While the World Bank’s resources for low-income countries have never been greater, they still pale in comparison with these countries’ needs. Governments always need to make hard choices between infrastructure needs, social programs, and fiscal discipline. One country was recently able to strike the right balance with the support of World Bank guarantees: Benin.

When Benin reached out to the World Bank, it had several objectives: getting support for poverty-reducing policy reforms, financing social investments, and refinancing short-term domestic debt. To achieve all these objectives the country could count on a $60 million IDA allocation. Benin’s objectives called for an innovative solution.

World Bank guarantees in action

The government of Benin, their financial advisors (Rothschild), and the World Bank analyzed the situation and evaluated available options. Benin had relied exclusively on domestic debt markets and concessional financing to fund its budget deficit. The domestic bond market offered limited liquidity, relatively high interest rates (7 percent) and short maturities. Clearly, Benin needed to diversify its funding sources.

Benin hadn’t yet accessed the international commercial loan market. However, they didn’t have an international credit rating and was unknown as a borrower to this market. IDA (the part of the World Bank that helps the world’s poorest countries) offered to support Benin by providing a $180 million equivalent of policy-based guarantees (PBGs), which cover commercial lenders against the risk of debt service default by sovereign governments.

Benin was able to secure this guarantee despite only being allocated $60 million in IDA funds because the World Bank has a mechanism for low-income clients whereby only 25 percent of a guarantee’s value is booked against the country allocation. This meant that by allocating $45 million to PBGs, Benin could really receive $180 million-worth and use the remaining $15 million allocated as a regular IDA credit.

A key risk in such transactions is foreign exchange fluctuations. Benin and IDA wanted to ensure that any new debt wouldn’t add substantial foreign exchange risk. Since Benin’s currency has been pegged to the euro for decades, Benin decided to borrow in euro to mitigate the risk.