ENVIRONMENTAL LENDING MAY BE HARMFUL TO THE ENVIRONMENT

PCDForum Article #14,   Release Date July 10, 1995

by Frances F. Korten

In response to mounting worldwide evidence of environmental deterioration, world leaders have called on the multilateral development banks to step up lending for environmental projects.

The banks have welcomed the new mandate, partly out of concern for the environment and partly because they are seeking justifications for increased lending to meet developing countries' fiscal needs. The multilateral banks have used new loans to provide the hard currency those countries need to repay past loans and maintain their imports. Environmental lending would appear to at once meet both fiscal and environmental needs. However, a closer look casts doubt on the wisdom of combining the two agendas.

The Philippines provides a useful example. Its economy has been fiscally stressed. In 1992, servicing its $32 billion external debt consumed some 28 percent of its exports, while imports exceeded exports by $1.4 billion. It is also environmentally distressed. Due to rapid deforestation, conservationist Norman Myers named the Philippines one of the world's 10 "hot spots," where biodiversity is most severely threatened. Finally, it has been a major recipient of official environmental loans, concentrated primarily in forestry projects. Between 1988 and 1992 the Asian Development Bank (ADB), the World Bank, and the Japanese government lent $731 million for forestry projects--more than 10 times the $60 million of international lending provided for forestry projects during the previous 12 years.

From the fiscal perspective, massive environmental lending for Philippine forestry projects is nearly ideal, because most of the actual costs are local. Therefore the foreign currency that is borrowed can be used to repay foreign debt and finance imports, while project costs are covered with local currency. An examination of the loans from an environmental perspective, however, reveals that in the design of these projects, the banks have placed fiscal needs ahead of environmental ones to such an extent that the environment may be a net loser.

An indicator of the fiscal emphasis is found in the extent to which loan size exceeds any reasonable estimate of the capacity of implementing agencies to use the funds effectively. The first of the environmental loans to the Philippine forestry sector was for $240 million--half from the ADB and half from the Japanese government. Its stated purpose was to reforest lands denuded by a combination of logging and slash-and-burn agriculture. The project design called for the Department of Environment and Natural Resources to contract with private groups to reforest 358,000 hectares over five years. According to a German study, over the previous 71 years this Department had successfully reforested a total of only 70,000 hectares. The project called on it to reforest an average of 71,600 hectares each year.

To its credit, the Department actually met and even exceeded the loan-funded program's contracting targets. It did so, however, by sacrificing the program's potential effectiveness. Department planners had expected to contract primarily with well established groups or families living close to the reforestation sites who would have a direct interest in the long-term environmental and economic benefits the trees would bring them a condition shown to be critical to the success of reforestation efforts throughout Asia. To meet the high targets set by the lenders, Department personnel were forced to contract with many urban groups that hastily formed to gain short-term profit from the contracts. Independent evaluations studies revealed that under such circumstances the residents in replanted areas had little or no commitment to protect the trees. In several cases where the laborers' wages were delayed, they burned the trees.

The scale of the project so far exceeded the Department's supervisory capacity that despite earnest watchdog attempts by senior management, evidence of corruption abounded. Spot checks identified a disturbing number of cases of contracts with phantom parties, contractors who were not paid the amounts stipulated on their receipts, and others who were never paid at all.

Another consequence of the unrealistic targets was the use of a single variety of seedlings. Planners had expected contractors to plant a variety of tree species suited to the local environment. But to meet deadlines, contractors commonly used readily available Gmelina arborea seedings, a fast growing tree with a natural life span of only fifteen years in the marginal soils of reforestation sites. While good for paper pulp, its short life makes it a poor choice for conservation purposes.

A commonly neglected feature of environmental loans is that the borrowing country is borrowing foreign exchange, which must eventually be repaid in foreign exchange. If the borrowed foreign exchange is being used to repay previous loans and finance current imports, it is appropriate to ask two commonly neglected questions: 1) are the imports moving the economy toward increased equity and sustainability; and 2) how will the additional foreign debt eventually be repaid?

The answers in the Philippine case are not reassuring. In addition to its already substantial debt service burden, a substantial portion of the Philippine's foreign exchange shortage could be traced to its highly oil-inefficient economy, which boasted the lowest price of petroleum in the region (lower even than oil-producing Indonesia); and to the import of substantial quantities of luxury goods to stock the shelves of air-conditioned mega-shopping malls that were springing up around the country.

With regard to loan repayment, it is fairly typical of environmental loans such as the Philippine reforestation projects that the loan-funded activities are not expected to generate foreign exchange. There is, however, no point in the project design and approval process at which anyone asks from where the foreign exchange for repayment will be obtained or with what environmental consequences.

In the Philippines, the need for export income to pay outstanding foreign debts was one of the most common justifications put forward for the unrestrained logging that contributed to the deforestation the ADB loan was intended to correct. However, with the forests now nearly gone, timber exports are no longer a foreign exchange earner and the country has turned to other sectors for export earnings. Many have their own environmentally devastating consequences. Gold and copper mining, which seriously contaminates soil and water, produces several the country's top 10 exports. And the country subsidizes prawn farming for its export potential, despite the fact that pawn farms destroy protective coastal mangroves and commonly create salt water contamination of underground freshwater aquifers. The pressure to repay the environmental loans will likely accelerate such environmentally damaging export promotion.

The Philippine experience exposes the fallacy of addressing the very real environmental needs of indebted countries through massive international loan funding. A more appropriate approach to assisting low income countries with environmental problems would:

• Recognize that many environmental problems result from social and institutional conditions that are not readily corrected by large infusions of foreign funds;

• Build institutional capacities both within and outside the government to implement low-cost, effective environmental programs and keep assistance at levels that can be used efficiently;

• Provide assistance primarily in grant form, so as not to exacerbate indebtedness;

• Acknowledge the damaging environmental consequences of many developing country exports;

• Reduce export pressures by encouraging trade deficit countries to limit non-essential imports, especially for military hardware and luxury consumer goods;

• Provide debt relief in return for reduced foreign borrowing.

Under their current structure, multilateral banks will best serve the environmental cause by providing hard currency loans only to environmentally beneficial projects that generate the foreign exchange required for repayment. Since most environmental projects are not foreign exchange earners, their financing generally will need to come from agencies that can provide grants. Increasing the foreign borrowing of indebted countries in the name of environment protection will only accelerate the very damage the proponents of environmental lending seek to reverse.

Frances F. Korten is a Ford Foundation program officer. The column is distributed by the PCDForum based on her article "Questioning the Call for Environmental Loans: A Critical Examination of Forestry Lending in the Philippines, World Development, July 1994. The views expressed are the author's alone.

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