over 72,000 employees and 77 subsidiaries reporting consolidated revenue of $45 billion in 2005.

Success stories like LG have helped South Korea graduate from a war-torn, antiquated nation to a cutting edge country with an average annual household income of $36,000 – no longer far behind the US average of $45,000.

Furthermore, LG has turned around and invested in more than 25 emerging market countries.

More recently, the IFC stood beside Argentina and Colombia. Frank, of Darby Overseas Investments, says the agency played a very important role in sorting out corporate stress situations in Argentina after that country’s economy collapsed in 2001. “In the case of Colombia,” he adds “the IFC stepped in with a lot of foresight and started investing four or five years ago in very good companies and now that situation has improved and capital is flowing more regularly.”

Alberto Gutierrez, president of Colombian mortgage securitization company Titularizadora Colombiana, says the IFC was an important mediator between local investors and regulators when it invested in his company in the middle of Colombia’s 1998-2002 financial crisis, creating the first mortgage securitization in Colombia. That in turn spawned a secondary market for mortgages and kick started a housing boom in the country.

Titularizadora Colombiana wanted the IFC as an advisor and investor, Gutierrez says, because it promotes good corporate governance and is a responsive and efficient partner. “The IFC behaves more like a private sector institution than a development bank,” he adds.

A woman pours water drawn from a well in Senegal.

Two Steps Back
Not all IFC projects win praise. During the last decade, the IFC spearheaded privatizations of public utilities around the world. Some of those deals later came under fire from local communities for being too generous to investors; in turn, several private sector entrants complained that their businesses suffered from too much regulation.
For example, in a 1995 deal then-hailed as a model for water privatization, the IFC helped the municipality of Buenos Aires sell a $4 billion, 30-year water concession to Aguas Argentinas, a consortium led by French water company Suez.

But the deal went sour. In March, the Argentine federal government stripped Suez of its contract and created a state-run company called Agua y Saneamiento Ambital. Suez’s exit from Aguas Argentinas came after years of rocky negotiations following a January 2002 emergency freeze on utility rates during the nation’s financial meltdown.

Commenting in early April on the reverse privatization, Argentine Economy Minister Felisa Miceli said: “In spite of the improved economic levels of the people living in the area, there was a lack of financing – so the government decided to invest.”

Elsewhere, some of the IFC’s efforts have had more longevity. In 1995, the agency, together with French energy groups SAUR and Electricité de France, co-financed the Ciprel plant in the Ivory Coast. The plant – sub-Saharan Africa’s first independent power project – helped the country cut its electricity bill by 30%. SAUR continues to own and operate the plant.

Can-Do Man

Before becoming executive vice president of the International Finance Corporation (IFC) this year, Lars H. Thunell was CEO of Skandinaviska Enskilda Banken AB (SEB), Sweden’s second-largest bank by assets.
At SEB, which oversees $240 billion and employs 20,000 people, Thunell masterminded an expansion plan for Eastern Europe. Prior to his eight-year stint at SEB, Thunell ran Trygg-Hansa, a Swedish insurance company; led Stockholm-based asset management company Securum, which was established by the Swedish government after that country’s 1992 financial crisis; and acted as deputy CEO of Nordbanken, a bank that the Swedish government partly privatized after rescuing it from financial ruin. While working outside his home country, Thunell was credited with building ABB Zurich’s financial services division in Switzerland. He also put in time at American Express in New York. Thunell holds a doctorate degree from the University of Stockholm, and he was a research fellow at Harvard University’s Center for International Affairs.

Go With the Flow
Yet private investment flows can be fickle. “The experience of the past 15 years shows that private capital mobilization for development-oriented investment has been uneven, unreliable and inadequate,” the World Economic Forum summarized in a January report.

To balance this fickleness, development banks say they themselves need to get involved, especially on infrastructure projects. The World Bank estimates that emerging economies need to invest 5.5% of their annual GDPs on projects like roads to compete in a more globalized world.

Some emerging markets are kicking in more money than others. According to the Inter-American Development Bank (IDB), total infrastructure investment in Latin America last year amounted to $47 billion, or about 2% of regional GDP. Comparable investment in Asia and Eastern Europe was three times higher.

Carlos Guimarães, the IDB’s private sector coordinator, says that infrastructure investment in Latin America and the Caribbean appears to be dropping while simultaneously picking up in other regions of the world.

“This means that we are growing more slowly, both because of lower allocations to infrastructure per worker and as a result of a loss of markets to competing regions that produce and transport goods at a lower cost and faster than many countries in our region,” he said at the IDB’s April meeting in Belo Horizonte, Brazil.

The IFC is getting the infrastructure message. Last year, the agency invested $883 million in infrastructure projects. By contrast, in the two decades from 1967 to 1987, the IFC booked only seven such deals worth $78 million. And while the IFC has been making infrastructure investments for decades, it didn’t seriously consider health and education projects until the late 1990s.

Today, the IFC’s health and education portfolio exceeds $300 million. Likewise, the IFC’s founders never envisioned investments in housing or public utilities like electricity.

As the times change, the IFC has found ways to branch out in financial instruments, as well. Traditional loans can tie up capital for years and limit the IFC’s ability to invest in projects, whereas capital markets standbys like bonds give the lender more flexibility.

The IFC has launched a succession of domestic currency bonds in markets around the world. Last year, for instance, it was the first multilateral to issue a so-called “panda” bond in China, where it sold a 1.13 billion renminbi-denominated ($140 million) issue.

Chinese investors, who mainly hold government debt, jumped on the chance to diversify by scooping up the IFC bonds.

Similarly, the IFC’s use of partial credit guarantees, which require less committed capital, have helped bring domestic issuers around the world to market. By only guaranteeing part of the debt, the IFC can keep more cash on hand to mobilize financing for additional clients.

The IFC demonstrated the power of this financial tool in 2004 when it brought a sub-sovereign borrower, the City of Johannesburg in South Africa, to market. Together with the Development Bank of Southern Africa, the IFC guaranteed 40% of the principal on a $153 million, 12-year bond denominated in the South African rand; local private investors ate the deal up at 40 to 50 basis points over the market rate.

The IFC wants to replicate the success of the Johannesburg deal for municipalities in other emerging markets.

Frank describes the IFC in recent years as a “dealmaker” that seizes opportunities to make savvy investments, but that sometimes forgets it needs to encourage private involvement by promoting structural reforms. “The IFC needs to say: There is no deal here. We are trying to improve the system and help governments improve the local capital markets,” he recommends.

As the IFC celebrates its 50th birthday, it has the best financial health in its history. It can afford to do more.