Lenders are Leaning on Governments

“You don’t fight corruption by fighting corruption. You have to go to the fundamental
weaknesses of the institutions of the state.”
– Daniel Kaufmann, World Bank Institute

Much to the dismay of Latin American governments, their counterparts in rich countries and other organizations are pressuring the World Bank, the International Monetary Fund and other multilateral lenders to make lending conditional on issues that have little immediate bearing on finance or economic policy.

Issues such as good governance, independence of the judiciary, environmental policies and broad social policies have long been conditions for disbursing loans. Now, borrowers are under pressure to deal with corruption as well.

Leaders attending the G-8 summit in Okinawa in July discussed suggestions that the IMF take countries’ regulatory regimes into consideration when deciding whether to extend loans. James Wolfensohn, the World Bank president, has made the fight against corruption a priority. In September, the World Bank is holding an anti-corruption summit in Washington.

Many Latin American government officials oppose tighter guidelines not because they favor corruption, but because they say these new rules are both an unwelcome interference in domestic politics and because they distort lending policies.

Armínio Fraga, Brazil’s central bank president, says additional conditions are unnecessary. “We have always shown our interest in governance, the environment, and protection of the poorest. These are a priority of ours. We [already] have all the incentives [needed] to tackle this. The financial aspect [of each loan] should have its own objectives. World Bank loans have to [address] a broad range of issues and a liquidity loan from the IMF has to be [exactly] that, an emergency short-term loan.”

Athough poll data from Transparency International indicates that corruption in Brazil has receded sharply in recent years, probably because economic liberalization has reduced opportunities for corruption, coping with corruption remains a constant problem in many other countries in the region. A Colombian government study estimates that the misuse of public funds wastes about one percentage point of gross domestic product per year.

Portfolio investors shun countries perceived as corrupt. “It is not enough to have the right economic policies,” says one Wall Street analyst, “you have to deal with corruption as well. Progress on this front is one of the criteria used to differentiate one country from another.” However, it is hard to distinguish cause from effect. Although it is clear that badly managed countries such as Ecuador or Paraguay are plagued by widespread corruption, it is not clear whether mismanagement is a cause or a consequence of corruption.

However, Daniel Kaufmann, senior manager at the World Bank Institute in Washington, an advisory body, says the multilateral organizations have accepted that “corruption is not just a moral issue, but a developmental issue, as well.”

He says the World Bank has already stopped lending to governments it considers to have made insufficient progress in dealing with its concerns. In 1997 it suspended loans to Paraguay and closed existing programs due to poor performance of its loan portfolio caused by corruption. Although Alejandra Viveros, a World Bank spokesperson, says Paraguay has made progress over the last six months, the bank has not reinstated any of its programs.

Other multilaterals have followed the World Bank’s lead. In April, for example, the Inter-American Development Bank suspended a $6-million loan after prosecutors in Bogotá launched an investigation into 550 suspect contracts signed by members of the lower house of Congress.

There are cases where this frontal method does not work. Kaufmann says “there are times when, notwithstanding a government’s best of intentions, progress can only take place slowly, whether because a clear diagnosis of the problem is needed first, or due to the nature of the required institutional reforms.” He says “in these instances of constructive engagement, it doesn’t help for the World Bank to just walk out.” An example of this approach is Bolivia, where successive governments have struggled to push ahead with structural reforms for 15 years.

The World Bank is leading by example with efforts to maintain the integrity of its lending and procurement decisions. The bank posts the names of companies it has found to be corrupt on its website and refuses to do business with them.

Corruption can be a complex issue and requires a sophisticated approach. Kaufmann says, “You don’t fight corruption by fighting corruption. You have to go to the fundamental weaknesses of the institutions of the state. You have to de-personalize the problem and study it as systemically and rigorously as you do other macro issues.”

In Guatemala, the World Bank underwrote a fundamental reform of the government’s budgeting, accounting, cash management and procurement systems. It also reformed the government’s debt management and public investment policies.

There is a growing consensus that tougher action is also needed to deal with corruption as a transnational phenomenon. Western governments are responding by demanding a crackdown on offshore tax havens and tougher enforcement of international money laundering rules.

A regional approach is also seen as more effective in persuading individual countries to take action. “The more countries are on board, the harder it is for them to hide,” says Claudio Grossman, dean of the Washington School of Law in Washington DC. “This is not an issue for government leaders alone, it requires coalition building.”

Following the Summit of the Americas in 1994, the Organization of American States drew up the Inter-American Convention Against Corruption, which requires countries to make it a criminal offence to both solicit and accept bribes. The OAS convention also bans states from using bank secrecy laws as a justification for not cooperating with investigations. It strengthens procurement rules, raises conflict of interest standards for public officials by providing for disclosure of assets, and provides for whistle-blower protection.

The challenge, is to put these commitments into action. “It is critical to defeat the perception that Latin American countries make grandiose commitments without following through,” says Grossman. “We need to take the prose and translate it into action,” adds Nancy Zucker Boswell, managing director of the US chapter of Transparency International. Only 20 of 34 OAS member states have ratified the agreement, the most recent to do so being the US in July. Brazil now stands out as the largest country in the region yet to ratify the convention, mainly because its Congress does not see it as a priority. Eight countries have not even signed the agreement.

Grossman says that “the pressure to ratify the agreement is increasing. At their February meeting in Cancun, the region’s finance ministers urged the countries that have not ratified the convention to do so. With the US now on board, pressure for ratification should increase. “The more universality you get, the more legitimacy the initiative gains,” says Grossman.

On June 5, the OAS adopted a resolution requiring it to study different monitoring models and decide on a recommended monitoring framework by the end of 2000. The idea is to have a particular approach to recommend for adoption at the April 2001 Summit of the Americas meeting in Canada.

However, there is scant support for a top-down approach, such as the reviled US drug certification review process. There is greater backing for a peer-review method, such as the Financial Action Task Force’s fight against money laundering or the OECD’s convention against bribery. The finance ministers of the region, for one, expressed their preference for a mutual review in a communiqué at their February meeting.

“The peer review approach has been shown to work,” says Stanley Morris, a consultant on money laundering and former director of the US Treasury Department’s Financial Crimes Enforcement Network. That has certainly been case of the Financial Action Task Force and the OECD convention. “But a peer review must be just that,” says Morris, “each country at the table must treat each other as equals and be willing to accept criticism from expert teams carrying out monitoring and each other, whether a country is as large as the United States or as small as Belize.”